When might the USA’s ‘bubble of everything’ burst?

Central banks are starting to accept that inflation is not temporary, but a long-term problem that needs to be addressed. Across the western world, the inflation rate is at a multi-decade high.

At the onset of the Covid-19 pandemic, stock markets collapsed. Whether it was the FTSE 100, S&P 500, the DAX, S&P ASX 200, the CAC 40, they were all hit the same. The month of March 2020 saw each of these internationally tracked indexes lose around 30% of their value. Governments panicked and turned on the quantitative easing taps. Interest rates, already low, were reduced to just above 0%. And this hyper-relaxed monetary policy has seen every asset class bubble up, across the UK, Euro Zone, Australia, and New Zealand. But in the USA, it appears that the situation could be about to get markedly worse.

This ‘bubble of everything’ can only end in one of two ways. Either assets will plateau for a significant length of time, allowing wages and the real economy to catch up. Or the bubble is going to pop. But as the economic damage would be disastrous, the Federal Reserve will delay the pop as much as possible. And in the long run, that could make the situation worse if the bubble eventually bursts.

The bubble of everything

GDP growth slowed from 6.7% in Q2 2021, to 2.1% in Q3, ‘led by a slowdown in consumer spending. In 2020, GDP fell by 3.5%, the first time it’s fallen since the credit crunch of 2009. However, the problem is that inflation in November hit 6.8% according to the US Consumer Prices Index.

And in times of high inflation, a central bank’s most powerful tool is to raise the currency’s base interest rate. However, this makes debt more expensive, restricting the ability of companies to grow. And this is precisely the quandary the US’s Federal Reserve finds itself in. Federal Reserve Chair Jerome Powell recently said it is time to ‘retire’ the word ‘transitory’ to describe inflation, paving the way to increase the ‘tapering’ of the US’s quantitative easing program, and potentially raise the base rate in 2022. The program has already added $4.5 trillion to the Reserve’s balance sheet. While it is expected to end by mid-2022, a faster taper along with a rate rise could be the catalyst for a market crash.

Disposable income collapse

US inflation is at its highest level since 1982. But for 44.7 million Americans, there’s a bigger problem about to hit their personal finances. The moratorium on student loan payments, collections and interest, which was introduced at the beginning of the pandemic, is coming to an end on 31 January 2022.

In the UK, plan 2 graduates currently pay back 9% of any income earned over £27,295pa towards their student loans. While this can amount to a significant sum over a lifetime of repayments, their burden pales in comparison with the debt facing US graduates, who together owe a whopping $1.86 trillion.

The UK system is unfair to some graduates. Median-earning graduates pay back more money over their working lives, compared to higher and lower earners. However, one key advantage over the US system is that there are no repayments due if a graduate’s income remains below the repayment threshold. With the US system, the debt is treated like commercial debt and must be paid regardless of income. And the Student Debt Crisis Centre has found that 89% of US graduates are not financially secure enough to restart payments next year.

The average debt per graduate is $30,000, while the average interest rate is 5.8%. This means the typical US graduate is accruing $1,740 of interest each year, with compound interest on top. Meanwhile, the Consumer Confidence Index decreased in November, from 111.6 points in October to 109.5 in November. With inflation rocketing, a cost-of-living crisis could be about to hit America’s middle class soon.

Then there’s the housing crisis to consider. Often viewed as the main marker for consumer confidence, an over-bloated housing market could be the first bubble to burst. Like the UK, the mass take-up of homeworking has led to a ‘race for space,’ and the results have seen prices rocket. CoreLogic’s Home Price Index shows that between October 2020 and October 2021, the price of the average US home went up 18%, which is the largest increase in 45 years.

However, 51% of the period’s mortgage applications were made by millennials, aged between 26 and 41, who are more likely to be first time buyers with a small deposit at high risk of negative equity in a downturn. Economists at Fannie May believe the median price of a previously owned home will hit $400,000 by the end of 2023. The median wage in the US is $34,248.45 per year. It’s not hard to see what could go wrong if interest rates rise.

Stock market crash

Like the FTSE 100, the S&P 500 should be a relatively low risk, stable index. But at 4,712 points right now, it’s up 29% over the past year. On 20 March 2020, it was worth 2,305 points after the pandemic-induced mini-crash saw it collapse from 3,380 points a month earlier. This kind of volatility is not normal.

And arguably, the index’s companies are only performing so well due to the quantitative easing being pumped into the United States’ economy. According to the Treasury Department, Congress has approved $4.5 trillion in federal aid, with $3.5 trillion in payments made to date. The level of spending is astronomical— the March 2021 American Rescue Plan cost $2 trillion alone. With a $1.2 trillion infrastructure bill recently passed, and the $1.75 trillion ‘Build Back Better’ social plan in the works, an interest rate rise may be necessary to keep inflation in check.

Meanwhile, the employment picture is no less reassuring. Unemployment peaked at 14.7% in April 2020, its highest rate since the Great Depression. But it’s now at 5.2%, with a labour shortage so acute that McDonald’s has turned to child labour to keep some restaurants going. And the supply chain crisis shows no sign of letting up either.

And in the background, the Omicron variant threatens to undo much of the pandemic progress created by the vaccines. Evidence from the UK Health Security Agency shows that two jabs are not enough to be protected from the variant. While a third booster jab offers up to 70% protection, there remains the fact that right now, millions of previously protected Americans are once again vulnerable to coronavirus. Whispers of another finacially chaotic lockdown stalk the corridors of the White House.

Inflation is rocketing, while every asset class is at near record highs. An interest rate rise, a stock market correction, or an Omicron lockdown could see the US’s bubble of everything go pop. Of course, with so much public spending, it could inflate a while longer...

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