VOO - Are We Ready For A New 'Normal'

2023-05-25 16:43:19 ET

Summary

• For the past 40 years, the United States and the rest of the world have been facing credit inflation, where asset prices have risen regularly and wealth inequality has grown.
• Investor and business expectations have been built upon this narrative, and economic growth has proceeded and the wealthy have gotten more and more wealthy.
• Things seem to be changing, and asset price inflation might not be such a major factor and government economic policies might be aimed to achieve other goals.
• What should we do if asset price inflation ceases?
• What will be the future "normal" narrative investors will build from?

Just the other day I wrote about the Nobel-prize-winning economist Robert Lucas, who just passed away.

One of the things that Mr. Lucas taught us was about the impossibility of using economic models built during one period of economic conditions to try and explain or build policies for an economy that has experienced a set of changes that modify relationships.

Gillian Tett, writing in the Financial Times , cautions us about just such a situation that might impose itself on us right now.

In the early part of this century, economic wealth and wealth inequality accelerated in major ways.

She doesn't speak specifically of an asset price bubble or asset price bubbles, but she relates to us new information on what has happened to "the world's stock of paper wealth" that has spread globally through the "sharp rise in global debt and in the supply of money through quantitative easing."

Ms. Tett cites new data from McKinsey Global Institute that shows the:

"putative value of all global assets, relative to gross domestic product, from bout 470 percent of global GDP in 2000 to more than 600 percent today, with real estate and equity markets booming faster than the 'real' economy to a truly remarkable degree."

This measure is now at $160 trillion, or, as she shows us $160,000,000,000,000.

This advancement has continued on for so long and so steadily that it has become the "expected" scenario for the future.

And, people build their plans upon this narrative.

But, what Ms. Tett is asking us... is whether or not we should continue to base our plans on this narrative.

Credit Inflation

I would go even further than Ms. Tett in building up this picture.

I would go back to the early 1980s, when the United States went through a real battle to "break the back" of inflation. The inflationary environment of the 1960s and 1970s came about when first the Kennedy administration and then the Johnson administration constructed an economic policy for the U.S. based upon the economic models developed by John Maynard Keynes, augmented by the results flowing from the Phillips Curve.

The idea was to foster economic growth not only through monetary policy but also to design fiscal policies that would produce more economic growth.

President Nixon followed along this path, claiming that "we are all Keynesians now."

But, the consumer price inflation generated by this approach to economic policymaking was unacceptable. And, by the end of the 1970s, the inflation had to stop. It was stopped.

However, the policymakers liked the Keynesian approach supplemented by the Phillips Curve information to economic policy and worked to moderate the policy so as to avoid too rapid consumer price inflation.

This new approach I have spent a lot of time writing about. I call the approach "credit inflation." The effort by the government was to stimulate asset prices...housing prices, stock prices, gold prices, and so on...but not to stimulate consumer prices directly.

And, this approach was very, very successful.

Asset prices increased, the economy grew, and there seemed to be little to complain about. Especially by the higher wealth brackets of the country, and wealth inequality rose and rose and rose.

2010s

The second decade of the twenty-first century captured the very essence of this policy of credit inflation.

From the end of the Great Recession to the start of the Covid-19-connected economic recession, the U.S. economy grew by a compound rate of growth of about 2.2 percent.

Consumer price inflation was about the same, around 2.2 percent during this time.

Stock prices took off during this period, with very few down periods, and they were very minor. Housing prices soared, and so on.

The economic policy constructed by Fed Chairman Ben Bernanke specifically focused on stock prices, with the idea that rising stock prices would create an increase in consumer wealth that would stimulate aggregate demand and keep the economy moving. Quantitative easing was born and was steadily carried out.

And, so, the 2010 decade was a very good period. Economic growth was not quite where a lot of politicians would have liked it to be, but consumer price inflation was very acceptable.

Then we moved to the 2020s. The Covid-19 pandemic hit and then consumer price inflation started raising its head.

To fight the effects of the Covid-19 pandemic, the Federal Reserve and the federal government responded very, very generously.

These actions have led many economists, myself included, to argue that the Federal Reserve very definitely created an asset bubble at this time as the amount of liquidity extended was enormous.

And, as I argue, the efforts have left " lots and lots of money floating around ."

Even though the Federal Reserve started fighting the current inflation battle in March 2022 and created the policy program of quantitative tightening to reduce the size of its securities portfolio, the effort still seems to have a long way to go.

But, things seem to have changed.

The "New" Narrative

And, this is what Ms. Tett is getting at in her article.

The problem, "it is a trait of human nature to assume that whatever we grew up with represents 'normality' and will continue."

Moreover,

"Since stealthy asset price inflation has been happening for so long, even before 2000, it now feels entirely 'normal.'"

In the old world, "asset price inflation has been a key factor behind the rising wealth inequality...."

The "trend of ever-rising asset prices might be about to change."

"Interest rates have been on a decades-long downward trend making rates cheap. However, last year, rates jumped up, wiping some $8 trillion, equivalent to a third of the U.S. economy, from household assets in 2022 alone."

And, Ms. Tett expects this trend to continue.

"This week Jamie Dimon, head of JPMorgan Chase, warned that 'everyone should be prepared for rates going ((EVEN)) higher from here.'"

Then Ms. Tett asks the question,

"If we are moving into a new 'normal,' how will we cognitively adjust?"

This is the Robert Lucas picture presented at the top of this article.

Questions

Ms. Tett ends by asking two questions:

First, "can we adjust our minds to an era where asset prices do not always rise?";

Second, "what will be our future 'normal?'"

Mr. Lucas would like to know the answer to these questions as well.

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