Cutting interest rates now could set the stage for a collapse in the financial markets.
To widespread applause in the markets and the news media, from conservatives and liberals alike, the Federal Reserve appears poised to cut interest rates for the first time since the global financial crisis a decade ago. Adjusted for inflation, the Fed’s benchmark rate is now just half a percent and the cost of borrowing has rarely been closer to free, but the clamor for more easy money keeps growing.
Everyone wants the recovery to last and more easy money seems like the obvious way to achieve that goal. With trade wars threatening the global economy, Federal Reserve officials say rate cuts are needed to keep the slowdown from spilling into the United States, and to prevent doggedly low inflation from sliding into outright deflation.
Few words are more dreaded among economists than “deflation.” For centuries, deflation was a common and mostly benign phenomenon, with prices falling because of technological innovations that lowered the cost of producing and distributing goods. But the widespread deflation of the 1930s and the more recent experience of Japan have given the word a uniquely bad name.
After Japan’s housing and stock market bubbles burst in the early 1990s, demand fell and prices started to decline, as heavily indebted consumers began to delay purchases of everything from TV sets to cars, waiting for prices to fall further. The economy slowed to a crawl. Hoping to jar consumers into spending again, the central bank pumped money into the economy, but to no avail. Critics said Japan took action too gradually, and so its economy remained stuck in a deflationary trap for years.
Yet, in this expansion, the United States economy has grown at half the pace of the postwar recoveries. Inflation has failed to rise to the Fed’s target of a sustained 2 percent. Meanwhile, every new hint of easy money inspires fresh optimism in the financial markets, which have swollen to three times the size of the real economy.
In this environment, cutting rates could hasten exactly the outcome that the Fed is trying to avoid. By further driving up the prices of stocks, bonds and real estate, and encouraging risky borrowing, more easy money could set the stage for a collapse in the financial markets. And that could be followed by an economic downturn and falling prices — much as in Japan in the 1990s. The more expensive these financial assets become, the more precarious the situation, and the more difficult it will be to defuse without setting off a downturn.
The key lesson from Japan was that central banks can print all the money they want, but can’t dictate where it will go. Easy credit could not force over-indebted Japanese consumers to borrow and spend, and much of it ended up going to waste, financing “bridges to nowhere” and the rise of debt-laden “zombie companies” that still weigh on the economy.
Today, politicians on the right and left have come to embrace easy money, each camp for its own reasons, both ignoring the risks. President Trump has been pushing the Fed for a large rate cut to help him bring back the postwar miracle growth rates of 3 percent to 4 percent.
At the same time, liberals like Bernie Sanders and Alexandria Ocasio-Cortez are turning to unconventional easy money theories as a way to pay for ambitious social programs. But they might want to take a closer look at who has benefited most after a decade of easy money: the wealthy, monopolies, corporate debtors. Not exactly liberal causes.
By fueling a record bull run in the financial markets, easy money is increasing inequality, since the wealthy own the bulk of stocks and bonds. Research also shows that very low interest rates have helped large corporations increase their dominance across United States industries, squeezing out small companies and start-ups. Once seen as a threat only in Japan, zombie firms — which don’t earn enough profit to cover their interest payments — have been rising in the United States, where they account for one in six publicly traded companies.
All these creatures of easy credit erode the economy’s long-term growth potential by undermining productivity, and raise the risk of a global recession emanating from debt-soaked financial and housing markets. A 2015 study of 17 major economies showed that before World War II, about one in four recessions followed a collapse in stock or home prices (or both). Since the war, that number has jumped to roughly two out of three, including the economic meltdowns in Japan after 1990, Asia after 1998 and the world after 2008.
Recessions tend to be longer and deeper when the preceding boom was fueled by borrowing, because after the boom goes bust, flattened debtors struggle for years to dig out from under their loans. And lately, easy money has been enabling debt binges all over the world, particularly in corporate sectors.
As the Fed prepares to announce a decision this week, growing bipartisan support for a rate cut is fraught with irony. Slashing rates to avoid deflation made sense in the crisis atmosphere of 2008, and cutting again may seem like a logical response to weakening global growth now. But with the price of borrowing already so low, more easy money will raise a more serious threat.
By further lifting stock and bond prices and encouraging people to take on more debt, lowering rates could set the stage for the kind of debt-fueled market collapse that has preceded the economic downturns of recent decades. Our economy is hooked on easy money — and it is a dangerous addiction.
On 4/5, Prof. Elizabeth Morrison, Vice Dean of Faculty, welcomed Professor Adam Alter and esteemed author & journalist Malcolm Gladwell, for a conversation on Professor Alter’s latest book, “Irresistible: The Rise of Addictive Technology and the Business of Keeping Us Hooked.” Nearly 400 alumni, students and faculty set aside their phones to learn about the complexities of addiction and how it manifests in the modern age.
What economic theory can teach us about reining in our screen habits
On July 21, 2016, just hours before he accepted the Republican presidential nomination, Donald Trump and I sat down for an interview. What he said on that occasion would serve as a remarkably candid foreshadowing of how Trump would handle his relationship with the media in what, on that day, seemed the unlikely event that he would actually become president.
“I don’t need you guys anymore,” Trump told me.
He pointed to his millions of followers on Twitter and Facebook, explaining that the days of television anchors and commentators acting as gatekeepers between newsmakers and the public were essentially over. Without discernible acrimony, Trump trotted out one of the early versions of what would eventually become a leitmotif of his presidency: The media was made up of largely terrible people trafficking in fake news. There was nothing personal in the observation. It was the unsheathing of a multipurpose device, one he used adroitly in tandem with the endlessly adaptable political vehicle provided by social media during the election campaign and now during his presidency.
Is there any reason to believe that what worked for Trump before he was elected and while in the White House won’t be equally effective after he leaves office?
There is a disarming innocence to the assumption that whether by impeachment, indictment or a cleansing electoral redo in 2020, President Trump will be exorcised from the White House and that thereby he and his base will largely revert to irrelevance.
It imagines that, for some reason, Trump in defeat or disgrace will become a quieter, humbler, more restrained presence on Twitter and Facebook than heretofore. It assumes further that CNN and Fox News and MSNBC, perhaps chastened by the consequences of their addictive coverage of Trump the Candidate and Trump the President, will resist the urge to pay similar attention to Trump the Exile.
Let the record show that Trump has launched the careers of numerous media stars and that expressions of indignant outrage on the left and breathless admiration on the right have resulted in large, entirely nonpartisan profits for the industry of journalism. Why anyone should assume that Trump and those who cherish or loathe him in the news business will easily surrender such a hugely symbiotic relationship is hard to understand.
It is all but inevitable that whoever succeeds Trump in the White House will be perceived by 30 to 40 percent of the voting public as illegitimate — and that the former president will enthusiastically encourage them in this perception. Whatever his failings, Trump is a brilliant self-promoter and provocateur. He showed no embarrassment, either as candidate or president, about using his high visibility to benefit his business interests. Untethered from any political responsibility whatsoever, he can be expected to capitalize fully on his new status as political martyr and leader of a new “resistance” that will make today’s look supine.
The dirty little secret about the United States’ relationship with Trump is that we have become addicted to him. His ups, his downs, his laughs, his frowns are (as the lovely song from “My Fair Lady” once put it in another context altogether) “second nature to [us] now, like breathing out and breathing in.”
When he fails to tweet for even a few hours, Trumpologists search for meaning in the silence. Hours are devoted on cable television, each and every day, to examining the entrails of his most recent utterances. Has there been a day in the past two years without a Trump-related story on the front page of every major U.S. newspaper? How does the president lie to us? Let us count the ways. And we do, endlessly, meticulously.
Do you believe for a moment that Americans are ready to give that up merely because, for one reason or another, Trump has been obliged to reoccupy Trump Tower full-time?
A President Pence would not satisfy that hunger. Nor, for now at least, is it easy to discern within the growing ranks of potential Democratic candidates a man or woman with a matching aura of glitz, a similar degree of shamelessness, a comparable pairing of so much to be humble about with a total lack of humility.
A new president may provide a sense of relief and normalcy. But he or she will not satisfy our craving for outrage. Trump’s detractors are outraged by him. His supporters are outraged with him. He is a national Rorschach test. Love him or hate him, you can’t ignore him. One way or another, Trump will be renewed for another season.