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June 1, 2015

U.S. Economy: A Cinderella's Pumpkin Carriage?

The past six years of expansion have been as illusory as Cinderella's magic carriage.

The clock is about to strike midnight, and our Cinderella economy's magic carriage will revert to a pumpkin. The magic of the Federal Reserve's flood-the-fields policies of zero interest rates (ZIRP) and liquidity (via quantitative easing (QE) and other programs) had an expiration date of December 2014, judging by the negative gross domestic product (GDP) in the first quarter and the deep slump in corporate profits:
U.S. GDP falls 0.7%
U.S. corporate profits sink 5.9%, biggest drop since 2008
There are many other indications that the Fed's magic has worn off: new orders are slumping, for example:

In a recent conversation with Chris Martenson of Peak Prosperity, I suggested that the Fed's policies were akin to monoculture agriculture.At first, slamming fields with nitrogen and phosphate fertilizers and herbicides and pesticides yields bumper crops.
In an analogous fashion, the Fed's zero-interest rate policy and massive goosing of credit appeared to work wonders on the U.S. economy: growth exceeded 2% and inflating bubbles in bonds, stocks and real estate have fueled a speculative frenzy, all based on a simplistic faith in the Fed's power to keep assets rising forever.
But the magic of flooding the fields with credit/fertilizer doesn't last forever. The soil is stripped of value and yields plummet; at some point, the returns on flooding the economy with credit diminish: only marginal borrowers and the riskiest speculations are left to exploit.
Just as insects quickly develop resistance to pesticides, the economy develops resistance to cheap credit. Since interest rates cannot fall much below zero, there are no more gains to be had from lowering rates. Since qualified borrowers have already bought a new vehicle or home, the only borrowers that are left are the ones that will default at the first layoff, medical emergency, etc.
Just as flooding a field with fertilizers and pesticides does not restore the soil, flooding the financial system with liquidity and cheap credit does not restore health to a stripmined, financialized economy. Just as monoculture erodes the soil, financialization hollows out the economy and strips away the values that underpin sustainable, healthy expansion. What the Fed has fueled is the predation and pillage of the real economy by Wall Street and financiers.

The Fed insists that Cinderella's carriage is forever golden, ignoring the increasingly obvious reality that the carriage is turning back into a pumpkin before our eyes. The Fed's magic was always a short-term fix, akin to over-fertilizing and over-poisoning our economy to create the illusion of massive growth in profits and stock, bond and home valuations.
The past six years of expansion have been as illusory as Cinderella's magic carriage. Now that the magic is wearing off, the reality is going to hit everyone who believed the fantasy of permanent asset bubbles especially hard. 

About the Author: Charles Hugh Smith at Of Two Minds, also the author of Get a Job, Build a Real Career and Defy a Bewildering Economy 

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle
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