Michael Hudson : The Bubble Bursts — and the economy with it

From Michael Hudson, from his Patreon Site.  

          The Oil War is going to cause cutbacks in spending on non-oil products, because paying more for gasoline, diesel and aircraft fuel, fertilizer, naphtha and sulfur will cut into profits, leading to layoffs.

            And some time this month, rising energy costs will force up electricity prices. This will limit the ability of IT and AI to meet the optimistic expansionary sales goals that they have set.

            This will lead many investors to consider the big runup to have reached its limit. And falling profits throughout the economy will be leading to a widespread stock decline.

            So let’s talk about what probably will happen.

            The IT boom is not just a stock market bubble by optimistic buyers, pension funds and mutual funds.

            The “magic 7” stocks have been bought largely on credit, that is, with margin debt to leverage capital gains. This purchase of stocks on credit, with small down payments, has been a characteristic of bubbles since the South Sea and Mississippi bubbles of the 1710s.

            So we are in more than just a stock market bubble and the “madness of crowds.” It is a credit bubble – and that means a debt bubble.

            This makes the “magic 7” a Ponzi scheme. In fact, the whole stock market has turned into a Ponzi Scheme. Such a scheme can be kept afloat only by new members subscribing, providing the money for the scheme’s operators to pay the dividends they have promised (and buy their own stocks to keep their prices high). The market rise – and even keeping its current level – thus requires a team of “greater fools” to keep on joining it.

            For the stock market as a whole, the “greater fool” providing money for the stock market has been the Federal Reserve, which has finance Trump’s budget deficits by creating electronic money to buy Treasury securities. Its holdings of these securities have ballooned – and both Treasury Secretary Scott Besant and new Fed head Warsh had argued that this monetization of the deficit should be not only stopped, but reversed.

            That is a plan of monetaey deflation. It would raise interest rates – and higher interest rates would remove the arbitrage incentive for private capital firms and the ultra-rich funds to buy more stocks on credit. the bubble would be over.

            And when a bubble stops expanding, it collapses as investors bail out and take whatever gains they have made.

            The Fed’s protective coloration may be to claim that high interest rates are needed to stem the price inflation that will result from rising oil costs. Milton Friedman told his Chicago Boy cult (echoing Ricardo) that “Every inflation everywhere is a result of too much money creation.”

            But it isn’t money creation that is pushing up prices. It’s the real economy’s cost of energy. Monetary deflation can’t cure it.

            The aim ever since Paul Volcker’s era was that the Fed’s role is to keep unemployment high, so as to keep a large “reserve army of the unemployed” to make wage earners desperate to take jobs for whatever is being paid in a shrinking job market. But higher interest rates today will be occurring in an economy already suffering unemployment and low wage growth – with wages unable to enable most families to afford their cost of living without going even deeper into debt.

            So the effect will be debt arrears leading to rising default rates.

            This is the effect of the Oil War combined with the junk economics that passes for money and banking theory taught to mainstream economic students and repeated in the mass media. Nobody likes to think about the unthinkable.