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Next month Wilbur Ross, 86, the private equity luminary and former commerce secretary under Donald Trump, will publish a memoir, Risks and Returns. Investors should pay attention.
For tucked into the saga of Ross’s striking business career — and conversion from left to right-wing politics — there is a startling episode involving Jay Powell, the Federal Reserve chair.
Back in 2018, as Ross tells the tale, the president became so furious with Powell’s decision to raise interest rates that he told Ross to “please call this idiot, and explain to him that I will repudiate” his job unless Powell changed tack.
Ross balked, replying that “Mr President . . . It’s not clear to me that it would be in your interests to threaten to replace [Powell].” And when Ross did eventually place a call, Powell insisted that he had “no obligation to debate” policy with the White House. Fed independence, in other words, prevailed.
Six years later, this might seem ancient history. Or maybe not. For one thing, it highlights the risks that will loom if Trump does prevail in November. But it also reveals another point: the degree to which markets are now haunted by a phenomenon known as the “normalisation of deviance”.
In recent weeks equity prices have surged, pushing the Dow Jones to a record high. That has not just reversed the market tumble seen in early August but delivered a better performance for stocks than almost all recent Augusts, as Zachary Karabell notes on his Edgy Optimist Substack.
This market performance reflects rising optimism about the prospect of a “soft landing” for the American economy, after Powell signalled at Jackson Hole that a rate cut looms in September.
But the paradox is that this sunny mood has emerged even as clouds — ie risks — keep on building. A new wave of geopolitical risks threatens to (at best) disrupt supply chains and (at worst) produce more war in the coming months. Meanwhile America’s November election seems highly likely to produce (at best) profound policy uncertainty and (at worst) domestic conflict.
The issue is not just what Trump might do with the Fed; his team also seems keen to weaken the dollar and implement tax cuts which would add more than $4tn to national debt, according to Penn Wharton.
This would be alarming in almost any circumstances. But it looks doubly risky now given that America must maintain the confidence of global investors if it is to fund its exploding debt.
As Torsten Slok of Apollo notes, the US debt to gross domestic product ratio is heading far above 100 per cent, debt servicing costs are already 12 per cent of total government outlays and a third ($9tn) of government bonds must be refinanced in the next year alone. Gulp.
A Kamala Harris victory might deliver more policy continuity; she is unlikely to fire the Fed chair, for example. But her economic plans could raise debt by $2tn, Penn says, and they feature unorthodox ideas such as price controls. The other enormous risk is that if Harris wins by a small margin, she will almost certainly face protests, legal challenges and possible civil unrest from some Trumpians.
None of this is good for global confidence in America. But what is most remarkable is how few of these risks seem to be priced into asset markets (except gold); instead the sense of “soft landing” optimism prevails.
Why? One reason is the volume of liquidity still swirling in the financial system after years of quantitative easing. Another is a belief — or hope — that Trump’s bark will prove worse than his bite, and that his more dangerous instincts will continue to be reined in by people like Ross.
However the third issue is the so-called “normalisation of deviance”. This concept was first developed by a sociologist called Diane Vaughan when Nasa asked her to study the 1986 Challenger shuttle disaster.
Before Vaughan’s study, it was presumed that the tragedy had occurred because of one big safety lapse. However she argued that the real cause was that, prior to the disaster, there had been numerous tiny “breaches” in safety standards.
These were tolerated at the time because the system was resilient enough to absorb them. However, their cumulative impact was to change the sense of “normal” in a slow and stealthy manner. After numerous such breaches, deviance become normalised, and was thus ignored until it produced a disaster.
Markets are different from rockets. But in recent years investors have faced such a startling stream of domestic and international shocks that they have almost started to normalise these too. A decade ago, investors might have panicked if an American president threatened to defenestrate the Fed chair or expand the budget deficit by trillions of dollars. Now they barely blink.
In some senses this is cheering. It certainly shows how adaptable humans can be. But it also creates a risk of complacency — and a presumption that the financial system will always be able to absorb new shocks.
So if the stock markets keep soaring, investors should think hard about how to hedge the “what if” scenarios that loom this autumn. Then they must ask themselves what deviant threats they have learnt to normalise. Threats to Fed independence may just be the start.
