This past week saw the Dow Jones crater more than 800 points in a single session. The largest route since October was blamed on everything from the U.S. versus China global struggle for dominance to a bond market inversion that likely means a coming economic recession.
Meanwhile, the air continued to deflate out of various bubbles in the economy, and most noticeably these past weeks from the auto bubble. GM announcing that it is closing five North American plants and laying off about 14,000 workers because of slow car sales is a significant moment in the twilight of the decade-long, feeble economic recovery from the Great Recession and Global Financial Crisis.
Remember that GM’s discouraging revelation follows close on the heels of Ford’s announcement back in October that it will slash many global employees. According to Morgan Stanley, this will involve over 20,000 Ford salaried job cuts from around the U.S. and the world. In both cases, what you see happening is the long engine of economic growth from the car bubble stalling out. If the bubble has not popped, it is certainly deflating fast.
GM blames the necessary drastic cutbacks on declining vehicle sales, per the New York Times report. Another specter appropriately raised is the fact that the auto industry is up against the same dilemma facing the home building and housing markets. This is the rising interest rates which the NYT says are “generating headwinds.”
In point of fact, automobiles and real estate both prove to be most sensitive to higher interest rates in the American economy. In order to afford the high costs of either a new vehicle or house, Americans must be able to borrow money. It is a simple function of supply and demand economics that as the costs for such borrowing rise, the demand for these loans and resulting sales in automobiles and housing will naturally fall.
We all knew that this painful moment was coming when the Fed opened the flood gates of unnaturally cheap money (free or nearly free borrowing) and then maintained it for nearly ten years. The only result of such reckless policies had to be artificially inflating bubbles throughout the economy.
Ridiculously easy money did what it always does throughout history— boosted buying of assets across the board. Now that the Federal Reserve has reversed course and pulled the proverbial plug on this cheap and easy money, the air is quickly escaping from the bubbles that underpinned the stock markets not only in the U.S. but around the planet.
Back in the spring, the subprime car loan bubble was already in trouble. It was only in April of this year that car loan delinquencies touched highs dating back to 2010, the peak in the Great Recession. Remember that subprime mortgages nearly brought down the entire banking system and world economy a decade ago.
Where does that leave us today? The inevitable interest rate tightening will prick the series of bubbles like cars and housing, which together with stocks and bond investments equal the “everything bubble.” Almost all of the rate tightening cycles the Federal Reserve has ever engineered have ended badly in some form of economic crisis.
This chart below reveals that fully¬ 16 of the past 19 Fed interventions in the pursuit of higher interest rate policies have crushed the equities markets:
As is painfully clear in the historical chart above, this is not a new process. Instead, from the Great Depression to the Dot-com collapse, to the housing bubble induced financial crisis, to the everything bubble crisis of today the same cycle continues to be tirelessly repeated once again.
Looking back at the last severe bubble in housing and subprime mortgages, it only needed two years of Fed-induced one percent interest rates to cause a bubble so severe that the resulting crash and collapse was the greatest since the Great Depression. The everything bubble had over five years of historically abnormally low interest rates to inflate.
Is Your Retirement Portfolio Prepared for the Deflating Auto and Everything Bubbles?
In December of 2015, the Federal Reserve started its present day interest rate tightening policies and cycle. The blow back effects of this are already hitting the economy in auto sales, subprime car loans, and real estate slowdowns. As the air dangerously escapes from these bubbles, wild swings in the stock market are becoming increasingly noticeable. The long-overdue recession is coming.
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