Howard Gold had an article last week at Marketwatch:
Why is the US stock market weak? Because the economy is too strong.
What does it mean for the economy to be “too strong”? Isn’t growth supposed to be good for stocks? Gold’s reasoning is that Fed tightening is driving up the value of the dollar which in turn causes weakness in foreign economies that ultimately comes back to the US in the form of lower profits for our multi-national companies. His argument seems to be that “too strong” growth causes Fed tightening which causes weaker growth. But if Howard Gold knows that don’t other market participants too? If the dollar rises because of “too much” growth but “too much” growth causes the Fed to tighten which causes weaker growth why would the dollar rise in the first place? Is the rest of the market just slower on the uptake than Howard Gold?
Why do we think the Fed knows how much growth is too much or not enough or just right? Economic growth is not just a function of monetary policy. There are a myriad of factors that affect growth: regulatory policies, tax policies and trade policies just to name a few. If all the factors other than monetary policy are creating conditions for higher economic growth, why would we want the Fed to offset that with monetary policy? If the dollar rises because foreigners – and Americans – want to invest in the US isn’t that a good thing? Shouldn’t that increased investment create more growth?
The concern of people like Howard Gold and the members of the FOMC is that the economy will grow too fast and cause inflation. The mechanism is the cost push inflation of the Phillips Curve, where low unemployment causes a rise in wages which in turn causes a rise in the general price level. That seems to me a fundamental misunderstanding of what causes inflation (as well as a fundamental misunderstanding of the Phillips study). If a previously unemployed person becomes employed then they should add at least enough to aggregate supply to offset what they add to aggregate demand, i.e. a newly employed person should not cause inflation.
There is the case where the newly hired person doesn’t add enough to aggregate supply to offset their own demand. In that case, inflation would be the obvious result. But doesn’t that imply that the person is not sufficiently productive to hold the job? Or that the “job” they are doing isn’t one that adds to productivity? That just isn’t a concern for the private sector. Companies are not going to hire people they don’t need or that can’t do the job.
Is a rising dollar a problem? The dollar may be rising now because the market perceives US growth to be better than the rest of the world. But it isn’t Fed policy that creates that perception. Real interest rates are not rising because of the Fed’s rate hikes; they are rising because of all those other policies I mentioned above. And rising real rates means rising expectations for real growth and makes the US economy an attractive destination for investment. That is not a bad thing and is not why stocks are falling.
Stocks and the economy are, believe it or not, not highly correlated in the short term. There are many reasons why stocks might be falling but a “too strong” economy isn’t one of them. It isn’t a rising dollar per se either. Indeed, if the US economy is functioning properly, the dollar should rise as productivity rises. That is the classic definition of deflation and exactly what we should want and get from a properly functioning capitalist economy.
Can an economy be “too strong”? Monetary policy can certainly create conditions where inflation is too high relative to real growth but that isn’t a too strong economy. It’s an economy with too much inflation, with faulty monetary policy. And I doubt the dollar would be rising in such a scenario. An economy that is well balanced – strong – will eventually be reflected in stock prices. But limiting the growth of the economy because the stock market is going through some kind of emotional upset is letting the tail wag the dog.
