Second-Order Effects: The Unexpectedly Slippery Path to Dow 10,000

Dow 30,000 is “unsinkable,” just like the Titanic.

A recent Barrons cover celebrating the euphoric inevitability of Dow 30,000 captured the mainstream zeitgeist perfectly: Corporate America is firing on all cylinders, the Federal Reserve’s god-like powers will push stocks higher regardless of any other reality, blah blah blah.

While the financial media looked elsewhere for its amusement, the coronavirus epidemic in China just poured fentanyl in the Dow 30,000 punchbowl. The mainstream continues to guzzle down the punch, oblivious to the fentanyl, confident that the coronavirus will quickly fade and China will soon return to its winning role of growth chariot pulling the global economy to ever greater heights.

As I noted in Could the Coronavirus Epidemic Be the Tipping Point in the Supply Chain Leaving China?, there’s a factor few of the sublimely confident Bulls consider: second-order effectsfirst order, every action has a consequence. Second order, every consequence has its own consequence.

The media’s focus is solely on the first-order consequences: the number of infected people and fatalities, government responses such as quarantines, and so on. The general expectation is these first-order consequences will dissipate shortly and life will return to its pre-epidemic status with virtually no significant changes. Will You Be Richer or ... Smith, Charles Hugh Best Price: $10.99 Buy New $11.55 (as of 05:55 EST - Details)

If we consider second-order effects carefully, we draw a much different conclusion: China will experience social unrest and economic dislocation that will unleash self-reinforcing chaos in global markets. This is not a mainstream opinion, of course, because the mainstream assumes second-order effects simply won’t matter, i.e. they don’t exist. As I describe in my latest book, Will You Be Richer or Poorer?, acting as if inconvenient realities don’t exist doesn’t make them actually vanish. Ignoring realities that are difficult to measure or that don’t fit the happy story is ultimately suicidal.

Though China Bulls will never admit it, China’s economy has become increasingly fragile in a process of diminishing returns reflected in the chart of China’s S-Curve below. What worked in the boost phase (picking the low-hanging fruit of development) no longer works.

The conventional view in the West is that the Chinese people are docile and obedient, obeying the central government’s edicts without question. The idea that the working class in China could refuse to comply is not even on the margins of Western understanding.

But if we consider the thousands of spontaneous protests and wildcat strikes against authority that have occurred in China in recent years, we realise it’s Americans who are docile and obedient, slavishly worshiping at the altar of the Federal Reserve / Dow 30,000 while their “billionaire betters” pile up fortunes and political influence, reducing the vaunted American middle-class to passive, beaten debt-serfs and tax donkeys.

Despite the paper-thin veneer of official Communist rhetoric, the social contract in China is entirely financial: you (the ruling elites) make us more prosperous every month and we’ll obey. Prosperity is of course financial–higher wages, more social benefits, higher real estate valuations, and so on– but it also includes intangible forms of capital such as greater security, cleaner air and water, wider avenues of social mobility, etc.

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