Normal and not normal…

This past Saturday was Fall Fun Day up here in the mountains of Virginia.

Fall Fun Day is an annual festival featuring food, beverages, music, and a variety of outdoor games for adults and children alike. There are sack races… mummy wrap contests… hay rides… and I witnessed a little spontaneous karaoke as well.

Here’s a shot of a small gathering underneath an ancient elm tree:

There’s a long tradition of annual harvest festivals throughout America’s Appalachia region.

The autumn harvest itself may have lost significance since our conquest over food scarcity… but these annual celebrations are still rooted in the region’s agricultural heritage. It’s Thomas Jefferson’s vision for America actualized.

While Fall Fun Day has become a normal occurrence for us each year, there’s nothing normal about what’s happened to our economy over the past 16 years.

When we left off last week, we were talking about interest rates – where they are going and what it means. As we discussed, my conclusion is that rates are not going to fall as fast nor as far as people seem to expect.

Sure, the Federal Reserve (the Fed) will likely make additional cuts to its target interest rate benchmark the federal funds rate. But Fed Chair Jerome Powell has made it clear that “normalization” is still his aim.

Let’s talk about what normalization means this week. We’ll start with an abbreviated overview of how a normal economy functions…

It all starts with a market-based system and sound money.

Markets match up production with consumer demand… and they empower entrepreneurs to create innovative ideas that improve efficiencies and increase the availability of goods and services.

Meanwhile, sound money keeps the price system honest. And it enables everyone to save their purchasing power for future use. Those savings can then be used for investment in productive companies and projects which drive economic growth.

That economic growth strengthens the division of labor by creating jobs that didn’t exist before. This creates new opportunities for individuals while also increasing economic productivity. In turn, standards of living rise throughout the economy.

In a normal economy, this dynamic tends to result in the stock market rising in parallel. That increases savings… and those savings can then be invested directly in productive companies and projects to power continued economic growth.

This creates even more opportunities for entrepreneurs who create startup companies with ever-more lofty goals and ambitions. After getting their startup off the ground, these entrepreneurs can take their company public to raise growth capital. In a normal economy, this happens when the company is still quite small.

That growth capital empowers the startup to scale and potentially provide game-changing goods and services to consumers. At the same time, regular folks can invest in the startup’s stock when the company is still small – providing them with the potential for an outsized investment gain.

Amazon.com (AMZN) is a great example of this.

Amazon went public at an enterprise value (EV) of $375 million. That’s tiny when it comes to publicly-traded companies.

At the time, Amazon.com was just an online bookstore. Many analysts compared it to incumbents like Barnes and Noble and thought that Amazon was doomed from the start. “There’s no way this little online bookstore can compete with the big boys”, they said.

Fast forward to today and Amazon.com sells virtually everything online. It also sports the most advanced logistics and delivery ecosystem in the world – as well as one of the most advanced cloud computing architectures in the world.

Yet, regular investors had the chance to buy AMZN at $0.075 a share because it went public so early in its lifecycle. Anyone who did would have turned every $100 invested into over $242,000 at today’s price.

That’s only possible in a “normal” economy. More on why later this week…

Another facet of a normal economy is that only the best startups can attract the growth capital they need to scale. The bad companies – those that are inefficient and unproductive – eventually go bankrupt. Because nobody is willing to invest in them past a certain point.

This tends to happen in waves. That is to say, investors tend to become more cautious at the same time – withholding investment dollars from bad companies simultaneously.

This causes a wave of companies to go bust… which results in a lot of people losing their job at the same time. We call this a “recession”.

The Keynesian economists tell us that recessions are bad. But they aren’t. They are normal and necessary.

Recessions “clean out” the system. They liquidate malinvestment and pave the way for better companies to rise up – creating better jobs in the process.

In other words, recessions are temporary adjustments that ensure we can have continuous economic growth in a healthy, normal way. After a recession, we gradually see savings and investment rise—which starts the process all over again.

That’s what “normal” looks like in a nutshell. Tomorrow we’ll look at how every step in the process described above has been abnormal in recent years.

-Joe Withrow

P.S. Perhaps the best book for understanding the economy today is Per Byland’s How to Think About the Economy: A Primer. You can find it on Amazon right here. 

Along the same lines, I also highly recommend Ludwig von Mises’ Economic Policy: Thoughts for Today and Tomorrow. It’s derived from a series of lectures that Mises delivered to students in Argentina in 1958… and his insights could not have been more prescient. You can find it on Amazon here: https://www.amazon.com/Economic-Policy-Thoughts-Today-Tomorrow/dp/1933550015/