Monday, February 24, 2020

This Week's Message: The Weber-Fechner Law In Action

If it seems like I've been picking on policymakers and their penchant for printing, borrowing and, thus, punting economic excesses, stresses and strains into the future, well, I indeed have. For, in their attempts to allay the necessary pain/purging that is part and parcel to virtually all cyclical phenomena, they in effect camouflage (and exacerbate) the inflation of real-world issues until they grow too heavy to punt any further down the road. At which point market forces, having been held too long at bay, must resort to the most extreme and painful measures if they're to effectively clear a path for healthy, sustainable growth going forward.

In the early stages of expansion, by virtual definition, the economy (producers and consumers) are lighter, leaner, if you will, having just experienced the purging of the last recession. That's when an ounce of government and/or central bank stimulus carries its greatest punch.

In the latter stages, however, when companies are heavy with the purge-worthy stuff that invariably accumulates during extended periods of high confidence — the careless allocation of cheap money (debt) perpetuated by central banks, and the government subsidies (tax breaks and the like) that, having been politically-inspired, virtually never cease on their own accord — a pound of stimulus, a ton even, is doomed to carry very little if any real-economy impact: Typifying the late-stage phenomenon that sees stock prices run far away from fundamentals (the stimulus has to go somewhere); setting the stage for what will be history’s next great round of painful, yet utterly necessary, purging.

It’s your classic Weber-Fechner law in action:
“The Weber-Fechner law was developed by nineteenth-century psychologists Ernst Weber and Gustav Fechner to explain how subjects react to different physical stimuli. In a series of experiments, Weber asked blindfolded men to hold weights. He would gradually add more weight to the weights the men were already holding, and the men were supposed to say when they felt an increase. It turned out that if a subject started out holding a small weight—just a few grams—he could tell when a few more grams were added. But if the subject started out with a larger weight, a few more grams wouldn’t be noticed. It turned out that the smallest noticeable change was proportional to the starting weight. In other words, the psychological effect of a change in stimulus isn’t determined by the absolute magnitude of the change, but rather by its change relative to the starting point."

As for this week's message and the issue of the day, well, you tell me; under what conditions do you suppose an economy can best cope with an unforeseen exogenous shock, like, say, the threat of global pandemic: when it's lighter, leaner, smarter, when it's been dis-(or less)-encumbered of past excesses; or, when, having -- via a steady drip of artificial stimulus (supercharged virtually every time a counter-cyclical risk arose) -- grown sluggish, bloated, complacent?

You can equate it to a patient whose doctor -- viewing perpetually healthy patients as his/her ticket to job security -- prescribes an antibiotic for every sniffle. My, the risk of serious illness when that weakened immune system meets with more than just your common cold!

Historically-high stock market valuations, waning industrial sector data, excessive leverage (to put it mildly [in the corporate space]), etc., amid record low interest rates and a tepid 2% GDP, in a nutshell, characterize current conditions and, thus, strongly support our late-stage, weak-immune-system thesis.

All of the above said, with regard to the stock market, remember, stage 6 (twilight period where traders continue to play the game but they no longer believe in it) of the boom/bust cycle can proceed for a very long time. Although present circumstances are certainly putting it to the test...

Thanks for reading!

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