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Indexing, Policy, and Institutions Lacking Incentives

May 28, 2019

|Daniel A. White

The next recession will be made worse by the collective monetary policy response of experts to the last recession.

That is, index investing was seen as the cure-all for the last recession’s monetary woes. But it’s that exact strategy that could make the next recession extremely painful.

Retirees and pre-retirees currently hold 75 percent of all the wealth in the U.S., and a whole bunch of it is in index funds. Thus, when market trends dip downwards, the value of these index funds will drop as well. It’s a big reason why even the late Jack Bogle, the father of passive investing, said they’re getting out of control before he passed away.

And, it gets worse.

Public pension funds, which are notoriously underfunded, invest heavily in index funds. A bear market could make their situations worse, and if that happens, expect the political pressure to rise. The situation was bad in 2016 and it’s not much better today.

But fear not, central bankers have a proven recession playbook – cut interest rates, increase liquidity, and make more capital available to the private sector. Businesses hire, wages increase, and everything recovers as hoped.

But that went out the window in 2008.

There was so much debt that adding more didn’t work. Easy money created the situation. And short-term interest rates dropped to 0 percent, which didn’t help, because credit worthiness kept people from borrowing.

The Fed’s answer under Ben Bernanke was Quantitative Easing because it was projected to generate more loans with longer payback periods. However, banks used the easy money to deleverage themselves.

And public companies did the same. They bought back their own shares with easy, low-cost funding, or outright purchased competitors. So much for competition.

All of it increased asset prices, making it appear that the economy was getting back on track. But what we’re left with is the slowest recovery on record.

Ultimately, it created companies that have operated for a decade or more and can’t even pay the interest on their own debt. Profit? Yeah right.

Yet, they’re still in business.

Faced with a loss, lenders will keep adding fuel to the fire rather than accept defeat and cut bait. They’re charmed by hot-shot executives who lull them into thinking one more quarter or one more year will do the trick.

But it seldom happens.

Instead, we end up with firms that stay in business, despite no discernible ability to run a business profitably. They’re propped up by easy money when they should fail.

Where does it all take us? Downward.

Competition, innovation, creative disruption – all are tossed to the trash heap – replaced by powerful monopolies with little incentive to improve. They consume revenue from costumers with little or no choice in the matter, and it’s happening everywhere:

It seems the promise of capitalism has been replaced by the grind of monopolistic game rigging. It’s no wonder growth projections are stagnant – there’s no hunger for growth among the cash cows! And it all stems from bad policy – the politicians and the Fed made a mess of it all.

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