The first week of 2025 is coming to an end. And the final days of Biden’s presidency cannot come too soon. Four years of large deficits and massive interventions have severely distorted the economy and stock markets. Both are maximally swollen.
President-elect Trump wants to keep both the stock market and the economy going. Asset prices and low unemployment give the appearance of good health on the surface. Trump is a reality TV expert. He wants things to look good. He wants rising stock prices and low unemployment as validation for his policies.
At the same time, Trump has said he wants to curb deficit spending. He wants to reduce waste and inefficiency. Both are really good goals. But they are at odds with the goal of a sustained revival of the stock market and economy.
Does Trump understand that the cause of the stimulus is deficit spending? What would happen if we eliminated $2 trillion in deficit spending? Will the economy collapse? Will stocks go south?
To be clear, cutting $2 trillion in deficit spending would be a good start to restoring America’s economic health. But there will also be short- and medium-term consequences. That means unemployment will soar and the stock market will crash.
Over several decades or more, the economy will rebuild itself on a sounder foundation. Jobs will be linked to productive outcomes rather than political conflict or special interests. Stock prices will also reflect the underlying value that the stock represents. Gambling on stock prices no longer pays off.
But getting there from here will be a long and painful toil…
perfect price
As we observed last week, there is little chance that Washington will balance its budget. Too many promises have been made to too many people for too long. Trump will not give up Social Security, Medicare or defense spending. And without cuts to these spending programs, it will be nearly impossible to eliminate the deficit.
Perhaps Musk and Ramaswamy can trim some of the fat around the edges. They may stop funding. ice skating drag queensThere are also gripping projects, such as a $12 million pickleball complex in Las Vegas. This would be the first step toward fiscal restraint. But the fundamentals of Washington’s budget problems will not change.
That’s the reality of how things stack up. We don’t like it. But that doesn’t change the unpleasant facts.
But posting large deficits is no guarantee that 2025 will be another fantastic year for stock market investors. Even if a deficit of $2 trillion remains, the situation is so heated that it is inevitable that it will eventually collapse.
In fact, the stock market has become so overheated that even the Federal Reserve (Fed) cannot remain still. For example, on Monday, Federal Reserve President Lisa Cook warned That:
“Valuations are rising across several asset classes, including equity and corporate debt markets, where expected risk premiums are near the bottom of their historical distributions. This suggests that the market may be priced perfectly, so a big decline could occur. “It’s caused by bad economic news or changes in investor sentiment.”
The Federal Reserve rarely comments on stock (i.e. stock) market conditions. As far as we can remember, this hasn’t happened in almost 30 years. Nonetheless, Cook’s comments are very accurate and should be taken seriously by investors.
irrational exuberance
Early in the stock market boom of the late 1990s, Alan Greenspan asked whether an irrational mania was at work. While speaking at the American Enterprise Institute on December 5, 1996, Greenspan asked.:
“But how do we know whether irrational excess has caused asset values to rise excessively, leading to unexpected, prolonged contraction, as has happened in Japan over the past decade? And how do you factor that assessment into monetary policy?”
Irrational excess later became a term used to describe speculative markets where unfounded optimism moves markets well above their fundamental values. Greenspan’s remarks implied that monetary policy also has some role to play.
On December 5, 1996, Greenspan continued to pour credit into the financial system despite concerns about irrational excesses. The Dow Jones Industrial Average soared from 6,437 on the day of the speech to a record high of 11,722 on January 14, 2000.
Over the next few years, Greenspan always found reasons to use monetary policy to apply liquidity to the financial system. He lowered interest rates after the collapse of hedge fund Long-Term Capital Management in 1998. Nasdaq, which was the starting point of the irrational craze, rose 86% in 1999 alone and peaked on March 10, 2000.
Then irrational enthusiasm gave way to rational despair. The stock market bubble burst in 2000-02. The DJIA fell nearly 40% and the Nasdaq tumbled. 77%.
Greenspan worked overtime to rekindle the spark of irrational enthusiasm by pumping credit into the financial system. This time, credit affected not only the stock market, but also real estate, oil and gold prices. Monetary stimulus was a key factor in inflating this series of bubbles.
Moreover, monetary stimulus has become a key policy of the Federal Reserve…
rational despair
After the 2008-09 financial crisis, the Federal Reserve poured additional credit into financial markets. This time, the Federal Reserve added quantitative easing, creating credit out of thin air and purchasing Treasury bonds and mortgages, to its extreme intervention measures and methods.
Quantitative easing, which had been recklessly abandoned during the coronavirus panic of 2020-22, has been re-adopted. The Federal Reserve applied stimulus without reservation. This time, it inflated consumer prices, stocks, real estate, and Bitcoin.
All this easy credit has led major stock market indices to their current extreme valuations. The risks are so great that even a small drop in corporate profits can cause a sharp sell-off in the stock market.
Nonetheless, irrational mania, along with continued Fed interest rate cuts, continues to drive stock markets higher. Shiller’s cyclically adjusted price-to-earnings (CAPE) ratios are as follows: 37 years or older It’s approaching the all-time high of 44, set in December 1999, months before the dot-com bubble burst.
Perhaps this is why some market analysts point out the following: 1999Looking forward to another monster year in 2025. And they may be right.
The stock market, as measured by the S&P 500, has enjoyed high valuations over the past 15 years. As a result, people who were irrational in their expectations of huge stock price increases performed much better than rational people.
We have behaved recklessly for so long that recklessness has become the norm. Blindly throwing money into the stock market has been a rewarding strategy.
Conversely, cool-headed people who look at the stock market rationally have observed a rise in stock prices that is completely out of touch with reality. Some investors have been sitting on the sidelines since 2016, waiting for the stock market to crash. They were rewarded with nothing but despair.
A sober perception of reality has not yielded any results for many years. But that could soon change.
And rising Treasury yields could finally be the pin that pricks the bubble.
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thank you,
minnesota gordon
for economic prism
A return from rational despair to an economic prism.
