Hallmark of An Economic Ponzi Scheme

The comments below are an edited and abridged synopsis of an article by John Hussman

Experimental monetary policy and subdued growth in wages following the global financial crisis has contributed to a dysfunctional equilibrium with massive increases in debt burdens at government, household and corporate levels.

Minimal savings and growing consumer debt have contributed to elevated profit margins that investors treat as permanent. Corporations, lured by low interest rates, have engaged in a massive leveraged buy-out of stocks, partly to offset dilution from stock grants to executives, and in the misguided belief that valuations and market returns are unrelated. Equity valuations rival those of the 1929 and 2000 market extremes. Stocks are likely to substantially underperform Treasury bond yields in coming years. Valuation extremes cannot be justified by low interest rates; when interest rates are low because growth rates are low, no valuation premium is justified at all.

Amid these risks, near-term outlook would be more neutral if an improvement in market internals was to indicate fresh speculative psychology among investors. Still, further speculation would only make the completion of this cycle even worse.

The hallmark of an economic Ponzi scheme is that the operation of the economy relies on the constant creation of low-grade debt in order to finance consumption and income shortfalls among some members of the economy, using the massive surpluses earned by other members of the economy. The debt burdens, speculation and skewed valuations most responsible for today’s lopsided prosperity are exactly the seeds from which the next crisis will spring.