Wall Street’s implosion is terrible news for Biden - and it’s going to get worse

Is Jerome Powell, chairman of the US Federal Reserve, an Arthur Burns, who chaired the Fed throughout much of the 1970s and was mercilessly pushed around by his political masters, or a Paul Volcker, who became Fed chair soon after Burns and stubbornly pursued his own independent course in exorcising inflation from the US economy, even when it meant inducing a deep recession?

The now established bear market in the US, with the S&P 500 off by more than 20 per cent since its turn of the year peak, strongly suggests that even if he didn’t begin as Volcker, Powell is fast turning into him. Investors are behaving accordingly - with their feet.

Fed chair’s Jerome Powell belated determination to rein in inflation will damage Joe Biden’s re-election prospects.Credit: AP

Against a backdrop of steadily worsening inflation, the Fed’s Open Market Committee raised interest rates by a full 0.75 percentage points at its meeting this week - the first time it has increased rates by this amount since 1994.

After months of dithering, Powell appears ever more serious about pursuing his price stability mandate, even if it means crashing previously buoyant asset prices. This has big political implications, both for the midterms and for Joe Biden’s chances of re-election further out.

The stock market is not the economy, but it is perhaps a closer reflection of it in the US - where a substantial proportion of the population is directly invested in stocks and shares - than almost anywhere else.

The upshot is that falling stock prices feed much more powerfully into economic activity via wealth effects in the US than they do in the UK and much of the rest of Europe. If people feel less wealthy, they are likely to spend less, with adverse consequences for aggregate demand.

When he first ran for president in 1960, Richard Nixon roundly blamed his defeat on the Fed, and the tight money and recessionary conditions of the time.

He was not going to allow that to happen to him again, and after finally winning the presidency in 1968, he appointed Burns with specific instructions to ensure easy credit in the run up to second-term elections in 1972. Jobs and growth were prioritised over rising inflationary pressures, which Nixon instead attempted to tame through price and wage controls. It didn’t work. Consumer price inflation averaged around 9 per cent per annum during Burns’ eight-year tenure at the Fed.

Then, after a year’s gap, in comes Volcker, nominated by Jimmy Carter to do the right thing and put the inflationary genie back in its bottle. Unfortunately, doing the right thing often doesn’t pay politically, and though the economy wasn’t the only thing that doomed Carter’s chances of a second term, Volcker’s medicine was certainly a contributory factor. Hence Ronald Reagan’s famous quip: “Recession is when your neighbour loses his job. Depression is when you lose yours. And recovery is when Jimmy Carter loses his.”

Powell was nominated by Donald Trump with the same purpose in mind as Nixon’s appointment of Burns, in that he believed Powell would be a patsy who would “prime the pump” - an expression that bizarrely Trump seemed to believe he had invented himself - with easy money, keeping both the stock market and Trump’s own chances of re-election sweet. Ironically, he might have done better with Powell’s ultra-dovish predecessor, Janet Yellen, but she was a Democrat, so stood no chance of a second term.

In any case, Trump soon fell out with Powell, who refused to go along with the full extent of the “pump priming” Trump demanded. By the end, the two couldn’t so much as be in the same room together. Powell eventually got a second term from Joe Biden, and then repaid the favour by keeping monetary policy far looser than it should have been given the extent of Biden’s fiscal stimulus.

As far as markets are concerned, the bad news is that the recent losses merely consist of the speculative froth and overvaluations of the tech sector. The more the Fed slams on the brakes, the more the sell-off will work its way into the wider market.

Fast-forward to now, and Powell has transmogrified into Volcker; he’s determined to win back lost credibility by coming down hard, possibly harder than strictly necessary, on the sudden resurgence in inflation. This indeed is what he should do, but if it induces a recession, it’s cold comfort to Biden, who finds himself in much the same position as Carter. Finally, Powell is doing the job Trump demanded of him, only the other way around - bolstering Trump’s electoral chances in opposition while undermining those of the incumbent.

There has always been a strong correlation between the electoral and the economic cycle, but rarely more so than now. Gone are the days of the “Greenspan put”, when at the first sign of trouble in markets, the Fed would come riding over the hill, like the seventh cavalry, with another dollop of easy money. Investors could always rely on the Fed to rescue them. Yet the ability to do so relied on an altogether different, disinflationary age, when however low interest rates went, price stability seemed unaffected. With inflation approaching double digits, there is no such flexibility today.

Wall Street’s benchmark index just entered a bear market, and more pain could be ahead.Credit: AP

All things considered, it’s remarkable how long the buoyancy in stock markets persisted. In part, that’s down to the pandemic, when after a brief flurry of nerves - in which it was feared that we were all about to die - the stock market came roaring back, led by a newly reinvigorated tech sector all fired up by the delights of streamed entertainment, while notionally working from home, and underpinned by another giant splurge of monetary and fiscal stimulus.

It was the last hurrah of what now looks almost like a bygone age. As far as markets are concerned, the bad news is that the recent losses merely consist of the speculative froth and overvaluations of the tech sector. The more the Fed slams on the brakes, the more the sell-off will work its way into the wider market.

The only reason we’ve not yet seen quite the same level of damage over here in Britain is that our own plodding FTSE 100 was largely bereft of tech in the first place. Top heavy in oil and other commodity stocks, what was the FTSE’s weakness is today its strength. That and the weak pound, which cushions the impact of globally falling asset prices.

Hold on to your hats. If Jerome Powell really has been reincarnated as Paul Volcker, stock markets are going to get quite a bit rougher yet before they get better.

The Telegraph, London

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