Wall Street’s soothsayers have euphemisms for pretty much everything. Stocks go up: bull market. Stocks go down: bear market. Market a little overheated, “correction” time.
“Correction” is an amusing term, because it implies that there is somehow a “correct” valuation for a stock-market index. There isn’t. Market valuations reflect those Keynesian “animal spirits” that motivate buyers and sellers alike. Occasionally, these spirits produce herd mentalities such as the 2000-2001 tech stock boom and bust, or the 2008-2009 housing market boom and bust. Today’s “animal spirits” lurk in the complex algorithms that drive Wall Street’s mostly computerized trading.
Markets get overvalued when share prices rise above what reasonable price/earnings ratios suggest are sustainable. For some, this might be a good speculative opportunity; others may consider it a risky bet inviting a “correction.” In either case, the price is what it is — the price is always “correct.”
So, why the wildly fluctuating stock exchanges in December 2018? The Dow Jones Index might fall over 500 points one day only to rise by almost 1,100 points the next. Is there a problem here or just another normal day in our financial-market casinos?
December’s decline has been the worst December since the Great Depression. Yes, you read that correctly: since 1931, not the 2009 Great Recession. While President Trump’s recent actions (trade wars, Syria, partial government shutdown, firing Mattis, threatening the Fed) don’t help, December’s losses aren’t his fault. The causes are deeper, more fundamental, and longstanding.
Years of excess liquidity from loose central bank monetary policy and excessive government deficit spending created today’s situation. But thanks to the late Herbert Stein, chairman of President Nixon’s Council of Economic Advisers, we know that if something is unsustainable, it will stop. The recent stock market highs were unsustainable; they are now stopping.
We hear that the economic fundamentals are sound: weak inflation, low interest rates, near record unemployment, and relatively cheap oil. There’s a big “but.”
We are now in the 10th year of an economic recovery fueled primarily by massive debt — at all levels, at home and abroad. Everywhere you look, there’s enormous and growing public and private debt: student loans, the corporate and individual sectors, Europe (minus Germany), Japan, and China. With its debt at roughly 300 percent of its gross domestic product, China now has one of the highest debt-to-GDP ratios in the world. Comparable figures in the U.S. and Japan are 105 percent and 250 percent, respectively. As China’s economy slows significantly, the Chinese government is actually considering running up more debt.
In the United States, we’ve had 10 years of near-zero interest rate policy (“ZIRP”), and in nearly a quarter of the global economy, interest rates have been below zero. (This means you pay the bank to hold your money!) Through three rounds of Federal Reserve quantitative easing — printing dollars to purchase government and corporate bonds to bolster the economy after the 2008 Great Recession — the Federal Reserve has grown its balance sheet from $500 billion to $4.5 trillion. Now the Fed has signaled a reversal of that 10-year era of cheap money by raising interest rates and unwinding its balance sheet through what is now called quantitative qightening.
A decade of cheap money has created price distortions throughout our financial markets and enabled rampant speculation in those markets rather than ensuring that capital is deployed in ways that boost future productivity through investments in plant, equipment, and technology. Instead, we’ve gotten stock dividends and buybacks, excessive executive compensation, financial arbitrage, and high-priced mergers and acquisitions.
Think of today’s situation in terms of two analogies: a personal credit card and a cocaine addiction.
What would happen if banks issued credit cards with high credit limits and without regard to one’s ability to pay? And then the issuing banks said: OK, there’s no interest charged and no need to make a minimum monthly payment. Plus, each year, we’ll double your credit line. A little debt can be healthy, but in this situation, credit card debt would rapidly spin out of control — until banks realized that they had to reduce limits, mandate monthly payments, and charge increasingly higher interest rates. The unsustainable would stop.
Cocaine addicts might feel a rush after each snort, but sustaining their highs requires more and more white powder. Ultimately, repeated cocaine highs destroy one’s health and, potentially, cause death. As long as the drug is readily available, life seems great — at least for a while. But when the addiction becomes life-threatening, or the supply is stopped, hard times usually follow.
As a nation, we’ve become addicted to cheap money and high debt levels to sustain our economic growth and prosperity. When money is no longer “free” and the cost of borrowing rises even just a little (as it is right now), then repayment pain suddenly kicks in. Our seriously addicted economy is now entering its withdrawal period.
On Aug. 15, 1971, President Nixon suspended convertibility of the U.S. dollar into gold, thereby effectively ending the Bretton Woods Agreement that provided at least some U.S. monetary discipline. We are now approaching 50 years of living with a fiat currency, money that is backed not by a commodity but by the ability of our political system to manage prudently the “exorbitant privilege” of owning the world’s principal reserve currency. This privilege has enabled us to live far beyond our means and to indulge in unsustainable, debt-driven levels of economic growth. We have abused that privilege, and we will now pay the price.
This is not an argument for returning to the gold standard — but it is an argument for rethinking the underlying fiscal and monetary policies along with the structures that have created today’s crisis.
Soft landing ahead? Don’t bet on it.
Charles Kolb was deputy assistant to the president for domestic policy in the George H.W. Bush White House from 1990-1992. From 1997-2012, he was president of the nonpartisan, business-led think tank, the Committee for Economic Development.
The views and opinions expressed in this commentary are those of the author and do not reflect the official position of The Daily Caller.