Last time I wrote to you in these pages, I warned about a big risk facing our country today…

It’s not coronavirus. It’s not China. And it has nothing to do with the results of November’s election.

The risk is much more subtle. It may even seem irrelevant to most. And yet it has the power to affect our lives in ways you may not imagine.

What is this risk, and what can you do about it? Read on… 

1970s Redux

The risk I’m talking about is the general trend towards deglobalization we’re seeing in the world today. And if this doesn’t concern you, it should. 

The stagflation in the 1970s may have its roots in the “guns and butter” program of the 1960s. But what sped up this trend was the supply shock in the oil markets.

If deglobalization speeds up even more today, it could easily lead to a severe supply shock in a variety of products and markets. This could create a severe price shock without the corresponding economic growth.

Put more bluntly, we could well be on the way to stagflation once more – a damaging combination of high inflation, high unemployment, and stagnant economic demand.

The current economic recovery is still quite tentative. Unemployment is still very high, and the pace of the decline in unemployment is going to slow under the best of circumstances.

We won’t be getting additional interest rate stimulus to help turbo-charge growth, so fiscal expansion is the only way to give the economy a major boost over the coming years.

Fiscal Expansion Comes at a Price

Unfortunately, fiscal expansion comes with a risk of its own…

The U.S. could lose its status as the true global hegemon.

Along with that, the dollar could lose its status as the world’s reserve currency and start to weaken dramatically.

That would be catastrophic for many reasons, not least of which is our ability to finance our debt.

Debasement of our currency could produce some upward price pressures, but it is unlikely to bring about notable benefits. In fact, due to the dollar’s reserve status, an aggressive debasement of the dollar is the riskiest of all strategies.

But as much as I hate seeing a widening of our fiscal deficit, I don’t see another way out of the trap in which we find ourselves.

Put differently, if we don’t get further stimulus spending, we could see fourth-quarter GDP come in much, much lower than first forecasted.

However, this fiscal spending must be better planned and executed. It must drive increases in productivity, create jobs, and provide for education and job training that will pay long-term benefits.

Bubble of Epic Proportions

The recent emergency fiscal spending was largely ill-planned, poorly executed, and clearly a drastic effort to stop some serious hemorrhaging. And this has huge implications for the markets.

The current scenario is not conducive to a friendly, risk-on environment, but the disconnect between equity markets and the real economy can continue for some time and even widen.

In fact, the perverse impact of zero interest rates due to economic weakness is that people are being forced to buy stocks due to their desperation to earn returns on their assets.

This has created a bubble of historic proportions that is very, very dangerous.

It would not surprise me to see another short-term stock market surge if we get a fiscal package executed before the election. But in light of all the other risks – both short-term and long-term – I wouldn’t expect that rally to be sustained.

And I haven’t even pointed out the pink elephant in the room – the prospect of an acceleration of Covid-19 cases as people go indoors for the winter.

We will likely have some vaccines available for limited usage before year-end, but they won’t be approved by the FDA or available on a large-scale basis for many months.

This means that we need to assume that consumption will be somewhat limited, as people ultimately will seek safety at the expense of many forms of travel and entertainment.

If we get a sharp increase in Covid-19 cases over the coming months, the consumption and spending numbers will be worse than expected, as will the personal income numbers.

Beware the Fed’s Super-Easy Money

In short, the prognosis that my colleague Imre Gams and I have is not a very happy one. Unless U.S. policies change, we are potentially looking at a very ugly scenario over the coming years.

As if that weren’t enough, we currently have what is arguably the most overvalued stock market in the last 100 years. See for yourself…

The chart above is an overlay of the Dow Jones Industrial Average over two periods of time: 1919-1932 (dark blue with levels on the right) and 2009-2020 (light blue with levels on the left).

I hope things don’t play out like they did after the peak in 1929. But if they do, people will be very sorry they sought returns in a grotesquely overvalued stock market rather than just seeking safety and capital preservation.

You can draw your own conclusions from the graph.

But don’t be fooled by the false notion that the Fed’s super-easy monetary policy is an inviolable put option that will protect you from all downside market risk.

Regards,

Andy Krieger
Editor, Money Trends