The US economy is broken.
I tried to explain that belief often over the past 10 years. I argued that not only was the American economy weak, but it was damaged — broken — by years of too-low interest rates, excessive federal spending and experimental Federal Reserve policies.
Now you are beginning to see what I meant.
Over the past few months, US economic statistics have shown some signs of life. Even inflation picked up last month.
That’s what you saw happen over the past two weeks when there was a massive drop in stock and bond prices — and a huge jump in interest rates.
The modest improvement in US businesses — with the economy growing at an acceptable, but not robust pace of around 3 to 4 percent a year — is causing overreactions by the financial markets.
And that will probably lead to more tightening of interest rates by the Fed than would have occurred otherwise.
The stock and bond markets were clearly in a bubble. I predicted at the start of 2018 that the bond market bubble would be the first to burst and that it would take stocks down with it.
And that’s what is happening.
The bond market bubble has been caused by an excessively accommodating monetary policy by the last three Fed chiefs — Alan Greenspan, Ben Bernanke and Janet Yellen. They had their reasons for doing that, but the result was a country awash in money.
Now the fear of inflation begins. If these were normal times, the slight improvement in the economy wouldn’t cause this overreaction.
President Trump is correct on one thing — it used to be that good news was celebrated by Wall Street. It didn’t cause violent reactions in the markets like what began after the Labor Department announced a reasonably good, but not stellar, employment report for January.
Not only did the Fed keep interest rates abnormally low, but Bernanke concocted a policy called quantitative easing that printed trillions of dollars in extra money that was used to buy US government bonds.
With that, the Fed could make it look like there was strong demand for Washington’s bonds, which in turn caused interest rates to stay much lower than they would have been. It was a flim-flam maneuver.
Now it’s payback time. Because of past policies, the Fed is being forced to jam on the brakes before the economy really gets rolling. And quantitative easing is being undone.
The Fed really doesn’t have a choice because the financial markets are already hypersensitive to any improvement in the economy.
The 10-year Treasury note, which is now considered the benchmark, is quickly approaching the 3 percent level. It had been below 2.55 percent at the start of 2018.
Rates are shooting up despite scant evidence that the economic improvement is going to last.
Part of the reason for the rate jump is the tax cut passed at the end of last year by Congress.
Another part is the fact that the Trump administration seems to be unconcerned about federal deficits, as evidenced in the budget put out this week.
And if the economy wasn’t broken, the tax cuts should have been celebrated by the markets because of what it might — and I emphasize “might” — do for the economy.
Instead, the cuts created a panic in the financial markets.
The same thing happened with the temporary budget deal announced earlier this month. The government decided to spend more — and increase the deficit — and the markets didn’t like it.
The Dow Jones industrial average dropped 1,000 points right before the deal was signed.
What’s eating at bonds?
For one, the US is already $20.6 trillion in debt — and rising — with no relief in the form of slower spending by Washington.
Second, the tax cut is going to add to the deficit by cutting the amount of tax revenue Uncle Sam receives.
And third, higher interest rates caused by the tax-cut stimulus are going to cost Washington more to finance its debt — which will also increase our country’s annual deficit and the overall debt.
In other words, the US economy can’t handle even the slightest good news. So that good news creates problems in the financial markets, which causes bad things to happen.
The economy is broken.
Take what happened two Fridays ago as an example. Labor announced that 200,000 new jobs were created in January. That’s a good number, but not a great one.
And had anyone bothered to dive a little deeper into the number, they would have found that January really wasn’t a good month after all. That 200,000 gain came from seasonal adjustments.
Before the adjustment, the raw data show a monstrous loss of 3 million jobs.
Worse, if the job figure overstated the health of the economy because of seasonal adjustments, that also means the large increase in wages that really bothered investors was probably also a mirage.
But the headline figure of 200,000 and the wage growth are what Wall Street paid attention to — and it wasn’t happy.
This stock and bond markets can’t handle even a little good news without worrying. That’s why I think it is broken. And slapping on the same old kind solutions isn’t going to mend it.