Let's play the market meltdown blame game

According to an old proverb, success has many fathers, but failure is an orphan. That proved to be all too true of the 2008-09 Great Recession. In its aftermath, nobody in the policymaking, financial or academic communities stepped forward to accept responsibility for the worst global economic setback in the past 70 years. 

It is most unlikely that anyone (most certainly not President TrumpDonald John TrumpStates slashed 4,400 environmental agency jobs in past decade: study Biden hammers Trump over video of world leaders mocking him Iran building hidden arsenal of short-range ballistic missiles in Iraq: report MORE, who is already blaming Federal Reserve Chairman Jay Powell) will take credit for the current U.S. stock market free fall, which, after the worst December since the Great Depression, is all too likely to be not just a correction but an overdue unwinding of years of excess.

ADVERTISEMENT

Whether the damage remains limited to markets or spills over into the general economy remains to be seen. However, we could very well be on the verge of another global economic and financial crisis.

A striking aspect of the present stock market meltdown is that it is occurring so soon after President Trump kept boasting that his actions were leading to the stock market shattering records and after former Federal Reserve Chairwoman Janet YellenJanet Louise YellenWhat economic recession? Think of this economy as an elderly friend: Old age means coming death On The Money: Rising recession fears pose risk for Trump | Stocks suffer worst losses of 2019 | Trump blames 'clueless' Fed for economic worries MORE assured us that we would not see another global economic crisis in her lifetime

It is also occurring against the backdrop of the academic economic community again distinguishing itself by its virtual silence about the dangers of bubbles and of bankers continuing to make very risky loans as the music played on. 

It should have come as no surprise that sooner or later, the global financial markets would unwind as violently as they now seem to be doing, considering how far they were allowed to get out of line with their underlying values. It was only a matter of time before a market bust was going to occur.

It was not simply that nothing was done to stop global stock market valuations from reaching levels seen only three times in the past 100 years. It was also that government bond yields were allowed to drop to historically low levels, and nothing was done to stop financial institutions from making very risky loans to unworthy borrowers at unusually low interest rates.

One can perhaps partly excuse the world’s major central banks, including the Federal Reserve, for having set in motion our present boom-bust cycle by its highly unorthodox monetary policy response to the Great Recession. 

With the economy then in danger of succumbing to a deflationary spiral, with interest rates having gone as low as possible and with strong political opposition to fiscal stimulus, the world’s central banks had little option but to buy government bonds on an enormous scale to encourage investors to take on additional risk.

At the time, that seemed to be a price worth paying, even though it came at the risk of distorting financial market prices and creating a global market bubble.

Less easy to excuse was the Fed’s failure in 2017 to remove the low-interest-rate punch bowl when the global economic party was showing clear signs of getting out of hand.

With the American economy having reached close to full employment, with a 25-percent jump in equity prices and with a 10-percent dollar depreciation, why was the Fed so reluctant to increase rates?

A more aggressive monetary policy in 2017 might have brought sense back to the market and reduced the chance that the American economy might overheat and bring inflation in its wake. 

It is even more difficult to excuse the Trump administration and the Republican-led Congress for providing us with a large unfunded tax cut at precisely the wrong time in the economic cycle.

With unemployment very low and with the economy growing at a healthy clip, the last thing the economy needed was a fiscal stimulus that might stoke fears of inflation and force the Federal Reserve to raise interest rates. 

It is certainly not helping matters now at a time of heightened market volatility to have President Trump so publicly blaming Jay Powell for the stock market bust when public confidence so urgently needs to be restored.

This is all more so the case considering that it was Trump’s overly expansive fiscal policy that forced the Fed to raise interest rates to avoid the risk of economic overheating.  

ADVERTISEMENT

The academics and bankers also deserve blame for having learned so little from the world’s last boom-bust cycle. Is it too much to ask of academic economists to learn that excessive asset price inflation is not consistent with long-run economic stability — and that their role should be to sound the alarm when bubbles are forming?

Is it too much to ask of the financial sector to remember that making reckless loans gets us all into deep trouble when the music eventually stops playing? 

I raise all these questions not so much as an exercise in finger-pointing as in the hope that over the months ahead policymakers and economists will draw the right lessons about how we got into this very difficult economic and financial market situation.

Only then will there be some chance that we might escape these boom-bust cycles, which now appear to be occurring on all too regular a basis.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.