But you really shouldn’t be terribly surprised by the rally. Even the worst bear markets see substantial bouncebacks. And you can expect the market to give back all of its recent gains in the months ahead as the economic fallout of the lockdowns becomes apparent.
This bear market has a long way to run. And we could actually be looking at the worst recession in 150 years if one economist is correct. Let’s unpack this…
My regular readers know I have a low opinion of most academic economists, the ones you find at the Fed, the IMF and in mainstream financial media.
The problem is not that they’re uneducated; they have the Ph.D.s and high IQs to prove otherwise. I’ve met many of them and I can tell you they’re not idiots.
The problem is that they’re miseducated. They learn a lot of theories and models that do not correspond to the reality of how economies and capital markets actually work.
Worse yet, they keep coming up with new ones that muddy the waters even further. For example, concepts such as the Phillips curve (an inverse relationship between inflation and unemployment) are empirically false.
Other ideas such as “comparative advantage” have appeal in the faculty lounge but don’t work in the real world for many reasons, including the fact that nations create comparative advantage out of thin air with government subsidies and mercantilist demands.
Not the Early 19th Century Anymore
It’s not the early 19th century anymore, when the theory first developed. For example, at that time, a nation that specialized in wool products like sweaters (England) might not make the best leather products like shoes (Italy).
If you let England produce sweaters and Italy make shoes, everybody was better off at the end of the day. It’s a simple example, but you get the point.
But in today’s highly integrated and globalized world, where you can simply relocate a factory from one country to the next, comparative advantage has much less meaning. You can produce both sweaters and shoes in China as easily as you can produce them in England and Italy (and much more cheaply besides).
There are many other examples of lazy, dogmatic analysis among mainstream economists, too many to list. Yet there are some exceptions to the rule.
A few economists have developed theories that are supported by hard evidence and do a great job of explaining real-world behavior. One of those economists is Ken Rogoff of Harvard.
It’s not the early 19th century anymore, when the theory first developed. For example, at that time, a nation that specialized in wool products like sweaters (England) might not make the best leather products like shoes (Italy).
If you let England produce sweaters and Italy make shoes, everybody was better off at the end of the day. It’s a simple example, but you get the point.
But in today’s highly integrated and globalized world, where you can simply relocate a factory from one country to the next, comparative advantage has much less meaning. You can produce both sweaters and shoes in China as easily as you can produce them in England and Italy (and much more cheaply besides).
There are many other examples of lazy, dogmatic analysis among mainstream economists, too many to list. Yet there are some exceptions to the rule.
A few economists have developed theories that are supported by hard evidence and do a great job of explaining real-world behavior. One of those economists is Ken Rogoff of Harvard.
The Worst Recession in 150 Years
With his collaborator, Carmen Reinhart and others, he has shown that debt-to-GDP ratios greater than 90% negate the Keynesian multiplier through behavioral response functions.
At low debt ratios, a dollar borrowed and a dollar spent can produce $1.20 of GDP. But at high ratios, a dollar borrowed and a dollar spent will produce only $0.90 of GDP.
This is the reality behind the phrase “You can’t borrow your way out of a debt crisis.” It’s true.
Meanwhile, the U.S. debt-to-GDP ratio was about 105% even before the crisis. It’s only going higher. We’re just digging a deeper hole for ourselves.
So when Ken Rogoff talks (or writes), I listen. In his latest article, Rogoff offers a dire forecast for the recovery from the New Depression resulting from the COVID-19 pandemic.
He writes, “The short-term collapse… now underway already seems likely to rival or exceed that of any recession in the last 150 years.”
That obviously includes the Great Depression and many other economic crises.
This is something you should really consider before you decide the coast is clear and it’s time to jump back into stocks.
With his collaborator, Carmen Reinhart and others, he has shown that debt-to-GDP ratios greater than 90% negate the Keynesian multiplier through behavioral response functions.
At low debt ratios, a dollar borrowed and a dollar spent can produce $1.20 of GDP. But at high ratios, a dollar borrowed and a dollar spent will produce only $0.90 of GDP.
This is the reality behind the phrase “You can’t borrow your way out of a debt crisis.” It’s true.
Meanwhile, the U.S. debt-to-GDP ratio was about 105% even before the crisis. It’s only going higher. We’re just digging a deeper hole for ourselves.
So when Ken Rogoff talks (or writes), I listen. In his latest article, Rogoff offers a dire forecast for the recovery from the New Depression resulting from the COVID-19 pandemic.
He writes, “The short-term collapse… now underway already seems likely to rival or exceed that of any recession in the last 150 years.”
That obviously includes the Great Depression and many other economic crises.
This is something you should really consider before you decide the coast is clear and it’s time to jump back into stocks.
- Source, Jim Rickards via the Daily Reckoning
