The most bizarre single feature of capitalism is probably the stock market. It seems to have the ability to defy mere economic reality. Back in the 1990s, Alan Greenspan, then chair of the US central bank, the Federal Reserve Board, complained about the market’s “irrational exuberance”.
Now we have irrational exuberance on stilts. We are in the grip of a deadly pandemic that is killing millions of people worldwide. Largely as a result, the world economy is suffering the deepest slump perhaps in its entire history.
Yet stock markets have been soaring, globally by 74 percent since March. Leading investment strategist Jeremy Grantham wrote at the start of the year, “The long, long bull market since 2009 has finally matured into a fully‑fledged epic bubble.
“Featuring extreme over-valuation, explosive price increases, frenzied issuance, and speculative investor behaviour, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”
So why is this bubble in such dreadful circumstances? The first reason reflects the way the world economy has been managed since the global financial crisis of 2007-9.
Economic growth has been sluggish, reflecting the fact that the rate of profit is still below the peak it reached in the neoliberal era in 1997.
The turn to austerity around 2010 meant governments have not used fiscal policy—ie higher spending—to stimulate their economies. The gap has been filled by the central banks, which control monetary policy. They have kept interest rates very low and have run programmes of quantitative easing—ie buying government and corporate bonds as a way of pumping money into the financial system.
These policies have made it cheap for firms to borrow. But, because of low profitability, productive investment in new plant and equipment has been relatively low. A lot of the money has gone into the financial markets.
Companies have launched huge share buy-backs—in other words, they have bought their own shares. Boosting share prices keeps investors happy and increases the wealth of top executives.
There are also more short-term factors at work. According to the Financial Times newspaper, “Fund managers have largely mentally moved on from the coronavirus crisis. Faith in vaccines has taken over.” This is almost certainly premature, but it has helped lift the share prices of sectors such as commodities and manufacturing.
Finally, there is the impact of politics. In Britain, there is relief that Brexit has taken place with a deal with the European Union, however bad. Joe Biden’s advent as US president also promises a more predictable future.
In Britain the Bank of England’s (BoE) monetary policy has operated effectively to finance the huge increase in public spending in response to the pandemic.
The government has been borrowing by selling more Treasury bonds (or gilts), which analysis by the Financial Times shows have been taken mainly by the BoE.
The paper reports that “investors are convinced the BoE bought an additional £450bn of gilts during the COVID-19 crisis in order to ease the government’s huge programme of borrowing by keeping debt servicing costs at rock bottom.”
Now Biden is promising a £1.4 trillion fiscal stimulus. Because the Democrats, after capturing the two Georgia Senate seats, will control both Houses of Congress, he may be able to implement his plans. They will also be financed by extra borrowing. So fiscal and monetary policy may be converging in the US as well.
The prospect that the stimulus may push up economic growth is also boosting share prices. These are helped also by probably exaggerated fears that all this extra spending will lead to a leap in inflation. Central banks would react to this by raising interest rates, which would make shares a more attractive investment than bonds.
So, more than a decade after the crash in 2007-8, the world economy remains on life support, propped up by central banks and governments. And, Grantham warns, like its predecessors, “this bubble will burst in due time”.