Stock markets around the world are surging because of two things: an expected interest rate cut by the Federal Reserve and an AI investment boom. But neither of these things necessarily signal actual strength in the economy.
Interest rates are set by the Federal Reserve, which is supposed to be completely independent from the legislative and executive branches. When the Federal Reserve was founded in 1913, it was carefully set up to be free from political control, as politicians would be tempted to expand the money supply in order to give the economy a short-run boost to help their political chances. President Donald Trump is trying to do exactly that — he has broken longstanding norms by attempting to strongarm Federal Reserve Chair Jerome Powell into cutting interest rates. In other words, the current surge in the stock market reflects investors' expectations that we will get a short-term boost but long-term inflation — the higher prices of stocks don’t necessarily reflect increased production of actual goods and services.
Don’t feel too sorry for Powell. His decisions during the COVID-19 shutdown contributed to the massive wave of inflation in 2021, the fallout of which played a significant role in Trump’s return to the Oval Office. Now, Trump is pressuring the Fed into lowering rates to help him politically. He is exactly the kind of politician that the Central Banks are designed to be shielded against, yet the actions of Central Bankers are a big part of the reason Trump gained political power in the first place.
Economic downturns like recessions and depressions happen in part because a lot of people make the same investment mistake simultaneously. When all those investments fail in tandem, the result is a sudden decrease in wealth and economic production. This phenomenon is perhaps most likely to occur when a particular industry or investment opportunity is over-hyped.
Today, that industry is artificial intelligence. If too many people buy into the hype – as they seem to be doing –overinvestment will cause tthey will all invest too much, the bubble will to pop, and the result will be an economic downturnAmerica will face an economic downturn. overinvestment will cause a bubble, and when it pops America will face an economic downturn.
This is precisely what happened with the dotcom boom of the 1990s. Back then, the emerging technology was the internet itself. People poured billions of dollars of investment into dubious internet businesses, and the boom turned out to be more hype than substance. Many of the internet investments failed, resulting in a market crash and a small recession in the overall economy.
This is not a case for government intervention. History has shown that central planners make far more mistakes than free markets. But it is to say: investors be warned.
If the past is any guide, the current hype surrounding AI is causing an investment bubble, meaning the real value of AI investments is less than what is currently recorded in the stock market. There’s reason to be skeptical that this surge reflects a truly strong economy.
So, while the stock market is reaching record highs right now, the high stock prices are driven in part by two factors that don’t correspond to actual economic strength. First, investors await loose monetary policy from Chairman Powell – urged on by President Trump – which would give a short-term boost to the economy (though long-term costs in the form of higher inflation). The other factor is an AI investment wave that may turn out to be more fluff than real growth. Beware.
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