09/02/2021

The United States between two major crises: Bubbling Capitalism

In the period that goes from the end year of the Cold War to the year prior to the outbreak of the financial crash of subprime mortgages, US GDP, measured in current dollars, grew at an annual average of 7.3% (BEA).

This period is known as the golden cycle of globalization (1989-2007), in which the expansion of demand was supported by massive credit, supported by the strong increase in liquidity through monetary issuance and the deregulation of the rules of rate risk.

Income policy was not one of the demand’s drivers. The higher level of employment, before the rise in wages, was the source of additional resources for households. Therefore, the insolvency crisis of indebted families and companies would slowly incubate.

The consumer bubble that held debt would explode in 2008, dragging many financial institutions into bankruptcy.

During the period following the financial crisis and until the arrival of the pandemic virus (2008-2019), the GDP of the first planetary economy, measured in current dollars, presents an annual average evolution of 3.5% (BEA), that is, half of the previous cycle, adding a sharp deterioration of the average workers’ income.

The presidency of Barack Obama (2009-2017) aimed to solve the crisis through an expansive monetary policy: the available means of payment increased by 38% in his government, equivalent to 2.1 trillion dollars (FED).

The Quantitative Easy monetary programs 1, 2 and 3 allocated 3.5 trillion dollars to the purchase of depreciated financial assets and raised their price significantly as a means of saving companies and financial institutions.

The way out of the crisis consisted of promoting a gradual liquidation of debts by means of a pronounced decrease in the interest rate of the Federal Funds sustained in ranges of 0.00-0.25% throughout the Democrat administration.

This scheme led to a strong revaluation of private securities and assets above the performance of the real economy, with the expectation of the FED authorities that the wealth effect and the abundance of means of payment would have a favorable impact on consumption and investment. The table quantifies the disconnection between the real economy and the stock prices of the main US companies:

Comparative evolution of the US GDP with the main stock market indexs

Source: own elaboration based on data from: World Bank, US-Bureau of Economic Analysis and NY Stock Exchange

Dow Jones Industrial Average-30: Insixw compiled with the top 30 firms listed on the NY Stock Exchange

Nasdaq-100: index prepared with the 100 technology and communications firms listed on the NY Stock Exchange

The 2020 GDP figures are provisional.

As can be seen, in the 2008-2019 period, GDP grew at an average annual rate of 3.5%, while the prices of the main industrial and technology firms did so at an average of 11.7% and 19.9%.

This effect was described by the global finance expert German Fermo as reflation, optimistically maintaining that it would last as long as the dollar does not depreciate against other international reserve currencies such as the euro, the pound, the yen and the thriving yuan which is struggling to internationalize.

The arrival of Donald Trump to the presidency (2017-2021) was an attempted breakthrough of the Democrat scheme, retracing the globalized path of the United States with an economic policy that combined strong protectionism with fiscal incentives for investment, based on energy self-sufficiency.

He built a political consensus that supported him when he came to power and resolutely accompanied him in the failed reelection attempt. Political support constituted by those excluded from the benefits of the globalization rebuilt by Obama. Geographically located in the center of the country and opposed to the coastal winners.

However, the Fed's response to the arrival of the virus was to reproduce the design inaugurated by Bernanke and followed by Yellen. The current head of the organization, Jerome Powell, quickly appealed to exponential monetary issuance to face the recession caused by the slowdown on activity because of the social isolation imposed by the virus.

Throughout 2020 the monetary base increased by 1.8 trillion dollars, equivalent to a 52% expansion, from 3.4 trillion to 5.2 trillion dollars (Dec19 / Dec20). At the same time, the interest rate of the Federal Funds was again in the range 0.00-0.25%.

The Quantitative Easy 4 has already disbursed in one year half of what the previous three had in five years.

In the previous table, it is possible to see that the reflation effect of private securities stroke in 2020, with the industrial and technological stock market indicators showing year-on-year increases of 6.8% and 44.9% respectively, compared to an estimated fall of -0.9%.

An equity revaluation bubble driven by monetary policy even larger than in the preceding cycle.

The United States is dealing with the impact of the pandemic on its economy in the same way that it did in the face of the subprime financial crisis more than a decade ago: causing a nominal wealth effect on the market value of its companies sustained by the purchase of shares carried out by the Fed and ensuring that this positive impact is transmitted to the real economy by encouraging consumption and investment decisions.

It is expected that GDP will tend to increase due to consumption and investment flows induced by monetary policy that expands the nominal value of companies, generating confidence in economic agents and, at the same time, that the dollar depreciated against the value of shares does not do so with respect to the value of other global currencies.

The newly inaugurated president Joseph Biden is likely to hold the described scenario, as he was Obama's Vice President after all.

Roberto Feletti serves as Administrative Secretary of the Senate of the Province of Buenos Aires. He was Vice Minister of Economy of Argentina until his election as a National Deputy in 2011, by the Frente Para la Victoria.