How the normal became abnormal

Yesterday we discussed how a normal economy operates. We can summarize it as follows:

Market-based system & sound money –> savings –> investment –> economic growth –> strong division of labor –> standards of living rise –> increased savings –> increased investment –> stock market rises –> increased entrepreneurship –> more startups –> outsized gains for investors –> good companies scale… bad companies go bust –> recessions clean out the system –> resumed economic growth

The problem is, these days we have interventions at every stage in the process described above.

For starters, arbitrary regulations and an arcane tax code distort activity throughout the economy. Paired together, regulations and taxes create a system of incentives and disincentives that influence economic activity.

Certain incentives may make a particular company or project look worthwhile when it otherwise wouldn’t be. And the reverse is also true. Disincentives can make a particular investment look bad when it otherwise would be productive.

When this happens, it throws a wrench in the free-flowing system we outlined above. It doesn’t take long before market signals are muddled. Then malinvestment sprouts up to cover the wheels of commerce like kudzu on a neglected building.

Meanwhile, we abandoned the last remnant of sound money in 1971. That’s when President Nixon closed the international gold window – removing the dollar’s final link to gold.

This allowed the government to print money year after year to cover ever-growing fiscal deficits. That caused the dollar’s purchasing power to plummet. And it also drove interest rates down to zero.

This sent consumer prices skyrocketing across the board. It also eliminated the ability for households to earn a rate of return in savings accounts. This combination made it hard for regular folks to get ahead… And made it difficult for “Main Street” entrepreneurs and small businesses to thrive.

And that’s not an exaggeration.

The average US savings account paid 0.05% in 2021. Yet, the consumer price index (CPI) rose 7% that year. The CPI is the “mainstream” measurement of inflation… and it understates true price inflation materially.

At the same time, most of the money created from nothing funneled to the country’s power centers – Washington, DC, Wall Street, and Silicon Valley. That’s thanks to the “financialization” of the US economy.

This gave rise to the private equity (PE) and venture capital (VC) industries in the 1980s. Over time those industries became awash in trillions of dollars. They used those dollars to invest heavily in America’s most promising startup companies.

As a result, the best companies refrained from going public for an extended period of time. Over a decade in some cases. Then when they did go public, they did so after the institutions had already milked all the investment gains.

The financial media may have touted some of these companies as “hot” IPOs. But the reality is that retail investors were getting nothing but scraps. The days of regular folks being able to invest in game-changing companies like Amazon.com at their IPO are long gone.

However, this same dynamic also enabled bad companies to attract growth capital.

With trillions of dollars pooled up, the PE firms and the VCs didn’t need to be picky with their investments. So they invested heavily in lower quality startups as well… just in case. After all, a $10 million investment seems immaterial when you’re sitting on hundreds of billions in cash.

Today it’s estimated that roughly 10% of all publicly traded companies in the US are “zombie companies”. These are companies that do not produce enough economic value to pay for themselves. Meaning, there isn’t enough market demand for their goods and services to pay for their expenses.

These zombie companies should have gone bust a long time ago. That would have cleared the way for better companies and better jobs to spring forth. But thanks to the availability of cheap money and historically low interest rates, they’ve managed to suck up just enough investor capital to stay afloat.

None of this is normal. And collectively, all these distortions are a massive drain on economic growth. Especially for those of us on Main Street.

I would suggest that this is why populist ideas have exploded here in America. It’s also why public trust in America’s institutions is at an all-time low.

Simply put, the current trajectory is unsustainable. We’ll quantify that tomorrow…

-Joe Withrow