What Investors Really Fear

The specter of inflation—that ever-feared and never-appeared boogeyman—is haunting Wall Street.

The Dow Jones Industrial Average has fallen by 1,000 points only twice in its 122-year history. The first time was Monday. The second was Thursday.

There are two points to make about this. First, stocks have had a miserable week. The Dow erased nearly $3 trillion in wealth with a 10 percent plunge that officially qualifies as what’s called a market “correction.”

Second, stocks have had a marvelous decade. The Dow has thousands of points to lose because it has accumulated thousands of points in the last few years, quadrupling since 2009. With this latest collapse, the index of 30 stocks has fallen way, way back to levels not glimpsed since the dystopian hellscape of … Thanksgiving 2017.

So, what’s this all about? The stock market is a synthesis of stories about the future, a global anthology of investors’ financial predictions. When stocks rise steadily with little volatility—as they have for the last few years—it suggests widespread agreement on the world’s economic narrative. For a long time, the story went that corporate profits were rising in global unison for the first time in years, as both inflation and interest rates stayed low, creating a relatively risk-free environment for equities.

Then, rather suddenly, the story changed. On Friday of last week, the Bureau of Labor Statistics announced that wages had grown by 2.9 percent over the previous 12 months, a record high for the current expansion. This seems to have triggered fears that higher wages chasing a finite number of goods and services would lead to higher prices and furthermore that higher prices would encourage the Federal Reserve to raise interest rates to combat inflation.

Just as low interest rates had buoyed stock prices for years, the fear of rising interest rates has the opposite effect, inspiring a “flight to safety” as traders switch from stocks to fixed-income investments, such as government bonds. As investors scrambled to move money from equities to bonds, many traders who had bet against this sort of volatility—through a (now controversial) financial instrument, called XIV, that essentially allowed people to place wagers on continued calmness in the markets—were nearly wiped out. It all led to the worst nominal loss in the history of the Dow.

And that was just Monday. On Tuesday and Wednesday, stocks whirled like a plastic bag in a hurricane, at one point recovering most of their losses. Then, on Thursday, everything fell apart all over again in the midst of a crowded news cycle, as China’s trade surplus narrowed, and Republicans announced their plan to pass a deficit-swelling budget.

The significance of this week’s market gyrations can be stated simply: There is no reason to believe that this is the beginning a global financial crisis. Nor is there reason to believe this is the foreshadowing of a U.S. recession. Assigning monocausal blame for soaring or plunging stocks is a rough business, but what happened this week is in all likelihood a tizzy over inflation.

But if markets are afraid of inflation, they are fearing a ghost. Ever since the 2008 financial crisis, warnings of incipient inflation have been both persistent and wrong. The Federal Reserve has routinely aimed for 2 percent inflation in the years following the housing crash, and its aim has been routinely low. In 2016 and 2017, wage growth accelerated for lower-income Americans. But annual growth in “core personal-consumption expenditures”—the Fed’s most commonly used inflation measure—was 1.7 and 1.5 percent in those years. Wages perked up a bit. Prices didn’t.

If investors are afraid of the Fed’s approach to inflation, it is ironic that this season’s research note from the Federal Reserve Bank of St. Louis is titled “Why is inflation so low?” “The U.S. inflation rate has been below the Fed’s 2 percent inflation target since 2012,” the paper begins, going on to cite “several reasons to be concerned about very low inflation,” such as the risk of a recession caused by falling prices, or deflation. This isn’t a purely American phenomenon, either. The world has been trapped for years in a steady state of low price growth. In 2017, annual inflation across the rich countries that make up the Organization for Economic Cooperation and Development was just 1.7 percent.

Is this story about to change? Nobody knows. But one data point of 2.9 percent wage growth is just that: one point of data. It’s not proof that wages are taking off. It’s certainly not proof that accelerating wage growth is driving up prices. For now, it’s just a statistic, yet it seems to have helped trigger a frenzy of fear across global markets that inflation—that ever-feared and never-appeared boogeyman—will finally materialize.

For years, stock prices have inflated in part due to constraints on labor costs. Now at the slightest sign that labor costs might themselves be inflating, equities seem to be crashing for fear the central banks might rein in their support of economic growth. That’s quite a shame. If investors are wary of central bankers because they think bankers are wary of labor’s gains, it sets up a dynamic where capital specifically defines risk-free success by its capacity to restrain the prospects of labor. Capitalism may be the best flawed economic system out there, but is it any wonder that more Americans are starting to doubt that it’s working?