There is a growing consensus in Washington the only way to fix the worst economic downturn in more than 70 years is by giving out more free money.  There is a demand for more “stimulus.”  However, the reason the previous programs failed is the stimulus doesn’t lead to organic growth.

Let me explain.

Joseph Carson, the former Chief Economist at Alliance Bernstein, recently noted:

“Suppose Congress passes something close to Biden’s Administration stimulus proposal of $1.9 trillion. In that case, that will lift the cumulative amount of fiscal stimulus in the past 12 months to $5 trillion—three tranches $2.2 trillion, $900 billion, and $1.9 trillion.

In the past year, nominal GDP totaled $21 trillion, so the cumulative injection of fiscal stimulus amounts to almost 25%.

Nothing in modern times comes close, especially during peace times. CBO published a report in 2010 on the military costs of significant wars. The military war costs of World War 1 amounted to 13.6% of GDP and World War 11 35.8%—-so the current spending/stimulus is in the middle of the two World Wars.”

 

 

It is an incredible amount of intervention relative to the underlying crisis. As Joseph pointed out, there is a significant difference between today and WWII.

“During World Wars, activity in the private sector is depressed. That’s not the case today. The housing sector is booming, with housing starts at the highest levels in 15 years, and prices are rising double-digit to record levels. At the same time, the manufacturing sector is experiencing a mini-boom in orders and production.”

 

 

That surge in the third quarter, and surging stock market to boot, directly responded to both the fiscal and monetary stimulus supplied. The chart below adds the percentage change in Federal expenditures to the chart for comparison.

 

 

The spike in Q2 in Federal Expenditure was from the initial CARES Act. In Q1-2020, the Government spent $4.9 Trillion in total, which was up $85.3 Billion from Q4-2019. In Q2-2020, it increased sharply due to the passage of the CARES Act. Spending for Q2 jumped to $9.1 Trillion, which is a $4.2 Trillion increase over Q1-2020. In Q3 and Q4, spending was still well above normal levels running at $7.2 and $6.0 trillion. 

Importantly, note that the rate of change in spending is declining along with economic growth rates. That is the “second-derivative” effect of growth.

Second Derivative

The next chart shows how the “second derivative” is already undermining both fiscal and monetary stimulus. Using actual data going back to the Q1-2019, Federal Expenditures remained relatively stable through Q1-2020, along with real economic growth. However, from Q2 through Q4-2020, Federal Expenditures surged. However, the economy still hasn’t returned to positive growth.

 

 

The chart below shows the inherent problem. While the additional fiscal stimulus did help stave off a more in-depth economic contraction, its impact becomes less over time.

 

 

However, this is ultimately the problem with all debt-supported fiscal and monetary programs.

Stimulus Doesn’t Provide Confidence

The problem with monetary interventions, like direct checks to households, is that while it may provide a short-term bump in spending, it does not promote confidence. As shown in the chart below, despite a surging recovery in the economy and the stock market, consumer confidence remains mired at recessionary lows.

 

 

The reason that stimulus payments didn’t improve consumer confidence is due to the understanding that such payments are a one-time benefit. What increases economic prosperity and confidence are employment and wage growth.

Such is the problem with artificial stimulus. To increase employment and wages, it is the confidence of employers that needs to improve. The chart below replicates how the economy works. Individuals must produce first before they can consume.

 

 

While stimulus will bypass the “production” part of the equation creating short-term demand, such does not create the repeatable demand necessary for businesses to increase employment. We saw this in the recent National Federation of Independent Business (NFIB) survey.

“Small businesses are susceptible to economic downturns and don’t have access to public markets for debt or secondary offerings. As such, they tend to focus heavily on operating efficiencies and profitability. If businesses were expecting a massive surge in ‘pent up’ demand, they would be doing several things to prepare for it. Such includes planning to increase capital expenditures to meet expected demand. Unfortunately, those expectations peaked in 2018 and are lower again.”

 

 

“There are important implications to the economy since ‘business investment’ is a GDP calculation component. Small business capital expenditure ‘plans’ have a high correlation with real gross private investment. The plunge in ‘CapEx’ expectations suggests business investment will drop sharply next month.”

 

 

The bigger problem with the stimulus is that it is based on increasing debt levels to provide it.

You Can’t Use Debt To Create Growth.

The biggest problem with more stimulus is the increase in the debt required to fund it.  There is no historical precedent, anywhere globally, that shows increased debt levels lead to more robust rates of economic growth or prosperity. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the change in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.

 

 

We can view the impact of debt on the economy by analyzing the economic growth created. As shown, it takes an increasing amount of debt to generate each dollar of economic growth.

 

 

For the 30 years from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Such is why the Federal Reserve has found itself in a liquidity trap.

Interest rates MUST remain low, and debt MUST grow faster than the economy, just to keep the economy from stalling out.

The deterioration of economic growth is seen more clearly in the chart below.

From 1947 to 2008, the U.S. economy had real, inflation-adjusted economic growth than had a linear growth trend of 3.2%.

However, following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Unfortunately, instead of reducing outstanding debt problems, the Federal Reserve engaged in policies that expanded unproductive debt and leverage.

 

 

Coming out of the 2020 recession, the economic trend of growth will be somewhere between 1.5% and 1.75%. Given the amount of debt added to the overall system, the ongoing debt service will continue to retard economic growth.

A Permanent Loss 

The permanent loss in output in the U.S. was shown by Bank of America previously. The bank laid out the pre-COVID trend growth and compared it to its base case recovery.

 

 

Such aligns closely with our analysis shown above. Given the permanent loss in output and rising unproductive debt levels, the recovery will be slower and more protracted than those hoping for a “V-shaped” recovery. The “Nike Swoosh,” while more realistic, might be overly optimistic as well.

However, this is the most critical point.

The U.S. economy will never return to either its long-term linear or exponential growth trends……UNLESS there is a debt reduction strategy.

 

Read that again. 

 

A Continuation Of Boom/Bust Cycles

 

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 40-years.

As Joseph Carson, former Chief Economist at Alliance Bernstein concluded:

“Given the scale of fiscal stimulus, one would expect the Fed to be thinking of “leaning against the wind.” But not this Fed–the Fed is using the same playbook from the Great Financial Recession, providing unneeded stimulus to the red-hot housing market.

What’s the economic and financial endgame? It’s hard to see anything but a ‘boom-bust’ scenario playing out with fast growth and rising market interest rates in 2021 and early 2022, followed by a bust in late 2022/23 when the fiscal stimulus/support dries up.

The US experienced mild recessions following the sharp drop in government military spending after the Korean and Vietnam wars—-and back then, the scale of military expenditures amounted between 2% and 4% of GDP. The ‘sugar-high’ today is unprecedented, raising the odds of a harder landing.

While mainstream economists believe more stimulus will create robust economic growth, no evidence supports the claim.

Yes, we will get a short-term burst of inflation and interest rates, most certainly. However, such will quickly collide headlong into the massive debt levels overhanging the economy.

Such is the trap that will put the Federal Reserve in a box of hiking rates and reducing monetary accommodation at precisely the wrong time.

 

Inflation?

 

Inflation risk increases with time, which is why it has a greater effect on long-maturity bonds. One way to track this is via the “breakeven rate” on Treasury Inflation-Protected Securities. Breakeven is the yield difference between traditional T-bonds and those that adjust for inflation. As the chart shows, the 10-year maturity level is now at levels last seen in 2014 (though 2018 was close).

 

 

This means bond investors expect inflation to average 2.21% over the next 10 years. That’s not especially high in historical perspective, but it is more than we have seen recently. And it got here fast, too, rising from a historically low 0.55% less than a year ago. The inflation breakeven rate is a guess that can be wrong, and often is. The latest spike seems driven by the likely passage of large fiscal stimulus combined with higher growth as the virus recedes. That outlook contains many assumptions but may be right. We’ll know in 10 years.

We are about to inject far more money than the economy can handle. It will have to emerge somewhere and may do so as price inflation. Given the commitments the Fed has made, administration officials’ dismissal of even the possibility of inflation, and the difficulties in mobilizing congressional support for tax increases or spending cuts, there is the risk of inflation expectations rising sharply.

The world’s strongest economy is currently deflating and everyone believes the US is on the verge of a new inflationary experience because of temporary, if large, “stimulus checks”—this isn’t actually real stimulus, it is charity, and less than 30% of it finds its way into the economy and all it does is ensure that rent payments, utilities and food bills get paid. The “New Deal,” this is not. These sort of debt-financed stimulus programs provide only a short (a quarter or two), transitory GDP boost.

These programs actually have a negative multiplier once the effects play out over a few years. The new debt issued to pay for them weighs on growth, the velocity of money falls further, and the economy is worse than ever. Raising taxes wouldn’t help, either. Both taxes and government debt divert money out of the private sector.

Fed Chair Jerome Powell said, “We need more stimulus and inflation is not a worry”.

That says it all.

 

UNDER employment

 

Last week’s January jobs report showed some improvement in the unemployment rate, but unfortunately it was mostly because people dropped out of the labor force. You aren’t “unemployed” unless you are available to work and looking for work. There are other categories. Some people are “underemployed,” meaning they are presently working part-time but want a full-time job. This chart compares that measure with the headline “U3” unemployment rate. The difference is enormous.

 

 

As of January 2021, the US had 10.1 million unemployed people, plus another 6 million underemployed, plus another 7 million who want a job but aren’t actively looking. So the amount of “slack” in the job market is quite a bit higher than the headline unemployment rate suggests. This reduces the odds of significant wage inflation this year.

 

US Economy

 

  • Economists are concerned that the additional $1.9T fiscal stimulus will overheat the nation’s economy.
  • The budget deficit will hit a new post-WW-II record.
  • BofA revised its GDP forecast higher and now expects the economy to overheat next year at full employment, triggering inflation.
  • With additional fiscal stimulus and vaccination rollout, SunTrust expects GDP growth to be the strongest since 1999.

 

 

  • When will the GDP reach its pre-COVID path?
    • According to Morgan Stanley, it will be in Q3 of next year.
  • Job postings on Indeed have recovered.
  • Migration from urban neighborhoods has been remarkable.

 

 

  • The NFIB Small Business Optimism Index deteriorated further last month.
  • The NFIB report points to higher consumer inflation ahead.
  • December job openings surprised to the upside.
  • According to Moody’s Analytics, US renters owe some $57 billion in back rent, with a typical balance of $5,600 (plus fees for late payments). Lifting the eviction moratorium will be painful.
  • The January CPI report was a bit weaker than the markets were expecting.
  • Treasury yields pulled back.
  • Owners’ equivalent rent CPI has been under pressure, especially in large cities.
  • Other items contributed to core CPI weakness in January.
    • New cars:
    • A massive decline in admission prices for sports events:
    • Airline fare:
    • Inpatient hospital services:
    • Funeral expenses:
    • College tuition…lower:
  • The market is pricing in less bankruptcy risk ahead.

 

 

  • The NY Fed’s activity index has deteriorated in recent weeks.
  • A faster pace of vaccinations should help.
  • Mortgage delinquencies slowed last quarter.
  • Helped by mortgage forbearance programs and housing market strength, the foreclosure rate shows no signs of last year’s massive job loss.
  • The February U. Michigan consumer sentiment report was surprisingly soft (economists were projecting an uptick).
  • The index of expected changes in personal finances hit the lowest level since 2014.
  • Survey participants are reporting higher home prices.
  • The indicator of buying conditions for vehicles continues to deteriorate. It’s a bit surprising, given that vehicle sales held up relatively well last year despite the massive job losses.

 

Interesting

 

 

 

 

All content is the opinion of Brian J. Decker