Economic crises are great opportunities for renewal and social progress. They create a consensus for economic and political reforms. Franklin Roosevelt seized the chance offered to him by the Depression to lay the foundation for America’s victory in World War II and broadly based economic prosperity of the postwar decades.
Barack Obama, on the other hand, not only squandered a major financial crisis but failed to lay the 2008 debacle at the feet of its nominal culprit, George W. Bush.
Obama did not dramatically alter the economic system that created the financial bubble. Trump is merely doubling down on them. Sooner or later the bubble will burst, and to prevent Trump blaming everyone else but himself for yet another one of his failures, the current bubble and the future crisis should bear his name.
Yale economics professor and Nobel laureate Robert Schiller recently asserted that the US stocks have plenty of room to go higher. The Trump rally, which has gone on since the night of the presidential election in November 2016, will last through 2020, Schiller predicted.
The reason for such optimism? Why it’s Trump himself.
According to Schiller, the President is the first motivational speaker to occupy the White House and his endless bragging about the economy builds business and consumer confidence. In other words, Trump generates “animal spirits” which are a key concept in behavioral economics of which Schiller is a prominent proponent. He is a co-author of a 2009 book actually called Animal Spirits, explaining how human psychology drives economic activity and financial markets.
Schiller has a stellar record forecasting financial debacles. He predicted the dot.com crash in the late 1990s as well as the collapse of home prices in 2008. While there was no shortage of cheerleaders for home values at the time, Schiller explained that house prices had to rise no more rapidly than the rate of inflation. Since prices had rocketed in the early 2000s, he warned that the housing bubble would inevitably burst. Which duly happened soon thereafter.
Trump indeed misses no opportunity to tout the twin economic successes of his presidency — a record-breaking run-up in stock prices and a spectacularly low unemployment rate. Apparently, animal spirits are at play.
But animal spirits are not enough. There have to be some real underpinnings for rising share prices in the form of profits and, at least eventually, dividends. In this regard, has the Trump administration done enough to justify a massive 50% increase in stock prices since the 2016 elections?
Sure, there has been a deregulation drive that cut some of the red tape (a modest source of savings for businesses) and eased restrictions, notably environmental ones. Being allowed to pollute more doesn’t translate into massive profits, and moreover forward-looking managers realize that under practically any future administration regulations will be tightened once more — and what they do now could result in litigation and fines.
The trade war that Trump initiated on several fronts at once has not been beneficial for the US or world economy, a recent study found, and results so far did not swing terms of trade as much in favor of the US as the America First slogan promised.
Then there was the Trump tax cut. Economists believe that it failed to trigger a corporate investment boom. Nor has there been a marked increase in hiring or higher pay for employees.
As for ordinary Americans, the official Twitter account of the Republican Party claimed that the tax cut resulted in a $1,437 savings for every person in the state of Michigan. (Trump happened to be holding one of his rallies there). This was an average, typically skewed toward the upper brackets since richer people got a bigger tax cut. Meanwhile, Trump’s $1 trillion deficit saddles every American — man woman and child — with over $3,000 of additional debt every year, i.e., double the amount of the average savings.
Why all the exuberance in the stock market then? It is due to a variety of factors which of course include strong US economic fundamentals and the Trump administration’s pro-business policies, but their contribution has not been in any way decisive. Far more important is the Fed’s extremely low-interest rate policy which has endured for over a decade. Raising rates only a little created considerable nervousness in the stock market, and renewed easing has been responsible for the new record-breaking upswing at the end of 2019.
The corporate tax cut put financial markets on steroids, since it gave businesses cash to buy back their own shares and increase dividends.
Finally, there has been global political instability and slowing economic growth. The United States is a traditional safe haven. Faced with a wave of protests sweeping their countries, as well as Brexit in the U.K. and uncertainty in the EU, rich people everywhere are fleeing to US assets.
Underpinning all that are Schiller’s animal spirits which are bringing people to the stock market now that it is on the rise again. The insight by behavioral economics about animal spirits is valid: if people feel confident about their jobs, if their bank accounts, house price and retirement accounts are growing, if the economy is expanding they will spend money more readily, make discretionary purchases, take longer vacations, etc., and this contributes to overall economic activity.
The question is whether the contribution is sufficient and animal spirits don’t run ahead of economic reality. When animal spirits outrun the fundamentals is when dangerous bubbles develop. Moreover, while the real economy tends to grow (and decline) by a small margin, the mood among economic players can change on the dime, adding to upswings and downswings in financial markets.
During the housing bubble there were also plenty of motivational speakers who were saying that home prices never go down and, even if they did, homeowners would never default. And Trump with his nonstop bragging sounds a lot more like a snake oil salesman than a real motivational speaker.
The 50% jump in the value of the Dow Jones Industrial Average, consisting of thirty most valuable — and supposedly most stable — US multinationals, is the work largely of animal spirits, which created some $10 trillion of paper wealth. But the federal budget deficit and the growing pile of US government debt at the peak of an economic cycle are a real thing. Ditto the massive amount of debt in every sector of the US economy and worldwide. Other things, such as demographic pressures, climate change and political instability are also real.
The bubble will inevitably burst, and from benign those animal spirits can turn evil. Especially if in any downturn the service economy sheds jobs as massively as it did in 2008-09. And a loss of confidence could be catastrophic in the modern dematerialized world, where money, financial transactions and financial obligations exist in virtual reality.
Forecasts of a financial debacle have been heard before. They typically ebb and flow along with the stock market. The rally at the year-end has brought a crop of optimistic predictions of smooth sailing in the year ahead. Based on previous experience, it may be the moment when the bubble enters its final hyperinflated stage.
If so, hold on to your hat in 2020.
