[Today’s post is excerpted from the October Austrian Investment Monthly newsletter. To subscribe please visit St Onge Research]
2014 has been a nail-biter for GDP watchers. After a 2.1% decline in Q1, the worst in years, Q2 rebounded with a ripping 4.6% print. Why all the excitement?
In any story you first decide where to begin. And 2014 starts with 2011. Why 2011? Because that’s when the economy grew out of the 2008 rebound and started getting nervous.
2011 gave us a pattern starting down the 2008 path, as consumption gobbled up ever-more resources, and the economy flirted with deflation. Gold, predictably, soared. That would have been a good time to let the mini-recession come, to clear up some of the gunk that had accumulated after 3 years of near-zero rates. But of course this Fed is too cool to worry about zero interest rates (ZIRP, as the kids say). And so they pumped on. This Fed wants to diet, but is institutionally incapable of putting down that donut.
Since 2011, we’ve shifted into a proper “Misesian” boom, with easy money flowing into business loans. We can see the action in this chart of GDP components.
The most important bits here are the bright red box and the blue boxes. Just like in US politics, red means “investment” and blue means “consumption.”
What are we looking for here? Well, investment means that the economy will likely grow in the future — the purpose of investment is, after all, to make more stuff in the future. Of course that’s complicated when rates are this low and government this activist, since both low rates and political loans can steer investment into unproductive channels. Unproductive investment, or “malinvestment,” builds up trouble for the future, and the unwinding of that malinvestment is what we lovingly call a “recession.”
So we want lots of investment, but we should be a little suspicious if it’s happening with low interest rates, and very suspicious if it’s coming thanks to a relaxing of lending standards or political donor-driven projects.
On the consumption side, things also go two ways: on the one hand consumption is an indicator of present economic health. On the other hand, consumption itself destroys wealth. Hence the term “consumption” and not “creation.” So good consumption numbers are a bit like driving your car high-speed through an obstacle course: it proves the car is in great shape, but the car won’t stay that way for long.
So, what’s been going on since 2011? Consumption has been trundling along, taxing those future generations so we can live well. It zigs, it zags, neither broadcasting distress nor euphoria.
Instead, investment is where the action is. From an energetic start in 2011, fixed investment started petering out in 2012 before rebounding in 2013. And in Q1 2014 fixed invesment plunged, nearly to zero change. As of the current revision, Q2’s huge rebound serves as an unmistakable all-clear.
Why does this matter? Because there are two kinds of booms: consumption-led and investment-led. In a consumption boom, the Fed is redistrubuting assets from savers and investors to consumers. This harms savers, of course, but it also starves investment. It “runs down” the economy, pricing out new factories in favor of swimming pools and Disney vacations. The relatively slow growth amid easy money can ultimately lead to stagflation.
An investment or “Misesian” boom is a very different creature. Here, the Fed is redistributing assets to businesses. This tends to lead to a boom today, the catch being that all the easy money will progressively fund stupid projects, leaving lots of debris to get cleared out in the next recession.
So, based on Q1 and Q2 GDP numbers, where are we today? We came out of 2008 with a heavily consumption-led boom, that was leading us into stagflation until investment picked up in 2011. That began to shift in 2012, leaning back to consumer loans, before the pendulum came back in 2014. As of October, 2014, we’re looking at numbers that say we’re in for an investment, or “Misesian” boom. This bodes well for stocks, bonds, and badly for gold.
What to look out for? If investment collapses while consumption holds up, it indicates we’re shifting to a consumption boom, which raises the specter of stagflation. Broad stocks should do relatively badly, while gold and inflation hedges do relatively well.
On the other hand, if consumption drops while investment rises, it’s short-term positive for the stockmarkets, but raises the medium-term risk that the next recession will be more severe.
And if both consumption and investment hold strong? Then we just get a toned-down Misesian boom (toned-down since consumption hogs up some of the resources that could otherwise go to an investment-led boom).
And if both consumption and investment drop? Then liquidity is vanishing, either because the Fed is inflation-spooked and draining the punch-bowl or because FUD (“fear, uncertainty, doubt”) is spreading in the market. When this happens (and it’s when, not if), go to cash or bonds, sit tight while gold does its early recession dip, then shelter in gold until stocks turn.