U.S. stock prices have just reached record highs, erasing the losses since the previous 2007 peak. But the U.S. economy as measured by the labor-force participation rate, which captures the percentage of working-age people in the labor force, has just dropped to a new 34-year low of 63.3 percent.
Since the Great Depression, recessions have always been followed by strong recoveries within two years of market bottoms. Not this time. Gross domestic product (GDP) growth from the market bottom in March 2009 has averaged 1.94 percent annually, the worst post-recession rebound in the last 70 years.
Ironically, this subpar economic performance has been achieved despite record stimulus by Washington. During the last four years, deficit spending has averaged $1.24 trillion annually, while the Federal Reserve has been pedal-to-the-metal in injecting trillions of dollars into the banking system — the most aggressive monetary policy ever.
The risk-adjusted benefits of this assertive Keynesian approach can’t be justified, with a federal debt growth of more than 50 percent delivering less than 8 percent growth in GDP. The Fed, with its low interest rates, has become the enabler of government profligacy, which has created the largest bubble in history — record amounts and inflated prices of U.S. Treasury debt.
Instead of acknowledging the unsustainability of the present course, many in Washington obfuscate what’s going on with new language and deflection away from the risks of record deficits and debt.
Before the 2008 crisis, it was universally unacceptable for the Fed to monetize government debt because it would lead to inflation. Similarly, it was unthinkable for government deficit spending to exceed 5 percent of GDP, let alone reach a trillion dollars in a year. Now, some in Washington say there’s no problem because the deficit is falling, notwithstanding the likelihood of a fifth consecutive year of near-trillion-dollar deficits. And while the Federal Reserve’s balance sheet has grown to $3.2 trillion, few refer to it as the debt monetization that it certainly is. Rather, it’s referred to as quantitative easing, or simply QE – a term that sounds both sophisticated and helpful.
The purpose of QE, we are told, is to lower interest rates and stimulate the economy. It would be bad form to point out that an equally plausible purpose of QE is to keep the cost of the government’s deficit spending artificially low, thus hiding the real cost of the welfare state.
Similarly, it would be bad form to point out that the U.S. economy is now rigged, and no longer operating as a free-market system. When the most important price factor — the cost of credit — has been artificially depressed by the central planners at the Federal Reserve for more than four years, distortions and abnormalities impede the private-sector investment and job creation that drive a normal recovery.
Socialism fails because its politically driven central planning interferes with incentives, responsibility, and the pricing system. Prices are essential carriers of information that facilitate the efficient allocation of resources, including risk capital for new technologies and new industries. The consequences of a failing pricing system — and the attendant misallocation of resources – can be clearly seen in renewable energy. Of the 12 largest companies in that sector that were collectively provided $6.5 billion in federal loan guarantees by the Obama Energy Department, six have filed for bankruptcy. Solyndra will prove to be more the rule than the exception.
Up until five or six years ago, U.S. Treasury auctions were watched carefully and considered important carriers of information about the outlook for the economy. Now they are largely meaningless, as the Federal Reserve effectively sets the prices and buys up about 60 percent of the U.S. Treasury’s debt issuance.
Fed Chairman Ben Bernanke has said that a primary purpose of QE is to lift stock prices in order to help people feel wealthier and thus spend more. But to the extent that corporate profits are being driven by government deficit spending, and the stock market is discounting expected inflation, the QE “wealth effect” may be as illusory as it is risky.
A change of course is needed, in part, because the stock and bond markets are not sustainable by contrived liquidity from the Federal Reserve. What is needed is a solid foundation of market-driven price discovery based on a sustainable economy where people feel confident about their future.
The sooner Washington gets out of denial and cuts reliance on the false stimulus of debt-enabled deficit spending, the sooner the U.S. economy can start normalizing and generating the dynamic growth that has previously been America’s legacy.