The global Covid-19 pandemic will have lasting effects on the U.S. economy and financial markets that investors should separate from ephemeral noise. Four of them are increased government involvement in the economy, monetary policy that is ever more closely linked to fiscal policy, a retreat from globalization and shorter supply lines with more “in house” production of components and higher inventory levels, and a strengthening U.S. dollar. I’ll explore eight more in two future columns.
History shows that major national traumas result in increased government involvement in the economy and financial markets that never disappear -- at least in modern times. The 1930s spawned the New Deal and dozens of regulatory agencies including the Securities and Exchange Commission, Federal Deposit Insurance Corp., the Works Progress Administration and the National Labor Relations Board. World War II sired the GI Bill and federal government involvement in higher education, which led to $1.6 trillion in student debt and rising delinquency rates.
Executive orders are now routinely used by the President to supersede Congress. Former President Donald Trump issued 217 during his four years, the most for a four-term since Jimmy Carter, and President Joe Biden issued 48 in his first seven days in office. With an almost evenly-divided Congress, he’s also using executive orders to move forward his pledge to cut greenhouse emissions 50% to 52% below 2005 levels by 2030. Furthermore, the pandemic has opened the door to government redistribution of income, which the Democrats hope to accomplish by a 15% minimum corporate tax rate and increased levies on high-income individuals and capital gains while increasing government support for lower-income Americans.
The Federal Reserve has essentially become an arm of the Treasury Department. Its balance sheet expanded exponentially in reaction to the 2008 financial crisis and even more in response to Covid-19. The central bank’s assets have grown from $910 billion in 2008 to $8.56 trillion currently. In the last two years, the Fed acquired in excess of $3.3 trillion of Treasuries and mortgage-backed securities, financing more than half the federal budget deficit. And it returned 85%, or more than $100 billion, of the interest on its Treasury holdings back to the Treasury Department. Who owns whom?
Fed generosity in the form of record-low interest rates and quantitative easing propelled the 582% rise in the S&P 500 Index since March 2009, and Wall Street has come to rely on the central bank as a backstop for equities, corporate bonds and other riskier assets, first via the so-called Greenspan put, then the Bernanke put, followed by the Yellen put and now the Powell put. Also, by purchasing mortgage securities, the central bank moved beyond buying and selling Treasuries and raising and lowering short-term interest rates to aiding a specific sector, housing.
The pandemic has enhanced the retreat from globalization—the shift of manufacturing from North America and Europe to China and other low-cost Asian lands—that commenced four decades ago. Western consumers enjoy the low-cost imports from Asia, but the resulting loss of high-paying jobs and stagnation in real incomes gave rise to populism. Low-end manufacturing has moved from China in recent years to even lower-cost venues such as Vietnam, and India is the 800-lb. gorilla coming over the horizon.
Global supply chains involve many links but were established to minimize costs. And they went hand in hand with “just in time” inventory management, with supplies of parts kept to a bare minimum because incoming shipments would arrive just when needed. Supply chains’ share of world trade rose from 30% in 1990 to a peak of 48% before the pandemic-related drops, according to the World Bank.
But many links mean many vulnerabilities, and very long, efficient chains are very inflexible. Just when many people wanted more cars during the pandemic to avoid public transportation, problems ranging from Covid-19 disruption of computer chip testing in Malaysia to extreme weather in Texas curtailed chip output and, consequently, auto production. Ships bringing imports from Asia are anchored off the West Coast for lack of truck drivers. Supply chain disruptions are leading to more in-house production of components, higher inventories and shorter supply lines. Mexico will benefit at the expense of Asia.
The U.S. dollar will probably continue to strengthen in the aftermath of the pandemic and remain the only major safe-haven currency. That reverses the long slide since 1985 that allowed emerging markets that borrowed heavily in greenbacks to repay their debts with less of their own currencies. As a percentage of GDP, their government, individual and business debts leaped from 110% in 2007 to 236% in the first quarter of this year, according to the Bank for International Settlements.
Also, a rising dollar increases the cost to foreign countries of commodity imports. Of 45 important commodities, 42 are priced in dollars. The only three exceptions are palm oil (Malaysian ringgits), wool (Australian dollars) and amber (Russian rubles).
A stronger greenback makes imports cheaper in dollar terms and forces domestic producers of similar products to reduce prices to compete. It also makes U.S. investments more attractive to foreigners that enjoy currency translation gains. Conversely, a robust dollar renders U.S. exports more expensive to foreigners and overseas investments by U.S.-based individuals and businesses less attractive.
My next column will examine the lasting effects of the pandemic on the residential preferences of Americans, the increases in employee independence reflected in remote work, less commuting and flexible hours, the greater use of telecommunications technology and the boost to online shopping.
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