Americans beware: markets can be out of sync with reality

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The writer is a former US Treasury secretary

The stock market keeps reaching new highs: the S&P is up more than 7.3 per cent since the Iran war began. About 85 per cent of companies in the index reported first-quarter earnings that beat first-quarter expectations, and analysts have raised profit forecasts in recent months. 

However, these gains come alongside actions by the Trump administration that I believe will have significant adverse consequences. The administration did not just launch a war in Iran that destabilised energy markets, President Donald Trump threatened to annihilate the country’s citizens. He repeatedly voiced support for a criminal probe into outgoing Federal Reserve chair Jay Powell that was a thinly veiled attack on central bank independence. 

When Trump began his second term, the market served as a disciplining device. After his “liberation day” tariffs were announced in April last year, it faltered and recovered only when the administration announced that much of its trade agenda was on pause. 

By now, markets and the economy seem largely inured to the chaos, leading some to conclude that Trump’s policies have not resulted in the serious economic damage many predicted. I disagree. While not yet reflected in short-term data, I believe enormous damage has been done to the economy, with effects likely to play out over time. 

Markets can be out of sync with reality for an extended period, and then react rapidly and harshly. In the 18 months leading up to October 1987, the stock market soared, despite concerns about looming risks. Then, on October 19, the Dow fell by 22 per cent in a single day. More recently, Greek sovereign debt traded at very narrow spreads to others in the Eurozone for years, despite worries about Greece’s fiscal and economic conditions. Then, all of a sudden, Greek debt collapsed, triggering the European sovereign debt crisis.

Some recent policy choices have made existing problems worse: rather than addressing our unsound fiscal trajectory, we’ve enacted trillions in deficit-financed tax cuts; we have failed to reform our costly and inefficient healthcare system; and we’ve undermined support for less expensive alternative energy sources at a time when AI is driving up electricity demand and China is racing ahead with renewables. These choices will probably increase prices and diminish growth, while leaving the country less resilient. 

Other actions have introduced largely new problems — like politicising the Fed; assailing our universities; slashing federal support for scientific research; attacking undocumented workers who play a key role in construction and agriculture; placing new constraints on legal immigration; and imposing tariffs that increase prices and reduce growth. And while regulation was excessive at times, Doge’s slash-and-burn approach was hugely harmful to government functions. 

Market participants, thus far at least, seem comforted by the fact that truly catastrophic approaches are often walked back: take the ceasefire in Iran, the justice department dropping its probe of Powell and the administration’s acceptance of the Supreme Court’s ruling that its tariffs were largely unlawful. But disruption and uncertainty can wear away at an economy over time. 

America’s economy and national security have largely been well served by the postwar global order. But now we’ve become a source of instability. We’ve disparaged our Nato allies, pursued ownership of Greenland, seized the leader of Venezuela and waged a consequential war with Iran without coherent objectives. We’ve punished the dissent that is a hallmark of US democracy. And we’ve undermined faith in the rule of law — one of our economy’s underlying strengths, and a great advantage vis-à-vis China. 

Our economy, and our society, has done well under Republicans, under Democrats and with power divided between them. But this administration’s approach is radically different. It is driven by an authoritarian mindset, with extreme approaches that lie outside the traditional public policy debate and are not grounded in intellectually serious analysis. 

I do not mean to sound pessimistic. With the great strengths that it has, the US should remain the most attractive market for investment and economic activity. But we must avoid being lulled into complacency by a stock market that has performed well and economic conditions that are still reasonably solid. 

By the time these measures react to the damage being done, it may be far harder to get the economy back on track. This is a moment when our citizens can engage in the hard work of re-establishing government that respects our laws, bases action on fact and engages constructively with the rest of the world. We can do that by supporting fair and free elections, and candidates — whether conservative or progressive — who pass a simple test: are they serious about addressing the economic challenges before us, including those that our own recent actions have created?