It’s looking like 1987 again for US economy

It is August 1987 and the US economy is humming along. Memories of thedeep recession earlier in the decade are fading fast. Tom Wolfe is aboutto publish The Bonfire of the Vanities, which captures perfectly WallStreet’s greedy bullishness.The financial markets have Paul Volcker to thank for rising shareprices. As chairman of America’s central bank, the Federal Reserve,Volcker had given the US economy shock treatment to rid it of itsinflationary excesses. Record-high interest rates triggered the worstrecession in the US since the 1930s, but once inflation started to comedown borrowing costs were cut sharply and the economy recovered.The president at the time, Ronald Reagan, showed little gratitude forthe boom that won him a second term with a landslide victory in 1984.Volcker, who had been appointed by Reagan’s predecessor, the DemocratJimmy Carter, was seen as insufficiently keen on Reagan’s plans forfinancial deregulation, so he was replaced by someone deemed to be moreon message: Alan Greenspan. Two months later, in October 1987, there wasa market meltdown.Sound familiar? As in 1987, the US economy has been growing at a fairlick. Unemployment is low and signs of inflation are starting to appear.As in 1987, the dollar is weak and share prices have been on asustained upward run. And as in 1987, a Republican president has justreplaced an old hand at the Federal Reserve with someone new. JanetYellen presided over her last meeting as chair in the middle of a weekthat saw wobbles in both the stock and bond markets. Trump got rid ofher for the same reasons that Reagan got rid of Volcker, She was aDemocrat and not wild about deregulation.As it happens, Yellen may just have got out in time after helping togive Trump the dream start to his presidency, a year in the Oval officethat has seen solid growth, more people in work and Wall Street breakingrecords on a regular basis. Jerome Powell, her replacement, has beenput there by the White House to provide more of the same, something thatis going to be a lot more difficult than Trump appears to think.For a start, Wall Street is starting to worry about rising inflation.Last week’s jobs report showed unemployment at 4.1%, its lowest for 17years, and average hourly earnings rising at an annual rate of 2.9%, thehighest in eight years. The weakness of the dollar makes importsdearer, while Trump’s tax cuts will kick in at the worst possiblemoment, toward the end of a long cyclical upswing when there is a dangerof the economy overheating.Up until now, the Fed has been acting with extreme caution. Interestrates have been raised in baby steps and with ample warning. Wall Streetthought Yellen had got her strategy just about right. Stimulus wasbeing removed in order to forestall any pickup in inflation, but not sorapidly as to choke off growth.Last week saw a different mood in the markets. Now there is concern thatthe Fed is a bit behind the curve and will be forced into tougheraction than the markets had hitherto been expecting. The chances of amisstep have increased at a time when it has a rookie in the top job.The default position in the markets is that last week was just a squallthat will quickly blow over. Economic fundamentals, it is said, are goodand there will be no real inflationary threat from rising earningsprovided productivity also picks up.But the Goldilocks scenario – not too hot, not too cold but just right –doesn’t really stack up. Investment and productivity have both beenpoor since the financial crisis of a decade ago. Household debt is highand consumers have only been able to fund their spending by dipping intotheir savings or by borrowing more.As the years roll by, it becomes ever clearer that the collapse ofLehman Brothers in September 2008 was not a cathartic event. Thesub-prime mortgage crisis was supposed to be the bubble of all bubbles,yet here we are 10 years later watching speculators pile in and out ofbitcoin. In two years it will be the 300th anniversary of the South Seabubble. History has a strange way of repeating itself.Speculation has thrived in recent years because central banks pumpedmoney into the financial system through record-low interest rates andquantitative easing. This prevented the banks from going bust andensured that the recession of 2008-09 was not as severe as the GreatDepression of the 1930s, but at a cost.Markets now think that if they act irresponsibly and cause anotherspeculative boom-bust the response from central banks will be zero - ornegative - interest rates and another splurge of QE. The monetaryauthorities have created a huge moral hazard problem for themselves.Central banks did enough in 2008-09 to prevent the collapse ofcapitalism. The coming period will show whether that breathing space wasused to make good the structural weaknesses exposed by the crisis: debtdependency, rising inequality, under-investment. If that is the case,last week will indeed just have been a wobble.But that’s not really the way it looks, and Donald Trump was perhapstempting fate in Davos when he boasted that the stock market wasconstantly smashing records as a result of his economic stewardship.Trouble tends to arrive quickly for new Fed chairs. With Greenspan itwas within two months. For his successor Ben Bernanke, it was 18 monthsbefore the sky fell in. Powell would be well advised to brush up on howto handle a financial crisis. - Guardian News and Media