Biden will need Irish luck to avoid tough economic landing in 2022
James Carville, President Clinton’s political adviser, said that when it came to winning an election, what mattered most was “the economy, stupid.”
If Carville’s adage holds true in next year’s midterm election, President Biden could face serious difficulty maintaining control of both houses of Congress. This would appear to be especially true at a time when the risk of economic overheating and a pandemic peak occurs against the backdrop of a bubble in the US stock, real estate and credit markets.
Over the past year, the very expansionary stance of fiscal and monetary policy has led to a very strong economic recovery. But it did so at the cost of creating troubling bubbles in asset and credit markets that could burst in the run-up to next year’s election.
Unlike 2008, when the United States suffered from a housing and credit market bubble, it now seems to be suffering from an “everything” bubble. Equity valuations are now about double their long-term average, or at a level that has only been seen once in the past 100 years.
At the same time, US house prices are currently rising at an annual rate of 16% and are now above their 2006 peak. Meanwhile, interest rate spreads on high yield corporate bonds and high leverage are now close to their all-time lows.
The current asset and credit market bubbles appear to be based on two very dubious premises. The first is that today’s ultra-low interest rates will last forever. The second is that the current strong economic recovery will not be interrupted by another period of economic weakness.
As former Treasury Secretary Larry Summers keeps reminding us, Biden’s highly expansionary fiscal policy runs the real risk of causing economic overheating. This in turn could force the Federal Reserve to raise interest rates well ahead of the November 2022 election in order to meet its inflation target. Such a rise in interest rates could be the trigger for the bursting of bubbles in the stock and real estate markets.
The main reason to think that Biden’s fiscal stimulus could lead to economic overheating is that it is very large compared to the gap between the country’s current level of production and the level that could be reached at full employment. While the Congressional Budget Office estimates that the output gap is currently around 3%, the Biden budget implies that the US economy will receive around 12% of GDP in 2022. Combined with today’s unusually expansive monetary policy hui, that could make recent inflation recovering to a 30-year high anything but transient.
The only thing that could save the economy from overheating would be another economic foreclosure following the current Delta variant surge. By suppressing demand and raising unemployment, the Delta wave could calm inflationary pressures and prevent the Fed from raising interest rates. But it would do so at the risk of undermining the second premise of strong and continued economic growth on which today’s stock and real estate market bubbles are based. As was the case in March 2000, any sharp slowdown in economic growth could be the trigger for the bursting of real estate bubbles and today’s stock markets.
As next year’s midterm elections approach, the best Biden can hope for is that the current Delta wave will be strong enough to cool the economy enough to bring inflation under control, but not enough to burst the waves. current real estate and credit bubbles. For that to happen, Biden will need the luck of the Irish.
Rather than relying on luck, it would have been better for Biden’s 2022 electoral outlook had he heeded Carville’s famous adage. Maybe then he might not have opted for an excessively expansionary fiscal policy that contributes to a very strong economic recovery in 2021 but also prepares us for a tough economic landing in the next election year.
Desmond Lachman is a senior researcher at the American Enterprise Institute. He was previously Deputy Director of the Policy Development and Review Department of the International Monetary Fund and Chief Emerging Market Economics Strategist at Salomon Smith Barney.