THE WOLF STREET REPORT: When the Music of the “Wealth Effect” Stops

OK, so we have a phenomenon here that has taken on historically huge proportions in the era of the Everything Bubble (12 minutes):

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  44 comments for “THE WOLF STREET REPORT: When the Music of the “Wealth Effect” Stops

  1. Why didn’t my teachers just come out and tell me that “musical chairs” was a metaphor!?

    I love the irony of people desperately POURING money on the fracking industry, the EV (car sales) industry, and the car sharing industry at the same time.

    Thought provoking article, for sure. As others have said… is there a smooth exit from this? My instinct says no way in hell, but I accept that my instinct is an armchair economist.

  2. Satya Mardelli says:

    History tends to repeat itself. In 2000 the market was being saturated with IPOs. Prior to 2000 nearly all IPOs experienced a first-day pop. In 2000 that first day gain was a hit or miss proposition. The Dot Com bust occurred in 2000.
    This year most IPOs popped on their first day of trading with two notable exceptions; Uber and Lyft. Most VCs realize the market is running out of steam and want to cash out before the next crash. Hence the recent surge in IPO activity.
    If more IPOs flatline or fall on their opening day it might portend the end is nigh. Sentiment will quickly fade and the rush to the exits will begin.
    The only thing we need is a triggering event.

  3. Sandu says:

    Great description Wolf of how the spigot of easy money flows through the economy, leads to increased economic activity and what happens when that spigot shuts off!

    The unfortunate part is that a good part of that increased activity in the real economy is not directed towards the best uses – i.e. substantial increases in productivity and improvements in everyone’s life. This is proven by the fact many of these businesses are not profitable, and, as you say, a ponzi scheme is needed whereby new investor money has to follow after the old money to keep the scheme going.

    This economic growth creates the illusion of well-being and improved lives – to some degree there is real growth happening. For e.g. I love Uber as a concept – the fact that I can conveniently pool with someone else for a ride it’s truly a smart/beneficial innovation; it would be even better though if it could be profitable too. We are however nowhere close to the type of innovations and growth we have seen in other times: for e.g. in the gilded age. People like Peter Thiel talk a lot about the innovation stagnation of our era.

    Part of the explanation why we’ve seen better periods in our history might be tightly related to the fact that back then we had hard money, backed by gold and people were not afraid of very low inflation or even deflation – it was viewed as something that lifts everyone’s boat. Today’s companies hyper focus on short-term performance could be another factor too.

    I’ll just give one example of what I think is a negative impact of easy money, lack of a meaningful hurdle rate and perpetual losses: you mentioned the software engineers that get hired at a startup – there are so many of them chasing after same ideas or sometimes ideas with questionable societal value. This leads to companies that could put this talent to better use having a hard time to compete for engineers, needing to pay higher salaries and foregoing investments with better long term outcomes for the society as a whole.

    • Suppose money was invested in more affordable housing? What if $200 sq ft to build was 50? What if cars cost half as much? Clothing and food were ubiquitous? A wave of deflation would destroy the capital markets. Secondly the impact to institutions dedicated to the old nationalist, regional power struggle for resources would erase borders and governments. Why would any worker continue a daily grind while everything is made easy? Politicians with their carrot and stick economic policies would be eliminated. The compensating impulse is reactionary to put it in perspective.

      • Sandu says:

        A wave of deflation would destroy capital markets because the extraordinary reliance on debt. There were times when capital markets could live happily in a deflationary environment.

      • Hi says:

        It must correct you. A nuclear castrophe would destroy the markets. A 50 or 75 percent correction would cause social adaption which has occurred since the beginning of time. A event occurs and humans adapt to that event. The only thing that destroys something is if it is eliminated in its entirety. I think we all need to get over the significance of the markets. They really don’t matter because whatever happens humans will adapt.

    • Morty Mc Mort says:

      Easy Money – Mergers and Acquisitions. I see it all the time in my industry. Since Money is Cheap, everyone is loading up – Buying, selling companies, loading up on debt, and “Covenant Light” deals that are really shocking, in their lack of investor protection… One big Deal maker in my vertical, called it the “Golden Goose” Right to my face… think about it.. everyone in this area is making so much money, no one cares.. Someone else will hold the bag, when the music stops… or so they think…

    • Petunia says:

      The lack of innovation in the economy is not a financial problem, it is a political and social problem. Merit has been replaced with political correctness and the result is stagnation, if not downright devolution.

      It is not enough to be talented and innovative anymore, you must conform or you must go. There are talented people sitting on their hands because they will not conform or support ideologies they don’t agree with. This is what the left has wrought.

      • Juanfo says:

        Individuals with incredible skills lay dormant in the shadows cursed without a charismatic personality.

  4. DR DOOM says:

    Have you not just made the case for 0% interest rates and Q.E. forever and Mises case for Mal-Investment? Also it might be problematic that 150 million people ain’t been invited to the party.

    • Sandu says:

      Right on. Someone can keep his/her job for awhile by doing “busy work” as it looks like activity is being performed. Eventually the employer will ask for results.

      Those 150M people (+ many more in other countries) will ask too at some point for their share of results, especially if they see too much of that “wealth effect” skewed towards the top. Although history is riddled with the opposite, all we can wish for is that this will be resolved peacefully.

  5. Ian says:

    I’m guessing lower interest rate – here and abroad – will allow this bubble to continue and savers be damned.

    • Gold is says:

      The risk of bail-in already out-weighs the ‘benefit’ of putting cash in the banks at absurdly low rates.

      Those who get their cash out of the banks early will be the lucky ones – those who wait will get their funds out…at $250 per week as per Cyprus.

      It’s worth investigating private safe deposit boxes – while they are still available.

      • d says:

        “It’s worth investigating private safe deposit boxes – while they are still available.”

        Dont you remember/know what happened to bank safety deposit boxes in greece after the banks reopened?????..

        The contens of bank and in many cases private safety deposit boxes, can become STATE PROPERTY, anytime a thieving socialist/communist/criminal state, wants it to.

        Bank safety deposit boxes, are good for documents, data backups and the like, not much else.

      • RD Blakeslee says:

        “If you don’t have physical possession of precious metal, you don’t own it” Len Penzo (among others).

      • Bologna says:

        Oh but that pesky cashless meme doesn’t allow me to remove my cash from the bank

        • Juanfo says:

          My sister was born in 88. All her “employed” life she has relied on credit/debit cards for all of her transactions. Recently her employer switched from bank deposits to paying monthly salaries in cash. She literally lost half of it within a week. The rest she lost walking out of retailers after purchases. Too scattered to wait for change. After paying with a big head Benjamin for a seventy cent stick of Starburst candy.

  6. brudelphi says:

    BIS General Manager Agustin Carstens warned that while stimulus can help in the short run, it can have side effects further out such as over-inflating asset prices such as stocks and bonds, and feeding less productive zombie firms that wouldn’t survive without cheap borrowing.

    • polecat says:

      As a shark speaking to it’s fishy prey .. Got it !

      So who gets ‘schooled’ THIS time ??

  7. Ken says:

    The FED can stealth fund the economy through these cash burn companies instead being blatant like BOJ who owns most of the stock market.

  8. Michael Engel says:

    Shortening of the thrust : SPX road from 2,872 to 3,000 take 1.5 yr.
    A new all time high with lower momentum is bearish.
    TrumpKim, about Iran.

  9. Rinaldo says:

    Interesting aspect of those money burning corps. Never seen them as economic stimulus enterprises. Thank you!

  10. Kenny Logouts says:

    Inflation deflates debts, and bubbles.

    As long as you can make everyone think inflation is low you’re winning.

  11. Mike Are says:

    The spigot will NOT be turned off. It cannot be turned off without severe pain.

    The crisis will come in social disorder as the effects of stagflation slowly and inexorably crush more and more citizens. The final blow-off will come when the dollar loses trust throughout the world (slowly as in now, and then all of a sudden). That is when the money becomes worthless and the reset will have to occur.

    • Gandalf says:

      The problem is, all the major industrialized currencies in the world are doing low to zero rates and the US is the cleanest shirt in this dirty laundry.
      The US dollar did come close to losing its status as world reserve currency in the late 70s and again in the 90s back when Japan and Germany had thriving manufacturing economies and frugal governments
      Global investors have no where else to turn

  12. David Hall says:

    Penny mining stocks are notorious for burning cash while doing mine exploration. Many of them became bankrupt while searching for the mother lode. A few struck it rich after reporting high grade drill intercepts.

    An index of large cap company stocks outperformed inflation over the long run. One notable exception is the Japanese stock market that has not yet regained its 1990 bubble high.

  13. RD Blakeslee says:

    Wolf, I would like to see an article comparing econometrics in each of the eras when reserve currency status changed hands. The currency of several nations has lost it in turn over the last three centuries, or so. I’m not asking for a prognostication whether/when the dollar will lose its reserve status, understand.

    • Wolf Richter says:

      Every quarter I cover the reserve currency status of various currencies, including later today for Q1. As you will see, anyone waiting for the replacement of the top reserve currency (there are many reserve currencies) will have their patience severely tested. These changes take decades … many decades, not just one or two.

      • Bologna says:

        Yes but it starts very slowly at first then all of a sudden ….history shows that it begins with a currency war (2006-2015).now we move on to the trade wars (trump initiates ) .then world war ……this is when us will loose it’s status this is simply the way we change reserve currencies
        This scenario has already played out it was world war 2 when the poor British lost its reserve currency status

        The timing of the british pound loosing it’s status as reserve currency at the end of a world war and a trade war was of course a coincidence ,sarc

  14. Critics of MMT really are a laugh. We have BEEN doing this, let’s suppose we direct that funding toward something useful rather than dropping helicopter loads of money on Wall street. There is no fiscal stimulus bill, due to politics, and the idea of reinvigorating old technology, is like putting a new facade on the museum. If you put internet service in rural red states the anger will tone down. Who wants that? The debates have had record viewership. The current capital formation system is broken.

  15. OutLookingIn says:

    Money must flow into the system faster than the demand for it expands, because the maintenance of asset values is the key for the system of debt to continue.
    The non-financial corporate debt of $6.2 trillion, is now approaching 50% of the US GDP, which is a record high. This rise in almost free money (wealth effect) for “investment”, is simply used to mask the declining spending power and consumption, of the now financially decimated lower and middle classes
    This free money based debt is gathered together and bundled into derivatives, then sold as “investments”. One large problem lurking in plain sight, a major portion of those investors are pension funds. The ownership of zero-cost debt is now the functional equivalent of preferred equity!
    Do you know where your pension is?

  16. Bobber says:

    If the bubble doesn’t end sooner, it will have to end when there is political pressure to cut runaway deficit spending. At some point, the math comes home to roost. Maybe when people fail to receive their social security checks something will happen.

    One has to wonder why the USD hasn’t collapsed already. The US is headed toward recurring deficits equal to 5% of GDP or more, which sets the US apart from other nations. Plus, there is ZERO serious talk of reducing deficits in Congress. To the contrary, there are tons of proposals to increase spending, after huge tax cuts in 2017.

  17. Brant Lee says:

    Why does so much investment money go into fracking when it’s been obvious for years it’s a dead pony? Is the thinking ‘I can get rich if I pull at the right time?’

    • polecat says:

      To give the clueless plebs the illusion that We’re SaudiAmerica .. or something, spewing out an unlimited amount of Go Juice .. forever !.. to compliment our Big Nobby Club !

      It Won’t last forever, you can be certain of that.

    • Mike Are says:

      I’ll say it for the umpteenth time. The Federal Gov. is supporting fracking. It is a national security/strategic priority. The Wall Street banks have it covered and the Fed and Treasury have them covered.

      That is what is going on. Anybody disagree based on what is happening versus what is being said???

      • The Sarge says:

        So true. Energy underpins everything.

      • Dale says:

        I’ve suspected that for some time. Otherwise, it is just too convenient.

        And since we’re going there, what’s to say that the same effect, which Wolf has observed in various bubble businesses (per the podcast), is not also part of official policy?

        Yes, it does tend to kill innovation, and it does tend to enrich the incumbents. But it’s a lot of jobs…

  18. MarkB says:

    Getting better at these podcasts….. good work.

  19. brudelphi says:

    The lurking danger of cov-lite is not just the risk of poor recoveries. It is also the risk of “zombie” credits that do not default, but simply limp through a prolonged downturn. The costs and risks to investors in that scenario is not captured in these recovery numbers.

    That being said, there are clear indicators that cov-lite issued after the credit crunch—the 2.0 incarnation—will be more problematic in recovery than were its 1.0 predecessors.

    • doug says:

      Yep, almost dead , virtually zero, but you can’t write it off….not a good spot.

  20. Jason says:

    So far, so good indeed.
    But the global economy is a nonlinear system. Small changes in one part of it….

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