A woman eats outside her tent at the Echo Park encampment at Echo Park Lake in Los Angeles on March 24. As Fed chair Jerome Powell said recently, “...even though some parts of the [US] economy are just doing great, there’s a very large group of people who are not”. Photo: AP
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley
Coronavirus recovery: is the US economy set for a rerun of the Roaring Twenties?
Despite widespread enthusiasm in the financial press, the prevailing tone of optimism in US equity market sentiment feels too complacent
Public statements and Fed policy suggest the short-term future for the US might be more Grapes of Wrath than Great Gatsby
What could possibly go wrong? Economic optimism has pushed US equity markets ever higher amid expectations of a post-pandemic US consumer boom that will feed into enhanced corporate earnings. With so much money riding on it, though, even the most ardent proponents of such an outcome should at least consider alternative scenarios.
“Reading the financial press, it seems that most commentators believe we are set for a repeat of the Roaring Twenties, most especially in the United States,” Albert Edwards, global strategist at French bank Societe Generale, wrote last week before going on to question that logic.
Edwards’ cautionary stance has its merits. Markets should resist the temptation to uncritically embrace the notion that the combination of US fiscal stimulus, Federal Reserve monetary largesse and a post-pandemic expected release of pent-up US consumer demand will produce a US economic recovery similar to that of the mid-1920s.
Of course, everything might go swimmingly and everyone might end up partying like the characters in F. Scott Fitzgerald’s famed novel of 1925, The Great Gatsby. Then again, maybe not.
What tends to be forgotten about the Roaring Twenties is that the decade began with the United States and much of the world in recession. The end of World War I was followed by a global pandemic, the Spanish flu, which killed millions of people around the world.
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In addition, post-WWI inflation had led the Fed to tighten monetary policy in 1919 and 1920 despite signs that the United States was going into recession. The US central bank then became more accommodative for much of the rest of the decade before fatefully tightening policy in 1928 and 1929.
At the same time, the fiscal response of US president Warren G. Harding to the 1920-21 recession was limited. Rather than roll out fiscal stimulus, the Harding administration cut US government spending between 1920 and 1922. Yet, the US economy rebounded in 1922 and the Roaring Twenties were under way.
Fast forward to 2021 and the response of US President Joe Biden – as well as his predecessor Donald Trump – to the current pandemic has been to unveil ever-larger fiscal stimulus packages.
The Biden administration is now pushing for an infrastructure spending plan which seems closer to president Franklin D. Roosevelt’s attempts to deal with the Great Depression of the 1930s than policies seen in the Roaring Twenties.
US fiscal policy seems more akin to the Depression-era conditions of John Steinbeck’s famous 1939 novel The Grapes of Wrath than it does to Fitzgerald’s Gatsby.
Fed chair Jerome Powell referenced last week “a pretty substantial tent city” that he sees each day on his drive home and “we just need to keep reminding ourselves that even though some parts of the [US] economy are just doing great, there’s a very large group of people who are not”.
That does not sound like someone who thinks a rerun of the Roaring Twenties is just around the corner. It sounds like a man who has Steinbeck in mind, not Fitzgerald.
So it should come as no surprise that the Fed seems fully intent on keeping monetary policy ultra-accommodative. It will do so until it sees evidence that actual inflation is moving beyond parameters the US central bank is now prepared to tolerate and that the US jobs lost by the pandemic have been recreated.
Whether markets are prepared to look through future signs of rising prices as vaccine roll-outs lessen the threat from the pandemic remains to be seen, even if the Fed continues to choose to characterise increases in US inflation as being merely transitory.
Markets will already have noted that year-on-year producer price index (PPI) data in both China and the US leapt in March, as evidenced in data released by China’s National Bureau of Statistics and the US Department of Labour.
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Policymakers will undoubtedly argue that these year-on-year PPI rises in March are skewed by the base effect, given that factory gate prices a year ago were suffering a pandemic-derived deflationary hit. That is a plausible view, but if PPI rises continue, that argument will start to carry less weight with markets.
Edwards fears that “investors may be riding a cyclical wave that may now be cresting” and notes that, in any case, the Roaring Twenties “didn’t end so well”, with the Wall Street Crash of 1929.
The prevailing tone of optimism in US equity market sentiment feels too complacent. After all, even the Roaring Twenties turned out badly for Fitzgerald’s Jay Gatsby in the end.
Neal Kimberley is a commentator on macroeconomics and financial markets
