Stock and bond markets were down sharply over the second quarter as inflation flared.
During the second quarter, large-company stocks fell 16.1%, small-company stocks dropped 17.2%. Foreign stocks were down 14.5%, and even bonds lost ground, falling 4.7%. In the first half of 2020 as the pandemic took hold, the U.S. economy technically slipped into a steep, yet brief, recession. The U.S. government and the Fed responded quickly with interest rate cuts and economic stimulus programs, both designed to spur the economy. The plan helped to avoid what could have been broad economic calamity in the U.S. The economy rebounded and was recovering at a rapid pace by the end of 2020, and that momentum carried all the way through 2021.
By early 2022 that momentum began to fade. Also, all that federal spending over the preceding two years had generated a lot of cash which began sloshing around in the economy. We then had more money chasing fewer goods and the inflation rate began ticking higher, and tick higher it has. For the 12-month period ending in May, overall U.S. prices rose by 8.6%, the highest rate in more than 40 years. This has not gone unnoticed by American consumers, nor by economists and critics. There is a well-established precedent that U.S. presidents are credited for good economic conditions, and blamed for poor conditions. Inflation at these levels certainly qualifies as a poor economic condition. A wide range of factors contribute to price inflation in a large, complex economy. Even though it may seem like a reasonable assumption, crediting or blaming the current administration for current economic conditions, including inflation, is a hefty oversimplification.
Recent research from the Wall Street Journal suggests that we planted the seeds for today’s inflation more than a decade ago during the recession known as the Financial Crisis (2008-2009) when, in an effort to spur growth, the Fed actively employed the practice of cutting interest rates to ultra-low levels and holding them down for years following the recession. Low interest rates are known to be inflationary. When the low-rate environment met the heavy-spending government pandemic stimulus measures like the Payroll Protection Program, we set the stage for higher inflation. In May the Fed initiated an aggressive campaign of interest rate hikes in an effort to cool the overheating inflation. The risk here, and a primary explanation for the downdraft in stocks, is that rapid Fed rate increases could push the economy into a painful recession.
With so much turbulence in the economy, investors can view it myopically and even think about it as a unique entity, somehow detached from society. We’re wise to remind ourselves that the economy is merely one aspect of a whole and integrated ecological and social fabric. It is a system for producing needed goods and services and compensating its many contributors along the way. However, a free enterprise system, over time, channels power and wealth away from labor and toward the holders of capital (wealth). Indeed, in recent decades corporations have increased profits faster than households have increased incomes. This has contributed to wealth inequality in the U.S. and abroad and is an example of a social cost of economic activity.
“Economics is not a science, it’s merely politics in disguise,” wrote the great Hazel Henderson. While this has been a perennial truism, its more relevant than ever in today’s noisy political environment. These times are calling for a clear refocus on economic, social, and environmental interdependence, regardless of political stripes. If we’re to restore a stable and durable prosperity, we need to work toward common political ground to include sensible economic growth, broad inclusion in economic opportunity, and sincere commitment to environmental preservation.