Bull Markets and Economic Competence
After nearly a decade of sustained economic growth
in the aftermath of the Great Recession, volatility has finally returned to the markets with the Vix Index, a measure of future volatility, shooting from 14 to 37 in the days following the February 2nd sell-off. While the economy has retained its heat, especially after the GOP-led tax cuts and major spending increases, including an additional $80 billion to defense and $63 billion to liberal social programs, America is finally seeing signs that it is ready to cool off.
In an effort to promote sustainable growth, the Fed began raising rates in 2015, the first of five increases under former Board of Governors Chair Janet Yellen, and is poised to do so again under the leadership of Jerome Powell. Sustainability, however, may not be a part of the Trump Administration’s agenda as the GOP continues to lose ground heading into the midterm elections, which the party in control of the Executive Branch has historically struggled in. Massive tax cuts and spending increases, though appeasing to the electorate and even opponents, will add an additional $1 trillion to the national debt by 2019, bringing it to nearly $22 trillion. Most economically literate people would advise against such profligate fiscal stimulation due to the belief that it will result in unrestrained market growth, leading to instability, and that it is reckless in the way that it takes short-term political gain in exchange for long-term, sustainable growth.
One may notice a mild correlation between today’s economy and that of the late 1960s. After LBJ pushed the Kennedy tax cuts and his own Great Society programs through congress as defense spending for an unpopular war continued to escalate, the budget deficit quickly shot up from 0.2% to 2.7% of GDP (13.5x) in the years following 1965. Consequently, inflation boomed to 3% in 1968 and then 5% in 1969, culminating in a minor recession midway through Nixon’s first term. However, there are a number of differences between the economy of the 2010s and that of the ‘60s. 50 years ago, 1/3 of workers belonged to trade unions, compared to less than 11% now. ¼ had wage agreements tying their pay to inflation, a contract stipulation now so rare that it is difficult to find data for. Global competition and discounting from giant retailers like Costco and Amazon has done wonders in holding down the prices of goods. Unsurprisingly, our growth more closely mirrors that of the late 1990s, a decade where Fed Chairman Alan Greenspan insisted on business-friendly monetary policy that was able to push unemployment down to 3.8% as Clinton’s 2nd term neared its close. He felt that computerization would increase the economy’s productive capacity, releasing some of the pressure created by rapid expansion, and maintained a relatively hands-off approach as inflation stayed below 2% while wages soared. This policy allowed a bubble to form that ultimately began to burst as the country rolled into Y2K. Unlike the 90s, no single modern asset class has produced the irrational exuberance that the .com startups did. In fact, many students entering college this fall may have never heard of Healtheon or Compaq, both of which were once billion-dollar firms. The modern economy features a much more diverse range of expensive goods, with bonds and real estate serving as excellent examples, yet prices are frequently justified because low interest rates and booming growth make future flows of income look more valuable.
Playing Devil’s Advocate, one may also want to consider the theory that Americans shouldn’t necessarily worry that the Federal Funds Rate staying relatively low will lead to a leap in inflation anytime soon. First, proponents of Machine Learning and Artificial Intelligence feel that we may be on the brink of the second industrial revolution and believe that emerging technologies will allow firms to do more work with fewer laborers. Furthermore, rising wages should encourage firms to increase exploration into labor-saving technology, thus driving down prices in the long-run. Second, some economists believe that recessions damage the supply capacity of the economy as laborers’ skills may atrophy while they are out of work for months or years. A study conducted by economists at the University of California – Berkeley found that for every one percentage point rise in local unemployment during the recession, working age people were 0.4 percentage points less likely to be unemployed in 2015. While unemployment rates recovered, overall employment did not, suggesting that some were deterred from even re-entering the work force. That said, there is a relationship between falling unemployment numbers and an increase in participation by prime-age workers. Finally, making the assumption that the past is the best indicator of future behavior, we have had very reliably stable price-growth that hasn’t necessarily been disproportionate to the employment rate, effectively moving forward in a state of equilibrium that has yet to display any major signs of disruption. As a result, Americans may become less upset with globalization as the economy heats up, hiring at home expands, and firms compete for workers by raising wages while personal expenses continue to rise at a very manageable rate. Additionally, President Trump thoroughly enjoys touting recent economic gains for blacks and Hispanics, and he may continue to have the right to do so. Since 2016, wage growth has been strongest toward the bottom of the income distribution, with 27% of blacks and 26% of Hispanics living below the poverty line and experiencing some advancement, though marginal it may feel.
Regardless of the benefits, continued economic stimulation is dangerous, even reckless. Massive debt incurred by substantial tax cuts and spending increases will eventually weigh on growth. This begs the question: can America keep growing at this rate without an inflationary surge or a correction of unprecedented size. After years of weak wage growth and an expanding wealth-gap, many laborers feel that this is a worthy risk to take.