America on the Brink

George Floyd died at a moment of extreme dysfunction in American political life. Relations are so poisonous and so polarized between the parties that we are not seeing the kind of bipartisan meetings on Capitol Hill that typically occur at times of crisis. Hence, the feeling of things spiraling out of control – Business Historian Ron Chernow, quoted in Gerald Seib, “Virus, Unemployment, Riots: When Shocks Multiply, The Effects Usually Last”, WSJ, 6/2

A health crisis, an economic crisis, and a racial crisis have converged to produce a clear and present danger to American democracy – William Galston, “I’ve Never Been So Afraid for America”, WSJ, 6/3

Last night, I was sitting in my car reading at Carlmont Center in Belmont, CA, about 5 minutes from my home in San Carlos, when I received a text from my Mom that, due to a race protest that afternoon in neighboring Redwood City, San Mateo County had implemented a curfew starting at 8:30pm and running through 5:00am this morning. As I drove home, I saw high school kids carrying signs reading things like “We will not be silenced”. I’ve never seen anything like this in the affluent area where I live. It was quite disconcerting.

The sadistic murder of George Floyd by Minneapolis police officer Derek Chauvin has inflamed racial tensions that go back to the country’s founding and added one more crisis to a growing list. The murder has caused riots and looting across the country with no end in sight. Both Gerald Seib and William Galston compare the current situation to 1968. As if we weren’t already dealing with enough crises!

Just before Floyd’s murder, it seemed as if the country was beginning to recover from the coronavirus. While by no means contained, states had started re-opening their economies under political pressure to balance the public health against the economy. California began Phase 2 of the re-opening on Friday, May 22 and other states seemed to be following a similar trajectory. Economic activity began to pick up from extremely depressed levels. For instance, Lyft (LYFT) reported yesterday afternoon that rides in May were up 26% from April – though still down 70% from a year ago.

Another brewing crisis is the growing tension between the world’s two superpowers, The United States and China. The “Chinese Virus” added impetus to Trump’s attempt to bring manufacturing jobs back from China. It now seems inevitable that many supply chains will be removed from China but not without costs: “US security hawks should be aware that a broad-based attempt to disentangle the two countries’ supply chains and educational linkages will come at a significant cost to America’s own competitiveness” (Nathaniel Taplin, “A US-China Breakup Will Be Pricey for Both”, WSJ, 6/3).

Even more important is the stock market bubble which continues to inflate by the day – the S&P is up 9 days in a row now. Many investors and commentators are astounded by the disconnect between the stock market and the economy. A narrative of a V-shaped recovery combined with massive injections of liquidity by the Fed have created bullish crowd psychology unparalleled in history. The closest historical analogy is the Dot.com bubble but the current bubble is far broader in scope, encompassing not just tech stocks but the entire stock market, government and corporate bonds and commercial real estate.

The stock market has never been more important to the American economy. That’s because the economy is now structured into two classes of people: the “managerial elite” (James Burnham) or the “overclass” (Michael Lind) which make up about 20% of the population and the Service/Gig workers who serve them. The Top 20%’s spending is highly dependent on the wealth effect. That is, as their financial assets grow, they spend more on discretionary purchases like restaurants, travel, clothes and other such purchases. However, the reverse is also true: Were the stock market to deflate, the wealth effect kicks into reverse causing the wealthy to spend less on these discretionary items, hitting employment and income for The Bottom 80%. The middle class, historically the American economy’s strength, has been hollowed out by the outsourcing of manufacturing jobs to countries with cheaper labor like China. Therefore, when this bubble pops, it will decimate the economy, with The Bottom 80% bearing the brunt of the pain.

On top of that, the Fed’s massive policy response – a $3 trillion increase in their balance sheet since the onset of the coronavirus – threatens the dollar with a currency crisis. As we all know from Econ 101, an increase in supply, ceteris paribus, results in a decrease in price. When applied to the current case, that means the Fed’s policies are devaluing the dollar. The dollar is just a piece of paper, not backed by anything i.e. fiat currency. Its acceptance as a medium of exchange is therefore based on confidence. If the Fed continues to dilute the purchasing power of the dollar by creating more and more of them, confidence, that delicate thing, could be lost. In that case, inflationary psychology could take hold making economic calculation difficult and causing an increase in interest rates among other things. The modern global economy depends on the dollar to function as a medium of exchange. Should people begin to lose confidence in it, it would result in at least a Second Great Depression if not Civilization Breakdown (see my “The Possibility of Civilizational Breakdown”, 3/19).

Right now, the world is focused on the race riots and the coronavirus. However, while important, the more serious threat is the stock market bubble and the Fed’s policy response to the coronavirus. Should the stock market bubble pop, as I said previously, the wealth effect will kick into reverse, devastating the economy. Were that to happen, however, Fed Chair Jerome Powell has proven that he will not hold back. He will continue to fire bullets in the form of asset purchases, ballooning the Fed’s balance sheet, and threatening a currency crisis. Make no mistake about it: this is the biggest bubble in world history and when it pops, the race riots and the coronavirus, while still important negatives, will take a back seat to the ensuing economic collapse. America is on the brink and we have crossed the line of no return. The clock is ticking and it is only a matter of time now.

Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
825 San Antonio Road, Palo Alto, CA 94303
(916) 224-0113
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