The amount of cash currently sitting on the sidelines has just hit $7.2 trillion.
This represents money stored in money market funds, where institutional investors park their cash.
We’ve seen it jump by $2 trillion within just the last 2 years.
For comparison, it took 20 years for money market funds to grow by $2 trillion between 1981 and 2001.
So investors have been rushing towards cash at a record pace.
This kind of rush towards cash isn’t reflective of a healthy economy.
It may be a symptom of something more worrying happening beneath the surface.
The last 3 times we saw such surges in money market fund assets were:
- Late 1990s
- 2006-2007
- 2019
Each instance was followed by major economic shocks: the dot-com bust in 2000, the housing crash in 2008, and COVID in 2020.
This begs the question: Is history about to repeat itself?
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The Real Mechanism Behind Cash Accumulation
Most people think investors accumulate cash because they’re somehow aware of an underlying economic crisis and are preparing for it.
But it’s actually because investors flee towards cash that you eventually get an economic crisis.
Investors allocate capital based on expected returns from different assets.
When they’re allocating heavily toward cash, it means cash provides attractive returns relative to other investments.
This means less capital goes toward:
- Research and development
- Infrastructure projects
- Business expansion
- Hiring new workers
Individual consumers also become less likely to spend and more likely to save money at banks to earn higher interest rates.
This simple mechanism can completely suffocate the economy.
This is why interest rates on cash, controlled by the Federal Reserve, have such massive impact on economic growth.
Symptoms Already Emerging
We’re already seeing actual symptoms of this economic suffocation.
The index of leading economic indicators has been sharply declining since 2021.
The exact moment interest rates on cash rose rapidly from 0% to 5% is when the economy began to suffocate.
The leading economic indicators index includes:
- Consumer goods orders
- Manufacturing orders
- Building permits for housing
- Average weekly hours worked in manufacturing
- Other economic strength metrics
On average, since interest rates climbed, we’ve seen all these metrics declining significantly.
The Great Divergence
Historically, leading economic indicators track US stock market performance pretty accurately.
This time, we’ve seen a huge divergence between leading indicators reflecting weakness and the stock market surging higher.
This divergence between financial and the real economy is something we’ve discussed extensively.
While the S&P 500 has performed well over the last four years, small capitalization companies have been declining overall.
The US small cap index has declined 13% since its 2021 peak, which coincided perfectly with rising cash interest rates.
Small businesses represent the economy’s backbone.
They make up 43% of overall GDP and about half of all jobs.
This backbone is not very strong right now.
It hasn’t fully broken, but it’s definitely struggling.
A complete economic breakdown would mean a recession with rising unemployment.
The unemployment rate has been rising over the last year, reflecting underlying economic weakness.
But the rise hasn’t been aggressive enough to categorize this as full-blown recession like 2020, 2008, or 2001.
So what’s been keeping the economy from falling off a cliff?
The Oil Factor
One of the most influential financial variables of the last 150 years has been keeping the economy from completely cracking.
It’s uncontrollable, extremely volatile, and most economists completely underestimate its impact: the price of oil.
When we put oil prices with the unemployment rate, and shift oil forward by 1.5 years, the 2 lines align almost perfectly.
When oil prices rise, often uncontrollably and unexpectedly, it immediately pressures economic growth and is one of the few variables that can trigger recession by itself.
Every spike in unemployment since the 1980s has been preceded by a rise in oil prices.
In 2022, we had an oil shock, but the economy avoided a recession.
Since then, oil prices have been steadily declining, which we believe is a major reason the economy has avoided a recession this entire time.
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