The “Real” Economy and the “Financial” Economy: This Guy Gets It

[Ahlevah]

This young man does an excellent job explaining what is going on involving the divergence between the “real economy” and the “financial economy,” or what I call the “bubble economy.”

The main takeaways:

The History:

1. Growth of cheap credit and derivatives fueled excessive speculation in the financial
markets that eventually led to a financial panic in 2008 as a result of a lack of liquidity.

2. The Fed and provided record amounts of liquidity and expanded its balance sheet in order to stabilize the markets and the economy.

3. Much of the liquidity created in the wake of the Great Recession flowed not into the real economy, but the financial economy as the real economy was burdened by excessive debt.

4. The Fed has found new, innovative ways of adding liquidity without increasing its balance sheet, such as purchasing longer-dated Treasuries (which require lower bank reserve levels), various loan facilities such as the the Bank Term Funding Program (BTFP), and reverse repos.

5. Essentially, the financial markets have become addicted to cheap money while the real economy remains burdened with debt.

6. Follow the money. If you want to get a clue as to where the real economy is headed, follow the money supply (M2). To see where asset prices are going, follow liquidity, i.e. credit spreads between 90-day Treasuries and high-quality, short-term commercial paper.

The Future: Expect historic levels of inflation and hold a diversified portfolio of assets, including crypto.

Of course, the question we need to ask is is there a point at which it becomes unlikely or impossible for the Federal Reserve and fiscal authorities to successfully reflate our increasingly debt-burdened economy? Is inflation the only possible scenario, or is deflation also a risk? Yeah, I think deflation is definitely a risk if our rickety system breaks because of another financial panic or banking crisis. So, although it may be counterintuitive, having some Treasuries in your portfolio could prove to be a useful hedge.

 

[Lord Tammerlain]

Given the debt level of the US, inflation will occur not deflation. The government and Fed will do everything to prevent deflation, including creating hyperinflation.

Deflation would see collapse of all the banks as people default on mortgages. As not many people will pay a mortgage worth $200 000 for a property worth $100 000.


As for the financial economy, it has in my opinion added costs to the real economy that makes real production in the US expensive and uncompetitive on the world stage

 

[Ahlevah]

Given the debt level of the US, inflation will occur not deflation. The government and Fed will do everything to prevent deflation, including creating hyperinflation.

Large levels of debt can lead to deflation. This is what happens after the deflating of an asset bubble. Prices of assets drop—a lot—and unless monetary and fiscal authorities intervene with extraordinary measures to reflate the economy it will suck the oxygen (spending and demand) out of it like a themo-baric bomb. The question I have is is there a limit as to how many times the government can successfully reflate an economy by propping up bubble assets like houses until growth just flatlines? In the meantime, don’t hold the country’s currency for any extended length of time, and don’t keep your money in a bank, because reflation relies on a negative real rate of interest. The good news is high-quality, long-dated debt like U.S. Treasures can offer good capital gains when rates move down, which pundits increasingly are expecting as the economy continues to slow. We’ll get another clue when 2nd Quarter GDP figures are announced at the end of the month.

https://files.stlouisfed.org/files/htdocs/publications/es/10/ES1027.pdf

 

[CaughtInThe]

Hell, I'm just glad that Republicans are admitting that the economy is rocking. That's progress.

 

[Ahlevah]

Hell, I'm just glad that Republicans are admitting that the economy is rocking. That's progress.

The financial economy is “rocking” as the Fed supports it with ample liquidity, although its “higher for longer” interest rate stance is beginning to demonstrate signs of strain. The real economy is definitely slowing, and the Sahm Rule has never indicated a false positive for a recession. 1.4% GDP growth in Q1, which is nothing to write home about, only occurred thanks to government hiring and deficit spending.

https://www.inc.com/phil-rosen/fed-rate-cut-cpi-jobs-report-labor-market-outlook-investors.html

Real-time Sahm Rule Recession Indicator

Graph and download economic data for Real-time Sahm Rule Recession Indicator (SAHMREALTIME) from Dec 1959 to Jun 2024 about recession indicators, academic data, and USA.

fred.stlouisfed.org

 

[Lord Tammerlain]

Large levels of debt can lead to deflation. This is what happens after the deflating of an asset bubble. Prices of assets drop—a lot—and unless monetary and fiscal authorities intervene with extraordinary measures to reflate the economy it will suck the oxygen (spending and demand) out of it like a themo-baric bomb. The question I have is is there a limit as to how many times the government can successfully reflate an economy by propping up bubble assets like houses until growth just flatlines? In the meantime, don’t hold the country’s currency for any extended length of time, and don’t keep your money in a bank, because reflation relies on a negative real rate of interest. The good news is high-quality, long-dated debt like U.S. Treasures can offer good capital gains when rates move down, which pundits increasingly are expecting as the economy continues to slow. We’ll get another clue when 2nd Quarter GDP figures are announced at the end of the month.

https://files.stlouisfed.org/files/htdocs/publications/es/10/ES1027.pdf

The government can cause high inflation to combat deflation. " Mass printing " of money given out to everyone.

While inflation is bad deflation will collapse the economy

 

[Ahlevah]

The government can cause high inflation to combat deflation. " Mass printing " of money given out to everyone.

While inflation is bad deflation will collapse the economy

Well, decades of no or slow growth in your economy because you’ve propped up zombie financial institutions or unproductive assets like housing is bad, too. Poor people just get poorer as inflation erodes their standard of living. This is why they’re getting pissed off at the moment, except many of them are blaming rich people instead of the politicians spending money the country doesn’t have and the Federal Reserve that is accommodating them.

 

[Ahlevah]

One more thing. Historically, only about 20-30% of the Russell 2000 consisted of unprofitable companies. That figure has risen to about 40% of the index, which goes a lot towards explaining its poor performance over the last few years, especially since its peak in November, 2021. Notably, it rose 3.6% on Friday on weaker inflation data, its best performance since October, 2023, which indicates two things. One, weaker inflation and employment data imply at least one Fed rate cut this year, most likely beginning in September. Two, it demonstrates just how dependent Wall Street has become on the sugar high of cheap credit. In a healthy economy, more of these companies would be profitable.

 

[Lord Tammerlain]

Well, decades of no or slow growth in your economy because you’ve propped up zombie financial institutions or unproductive assets like housing is bad, too. Poor people just get poorer as inflation erodes their standard of living. This is why they’re getting pissed off at the moment, except many of them are blaming rich people instead of the politicians spending money the country doesn’t have and the Federal Reserve that is accommodating them.

Deflation in a highly indebted society would result in most people defaulting on debts. The debt defaults would further contract the economy leading to a reinforcing downward cycle. Which is not to say high inflation is good, just less worse

 

[Ahlevah]

Deflation in a highly indebted society would result in most people defaulting on debts. The debt defaults would further contract the economy leading to a reinforcing downward cycle. Which is not to say high inflation is good, just less worse.

If a society is highly indebted because speculation has run rampant that isn’t healthy either. Part of making sure that doesn’t happen is moral hazard. If a bank or Wall Street investment firm is too big to fail then it’s probably too big. We have many families in this country struggling because they’re spending more than half their incomes on their homes. A lot of that is thanks to cheap credit and speculators. So the economy doesn’t enter into a depression, but the speculators never get their comeuppance either.