The Democrats are about to be hammered by their own economic myopia

A seemingly innocuous recession meme has taken on dark new proportions

With stock markets in turmoil and talk of a recession in the US, it looks like the Democratic Party might be in trouble in the run-up to November’s election. The irony is that the party and its supporters at least in part created these problems for themselves.
In their quest to push the Federal Reserve to lower interest rates and give the economy a boost before the election, some Kamala Harris supporters even created a recession meme in the hopes it would push the Fed over the line. Instead, it has boomeranged on them as markets took an unexpected turn for the worse.
There is some evidence that a recession might be coming to America.
The most compelling is the recent uptick in unemployment. Those who support the recession narrative typically refer to the “Sahm rule”. This is named after Claudia Sahm, a former Federal Reserve economist. It states that the initial phase of a recession has begun when the three-month moving average of the unemployment rate is at least half a percentage point higher than the 12-month low.
Recession prediction is a difficult game – if not a mug’s game – as anyone who has tried to practise this dark art will tell you. But as rules go, the Sahm rule is not so bad. It fits well empirically, predicting most American recessions in the data.
And it also has a strong intuition behind it: namely, that when unemployment starts to rise after a period of falling or stability, this rise will tend to build on itself due to the underlying trends in the economy being reflected in the initial rise in unemployment.
The data shows that the Sahm rule was triggered in July, raising alarm bells among its adherents – adherents that also appear to be supporters of the Democratic Party. But then at the start of the August data showed a bounce back in non-manufacturing PMI which flipped from showing contraction to showing expansion.
The Sahmites may be correct, and their measure might be more powerful than the PMI, but then again it might not, and they might be wrong. Predictions are hard, as they say, especially about the future.
A real question, however, is why there was so much of a push to get everyone thinking that there was a looming recession.
Here there are two possible explanations.
The first is that market commentators have caught “Sahm fever” and have become completely convinced that her method of predicting recessions is robust. The second is that the Democrats saw the idea that there might be a recession as being useful to them politically.
Perhaps more market commentators are subscribing to the Sahm theory, but it seems likely that a political game could be being played here. But why would Democratic Party supporters see advantage in the idea that the economy is in recession?
Perhaps Harris supporters thought that creating the recession meme and convincing markets and central banks that Sahmism is infallible, the Fed would be pressured into action.
There was one problem with the strategy: markets are fickle entities and do not always behave like people would like them to. Markets also tend to absorb attempts to influence them and turn these attempts into reality, a phenomenon that George Soros has called “reflexivity”.
Earlier this week, as the Sahmites waved their recessionary placards, the Bank of Japan raised interest rates. They did this in response to a yen that was in freefall.
The high interest rates that the Fed was maintaining meant that it was profitable to borrow at very low interest rates in Japan and invest this money in high-yielding Treasury bonds in the US – this is known as the “carry trade”. Market practitioners refer to an operation like this as “market arbitrage”, but a non-practitioner would be forgiven for seeing it as a free money pump.
But not everyone wins when the markets operate the carry trade pump – the lower interest rate country sees strong downward pressure on its currency.
The Japanese people were none too happy about the falling purchasing power of their currency. So, the Japanese central bank stepped into the breach and raised interest rates.
Those that were highly leveraged in the Japanese carry markets got absolutely battered. Margin calls abounded. Fortunes were lost. Tears were spilled. And the yen bounced back. This triggered a major sell-off in the Nikkei which then spread to the South Korean market and others around Asia. These markets have not recovered since.
On Monday, the contagion spread to American stock markets, taking a particularly big bite out of the tech-heavy Nasdaq and the so-called Magnificent Seven big tech stocks that have been driving American markets forward for months.
Stock market volatility spiked, and even staid observers started warning of an imminent bear market. Things have stabilised since, but this often happens before a market tips into a bear run. The calm before the storm.
The previously innocuous recession meme has now become nocuous. If the stock market takes a turn for the worse in the coming months it could do serious damage to Harris’s candidacy.
If a bear market is taken as a signal that a recession is imminent and this becomes a self-fulfilling prophecy as business investment dries up, the economy could slow in the run-up to an election. The Fed may then cut rates, but inertia would overpower any such action.
The clever strategy to convince the Fed to lower rates will then become a teacher of men: beware politicising the dark arts of market prediction.