June 15, 2021
In a New York Times column today, William Cohan, a writer and former investment banker, warned of impending disaster if the Federal Reserve Board does not quickly move away from its low interest rate policy. Cohan tells readers:
“But many people wonder if Jerome Powell, the chairman of the Fed, has reckoned with the power of the easy-money monster the central bank spawned all those years ago. They worry that Mr. Powell has helped inflate bubbles in housing, lumber, copper, Bitcoin and stocks, bonds and other assets. The evidence is mounting: The Consumer Price Index, a gauge of inflation, rose 5 percent in May from a severely depressed number a year earlier — the fastest rate in nearly 13 years. And that’s just one worrisome indicator.”
The piece goes on to warn of all the horrible things to come if Powell does not soon start to raise interest rates. The basic story is that we have bubbles in many markets that will collapse, costing investors in these bubbles hundreds of billions, or even trillions, of dollars. [It is worth noting that lumber prices have been plummeting in the last few weeks.]
If this sounds familiar, that might be because Mr. Cohan had a very similar column in the NYT a couple of years ago. In August of 2019, Cohan warned that “only the Fed can save us now,” and urged Fed Chair Jerome Powell to stand up to Trump and raise interest rates. The piece begins:
“Here’s the moment I realized the next financial crisis is inevitable.”
We find out that this was the moment when he realized he was listening to a speech where Powell indicated that he had no plans to raise interest rates.
Later Cohan explains:
“But although a sense of euphoria spread through the room, as well as through debt and equity markets, I was overcome by a sense of dread. A decade of historically low interest rates has begun to warp our economy. As we learned to our collective horror during the 2008 financial crisis, a period of sustained low interest rates forces investors on a desperate search for higher yields, inflating asset prices and the risks of owning loans and debt of all kinds.”
To be clear, there are undoubtedly many bubbles in the U.S. economy right now. Bitcoin is the most obvious example, but we also have the proliferation of non-fungible tokens, as well as many stock prices that bear no relationship to plausible estimates of future earnings.
But none of this sets the stage for a 2008-09 disaster. In the years leading up to the Great Recession, the housing bubble was driving the economy. This was easy to see for anyone who bothered to look at the GDP data the Commerce Department publishes every quarter. Residential construction had increased from its normal rate, which is around 3.5 percent of GDP, to a peak of 6.8 percent of GDP. Similarly, soaring house prices led to a consumption boom, as people spent based on the bubble created equity in their home.
When the bubble collapsed, and housing construction fell to less than 2.0 percent of GDP due to overbuilding during the bubble. There was nothing to replace the loss of 4.8 percentage points of GDP or annual demand (more than $1 trillion in today’s economy). Similarly, the bubble driven consumption boom collapsed, costing us another 3-4 percentage points in demand.
This was the story of the Great Recession. The financial crisis was just the market working its magic on the banks and other financial institutions that had been reckless in issuing and marketing loans.
If we were to see a similar collapse in asset prices today, it would have no comparable impact on the real economy. If the roughly $1 trillion market capitalization in the digital currency market went to zero tomorrow, how would that affect the real economy? Some Bitcoin millionaires and billionaires would be very unhappy, but so what? There would be no economy-wide plunge in consumption. The same is true with asset prices in other markets.
Could this tank some banks that made bad loans? Sure, that’s what markets are for. Companies that are not competent are supposed to go out of business. The idea that this will create some financial crisis where we can’t undertake normal business transactions has zero foundation in reality.
In short, Mr. Cohan’s piece is just irresponsible fearmongering. There apparently is a big market for this stuff, but this is little reason to take it seriously.
Addendum
I should have mentioned that William Cohan’s columns forecasting disaster are a regular feature in the NYT, see here, here, and here.
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