Normally when a financial market rises amid a coup or extreme political instability, it is because the leftists are out and the animal spirits of business have been released. But last week in the US there was a different kind of result. Stock markets rallied, even as a group of pro-Donald Trump insurgents rampaged through the US Capitol. The reason, in brief, is that investors were cheering that a new Democratic administration that also controls Congress is about to take over.
President-elect Joe Biden will surely raise corporate taxes and increase regulation. From the perspective of business leaders, that’s never a good thing. But in last week’s elections in Georgia, Democrats won two Senate seats, giving Mr Biden’s party sway over both houses of Congress. That means Democrats will also be more able to push through fiscal stimulus in areas from infrastructure spending and healthcare, to education and aid to states. That in turn will complement the huge monetary tailwind still coming from the US Federal Reserve. Business, which had wrung all it could out of President Trump, is desperate for that kind of synchronised combination of fiscal and monetary stimulus.
For years, we have only had the latter. The actions of central bankers, combined with trillions of dollars of passively indexed investment that simply flows to wherever the market goes, have wiped out much of the market’s usual function of price discovery. Yet the disconnect from economic reality won’t last for ever.
As investment sage Jeremy Grantham wrote recently: “The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”
How could it not be? Low interest rates have encouraged a massive flood of debt, little of which is productive. Since 1980, total US debt rose from 142 per cent of gross domestic product to 254 per cent in 2019. As economist Atif Mian has pointed out: “If all this additional credit were to be used for productive investment . . . we should have seen an explosion in investment. Instead, the investment share of national output declined from an average of 24 per cent during the 1980s to 21 per cent during the 2010s.”
Some of that decline is due to the rise of the digital economy and because technology platform companies seem to require less capital investment. Another more troubling issue is that companies also put much of their spare cash into share buybacks. At the same time, public investment of the kind that creates broadly shared growth peaked in the late 1960s. Yet history shows that deep productivity booms come when the government invests in game-changing technologies — railroads or the internet in the past; 5G or green tech today — that the private sector then commercialises.
On top of that is the boon that Mr Trump will soon be gone. Even usually rightwing business groups such as the National Association of Manufacturers have called for vice-president Mike Pence to use the 25th amendment to remove him. That’s probably not going to happen — and it doesn’t really matter if it does, assuming we get to Mr Biden’s inauguration on January 20 without another debacle. More notably, it’s just the latest in a series of corporate outcries against the president, now joined even by longtime Trump supporter Steve Schwarzman, the co-founder of private equity group Blackstone.
All this shows we are at the end of an era. “Financialised” growth, built on debt and asset bubbles, has to be replaced by something real — just as the current president needs to be replaced by an actual leader. Last week’s insurrection in Washington only underscored that the future of US liberal democracy rests on the creation of a more stable political economy — one that generates more and better jobs for people who might otherwise be tempted to support the next homegrown autocrat.
The good news is that the Georgia results strengthen Mr Biden’s mandate to start remaking the economy in ways that will ultimately be good for a broad chunk of the country. Aid to beleaguered states rolling out the vaccines will rise. Climate-related spending will increase, with renewable energy being perhaps the biggest winner. That will mean more jobs in high-growth areas such as electric vehicles, green batteries and modernisation of buildings. Fiscal stimulus will also rise. Barring any major new coronavirus surprises, this will help economic growth in 2021.
But corporate taxes will rise, too, creating a headwind for stock prices. Furthermore, as vaccination coverage increases and the economy recovers, that may boost inflation and, possibly, interest rates — which will undermine asset prices. Mr Grantham even predicts a market correction as early as this summer. That would be a bitter pill for Mr Biden. But in our upside down world, investors should remember that a temporary market decline may actually indicate that the fortunes of the country are finally on the rise.