Is the US Economy About to Hit a Slow Patch?

After the “artificial recession” of Covid, it’s natural that the economy would rebound once the threat of lockdowns is over.

But, then what? It’s fine to ride the market euphoria of economic normalization, but once that happens, the market dynamics are going to be different. So what does it really mean for the market to be “normal” in a post-pandemic world?

Before covid, the US had record low unemployment and the economy was growing at a faster average rate than it had since the sub-prime crisis.

But is it realistic to think that the US economy will return to that, with everything that has happened in between?

So, what about Japan?

The US has experienced an extended period of low inflation; so long that virtually everyone in the market has no experience trading in a relatively high inflation environment.

Sure, the Fed insists that the rising inflation we see will be transitory. And the people who warn of impending inflation had their reputations a bit shaken after the subprime crisis. But there’s more on the horizon than just inflation.

Japan’s vaunted “economic miracle” of the post-war came to a screeching halt in 1990, and in many respects, has still not recovered from that crash.

Entire books have been written on the subject, but there are a couple of key elements. An extended period of low interest rates created an economic bubble that pushed stock valuations extraordinarily high.

Meanwhile, the price of housing went through the roof.

Where the parallels point

Where else have we seen massively overvalued stocks, and housing prices rising so fast many young people can’t afford a home?

Oh, right: in the US, today. Japan’s bubble burst after the BOJ raised rates in an effort to control runaway inflation. The reality is that at some point, the Fed is going to have to raise rates.

Just one point: p/e ratios in Japan reached 60 just before the crash. S&P 500 p/e ratios hit 44 just before the dot-com bubble burst.

And where are S&P 500 ratios now? 44.96 as of yesterday.

We’ve learned from the past, right?

Of course, the US is in a different situation than Japan was in 1990.

For one, there was no pandemic thirty years ago. However, the combination of massive deficit spending, plus low interest rates for extended periods of time, has gotten the Japanese economy to flourish.

Actually, low interest rates contribute to keeping the economy from advancing. And government subsidies and bailouts prop up too-big-to-fail “zombie” companies.

The reasoning behind the current stimulus programs is that government spending helps recover from a recession. That has been the case in the past. But government spending has to be paid for, either in increased taxes, which weigh on economic growth; or inflation, which also weighs on economic growth.

The US dollar is the world’s reserve currency. So, greenback inflation, in a way, is effectively a tax on the rest of the world to pay for the US’ debt.

But the US can’t hope to keep the dollar as a world reserve currency if inflation gets out of hand. Unlike other countries, the US has not faced massive inflation pressures; the Fed is more worried about deflation.

The economy might normalize on its own, but the “normalizing” of fiscal policy with this level of debt, both personal and governmental, is a very delicate task indeed.

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