U.S. stock market continues to fall
San José, CA – On Monday, May 9, U.S. stock prices continued to fall, with the broadest index, the S&P 500, losing more than 3%. This is the biggest one-day drop in stock prices since the onset of COVID in the United States in early 2020. The S&P 500 has fallen 17% since hitting an all-time record high in late March. This is approaching the 20% drop that is labeled a “bear market.” Stock prices of high-tech companies have fallen even more, with the technology-heavy NASDAQ index already in bear market territory.
Investors are facing up to the fact that the country’s central bank, the Federal Reserve, is more committed to slowing the economy to lower inflation than it is with propping up stock prices. Inflation has hit a 40-year high of more than 8% the last two months. The Fed has already raised short term interest rates twice, one time by half of a percent for the first time in 20 years.
The Fed has made public plans to begin to sell off its massive stash of bonds. During both the 2008 financial crisis and then the COVID recession in 2020, the Fed bought about $8 trillion in U.S. government and mortgage bonds, to lower short term interest rates to record lows and to reduce mortgage interest rates. The Fed plans to reduce its stash of bonds by almost $100 billion per month or more than $1 trillion per year. This will reduce the amount of money in circulation and in banks and will raise longer term interest rates. The standard 30-year fixed rate mortgage interest rate has gone from 3.11% at the beginning of the year, so 5.27%, a jump of more than 70%.
The Federal Reserve’s inflation fight is raising recession fears on Wall Street. Federal Reserve Chair Jerome Powell has been praising Paul Volker, who headed the Fed from 1979 to 1987. Under Volker, the Fed raised short-term interest rates, currently at 8/10ths of one percent, to a record high of 20% in 1981 to fight recession which had reached 13% just months before. While inflation did fall, the worst (at that time) recession since the Great Depression followed, with unemployment reaching 10.8%, even worse than the recession with the Great Financial Crisis in 2008.
Inflation has been eating at the purchasing power of workers’ wages. Even though hourly pay is up over 5%, with inflation over 8%, the purchasing power of workers’ wages has dropped by 3% over the last year. It is no wonder that there is growing dissatisfaction despite rising wages.
Supply side shortages have played a role in the rise of inflation. The COVID pandemic led to a severe drop in spending on services such as travel. People turned to goods, causing a spike in demand that U.S. factories, many still troubled by COVID, were unable to meet. The demand for imports rose, overwhelming ports and truckers. Then there were shortages of computer chips that restricted new car sales, which are off 20% from the current peak, while prices rise at double-digit levels. The lack of new cars increases the demand for used cars, while supply drops as people keep their cars when they can’t get new one.
The U.S. sanctions on Russia have pushed up oil and gasoline prices. The Biden administration has escalated the U.S. economic sanctions on China, causing shortages of solar panels. These shortages continue to crop up one after another helping to drive prices higher. Another supply side shortage is the drop in the number of new immigrants, which started under the Trump administration.
Demand has played a secondary role. When inflation started to take off a year ago, unemployment was still at 6%. While the massive government spending to prop up the economy played some role, it basically ended at the time inflation started to take off.
Inflation is rising in countries around the world, particularly in Europe, where sanctions on Russia have a greater impact. The U.S. and Europe’s economic war on Russia is pushing up grain and food oil prices, causing hardship in poor and middle-income countries dependent on trade with Russia for their basic foodstuffs.
One country much less affected by inflation is China. While China’s socialist economy no longer has extensive price controls like those in the Soviet Union, inflation has been much less than here, running around 1.5%. China was able to clamp down on COVID and limit deaths to about 15,000 as compared to the 3 million deaths there would have been if China had the same death rate at the United Sates. This meant fewer supply-chain disruptions and no need for the massive financial spending that the U.S. government needed to keep the economy alive. While producer prices are rising at almost the same rate as in the United States, the government can directly (through government-owned enterprises) and indirectly (through influence from state-owned banks and Communist Party committees in enterprises) keep businesses from passing on all the price increases. China also maintains a year or more supplies of raw materials such as metals and grains that can be released to curb production and food costs.