What Price Bubblenomics?

Chapter 7 (Complete)

Who knew?

As noted in the last chapter, Donald Trump was the first MMT-practicing president, albeit accidentally.  Despite that, his administration failed to jolt the U.S. economy out of the desultory 2% growth trend in which it had been stuck since the Great Recession/Global Financial Crisis.  Early on, however, that didn’t look to be the case. 

His surprise victory on November 8th, 2016, radically changed conditions not just in America but internationally as well.  This was contrary to intense fears leading up to the election in the unlikely event he should win (The Donald was a big underdog according to most polls).  The 1000-point drop by the Dow during the overnight trading session, as the electoral votes tilted in his favor in the wee hours of November 9th, reflected that anxiety.  It was also likely a function of overseas investors panicking since their perceptions of Donald Trump were nearly uniformly negative and their markets were trading many hours ahead of the U.S., as usual. 

On the first day of post-election trading in America, however, the big losses reversed “yugely” as the U.S. stock market spiked, finishing up 1.8%. Markets around the world also rallied hard, completely counter to the pre-election expectations, with the MSCI Global index rising 0.35% on Wednesday, November 9th. 

At first, the positive reaction was limited to investor, business, and consumer confidence. Soon, though, what had been a lethargic expansion, even in the U.S., and recurring recessions in many leading economies, evolved into what would be known by the end of 2017 as the “synchronized global expansion” referred to in Chapter 6.  While nearly all Democrats, a lot of Republicans and most U.S. allies (especially in Europe), were loath to admit it, Donald Trump’s election ignited the global economy and financial markets. 

In America, S&P 500 earnings, which had stagnated since 2013, began rising in 2017. As that year progressed, and especially as odds of an enormous corporate tax cut jumped, the stock market started discounting a 20% rise in profits by S&P companies in 2018, leading to 2017’s outstanding full-year return of 21.8%.

After years and years of anticipating robust earnings that never arrived, the market finally got it right in 2017. But, as is so often the case, the year of the actual earnings surge – 2018 – saw stocks initially sprint to the upside and then retreat. The usual culprit for this seemingly counterintuitive result was the Fed, which was belatedly taking away the proverbial punch bowl via its first ever double-tightening of raising rates and shrinking its balance sheet. (See Appendix).

Moreover, the synchronized expansion aspect quickly faded as one nation after another started reporting disappointing growth numbers. By the late summer of 2018, it was pretty much only the S&P and the U.S. economy that were still expanding to a meaningful degree. Even in the U.S., conditions began to fray, with housing prices in several key markets actually falling, leading to a brief bear market in home building stocks. Then it became clear the U.S. auto industry was decelerating despite record-breaking incentives to move the metal.

Meanwhile, in the U.S. stock market, a sharp correction early in the year soon faded into investors’ memories as prices rebounded and the S&P hit a slight new high in late September 2018. Yet, below the surface, there was definite erosion occurring. Fewer and fewer stocks, mostly tech companies with valuations pushing $1 trillion, were leading the advance. This narrowness, along with an accumulation of eight prior Fed rate hikes and the gradual unwinding of three prior quantitative easings (QEs) — the aforementioned double-tightening — were classic warning signs the bull market might not make it a record-breaking 10 straight up years.

The proof is in the borrowing

As we now know, the coal mine canaries back in the fall of 2018 were falling off their perches for good reason. As that year had matured, many (besides this author) questioned the wisdom of the budget-busting, Trump-engineered, corporate tax cut. Some, such as the estimable Lacy Hunt, were pointing out that the red ink situation was even worse than it appeared on the surface — and that was bad enough. The official deficit for the fiscal year ended 9/30/18 was roughly $800 billion. That was 17% more than the prior year, despite an economy that increased 4 1/2%, inclusive of inflation (i.e., this is not the more commonly cited real GDP gain). However, according to Mr. Hunt, the true deficit was closer to $1.3 trillion. The difference was due to creative accounting by the Federal government as it considered about $500 billion of spending “off-budget”.  Validating his view, the government sold approximately $1.3 trillion in debt to finance itself within the same year.

There are a couple of shocking aspects to this. First, deficits are supposed to fall — not run wild — during the latter stages of an economic up-cycle. Second, the leveraging-up of our national balance sheet left us extremely vulnerable to some kind of unexpected shock… like, say, a pandemic.  Instead of reducing our debt relative to the size of the economy to have borrowing capacity in the next crisis – as Germany did, for example – Mr. Trump and an acquiescent GOP ran our debt-to-GDP to an all-time high in the post-WWII era.  As I wrote earlier, there is plenty of bipartisan blame to go around for our current horrific national financial condition.

A key goal of the Trump corporate tax reduction was to encourage the repatriation of $4 trillion of profits sequestered overseas back into the U.S.  However, the actual numbers for 2018 and 2019 were $1 trillion.  That’s just a little bit of a shortfall, don’t you think?

The massive corporate tax cut was also supposed to cause companies to splurge on capital spending; as you can see, that didn’t happen, either.  The National Association of Business Economics found in a 2019 survey of 116 companies that 81% hadn’t increased their capital investments as a result of the Trump tax cuts.  

David Rosenberg was one of the precious few economists who recognized the housing bubble and also anticipated the economic disaster it would produce. Here’s what he wrote right before Christmas, 2018, on the erupting deficits caused by Trumponomics: “The fiscal recklessness from not ensuring the tax reform would be ‘revenue neutral’, and jeopardizing the quality of the national balance sheet in the process, will be viewed by historians as one of the greatest economic mistakes the US government has ever made.”

And yet it was this massive policy error that catalyzed the U.S. stock market to soar to valuations never seen before.  By some measures, the S&P 500 exceeded those of what was the most extreme equity bubble of all-time, the late 1990s, right before Covid struck in early 2020, while Mr. Trump was still in the White House.                                                                                                                                   

Admittedly, when I was writing this in real-time back in early 2019,[i] I expected that year would be challenging for stocks as they began to discount a recession.  Instead, the bear market would viciously unfold in just two months in early 2020, with nearly all of the carnage occurring in March of that year. 

As discussed in Chapter 5, it’s impossible to know whether a more standard recession and bear market would have occurred in the absence of Covid.  Ironically, thanks to both the Fed’s commitment to buying corporate bonds (crashing credit spreads, which is always an exceedingly bullish development) and its fabrication of four trillion dollars from its Magical Money Machine, the stock market has likely risen more than it would have in the absence of one of Planet Earth’s worst disasters.  (Even as I update this chapter, the Omicron variant is continuing to plague humanity — literally — and yet the S&P 500 continues to make a series of new highs, driving it up nearly 28% in 2021.)

David Rosenberg has also made the interesting point that the muscular earnings rebound by Corporate America coming out of the Covid recession has only brought profits back to where they were projected to be back in early 2020 prior to the pandemic.  In other words, as of 2021, earnings have merely attained the target set pre-Covid (the stock market discounts forward profits) and yet the S&P is up 40% since then! 

Accordingly, in another irony, since the Fed went into its hyper-printing mode and the federal government into its equally hyper spending mode, the rich have gotten even richer.  The wealth disparity has grown more extreme, even as the Democratic party has assumed full control.  Of course, tax policy appears to be poised to become much more hostile to the highest earners and asset owners.  While that may narrow the wealth gap a bit, I doubt it will be material.  What would be a major needle-mover would be a reversion-to-valuation-mean for U.S. stocks and real estate.  History has shown that the “great equalizers” are deep and lasting – not just flash crash – bear markets. 

The problem is that drastic tax increases and truly grizzly bear markets crush the economy, especially the latter.  On the former, Bill Clinton showed you can raise taxes somewhat and still have a strong economy.  However, he did have a big tail wind with falling interest rates and inflation, plus the then-unprecedented internet bubble.  And he left office just in time to avoid the damage from the tech-wreck, as well as the horrors of September 11, 2001, and the staggering costs of the war on terror.

As I observed in Chapter 6, the degree of tax increases needed to offset the amount of spending that already occurred due to Covid, the pending trillions of additional expenditures, and the looming years of reckoning for $100 trillion or more of unfunded Boomer entitlements, would clearly crush the economy.  Thus, taxation to pay for this spending blitzkrieg, much less to meaningfully address wealth inequality, is almost certain to be much less than required to avoid ongoing trillion-dollar-plus deficits.

For those who believe that government deficit spending has a positive multiplier effect — basically, that it will pay for itself over time — a review of history might be in order.  More likely, this is a classic case of the triumph of hope over experience.  As my great friend and business partner Louis Gave likes to say, such an attitude has much in common with second marriages or, in my view, pretty much all Hollywood weddings.

The biting reality is that from 2007 through fiscal year 2020 (again, the Federal fiscal year runs from October to September), our nation’s sovereign debt compounded at an 8 ¾% rate.  Meanwhile, the economy grew at roughly 4% (based on total, or nominal, GDP).  Adding in the budget blow-out in fiscal year 2021, the wrong-way gap, or negative multiplier, is going to be even greater.  Thus, our debt-to-GDP ratio looks like this these days, the highest it has been since the end of WWII. 

                                                                Figure 1        

Yet, as I write these words, this isn’t stopping a Democratic-controlled Congress from trying to ram through another multi-trillion spending program, spread over ten years (using reconciliation, a dirty budgetary trick the GOP employed for the aforementioned corporate tax cuts).  Donald Trump opened the Pandora’s Box of outrageous budget deficits, monetized by the Fed, but the Democrats, who now control all three branches of government, are taking this to a staggering new level. [ii]  All of us, as in U.S., Boomers should feel extremely sorry — and embarrassed — for the state of the country we are leaving to the younger generations. 

Perma-bulls on Wall Street point to the Energizer Bunny of the U.S. stock market as a nearly fifty-trillion-dollar rebuttal – roughly the size of the aggregate market value of publicly-traded American shares – of our economic malaise.  However, I would counter that counter with the question:  What price prosperity? 

What will be the ultimate cost to our long-term national wellbeing due to this monstrous equity bubble?  Moreover, as I’ve described earlier, there are bubbles almost everywhere — and of the whopper variety, not the old Hawaiian crooner Don Ho’s Tiny Bubbles. 

Throwing capitalism under the bus

Even pre-pandemic, Wall Street Journal editor Gerard Baker wrote, obviously representing a conservative publication (though not Fox network conservative), that “Faith in the American model of capitalism has been crumbling for a decade — and not just on the left.”

Baker’s article added this for good measure, referring to socialist Congresswoman AOC’s platform (which appears to have largely been adopted by the Democratic party in 2021): “The eye-catching proposals — the Green New Deal, universal free health care and education — seem like unfundable pipe dreams, and you don’t need a slide rule to know that a 70% top marginal tax rate really isn’t going to get you there. But if you think these messages — idealized symbols rather than developed policy proposals — don’t appeal to a rising generation of voters, for whom, opinion polling tells us, capitalism is a failure, then you need to get out more.”

What’s remarkable about when this populist trend first got rolling, both on the left and the right, was that economic times were still good, at least superficially. Ostensibly, Donald Trump’s election was a populist event. If so, he’s a very strange populist. Putting aside his immense wealth (though it’s probably not as immense as he likes to boast), some of his most important policy achievements were 180° removed from what most people would consider populism.  A prime example of that was the monster corporate tax gift that began the accelerated trashing of our national balance sheet.

Thus, it’s no wonder that ordinary Americans are disaffected by this pseudo-prosperity produced by what I believe has been pseudo-capitalism. For most of the last ten years, nearly the only policymakers pursuing the seemingly reasonable goal — emphasis on “seemingly” – of getting back to the pre-Great Recession economic growth rate have been the central banks.  But, with the passage of time, it has become apparent both how futile and dangerous their radical remedies have been.

As governments around the world appeared confused and used conflicting approaches — some employing fiscal “austerity”, which was never actually austere, and others using aggressive deficit spending – their monetary branches, the Fed, the European Central Bank, et al, led the charge. They valiantly and mostly vainly sought to bring the so-called wealthy nations back to their former trendline GDP growth rate.  This was despite a number of economic experts, usually outside of the central banks, who pointed out this was nearly impossible based on towering debt levels and aging work forces. The extreme indebtedness meant that additional debt brought little bang for the buck, per Figure 3 above showing the appalling deterioration in America’s federal government debt relative to the size of the economy.

Further, with the vast Baby Boomer generation heading into retirement, the labor force is destined to grow slowly for years to come. Basically, 2% GDP growth has become the new 4% but the monetary magicians have refused to face up to that fact. For sure, since the Global Financial Crisis/Great Recession, there have been a few spurts above 2% (or in Europe’s and Japan’s cases, up to it). Yet once whatever extraordinary stimulus wore off, like the Trump tax cuts, it was back down to that formerly paltry rate.

Essentially, in their maniacal pursuit of prosperity — or what they perceived prosperity to be — the central banks collectively decided the only viable approach was to pump up asset prices. In other words, they elected (not that they are; they’re appointed) to make the rich richer and, as we’ve seen, they succeeded spectacularly well.

As noted in Chapter 6, the Fed’s own studies showed minimal benefit from goosing asset values.  A key part of the reason for this ineffectiveness is that since the rich own most of the assets, as clearly shown above, they were the main beneficiaries of this scheme. Yet, as all economists know, the propensity to save by the wealthy is far higher than the inclination to spend. Ergo, there was almost certain to be a negligible boost to Main Street, just as the Fed’s internal studies projected.

On the other hand, money-for-nothing policies were a lavish gift to Wall Street. But in the process, these too-clever-by-half (in Brit-speak) central bankers have birthed a bastardized form of capitalism. A tragic aspect of this is that during the Covid crisis, free markets have become materially less free, as have our daily lives.  Government intervention in almost every aspect of life has dramatically increased—all in the name of protecting us, of course.  (How effective that’s been is an entirely different story). 

Central banks are so deeply involved in financial markets that prices no longer provide reliable signals, such as with interest rates that no bear no relationship to the current level of inflation.  Politicians on the far left have quickly seized control of the legislative process, with a “yuge” assist from Donald Trump.  Consequently, capitalism is in even greater peril than it was pre-pandemic. Folks like AOC and Bernie Sanders have been ecstatic with the multi-trillions in additional Fed-monetized spending, though, naturally, they wanted to see much, much more.  Yet, as 2021 ended, it was increasingly obvious that most Americans were not of like mind. 

Tucker Carlson, in a scathing tirade against the current economic paradigm (on the Fox network, of all places!), fumed that: “Libertarians are certain to view any deviation from market fundamentalism as a form of socialism but that is a lie. Socialism is a disaster. It does not work. But socialism is exactly what we are going to get and very soon unless… responsible people in government reform the American economy in a way that protects normal people.”  He ranted this in 2018 but his words have proven to be prophetic as MMT and socialist policies have gone viral in 2021. 

To his point, 80% of Americans live paycheck to paycheck and only 39% are able to cover a $1,000 unexpected expense out of savings. Northwestern Mutual Insurance has reported that, overall, Americans have on average just $84,821 in retirement savings. 21% have nothing at all saved up for their “golden years”.  Consequently, these individuals are easy prey for the siren-song of socialism, the poster child for what I call the “sounds good, works bad” school of economic theory (just ask any citizen of Venezuela, Cuba or North Korea). 

Additionally, in the most economically vibrant cities, and even in some of the decaying ones, housing is usually prohibitively pricey for all but the most affluent first-time home buyers. This reality afflicts most “rich” countries where the housing wealth is highly concentrated in the hands of the older generations while the young are largely priced out. That’s not great for social tranquility, and the insanely low interest rates created by hyperactive central banks played a massive role in this triumph of inequity.

Money for nothing central bank policies have also had an enormous impact on companies buying back their own stock, especially in America.  They’ve also caused severe distress for most retirement plans though that has, for now, been obscured by the heavily Fed-engineered never-ending bull market, once again, particularly in the U.S. (Both of these are important enough to receive full chapter treatment, which is coming up.)

Perhaps the average American, whomever he or she is, subliminally realizes how fragile conditions are despite the pseudo-boom caused by the central banks’ machinations. They may sense their 401(k)s are soon going to turn into 201(k)s, as they did in early 2009 – and almost did, briefly, in 2020 – due to the inflation of serial asset bubbles caused by reckless central bank policies. Maybe that’s why there is such an undercurrent of unease and even outright panic among so many in the developed world these days. They are losing faith in capitalism, but the irony is that what we’ve seen for most of the last 20 years or so has been a perverted form of it, not the real deal.

Repeated and extreme government interventions have distorted normal market mechanisms, creating a series of bubbles and busts, along with consistently disappointing economic growth. Frankly, I once had high hopes that current Fed chairman Jay Powell realized this sorry situation and was willing to move away from such meddlesome policies. But maybe he can’t. Perhaps it’s simply too late. Maybe the Fed is in too deep already, with its thumbprints all over the bubble-blowing machine and too afraid to be caught holding the pin that pricks the bubbles that haven’t yet popped—especially, large sections of the U.S. stock market.

In this regard, I was stunned at the time to read a quote from Jay Powell, in one of my friend Danielle DiMartino Booth’s newsletters from back in 2018. It was pithily titled The Powell Punt, a play on the “Fed Put” thesis. In it, she recounted that Mr. Powell, at a press conference with his two predecessors, apologetically said: “I was one who raised concerns when I first got to the Fed… they (his concerns) didn’t really kind of bear fruit… We didn’t see asset bubbles.”

Like me, Danielle thought Jay Powell would be a flashback to much stauncher Fed chairmen like William McChesney Martin and Paul Volcker.  How any sentient human, much less a Fed chairman, could survey market conditions in 2021 and not see bubbles everywhere is simply astounding — and exceedingly disconcerting.  Thanks to bubble-blindness like this, America’s central bank has morphed from indispensable under Paul Volcker, and most of Alan Greenspan’s tenure, to indefensible under the last three perma-easy money Fed-heads (Bernanke, Yellen and Powell).* 

Until then, and particularly until something causes this all-encompassing bubble to blow apart, investors reading this book should be preparing for what will be a spectacular demise.  While there could be multiple causes of the end of Bubble 3.0, my money — literally — is on what we’ll examine in Chapter 8.

*In Chapter 10, we’ll take a far more in-depth look at the depravity in today’s financial markets that these monetarily incontinent policies of the latter three have produced.

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[i] This chapter was updated in late 2021. 

[ii] Similarly, his obsession with the stock market, at least when it was rising, was another odd fit with a true populist politician. After all, who was really benefiting when the stock market rose by 15.4% over his four years in the Oval Office? The hard statistics are quite clear in that regard. Incredibly, 0.7% of the planet’s adults control 46% of the total wealth. Similarly, income has grown much faster for the top 1% than it has the rest of Americans. (To be fair, with government support payments included, the income gap isn’t nearly as wide.)