Revisiting 'the bezzle'

We have gone through over a dozen years of very high economic growth and massive market appreciation; some would argue, largely debt-fueled. But with several big 'shocks to the system', zero-COVID policies, Russian invasion of Ukraine, Brexit and, now, Fed tightening, could it be that we are entering a sustained period of recession? Time to revisit 'the bezzle'.

There are a variety of views on this topic, so I summarize a few of these taken from different reports, referenced by the article link.

"In a famous passage from his book?The Great Crash 1929, John Kenneth Galbraith introduced the term bezzle, an important concept that should be far better known among economists than it is. The word is derived from embezzlement, which Galbraith called “the most interesting of crimes.”

"Unfortunately, the bezzle is temporary, Galbraith goes on to observe, and at some point, investors realize that they have been conned and thus are less wealthy than they had assumed. When this happens, perceived wealth decreases until it once again approximates real wealth. The effect of the bezzle, then, is to push total recorded wealth up temporarily before knocking it down to or below its original level. The bezzle collectively feels great at first and can set off higher-than-usual spending until reality sets in, after which it feels terrible and can cause spending to crash."

"Yet another way the bezzle can confound GDP calculations is by artificially lowering the cost of capital. When equity or debt has been bid to higher prices than will ultimately be justified by future returns, this reduces the cost of capital for businesses by effectively transferring a portion of the cost to owners of equity or debt. These lower capital costs encourage more commercial activity—including investment that otherwise would not be considered productive—than might otherwise be justified. Such lower capital costs also feed into higher business profits, which in turn boost the value-added component of GDP calculations."

"The bezzle of the current bull market isn’t stocked with Ponzi schemes and outright frauds in my view. Rather it is built on the notion that risky assets have become practically risk-free thanks to central bank policies."

"Bull markets engender trust that verges on complacency, or even gullibility. When they start to drop — as they are doing right now — there is a sharp rise in mistrust, as frauds are uncovered and shady dealings condemned.

Why it matters:?Regulators have signaled they're more serious about cracking down on financial criminals than they have been in decades. Such activity is unlikely to be hard to find.

Driving the news:?Federal prosecutors in New York last month?charged?hedge fund manager Bill Hwang with federal racketeering charges that could send him to prison for the rest of his life. The Department of Justice is?reportedly?using big banks as its informants on Wall Street. And the SEC is?doubling?the size of its division devoted to prosecuting crypto fraud."

Concluding comment:

'The Bezzle': is it about fraud, is it about runaway monetary policy, is it about investor naivete, inadequate regulation of our markets? Or is it a combination of all of the above? Whatever, the next few years are going to be both interesting and challenging. Secondo me.

John D. Evans, CFA

10 June 2022