By Kevin Duffy*
During the late 1980s, Japan had the Midas touch. In the eyes of the mainstream media, Wall Street strategists, economists and politicians, the Japanese could do no wrong. America’s brand of capitalism—self-centered, greedy, chaotic, and unplanned—was no match for Japan’s unique brand of state capitalism, with the long-term-oriented government bureaucrat, aggressive businessman and diligent, loyal employees all working in perfect harmony for the common good. Newspaper headlines routinely lamented America’s decline as much as they feared Japan’s rise.
While a whole slew of Keynesians and mercantilists confused a liquidity bubble for an economic miracle, a handful of contrarians, including Jim Grant, John Templeton and Marc Faber, parted ways with the crowd. At the end of 1988, I wrote, in a letter to the editor that was published in the Wall Street Journal,
“By the end of this century, the question may not be “Will the U.S. be No. 1?” but “Will Japan still be No. 2?”“
That was a pretty bold prediction at the time. (I was young, naïve and didn’t know better.) There was some luck, no doubt. My study of financial bubbles, including Extraordinary Popular Delusions and the Madness of Crowds, implanted the idea that a frenzied crowd is almost guaranteed to be wrong. And my discovery of Austrian economics, especially Murray Rothbard’s America’s Great Depression, provided the economic rationale for why government intervention would not only fail in Japan, but likely intensify with the downturn and usher in a decade or more of stagnation. My sense was that the world’s financial markets were at a major inflection point and that sticking my neck out and flaunting the consensus would lead to significant returns.
A 239-Year History of Inflection Points in America
Does the everything bubble suggest a similar inflection point today? To try to answer this question, I’ve constructed a table of major financial turning points in the US, with coinciding political and foreign policy events, to see if a pattern emerges (see below).
Major US Inflection Points
|1783–89||Optimism||Bonds||Revolutionary War ends, Thomas Mifflin serves as 3rd president under the Articles of Confederation, Washington serves as 1st president under the Constitution||Great Britain|
|1803–12||Optimism||Louisiana Purchase,War of 1812||Great Britain|
|1861–63||Pessimism||Bonds||Gold||Lincoln signs The Revenue Act of 1861, Civil War begins||Confederacy|
|1893–98||Pessimism||Stocks||Overthrow of Hawaii’s monarchy,McKinley elected,Spanish-American War||Spain|
|1913–17||Pessimism||Federal Reserve Act, federal income tax,Wilson reelected,entry into World War I||Germany|
|1928–30||Optimism||Stocks||Gold||Hoover elected,Smoot Hawley Tariff|
|1941||Pessimism||Stocks||Japanese attack Pearl Harbor||Germany, Japan|
|1945–46||Pessimism||Bonds||V-J Day,Truman elected, Churchill’s Iron Curtain speech||Soviet Union|
|1964–66||Optimism||Stocks||LBJ’s Great Society speech, Medicare established,Vietnam War escalates||China, Cuba,Soviet Union,North Vietnam|
|1974–75||Pessimism||Stocks,gold||Nixon resigns, Vietnam War ends||Soviet Union|
|1980–82||Pessimism||Gold||Bonds, stocks||Iran hostage crisis, Reagan elected||Iran, Soviet Union|
|1989–90||Pessimism||Stocks||Berlin Wall falls,Iraq War I||Iraq, Japan,Soviet Union|
|20~00–01||Optimism||Stocks||Gold||Peace Dividend,G.W. Bush elected,9/11 attacks|
|2008–09||Pessimism||Stocks||TARP passed,Obama elected||Iran, Iraq|
|2020–21||Optimism||Bonds, stocks||Biden elected, withdrawal from Afghanistan||China, Iran, Russia, Trump supporters|
At first glance, our table reveals some obvious patterns:
Timing—The best time to buy stocks is at the point of maximum pessimism about the economy. The onset of wars tends to build the wall of worry further and ensure key bottoms: Spanish-American War (1898), World War II (1941) and the first Iraq War (1990). The start of the second Iraq War (2003) pinpointed a four-year bull run. One notable exception was US involvement in the Vietnam War, which began covertly right after World War IIand escalated from 1965 (first combat units introduced) to 1969 (five hundred thousand US military personnel stationed in Vietnam). Adjusted for inflation, the Dow Jones Industrials Average peaked in 1966 and didn’t bottom until 1982. Meanwhile, peace and prosperity generally coincide with stock market tops. E.g., the roaring ’20s (1929) and dot-com bubble (2000) witnessed an absence of external enemies.
Duration—Inflection points alter the course of stocks, bonds and gold for long periods of time, often decades. E.g., the 1946–81 bear market in bonds (thirty-five years) was replaced by a thirty-nine-year bull market.
Conflict vs. cooperation—The 1946 inflection point ended a long period of conflict between nations: centuries of imperial rivalry culminating in two world wars separated by a massive trade war. The end of World War II ushered in a seventy-year period of decolonization, globalization, expanding division of labor and relative peace. (While President Trump’s trade war with China arguably arrested this trend, at least in the short run, I believe the long-term trend will reassert itself.)
Megatrend: Big Government
The overarching trend in the US since 1789 has been an ever-expanding and centralized government. That year marked the scrapping of the Articles of Confederation for a more centralized federation of sovereign states with George Washington its first president. The new government was the outcome of a heated debate between competing visions for the United States, with the federalists (led by Alexander Hamilton, Washington’s first treasury secretary,) prevailing over the Anti-Federalists who were thrown a bone with the Bill of Rights to try to keep the central state in check.
(The federalists were clustered in commercial centers; their message was amplified by the press. The more agrarian anti-federalists included such luminaries as Patrick Henry, Melancton Smith, William Grayson, George Clinton, and Richard Henry Lee; most have since faded into oblivion.) Importantly, the new government’s Constitution opened the door to direct taxation and enforcement at the national level, roles confined to the states under the Articles. This was a boon to speculators in government bonds which had become practically worthless after the war with Britain.
Where the founders did agree (including Franklin, Washington, and Jefferson) was on national greatness and expansionism. According to Sheldon Richman in America’s Counter-revolution,
Even the government’s schools teach … that America’s founders had—let us say—an expansive vision for the country they were establishing…. Clearly, these men had empire on their minds. Indeed, in the eyes of the founders, the American Revolution was largely a war between a mature, exhausted empire and a nascent one. Many—but assuredly not all—Americans of the time would have cheerfully agreed.
In other words, the dramatic shift from the Declaration of Independence to the Constitution was the ultimate inflection point. As historian Vernon L. Parrington (1871–1929) wrote:
[It] marked the turning point in American development; the checking of the long movement of decentralization and the beginning of a counter movement … The history of the rise of the coercive state in America, with the ultimate arrest of all centrifugal tendencies, was implicit in that momentous counter movement.1
A key step on the path to centralization occurred in 1861 as state sovereignty became a casualty of the misnamed “Civil War.” The bloodiest conflict in US history, which took the lives of roughly 2 percent of the population—seven times the death rate of World War II—was over the South’s right to secede (taken for granted seventy years earlier), not a struggle between factions over who would run the government. As Tom DiLorenzo, author of The Real Lincoln and Lincoln Unmasked, wrote shortly after the 9/11 attacks:
Lincoln’s war established myriad precedents that have shaped the course of American government and society ever since: the centralization of governmental power, central banking, income taxation, protectionism, military conscription, the suspension of constitutional liberties, the “rewriting” of the Constitution by federal judges, “total war,” the quest for a worldwide empire, and the notion that government is one big “problem solver.”
The next giant leap took place in 1898. According to Stephen Kinzer in Overthrow: America’s Century of Regime Change from Hawaii to Iraq:
Historic shifts in world politics often happen slowly and are hardly even noticeable until years later. That was not the case with the emergence of the United States as a world power. It happened quite suddenly in the spring and summer of 1898.
The seeds, however, were planted five years earlier with the overthrow of the Hawaiian monarchy:
In the months after the 1893 revolution in Hawaii, that country’s new leaders sought annexation to the United States, but [anti-imperialist] President Grover Cleveland … would not hear of it. He was quite right when he declared that most Americans rejected the seizure of faraway lands “as not only opposed to our national policy, but as a perversion of our national mission.” Five years later, this consensus evaporated. Almost overnight, it was replaced by a national clamor for overseas expansion. This was the quickest and most profound reversal of public opinion in the history of American foreign policy.
The April 21, 1898, invasion of Cuba began with a false flag incident (the Maine explosion) providing fodder for prowar yellow journalists (notably William Randolph Hearst), was sold to Congress and the American people as a mission to liberate the Cuban people from Spanish rule (Teller Amendment) and ended with broken promises and betrayal of the original cause:
In the United States, enthusiasm for Cuban independence faded quickly. Whitelaw Reid, the publisher of the New York Tribune and the journalist closest to President McKinley, proclaimed the “absolute necessity of controlling Cuba for our own defense,” and rejected the Teller Amendment as “a self-denying ordinance possible only in a moment of national hysteria.” Senator Beveridge said it was not binding because Congress had approved it “in a moment of impulsive but mistaken generosity.” The New York Times asserted that Americans had a “higher obligation” than strict fidelity to ill-advised promises, and must become “permanent possessors of Cuba if the Cubans prove to be altogether incapable of self-government.”
The long-term consequences of America’s interventions in Cuba would prove to be as profound as they were tragic.
The 1898 inflection point put the rest of the world on notice:
Outsiders watched the emergence of this new America with a combination of awe and fear … The Manchester Guardian reported that nearly every American had come to embrace the expansionist idea, while the few critics “are simply laughed at for their pains.” Some of these journalists were unsettled by what they saw … The Frankfurter Zeitung warned Americans against “the disastrous consequences of their exuberance” but realized that they would not listen.
Is the megatrend towards big government in the US nearing an end? For starters, history has not been kind to empires. The British empire had its day, peaking with the first world war. By the time of the 1947 partition of India it was in full retreat, ushering in a bipolar world with the United States pitted against the Soviet Union. The collapse of the Soviet empire in 1989–91 created a vacuum with the US assuming the mantle of global hegemon. The American empire appears to have peaked somewhere between 1988 with the absurdity of presidential candidate Michael Dukakis’s failed photo-op in a tank and 2003 with the hubris of President George W. Bush’s staged declaration of “mission accomplished” aboard an aircraft carrier just weeks into the second Iraq War. Public debt–to-GDP was 58 percent when Bush declared victory; today it stands at 123 percent.
To keep the game going, the political class has increasingly relied on borrowing, inflation and diversions like victimology, covid and climate change. “War is the health of the state” needs updating. The modern state has evolved, learning the lesson that any conflict feeds the Leviathan. Conflict is not limited to “us versus them” and “good versus evil,” but left vs. right, black vs. white, male vs. female, straight vs. LGBTQ, rich vs. poor, entrepreneurs vs. employees, young vs. old and even man vs. the planet. Wars have morphed into abstractions—e.g., war on poverty, war on drugs, war on terrorism, and now a war on a virus. The justifications for protecting party A against the predations of party B are endless.
This presents a problem for the state, however: the web of lies becomes infinitely more complex and impossible to keep stitched together. The truth is an ever-present nuisance, as Lew Rockwell, founder of the Mises Institute, so passionately argues:
The truth, no matter how seemingly battered and bruised, still shines through. It can never be wiped out, no matter how rotten the regime. In the end, the truth will triumph over deceit.
One sign that Americans are beginning to see through the lies: a record number are rejecting both major political parties.
Interventionists Jump the Shark
Perhaps the most convincing argument that a major change is at hand is the nature of bubbles and their ability to reverse long-running trends. If the everything bubble is unraveling, the game has changed. In classic form, a timeline of the past two and a half years reveals a burst of euphoria accompanied by peak absurdities, followed by increasingly visible warning cracks and general denial by the interventionists:
- March 2020—As covid-19 arrives and panicked investors dump stocks for safe haven assets, US thirty-year T-bond yield hits all-time low of 0.84 percent (now 3.52 percent); President Trump signs $2.2 trillion economic stimulus bill (CARES Act);
- April 2020—Fed Chairman Jerome Powell urges Congress to unleash “great fiscal power” to defeat covid, claims “we won’t run out of money”;
- May 2020—President Trump unleashes Operation Warp Speed to fast track a vaccine for covid; the death of George Floyd, a forty-six-year-old black man, at the hands of Minneapolis police, ignites months of “fiery but mostly peaceful protests”;
- June 2020—Quaker Oats cancels “Aunt Jemima” image from syrup brand to fight “racial stereotypes”;
- November 2020—Joe Biden narrowly defeats Donald Trump in disputed election;
- December 2020—President Trump signs $2.3 trillion stimulus bill (Consolidated Appropriations Act);
- January 2021—First wave of meme stock craze ends with GameStop topping out at split-adjusted 81.25 (now 28.64, down 65 percent);
- February 2021—Growth-at-any-price manager Cathie Wood’s ARK ETFs rake in $8.3 billion in new money, third behind fund giants Vanguard and BlackRock; ARK Innovation ETF peaks at 158.82 (now 42.58, down 73 percent); assets hit $23.3 billion as inflows total $8.8 billion over previous three months;
- March 2021—President Biden signs $1.9 trillion stimulus bill (American Rescue Plan Act); nonfungible token by a digital artist known as Beeple sells for $69 million;
- April 2021—Sri Lanka government bans all chemical fertilizers to make farming 100 percent organic, reverses course seven months later after mass protests by farmers and a surge in food price inflation;
- May 2021—Price inflation hits thirty-year high, with the year-over-year Consumer Price Index (CPI) +5.0 percent;
- June 2021—Italian artist sells “invisible” sculpture for more than £12,000; tiny activist investor Engine No. 1 wages successful battle to install three directors on Exxon Mobil’s board with goal of reducing company’s carbon footprint;
- August 2021—US ends twenty-year war in Afghanistan; Federal Reserve assets total $8.3 trillion, double prepandemic levels;
- September 2021—El Salvador adopts bitcoin as legal tender;
- November 2021—Bitcoin hits all-time high of $68,790 (now $20,040, down 71 percent);
- December 2021—University of Pennsylvania swimmer Will Thomas (identifying as “Lia”) qualifies to compete as a woman after taking a year of hormone treatments, records fastest national times in the 200- and 500-yard freestyle, and wins 1,650-yard freestyle by forty seconds;
- January 2022—S&P 500 hits all-time high of 4,819 (now 3,873, down 20 percent); New York City mayor Eric Adams takes his first paycheck in cryptocurrency;
- February 2022—Canadian truckers protest Trudeau government’s vaccine mandate; price inflation hits forty-year high, with year-over-year CPI +7.9 percent; Engine No. 1 launches climate change ETF; Russia invades Ukraine;
- March 2022—Federal public debt tops $30 trillion, up $7.2 trillion from prepandemic levels, and Lia Thomas becomes first transgender athlete to win NCAA Division I championship in any sport;
- April 2022—President Biden’s approval rating sinks to new low, Nasdaq Composite enters bear market territory; Federal Reserve assets peak at $8.9 trillion (now 1.5 percent lower);
- May 2022—Treasury Secretary Janet Yellen admits she didn’t see inflation coming, Sri Lanka defaults on its national debt; Solomon Islands signs new security agreement with China;
- June 2022—Two-thirds of economists anticipate a recession while Jerome Powell sees “no sign of a broader slowdown;” the National Institute of Allergy and Infectious Diseases director Anthony Fauci tests positive for covid-19 despite being fully vaccinated and twice boosted; Supreme Court overturns Roe v. Wade, returns power to the states; Sri Lanka government collapses; and
- August 2022—Anthony Fauci announces his resignation, effective in December; California plans to ban sales of new gasoline-powered cars by 2035, two-time NBA MVP Giannis Antetokounmpo helps launchESG fund.
“It has been 241 years since Thomas Jefferson wrote the Declaration of Independence. Being short America has been a loser’s game. I predict to you it will continue to be a loser’s game.”
—Warren Buffett, CNBC interview, September 21, 2017
“In the beginning of the QE period, I became convinced that the system was going to destroy the nature of money itself. I became convinced that the rules of the game had changed completely. When the rules change, the basic framework with which you make decisions need to change.”
—Tony Deden, Q&A with Grant Williams, July 5, 2018
With all due respect to Warren Buffett, if we are at a major inflection point reversing a 239-year megatrend in government growth, the last thing you want to do as an investor, entrepreneur, or young person launching a career is to play by the old rules and blindly emulate past winners. Government bonds should be avoided; likewise, the stocks of companies sucking up to government, looking for favors, and peddling official narratives. Under the new rules, investors will likely pay a premium for independence—i.e., companies that can stand on their own.
While Warren Buffett and John Bogle have had great runs (fifty-seven and forty-eight years, respectively), their playbooks are widely copied. Imitation is the sincerest path to subpar returns. Admittedly, much of their wisdom is likely to stand the test of time—e.g., the circle of competence, patience over activity, and keeping fees and turnover low. However, I suspect paying attention to macroeconomic issues will pay dividends because this is largely dismissed by the Buffett faithful as an exercise in futility. Likewise, active investing will be rewarded because Bogle’s brainchild, the index fund, is far too popular.
At the end of 1988 I suggested looking forward, not backward:
The world is still in the early stages of a third economic wave—the transition from an industrial to an information-based economy. Innovators tend to lead, whereas imitators tend to lag such waves. As the world’s best imitators, the Japanese capitalized on the ending of the industrial age. As the world’s best innovators, Americans should be the main beneficiaries of the beginning of the information age.
That advice still holds today. The information age is thirty-four years older, but shows no signs of slowing down (although it has become far more global and not nearly as concentrated in Silicon Valley). Likewise, the “hockey stick of human prosperity” is still early, having begun just 250 or so years ago, up against five thousand years of recorded history. “You can’t afford not to be invested in the relentless ascent of man,” advises Dan Ferris in so many wise words.
All bubbles are destructive in nature and based on a false belief that must be exposed and repudiated. In this case, the bad seed is government as universal problem solver. Bear markets have their place, to impart lessons, change behavior, restore health, and introduce the deluded to reality.
Major tops are a process, not an event. The trend in centralized power was a long time in the making. Its reversal could play out over a century or more (with plenty of heart-wrenching rallies along the way). The transition will be messy and painful for those who are unprepared or live in the past, but wildly bullish long-term as the government parasite withers and dies.
If I am right, the everything bubble helped seal the fate of big government. The state will increasingly be seen as an impediment to human progress and vestige of the past.
- 1.Vernon L. Parrington, quoted in <em>America’s Counter-revolution</em>, pp. 58–59.
*About the author: Kevin Duffy is principal of Bearing Asset Management which he cofounded in 2002. The firm manages the Bearing Core Fund, a contrarian, macro-themed hedge fund with a flexible mandate. Bearing gained notoriety during the Great Financial Crisis by betting against stocks like New Century Financial, Fannie Mae, Bear Stearns, and Lehman Brothers. Duffy wrote extensively on the housing and credit bubble, including articles, “Alan, We Have a Problem,” “Mr. Mozilo Goes to Washington,” and “Honey, I Shrunk the Net Worth.” In May 2007 he gave a speech in NYC titled, “It’s a Mad, Mad, Mad, Mad World,” identifying root causes of the bubble. A month later, he issued a warning in an op-ed for Barron’s titled “For Whom Do the Bells Toll?” The Bearing Credit Bubble Index was cited by Marc Faber in speeches and The Gloom, Boom & Doom Report. Prior to Bearing, Duffy cofounded Lighthouse Capital Management and served as director of research from 1988 to 1999. He chronicled the excesses of the Japan and technology bubbles of the late 1980s and late 1990s, respectively. The firm was later sold to Fisher Investments. Duffy bought his first stock at the age of thirteen. He earned a BS in Civil Engineering from Missouri University of Science and Technology and has a passion for financial history, Austrian economics and pithy quotes. He also publishes a bimonthly investment letter called the Coffee Can Portfolio.
Source: This article was published by the MISES Institute