Examining America’s Economic Landscape in 2025
The first full week of 2025 is drawing to a close, and many are eager for President Biden’s term to end. His four years in office have led to significant deficits and heavy intervention, leaving both the economy and the stock market in a state of inflated distortion.
President-elect Trump aims to sustain the current momentum of the stock market and the economy. Despite the underlying issues, rising asset prices and low unemployment create a superficial illusion of prosperity. As a figure steeped in reality television, Trump seeks vibrant stock indexes and robust employment data to substantiate his policies.
At the same time, he expresses a desire to reduce deficit spending by eliminating waste and inefficiency. While these are commendable goals, they conflict with the pursuit of maintaining higher asset valuations and economic stability.
It’s critical to understand that the deficit spending, currently amounting to $2 trillion, is fueling this inflated economy. What would happen if such spending was curtailed? Would the economy falter? Would stock prices decline?
Eliminating that $2 trillion deficit could indeed be a beneficial step towards restoring economic health. However, the immediate and medium-term fallout would be severe—unemployment would likely spike, and the stock market could experience a sharp downturn.
In the long run, a healthier economy could emerge, founded on genuine productivity rather than political favors or special interests. Stock valuations would align more closely with real underlying value rather than speculative gambling.
However, transitioning to such a state would entail a challenging and prolonged process.
Priced to Perfection
As we discussed last week, the chances of Washington balancing the budget are virtually nonexistent. Numerous commitments have been made over the years, and Trump is unlikely to cut Social Security, Medicare, or defense spending. Without addressing these key areas, significantly reducing the deficit remains an uphill battle.
While figures like Musk and Ramaswamy might manage to trim some wasteful expenditures—such as funding for ice-skating drag queens or the costly $12 million pickleball facility in Las Vegas—this would only constitute a minor first step. The fundamental budgetary issues in Washington are deeper and far more complex.
This is the sobering reality we face. Acknowledging it doesn’t make it any more palatable, but it’s the truth.
Nonetheless, maintaining large deficits does not ensure a repeat of the stellar stock market performance seen in 2025. Even if that $2 trillion deficit continues, an overheated market inevitably faces risks of failure.
The stock market has become so unsustainably high that even the Federal Reserve feels compelled to speak out. For instance, Federal Reserve Governor Lisa Cook recently warned that:
“Valuations are elevated in a number of asset classes, including equity and corporate debt markets, where estimated risk premia are near the bottom of their historical distributions, suggesting that markets may be priced to perfection and, therefore, susceptible to large declines, which could result from bad economic news or a change in investor sentiment.”
Such remarks from the Fed on stock market conditions are exceedingly rare. The last time we recall this happening was nearly 30 years ago. Therefore, Cook’s insights should not be taken lightly by investors.
Irrational Exuberance
Recalling the late 1990s stock market boom, Alan Greenspan famously questioned if irrational exuberance was at play. On December 5, 1996, during a speech at the American Enterprise Institute, he posed the following query:
“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions, as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?”
Irrational exuberance later became synonymous with markets driven by unfounded optimism, leading to asset prices surpassing fundamental values. Greenspan’s comments hinted at the Fed’s influence over monetary policy in such a scenario.
Despite his concerns about irrational exuberance, Greenspan continued his practice of flooding the financial system with credit. The Dow Jones Industrial Average surged from 6,437 at that time to 11,722 by January 14, 2000.
In subsequent years, Greenspan persistently found reasons to inject liquidity into the market, even going so far as to cut interest rates following the implosion of hedge fund Long-Term Capital Management in 1998. The NASDAQ, a focal point of irrational exuberance, soared by 86 percent in 1999 alone, reaching its peak on March 10, 2000.
Eventually, the tide turned, and what began as irrational exuberance gave way to rational despair, culminating in the stock market collapse between 2000 and 2002. The DJIA plummeted by nearly 40 percent, while the NASDAQ saw a staggering 77 percent drop.
Greenspan, aiming to reignite that earlier excitement, once again flooded the market with credit. However, this time, credit infiltrated not just the stock market but also real estate, oil, and gold prices. Such monetary stimulus became a recurring theme for the Federal Reserve.
Rational Despair
After the Great Financial Crisis of 2008-09, the Fed further pumped credit into the financial markets. This included the implementation of quantitative easing, which enabled the Fed to create credit from nothing and purchase Treasuries and mortgages as part of extreme intervention.
Quantitative easing reached new heights during the COVID-19 panic from 2020 to 2022, with the Fed engaging in unrestrained stimulus. This led to inflated consumer prices and soaring valuations for stocks, real estate, and even cryptocurrencies like Bitcoin.
Such easy credit has pushed major stock market indices to extreme valuations. The associated risks have become so pronounced that even slight drops in corporate earnings might trigger a sharp sell-off.
Yet, despite the ongoing Fed rate reductions, irrational exuberance continues to buoy the stock market. Schiller’s cyclically adjusted price-to-earnings (CAPE) ratio is currently over 37, nearing its record high of 44 achieved in December 1999, just months prior to the dot-com burst.
This could explain why some analysts are drawing parallels to 1999, anticipating another extraordinary year in 2025. They may well be correct.
For the past 15 years, the stock market, as indicated by the S&P 500, has been sustained at elevated valuations. Consequently, those who have chosen to embrace irrational hopes for rising share prices have outperformed those who opted for a more rational approach.
It has often proved lucrative to take risks, making recklessness appear the norm in investing. Meanwhile, investors cautious enough to critically assess the stock market have found that their more grounded expectations for growth have gone unfulfilled. Many have waited on the sidelines since 2016, anticipating a market downturn, and they have been met with nothing but disappointment.
A realistic outlook on the market hasn’t yielded rewards for a long time, but that could soon change.
As rising Treasury yields emerge, they may well become the trigger that finally punctures this inflated bubble.
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Sincerely,
MN Gordon
for Economic Prism
