Stimulus is a Phantom Menace

Bubbles are unsustainable periods of froth where too many investors rush to get into a particular asset or product or country or whatever. After the fact most if not all investors, analysts, economists and consumers admit that there was a mania, that it was unsustainable, and that it led to a huge waste of productive resources (empty suburbs, un-visited websites, abnormal concentrations of wealth among bankers etc).

This really is generally not in dispute. Why then does it all go haywire after this? Surely it is a logical progression that if the boom is unsustainable froth then the bust must be a necessary correction? Yet, while this is plain logic, it seems that when the time comes for bust, people, politicians and unthinking economists (ie most economists) start conjuring up weird and wonderful theories of how to combat the recession. It is as if the recession air holds in it some intoxicating gas that targets that part of the brain responsible for not being an idiot.

And so, after the generally accepted mania, froth, boom, bubble hysteria, a new even more irrational hysteria sets in that sees everyone toiling with all their power against the evil recession monster. That the recessionary bust is the market’s most efficient and least painful way to remedy the unsustainable boom frenzy is lost on just about everyone.

Then we get the media scribbling gloomy horror stories about people losing their jobs and companies going bankrupt, and we get companies lobbying for special protection from the government in the form of bailouts at the expense of everyone else still with the financial means to do so, and we get politicians promising to make the bad monster go away.

The net result is one of the tragic ironies of economics: A whole nation of people, investors, business owners, analysts, political leaders and policy makers all trying their sweaty-browed best to fight the necessary correction from the unsustainable fantasy land. In other words, everyone, especially government, is effectively doing their utmost to prolong the recessionary pain that must be taken.

Government policies begin to work directly against the market mechanism. In a best case scenario the government does very little and the market correction overrides the weak hand of the state to bring about the necessary economic adjustment quickly and as painlessly as possible. In the worse scenarios you get a Japan style deadlock between market correction and government support, where the economy kind of just sits in limbo with prolonged periods of zero growth and perpetual pressure for prices to fall. Then there’s the worst case scenario, when government and the central bank push back so hard against the market forces that they succeed in reversing the recessionary conditions and re-inflate the bubble conditions.

This worst case scenario appears to be a policy success, especially if the new bubble is able to last for a few years and people begin to credit the government with ‘fixing’ the economy. The problem is that this fake economy is always on borrowed time and will eventually turn to bust again. A classic example of this was seen after the tech bubble at the turn of the century. Alan Greenspan simply turned on the taps and George Bush started running larger budget deficits. The monetary stimulus cushioned the tech mess but then fed straight into a housing bubble. The popping of the housing bubble made the tech torment look tame.

Now the Fed is playing double or quits again, trying its level best to avoid deflation in any asset and pouring out monetary stimulus that makes the tech-tonic look timid.

Each time the Fed tries to fight the recessionary foe it creates a bigger mess on the other side of the re-inflated bubble. All this time the economy is producing the wrong mix of goods for the needs of the people and all the while real wealth is being destroyed. Eventually the market correction is so hard that almost no amount of central bank fantasy land candy can stop the recession. It is faced at this stage with two painful choices:

1. Let the whole edifice crash and realign the economy according the correct production structure
2. or, throw one last cream pie at the target and hope it’ll stick.

Depending on the choice, this is either followed by a major asset price deflation tsunami that no-one can or must try to stop (option 1), or it results in the crack-up inflation boom (option 2), when the currency is inflated beyond belief, Joe Public stops trusting the currency, and a hyperinflationary depression sets in, the results of which are almost utter destruction of the productive base of the economy and a deep prolonged period of poverty.

If the Fed and its central banking minions from around the globe keep insisting on following these obviously irrational policies, paper currencies’ days are numbered and the potential for us to live through the deepest and most protracted period of wealth destruction will only grow ever more real.

Yes, it’s that serious.