While Wall Street is seemingly unfazed by this rather extraordinary performance, the Federal Reserve feels it might be time "to take away the punch bowl", as Federal Chairman William McChesney Martin Jr. used to say when the market got overboard, meaning it's time to drain cash from the system to cool the market enthusiasm. But before looking into this, we must go a step backward.
Manufacturing a bubble
In early 2009, the Federal Reserve launched a new policy dubbed "quantitative easing" whose undeclared goal was to rescue Wall Street from the 2008 crash. It worked. The stock market recovered. By march 2013, the S&P500 exceeded its pre-crisis level (1569 versus 1549) (graph 3). Of course, the policy did not achieve the same success with the rank-and-files. It took over six years for employment to return to its pre-crisis levels, a much longer elapsed time than in previous crises (graph 4). [1] Concerned the stock market may rise too fast, too quickly, the Federal Reserve attempted to slow it down on two occasions, under Ben Bernanke's and Janet Yellen's chairmanship but without much success.
The situation got out of hand when the stock market unexpectedly collapsed in February 2020. In a matter of days, the market dropped like a stone in an October 1929 fashion (graph 5). A culprit had to be found. COVID-19 took the rap even though on February 19, 2020 - the day the market began to fall - there was no Covid death reported in the United States. Congress reacted with an unusual speed. The operation was well choregraphed and flawlessly executed. Within ten days, Congress approved the "largest economic relief bill in U.S. history": $2.2 trillion, 10% of the gross domestic product. The Senate approved it unanimously on March 25. It was passed via a voice vote in the House the next day, and signed into law by President Donald Trump the following day (March 27). Common folks received $1,200 per person, plus $500 for each dependent. Unemployment benefits were expanded from 26 to 39 weeks with an additional $600 per week. Quite a feat! And should anyone doubt the officials' intentions, the name of the bill is meant to reassure the skeptics: The CARES Act!
Graph 5
Graph 6
The truth of the matter is that the package has a little to do with COVID but a lot with the stock market. The main beneficiaries were the banks and the corporations. Shortly after the CARES Act was signed, the Federal Reserve began injecting cash into the market, nearly doubling its size in four months, raising it from $4.2 trillion on February 19, 2020 to $7.2 trillion on June 10, 2020 (graph 6). The combined action of Congress and the Federal Reserve was a success. The stock market began to rise in April and by early June the Dow Jones had fully recouped its losses. The same cannot be said of the job market. On Joe Biden's Inauguration Day, 20 million Americans were still unemployed, down from 32.4 million at its peak on June 20, 2020 (if one adds the Pandemic Unemployment Assistance statistics to the Unemployment Insurance data). [2] On June 26, 2021, nearly 13.8 million workers were still unemployed.
To remedy this situation, Joe Biden signed on March 11, 2021, the $1.9 trillion American Rescue Plan Act which includes a $1,400 direct payment to individuals, a 15% increase in food stamp benefits, and a number of tax provisions plus grants to small businesses. This Act is to be followed by a $2 trillion infrastructure plan and a $1.8 trillion family plan. Altogether, the President's three plans amount to $5,7 trillion. Adding Donald Trump's $2,2 trillion CARES Act, the total comes to $7,7 trillion, or over a third of the American growth domestic product. This is an enormous jolt to the economy. While few doubts the need to repair the nation's infrastructure, strengthen R&D budgets, facilitate access to higher education, reinforce social services, and provide a job to every able person, one cannot help wonder what the impact of these plans on the public debt will be, if they ever come to fruition and, subsidiarily how they will be financed. American savings won't be enough, nor will foreign savings. The Administration probably calculates that the boost to the economy the plans will generate will outgrow the debt - a debt whose volume exceeds that of World War II level (graph 7). The Administration may be right but there is no guarantee this will be the case. If it doesn't, the Federal Reserve will have to come to the rescue through money creation with the risk of igniting inflation. Today, it holds 17% of the public debt (graph 8). This is twice the amount it held in 2007, prior to the subprime crisis. Furthermore, if things do not work as planned, the dollar will depreciate, as explained in a previous post.
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