March 11 2025 - 1:15pm
The market slump at the beginning of this week came about, simply, because prices were unsustainable. Robert Shiller’s famous CAPE (Cyclically Adjusted Price Earnings) ratio was approaching its historic peak in December — almost as high as during the dot-com bubble, and already higher than during the crises of 1929, 1987, or 2008. This is the only reason why markets ever crash. Everything else is folklore, airtime filler for CNBC or Bloomberg.
Donald Trump plays into this to the extent that his policies will end the long and unsustainable era of massive monetary and fiscal expansion. Team Trump seems serious about cutting the deficit, with Treasury Secretary Scott Bessent providing a target reduction from 6% to 3%. His predecessor Janet Yellen, in contrast, said 6% was perfectly sustainable. When she was a central banker, she also advocated quantitative easing. The markets loved these reflationary policies, and hate it when they end.
Such policies fall into the sustainable-for-long-but-not-forever category, with which we Europeans are only too familiar. Into this box we can also place the vast majority of Angela Merkel’s policies during her time as German chancellor: the euro should it continue with a fiscal union forever, and transatlantic dependencies in security and economics. What makes these cases so treacherous is that the resulting delusions can be sustained for very long periods, as with Merkel’s 16-year term, and still prove unsustainable.
Markets remain a superior method of organizing capital allocation, but they are poor judges of sustainability. What’s more, they are prone to herd behavior. Take interest rate markets, which were optimistic in 2022 when rates started to rise, and over-optimistic on the way down. During both phases, they biased in favor of lower inflation and lower interest rates. The Harvard economist Jason Furman was therefore wrong to suggest yesterday that “if you are implementing a credible plan that entails short-term pain for long-term gain, the stock market will go up not down.”
By that definition, the markets should have reacted to quantitative easing with a downturn, on the grounds that these policies lead to inequality, political radicalization, the end of globalization, and possibly even the breakdown of NATO. At the time, however, markets were entirely unreceptive to any notion of negative long-term consequences from these policies.
Trump’s policies should then be seen as a trigger, not a cause. He is closer to the proverbial central banker who takes the punch bowl away before the party gets going, rather than the perpetrator of a wantonly reckless political act. Bessent’s four-year deficit reduction plan may well trigger a market crash, but ending an unsustainable policy is not unreasonable, even in these circumstances.
The jury on Elon Musk’s DOGE experiment is still out, but the forecasts that it would go up in smoke early on have clearly not been vindicated. Tariffs may be a crude way of addressing global imbalances, but it’s also true that nothing else has worked. The question which remains is whether the US President will fold. Trump said this week that he was willing to accept a recession and a one-off hike in import prices due to tariffs. This was an interesting comment, at least in how different it was to the politician to whom we’ve become accustomed over the last decade. Is it possible Trump recognized that, in order to implement his policies, he cannot just roll with the markets?
This is an edited version of an article which originally appeared in the Eurointelligence newsletter.
