Looking at the markets these days is like looking at the seven stages of grief – shock, denial, anger, negotiation, depression, testing and, finally, acceptance. It is clear that we have not yet reached this last stage. It’s not really coronavirus – it was just the trigger for a fix that I’ve been waiting for a long time. The United States is experiencing the longest cycle of economic recovery ever, with mounds of global debt, declining credit quality and decades of low interest rates that have pushed asset prices to unsustainable levels.
The reluctance of investors, politicians and central bankers to accept this is not only an example of the natural human tendency to push back pain. Rather, it is something more frightening and more factual. The truth is that the US economy now depends on asset bubbles for its survival.
This was clearly quantified in a recent edition of financial analyst Luke Gromen’s weekly bulletin “The Forest for Trees”. About two-thirds of the US economy is consumer spending. But people’s spending habits are not based solely on their income. Our personal consumption is also linked to our expectation of wealth held in assets such as stocks and bonds.
What is amazing is how American fortunes have become totally dependent on inflation in these asset prices. Mr. Gromen calculated that net capital gains plus taxable distributions from individual retirement accounts correspond to 200% annual growth in US personal consumption expenditure.
This does not necessarily mean that people are withdrawing money from their retirement accounts to buy hand sanitizer, bottled water and masks. But Gromen argues that this means that US gross domestic product “cannot increase mathematically if asset prices fall”.
No wonder the US Federal Reserve cut rates 50 basis points last week. This decision was accompanied by a foreseeable risk of frightening the market – and it did. The S&P 500 fell almost 3% that day. But the fundamental risk of inaction was considered to be greater.
Central bankers are smart people. They know that they cannot solve pandemics or political dysfunctions with monetary incentives. In the United States, more than anywhere else, they found themselves in an unenviable position: managing an economy that, in recent decades, and in particular since 2008, has depended on low interest rates to drive up prices. actives. In turn, this has made it less obvious to consumers (and voters) that the average real weekly earnings of the poorest 80% are about the same level as in 1974, and that the things that make the middle class – health care, education and housing – have become unaffordable.
Seen from this angle, President Donald Trump’s dishonest attempts to equate the fortunes of Wall Street with those of the country as a whole have a kind of sinister meaning. The value of the S&P 500 is less an indicator of the general health of American businesses or consumers than of the wealth of a few tech companies and the value of the 2017 tax cuts. These accounted for two-thirds of the overall increase corporate profits between 2012 and today.
But the stock price increases represent a disproportionate amount of income tax paid by the top 5 percent of employees, who pay 60 percent of tax revenue. Given the importance of rising asset prices in tax revenue and GDP growth, it is hard to imagine a world in which the Fed will not continue to cut rates indefinitely. Live by the market, die by the market.
It was not to be, and this situation did not develop overnight. The United States has built an economy that has dangerously depended on the whims of Wall Street little by little since the 1970s. It is the result of policy changes driven by Democrats and Republicans.
Among them was the 1982 rule which authorized the repurchase of shares under specific conditions, even if this had already been considered as market manipulation; and the decision to grant favorable tax treatment to stock options, which enabled already wealthy people to take advantage of the higher valuations of the companies for which they worked. The most fundamental change was the shift from defined benefit pension plans to 401 (k) defined contribution plans, which linked the future of so many Americans, in a Faustian way, to the vagaries of the market.
All of this was supported by the myth that stock prices are the ultimate indicator of what goes on inside a company and ultimately an economy.
I don’t think this has been true for a long time, something that was underlined by the death last week of former General Electric CEO Jack Welch. He came to represent the rise, and ultimately, the fall, of shareholder-centered capitalism. After the 2008 crisis, it became clear that GE’s share price under Welch had been artificially supported by debt and leverage.
Welch ultimately dismissed “shareholder value” as “the world’s stupidest idea.” I can only hope that this market downturn will force more people to come to the same conclusion. How much longer can we manage an economy so disproportionately driven by bubbles of financially structured assets? The coming weeks and months could give us the answer.
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