The Cash Economy

Large-scale money printing was launched by Alan Greenspan, who believed that additional liquidity would be needed to cushion the shock of the millennium rollover. The shock never happened, but the easy money continued as the dot-com bubble popped, eventually leading to the housing bubble and its culmination with the failure of Lehman and the 2008 financial crisis. The Fed’s response was to turn on the afterburners. The December 2007 monetary base was 0.84 trillion dollars. By December 2019, it had risen four-fold to 3.4 trillion. And the the Fed lit the JATO bottles as well and we got real liftoff, as by December 2021 the monetary base had risen to 6.4 trillion dollars.

This matters because it means the economy is awash in cash. Monetary velocity has fallen from a pre-2009 low of 1.65, set in Q4 of 1964, to 1.15 as of Q2 of 2022. That means that much of the cash is idle, not being spent. All that cash is buying power in the hands of people and institutions. This means that interest rates and availability of credit are less important, and the Fed’s mission to reduce inflation by reducing demand faces an uphill battle. The Fed has begun reducing the monetary base by selling its pile of Treasuries and MBS. This is far more important than raising rates, but it will be a long time before its effects start to be felt because the current position is so extreme.

The poster child of the 2008 crisis was the NINJA (No Income, No Job or Assets) home buyer. The NINJA borrower has been replaced by the US government. Federal debt has nearly quadrupled since 2008.

This is why we have inflation. It is not going away until the deficit spending is reined in. Every dollar of new federal debt becomes a dollar in savings – and potential spending – for the private sector.

Where The Fugawi?

The flightless Fugawi bird lives in the tall grass of the African savannahs. Unfortunately, this bird is not as tall as the grass that surrounds it, hence its mournful call. The mavens of Wall Street seem to share the bird’s frustration as they focus on fractional changes in economic data, in the hope that they will foreshadow a return to the peaceful, sunlit uplands of free and flowing money.

Alas, it is not to be. We are fated to do battle with the multi-headed Scylla of inflation and, if we win, it is only to be sucked into Charybdis’ whirlpool of depression. Massive increases in government debt have, inevitably, increased private sector savings and pulled consumption forward in time. If these increases continue, Scylla will dine well as hyperinflation ruins the dollar. If they do not, consumption will, of necessity, fall as the credit impulse reverses. Charybdis’ whirlpool is a fine metaphor for the negative feedback cycle that will result from bankruptcies and defaults. If I do say so myself.

Jeff Gundlach Interview

Jeffrey Gundlach is the billionaire founder and CEO of DoubleLine, a Los Angeles based investment boutique mainly specializing in bonds, ranks among America’s highest-profile investors. His bold calls and correct prediction of the 2007 housing crash have earned him a solid reputation. A recent interview is most interesting in that he clearly, if intuitively, understands the instability inherent in the Fed’s attempts to control the economy by hindsight.

The next shock is that we’re having to put in a big overreaction to the inflation problem which we created from our initial reaction of excess stimulus. My guess is that we will end up creating momentum that’s more deflationary than a lot of people believe is even possible.

Of course he is very probably correct. A deflationary economic collapse is very likely to follow the inflationary phase. So long as the Fed is willing to make massive interventions in the economy without understanding the dynamics of control, we are utterly screwed. There comes to mind a well-known class of control systems known as bang-bang control.

Moral Hazard

Apparently Biden the inflation-fighter has another huge spending program to put away the beast. This is forgiving a portion of outstanding student loans, a program estimated to cost between $300 billion and $900 billion over the next ten years.

The Federal government should never have been in the student loan business in the first place. It has caused massive hikes in college prices, far outstripping inflation, purely because the students can borrow the money to pay whatever the colleges ask. Then the students are saddled with big debts. The right solution is for colleges to have a financial commitment to the future success of their students, with a positive return on their education investment. Colleges should accept a share of future income instead of up-front fees, encouraging them to invest in the quality and relevance of education rather than lavish facilities and top-heavy administration.

The inevitable result of this program is more moral hazard. Students will expect further bailouts, and colleges will charge more.

Government Subsidy

Biden triumphantly put a $7,500 credit out there for electric vehicles. This caused Ford to increase the price of its electric pickup by $7,000 to $8,500, while Chevy added $6,250, to its electric Hummer. Piling another $7,500 of debt onto the taxpayers for each vehicle. So there’s a double whammy of inflation. Another self-inflicted wound. And by the way these vehicles will consume huge amounts of energy due to their weight – 6,000 lb for the Ford and a staggering 9,000 lb for the Hummer. These vehicles are on the wrong side of the curve – heavy to start with, they need lots of heavy batteries which make them even heavier in a vicious circle.

Edit: According to the industry group, Alliance for Automotive Innovation, “there are 72 EV models currently available for purchase in the United States including battery, plug-in hybrid and fuel cell electric vehicles. Seventy percent of those EVs would immediately become ineligible when the bill passes and none would qualify for the full credit when additional sourcing requirements go into effect. Zero.” So, Ford and Chevy, I take it back. But I still think these massive trucks are a bad idea.

Pivot – To What?

It seems as if every financial writer has no more important subject to opine upon than the exact date of the Fed “pivot,” when the Fed will be “forced to” resume supporting wild speculation.

Such opinions may be successful clickbait, but any such pivot is economically meaningless. Just look at the last employment report. The number of jobs increased significantly, but the number of employed persons hardly moved. People are taking on more jobs in order to, as President Bush put it, “put food on their family.” This can only go so far, for obvious reasons, and it means there are insurmountable limits on the economy’s ability to grow. Production equals labor hours times productivity. Productivity is slow and hard to improve, so not any help. Labor hours are pretty close to the wall, as shown by the average workweek which has flatlined at 34.6 (FRED). This all means that the economy cannot grow in response to stimulus. Easy money and/or a return to QE will simply result in more inflation, which will do as much or more damage to the economy and corporate profitability than higher interest rates. I cannot believe that the Fed is unaware of this reality. There is no free lunch. Pain is coming, regardless of what the Fed may or may not do. Look back at the Great Depression when the Fed thrashed around, trying everything because nothing “worked.”

Recession

In my view, it is highly likely that the US economy has already entered a recession. I’m using ECRI’s definition of recession:

A recession is a self-reinforcing downturn in economic activity, when a drop in spending leads to cutbacks in production and thus jobs, triggering a loss of income that spreads across the country and from industry to industry, hurting sales and in turn feeding back into a further drop in production – in effect a vicious cycle.

The big question is what happens to inflation. And that largely depends on the Fed. The government will continue on its path of reckless spending, that is a given. Anything that might buy votes from the naive and foolish. The question is whether or not the Fed will return to its habit of monetizing the spending or not. Since the Fed does not understand the reasons for its inability to control inflation or employment, it could do anything. One can only wait and see,

Quo Vadimus?

We are either in recession already or about to enter one. Lakshman Achuthan of ECRI thinks we’re in a Roadrunner moment – we’re off the cliff but  haven’t looked down yet. It sure feels like that – too many analysts are supremely confident that inflation will fall away, the Fed will pivot back to money-printing and everything will be back to the way it was – the “new normal.” It just sounds too good to be true.

Powell isn’t fighting inflation. Dinky little increases in interest rates are an attempt to build confidence that the Fed is doing something. This excellent article makes a good case that he’s channeling Arthur Burns, not Paul Volcker.

The massive government deficit hasn’t gone away. Sure, it has moderated somewhat, but the Biden administration still firmly believes that it can spend whatever it wants without consequences. Biden is channeling Nero.

The “climate change” idiocy continues. No need to repeat previous posts on this subject, other than to observe that reducing the availability of fossil fuels without providing a new base load infrastructure is economic suicide.

Tight labor markets mean that the wage/price feedback loop can – and will – be sustained.

The housing market continues manic, despite rising mortgage rates. Of course the individual first-time buyer is affected, but institutional buyers with cash have moved in. Shelter is the largest component of CPI and is a lagging indicator.

This spring and summer’s crops were planted with last year’s fuel and fertilizer costs. These costs will bite with the fall harvest. And by the way the west of the country is in severe drought.

Other than that, Joe, how’s it going? Joe? Anybody home?

Thanks A Lot

But we do have much, much more government surveillance and intrusion into our lives. And of course much more debt and government spending. Soon we won’t need a private sector at all.

Debt

According to the St Louis Fed, from Q1 2000 to Q1 2022, federal debt has expanded from $5.77 trillion or 58% of GDP to $30.4 trillion or 125% of GDP. And the deficit spending continues unchecked. History says that government debt of over 80% of GDP inhibits economic growth.

The interest rate on the debt is currently about 1.5%, but 70% of the debt is due at various dates within 5 years, and will be rolled-over and re-priced at whatever rates are current at its maturity. However, the following chart shows that the highly negative real rates currently in effect do not persist for very long. The red line is the inflation rate, the black line is the Fed funds rate and the blue line is the “real” rate – the nominal Fed rate minus inflation. It seems likely that the Federal budget and interest expense will have a nasty collision in the next few years unless inflation falls rapidly.