As I write this, consumer and business confidence is plunging as the tech-heavy Nasdaq and broader-market S&P 500 stock indexes have fallen into correction territory, defined as a price decline of 10% off a peak, which for both indexes came only a month ago.
The blue-chip Dow Jones Industrial Average sits a hair’s breadth above correction level, while the Russell 2000, an index of smaller firms, is approaching bear market territory, defined as a decline of at least 20%.
Bitcoin is down 24% since its peak six weeks ago.
Investors in the S&P 500 and Nasdaq alone have lost $8 trillion in only three weeks.
That’s an enormous amount of money to vaporize from the economy in such a short period of time. Investors who feel $8 trillion poorer are likely to cut back on their spending, removing a crucial prop from under the economy. And I doubt the carnage is over.
While stocks took a beating, gold went up $50/oz. over the same period—more evidence that having the yellow metal in your portfolio provides protection in white-knuckle times.
It’s tough to remember that just a month ago, stock markets were flying high at record levels, inflation had fallen close to the Federal Reserve’s target, and consumer and business confidence was rapidly improving.
The specter of a global trade war has wiped out those highs. Threats to impose exceptionally high tariffs, followed by promises of retaliatory tariffs by our trading partners, have raised fear that the economy will fall into recession.
The conventional wisdom today is that the odds are 80/20 against a recession this year, although some analysts place them as high as 50/50.
I think it’s impossible to give odds unless you know whether tariff threats will turn into actual tariffs. Only a few people inside the administration might know that answer.
The answer probably depends on our trading partners’ responses to our tariffs. The outcome from this brinksmanship is unpredictable. Unintended and unforeseen consequences should be expected. It’s a high-risk play with the potential for high reward, either political or economic.
I think the prospects for a recession depend on two contingencies:
1) Whether the tariffs the Trump Administration has threatened are ultimately imposed and for how long and
2) Whether Congress and the President can prevent a summer debt limit crisis from generating widespread fear of default.
As I’ve said, the prospects of a trade war are impossible to estimate today, but I believe the bigger wild card lies in a debt limit crisis.
Republican senators who have discussed the matter with the President say he is not yet ready to turn his attention to the debt limit (one can imagine why, what with all the other balls he has in the air). The President’s full attention will be crucial to finding a way forward and avoiding fears of a default from roiling markets.
Getting the proposed budget agreed upon will be a tough negotiation, too. The budget passed by the House last month would raise the nation’s debt by at least $5 trillion over the next decade, according to the nonpartisan Penn-Wharton Budget Model of the University of Pennsylvania. That would place the debt at $43 trillion in 10 years. More pessimistic projections put the projected debt as high as $55.6 trillion. Deficit hawks in the Senate will find that hard to swallow, and the President has room to lose only a few votes.
Under either scenario, the debt-financing burden would cripple economic growth for at least a decade. And with China expected to increase its debt to stimulate its failing economy and Europe raising its debt to fund higher defense spending to counter Russia, a tsunami of new debt will severely test the appetite of global bond markets.
When U.S. markets finally wake up to the risks these huge debts pose for us, the immediate economic consequences could be dramatic.
A debt limit crisis this summer could be the shock that sends us into a recession. Or maybe we’ll continue sleepwalking a while longer.
In recent years, the United States has been the single engine of the global economy, so a recession here is likely to topple the world into a global recession. In such hazardous environments, the world seeks safety in gold and U.S. Treasurys. But Treasurys will be implicated in the crisis, so I expect gold to be the favored safe-haven asset for people around the world, adding fuel to a rally that has now seen gold break the $3,000/oz. threshold.
