What’s Going On?

August 21, 2015

In this week of market upheaval, the most consistent theme is reversal.  The dollar, which early in the year inspired great optimism, is fading.  Share prices are correcting sharply downward around the world.  Many Fed officials are itching to raise interest rates, even as oil sinks below $40/barrel for the first time since 2009.  Many other commodities are faltering, too, and wage data have been mixed and mostly subdued on the whole.  Growth in the world’s second largest economy, China, continues to recede, and officials there seem pretty clueless about how to reassert control over economic trends and financial flows.  The European Currency Union resembles a marriage gone badly wrong but where the partners favor the devil they know rather than take a leap of faith into new relationships.

The case for a Fed tightening is weak if justified by economic trends but convincing when based on the reality that a zero rate policy was adopted way back in 2009 in response to an emergency that no longer is so acute.  A second rationale for the Fed to raise rates is that the ultra-low levels have corroded money markets and will inflict intensifying damage if retained much longer.  The great question regarding U.S. monetary policy, so it seems, is not when the FOMC first acts or even how quickly and much rates are lifted thereafter.  It concerns whether the U.S. and world economies will be able to tolerate that transition.

Cheap money since the Great Recession has distorted the economy, whose real side has not performed as well as share prices.  If one takes a broad look at the stock market, in fact, it has not done well, either.  From a peak of 11,723 in the DOW Jones Industrials reached on January 14, 2000, to the closing today, that summary index appreciated only 2.2% per annum over 15-1/2 years.  By comparison over the previous 17-1/2 years between the DOW’s low of 777 on August 12, 1982 and January 14, 2000, the index soared at a rate of 16.9% per year.

It is indeed fitting that equities did not perform as well so far this century as such did over the last two decades of the 20th century because neither have the trends in U.S. jobs, productivity and real GDP.  Ordinarily in a risk averse financial market environment, one would expect the dollar to be rising, not falling as it did this past week.  While the U.S. economy compares poorly with historical U.S. norms, comparisons with Europe, emerging economies, and Japan are favorable, and China has seen one of the sharpest growth decelerations of anybody since 2010.  But typical currency patterns have been trumped by the tendency for market trends everywhere to correct from their direction earlier in 2015.   The dollar was rising 2H14 and early this year, so now it is falling.

All this begs the question of why economies aren’t doing better given the proliferation of life-changing technology this century.  The problem seems to lie in the kind of technological advances.  Instead of favoring the productive side of the economy, newer products affect consumer leisure.  They don’t boost the productivity of labor.   As wealth and income becomes more polarized, the skills required for individual success increasingly involve rare types of intelligence and other intangibles.   Creating a labor force that meets the demands of tomorrow is going to take a very long time.

With structural change grinding away at a slow pace, inflation subdued, and global GDP not expanding fast enough vis-a-vis population, one of the most attractive quick fixes will involve currency depreciation.  For now, the dollar is falling, and that will favor the United States.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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