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October 26, 2018

Are We Better Off Today Than Two Years Ago?

Two weeks from now Americans will head to the polls to vote in what has been billed as “the most important election of our lifetime.” That may be a bit of hyperbole, but it will no doubt be one of the most important – maybe not as important as the previous one in 2016, but certainly a close second.
Since then, there have been some huge changes in the financial markets and the economy, nearly all of them wildly – and demonstrably – positive. CNBC was nice enough to quantify them the other day in this chart, and the numbers are startling.
I’ll just mention a few:
  • S&P 500: Up 32% since the 2016 election.
  • Average hourly earnings: Up 5%, to $27.24 from $25.88.
  • Nonfarm payrolls: up 4.4 million, to 149.5 million from 145.1 million.
  • Unemployment rate: 3.7%, down from 4.9%.
  • Consumer confidence: up 37 points, to 138 from 101.
  • Corporate tax rate: 21%, down from 35%.
  • Assets held by the Federal Reserve: down 6%, to $4.22 trillion from $4.52 trillion.
Needless to say, there have been some negatives:
  • Federal deficit as a percent of GDP: 12.5%, up from 2.9%.
  • Federal debt: up 9%, to $21.5 trillion from $19.8 trillion.
  • 10-year Treasury note yield: up 120 basis points, to 3.10% from 1.80%.
  • Federal funds rate: up 190 bps, to 2.2% from 0.30%.
No doubt, the federal budget numbers aren’t anything to be proud of, but we’ve managed to live with enormous budget deficits and federal debt loads for decades, so they are a lot more manageable than the raw numbers – ugly as they are – appear.
One could also argue that the last two items are actually positive signs since they reflect the robust economy we’ve had over the past two years. Interest rates and bond yields are rising because the economy is growing and the Fed is concerned – justifiably so – about the resulting rise in inflation.
It’s still way too early to judge, but so far it appears that the Fed has deftly handled the transition from the post-crisis economy to the boom we’re experiencing now. The fed funds rate has gone up in fairly predictable 25 basis-point increments over several years, and the Fed has telegraphed its every rate hike months in advance. At the same time, in the background, the Fed’s huge balance sheet has been slowly whittled down, largely through bonds being allowed to run off as they mature.
If the Fed can pull off this unprecedented move – unwinding all of the monetary stimulus it put into effect after the financial crisis without causing too much disruption in the overall economy and financial markets – it will be a historic achievement. The Fed deserves a lot of the blame for causing the crisis in the first place, so it would be appropriate if the Fed were to make up for some of that damage by steering the markets and the economy safely back into normalcy.
Remember, in the subprime housing boom in the early aughts, it was the Alan Greenspan Fed that kept interest rates too low for too long, which enabled homebuyers and homeowners to keep borrowing against their properties until millions of them were hopelessly under water, many of them losing their homes. It was the same Fed that forgot all about its bank regulatory function and did basically nothing to halt the spread of low- and no-down-payment mortgages to people with lousy credit, enabling the housing bubble to grow to unsustainable proportions. We shouldn’t forget that, nor that the Fed may have subsequently created a bubble in financial assets that has yet to play itself out.
That’s why it’s important that the Fed ignores President Trump’s now nearly constant criticism of its monetary tightening and rate-rising strategy and continue apace. Knuckling under will not only be very obvious if it all of a sudden halts the process, but the ramifications to the economy and the president’s beloved markets are likely to be devastating, undoing all of the good that has been done over the past two years, with hyperinflation and soaring interest rates the likely result.
As I said, however, the Fed’s job isn’t even close to being finished. The fed funds rate has at least 100 basis points – or more – to go before it reaches a historically normal level. Bond yields likewise. Another trillion dollars or more needs to come off the Fed’s bond portfolio. We’re still in unchartered territory here. What happens to stock and bond prices at the end of the day is anyone’s guess – a soft landing or another crash?
The next couple of years should, therefore, be very interesting. But throwing out of office the people who have largely made the last two years of economic growth possible doesn’t seem like the smart thing to do.
Courtesy of George Yacik, INO.com  
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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