The End Of Abundance (?) & Eight Externalities
By Daniel R. Amerman, CFA
TweetWhen it comes to economics and the investment markets, we are currently living in very rapidly changing times. There is no path back to the markets of recent years, there is no way back to the 2000s or 2010s.
It is now looking likely that the conventional financial planning model will badly fail sometime within the 2020s, in a process that is already underway. Tens of millions of retirees and those saving for retirement are unlikely to achieve their financial goals in inflation-adjusted terms, particularly if they continue to invest for a past that no longer exists.
President Macron of France in a recent major speech said that we have reached "the end of abundance". What is on the way in Europe this winter - unless something changes and soon - is likely to be very painful, even transformative, and there will be major implications for the US and around the world. On a longer-term basis, there is a bit of irony here as Macron is a prominent advocate of the long-term policy changes for energy and agriculture that will help to force the end of abundance.
Macron is far from alone, particularly in Europe. Long recessions are being discussed, and multiple winters of economic pain, as the economies are forced to transition to new forms of energy. Now, that does not mean that "the end of abundance" is inevitable in the US (hence the ?), but it is currently the dominant direction, and given the multiple issues going on in practice right now, it is worth taking a long look at where this path may be taking us.
Where this becomes particularly problematic is that almost every aspect of conventional long-term financial planning in the US is dependent on the assumption of unending and ever-growing abundance. When one follows the underlying numbers, what Social Security promises, public & private pension promises, and most retirement investment strategies are all based upon is the purported certainty that the real US economy will (on average) keep growing wealthier at an exponential rate over time.
While most people who are counting on the future income don't realize this is that what these promises of future wealth have in common is that our current wealth isn't enough to pay them. They aren't fully funded and there has to be a substantial growth in the abundance of wealth over time. Remove that real economic growth - and the numbers fail in every category, whether it be Social Security, pensions or retirement investments. The farther out we go in time, then the greater the shortfall and the worse the failure. The result is that everything breaks in a process over time, regardless of what political promises have been made. Participation is mandatory, whether someone has any idea of the assumptions underlying the long-term promises or not.
As regular readers know, I've long argued against accepting a false dichotomy between blind mainstream investment optimism and doom and gloom pessimism. Yes, there is a possibility of sudden financial and currency collapse, but the more likely path is a long process over the course of many years. It is this long process that may break most conventional financial plans - even as it opens up new opportunities.
Impoverishment is already increasing, with one in six households reported as being not able to pay their rising utility bills, even as credit card debt soars upwards as households attempt to keep up with inflation. However, this impoverishment is not and will not be uniform. There will still be vast wealth in the United States. Some investment strategies will fail, and others will succeed. For those who are not of retirement age, who are building wealth and financial security, they will be facing an environment where opportunities will still be there - but there will be fewer of them, and often in different places.
This is a particularly substantive analysis, that is an outtake from my upcoming workshop, it covers about half of the workshop overview in the brochure (brochure link here). As we will be exploring at the workshop there are eight externalities that are overriding the assumptions that conventional financial planning is based upon. We will be integrating the externalities, the physical supply effects, and the monetary responses. This will then give us the impact of each externality - in sequence - upon inflation, the economy, and the investment implications for the four major investment categories of stocks, bonds, real estate, and precious metals.
3. Geopolitical Risk, Energy Policies &The Weaponization Of Inflation
Current macroeconomic theories are based upon decades of theoretical "advances" in a process of academics writing papers, often dense with equations. Because economic reality is too complex to be successfully modeled, the equations are based upon a series of simplifying assumptions. If enough properly credentialed economists working for the properly prestigious institutions agree on the assumptions and the resulting equations, as published in mutually peer-reviewed papers, then we have the Truth, what Experts know to be true. Note that this is not the result of an empirical process, but rather assumptions that are postulated by academics to be true, sometimes as a matter of economic philosophy.
Most people - including most investors - don’t worry about these sorts of things. These abstract, theoretical types of considerations seem quite impractical. Instead, many investors seem to (implicitly) think that investments are in some sort of parallel world, a world of time-tested solutions and patterns, where long-term investment strategies mean that “x” dollars of investments can reliably deliver “y” inflation-adjusted standard of living for “z” number of years. This is what people want, they badly want to believe that there can be some type of assured security when it comes to their personal long-term financial plans. There is an enormous confirmation bias involved in seeking those kinds of “settled science” solutions, and one could argue that the primary business model of much of the financial industry is to serve that confirmation bias.
The problem is that we are in a time of unprecedented governmental and central banking control over the economy and the markets. The old free markets that financial planning implicitly endlessly projects into the future - don't exist anymore.
A very good example is the pandemic shutdowns, the massive stimulus check spending, and the extraordinary increase in the national debt. These changed the economy and the financial world - and they can't be found in history and the usual approaches to financial planning. What happened was massive political and monetary interventions that were "exogenous", externalities that came from outside the normal economy and free markets.
The massive interventions were based on theories. The political theory that national and global economies could be shut down and then started back up again without triggering major consequences - failed. The monetary theory that the central bank could lend the spending power in our bank accounts to the government, in order to flood the nation with stimulus checks, without triggering inflation - failed. As covered in "The Stealthy Raid On Our Bank Accounts", the monetary theory in fact dated back to 2002, when a fast-rising Princeton professor named Benjamin Bernanke proposed dealing with recessions by flooding the nation with stimulus checks funded by the government, with the government borrowing the money from the Federal Reserve. According to the accepted simplifying assumptions, this daring monetary experiment should have worked brilliantly.
The two theories in combination - failed badly. The problem is that if Reality is outside of the simplifying assumptions and agreed-upon equations, then it doesn't matter what the impeccably credentialed Experts or "fact-checkers" say, an economic system built on that theory can become quite fragile and prone to collapse. This may sound abstract for most people, but as explored in the analysis linked below, 98% of our current inflation was a surprise to the economics profession, because what actually happened when physical supply was artificially restrained by pandemic shutdowns even as the nation was flooded with money was outside of the simplifying assumptions.
http://danielamerman.com/va/ccc/J5InflationMystery.html
As regular readers know, for some years now I've been using an analogy about the real powers of central banks such as the Federal Reserve. In ordinary times, the central bank can seem all-powerful to investors, and this can be true for decades at a time. However, the central bank is really just the tail of the dog, the real power is politics and nations. When the Big Dog of politics gets up and moves sharply, the tail - and the markets - are just along for the ride.
In 2022, the Big Dog is moving, and politics is arguably the single greatest source of investment risk, for now and potentially for the rest of the 2020s as well as the 2030s. However, it isn't just the politics that matters. Instead, the political decisions are filtered through our current massive monetary experiment, with a Federal Reserve swollen to ten times its previous size borrowing the money to dominate the markets even while funding unprecedented amounts of government spending.
The really big political factor right now is geopolitics and the war in Ukraine. With regard to the Ukraine, there are currently two distinct wars in progress. One is the physical Russian invasion of the Ukraine, the actual fighting, which is also being characterized as a proxy war between Russia and the West. The other is the global economic war that is in process. Both sides think they can win the ground war. Both sides think they can win the economic war.
This is what we introduced at the April workshop. and it has grown far more important since that time. The new danger is the intentional weaponization of supplies and inflation against the weak points in the U.S. and global financial system. This could turn out to be the heart of what some are referring to as the "gray zone" war between the United States and Russia (and possibly China as well). The outcome of this war could potentially become one of the most important financial events of our lifetimes.
To be clear, the workshops are apolitical - this isn't about Republicans and Democrats or political opinions and arguments about who is right and who is wrong. Instead, we have a series of large exogenous interventions underway, where external political decisions from outside the markets are transforming the markets and economy. The government shutting down millions of businesses was an external intervention on an extraordinary scale. The invasion of Ukraine, the sanctions, and the reduction of natural gas deliveries to Europe are all external interventions that can nonetheless transform global economic and investment outcomes.
The attempt to overthrow the reserve status of the US dollar is political in origin, but could have potentially extraordinary economic and investment consequences. The political attempt to radically change energy, agricultural and other policies in the name of fighting global warming - if it happens - could also become the dominant financial and economic force of the 2020s and 2030s, while also dominating retirement investment performance.
In short, it's looking like the dominant determinants of inflation and investment performance in the coming years - which will then determine real standards of living - will be coming from external political decisions that are outside the markets. The problem for both economics and investments is that the simplifying assumptions can't handle this, and this is true not only for economics but also for Modern Portfolio Theory. Again, this may sound a touch abstract - but it is absolutely fundamental, it rules. If someone is following mainstream financial theory - like the overwhelming majority of investors (knowingly or not) - then what is happening right now with a series of market dominating external interventions is excluded by definition. Because this is Reality, however, the foundation of investment theory is broken, and people will have no protection, or assurance of any kind for expected future performance.
4. Integrating The New Factors
So, to get to investment results, if politics and geopolitics are dominating the markets, then we need to start with the external (often political) interventions and move them through the filter of a new and already straining type of monetary policy. This determines inflation and economic growth (or shrinkage), which then dominates the markets and investment results.
One problem is that this is not a natural process for most people. Another problem is that this is happening with multiple issues at the same time, that are part of the same process and are interrelated with each other.
At the workshop we will be integrating all of these factors, using a new graphical approach that I've been developing this summer. As outlined on pages 21 to 22 of this brochure, the objective is to link together in sequence eight different recent, current, and future economic issues that each have the potential to change or dominate investment performance. (As always, the specifics of the workshop can change with developing events, so we will be covering the situation in late October rather than August.)
As shown in the outline, we will use a basic framework of A through F in evaluating economic issues.
A) We will start with the external intervention, which will usually be politically based. In other words, we start with a Reality that is generally excluded by definition from the monetary and financial theories, meaning we start with the pressure point on investments.
B) We will graphically move to the physical, such as the supply of energy and supply chains. This is where modern economic theory has such issues, as it effectively treats abundance as the natural state, with the rest of the world competing to deliver abundance to the US. When this isn't the case - things break and the theory guiding our economy and money system doesn't work.
C) We will then move to the attempt by the Federal Reserve and the government to contain or control the issue, always keeping in mind our starting place of massive government debt, and a Fed needing to borrow by the trillions as it wields purely monetary tools against what can be physical issues, while staying within the boundaries imposed by interest rates, investment prices, inflation, and recessions. This degree of direct market intervention is itself an ongoing experimental external intervention, where the historic economic and financial track record is lacking.
D) We will graphically look at how this is likely to change the pressures on inflation, and the potential changes in inflation.
E) We will graphically look at how this could be changing economic output, and the potential change in the US economy.
F) We will combine A through E, and look at the potential impact of each of the four major investment categories of stocks, bonds, real estate, and precious metals.
i) This isn't a full category, but there is a feedback loop going on, where political changes create major economic changes that can loop back and influence subsequent political changes. We are living in a time of unprecedented political polarization in the US (for the modern era), this will be coinciding with a time of potentially unprecedented financial change, and the two may merge together. Not the main focus, but it has its own potential life-changing implications, so we will briefly note the potential political pressure points before moving on to the next economic issue.
The ending point for one economic issue will be the starting point for the next, as we move through the 1 through 8 sequence.
5. The Eight Externalities
1. We will examine the intersection between the physical and the monetary, and show how both inflation and the economy were changed by the extraordinary monetary interventions of the Fed and the massive government stimulus. Keep in mind that this is a theoretical but understandable education, in a classroom atmosphere, with huge practical implications as investment performance is dominated by inflation and the economy.
2. We will then move to the externality of shutting down much of the economy. We will again integrate the physical and the monetary, and show how the pandemic physical shutdowns slammed into the monetary interventions to change inflation and the economy - with the quite tangible and investment dominating result of the highest inflation in forty years.
3.The Federal Reserve can't use its usual tools in response, as the necessary increase in interest rates would likely break the financial system, so it is instead doing what it can with what it has. This is new and risky territory for all of us - we will look at how the Fed is trying to move the intersection of the monetary and the physical to bring down inflation, and the inflation and economic risks that are necessarily being created in the process.
4. At this point we were already several layers deep in a new process, an all new economic place, and then Russia invaded the Ukraine, sanctions were imposed in response, and the economic warfare got going. What Russia is trying to do is to take an already very difficult situation, and then use the physical to try to push the monetary past the breaking point. We will graphically use the physical and the monetary to integrate this new external pressure on an already straining situation, and see the attempted body blow at rates of inflation and the economy (and then necessarily, investments and standard of living).
Narratives tend to become more extreme in wartime, and in this case what is most extreme is the difference between what is being covered and what is not being covered. The risks to the US and global economy are not in my opinion being adequately covered, due to the impact on public opinion. But yet, the risks are the risks, refusing to cover them does not make them go away - and we will go past the Narrative and look at the uncertainties.
5. When we extend to this winter and into 2023, then the risks potentially get even greater. Europe is more vulnerable than the US, and Russia has the ability to strike a much harder physical blow - to an inherently weaker monetary system whose primary source of strength is the very German economy that will be bearing the worst of the blow. As we will integrate with the physical and monetary, Russia going through the back door - hitting a devastating blow at our closest economic allies with our thoroughly interlinked supply chains and financial systems - if it happens, is likely more dangerous for US inflation and our economy than the struggle through the "front door" that we are seeing right now.
There is another level of integration that is also critical, and it is a key part of why I wrote the book "The Stealthy Raid On Our Bank Accounts". The US and European banking systems are deeply intertwined, this is why the Fed was secretly lending heavily to European banks in the midst of the 2008 crisis, with the beneficiaries of the loans not being disclosed until years later. If the European economy does go deep into recession for the end of 2022, and perhaps all of 2023 as some are expecting, then this will put enormous pressure on the banking system, and there may be large losses. This means the European and US banks may need to turn to their large reserves.
Except the problem is that the reserves have all been spent, as covered in Chapter Nine. Our checking accounts funded the reserves that the banks deposited at the Fed, and the Fed then lent that money to the US government - which the US government spent. It's gone. The only way to get the banks their reserves back if they need them - is for the Fed to borrow the money. A very similar situation exists in Europe, with the Eurozone banks having their reserves on deposit at the European Central Bank, and the ECB having spent the money. To get more money - they will have to borrow it.
We've had a shell game going on with the banks since 2008 (2012 in Europe), where bank deposits are given to central banks as reserves, and the central banks are then passing the money to the governments to spend. From the standpoint of legal and regulatory definitions - the Narrative - these are the safest reserves in the world, as agreed to by experts and fact-checkers. However, from an economic perspective - the reserves don't exist, as the money has already been spent. This hollowing out of the bank reserves for the benefit of the government can be very stable for many years - until the banking system goes into crisis and badly needs those reserves, as may be happening this winter and in 2023.
It is also critical to keep in mind that Europe will likely be experiencing the most extreme conflict that we have seen yet between the monetary and the physical, with digital balance sheet entries for "reserves" and money creation going up against potentially severe physical shortfalls. Most of the world will be blindsided if this happens. At the workshop, we will bust through the Narrative to see what is happening, as well as the many potential implications for our financial futures and financial choices.
6. This ties into one of the biggest risks of all, which is Wall Street pricing in the belief that the Federal Reserve will be forced to pivot in 2023, and reverse course to fighting recession instead of inflation, slamming interest rates down. As previously reviewed, the Fed does not have access to the full power of its traditional tools for fighting recession or inflation, and in fighting recession, it is left with the one-way ratcheting mechanism of turning to still more money creation, taking more spending power from our bank accounts, and exploding the size of the national debt up that much further, in order to fund still more stimulus spending.
Note that fighting recession with the new methods requires going to the same source as redeeming bank reserves in the event of a major recession - borrowing still more money in each case, both in huge quantities, and both at the same time. So, it's not just Europe in crisis, and it's not just the extraordinary pressure of the US resulting from an attempted pivot, but it is the two at the same time, "fishing the same pool" for the same dollars and same limited trick bag of monetary tools, even while the physical drives shortages and recessions. This is an awful design flaw when it comes to the stability of the new global financial system - but it didn't matter, nobody cared.
It is a major long-term risk that was created by the greed of Wall Street and Washington, they did not think through how the new economic structure could handle repeated rounds of recessions, particularly in a stagflationary environment, nor did they think through a simultaneous major banking crisis in the midst of a severe recession - there was too much money to be made in the short term, and long term risks for the nation were irrelevant. This wraps around to a core part of our April workshop - the supposedly "best of the best" experts making the decisions were and are not taking into account simple second order effects, let alone third order effects. But yet, our new monetary system is inherently more complex and fragile than the old one, it is under high and building stress right now, and it is the second and third order effects that are beginning to take over the global economy.
At the workshop, we will integrate the physical with the monetary, and look at the combined impact on inflation, the economy, and investments, as the Fed attempts to fund the government spending its way out of recession, in the midst of what could be economic stagflation across much of the globe at that point.
7. There is another very important issue that has been emerging as well, although with little discussion of the second order effects. Politicians in the United States and Europe have been talking about the "good" parts of the energy shortages and the surge in energy prices - they are helping to transition the world to an economy that is based on fighting climate change. With what we are seeing now being the early stages of a long process that aims to radically reduce fossil fuel usage for energy, while also transforming agriculture and the food we will eat.
There is a huge debate about this, which we will not participate in at the workshop, but what we will do is integrate the physical with the monetary, and look at the inflation and economic implications of the planned process. There are fundamental financial consequences for the great majority of the US population, it will be far worse for some of the nation than the rest (especially rural areas, small cities, and the Heartland in general), but the current Narrative is to not discuss this in any way. At the workshop, we will connect the dots, and we will do so in manner that focuses not on politics, but on the financial and investment consequences for the nation and for investors. This is a dominant influence, it is an external intervention, it should be central to financial planning - but the second and third order effects of this new economic and investment world are not being taken into account.
8. Again, timing is everything. As long-time readers know, I've been examining the demographic aspects of long-term investment strategies for many years now, and something we have long known is on the way is about to arrive. We're going to have a huge "bulge" of sorts go through the system between about the mid-2020s and the mid-2030s, when we will have peak numbers of retirees planning on physically supporting themselves based upon purely financial wealth - whether it be retirement investments, pensions, Social Security or a combination. Now, it's easy to make political promises or to project compounded investment results, but whether this process works as planned has always been dependent on the actual economy at the time, the actual workers and what they are producing, the physical and not just the monetary or the financial.
So, according to the best information we currently have, we will have a building collision of sorts on the way over the next few years, where the economy and markets will be in the process of being fundamentally transformed by the politically directed process of fighting climate change, at the same time as the peak number of people believe that they will be achieving a promised standard of living in retirement. This merger of two game-changing primary factors will lead to second and third order effects that are likely to be fundamental game-changers for money, investments and financial security. The current retirement plans of the nation are unlikely to survive the collision, including Social Security, pensions and retirement investments. However, at this point, neither the second or third order effects or even the looming conflict are being discussed by those politically driving the agenda, or by the financial industry.
Another way of phrasing is that never before have so many people been building their life plans upon (unstated) assumptions of unending monetary abundance - even as we may be well into an externally directed physical "end of abundance". The mismatch is fundamental, it may dominate everything, and any long-term financial plans that do not take this into account are likely to fail badly over time - no matter how impeccable the credentials and reputation are for those currently making the projections.
At the workshop, we will do what the politicians, the media, and major financial firms are not doing - we will thoroughly discuss what seems to be on the way. We will integrate the physical and the monetary, explore the second and third order effects, and follow the extraordinary implications for inflation, the economy, and investments. Among other things, what we will find is Sequence of Returns Risks. When Vicious Circles occur, they can occur for an entire nation at the same time, and they can be a one-way path for those caught up in it, who were not prepared for it. It should also be noted that for political reasons, public pensions and Social Security are inherently vulnerable to an exaggerated form of Vicious Circles, and this could become a dominant financial and political factor in the 2020s and 2030s.
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Workshop brochure link here, including Sections 1-2, 6-7, and the detailed topic outlines for the eight externalities.
