The economy, of course, moves in cycles.
There’s precedence for unprecedented growth: It always ends. No matter how you slice it, it would seem there’s only so much more climbing before a fall. But what will set off a downturn? How bad will it be? And when will it actually happen? To answer these questions, here are economists Steven Kyle and Peter Schiff, who also predicted the 2008 financial crisis before it hit.
Steven Kyle is an Associate Economics Professor at Cornell University
What will happen: A normal sequence of events would be interest rates go up, they pull back on investments, inventories start piling up, then we start to have a downturn. The economy always has inertia in whichever direction it’s going, so once you start a downturn it starts to feed on itself to some extent. At which point, the Federal Reserve will reverse course and start dropping interest rates again.
But we better hope that we don’t get to that point at least for a little while, because right now the Federal Reserve doesn’t have very far to drop interest rates before they run out of anywhere to go, because we’re not that far above zero right now. So the Fed’s capacity to counteract it is limited by how many interest rate cuts they can do.
Disastrous downturns are often the result of implosions in financial markets, and it’s not obvious that that’s cooking right now. There are no signs of that.
Why: Another big thing is that the Federal Reserve is very much in the mode of raising interest rates. They are raising it by a quarter of a point each time. They’re on course to do at least four of those this year. And they are also in a guessing game, figuring out how fast to go, when to stop, so on and so forth. But the more they raise them, the more likely it is eventually we will reach the peak and tip over into a downturn.
When: I hope to god we have a downturn when Donald Trump goes up for reelection. The political models say that rate of change is highly correlated to throwing out an incumbent. Not that I hope for people to lose jobs, but I sure do hope for all our sake’s we get rid of that guy.
Certainly we’re not going to see a turnaround this year. It’s possible next year. And it gets more likely thereafter.
The normal “turnarounds” are caused by the Federal Reserve raising interest rates, or the usual inventory story of inventory building up. And we’re not seeing that to any great degree yet. That’s why I’m saying not this year, but possibly next year, and becoming more likely after that.
Wildcards: Everything I said is predictable; it’s in the data. The other thing is the things that come out of left field. And who knows what the hell they might be?
I will say this: The markets don’t like uncertainty. And Mr. Trump is an uncertainty generator on a daily basis. Let me take off my obvious partisan leanings for a minute. Trump’s own advisers will tell you they’re sometimes puzzled at what policy is, and they don’t know what he’s thinking.
In ’08 and ’09 at the moment the crisis hit, George W Bush, and Henry Paulson as Treasury Secretary, and Ben Bernanke in charge of the Federal Reserve, they all did exactly what they had to do. And there were a variety of choices, depending on whether you were a Democrat or a Republican. But that it needed to be attacked was never in doubt; they acted quickly.
But I have my doubts about the people in the White House now. Would they even recognize that something needed to be done? Would they know what it was? I’m not worried about the Fed. Jerome Powell is a smart guy and a steady person as far as anyone can tell.
But Secretary of Treasury Steven Mnuchin? I don’t have confidence in that guy.
And [Director of the National Economic Council] Larry Kudlow, he’s almost a cartoon of an economist.
And Trump doesn’t know anything about anything as far as I can tell.
So if quick action were needed, would they do it? I don’t have confidence. And I bet nobody else does either, including our various trading partners.
Today we have Mr. Trump threatening government shutdowns. That’s a scary thing. The man doesn’t seem to understand that that’s a very bad thing. And we’ve had this before. It causes all kinds of disruptions and costs that are entirely avoidable. So even just talking about is another risk that we don’t need to have.
And then, as tariffs stand right now, we’re talking about relatively small potatoes compared to the economy — we’ve targeted a few things, [our trading partners have] targeted a few things in retaliation. But if it mushrooms beyond that, it could be a very bad thing.
What government shouldn’t be doing: Well, what we shouldn’t have done is have a massive stimulus when we’re on an upswing, as they just did with the massive tax cut bill earlier this year. This was not the time to do that. The time to do a stimulus is when you’re sinking and the economy needs it. I and many other economists were almost screaming for like five years after ’09 that we needed a stimulus and we should do it in something productive like fixing our roads, our bridges, our ports, our airports.
Peter Schiff is an economist, financial broker/dealer, and author
What Will Happen: I think we’re bound for something a lot worse than a recession. We’re going to continue what we began in 2008.
Why: [The 2008 meltdown] was interrupted by the Fed and the government — by the bailouts and the stimulus and all that. But those programs did not solve the problems that created the crisis. They actually compounded the problems. The tradeoff was they were able to postpone some of the consequences of the problems to a later date. And that’s where we’re headed, to that later date.
The reason that we had a crisis is that the Federal Reserve had kept interest rates too low for too long leading up to the financial crisis of ’08. The result of that was a misallocation of resources, an over-investment in housing, not enough savings, not enough capital investment, too large trade deficits. We just inflated this bubble.
And when the market tried to correct all that and we had a recession, we didn’t allow the correction process to complete itself, which would’ve been a bigger decline in real estate prices and stock prices, a lot more bankruptcies, and a lot more resources freed up to move to where they needed to be, meaning away from housing, away from banking, into capital spending, into manufacturing, into real goods production and things like that.
It would’ve meant Americans really rebuilding their savings and not buying stuff with credit cards and making due with their old cars instead of taking out loans to buy more expensive newer cars, and more people going to trade school instead of borrowing money to get philosophy degrees.
A lot of these bubbles were facilitated by the Fed slashing rates to zero percent and propping up a lot of institutions that should’ve failed. We should’ve allowed Fay and Freddie to go bankrupt completely, not just go under government control; they should’ve been completely eliminated from the marketplace.
We should’ve returned to a free market in housing, meaning that people buy houses that they can afford, not based on a government guarantee where the government enables people to buy houses they can’t afford. So a lot of changes for the good would’ve taken place, but for the stimulus and the bailouts and everything that we did to try and blow air back in the bubble.
How this will transpire: If you go back in time, I’m surprised at the length of time we were able to buy. I’m surprised we’ve made it this far. But that’s not a good thing. The longer we delay, the bigger the problems become. And so, what we’re going to go through economically is going to be far worse as far as being painful to endure for the people than it would’ve been had it happened five years ago or three years ago or whatever.
And the longer we succeed in delaying it, the worse it gets. Because it can’t be delayed indefinitely. It can be delayed, but nobody can really say for how long. One thing is sure is the longer we delay, the worse it’s going to be.
I think the attention is going to focus back to the US again. I think the U.S. is in worse shape than Europe. I think we’re in worse shape than Japan, not that Europe and Japan are not in trouble, they are. But I just think we’re in more trouble. As inflation really starts to overwhelm the world — right now, the central bankers are still acting as if we’re around 2 percent, when I’m sure we’re much more than that — but at some point all these official inflation measures are going to be reading 3 percent, 4 percent, 5 percent.
And the central banks around the world are going to have to raise interest rates. And that’s when there’s really a disaster, because we can’t afford the higher interest rates. We can barely afford the higher interest rates we have now, and we’re at 2 percent. I mean, look what’s happening with the housing market, look what’s happening with the auto market. Despite all this hoopla about a booming U.S. economy, all the signs are pointing to a recession around the corner anyway. And that’s with interest rates still at ridiculously low levels. We’re not even close to normal.
Wildcards: There are a lot of bubbles. The bond market is a bubble. The stock market, housing market. the whole U.S. economy, really, is one gigantic bubble. Ironically, the trigger could end up being our own actions. I mean, the trade war could end up doing it. One of the things that’s been keeping the bubble going is China’s willingness to supply us with consumer goods at a low cost and lend us the money to buy it.
The massive trade deficits with China are one of the reasons that we’ve been able to kick the can down the road. So to the extent that we actually forced the Chinese to do what they should’ve done a long time ago, we can accelerate the collapse, which in the long run I suppose is going to be good, although politically it could be a disaster. That’s what I’m really worried about, because if we have this massive crash while Trump is president, he ain’t going to be president in 2021, and it’s probably going to be a socialist, and he’s probably going to have a socialist congress. So we could do a lot of damage.
What government should be doing: The United States should be doing a lot of things differently, but we’re not going to. What we should be doing is instead of waiting for the crisis to be pushed on us by factors beyond our control, we ought to take control of it ourselves, like a controlled burn instead of a forest fire. So we should be slashing government spending now; we should be allowing the Fed to allow interest rates to find a real level, which is much, much higher than they are now; and then we’re going to have to deal with the bankruptcies.
We’re going to have to deal with a decline in the stock market, the bond market. We’re going to have to deal with a lot of defaults, [and] a lot of debtors are going to go broke. It’s going to be a painful process even if we bring it on ourselves. But if we wait for the crisis to happen on its own because it’s imposed on us by the world, it’s just going to be worse.
What government shouldn’t be doing: In a book predicting the 2008 financial crisis, I wrote the government would react to that crisis by doing the wrong thing, that they would cut rates and print a lot of money. And I thought they were going to try and reflate the bubbles in housing and the stock market. I did not believe they would succeed.
I thought their attempt to reflate the bubble would fail, because I thought a dollar crisis would prevent it. But that never happened. A lot of things happened to keep the dollar going up. And so, instead of just attempting to reflate the bubbles, they actually succeeded. They actually were able to blow an even bigger bubble than the one that popped in ’08.
Now the economy is more screwed up than ever before. So the correction is going to be much worse. And this time, there’s just no way that they can try to reflate the bubble. It’s going to be impossible. The dollar will just be completely destroyed if the Fed goes for QE4 [a fourth round of quantitative easing]. If they take rates down to zero again and then launch QE4, that’s it. Now, I do think that that’s what they’re going to do, so it’s going to be a real mess. So we could do a lot of damage.
It’s very ironic, hearing “We’re going to punish China. We’re going to get China.” [Laughs.] You talk about biting the hand that feeds you. The trade deficits are a huge problem. I’ve been warning about it for years, but they’re really the consequence of the problem. The problem is that our economy is producing these trade deficits.
The problem is that we’re accumulating massive debt to our trading partners. But the reality is we can’t pay our trading partners back, so they’re the suckers. Because we’re just going to default or inflate and give them worthless money. But when we give them worthless money, that means that our money is worthless too. If the dollar crashes and you have hyperinflation, the U.S. will suffer far more than our creditors, who ended up getting screwed on what they loaned us.