Good economic news from the United States this week has provided a graphic example of the irrationality of the global system. Defying gloomy forecasts, the US economy added over half a million new jobs to its total in January, taking unemployment to its lowest level since 1969. Happily timed for President Joe Biden’s State of the Union address, rising employment has also come with average pay rises that remain, at 5.5 per cent a year, well above the pre-Covid average of just over 3 per cent annually.
This ought to be cause for some celebration – and Biden himself was, of course, quick to take credit. But the immediate reaction from the US stock market was to slump on the news. This isn’t how things are supposed to work. Former President Donald Trump never tired of pointing to a rising stock market as supposed proof of his stable economic genius. A rising stock market is supposed to mean the times are good, with more to come. Yet that isn’t what is now happening on Wall Street. And the contradiction between rising jobs and higher pay, but falling share prices, points to a tension running through the centre of the global economy.
To understand what is happening, we need to remember that the US central bank, the Federal Reserve, has set itself the ambition of raising unemployment. It doesn’t often say it quite so explicitly, but when the Fed decides to raise its interest rate, the aim is to clamp down on economic activity by making borrowing more expensive, and so push more people out of work. They believe, and their economic models tell them, that when unemployment rises, people will not be so keen to demand higher pay. And if – the Fed logic continues – people are working for lower pay, inflation will also start to come down.
Never mind that inflation today, in the US, as across the rest of the world, is coming from huge external factors. The Russian invasion of Ukraine, or extreme weather disrupting harvests, or the recent major bird flu outbreak have nothing to do with how much workers in the US are paid, but all of them are pushing up inflation. And whilst wages and salaries are typically going up faster than before, they are still not rising as fast as prices – inflation is higher than average pay rises in the US, as across much of the world. Clearly it can’t be pay that is pushing up prices.
But this is what the Federal Reserve believes, like every other major central bank. So as inflation rose it has been jacking up interest rates and letting it be known that more rises will come over this year.
Now this is bad news in general – if the Federal Reserve pushes up its own interest rate, that tends to turn into higher borrowing costs for everyone. But it’s particularly bad news for those people and institutions trading in financial markets. Over the last few years – arguably even longer, since the early 2000s – Wall St has become very dependent on “cheap money” to fuel its booms. When interest rates are low, and money is readily available to borrow, speculators can buy up shares and other assets, and drive prices up. Quantitative easing by the Fed, when the central bank issued trillions of new dollars over the last decade, reinforced this mechanism. Cheap, easily available money turned into financial speculation.
But as inflation bit over 2022, the Fed, believing higher interest rates would reduce inflation via reducing demand for employment, began to raise its interest rate quite rapidly. This had immediate consequences for financial markets: the huge bubble that had built up in tech stocks since 2008 began to deflate. Amazon, Google and other major tech companies are all now worth far less than they were.
But notice what has happened here. Because the Federal Reserve believes inflation is coming from what happens in the labour market, good news in the labour market – more jobs and higher wages – will lead to it pushing up interest rates. And that’s bad news for the stock market. On the other hand, more unemployment and lower wages means the Fed is less likely to put up interest rates – good news for the speculators!
So in complete defiance of the traditional, Trumpian belief that rising stocks are good for US workers, the complete opposite now applies. The worse the news for US workers, the better for the stock market, via the Federal Reserve. It’s a crazy situation – nothing in this makes much sense, from the Fed’s stubborn belief that bashing workers will cut inflation, to the stock market bubbles it has created to the tremors across the rest of the world rising Federal Reserve rates induce. Those typically poorer countries with significant dollar debts face ruin over this year as the interest due on those dollar debts rises.
Can anything be done about this? A starting point would be for central banks to admit the limits to their own competence. There is little the Fed can do about inflation of the kind we have, and it shouldn’t be US workers – or the poor of the Global South – who have to bear the consequences of its dogged failure.