Can Cheap Money Spark a Continued Economic Recovery?
A prominent narrative within the financial commentariat is that Wall Street loves easy, cheap money. What’s odd about this untrue, and much unexamined belief is how the mere suggestion is at complete odds with a highly numerical reality.
In truth, the symbol that is Wall Street suffers mightily during periods of easy money, while it thrives during times of relative dollar strength and stability. This will soon become apparent below, but with “Wall Street” always and everywhere an easy target for writers looking to make a splash, the snarky opinion that the financial world revels in dollar destruction has taken hold despite all the evidence to the contrary.
To begin, it’s best to start with the basics of stock-market returns. “Easy money” is a somewhat modern, 40-year old concept given how the dollar had a gold definition up until 1971. But the 40 years since give us four decades of returns since with which we can examine this widely held presumption.
Looking at the 1970s, the dollar bought 1/35th of an ounce of gold (NYSE:GLD) (less than that in private markets; gold was trading in the $40+ dollar range) as of 1971, but reached a then all-time high of $875 in early 1980. The S&P during that decade of “easy money” rose 17%, but in real terms it plummeted owing to the dollar’s severe decline. By the end of the devaluationist ‘70s equities were almost a forgotten concept, with BusinessWeekputting on its cover a now laughed at story about the supposed “death of equities.” For more analysis on our support levels and ranges for gold and silver, consider a free 14-day trial to our acclaimed Gold & Silver Investment Newsletter.
Happily the early part of 1980 marked the ascent of Ronald Reagan, including his victory in the GOP New Hampshire primary. And with Reagan on record as a strong dollar, gold standard advocate, the yellow metal began a long decline.
Amid the dollar’s rise, equities began a long bull market that was only reversed in 1987 thanks to looming legislative mistakes of the tax (LBOs would be made more difficult to complete from a tax perspective) and tariff (Rep. Gephardt’s threatened duties on Japanese goods) variety, not to mention that Treasury Secretary James Baker went on television the day before the ’87 crash to talk down the dollar.
Happily, the bull market resumed after the crash thanks to market relief that what had spooked investors would not come to pass. Needless to say, what we call Wall Street boomed in the Reagan ‘80s with many great talents migrating there to be a part of all the wealth creation that made financial firms flush.
Jumping to the 1990s, President Clinton stumbled a bit at first with tax rate increases, a Treasury Secretary (Lloyd Bentsen) who preferred a weak dollar, plus threatened tariffs on luxury Japanese autos which were an explicit signal of the Administration’s preference for a weak, easy dollar, but by 1995 Clinton righted the ship with the help of a Republican Congress. Capital gains tax rates went down, and thanks to Clinton’s elevation of Robert Rubin to Treasury Secretary, dollar policy improved impressively. Indeed, Rubin meant what he said about his preference for a strong dollar, and the evidence supporting the latter claim is that once Rubin was in place, never again did a responsible Clinton administration official ever complain about the Japanese yen being too weak.
With the dollar strengthening alongside reduced tax rates on capital gains, the stock markets soared yet again; the S&P rising 208% during Clinton’s presidency. Though the dollar ultimately rose into deflationary territory by 1999 (with unfortunate results), policy was mostly good and the dollar very strong and stable up until then such that stocks roared upward.
Moving to the 2000s, the Bush administration made its preference for a weak dollar apparent almost immediately through Treasury pressure on China about the yuan, along with tariffs placed on steel, softwood lumber and shrimp. Thus began a decline in the dollar that drove a recessionary rush into real estate (much like the Carter years), and then when the markets tried to correct this through a few bank failures, the Bush administration along with politicians from both sides of the aisle created a crisis by virtue of bailing out institutions the failure of which signaled an economy on the mend.
Looking at stock market returns, equities have still not reached highs first achieved over 11 years ago, Wall Street has suffered three bouts of layoffs since 2001, and thanks to the bailouts that only became “necessary” due to weak dollar policy that drove horrifying malinvestment, what commentators call Wall Street is now a weakened symbol of once-great glories, many of its proudest institutions either dead or bought out on the cheap, while a great number of the financial firms that managed to survive owe their existence to a federal government that does not believe all that strongly in profits. The bailoutsweakened Wall Street, and set back the economy more broadly as a result. End of story.
So does Wall Street really love easy money? Quite the opposite, and the reasons why are obvious. Easy money is a euphemism for the dollar destruction that drives investment away from the returns of the stock/bond assets that don’t yet exist and that Wall Street sells, and into the hard assets of yesterday that already do.
Dollar devaluation is anti-investment because assuming those willing to commit capital actually achieve returns, they’ll get back dollars that are reduced in value. This is why periods of easy money (think the ‘70s, and the ‘2000s) always coincide with bad stock markets.
Of course it’s during periods of rising stock markets (think the ‘80s and ‘90s) when financial firms do well. They prosper because good stock markets coincide with rising demand for their investment products and trading services, not to mention their investment banking services of the M&A and capital markets (think IPOs) variety.
To see the horrors that “easy money” brings to Wall Street, we need only reference a New York Times article from last Friday which led off with “Wall Street plans to get smaller this summer. Faced with weak markets and uncertainty over regulations, many of the biggest firms are preparing for deep cuts in jobs and other costs.” This latest round of reductions follows major staff cuts that occurred in 2008 and 2001.
Even Goldman Sachs (NYSE:GS) plans to reduce head count according to the aforementioned article, along with $1 billion in non-compensation costs. It’s notable with Goldman that back in the late ‘90s (full disclosure: I worked there from 1998-2001) amid a soaring dollar, the firm offered compensation to employees who referred new ones, paid out stock bonuses to reverse the outflow to a Silicon Valley made flush (venture capital backed IPOs totaled 46 in 2010 versus 210 in 2000) by the firm’s brilliant capital markets team, plus a “coolness committee” was established to make the venerable investment bank more welcoming to the great talents that rode its elevators each day.
But after a decade of dollar debasement overseen by two hapless administrations, one Republican and one Democrat, Wall Street is on its knees just as it was after a similar experiment was tried and failed miserably in the 1970s. Much as the commentariat might like to think otherwise, Wall Street is very much a part of Main Street, and when Main Street struggles thanks to pathetic dollar policy, so does its much-maligned cousin in Lower Manhattan.
John Tamny is a senior economic advisor to Toreador Research & Trading, a senior economist with H.C. Wainwright Economics, and editor of RealClearMarkets and Forbes.