Relax, The Stock Market Correction Is Your Friend
It's long been a rule of thumb that the economy can't boom when oil is trading above $50 barrel. Conventional wisdom about the latter would be that high gasoline prices erase the diposable income of most consumers.
While there's some truth to the above, the real explanation is a bit more nuanced. In reality, oil can only reach $50+ if the value of the dollar is in decline. Economic growth is a function of investment followed by increased production, production is always and everywhere the source of our demand, but if the dollar is falling so by definition must investment be in retreat.
In short, $50 oil and beyond is a certain signal that investment is migrating into the wealth of yesterday over stock and bond investments representing forward-looking wealth that doesn't yet exist. Though economists wax rhapsodically about the wonders of currency devaluation, history isn't so kind. Devaluation is an investor repellent, and because it is, it lays a wet blanket on growth.
That's why it's important for investors to quickly dismiss all the nonsensical commentary of late about a stock market that can't stand on its own two feet absent a continuation of Ben Bernanke's quantitative easing. None of it is credible.
For one, to believe that easy money has boosted the stock market is to presume that buyers can exist without sellers. It's also to believe that stocks become more attractive when a central bank acting with the full support of Treasury devalues the very dollar income streams that lure investors into the market to begin with.
After that, one would be wise to look back to the ‘80s and ‘90s. Back then interest rates across the yield curve were much higher, the Fed had more adult leadership that didn't presume money creation meant to buy Treasuries and agency debt would somehow foster entrepreneurship in Silicon Valley, Austin and Route 128, and because the dollar was strong alongside mostly normal policy, the economy and stock markets zoomed upward.
Importantly, the economic renaissance that began in the early ‘80s in a sense tells us something about what's happening now -- if our federal minders let the correction run its course. Indeed, the 1970s very much resembled the economy of the last 12 years. Presidents Nixon, Ford and Carter were every bit as clueless about economic policy as their modern equivalents in George W. Bush and Barack Obama, and this most cruelly revealed itself through dollar policy.
In the ‘70s the dollar went into freefall, and because the dollar was in decline, stocks and the economy sagged alongside a boom in the commodity sector. Then as now, people who should know better presumed that high oil prices signaled scarcity over money illusion, and the result was that massive amounts of investment chased prosaic and plentiful commodity plays over the wealth of the mind. And with money illusion sucking investment into yesterday's industries and yesterday's already created wealth, the economy and stock markets sagged.
Happily, relief came in the form of Ronald Reagan. After he won the New Hampshire primary in early 1980, the markets started to price in the election of someone who didn't buy into the economy-suffocating falsehood that says devaluation is the path to prosperity. The dollar rose as Reagan's electoral chances improved, and with its rise, gold, oil and other commodities fell. Housing was similarly a hot asset class in the weak dollar ‘70s, yet as the dollar's value increased this middle class devaluation hedge went into a slump.
In a technical, GDP sense, the U.S. economy fell into a major recession, and the Dow Jones Industrial Average tumbled into the 700s by 1982. Paul Volcker's flirtation with Milton Friedman's monetarism also played a gruesome, unnecessary role in the early ‘80s downturn, but the correction was ultimately healthy. The ‘70s weak dollar had lured all manner of investment into inflation hedges and easy to tax, slow-growth commodity plays, so the reversal of those policies was going to bring with it some pain.
Ultimately, and this is why Reagan was re-elected by a landslide in 1984, the near-term pain was good. Yes, the markets and the economy had to adjust to a reorientation of investment away from the wealth of the earth, but the migration of investment back into hard to tax, innovative concepts of the mind set off a profound economic and stock market boom that for the most part didn't cease until Bush '43.
Fast forward to the present, and the U.S. economy has as mentioned suffered a cruel ‘70s replay. A falling dollar has fostered a slow-growth rush into housing, commodities, and other devaluation hedges. Much of this has coincided with Ben Bernanke's time at the Fed. Bernanke, like most economists, believes that dollar devaluation and the mass creation of money for the sake of it leads to actual wealth creation. The result has been the economy-sapping perversion of money that is quantitative easing.
And just like the 1970s, investment has reflected Bernanke's tragic misunderstanding of the role of money. The presumed, utterly merciful end of quantitative easing, not to mention the even happier news of Bernanke's looming departure, has given the appearance of shaky markets. Investors should relax. This correction is healthy, and if left alone, promises to reveal itself soon enough in a stock market boom.
The correction speaks to an unwind of all the economy-retarding investment that has coincided with bank crack-ups, financial crises, and jobs bereft ‘growth.' This unwind will bring with it pain, and if done properly such that the dollar pushes gold down into the $800 range, a recession in the technical, GDP sense, will ensue. But much like the ‘80s and ‘90s boom that followed the post ‘70s unwind, we need one now to unlock all the growth capital stuck in inflation hedges and other commodity-related concepts that signaled our lurch backwards.
Put simply, we need a downward market and economic correction in order to experience the opposite. Twelve years of dollar debasement has truly defaced the economy, and to fix the damage done, we must experience near-term pain that pushes investment back into the growth-oriented economy of the mind. Investors need to relax, because the market correction is their friend.