Central Banks are Confirming a 71-Year-Old Prophecy from Austrian Economics
On Monday, Feb. 2, 2020, the Dow Jones industrial average roared higher by nearly 1,300 points. The single-day rally was the Dow’s best day in more than a decade.
And the Dow was only one part of it. Stocks in general were up big on Monday in the anticipation of central bank stimulus.
The story is well known: When things get bad, central banks ride to the rescue. Investors have learned this lesson over and over for 30-plus years, dating all the way back to the crash of 1987.
But then a funny thing happened. On Tuesday morning, the Federal Reserve announced an emergency half-percentage-point rate cut — a huge and powerful move that was just what the doctor ordered.
The Fed’s emergency cut was the rescue effort stock investors wanted and anticipated. It was also the potential kick-off move for a coordinated global effort, in which the Bank of Japan, the European Central Bank, and others might help, too.
But after an initial rally on the Fed’s move, the major indexes reversed course — they started falling.
The market isn’t yet closed as of this writing, but the Dow, S&P 500, and Nasdaq composite are deep in the red. Of the few areas solidly green on the day, two are gold and gold stocks.
To see this kind of ominously bearish price action after the Fed’s big rescue move has to be concerning for stock market bulls. It suggests the market contemplated the Fed’s big action and decided: “Meh.”
Or worse yet, “That isn’t going to work.”
There are two reasons why a big rate cut and central bank stimulus effort would be seen as “not enough” by the stock market. The first has to do with the demand-shock nature of the coronavirus. The second has to do with a 71-year-old prophecy from Austrian economics.
On the demand-shock side, it isn’t clear how central bank rate cuts and stimulus will get consumers spending again.
If a bank needs bailing out, that’s one thing. Or if companies need cheap loans to pay wages and service their debts, that’s another thing. Central banks understand such problems because they relate to liquidity and credit. If you can point a firehose of money at a problem, you can potentially solve it.
But what happens when upper-middle-class consumers, who have good jobs and plenty of money in the bank, decide to hunker down because of the coronavirus?
What happens when the U.S. economy slows down dramatically, not because consumers are broke, but because they don’t want to go outside?
A Wall Street Journal headline reads, “Federal Reserve Cuts Rates by Half Percentage Point to Combat Virus Fear.” But what is the method of combat exactly?
There is no clear connection between 1) economic slowdown caused by widespread fear of biological infection and 2) a ramping-up of money and credit.
As this realization sinks in, hopes for a central bank “rescue” begin to fade. Unless they can stop the spread of the virus, or convince consumers en masse it is safe to go about their normal consumption-oriented lives again, central banks may not be able to help this time at all.
Another problem the Fed faces is captured in that Austrian economics prophecy we mentioned.
It is not a prophecy in the mystical sense, so much as a blunt statement about how the boom-and-bust credit cycle ultimately works.
The prophecy is delivered as a quote from the legendary Austrian economist, Ludwig Von Mises, in his book Human Action: A Treatise on Economics, first published in 1949. Here it is:
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
Ever since the crash of 1987, markets have been propped up and stimulated by central bank actions. Every time there was a mini-crash, or even just a hiccup, the recipe was the same: Add more stimulus. Keep interest rates low. Keep the credit expansion going.
Then, in the aftermath of the 2008 financial crisis, central bankers tripled and quadrupled down, supplying the world with more stimulus and credit than anyone had ever seen.
Now, more than a decade after 2008, we may be entering the final stages of this multi-decade expansionary boom.
If Von Mises is right, it would suggest the world is now so loaded up with debt and credit that additional efforts to stimulate it won’t work. The whole thing has just gone too far.
But if the prophecy holds, that means something else, too: “A final and total catastrophe of the currency system involved.”
The way you get a “final and total catastrophe of the currency system” is for central banks to fall into a state of panic. If their first round of rate cuts and stimulus fails, they try a bigger round. And then a bigger one. And then a bigger one.
Then they start proposing ever crazier measures, like buying stocks directly and pumping trillions into the bond market, and so forth. As they do all of this, investors realize in horror that the panicked bankers are flooding the system with more fiat currency than anyone could ever want or spend.
At this point, faith in the currency starts to disappear — and then, as Von Mises described in 1949, you get the “final and total catastrophe of the currency system involved.”
It may be the world was already on this path. Von Mises certainly expected as much. That is why he wrote with such authoritative tones in 1949.
If you try to facilitate an endless expansion driven by credit, you either collapse the economy or collapse the currency in the end — and the second always gets sacrificed in a Hail Mary effort to save the first.
It might further hold that the coronavirus is accelerating the end game. Central bankers are panicking now in the face of a coronavirus demand shock — and Wall Street’s early reaction is telling us it isn’t working.
The next stage may be a loss of faith in fiat currencies — a kind of central-bank-inflicted forex sickness — as ever-crazier stimulus measures are tried.
If this is indeed the path of things, gold, gold stocks, and Bitcoin will all head into the stratosphere.