Stocks Plunge Most On Record Last Week, Oil Down 10%

Gary D. Halbert


In the first week of 2016, US stocks plunged by more than in any other first week of January since records have been kept (before 1900). The Dow Jones Industrial Index fell over 1,000 points from 17,591 at the close on December 31 to 16,519 at the close last Friday – a loss of over 6% in one week.

The S&P 500 Index shed over 100 points from 2043.7 at the close on December 31 to 1922.0 at the close last Friday – a loss of 6.0% in one week. The Nasdaq Composite lost 7.3% during the worst first week of January on record.

Most global stock markets were hit with similar losses or even worse in some cases. Investors around the world were stunned and are wondering what happened in the worst New Year’s  week in history for share prices – and worry if more pain is to follow.

The financial media maintained that the carnage was caused primarily due to new economic data out of China, which was worse than expected. I will get into that as we go along today, but the rout was due to more than just disappointing Chinese data.

The collapse in crude oil prices since mid-2014 is also becoming a serious global concern for reasons I will outline below. The price of West Texas Intermediate Crude has collapsed over 70% since mid-2014 from near $105 per barrel to below $33 a barrel as of last Friday’s close. It fell 10% last week alone and is down so far this week.

While sharply lower gasoline and energy prices are a boon to consumers, there are now serious concerns about sovereign debt defaults in numerous oil producing countries. In addition, there are growing fears of global deflation as a result of collapsing oil and other commodity prices. I will tell you why below.

Yet before we get into the complicated issues raised above, let’s take a few moments to discuss last Friday’s stronger than expected unemployment report for December.

December Jobs Report Was Stronger Than Expected

The Bureau of Labor Statistics (BLS) released a significantly stronger than anticipated December jobs report Friday, making the final month of 2015 easily among the top three of the year in terms of jobs added.

Employment data out Friday showed employers in the United States added 292,000 net new jobs last month. Economists had been expecting only 211,000 payroll additions in December. The headline unemployment rate held steady at 5.0% for the third month in a row.

US Non-Farm Payrolls

The BLS also revised payroll counts from October and November up by over 50,000 new jobs combined. November new jobs were revised up from 211,000 to 252,000 and October was revised up from 298,000 to 307,000. It was a great report on the surface, but let’s not forget that the December report always includes a large seasonal adjustment by the BLS.

Yet Some Bad News in the Very Good Jobs Report

For all of 2015, the nation added 2.65 million jobs. That sounds good, right? Not really. When measured against a year ago, last week’s jobs report doesn’t look nearly as good. In fact, job growth slowed in 2015, the first annual dip in new jobs since the Great Recession. As you can see in the chart below, for all of 2015 employers added 466,000 fewer jobs than in 2014, when employment increased by 3.1 million.

Number of Jobs Added Per Year

So, is the American economy slowing, or is the slowing job growth simply an indication that the job market has recovered and adding more jobs is getting tougher? After all, the unemployment rate hit 5% in October, down from 10% in late 2009, and it has stayed at that level ever since.

Eventually, job gains will slow down even if the economy is still healthy. Put another way, is the economy nearing full employment or are job gains once again falling short? To answer that question, you can compare the job gains of the current economic recovery to other recoveries.

Since the end of 2009, employment has increased by 13.6 million jobs. In the six years following the early 1980s recession, the number of new jobs rose by 18.1 million. The 1990s recovery saw a slower increase of 16.2 million jobs in the same period. Yet it was still a larger overall gain in new jobs than what we are currently experiencing.

The bottom line is: In 2015 the economy created fewer jobs than in 2014, the first yearly drop since the Great Recession. We should keep last Friday’s impressive jobs report in the context of an economy that is only growing at about 2% a year, which is still well below expectations.

Let’s now move on to our main topic today where the news is not nearly so good – what’s happening in the markets. I hope to be able to add some clarity to what was the most stunning start to a New Year on record.

US Stocks Plunge the Most on Record Last Week

As noted in the Overview above, the Dow plunged 6.1%, the S&P 500 6.0% and the Nasdaq 7.3% all in one week, making last week’s decline the worst on record for the start of a year. The catalyst once again was China. Adding to the China fears was the precipitous decline in crude oil which lost 10% in the first week of the New Year.

Let’s start with China. Before our markets opened on Monday, January 4 there was disappointing economic news out of China, and stocks tumbled worldwide.  Then on Wednesday, January 6 we learned that China’s manufacturing index had dropped to a 17-month low. And on Thursday, the Chinese central bank devalued the yuan for the third time in less than a year.

And the news out of China only got worse as last week unfolded. Chinese stocks plunged over 10% last week, forcing authorities to suspend trading in its equity markets based on “circuit breakers” put in place at the end of last year.

But it quickly became apparent that the circuit breakers only made the panic worse, causing even more selling as Chinese investors worried that they could be locked into positions if trading was halted due to large losses.

On Thursday before the stock market opened, China’s central bank devalued the yuan (also known as the renminbi) to 6.5646 to the US dollar, its lowest point in almost six years. When stock trading started, investors dumped shares and the market was down 7% in less than a half-hour, at which point the circuit breakers again shut down the market.

Shanghai Composite Index

Later that same day, Chinese authorities decided to abandon the circuit breakers starting on Friday, but the severe damage to share prices was already done. Fortunately, the Shanghai Composite Index (SCI) closed up almost 2% on Friday.

Equity markets around the world plummeted in lock-step with the decline in China’s stock markets last week. For most stock markets around the world, it was the worst New Year’s week in history. While the SCI fell another 5.3% on Monday, US stocks managed to post a modest gain. Today’s trading was mixed with a rally near the close. Yet volatility is likely to remain high in the weeks just ahead.

China’s Massive $4 Trillion in Reserves is Dropping Fast

At mid-2014, China’s vast holdings of foreign currency reserves (mostly US dollars) was estimated to be nearly $4 trillion, the largest such stockpile in the world. To many that seemed to be a gold-plated insurance policy against the country’s current market chaos, with a depreciating currency and a torrent of capital leaving the country.

The problem is the alarming “burn rate” of dollars at the People’s Bank of China. The nation’s stockpile of foreign exchange reserves plunged by $513 billion, or 13.4%, in 2015 to $3.33 trillion as the nation’s central bank coped with a weakening yuan and an estimated $843 billion in capital that left China between February and November of last year, the most recent tally available according to Bloomberg.

China's Foreign Currency Arsenal

It is widely believed that trillions of dollars in reserves held by the Peoples Bank of China (PBOC) are invested in safe liquid securities, including Treasury bills and bonds. However, the US Treasury reported late last year that China’s direct holdings of Treasuries stood at only $1.25 trillion – although it cautioned that the figure may not reflect the true ownership of US securities, as some may be held in custodial accounts in other countries.

In China, like some other countries, the exact composition of its foreign exchange reserves is a state secret. But analysts worry the currency armory may not be as strong as it looks. That’s because some of the investments may not be liquid or easy to sell. Others may have suffered losses that haven’t been accounted for. 

In addition, some Chinese reserves may have already been committed to fund pet government projects like the Silk Road Fund to build roads, ports and railroads across Asia or tens of billions in government-backed loans to countries such as Venezuela, much of which is repaid through oil shipments.

Then there are other liabilities that China needs to cover, such as the nation’s foreign currency debt to finance and manage imports denominated in overseas currencies. When those factors are taken into account, some $2.8 trillion in reserves may already be spoken for just to cover its liabilities, according to Hao Hong, chief China strategist at Bocom International Holdings Co.

This is yet another reason why the whole world is watching and worrying about China.

Crude Oil Price Hits 12-Year Low, Down 10% Last Week

US West Texas Intermediate (WTI) closed at $33.16 a barrel on Friday, down about 10% for the week. Brent crude closed Friday at $33.51 a barrel. It hit a trading session low of $32.16 on Thursday, the lowest since April 2004. Oil prices are plunging due to global oversupply and weak demand. Prices continued to plunge this week to below $31 a barrel for WTI.

WTI Crude OilOver the past year, the world has been producing more oil than it consumes by an average of 1.5 million barrels per day, according to the International Energy Agency. In the second half of last year, global daily production of crude topped 97 million barrels a day, versus daily demand of only about 95.5 million barrels, so there is literally a glut of oil on the market.

With the economic slowdown in China and elsewhere, OPEC and the International Energy Agency expect global oil demand to fall in 2016 – despite the lowest price in 12 years.

Normally, cheap oil prices are good for consumers, leaving them with more to spend on other goods and services. Yet with oil prices well below $35 per barrel, there are growing concerns about sovereign debt defaults in numerous oil producing countries – some even fear that Russia could be at risk if prices continue to fall.

So we’re at the point where falling oil prices are actually hurting the equity markets due to these growing concerns. With talk of $20 crude prices becoming more common, investors around the world are worried about sovereign debt defaults and widespread bankruptcies in the energy sector in 2016.

Finally, the plunge in energy prices, along with many other commodity prices, is increasing concerns about global deflation. Clearly, China is experiencing deflation as well as a host of other countries. This bears watching closely just ahead.

In conclusion, the wild markets we saw last week are likely to continue in the weeks and maybe months to come. For those who took my advice back in March and April of last year to cut your long-only equity exposure by at least 50%, I would remain in this defensive position for now.

There may be an opportunity to reload just ahead.

Given the sharply increased market volatility that we’ve seen so far this year, now is the time to consider some of the professionally managed equity programs that we recommend at Halbert Wealth Management – some of which have the ability to move to cash (money market) or hedge long positions if market conditions warrant.

An Attack on Democracy?

Worries over Poland Mount in Brussels and Berlin

 Photo Gallery: Poland Follows Hungary's Footsteps

From the courts to the media, Poland's new government has passed a number of new reforms that have the EU concerned about creeping autocracy. Complaints thus far have fallen on deaf ears in Warsaw, triggering calls for firmer action from Brussels. By SPIEGEL Staff

No, Frans Timmermans says, unfortunately he still hasn't received an answer. The deputy head of the European Commission has written to the government in Warsaw twice in recent weeks to express his concern over the rule of law in Poland. Instead of the requested letter, all he got was gloating on the part of new Polish Foreign Minister Witold Waszcykowski. Any EU official "who came to office via political connections" is "not a legitimate partner" for a government elected by the people, Waszcykowski scoffed.

Timmermans these days is having to exercise his utmost diplomatic skill in order to avoid an escalation of tensions. When, during a visit to Amsterdam on Thursday, Timmermans was asked about the Polish foreign minister's jibe, he could have struck back. But there is already enough tension, so he chose to take a different tack, instead praising the transformation of Eastern European countries from socialist dictatorships to free societies. But, he added, true democracies include two important elements: the protection of human rights and adherence to the rule of law.

The fact that Timmermans had to utter something that obvious says a lot about the current state of the European Union -- and developments in Poland. In less than two months, the country's new nationalist-conservative government has succeeded in disempowering the constitutional court, passing a law establishing government control over public broadcasting and installing party-aligned political appointees at the head of its intelligence services. "We want to cure our country of a few illnesses," Foreign Minister Waszcykowski told Germany's tabloid Bild earlier this month.

Increased Scrutiny

It's a choice of words most often associated with autocrats and has alarmed the European Commission. On Wednesday, the EU executive is expected to discuss whether or not it will open the so-called "rule of law mechanism." Should it do so, it would mark the first time a member state has been subjected to that level of scrutiny for violating the fundamental values of the European Union.

The procedures were established in 2014 as a kind of early-warning system to counter anti-democratic developments. If invoked, it stipulates that governments must account to the EU for changes to legal and constitutional changes -- and ultimately to repeal those law that run afoul of EU policy.

With his suggestion that Warsaw be placed "under supervision," Günther Oettinger, Germany's member of the European Commission, fueled widespread suspicion within the governing Law and Justice (PiS) Party in Poland that the developments coming out of Brussels might be part of some kind of Berlin-led conspiracy. "No pressure, no words, especially those from the lips of German politicians, will defer us from this path," PiS party boss Jaroslaw Kaczynski told supporters on Sunday. "We will repair Poland. We will implement this reform program."

'Putin-Style Politics'

So far, Merkel's government has resisted openly criticizing Poland in light of historical burdens in the relationship between Germany and Poland. But other politicians have been outspoken, including Martin Schulz, the center-left Social Democrat -- and German -- who is president of the European Parliament. On Sunday, he likened current developments in Poland to "Putin-style politics." And in an interview with SPIEGEL published on Saturday, Volker Kauder, conservative floor leader in German parliament, pleaded for sanctions against Poland if the country continues to violate the principles of rule of law. "If violations of European values are identified, then the member states must have the courage to apply sanctions," he said. "The Polish government needs to know that certain fundamental values in Europe cannot be infringed upon."

Those comments and others made by German politicians prompted Poland's foreign minister to summon Germany's ambassador to a meeting on Monday to discuss "anti-Polish" statements. After the meeting, the Polish foreign minister pleaded for more frequent visits by leading German politicians as the best solution for "communications problems."

In Berlin on Monday, Foreign Minister Frank-Walter Steinmeier announced he would accept an invitation by the new government in Warsaw "in the very near future." Meanwhile, Chancellor Angela Merkel's spokesman also emphasized close ties. "Germans and Poles are neighbors, partners, friends," he said. "We want to preserve and further precisely that -- even deepening it where possible."

"We cannot allow the current debate to lead to a bilateral conflict between Germany and Poland," says Michael Roth, the center-left Social Democrat state minister in the Foreign Ministry responsible for European affairs. Instead, Berlin is counting on the European Commission -- and is hoping that Warsaw isn't seeking to distance itself from European values in the long run.

'Pure Arrogance'

But is that realistic? "We view the allegations that we are breaching rule of law as pure arrogance," says Karol Karski, a constitutional law expert and PiS member of the European Parliament representing Poland. He says his party is unruffled by the prospect that the rule of law mechanism may be opened. He says it was the liberal government that preceded his, after all, that populated the constitutional court and the media with its people. Karski claims the moves had been made in order to make it impossible for PiD to govern and that this is now being corrected.

Still, the pace at which the nationalist-conservatives have been pushing through reforms in parliament has caught many Poles off guard as well. During the election campaign for the presidency and parliament, Jaroslaw Kaczynski's party had positioned itself as moderate and avoided polarizing, nationalist tones.

Almost as soon as they were in power, however, the nationalist-conservatives began showing their true face. First they began appointing their own party members to the constitutional court and then followed up with a singular blow to the freedom of the press. Between Christmas and New Years, a time when politics usually comes to a standstill in this deeply Catholic country, the government used its majority in parliament to pass a new media law mandating that the most important posts at public radio and television stations will be appointed directly by the government. For its next step, the government is planning to suspend the contracts of all journalists at state broadcaster TVP. A director appointed by TVP is then expected to "review" each individual journalist before making any rehiring decisions.

'Government Propaganda Broadcasters'

"We're heading towards conditions that fit the pattern of Moscow, Minsk or Budapest," says Tomasz Lis, Poland's most important news anchorman, but also arguably the journalist most-hated by the nationalist-conservatives. "PiS is going to turn the state stations into government propaganda broadcasters," he argues. "They see no difference between the interests of the state and those of the party. We're still familiar in Poland with that kind of conception from communist times."

The most controversial move so far is a new law passed that requires a two-thirds majority for decisions by the Constitutional Tribunal, which decides on the constitutionality of Polish laws, rather than the previous simple majority. PiS is expected to follow the move in the coming year by seeking to bring further institutions key to power and the administration of justice under its control. These include the highest court, the highest administrative court and the office of the human rights commissioner. In March, PiS also intends to introduce its plans for the reform of the state prosecutor's office. Under the reform, the justice minister would also assume the role of chief prosecutor in what would be a clear violation of the principle of the separation of powers.

Behind all the moves is PiS party leader Kaczynski, a nationalist who emerged as a political figure in the anti-communist opposition during the 1970s. "He belonged to the conservative faction," says Wojciech Sadurski, a law professor in Sydney who studied with him. "What bothered him most about communism was less the fact that it was undemocratic and more that it was 'un-Polish.'" For many, the Polish People's Republic was nothing more than the manifestation of Russian foreign control over Poland, he says. "Kaczynski still dreams today of centralizing power," says Sadurski. He argues that Kaczynski finds protracted democratic policy debates, internal party wrangling and minority interests with suspicion.

The PiS chairman is also the reason it will be difficult for Poland's EU partners to convince the country to make concessions. There is little contact with the 66-year-old. Given that Kaczynski has no official government function, it would also be unusual in terms of diplomatic protocol for leaders like Chancellor Merkel or European Commission President Jean-Claude Juncker to request meetings with him. The nationalist-conservative prefers staying in the background, meeting only seldom even with his own party colleagues. "He will continue with the restructuring of the state," former college friend Sadurski says.

Since December, tens of thousands of people have taken part in Warsaw and other cities against what some have described as a "creeping coup." In order to contain popular outrage, the government is currently preparing a series of social reforms. Among the initiatives is a move to sink the retirement age again -- which was raised by the previous government -- to 60 for women and 65 for men. The minimum wage is to be increased and Polish mothers will also get a 500 zloty monthly family allowance. Following the Hungarian model, special taxes would also be imposed on supermarket chains in order to ensure that small Polish businesses remain competitive. Legal expert Sadurski calls these measures "attempted bribery."

Ultimately, the European Commission's room for maneuver is limited. It can deploy the rule of law mechanism, but the process is a complicated one. If the dialogue on the rule of law deficits between the Commission and the member state fails to make headway, the Commission has the option of introducing procedures outlined in Article 7 of the Lisbon Treaty.

High Hurdles for Sanctions

At that point, however, high hurdles are set in place for any sanctions. First, the European Council, the powerful body representing the leaders of the member states, would be required to determine with a four-fifths majority vote that there is a "clear risk of a serious breach of the EU values by a member state." It's hard to imagine that other countries that have been the subject of criticism for their democratic deficits, including Hungary and Slovakia, would leave Poland in the lurch.

In addition, sanctions like the suspension of voting rights can only be imposed if the European Council unanimously agrees that the breach of EU values existing in the member state in question is "systemic and persistent." As grave as the PiS' state incursions have been, they are unlikely to fulfill that criteria. "There would have to be something like a military putsch in Warsaw for that to happen," says one veteran EU diplomat.

As such, officials in Brussels and Berlin are considering other ways to pressure Poland to shift its stance. Like the Baltic States, the country is demanding solidarity from the Europeans when it comes to dealing with potential problems with neighboring Russia. It's a card that the Poles have often played in the past -- most recently only a few days ago. Warsaw officials said a vote in favor of British EU reform proposals was conceivable if Britain were to increase its military presence near the Russian border. The government in Warsaw would also like to see the establishment of a permanent NATO base in Poland, a move Western Europeans have so far rejected out of consideration for sensitivities in Moscow.

'Those Who Want Something also Have to Give'

Better leverage, however, may be offered by this year's review of the EU's financial framework. During the European refugee dispute, European Parliament President Schulz already suggested he would be prepared to use this mechanism in order to force the Poles to behave. "The medium-term planning requires unanimity," he said. "Those who want something also have to give."

In mid-January, the European Parliament plans to address events in Poland during a session in Strasbourg. Herbert Reul, who heads the conservative Christian Democrats' faction in the EU parliament, says it is likely that a strongly worded resolution will be drafted. "If political means of dialogue don't work, then we need economic sanctions," he argues.

Reul believes the Poles should be threatened with the withdrawal of EU subsidies. In 2014 alone, Poland netted €13.75 billion ($14.9 billion) in funds from the European budget. Indeed, no other country has profited as much from the European cash bonanza. The Brussels subsidies, for example, made the rapid construction of Poland's highway system possible.

Even as Merkel has thus far avoided making public statements on the issue, her patience with Poland is finite. "It strikes me as somehow very strange that those who consider themselves lucky that they have lived to see the end of the Cold War now think that one can completely stay out of certain developments of globalization," she told members of the center-right European People's Party at the beginning of October in Strasbourg.

It appears that Warsaw isn't entirely indifferent to perceptions in Brussels and Berlin. Many EU parliamentarians were taken by surprise the weekend before last when they received hundreds of emails from anonymous Polish addresses written in their respective languages.

"We want to reassure you," the messages read, "democracy in Poland is in no way under threat."

Despite all its reservations about German dominance in Europe, Warsaw needs to be careful not to allow relations with Germany to cool off, argues Krzysztof Bluszcz of the Warsaw-based think tank Demos Europa. He says the alliance with Germany is important, especially when it comes to the Ukraine crisis. PiS, he says, is highly critical of Russia and considers it imperative that sanctions against Moscow be maintained.

But if Warsaw begins fighting with Berlin, Poland could fall into a situation in which historical traumas are reawakened -- one in which it finds itself wedged between the major powers Germany and Russia, ignored in Berlin and viewed with hostility by Moscow. This may explain why PiS politicians are currently stressing the importance of their good ties to Germany, wherever they get the chance. Even EU parliament member Karski says, "We want the best of relations."

After months of silence, Warsaw is now seeking dialogue with its German neighbors. Last week, the office of Prime Minister Beata Szydlo contacted the Chancellery in Berlin. She is finally expected to make her first official visit to German Chancellor Merkel on Feb. 12.

By Peter Müller, Ralph Neukirch, Christoph Pauly, Jan Puhl and Christoph Schult

Reforming or Deforming the Fed?

Barry Eichengreen

 Ted Cruz  
BERKELEY – The silly season that is a presidential election campaign in the United States has taken a particularly absurd turn as the candidates offer their proposals for monetary-policy reform. This is not the first time, of course, that presidential candidates have proposed changing how US monetary policy is conducted. But the radical, sometimes harebrained, nature of the current crop of schemes is exceptional by historical standards.
Why such proposals appeal to the candidates and potential voters is no mystery. Since the financial crisis, the US Federal Reserve has taken a series of unprecedented steps, cutting interest rates to zero, massively expanding its balance sheet, and bailing out troubled financial institutions. Those measures were intended to treat the economy’s ills, but their very association with those ills encourages the belief that they are somehow the underlying cause.
Likewise, the Fed’s participation in rescues of troubled financial institutions is criticized for favoring Wall Street over Main Street. And, separately, the Fed is slammed for creating inequality, first by keeping interest rates low, which hurts those on fixed incomes, and now by raising rates, which keeps a lid on wage growth.
Clearly, the Fed just can’t win – and for reasons that have nothing to do with current monetary policy. Two of the most deep-seated features of American political culture – with roots extending back to the eighteenth century – are suspicion of powerful government and distrust of concentrated financial power. The Fed is the single institution that best encapsulates those fears.
Thus, we have proposals by Republican candidates Ted Cruz, Rand Paul, and Mike Huckabee to require the Fed to maintain a fixed dollar price of gold. To call these actual proposals is a bit generous. The proponents do not specify whether the Fed would be obliged to provide gold at this price to all comers, as before 1933, or only to foreign governments, as between 1945 and 1971. Nor do they explain whether that obligation could be suspended in an emergency, as in those earlier eras.
More fundamentally, they fail to explain what is special about gold aside from its talismanic quality.
They do not clarify why the Fed should focus on stabilizing the price of this particular metal, rather than on the price of a representative basket of goods and services. Indeed, if the critics focused on the latter, they could give their proposal a name. They could call it “inflation targeting.”
Proposals for a “Taylor rule” are more serious, if only because such a rule, first described by Stanford University economist John Taylor, links the policy interest rate to just such a representative basket of goods and services, namely the consumer price index, while adjusting for the rate of unemployment. But the rule is merely a formula purporting to explain why the Fed set its policy interest rate as it did in the 1980s and early 1990s, the period Taylor considered in his original study.
Indeed, a Taylor rule is a guide for desirable policy only if one thinks that the policies followed in that period were desirable, or, more to the point, that similar policies will be desirable in the future. It provides no direct way to address other concerns, such as financial stability, which most people will agree should, in light of recent events, figure more prominently in monetary-policy decisions.
Some of the reform proposals by Bernie Sanders, a contender for the Democratic nomination, also deserve to be taken seriously. The fact that three of the nine directors of the Fed’s regional reserve banks are private bankers is an anachronism that creates the appearance, and potentially the reality, of a conflict of interest. Sanders’ suggestion that the US president, rather than their own directors, nominate the regional reserve banks’ presidents is also worthy of consideration.
It is important to recall that the peculiar arrangements prevailing today were designed to overcome the financial sector’s opposition to the establishment of a central bank when the Federal Reserve Act was passed in 1913. This, clearly, is no longer the problem; on the contrary, the financial sector today is one of the Fed’s last staunch defenders.
Other proposals by Sanders are more dubious. For example, to release full transcripts six months after Fed meetings would guarantee a scripted debate. Meaningful discussion would simply move to the anteroom. The result, perversely, would be a decline in policy transparency.
Above all, Sanders’ recent statements betray a disturbing inclination to interfere in the conduct of monetary policy. The Fed, he argues, should not have raised interest rates in December in response to “phantom inflation.” He may be right. But it is not the role of the US president to tell the Fed how to manage its policy rate. The independence of the central bank is an essential cornerstone of effective monetary policy. Even – or especially – an aspiring president should be sensitive to this fact.

Revolt of the Politically Incorrect

Donald Trump and Ben Carson popped the valves on decades of pent-up PC pressure.

By Daniel Henninger

GOP presidential hopeful Ben Carson in Nashua, N.H., Dec. 20.

GOP presidential hopeful Ben Carson in Nashua, N.H., Dec. 20. Photo: Bloomberg News

Soon we’ll all be camped in the fields of primary politics, as that great threshing machine called the American voter methodically separates the contender wheat from the candidate chaff. Let’s not go there, though, without recording 2015 as the year that political correctness finally hit the wall.

Many thought political correctness lived on in our lives now as permanently annoying background noise. In fact, it has been more like a political A-bomb, waiting for its detonator.

On Dec. 7, Donald Trump issued his call for a ban on Muslim immigration into the U.S.—“until our country’s representatives can figure out what is going on.” It’s hard to recall a statement by a public figure that was met, instantly, with almost universal condemnation, including from most of the Republican presidential candidates.

Between that day and the end of 2015, Donald Trump’s support in the national opinion polls went up to nearly 37%, a substantial number by any measure.

Welcome to the revolt of the politically incorrect.

Forget the controversy over Donald Trump’s Muslim ban. This unique political campaign is about more than that. Donald Trump and indeed Ben Carson popped the valves on pressure that’s been building in the U.S., piece by politically correct piece, for 25 years. Since at least the early 1990s, a lot of the public has been intimidated into keeping its mouth shut and head down about subjects in the political and social life of the country that the elites stipulated as beyond discussion or dispute.

Eventually, the most important social skill in America became adeptness at euphemism. It isn’t an abortion; it’s a “terminated pregnancy.”

Some keywords in PC’s history:

Identity, gender, gender-neutral, diverse, inclusive, patriarchy, workplace harassment, multiculturalism, dead white males, sexism, racism, organic, “privileged,” hate speech, speech codes, prayer in schools, affirmative action, respecting our differences, microagressions, trigger warnings.

That’s just the tip of the iceberg—which political correctness slammed into with the Trump and Carson campaigns.

Ben Carson especially made PC an explicit tenet of his campaign. In a 2014 essay for the Washington Times, Mr. Carson wrote: “Political correctness is antithetical to our founding principles of freedom of speech and freedom of expression. Its most powerful tool is intimidation. If it is not vigorously opposed, its proponents win by default, because the victims adopt a ‘go along to get along’ attitude.”

The left found Mr. Carson’s PC concerns almost quaint. But the email traffic I was seeing last summer suggested the Carson anti-PC critique was a big reason for his surge among middle-class voters. My favorite Carsonism: When asked in the Fox News debate if he’d resume waterboarding, he replied, “There is no such thing as a politically correct war.”

When Donald Trump’s mostly working-class voters repeatedly said that “he tells the truth,” this is what they were talking about—not any particular Trump outrage but the years of political correctness they felt they’d been forced to choke down in silence.

American society has never been static. A fair-minded person would concede that many of these controversial subjects involve legitimate and complex issues. Politics exists to mediate them.

Mediation? We should have been so lucky. The left never modulated its PC offensive. The 2006 Duke University lacrosse scandal, a travesty of PC trampling on individuals, should have been a red flag. Instead the Obama Education Department imposed what are essentially kangaroo courts on American campuses to enforce Title IX sexual-abuse cases.

Policies like that don’t emerge from the marketplace of ideas, much less political debate. They come from a kind of Americanized Maoism. The left goes nuts when anyone suggests political correctness has totalitarian roots. But the PC game has always been: We win, you lose, get over it, comply.

But people don’t get over it, and they never forget. For a lot of voters now, possibly a majority, their experiences with enforceable, politically correct behavior, speech and thought have bred a broad mistrust of elites.

Average people think individuals in positions of leadership are supposed to at least recognize the existence of their interests and beliefs. The institutions that didn’t do that or were complicit include the courts, Congress, senior bureaucrats, corporate managers, the press, television, movies, university administrators.

Somehow, the standard model of political comportment—represented by most of the GOP’s presidential candidates—just isn’t up to dealing with a degree of voter social alienation that isn’t particularly rational at this point. So voters turned to “outsiders”—people more like them.

The election’s two big issues remain: a weak economy and global chaos. But for many voters, the revolt against political correctness is on. Hillary Clinton, hostage to a PC-obsessed base, must mouth politically correct pabulum. Donald Trump joy-rides the wave. An opening remains for an electable candidate who can point this revolt toward what it wants—a political win, at last.