Based on the rapid rise of the stock market, the economy is booming. Then why are so many American consumers broke, stressed, and buried in debt?
During a recent interview with Kitco News, economist Dr. Mark Thornton said the growing disconnect between Wall Street and Main Street is the direct result of central bank monetary policy that led to decades of artificially low interest rates and monetary expansion.
Many people believe that interest rates are high right now, and there are growing worries that the central bank will hike further, but from a historical perspective, interest rates are relatively low.
As the Federal Reserve waged its post-pandemic inflation fight, it hiked rates to 5.5 percent, but even that was still slightly below the historical average. Today, the rate is set at between 3.5 and 3.75 percent.
The current interest rate environment only seems high because it was so low for so many years following the Great Recession. Today, we have a whole generation of people working in finance who can’t conceptualize “normal” rates. This explains why so many people are desperate for rate cuts today. Zero percent seems closer to normal than 6 percent.
Artificially low interest rates come with incentives. Thornton notes that they help governments and corporations borrow money for expansion.
“It also helps the wealthy because they can leverage up their assets. And lower interest rates, as everybody knows, increase the price of assets.”
On the other hand, loose monetary policy doesn’t do much for working people.
“People who have very little in the way of physical assets outside of maybe a home or a few things like that, but they’re not really leveraging up very much, and so what they experience is just the eventual higher prices from increasing all that money.”
Among the assets juiced by easy money are stocks.
Thornton said the stock market is significantly overvalued in terms of historical norms, and it’s a direct result of the inflationary impact of easy money. He noted that the Buffet Indicator is two-and-a-half standard deviations above the historical long-term average, and the Case-Shiller measure of valuation of the S&P 500 is at the second-highest level in history.
Thornton said these high stock market valuations can be explained by the Cantillon effect.
“The new money goes into the economy in general, but it goes into the hands first of a certain group of people. And so those groups are going to be advantaged because they’re getting fresh money at current prices.”
This explains the Wall Street boom and the giddiness on Wall Street.
But there is a dark side. As this new money circulates in the economy, it drives up prices on Main Street.
“Sometimes that’s almost imperceptible increases in prices, but it’s forcing prices up somewhere in the economy – assets, land, real estate, products, raw materials, and so forth, labor. … What is showing up on the kitchen table is higher prices.”
Thornton said the Iran war is exacerbating the pain on Main Street by driving up energy costs. While this isn’t the same as monetary inflation, the impact on the people around that kitchen table is no different.
“This is a tidal wave that is going to come back and smack the American consumer.”
So, how long can an economy continue to run on two tracks?
Thornton notes that it’s been going on for “quite some time.”
“Lately, it’s been very intense because of COVID and the $5 trillion that was unleased.”
He noted that the Fed has been on an inflationary path for more than a year, pointing out that the central bank has effectively relaunched quantitative easing.
“They are unrelenting in, you know, dosing the American population with this inflationary gas. Eventually, it’s going to light on fire and burn the economy down, in some respect.”
How will the central bank respond?
Thornton said the Fed is in “a Catch-22 position” and is likely looking for an excuse to cut rates despite the inflationary pressure.
“I think they’re going to be looking for the emergence of a crisis. They might call it a liquidity crisis, or a financing crisis, or a war crisis where they actually have to not increase interest rates and possibly cut interest rates. … I wouldn’t be surprised if something comes up where they actually get the opportunity to cut rates.”
This reveals a more fundamental reality. While the Fed’s job is theoretically to maintain stable prices and employment, it has different priorities in practice.
“The idea of the Fed is to help finance government largesse – to finance government spending and government deficits. That’s really what their true role is. It’s not balancing inflation and unemployment.”
That’s why, when push comes to shove, the Fed picks rescuing the economy with low interest rates and money printing rather than tackling inflation.
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