Advisor Sees Us on a Course for Economic Crisis

Economic Crisis

Hedge fund advisor Avi Tiomkin sees us heading for some real gloom and doom due to the economy contracting and deflationary trends unless we do something really drastic.

There are always a variety of opinions out there about the economy. While some may be much more well informed than others, it is important that we take all concerns seriously and ensure that we don’t just exclude views because they are so far off the beaten track.

Often times, those who are seen as dissenters end up being righter than the prevailing view, and even when they are not, they still might have some views that may shed some real light on situations and even cause us to rethink and adapt our views.

Avi Tiomkin has served as an advisor to hedge funds and specializes in global macroeconomic analysis. He is known for his rather extreme economic views but we should want to hear from this camp as well, and if he or anyone else who expresses views like this ends up making good points, and if the stakes are also high, we may be ignoring these views at our peril.

Tiomkin has recently written an article about just how bad of a situation we find our economy in as well as suggestions about what we need to do in order to escape the clutches of this coming “economic, political, and social crisis.” That should be enough to grab our attention, especially given that there doesn’t seem to be anything close to this alarming going on, and we may therefore benefit from seeing the situation through his eyes.

What is precipitating this crisis is the fact that “the global economy is contracting, and deflationary trends are growing stronger.” These things are occurring, but the question needs to be whether the global economy is contracting enough or if deflationary trends are strong enough to be concerned about this beyond what we are already doing.

Tiomkin isn’t calling for anything like the one or two more cuts that people are expecting the Fed to make, or the end of their quantitative tightening that they just put into place, he is instead calling for much more drastic measures than this, perhaps even more drastic ones than we saw during the crisis of 2008.

According to Tiomkin, the crisis of 2008 is still waging on, and for all that we have done to improve economic conditions since, we are still stuck in the same quagmire and we’ll need to do more than this to get out of it.

Does Tiomkin Want to Expand the Economy or Contract it, or Both Perhaps?

What is particularly interesting about his proposed solution is that he is calling for both massive spending, even seeing the government give huge handouts to banks again like they did with the TARP program, and “higher interest rates.”

Wait a minute though, is he really concerned about the economy contracting and wants higher interest rates to counter that? The idea behind lower interest rates is that this increases money supply and the economy in turn, where higher interest rates reduce the money supply and contract the economy.

This demonstrates a very fundamental misunderstanding of how these things work. Perhaps he’s not worried about economic contraction at all, and instead is concerned about interest rates being too low, and he does speak of how concerned he is about low interest rates so that seems to be what he is focused on more.

He goes on to say that “central banks lowered rates and infused capital into the markets, but this strategy has exhausted its usefulness and should no longer be applied.”

This would be akin to saying that the fire department is struggling to put out a fire and therefore they should just walk away from it. What happens to our house seems to be left out of consideration though.

If we were looking to contract the economy, there is no surer way to do it than to raise interest rates and especially to a level which is designed to provide the kind of shock to the economy as he is suggesting we need. This wouldn’t just be walking away from our house on fire, it would involve hosing our house with gasoline instead.

This is not one of those things which are subject to interpretation, opinion, or debate, as we know this with absolute certainty, because that’s the way the economy works. You can’t contraction with more contraction.

He goes on to say that low or negative interest rates “not only fail to contribute to a healthy economy but are also causing omnipresent damages.” If providing stimulus is what is needed to get the economy healthier though, this is needed and doing the opposite will ensure that it is made less healthy and would cause real damage, without a doubt.

We may wonder what sort of damage he is seeing. He remarks that expansionary monetary policy “increases supply, not demand, in the world.” He is concerned about contraction but is also against expansion, and demonstrates an egregious lack of coherence throughout the piece.

Expansionary monetary policy actually works by increasing demand, not decreasing it. There is more money to spend, and people like spending money, so they will spend more. Supply will increase as well to meet the increasing demand. Nothing damaging or even out of the ordinary yet.

Contractionary policy will put both supply and demand down, and we use it to do just that in times where growth is too high and this is causing too much inflation. If you want to fight contraction and fight a potential recession, you need to expand the economy, not contract it.

He goes on to say that “low rates lead to increased savings and reduced consumption.” He seems to have a lot of things backwards and this is definitely among them. Low rates lead to less saving and more spending, although most of the impact of low rates comes from the greater spending resulting in the expansion of credit, which is what almost all of our money supply consists of.

How much we save or not is only a small part of this equation, but it does contribute a little and contributes to more spending, not less, if rates are low. When rates go up, people save less, but much more importantly, they borrow less, and this means less spending. This is why central banks lower rates when they want people to spend, because they will borrow more and spend more, in addition to the lesser effect of their saving less and spending more.

He thinks that if rates go even lower, we will see less consumption, because if we look at countries with lower rates, their consumption has declined. This reasoning is flawed though because we know that if both consumption and interest rates have both declined, consumption has declined in spite of the lower rates, not because of them, and if anything, we may need to lower them further to bring consumption back up.

Tiomkin’s Article Displays Misunderstanding in Great Abundance

He also claims that lower interest rates are “harming banks, pension funds, and insurance companies,” and believes that the lack of growth in the stock prices of U.S. banks are evidence of this, claiming that they have not moved up over the last 2 years.

Not that this would matter, but this is incorrect, as these stocks have moved up nicely over the last 2 years. Stock prices don’t matter to economics anyway, but the health of these banks does, and they are quite healthy actually.

Whether or not a particular sector of stocks are doing well or not is not within the concern of economic policy, and there are several sectors that are indeed struggling, but it is not the place of the central bank to look to play favorites here as their goal is to manage the economy as a whole, not manage how particular side bets on it may be faring, which is what the stock market consists of.

He also has it in for stock buybacks and mergers and acquisitions (M&As). It isn’t that clear why these are seen as a problem, and we know that M&As at least strive for more efficiency and buybacks are simply people spending their money as they choose.

It isn’t clear what the issue really is with M&As, but he sees the buybacks as doing damage by not having companies spend more on research and development. This is really a corporate decision though and the choice here typically, after all these considerations are accounted for, is whether to pay out profits in dividends or re-invest them in the company’s stock, so even if we look to curtail this, this will likely just put dividends up.

Perhaps we should outlaw dividends as well, which his reasoning also leads to. This all strikes at the heart of the free market itself and isn’t something we can intervene with without violating the most basic principles of our economy.

He particularly objects to companies borrowing money for these activities, although that’s expansionary as well, and while it is hard to tell whether Tiomkin wants it to expand or contract, it is clear that he is against these practices, although we require justification far more connected with reality and reason than he has provided us.

Apparently, these buybacks have created a distortion that the economy is actually growing and inflation is being kept at a manageable level, but it’s not really clear how buybacks even affect these things, and he seems to be confusing stock prices with real world activities.

Buybacks can create the “illusion” of a company’s stock rising, although this isn’t an illusion, it’s the real deal. If a company is making a certain amount of money and spending a certain amount on this, it’s the amount that they are making that is central to this, which is the sort of thing that is measured when we measure economic growth, not stock prices.

To top things off, aside from our needing to raise interest rates, he is also calling for massive bailouts, not bailouts mind you because you usually need to get in trouble to need this, but instead massive government spending including just handing out massive amounts of money to banks just to stimulate the economy.

If we are looking to incite social unrest, we know what happened the last time we did this, and we needed it that time, so who knows that the mob will think of handouts like this when they are not needed and banks are already making so much money.

He also wants to see a huge amount of quantitative easing during this, which runs completely counter to his wanting interest rates put up. Doing both together would be madness, but that actually fits pretty well with the theme of his article.

While we do want to take heed of even the most off-the-wall views, Tiomkin’s article on this is terrible beyond description, which should be obvious provided we even have a bit of understanding of how economics works. The errors here are so egregious that we may wonder how someone who is supposed to have some sort of background in economics could come to these views without first losing their mind.

Fortunately, we do have people at the Fed and at other central banks who do get the basics of what they are doing, so don’t expect them to take Tiomkin’s ideas to heart anytime soon, or ever.

Eric Baker

Editor, MarketReview.com