Wall Street has been on a tear. The bull market in stocks, already nearly a decade old, got a new lease on life since the election of Donald Trump, responding not only to accelerating cyclical economic growth but to the Trump Administration policies of deregulation, corporate tax cuts and economic nationalism. The first week of the New Year has been especially stellar, as all major indices rocketed far into record territory and the best performing companies of 2017 added even more to their gains.
The curious aspect of the current boom is that it comes against persistent warnings of a financial bubble. Uncharacteristically, even investment banks, whose job it is to sell stocks and support investor optimism, have been apprehensive. Many standard measures of value indicate that the stock market is historically extremely expensive. Meanwhile, the debt overhang is becoming unsustainable and a wide variety of political and economic risks loom.
Investors still remember the stock market carnage of 2007-08 but, curiously, it only adds to their willingness to buy stocks. That’s because they maintain supreme confidence in the US Federal Reserve. When the financial crisis erupted, the Fed began pumping money into the financial system, bailing out failing banks and drowning the crisis in cheap liquidity. This liquidity continues to drive the speculative boom in US stocks while the unshakable belief in the Fed’s omnipotence provides a safety net for financial speculators: if stocks begin to drop, they reason, the Fed will open up its financial spigots once more. Even if the worst comes to worst, it will then be a buying opportunity.
However, the stratospheric appreciation of the bitcoin and other cryptocurrencies over the past year suggests that the next crisis may prove quite different and that the Fed won’t be able to bail out the economy in the same way. It may hit the US dollar and even though the dwindling trust in the greenback and paper currencies in general predates Donald Trump, his election and the foreign policy pursued by his administration present a new major risk.
The 20th century has been called the American Century, but it was also the Age of the Dollar. In the post-World War II era the dollar and dollar-denominated US government debt securities assumed the role historically played by gold in financial systems. So much so that economists talked about the demise of monetary gold for the first time in history. Why would you need to hold gold which was cumbersome, heavy, could be lost or stolen and, unlike financial assets, paid no interest or dividends? The dollar was just as solid and had plenty of advantages over gold.
Thus the gold standard was abandoned, the connection between paper currency and the yellow metal broken and it became fiat money – meaning that it had value only as long as buyers and sellers agreed that it did. Instead of traditional gold holdings, world central banks now mostly hold dollar-denominated Treasuries as reserves.
Except eventually Washington began to abuse its ability to print the reserve currency. Starting with the George W.Bush’s administration such abuse became rampant. Bill Clinton’s attempt at fiscal discipline was thrown out the window with a massive tax cut; after 9/11 monetary policy was dramatically loosened, as well. A Brown University study found that the War on Terror cost the United States about $5 trillion over 15 years – paid for by a combination of heavy borrowing and printing dollars.
Americans were consuming much more than they were producing and paying for excess consumption with pieces of green paper. Any other country would have gone bankrupt – witness Zimbabwe or Venezuela, or even the southern members of the euro-zone who suffered a financial crisis in 2010 because they lived above their means. But not the United States. World central banks were using their surplus dollars to buy US debt securities and printing more of their own currencies to keep them from appreciating against the dollar.
Printing money became rampant after the financial crisis of 2008. The Fed produced $3 trillion of free liquidity and central banks in Western Europe and Japan added comparable amounts over the past decade.
The money went on to create a super-wealthy class that has since privatized America’s political system. Ordinary Americans also benefited from the flood of liquidity: they were able to maintain a higher living standard than it would have been otherwise – or rather, they were growing poor much slower than if America was forced to live within its means.
But China was the real winner in the orgy of money printing. It developed, industrialized and grew powerful so rapidly because demand from the United States, fueled by those paper dollars, provided capital to invest into industrial plants, top-notch infrastructure and the military.
Vladimir Putin’s regime also owes a debt to loose US fiscal and monetary policies. As China and other countries in Asia started to develop in the early 2000s, demand for oil increased and oil prices rose to record levels, Russia had a sudden bonanza of petrodollars, allowing Putin to consolidate control over the country.
China has become a bona fide rival for Washington while Russia has emerged as a dangerous disruptor of the world order. Both were weaned on surplus dollars – just as England and Holland had been built up in the 16th and 17th centuries thanks to Spanish gold imported from South American colonies and transferred to those industrial countries in payment for their textiles and other goods.
Distrust for the dollar has been building since 2001, reflecting the growing abuse of its status as a global reserve currency by the government in Washington and the Fed. Monetary gold has already made a comeback. Having averaged around $300-350 per ounce until 2000, gold rocketed to touch $2000 a few years ago and is now trading above $1300.
But gold is only part of the story. Now, things are coming to a head. Assets of all kinds are rocketing in price because the rich increasingly want to to get rid of their dollars. Real estate in many parts of the world is in a bubble stage, and the art market, especially the market for worthless contemporary art, has become a place to park billions of dollars. A questionable painting presumably by Leonardo da Vinci going for nearly half a billion tells you everything you need to know about the declining value of the greenback.
Other paper currencies are also losing value relative to assets because they are sustained by reserves held by their central banks – which are mostly denominated in dollars. Therefore, the cryptocurrency boom may be a speculative bubble of the tulip mania kind that swept Holland in the early 1600s, but the frenzy surrounding the bitcoin and its cousins is also an alarming reflection of rising distrust for conventional currencies that are all tied to the dollar.
In this environment, the Trump phenomenon is extremely dangerous. The very fact that America, the global leader and the guarantor of international economic and political stability, is so radically divided and that it was capable of electing and seating a remarkably unfit president is troubling. Trump’s America First policies are confirming that Washington is no longer willing or able to act as a global leader. Sooner or later it will hit the trust for the dollar, with disastrous consequences for the US economy.
The greenback being a fiat currency trust is the only thing that gives it any value. Once the trust is eroded, its value can evaporate quickly. The flight from the dollar has been building up slowly since 2000 but when questions about Trump and his United States reach a critical mass events will move with breakneck speed.
Easy money and profligate government spending created a bubble economy and boom/bust cycles. We’ve had at least three of them since 1987. Each has been more severe than the previous one but they had one thing in common – a financial sell-off. The Fed addressed them all in the same way: by infusing even more liquidity in the market. It solved the immediate problem and but set the stage for the next, more severe debacle.
The dollar crisis will be very different. It will trigger inflation, not deflation as before. Adding more money would be, to use Keynes’ expression, like pushing on a string. It is extraordinary – but by no means surprising for this clueless administration – that Trump and his associates are blithely leading the country and the global financial system to a massive catastrophe.
