Over a month ago, Janet Yellen was nominated as the new United States Treasury Secretary. During her speech, she told the members of Congress that the time had come for the government “to act big” to stimulate the economy. This event has become known as the ‘Yellen moment’ and could well become historic. Just as historic as the famous Volcker shock with which Federal Reserve Governor Paul Volcker fought inflation in 1979. Or more recently, the now-famous words of former ECB governor Mario Draghi “Whatever it takes” in 2012 to save the euro and the markets. Like these two memorable moments in financial history, Ms. Yellen’s statement looks set to become a major turning point for the economy and markets.
Volcker raised the Fed Funds Rate to 20 percent and this action would eventually kill off the rampant inflation in the United States. As we all know, since then the interest rate – at one point even 21.5 percent – has begun a long-term downward trend. . Governor Mario Draghi – currently Prime Minister of Italy – let slip at a meeting in London that the ECB would do everything in its power to keep the euro afloat. He also added the line “and believe me, it will be enough”. He was referring to the central bank’s buy-back programme that would be launched years later. It proved to be the turning point in the euro crisis and the markets would recover.
For over 40 years, the financial markets were dominated by monetarism and neoliberal thinking. These were particularly propagated by the IMF. A good government was above all a small government. Taxes had to be lowered, government spending brought under control and the market had to do the work. To make this possible, public spending was cut back, budgets had to be balanced and regulations reduced. Inflation – so typical of the 1970s – would disappear by itself. And so it happened. The financial markets were in for a treat. From the early 1980s onwards, stock and bond markets would embark on an unprecedented rise which, to this day, still seems to have not come to an end. Decreasing inflation made it possible for interest rates to fall further and further. Interest rates would even fall so far that there would be the talk of “free money”.
However, globalisation and the economic prosperity it brought also contributed to excesses that began to encounter increasing resistance from large sections of the population. The stock market was turning into a casino. The markets became increasingly unstable. The difference between winners and losers was widening. Populism emerged and then came the corona crisis. The virus accelerated these developments and many authorities began to realise that drastic measures might be needed to turn the tide. Central banks opened the money taps wide and governments abandoned any form of fiscal discipline. As so often, the United States took the initiative.
Is history repeating itself?
With the statement “Act Big” – also supported by many leading economists and the traditionally fiscally orthodox IMF – the United States government seems to be embarking on a new path. The Treasury Department and the Federal Reserve appear to be moving in tandem. The independent, autonomous position of the Federal Reserve seems to be abandoned. As a result, the markets will no longer have to rely solely on the support of the central bank. Comparisons are being drawn with the situation in the United States after the Second World War. The costly war had saddled the state with an enormous debt burden at the time. Debts had to be combated with very low-interest rates (financial repression) and large-scale state support. It would lead to an unprecedented boom period for the economy and the markets. A similar policy took place in Japan in the 1980s. There too, monetary easing and fiscal expansion went hand in hand. The result was an unprecedented stock market rally. The Nikkei index has never again seen its historic high of the early 1990s.
Investors get ready for a different world
The new 1900 billion dollar aid package from the Biden administration comes on top of the existing 900 billion dollar package from the Trump administration. Together, this amounts to government aid equivalent to 13% of GNP. Already there are concerns about the danger of inflation. Sounds that are perhaps not entirely unjustified. Free money seems nice, but it might turn out that it really does not exist. The world, under the leadership of the United States, has embarked on a bold experiment. Keynes’ theories are being dusted off again everywhere. Investors get ready for a different world.