Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. An earlier version appeared in The Guardian.
July 28, 2024 — The US stock market is on a tear. Since the start of this year, January 2024, the Dow Jones , S&P 500, and NASDAQ have each repeatedly set new all-time records. Indeed, the trend in stocks has been strongly upward for the last two or three years. For instance, the S & P 500 is about 40 % above where it was in January 2021, when Joe Biden became President [43 % higher].
The price of gold has also shown a strong upward trend, reaching $2,470 an ounce on July 17, the highest in history. Why are these assets so elevated?
- The stock market and gold
An increase in perceptions of risk due to recent political and geopolitical uncertainty, could explain the rising gold price. But it cannot explain the stock market. Anyway, the VIX has been declining during this period, not rising. That could explain the stock market, but not the price of gold.
Prices for chip-maker Invidia and other high-tech stocks have risen the most rapidly and have gotten the most attention, particularly inspired by the rapid emergence of artificial intelligence since late 2022. But even the rest of the stock market, with tech companies excluded, has seen a steady rise in prices.
Prospects of an easier monetary policy in the future could, in principle, explain both the high stock market and the high gold price. It is well known that the stock market depends inversely on the interest rate, holding other things constant. One way to think about it is that an increase in the interest rate reduces the presented discounted value of future corporate earnings. (Another way to think about is that an increase in the interest rate induces investors to shift out of equities and into bonds.) Conversely, lower interest rates would explain the higher stock market.
The real price of gold also depends inversely on the real interest rate, both in theory and practice. Prospects of easier monetary policy should raise demand for gold.
But interest rates, including long-term rates, rose during this period, which works to lower stock prices and commodity prices, not to raise them. So, where should we look to explain recent financial markets, the rise in real interest rates that has taken place over the last two to three years, or the likely prospects of reductions in the near future? For an answer, let’s turn to the foreign exchange market.
- The foreign exchange market
The foreign exchange market provides the most convincing evidence that recent movements in financial markets have come at a time when monetary policy is, if anything, tighter than had been expected two or three years ago, not looser. The dollar is 14 % stronger than it was three years ago [=log 117/102, for the index of advanced-country currencies.]. If real interest rates during this period were low or expected to fall, the currency should be weaker, not stronger.
One explanation that has been given for the run-up in gold prices is that many countries are diversifying out of dollars and into gold. This is likely to be especially true of the People’s Bank of China and other central banks of countries that don’t have good geopolitical relations with the US (for example, as reflected in voting patterns in the UN) and thus may fear future sanctions. But, again, the foreign exchange value of the dollar should have been weakening, if that were the explanation, which it is not. Furthermore, recent econometric evidence shows surprisingly little support for the hypothesis that geopolitical disaffection vis-vis the US is driving the global shift out of dollars.
- GDP growth can explain it all
What can explain simultaneously high prices in all three markets, gold, stocks, and the dollar? The answer is strong demand for these three assets coming from a strong US real economy. Two or three years ago, professional forecasters as well as the general public thought there was a high chance of recession in the near future, if indeed the economy was not already in one. But, contrary to those expectations, real GDP over this period has continued to grow.
Admittedly, in the case of the price of gold, one should look at global growth, not US growth. (Growth in Europe and China has lagged; but the IMF says that global output gaps are now closing in these places.) US consumer demand has been strong. Growth in 2021 and 2022 was boosted by the CHIPS Act, Infrastructure Investment Act and the Inflation Reduction Act. Members of neither political party are prepared to reverse the fiscal expansion in order to confront the rising national debt. And a global safe-haven demand for US assets, so far, has continued as strong as ever.
True, US economic growth, registering 2.5 % in 2023, has slowed relative to the rapid pace of 2021. But it is still higher than has been usual so far this century. (The average GDP growth rate since 2001 was 2.0 %.) And, most relevant for asset prices during this period, economic activity has been stronger than had been expected at the beginning of Biden’s term. Not only was growth in 2021 unusually high, but observers’ forecasts that growth would disappear in 2022, 2023, and 2024, were repeatedly surprised on the upside. The advance estimate of 2nd-quarter GDP was yet another upside surprise, at 2.8 growth%. Presumably, each time that economic activity was higher than expected, the demand for American stocks, gold, and the dollar rose. This would explain the upward trends in all three sorts of assets.
Whether this pattern of strength will continue after the November presidential election is anyone’s guess.
This post written by Jeffrey Frankel.
Lots of interesting links. I’m reading your papers on gold after checking out that August blog post which criticized the gold standard which of course Judy Shelton and Stephen Moore advocate – at least whenever Trump tells them to take the opposite position.
Makes good sense. When you look at growth and equity market performance abroad, the case for growth-driven equity-market performance gains support.
I’d propose an additional factor for stocks and, to an extent, gold – the prospect of lower tax rates on capital gains and on high incomes. Expected after-tax returns drive equity prices. Trump has promised lower taxes and if he wins, there’s a good chance Republicans will control both chambers in Congress. Lower taxes become highly likely.
Let’s watch what happens to stocks as polls swing on the way to November.
Sorry to go off topic but I JUST had to endure an interview with this MAGA piece of trash:
Former Trump aide Jason Miller said he hired prostitutes and visited massage parlors, court documents say
https://www.businessinsider.com/trump-aide-jason-miller-allegedly-admits-hiring-prostitutes-2019-7
Miller had his talking points to spin and whenever the woman on MSNBC tried to get actual facts in, Miller would literally scream “HOLD ON” returning to his spew of lies. Memo to news stations – please don’t allow this rude lying clown on your network as HOLD ON is nothing more than “SHUT UP b****”.
family values runs rather shallow in the trump republican party these days. affairs, hookers, lying, cheating, abortions, assault…fits into a trump administration really well. these are the people rick stryker adores.
Speaking of Rick Stryker – check out his movie career:
https://www.imdb.com/name/nm0835444/
It seems he has not worked in over 30 years.
Focus is increasing in the policy statement and press conference following next week’s FOMC meeting. The assumption being priced in is that, while there won’t be a rate cut, Fed chit-chat will encourage expectations of easier policy ahead. December futures are pricing in better than 60% odds of 75 basis points of Fed funds cuts this year. A month ago, priced-in odds were just below 20%.
No Summary of Economic Projections is scheduled for release, so we aren’t going to see an FOMC point estimate for rates; it’s all down to chit-chat.
From the IMF blog:
Growth in major advanced economies is becoming more aligned as output gaps are closing. The United States shows increasing signs of cooling, especially in the labor market, after a strong 2023. The euro area, meanwhile, is poised to pick up after a nearly flat performance last year. Asia’s emerging market economies remain the main engine for the global economy. Growth in India and China is revised upwards and accounts for almost half of global growth. Yet prospects for the next five years remain weak, largely because of waning momentum in emerging Asia. By 2029, growth in China is projected to moderate to 3.3 percent, well below its current pace.
Interesting chart of output relative to potential. The US has been slightly above potential while the Euro area has been slightly below potential. China on the other hand has been well below potential following the pandemic so its higher growth rates are only bringing it back to potential.
I say this because a while back our resident MAGA moron expected the US to grow as fast as China was growing even as: (1) China would tend to have a faster potential output growth; and (b) China started off below its potential output. And yes Brucie thought the two economies were “comparable”. Chalk this up as another term our favorite trolls knows not what they mean (as in exogenous, endogenous suppression, and yes Real Business Cycles).
Oh dear – I just listened to Art Laffer explaining to his moronic Faux News viewers why tariffs cannot be inflationary. Something to do with export prices falling ala Lerner Symmetry. I bet none of the sheep knew what he was talking about:
https://www.nber.org/system/files/working_papers/w23427/w23427.pdf
The Lerner Symmetry Theorem (Lerner, 1936) provides an important starting point for thinking about tax neutrality in a global economy. It establishes the equivalence between import tariffs and export taxes and, as a corollary, the neutrality of any tax reform that would increase import tariffs and export subsidies by the same amount.
Did I miss something? Project 2025 is not proposing export taxes or subsidies. And even if we levied export subsidies, wouldn’t that lower foreign consumer prices and not domestic consumer prices. Laffer never bothered to explain this and even if he did – Faux News viewers would have been clueless. So they all just nodded their heads thinks this faux economist was making a point.
Doesn’t Lerner imply that increasing either import tariffs or export taxes, but not both, is not neutral? If tariffs rise, then an adjustment must take place. How the adjustment is made depends on – you all know this one – elasticities! That certainly doesn’t exclude price adjustment in the form of higher import prices.
Does Lerner imply price stability, even with equivalent tariffs and import taxes? Relative prices remain the same, yes, but that doesn’t mean price levels are unchanged.
So Laffer got Lerner wrong when it comes to inflation just about every way possible. Doesn’t get better than that.
If you use the import tax revenue to subsidize exports you may be able to neutralize the loss of jobs from foreign tariffs on our exports. So in theory you may be able to gain jobs in domestic production (becoming more competitive due to the import taxes) and not lose jobs in the export sector. However, that presumes that the foreign countries don’t copy our policies, with their own export subsidies. Import tax schemes are great if you presume there will be no reciprocality from foreign countries – which is an idiotic presumption.
The Trump idea was that tariff taxes would be used for general government funding so the millionaires wouldn’t have to pay any income taxes – not that those taxes should be used on export subsidies.
Increased prices on imported products (inflation) is a direct effect of import taxes. It happens regardless of how that tax revenue is used. It also happens if it succeeds in shifting to domestic production. The domestic suppliers will sell at close to “original price + tariff” because they cannot produce and sell at “original price” (or they would have done that and been competitive before the tariffs).
The problem with trying to apply logic to the word salad of Trump and his clown parade, is that you presume there is supposed to be one. There is none. They just say words. Those words are not connected to any logic or facts or previous world experiences – they are just words. If you point to something being wrong or illogical or impossible, they simply say “no you are wrong!”. They will fling out groundless accusations and lies with great conviction and without hesitation. They know it is beyond their audience to fact-check or critically evaluate what they are saying. They know their audience are not susceptible to facts or logic but purely evaluate what is said based on what tribe the messenger belongs to.
What was really funny about Laffer’s appearance on Faux News was how he claimed that the reasons why inflation was still high (yea I know – Faux News was misrepresenting the inflation rate but hey) was simple – money supply growth was allegedly high while output was falling. This post notes output has been growing at a decent pace but has Laffer looked at M2 lately?
https://fred.stlouisfed.org/series/M2SL
Huh – over the past 36 months, nominal M2 has declined. But of course the MAGA morons who get their new from Faux do not know that.
My apologies. M2 was 2.7% higher not lower. A growth rate of less than 1% per year. Highly inflationary according to Art Laffer and his cocktail napkins.
Off topic – Kamala’s VP choice:
Trump exploited the process of choosing a VP for as many headlines as he could get. The actual choice hasn’t worked as well as the process – ego will do that.
Harris will do better. Her list of candidates doesn’t have any duds like Vance on it. Among the many being vetted, 3 names are getting the most press attention: Kelly, Shapiro and Walz. Put another way, that’s Arizona, with 11 electoral votes, Pennsylvania with 19 and Wisconsin with 10.
If it were a sure thing that Harris could win a state by picking a VP, the choice is pretty lopsided. Unfortunately, Shapiro has political baggage – bad on Israel/Palestine, bad on dealing with sexual harassment, worse because of a settlement including an NDA. Kelly, on the other hand, is straight out of an action movie, with a solid wife story. Walz is slightly less heroic, surprisingly light on scandal, strong on issues – guns the exception, which may actually help in some places.
If it comes right down to pick a VP, win a state, Shapiro is the guy. Things may change, but for now, winning Pennsylvania means winning the presidency. History doesn’t offer much support for VP’s deciding presidential elections, but after Hillary, risking Pennsylvania looks like a bad idea.
This is the best Fox News could come up with:
A former top aide to the governor, Mike Vereb, was accused of sexual harassment by a female subordinate. The governor’s office reached a $295,000 settlement with the accuser. However, Vereb did not resign until six months after a complaint was filed
Shapiro is not even being accused of harassment. Yes a FORMER aide was. If Vereb were a Republican, they would celebrate how he supposedly dominated women.
If they want sexual misbehavior and assaults to be the topic – I say bring it on, pussy-grabbers.
The language. Remember – when we quote Trump we say “grab them by the meow”!
Oh wait J D Vance is afraid of cat ladies. Meow!
my sane side of the family back in the midwest think shapiro should be the pick. they really like him. i don’t know much about him. i like kelly, but don’t know how well he will do in the national spotlight. but his credentials are impeccable. but does that really matter in today’s political environment? if so, trump would have been dumped as a dumb loser years ago…
There is a great article in NYT by Jen Harris. Fantastic communication of the errors of the Fed.
https://www.nytimes.com/2024/07/29/opinion/federal-reserve-interest-rates.html
She just nails it as to why the Feds policies have been counterproductive in the current supply chock situation. Not that it is news to real economists – but she makes it sounds so simple and easy to understand.
This from some reason caught my eye:
But by the 1970s, the economist Milton Friedman began to recruit a following for his view of inflation as “always and everywhere a monetary phenomenon,” meaning inflation occurred whenever the money supply outstripped the goods or services being produced. Mr. Friedman’s restrictive monetary policies came as part of the broader revolution he ushered in across economics. Decades later, there are real and mounting doubts about whether Mr. Friedman was right.
Two related things.
Dr. Milton Friedman had a Ph.D. in economics. In fact he won a Nobel Prize in economics. Now if you want to call Art Laffer Mr. Laffer – be my guest.
While Dr. Friedman used to believe in this outdated version of monetarism, later in life he recognized its failures. Mr. Art Laffer just the other day proved he was so clueless as to repeat this sillines.
There may be something to the concept that if the Fed is willing to completely ignore its mandate for economic growth, and throw the country into a massive depression, then even inflation driven by supply chain problems can be “cured” by massive increases in interest rates. But that is like saying that an irregular heart beat can be cured by killing the patient. Technically true but not how you want to go about it.