By: TheInvestor
The Dow Jones Industrial Average plummeted 1,175 points on Monday, the largest one-day drop in its history. This was after a 666-point plunge on Friday. In the past three trading days, the S&P, another important stock index, also lost more than $1 trillion in market value.
If, like me, you’re not an expert on the stock market, it can be hard to make sense of sudden collapses like this. So I reached out to Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics, for some broader context.
I asked him what happened with the market yesterday, if we should be alarmed, and if the dip is related at all to President Trump’s fiscal policies.
A lightly edited transcript of our conversation follows.
Sean Illing
What’s going on with the stock market?
Jacob Kirkegaard
First of all, we need to be clear that very violent swings in the market are increasingly a function of the fact that 90 percent of all trades are electronic; it’s computers trading with computers. And the way these computers are programmed doesn’t vary all that much, so when you have a shift in expectations for an important belief about the future, all of these computers change their trading at the same time.
Sean Illing
What was the variable that shifted on Friday or on Monday? What belief ignited this collapse?
Jacob Kirkegaard
What I think happened is that on Friday we got a reading of wage inflation in the latest jobs report, which was roughly 2.9 percent. That was the highest it’s been in a very long time. So this led the computers to change their expectations for future inflation. Basically, the computers calculated that even higher inflation is inevitable, and therefore they expect the Federal Reserve to raise interest rates more rapidly. And the spike in sellers reflected that.
Sean Illing
So this was a more or less predictable response to material changes in the economy?
Jacob Kirkegaard
Perhaps. You might say this was sort of the straw that broke the camel’s back. Obviously, this didn’t happen in isolation. We just passed a massive deficit-financed tax cut last month, which from a business cycle point of view comes at a crazy point in time. The US economy is operating at full capacity, in my opinion, and then we get this huge tax cut, which is like another shot of adrenaline to the economy. That can only drive inflation even higher.
There’s also a change in leadership at the Federal Reserve, with Janet Yellen stepping down and being replaced by Jerome Powell. Now, I don’t think there will be much difference between Yellen and Powell, but that’s just my opinion — there is still an added layer of uncertainty about where the Fed goes from here. So that’s another factor creating instability in the market.
Sean Illing
Is this decline a direct reaction to Trump’s tax cuts?
Jacob Kirkegaard
In a word, yes. This is a predictable outcome of giving large deficit-financed tax cuts when the economy is already operating at essentially full speed. Doing that was sure to produce more inflation, which, in turn, leads to market responses like the one we’re seeing. So yes, there’s a connection.
Now, there’s a larger debate to be had about inflation, tax cuts, and the larger declines we’ve seen in the market. The market has been going up for a long time without any clear indications that the US economy is any better than it was, say, a year ago. It’s much clearer that the global economy is better than it was a year ago, and that impacts what happens in the US market. But I think a correction of some kind was long overdue, and that may be what we’re seeing now.
Sean Illing
You’ve mentioned the deficit a couple times, and I want to be clear about its role in all this. How does the deficit factor into these sudden plunges in the market?
Jacob Kirkegaard
It has to do with the fact that when the federal government has very large deficits, and most projections indicate that the deficit may hit a trillion dollars next year, that means the federal government has to go out and borrow that money. It can’t just expect the Federal Reserve to print money, so they have to borrow that money on the market.
That means there will be more demand for money, and therefore the price of money goes up and interest rates go up. And this is entirely what you would expect when you have a massive deficit like we currently do, and it’s certainly what you’d expect when you finance tax cuts by adding even more to the deficit.
Sean Illing
How alarmed should people be by what we’ve seen the last few days on the market?
Jacob Kirkegaard
I don’t think people should be panicked at all. Fundamentally, the number that we got with the 2.9 percent wage increase is good news. But it does signal that perhaps the period of extraordinarily low interest rates and low inflation levels that we’ve had since 2008 is over. And stock markets and other financial markets will need to adjust to that.
But from the perspective of the average American, the fact that he or she gets, on average, higher wages is good news. Of course, it’s not so good if a week ago you put all your savings into the stock market, but there are always winners and losers, and the markets tend to balance out on a much longer timeline.
Source:http://theconservativeinvestordaily.com/2018/02/06/what-the-hell-is-happening-with-the-stock-market-i-asked-an-expert-vox/
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