An aircraft pilot about to crash will repeat the distress signal “Mayday.” Throughout the “May days” of this month so far, financial markets have been sending distress signals that may indicate an imminent crash of their own. The major stock market indices have all been experiencing steep sell-offs since May 4, extending a decline that began around the end of March.
Most analysts attribute the sell-off to inflation fears. Traders aren’t worried about how inflation will directly affect the economy, but how it will influence the decisions of a handful of bureaucrats. They fear that it will lead Federal Reserve officials to tighten the money spigot that is driving the inflation in the first place.
The Fed’s money pumping has driven up prices across the board, but especially the prices of capital goods (the value of which is derived from the value of the future consumption goods they will yield) relative to present consumption goods. That ratio, as Austrian economists explain, is the basis for interest rates. By distorting it with its money pumping, the Fed has artificially lowered interest rates so as to “stimulate” the economy.
This has been the Fed’s standard operating procedure since its founding in 1913, but it has precipitously ramped it up since the advent of Covid in order to prop up an economy staggering under the burden of draconian governmental responses to the disease.
If, as traders fear, the resulting inflation prompts the Fed to ease up on the money pumping, that will allow interest rates to rise by pulling out the props holding up capital prices at artificially high levels relative to present consumption goods. This upheaval in relative prices will translate into severe losses for most businesses, revealing that, lured by the Fed’s artificial stimulus, they had overextended themselves.
This general spike in market losses is what’s known as a “crash” and “recession.”
Wall Street is right to expect it, but it would be wrong to push for policies to forestall it, as it often does. A recession is a tough time, but it’s not a bad thing. The artificially inflated bubble was the bad thing. An economic bust is a necessary and beneficial repair of the economic distortion and damage that occurred during the deceptively pleasant artificial boom. The more you delay this repair, the more distortion and damage will accumulate, and the more painful the later repair will have to be.
The bust we need will be extremely painful, because the Fed has been money-pumping at ever-increasing unprecedented levels and without stint since the financial crisis of 2008. But kicking the can down the road even further will only mean an even more painful bust when the Fed finally does relent.
And that’s if we’re lucky. If the Fed never relents, its policy will eventually result in hyperinflation, which can be a civilization-killer.
The market is crying out Mayday. Let it crash. And then let it rebuild and re-ascend sustainably under its own power.
The government got us into this mess, but only the market can get us out. And, as the poets say, the only way out is through.
This article was adapted from an issue of the FEE Daily email newsletter. Click here to sign up and get free-market news and analysis like this in your inbox every weekday.