US' Economic Prowess Set To Take A Hit

The context of Covid-19, along with the oil price shock and trade tensions with China, points to the US’ declining influence

- Arvind Sahay/ Sudheesh Nambiath

It is not common for a central banker to say: “The US government has a technology called a printing press, it can produce as many US dollars as it wishes at essentially no cost.” That was Ben Bernanke in 2002, much before he took charge as Chairman of the US Federal Reserve and quantitative easing kicked off in 2008. This technology, which only US has been successful at manoeuvring through the global financial crisis of 2008-09, is an antidote to deflation. It’s a prescription that is being used again by the Fed now. Will it work this time as well? Or are we kicking the can down the road?

Irving Fisher in his debt-deflation theory in 1933, theorised how all the remaining factors carried less weightage when compared to debt and deflation in triggering a crisis of greater severity. So when the asset prices fall sharply, the Fed prints money enough to lift them; eventually, inflation keeps the real yields positive while the interest rates are still at zero per cent. This means the debt will keep ballooning, and as it keeps financing the purchase of assets, their prices shall keep increasing beyond normal levels driven by leveraging. Finally, Fisher said, over indebtedness leads to deflation. To understand what that means for the stock market, let’s examine how it works.

Debt obligation

Financial markets are premised on the fact that there are some underlying cash flows in companies and there are some earnings which get translated into a share price in the stock market. This means price is not just a function of the earnings, but also the money that is available to buy those shares in the market.