Coronavirus. Government-Mandated Economic Shutdowns. But is there a Third, More Fundamental Cause of the 2020 Economic Crisis?

I can’t answer that. But I can speculate.

Today’s economic collapse brought to mind a statement from an acquaintance during a long exchange on Facebook some time ago. In defending democratic socialism, the acquaintance said in 2018: “I fear we are headed for a collapse in the near future.” She was referring to an economic collapse, and blamed her fear on technology and  “unrestrained capitalism.”

I answered her misplaced blame in detail. But I never replied to her fear. The discussion was long and involved, so I never got around to it answering that fear. In view of the crisis we’re experiencing now (2020), I thought I’d post what I wanted to say back in 2018. Here is what I would have replied:

“I fear we are headed for a collapse in the near future.” 

Of course we’re going to have another collapse. The government’s interference into the economy has only increased since the 2006-2009 housing bust/financial crisis, which itself resulted from massive interference from the Federal Reserve, Fannie and Freddie, regulatory mismanagement, and the politics of “affordable housing.” What will cause the next collapse is anybody’s guess. But be assured that imbalances due to government policy are building up. This doesn’t mean the current (2018) prosperity is not real. But alongside the prosperity we’re having, the imbalances are building and danger is gathering beneath the surface. Trump’s regulatory reductions and corporate tax cuts will help, but will not nearly be enough.

FAST FORWARD: 

Sure enough, we got the catalyst--the coronavirus. A secondary, more serious catalyst is the massive shutdown of the economy engineered by our political leaders (It remains to be seen if this will ultimately cause more harm than good). These certainly are important factors. But I believe one of the biggest causes is getting too little notice. While those two are getting the public’s attention, a third and probably more important catalyst is greatly exacerbating the crash--the years of near-zero interest rates engineered by the Fed. These artificially low rates have incentivized massive increases in debt, both for individuals and for businesses (not to mention government), well beyond what people would do if markets set the rates. This huge mal-allocation of resources is now unwinding, giving a huge push to an already falling economy and stock market.

Let me focus on one sector--individuals. Typically, savers have reasonable low-risk interest-bearing options. But with interest income shriveling up, people have for years been looking for other options. That has meant common stocks. Hence, many people have been piling into stock market investments out of desperation for better yields. 

Now, I love stocks. They are a great way for average people to ride the coattails of business growth and entrepreneurial “prime movers” and build wealth over time. But thanks to the Federal Reserve’s near-zero rate policies, a lot of money has flowed into the stock market that shouldn’t have gone in--that is, has gone in for the wrong reason, yield. This means that a lot of people have put a lot of money into stocks that they normally would not have. This over-investment has made these people ripe for panic, and that panic is showing up in the stock market crash. This problem is particularly acute for retirees. Retirees, to put it bluntly, have been royally screwed for most of the last 20 years, when the Fed first reduced interest rates to near zero following 9-11. Retirees, who need a lower risk investment strategy and thus less stock exposure, were incentivized into taking on much more risk that prudence dictates. They are now adding substantially to the panic selling according to what I’m hearing on CNBC, the financial news program.

I believe that the acquaintance mentioned above was right, but not for the reason she believed. It’s not unrestrained capitalism (which doesn’t even exist, but should), but central planning, that is the problem. A collapse was going to happen. If coronavirus didn’t come along, something else would have, eventually.

As I said, I can’t say how the various factors influenced the current crisis. Economics is complicated. This period will be analyzed for years to come. But I am convinced that as long as the government coercively interferes in the natural workings of the market, and meets each crisis with more of the same, there will always be a realistic “fear we are headed for a collapse in the near future.”

Related Reading: 

A Tale of Two Bubbles: How the Fed Crashed the Tech and the Housing Markets: “Central Bankers appear to have learned little from recent history.”—Luka Nikolic for the Foundation for Economic Education. [This article was published on August 10, 2019. It is almost prophetic.]

The Financial Crisis and the Free Market Cure—by John A. Allison

A Free Market is the Only ‘Natural Order of Things’

Related Viewing:

The Pandemic and the Economy—with Onkar Ghate, Yaron Brook, and Rob Tarr from ARI