Mark Thornton Explains the Yield Curve, “Soft Landings,” and Today’s Bubble Economy

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[In recent months, Senior Fellow Mark Thornton has been covering today's economy in detail in his Minor Issues podcast, so we asked him some questions about where the economy is headed now.]

Mises Institute: You’ve become notable for the idea of the “skyscraper curse,” which is an illustration of how an inflationary economy can lead to more and more gargantuan construction projects. The projects keep getting bigger (and taller) until the bust finally kicks in. That is, in many ways skyscrapers have become a symbol of bubbles and malinvestments. Looking around today, can you point to any particular building projects that might be an indication of where we are in the business cycle right now?

Mark Thornton: The skyscraper curse, or skyscraper index, might appear to be broken, but attempts during the last cycle to build supertall skyscrapers in China either failed altogether or experienced very long delays. This resulted in the government banning such tall structures. China continues to build extremely tall buildings but is effectively prevented from establishing new records.

Also, as I have pointed out many times, the skyscraper curse is eminently fallible and imprecise, not subject to exact quantification, and this is especially the case as the skyscraper becomes a less important economic marker over time, just as canals and railroads once had their day.

The last case of a potential curse was the Jeddah Tower in Saudi Arabia that was supposed to set record in 2020 but was canceled due to regime change in that country. The builder and the promoter of the project were jailed by the royal family because of supposed corruption. The project sits unfinished in the desert.

It should be noted that many Austrian economists saw a crisis coming in 2020, and one was also anticipated by my own Skyscraper Curse book, which was published in 2018. As I see it now, the covid crisis turned 2020 into a false start of the crisis. However, it is worth noting that there was a “cruise crunch” when the Wonders of the Seas reached its launch date in 2020 to become the world’s largest cruise ship. Cruise ships and skyscrapers share many of the same characteristics applicable to such curses, a la ABCT [Austrian business cycle theory].

MI: What other bubbles—construction-related or not—do you suspect are indicators of the latest boom?

MT: Most booms and bubbles involve construction and real estate and are biased toward future-oriented investments in higher-order capital goods with “advanced technologies.” We have essentially experienced a very long boom in the economy since the global financial crisis, when the Fed started its ten-plus years of zero interest rate and quantitative easing monetary policies. When the economy started slipping into bust in 2019, it was met with the most massive and unprecedented monetary and fiscal policies, all justified by covid.

Consequently, we have bubbles in all types of real estate; systemic bubbles in the financial sector, including most especially banks; and consumption-related bubble industries, such as streaming, plus communications, information, and delivery services. This boom has infected most of the economy and has been dubbed the “everything bubble.”

Interest rates play a central role in the capitalization structure of the financial industry; businesses in general; insurance and pensions; household finance; and governments, who all now find themselves in distress because of massive debts, rising price inflation, and rising interest rates. Even the Fed with its portfolio of assets is “upside down,” is losing money, and would be bankrupt if it had to use generally accepted accounting practices and was subject to market constraints.

MI: Remind us what exactly “malinvestment” is. After all, isn’t it a good thing that we have a bunch of new buildings and other stuff that gets produced during economic booms?

MT: Science fiction fans, UFO enthusiasts and mainstream economic growth theorists are excited by advanced technologies, but in the economic context where we recognize concepts like efficiency and sustainability, we must focus on the fact that such artificially induced investments are not profitable, rational, or socially beneficial. They might be fascinating, and they could be profitable in the future, but malinvestments are not a good thing when viewed through an economic lens.

Also, malinvestments are not the ordinary failures we expect to see because of competition, entrepreneurship, and obsolescence—when, for instance, the worst (overall) restaurant in your city fails and is replaced by a better competitor or when bookstores are replaced by coffeehouses. Malinvestments take place in bunches during an artificial boom. They are later revealed as a “cluster of entrepreneurial errors” during the bust.

MI: You have said in your podcast Minor Issues (MI) that we need a “crash landing.” Why is this? Is there any hope of actually fixing these bubbles?

MT: The MI podcast focuses on issues that are ignored or downplayed by the mainstream media and mainstream economists but are nevertheless critical to understanding the economy. A crash landing stops malinvestment, quickly resolves past malinvestments, and hopefully leads to the rejection of the gross mistakes of monetary and fiscal policy of the government. Essentially, by admitting mistakes you quickly fix the economy through a great deal of economic pain in the short run. This was done in the US in the depression of 1920, when they raised interest rates and cut government spending and the depression conditions vanished. Few people are even aware of this, and it is not even mentioned in American history textbooks, and we therefore failed to learn the big-picture lessons. In that recent episode of MI, I link to all my articles from 2022 that explain how all this works.

MI: The hardest question, perhaps, is, Where are we in the business cycle right now? One big indicator that there is trouble approaching is the fact the yield curve has inverted. But now the “experts” are telling us that doesn’t matter anymore. What do you think?

MT: While the yield curve has fallen off the front page, it is the indicator that I am now focused on. Inversions occur when short-term interest rates are higher than long-term rates, and this is a major and reliable sign of financial distress. The curve has been inverted ever since July 2022 (as measured by the 10s minus 2s, the most conservative measure). It is now at its most extreme level since Volcker’s great inversion of the late 1970s and depression of the early 1980s.

Everyone is concerned about consumer prices, but we often forget about the prices producers pay for the inputs to produce consumer goods. Producer prices, as measured by the Producer Price Index, spiked by 40 percent from the end of 2020 to the middle of 2022 and have since fallen by less than 10 percent. So basically, business investment projects over the last decade have faced much higher costs than anticipated, and this is the real distress for businesses, who can also experience decreased sales and even falling output prices.

The Fed is a wild card here. They still have a gargantuan balance sheet of over $8 trillion despite more than a year of “unwinding.” Banks have more than $3 trillion of excess reserves, which the Fed pays them over 5 percent interest to not lend, and nonbanks have another $1.4 trillion in reverse repurchase agreements. In other words, the Fed could open these monetary floodgates simply by lowering the interest rate they pay.

MI: This brings us to the matter of the central bank’s insistence that it can manage the whole situation to a “soft landing.” Is this possible, and does the Fed even know what’s going on?

MT: The Fed is very powerful and has demonstrated its willingness to use those powers to achieve its own goals and to satisfy the powers that are in control of the government. A statistical soft landing is a possibility, but not in this case. Real people, households, and companies are already being significantly harmed. It is not even desirable and only means more economic pain for more people for a longer period. Anyone in touch with today’s real economy such as business owners and private sector workers already feels the recessionary-inflationary conditions, despite GDP [gross domestic product] moving higher and a plethora of job openings.

The Fed does not seem to care about the productive classes, but they do understand what’s going on. They know they face a great deal of uncertainty about the future, and they know the limitations of their backward-looking statistical methodology. Fed chairman Powell said it best in his recent speech at the Jackson Hole Fed conference, in which he concluded: “As is often the case, we are navigating by the stars under cloudy skies.”