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Next month, Wilbur Ross, 86, the private equity luminary and former Commerce Secretary under Donald Trump, will publish his memoirs. Risks and returns. Investors should be careful.
Because embedded in the story of Ross’ remarkable business career – and his shift from the left to the right political camp – there is a surprising episode involving Jay Powell, the chairman of the US Federal Reserve.
In 2018, Ross says, the president was so angry about Powell’s decision to raise interest rates that he told Ross to “please call that idiot and tell him that I’m going to quit” if Powell didn’t change course.
Ross balked, replying, “Mr. President… it’s not clear to me that it would be in your interest to threaten to remove (Powell).” And when Ross finally called, Powell insisted that he was “not obligated” to discuss policy with the White House. In other words, the Fed’s independence prevailed.
Six years later, this may seem like ancient history. Or maybe not. On the one hand, it highlights the risks that loom if Trump does win in November. But it also reveals another point: the extent to which markets are now plagued by a phenomenon known as the “normalization of deviance.”
Stock prices have soared in recent weeks, pushing the Dow Jones to record highs. Not only has that reversed the market plunge of early August, but it’s also given stocks a better performance than they’ve seen in nearly any August in recent memory, as Zachary Karabell notes in his Edgy Optimist Substack.
This market development reflects growing optimism about the prospect of a “soft landing” for the American economy after Powell signaled in Jackson Hole that a rate cut was imminent in September.
The paradox, however, is that this cheery mood has emerged just as the clouds – the risks – are gathering. A new wave of geopolitical risks threatens to disrupt supply chains (at best) and trigger more wars (at worst) in the coming months. At the same time, the US elections in November are very likely to generate deep political uncertainty (at best) and domestic conflict (at worst).
It’s not just about what Trump might do with the Fed; according to Penn Wharton, his team also seems interested in weakening the dollar and pushing through tax cuts that would increase the national debt by more than $4 trillion.
This would be worrying under almost any circumstances, but it seems doubly risky now, as America needs to maintain the confidence of global investors if it is to finance its exploding debt.
As Torsten Slok of Apollo notes, the US national debt-to-GDP ratio is approaching well over 100 percent, debt servicing costs already amount to 12 percent of total government spending, and a third ($9 trillion) of government bonds will have to be refinanced in the next year alone. Gulp.
A victory by Kamala Harris could provide more political continuity; she’s unlikely to fire the Fed chair, for example. But her economic plans could add $2 trillion to the debt, Penn says, and they include unorthodox ideas like price controls. The other enormous risk is that if Harris wins by a narrow margin, she will almost certainly face protests, legal challenges and possibly civil unrest from some Trump supporters.
None of this bodes well for global confidence in America. What is most notable, however, is how little of these risks seem to be priced into asset markets (except for gold). Instead, there is optimism about a “soft landing.”
Why? One reason is the amount of liquidity still circulating in the financial system after years of quantitative easing. Another is the belief – or hope – that Trump’s bark will be worse than his bite, and that his more dangerous instincts will continue to be kept in check by people like Ross.
The third problem, however, is what is known as “normalization of deviance.” This concept was first developed by sociologist Diane Vaughan when NASA asked her to study the 1986 Challenger disaster.
Before Vaughan’s study, it was assumed that the tragedy was the result of a single major safety breach, but she argued that the real cause was that there had been numerous small “breaches” of safety standards before the disaster.
These were tolerated at the time because the system was robust enough to absorb them. However, their cumulative effect was to slowly and insidiously alter the sense of “normality.” After numerous such violations, deviations became the norm and were therefore ignored until they caused a catastrophe.
Markets aren’t rockets. But in recent years, investors have been faced with such a terrifying barrage of domestic and international shocks that they’ve almost come to accept them as normal. A decade ago, investors might have panicked if an American president had threatened to throw the Fed chairman out of the window or increase the budget deficit by trillions of dollars. Today, they barely bat an eyelid.
In some ways, this is encouraging. It shows how adaptable people can be. But it also carries the danger of complacency – and the assumption that the financial system will always be able to withstand new shocks.
So as stock markets continue to soar, investors should think hard about how to hedge against the “what if” scenarios that loom this fall. Then they must ask themselves what aberrant threats they have learned to normalize. Threats to Fed independence may be just the beginning.
