Is this the calm before the storm? If the recent inversion of the yield curve (as measured by the 3-month yield vs. the 10-year yield) is any indicator – which it historically has been – then there are rough waters ahead.
The current boom, if that is what you want to call it, has gone on for so long that it is easy to become complacent. When today is basically the same as yesterday, it makes sense to think that tomorrow will be the same too. And it usually is. But eventually, something will change.
It only takes one big event to change the story quickly. It could be an international event (economically, militarily, or politically). It could be a major company suddenly on the verge of bankruptcy. It could just be a massive down day for the stock market.
We have no idea when that day of change will come. And even when it does come, we don’t know if it will reverse the next day.
A Look at the Data
Here is a summary of what has happened and where we are.
After the beginning of the financial crisis in 2008, the Fed went on an unprecedented spree of monetary inflation. The adjusted monetary base went from under $900 billion in 2008 to over $4.1 trillion in 2014. The federal funds rate was also near zero during this time.
After QE3 ended in 2014, the Fed stopped expanding, and it eventually started slowly decreasing its balance sheet around the beginning of 2018. The monetary base is now down to just under $3.4 trillion. This is more than $700 billion down from its peak, but obviously it is still multiples of where it was in 2008.
Meanwhile, consumer price inflation remained relatively low during this entire time. It is actually amazing just how consistent it has been, coming in around 2% per year. With the crazy monetary policy, that is one trick the Fed has been able to pull off so far.
The consumer prices have stayed tame largely because much of the new money created by the Fed went into excess reserves held by the banks. Excess reserves were close to zero up until 2008. Then they exploded, somewhat mirroring the monetary base. The excess reserves have fallen in recent years with the monetary base too. In fact, the excess reserves have actually fallen more, as they are down over $1 trillion since 2014. Perhaps this has helped to keep the “boom” going.
If we look at the Consumer Price Index (CPI), it is still relatively stable. The March 2019 numbers were just released, and they are a little higher. The more stable median CPI is now at an annualized rate of 2.8%. If you go to the gas pump to fill up your car, you will certainly notice a difference there. But oil and gas prices tend to be more volatile.
Meanwhile, stocks have been quite stable after some scary moments for investors over the last year. U.S. stocks look quite strong right now, but they typically do at the tail end of a boom.
You Don’t Need a Special Event
Eventually, this “boom” will turn into a bust. I put boom in quotes because it hasn’t been a boom for everyone. If anything, life has just become more expensive for the middle class.
Unemployment is very low right now, but that just means that the market is clearing right now in terms of labor. Despite minimum wage laws and labor regulations, employers are able and willing to pay workers to fill jobs.
The problem is real wages. Nominal wages have been going up, but so has the cost of living. The worst is probably health insurance and medical care. Insurance premiums are taking a huge bite out of people’s paychecks. I don’t think the CPI fully accounts for this.
In addition, asset prices have gone up, which doesn’t get reflected enough in the CPI calculations. If you are trying to buy your first house, then you are on the losing end of the asset boom. People who bought houses about 8 years ago are on the winning end, at least as of right now. Or perhaps it is better to say that they were less on the losing end. This will change for some people, if and when housing prices come down.
I don’t think the next downturn will be just like the 2008 financial crisis. I don’t think we are in quite as much of a housing bubble today as we were then. I also think the big banks are in a little better shape. They should be, since they have been getting bailed out for over a decade now. The Fed has bought their worthless mortgage-backed securities, and the Fed has been paying interest on bank reserves.
In terms of debt, we are in far bigger trouble today than we were in 2008, at least in terms of government debt. The national debt is astronomically higher, and the annual deficit is running near $1 trillion. And this is supposed to be during the good times.
One major point of emphasis I would like to make is that the 2008 crisis didn’t happen because of the collapse of Bear Stearns and Lehman Brothers. Those were consequences of the downturn. They just made the crisis more obvious.
People often confuse cause and effect in economics, and it is no different with the financial crisis. It wasn’t companies going bankrupt that caused the major recession and financial crisis. It was the recession that led to the bankruptcies.
Sure, there were a lot of foolish decisions with the banks and financial institutions, but it was obviously widespread. Without the housing bubble and previous loose monetary policy from the Fed (under Greenspan), then many of these financial institutions wouldn’t have gotten into such big trouble.
Therefore, don’t assume we have to have some big event to lead us to the next recession. And if we do have a big event, it just may be a marker that the recession already began.