The Looming Economic Bubble

by Conrad Black

Federal Reserve

There has been considerable discussion in the last couple of months about the rate of inflation in the United States, and polls now show that 85 percent of Americans are concerned about inflation. This is a demonstration once again of the wisdom of the average person.

While the United States, and to a lesser extent the West generally, is being subjected to a variety of threats and disappointments, and there is a natural aversion to highlighting additional negative developments that could be looming, it would be comforting if we heard anything from the secretary of the treasury or the chairman of the Federal Reserve about the current apparition of a gigantic financial bubble over the United States.

In the last year, the United States has had a money supply increase of 25 percent, an unprecedented event. What was originally billed as slight and self-correcting inflation increases are now gathering into a continuing and growing storm cloud, only thinly disguised by the unrepresentative composition of the official consumer price index. Year over year, hourly pay scales have risen by 7.5 percent, new cars are 10 percent more expensive, used cars and new homes 20 percent more expensive, and rental accommodation 12 percent more expensive. These increases all fall short of the money supply increase, and they all appear to be stoking up rather than settling down.

There has been a gradually rising 12-year buildup in equities values, only briefly interrupted by the tight V of the Covid interruption. This rise has been sustained by extraordinarily low interest rates, which are going to become extremely difficult to maintain as the rate of inflation increases; we cannot really expect the lending community to lose money and to loan money at rates below the rate of inflation.

The excellent stock market performance of these past years and the problem that now impends are based in part on the extraordinarily high levels of profitability in the American corporate sector. Where once the chief preoccupation of executives and directors of large companies was market share, it has latterly been profitability, and this has been assisted by the official American toleration of a higher than usual level of cartelism and informal price-fixing within industries. This has generated very high profits, and these have been powerfully reenlisted in the economy, but by any traditional standards, current American levels of profitability cannot be sustained.

These levels have reached unheard of proportions and are 80 percent above those in the rest of the world. The most remarkable characteristic of this market is that about 85 percent of this super-profit the United States is enjoying is produced by a small number of huge high-tech companies. There has never been anything like this in economic history: Apple has the largest market capitalization of any company in the world, and its sales have risen by 50 percent in the last year. Normally, companies of this immense size are mature and do very well with a sales increase of between 5 and 10 percent a year. The great American high-tech companies retain an immense potential for sales and profit increases, but no company in any market can run up 50 percent increases indefinitely long after it has become the largest corporation in the world.

American inventiveness, optimism, competence, the Trump tax system, and the fact that the United States has approximately two-thirds of the world’s most advanced research universities are all factors that militate in favor of the continuation of this trend, but it is impossible to imagine that it can continue at this rate indefinitely. Many traditions have been broken and buried by changes and innovations, but J.P. Morgan’s famous assertion that “like a tree, the market cannot grow to the sky,” retains some validity.

Because of the extreme vulnerability of almost the entire American public sector to increases in interest rates, that tool, which was always a blunderbuss anyway, of increasing interest rates to reduce demand and ultimately reduce inflation, although each one point rise in the lending rate initially adds half a point of inflation, is not really available to managers of fiscal and monetary policy now. A sharp increase in interest rates would have an impact on the U.S. national debt of nearly $29 trillion that would be calamitous, which effectively rules out Joe Biden’s proposed tax increases. If inflation produces deflation, the only obvious way out will be Reagan-like recourse to supply-side economics.

There are already worrisome signs of pre-crash market tactics: the British special purpose acquisition company index has slumped, and Bitcoin and Tesla are both well below their highs. Unique agents of growth have been the massive increase in the number of people speculating in the market and the unusually large dollops of stimulative spending of the Biden administration. There is a worrisome quantity of trading options, which increases the possibility of an immense obliteration of value if heavy sales start and are not contradicted.

There are now many other characteristics of a bubble in the current economic condition of the United States: Home prices as a multiple of family income are now higher in the United States than they were in the great housing bubble of 2006 and 2007. In all of the circumstances, it is both difficult and unwise to regard the current condition of the U.S. economy and of the West generally otherwise than as precarious. All economic bubbles burst eventually, although the economy always revives eventually. But it is becoming more complicated. People who read the works of Dr. Johnson and of Charles Dickens a century apart will see that the cost of basic items like a cup of tea or ordinary lodging for the night did not change from the mid-18th century to the mid-19th century in England; there was practically no inflation but there were terrible booms and busts. After the overwhelming economic crisis of the early 1930s, the major currencies detached themselves from the traditional discipline of gold and adopted the policy of using stimulative spending to end recessions and thus to avoid depressions. This has been substantially successful except that the incidence of inflation is unavoidable and exponential, and we see it in any comparison in the prices of anything except brand-new breakthrough products across the last 75 years since World War II.

Danger lurks in the widespread recourse in recent years to quantitative easing, which effectively meant that when U.S. government and other national bond issues went unsold, instead of raising the interest rate on them to assure their sale, they were effectively bought by the Federal Reserve, a related party of the U.S. Treasury, and were paid for in notes. This was paper chasing paper, and it is a very rickety structure for the fiscal and monetary edifice of a great nation. We are slipping inexorably into increasing emphasis on the velocity of money. Sometimes I use the example that if a small and rather poor country such as Paraguay required every adult citizen to write a poem each day and sell it and buy one from someone else, always for $10 regardless of the length or literary quality of the poem, at the end of the year Paraguay would have the highest standard of living of any country in the world (GDP divided by population), but no one would be any richer. This is obviously an extreme example, but to some extent that is what the United States has been doing as it exported its manufacturing capacity and allowed a great deal of completely superfluous activity that produced no added value to anything to pass as “service industry.” A trillion dollars of student debts have accumulated to provide millions of university graduates with qualifications that do not enable them to earn a living.

None of this can go on much longer, and there is no sign that anyone in Washington has the remotest idea of how to deal with what follows.

First published in the Epoch Times.