Mar 12, 2020
Whether you're invested in the stock market or not, you've likely noticed that it's been on a roller coaster lately. The White House and most of the D.C. Beltway crowd tend to equate the performance of the stock market with that of the broader economy. To President Trump's extreme chagrin, $3.18 trillion in stock market value vaporized during the last week of February. Stock markets around the world also fell dramatically. When all was said and done, $6 trillion had been at least temporarily erased from them. It was the worst week for the markets since the financial crisis of 2008 and it would only get worse from there.
In the wake of that, the Federal Reserve kicked into gear. By the first week of March, after high-level coordination among the Group of Seven (G-7) countries and their financial elites, the Fed acted as it largely had since the financial crisis, but with more intensity, giving the markets a brief shot in the arm.
In a move that Wall Street and the White House had clamored for, the Fed cut the level of interest rates by half a percentage point. The markets reacted by doing exactly the opposite of what the Fed hoped and, after having briefly soared, the Dow then tanked nearly 1,000 points that day. The next day, it rose 1,173 points (also partially attributed to Wall Street's embrace of Joe Biden's Super Tuesday results), only to plunge again soon after. Then, this Monday, within a few minutes of opening, the markets dropped more than 7%, triggering a halt in trading.
Dizzy yet? Okay. Let's take a step back.
Wall Street doesn't like uncertainty. Worries about the outbreak of, and economic fallout from, the coronavirus have stoked fears globally, only compounded by the start of an oil-price war. Big Finance doesn't deal well when its money is on the line. What's referred to as a liquidity shortage (or lack of free-flowing money) is Wall Street's deepest fear. That's what happened during the financial crisis of 2008. Under those circumstances, banks stop lending--both to each other, to corporations, and to real people--and look to external forces like its "lender of last resort," the Federal Reserve, and to the government to bail them out.
That's why what's transpired with the coronavirus is so illuminating. It's not like the financial crisis, but central bank reactions are similar. There is a known chain of events that underscores the transmission of diseases: close contact, shared food, a stray cough or sneeze. What's unknown with a novel virus is how long and far and deep that transmission will go into any society, how it might still mutate, and how disastrous--as in the case of the Spanish Flu of 1918--the consequences could be.
On our globalized planet, the constant movement of people across borders has made the world smaller and more connected than ever. This means that it's made diseases ever more communicable and its ability to throw a monkey wrench into a globalized economic system and financial markets so much greater. People of various ages from varied cultures, religions, and economic statuses have the ability to intermingle in transit, whether at an airport, in a grocery store, or on a subway platform.
Several passengers with the coronavirus, initially confined to a cruise ship off the coast of Japan, for instance, led to fatalities and contagion elsewhere and were among the many catalysts in the spread of that disease and of associated economic problems to a distinctly globalized and previously profitable travel industry. The coronavirus threat soon impacted that industry's workers, food and drink suppliers, entertainers, crews, cleaners, and all associated family members. As a result, with other cruise ships experiencing similar problems and airlines in crisis, the travel industry was crippled, while the demand for the goods and services associated with it shrank. It even undoubtedly cost the Trump Organization, in part a travel and resort business, a penny or two.
Now, bear with me for a brief, deep dive into economics. Consider the commonly used economic term "supply chain." It's just a chain of people or businesses that interact with each other where money, goods, and services are exchanged along the way. The more interactions that take place around the world, the more global it obviously is. That's why trade wars, though initiated by leaders (and their giant egos), impact the economic lives of so many from the top down.
In a world that's seen a dramatic rise in isolationist politicians and policies, the coronavirus reminds us that we still share a planet where not everything is controllable by brute force or posturing. Medical, climate, and financial crises can spread ever more rapidly in this distinctly globalized world of ours for a variety of reasons. That's why the old adage an ounce of prevention is worth a pound of cure still holds.
The reality is that an economy based on a kind of inequality once unknown to Americans is at a crossroads and the coronavirus seems to have infected it. So even with the cards stacked in their favor, the unseemly wealthy and the denizens of Wall Street can't prevent real people from taking the brunt of the blowback. Nor will the Fed, whatever its rate cuts, nor Donald Trump, whatever his tweets, be able to prevent the majority of Americans from taking a significant hit in what's sure to be a global economic storm. Maybe they can temporarily assuage stock market concerns, but there are no guarantees.
Even if the extreme inequality of the present moment has its obvious precedents, the volatility that's now whipsawing across the world is only likely to continue to widen that great divide, possibly to the breaking point.
This Time, Inequality Is Different
The prescription for the last major financial crisis went something like this: The biggest Wall Street banks faced a subprime loan abyss of their own making, but one that would come to hurt everyone else. They had crafted trillions of dollars' worth of toxic assets based on the assumption--bizarre in retrospect--that there would be more incoming subprime loan payments than there had been subprime loans to begin with. When the subprime mortgage crisis began and payments became delinquent or morphed into defaults, the toxic assets of those banks went belly-up. Having used other people's money to gamble on risk and having created complex assets to make their bets, they lost money themselves big time, but it was others who truly paid the price.
Some of those big banks, like two of my former employers Bear Stearns and Lehman Brothers, had borrowed too much from other big banks. When they couldn't repay the money they had borrowed to bet on those toxic assets, they went bankrupt.
The surviving big lenders and politically well-connected banks like JPMorgan Chase and Goldman Sachs played it differently. They extracted an epic level of support from the Obama administration (read: us taxpayers) and the Federal Reserve and so survived before, of course, going on to thrive. Other major central banks followed the Fed's lead in lowering rates, while purchasing assets from troubled banks in return for cash.
By December 2008, federal funds rates (the interest rates by which banks lend money to each other based on what they have on reserve at the Fed) had been pushed down to zero and they've remained at historically low levels ever since. According to a 2011 Government Accountability Office report, the Fed extended $16 trillion in loans in the wake of the financial crisis, most of which went to the financial industry. Over time, it also created more than $4.5 trillion to purchase Treasury and mortgage bonds from Wall Street firms, most of which it now houses on its own books.
During the financial crisis of those years, the world's major central banks, mostly in G-7 countries like Germany and Japan, created what was supposed to be an "emergency" policy, which soon enough became a new normal that's lasted 12 years. They kept the average cost of money flowing to those endangered banks, their largest corporate clients, and the markets at near zero percent or even, in some instances, at negative rates. This policy subsidized or socialized losses and eventually sent stock markets to all-time highs.
The prevailing narrative then (and now) was that this "cheap money" would incentivize banks to lend and that companies would use those loans to invest in the future and in their workers, a grand experiment, it was claimed, to spur economic growth for real people. Think of it as a classic case of a trickle-down economic theory on steroids.
What happened in practice was a staggering increase in global inequality. In effect, the major central banks became centralized ATM machines for the world's banking system and financial markets. The amount of debt created by their respective governments--because the rates and cost of borrowing that debt were so low--skyrocketed. The value of financial assets like stocks, as well as government and corporate bonds, ballooned, creating what even major business news channels would characterize as a "bubble."
Central bank leaders and politicians embraced the idea that the ongoing "emergency" creation of cheap money was for the good of the economy. And every time the markets got skittish, central banks turned to the same money-creating well to help them.
Like Dr. Frankenstein, the experiment became the monster. The byproduct of making lots of money available to a sliver of society was, of course, that it flowed to the top, only exacerbating the already significant inequality on this planet. That's why there's something the same and yet so different about today's inequality.
In Wall Street-speak, today's level of inequality globally is the "trend." After all, over the past three decades, the gap between the haves and have-nots has hit historic highs, especially in the United States. According to Daan Struyven, senior economist at Goldman Sachs (another of my former employers), "The wealthiest 0.1% and 1% of households [in the U.S.] now own respectively about 17% and 50% of total household equities, up significantly from 13% and 39% in the late 1980s." And just over half of Americans "own" stocks in some fashion, if you include those with 401(k) plans, shares in an equity mutual fund, or an IRA. So when the market pops up, inequality doesn't shrink. It only grows.
Yet, on the other hand, there's something dramatically different about this particular period of inequality. In quant speak, that's the genuine outlier. During this post-2008 crisis period, much of that low-interest-rate money unleashed by the central banks and its benefits have gone disproportionally to the top 1%.
The Fed, the Money, and the Inequality
In countries where central banks intervened the most, the increase in the total value of stock markets outpaced economic growth. Yet Fed Chairman Jerome Powell claimed that "there is nothing about this economy that is out of kilter or imbalanced."
In fact, the speculation and investing in these years flies in the face of that explanation. If it's cheap and easy to access money and someone wants to grow that money, investing has long been considered the go-to option. The stock market is an avenue where money can push up the value of share prices by the force of its mere presence. In the world of big finance and markets, however, what goes up can plummet down even faster.
The natural question then becomes: How did a soaring stock market, propelled by cheap money, create yet more inequality? As a start, of course, the increase in stock market values has gone predominantly to the relative few who are significantly invested in those markets. That's because, in terms of wealth, the top 10% of Americans own 84% of the stock market, up from an already staggering 77% in 2001. In addition, as Fortune Magazine put it recently, "The top 1% continues to increase their stranglehold on wealth in this country, while the middle and lower class are losing ground."
We're talking, of course, about the wealthiest people and companies in society, including corporate executives who get paid in shares and stock options and are often capable of pushing up the price of their own shares by deploying money to buy them back. If stock markets are floating on that cheap money, what happens if (or rather when) it goes away? What happens when serious trouble builds requiring something other than the ability of central banks to combat it with more cheap money? The answer could be a massive, even historic, stock market crash.
Finally, if cheap money can inflate financial assets more than the real economy and the wealthy possess more of it than most people, won't that simply increase inequality to yet greater heights? The answer is: yes. "So in some sense the source of higher inequality is Fed policies, which pushed stock prices and home prices higher," as Deutsche Bank's chief economist Torsten Slok noted.
The Election and Inequality
If we learned anything from the 2016 election (and from where the 2020 election is headed so far), it's that Americans, whether on the left or right, don't like having the deck stacked against them. President Trump struck a populist, anti-establishment chord in his voters in 2016 (despite being a billionaire), including among workers who had once voted Democratic yet were feeling ever more economically insecure when it came to their future and that of their children.
President Trump has taken aim at Fed Chairman Powell both for raising rates in 2018 and for not lowering them enough in response to the recent coronavirus dive. In tweets, he implied that Powell was the enemy of all that's good (for Trump) by being unwilling to bend fully to White House pressure on monetary policy. In the wake of Powell's recent lowering of those rates, the president tweeted, "As usual, Jay Powell and the Federal Reserve are slow to act. Germany and others are pumping money into their economies. Other Central Banks are much more aggressive."
Trump's policies--notably the trade war with China that has hurt American farmers and manufacturers--have placed workers in an ever more economically vulnerable position. At the same time, the administration's tax cuts for major U.S. corporations (and billionaires) haven't done the poor or working class any favors either.
But Trump knows that cheap money, if it flows anywhere quickly, will flow to a stock market that he's repeatedly touted as being up big under his administration. And until a couple of weeks ago, the Dow had indeed rallied by as much as 61% since the 2016 election. In comparison, the average annual growth in gross domestic product has been stuck around 2.5% per year.
If the coronavirus has shown us anything, it's that unforeseen factors can crush the market and, by extension, the economy and American workers. This will incite the Fed and central banks elsewhere to intervene under the guise of helping the economy. March's emergency rate-cut was the first since the financial crisis of 2008. It was also a clear sign that the Fed is deeply concerned about the dangers a potential global pandemic can inflict on a thoroughly globalized economy and its banking systems.
If recent years have taught us anything, it's that the official responses to crises will ultimately help Wall Street and the markets, while leaving real people behind again. It's a vicious cycle that will only stoke inequality further until, of course, whether thanks to the coronavirus or some unknown future development, it all comes tumbling down.
Only creating a more level playing field and a new, sustainable, more equal path forward could alter this fate--and count on one thing: that won't come from central bank interventions or from the Trump administration. You would need the sort of systemic overhaul that would result in real policies that could stimulate economies from the ground up. For the present, wash your hands, don't touch your face, and hold your breath.
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