The situation today: Two Meta Scenarios

Another Great Depression ahead

We do not just live in a world of facts but also in a world of perceptions. Perceptions are sometimes aligned with reality but frequently, reality is misinterpreted partly due to cognitive deficits but mainly as an almost inevitable consequence of information shortfalls or even inadequate theoretical grounding. This gap between perception and reality grows, sometimes exponentially, because of positive feedback loops that are a classic symptom of bubbles.

Are we in an asset price bubble now? This is the key question of our era because if we are, it is one of the biggest in history and will have dramatic if not catastrophic consequences. Since the beginning of the modern nation state in the early 17^th Century, there were at least four significant depressions following asset price implosions.

It began with Tulip Mania in 1636 ushering in a European great recession that sent the Pilgrims to the New World. Nearly a hundred years later, the South Sea Bubble in London and the Mississippi Bubble in France issued in the second depression. The Mississippi Bubble (unlike the South Sea Bubble) was a genuine venture but financed by the first introduction of paper money very similar to what Ben Bernanke did in the U.S.

When the Mississippi Bubble started, the share price increased at a similar rate to Bitcoin in 2017. Richard Cantillon (the first monetary economist to put his theories in writing) made his fortune trading in the bubbles of that era and getting out before they burst. His insights on the period are very enlightening. See his biography by Antoine Murphy.

The third “great depression” began in the U.S. in 1873 when railroads began to fail. The easy money of the post civil-war period led to massive overbuilding. President Ulysses Grant warned repeatedly against “greenback proliferation” but once the bankruptcies started, they spread like wildfire. This depression lasted over 20 turbulent years.

The third great depression was known as “The Great Depression” until 1939 when the crash that ushered in the depression of the 1930s took over the name. Eventually, recovery came because America annually exported about 6% of its gross national product to the British Empire (as well as debt financing its own eventual participation in the war.)

The case for another depression in the making is clear. Asset prices to GDP are at an all-time extreme; US debt to GDP is over 100%, rising to 115% under the new tax bill (another all-time record) & the quality of political leadership is at an all time low. However, some elements that precede a crash have not appeared…yet. There is no frenzy over assets in general. They have simmered higher with investors with the exception of Bitcoin mania which does not appear a systemic risk at this point (but could become so as futures contracts expand the market.)

We can’t be certain that we are in a bubble but if we are, we know the world will face a major global depression. Once the dam of confidence breaks, it is a fast slide downhill. This is one meta-scenario.

The Singularity – A New Golden Era

Another compelling alternative is what some call “The Singularity”. We have arrived at the starting point of a new golden era. The key to this alternative is not just new technology but artificial intelligence (AI). We have seen a first iteration of this in the latest development of Alpha Go, a self-learning program.

The Singularity evolves on the assumption that AI self-develops on a global scale and thus boosts global GDP exponentially. How it could do this is clearly explained by the Oxford philosopher Nick Bostrom in his fascinating book, “Superintelligence”. In traditional economics, the growth of the labor force boosts GDP proportionally; AI can boost the labor force exponentially at a fractional cost (effectively zero after initiation.)

With money remaining free from the Central Banks because inflation is absent along with an infinite supply of free labor due to AI, any good capitalist system would generate ever-rising profits and an ever-rising stock market. The apparent gap between net worth and GDP is therefore false as GDP is vastly underestimated, as is productivity as labor to output loses relevance.

Conclusion:

Under the Depression Scenario, we are in a classic mania made worse by the active participation of the Central Banks. Interest rates have been driven down to record breaking lows never seen before in the history of man. We have $11 trillion of bonds with negative yields. The last time interest rates were even close to this was in Babylonian times some 3000 years ago. So, when the bubble bursts, there is reasonable probability that the Central Banks will be powerless to do anything and their credibility will be destroyed. It will lead to an extreme political reaction with commerce irreparably damaged. A long-term bear market will follow.

Under the Golden Era Scenario, economic growth will continue to pick up at an exponential rate. Government revenues will rise and debt will be reduced. Machines will take over the burden of production and output while humans return to a pre-industrial life-style with their basic needs provided. Whether the machines can prevent rather than aid mankind’s impulse to self destruction is another matter.

Malcolm Tulloch

The writer is director of the firm Tulloch Research. The company provides bespoke advice to clients on macro-opportunities in financial markets.

“Intuition is a product of accumulated experience”

Tobias Truman