The arrival of a new bull market on Wall Street has myself and a lot of people waiting uneasily for the other shoe to drop. Why is it that the Fed keeps raising interest rates, economists keep warning about a potential downturn, and yet stocks keep rising and economic data keep coming in better than expected? The incongruity imparts a magical sheen to the markets, and whenever people start to engage in magical thinking about the economy, we can trust we are probably in the presence of a bubble. There is a "tulip mania" afoot, of the sort Donald Barthelme wrote it was ever a public duty to confront.
Yet, to see the froth is not necessarily to resist bathing in it oneself, while it lasts. One still checks back on the stock ticker each day, hoping to see those numbers rise. I have even developed a superstition that if I can somehow manage to resist the urge to look at the results each day, until after markets close at 4 PM Eastern, and save up all that dopamine for one big rush at the end of trading hours, then this very restraint and forbearance on my part would somehow itself act to drive prices higher.
I am reminded of the protagonist of Italo Svevo's classic novel Zeno's Conscience, who takes pride in his success gambling on "the Bourse" (the Continental stock exchange). His secret? It is, he tells us, to use his "mental willpower" to drive up the value of securities through sheer concentration. (William Weaver trans. throughout.) How's that for magical thinking? (Zeno's creator, by the way, worked as a banker and a businessman in real life, and he no doubt had a better grasp of the true, non-magical, workings of the economy than his most famous character displays.)
Magical thinking... magical thinking, everywhere we look. It's absurd, of course; but how much more absurd than our own galloping confidence of today? And when Zeno and his friends start to lose money, in Svevo's novel, it is also relatable from the point of view of our current plight: it occurs because magic has encountered something far more tangible and inarguable than itself. "Suddenly money in this world had become scarce and therefore costly," a friend explains to Zeno, and that is driving down prices.
Such, of course, is precisely what is happening now. The Fed is sucking money out of the economy, making credit more scarce. Will we not eventually start to feel the pinch as certainly as Zeno's business partner did?
But then, it's not like the recent bull market is truly inexplicable. It has stemmed in part from persistent good news about the underlying state of the economy. Inflation keeps ticking down every month, even as consumer demand remains resilient and unemployment sits at historic lows. The confidence of the American retail investor in the state of the overall economy is therefore justified. Why would they not be willing to invest? No magical thinking required here—the market is up because the economy is doing great, no?
Well, the problem is not so much that current stock valuations are without foundation—it's that the Fed may overshoot the mark and end up dynamiting those solid foundations. So far, to be sure, the Fed has seemed to engineer what once seemed too good to be true: the longed-for "soft landing," that is: a come-down in inflation without an accompanying recession. Its incremental success in this effort has been great enough that the central bankers even temporarily paused their campaign of rate hikes at a recent meeting.
Yet, the Fed is eyeing the still-high employment and 3% inflation numbers, and saying that both need to come down a bit further. Thus, they are almost certain to raise rates at their meeting this month. All of which makes sense at first blush—they have managed to incrementally lower inflation so far with periodic rate hikes; why would not the same gradual, smooth trend continue?
Yet, at least one thing is different about this round: the next batch of rate hikes will come right as payments are set to resume for millions of student loan borrowers, whose debts would have been partially written off under the Biden administration's loan forgiveness policy, but have instead ballooned back to their previous size thanks to the Supreme Court's decision to strike down the policy. And so, the economy might be hit with a double whammy: a sudden dip in ready cash from millions of ordinary consumers, plus the added expense of further borrowing contributed by the Fed's next rate hike.
In short, "money in this world" is about to get even more "scarce and therefore costly." The one-two punch of another rate hike plus sudden debt payments might lead to a crash in demand, and send the economy into the recession we have so far managed to avoid. We could therefore be in for as rude an awakening from our magical daydreaming as Zeno experienced. The Fed could overplay its hand and send us into a "hard landing" after all. And this would not even be the worst of it. As painful as a mild recession would be in the United States, it could have even worse ripple effects abroad: a debt crisis in the Global South from increased borrowing costs, for instance.
And if the Fed draws the wrong lesson from another spike in temporary supply-shock-related inflation—due, for instance, to Russia's sudden withdrawal this week from the Black Sea grain deal that is likely to send food prices spiraling upward again, unless the deal is promptly restored—then we could be in for an even harsher effort to tamp down U.S. demand in order to lower prices. The result of such a maneuver would certainly be to effect a cure worse than the disease. Inflation could well be tamed yet again, but at the cost of even worse economic horrors, such as prolonged inflation, a global sovereign debt crisis, and more.
And so I come back to the same thing I said last time on this subject. I support the Fed's campaign to lower inflation; I recognize its necessity, within limits. But it must not be pursued at the expense of all other economic goals. I agree with Abba Lerner, whom I discussed in the previous blog. Inflation is certainly an evil, but it is not the worst of all economic evils. And 3% inflation is far from the most evil sort of inflation there is. I would far rather have 3% inflation indefinitely, plus full employment, than 2% or lower inflation, plus the sort of economic and financial crisis we could get into, if we pursue that goal to the exclusion of all others...
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