Monetary and fiscal policy won’t lift us out of the new depression. Let’s first take a look at monetary policy.
Fed money printing is an exhibition of monetarism, an economic theory most closely associated with Milton Friedman, winner of the Nobel Memorial Prize in economics in 1976. Its basic idea is that changes in money supply are the most important cause of changes in GDP.
A monetarist attempting to fine-tune monetary policy says that if real growth is capped at 4%, the ideal policy is one in which money supply grows at 4%, velocity is constant and the price level is constant. This produces maximum real growth and zero inflation. It’s all fairly simple as long as the velocity of money is constant.
It turns out that money velocity is not constant, contrary to Friedman’s thesis. Velocity is like a joker in the deck. It’s the factor the Fed cannot control.
Velocity is psychological: It depends on how an individual feels about her economic prospects. It cannot be controlled by the Fed’s printing press. It measures how much money gets spent from people to businesses.
Think of when you tip a waiter. That waiter might use that tip to pay for an Uber. And that Uber driver might pay for fuel with that money. This velocity of money stimulates the economy.
Well, velocity has been crashing for the past 20 years. From its peak of 2.2 in 1997 (each dollar supported $2.20 of nominal GDP), it fell to 2.0 in 2006 just before the global financial crisis and then crashed to 1.7 in mid-2009 as the crisis hit bottom.
The velocity crash did not stop with the market crash. It continued to fall to 1.43 by late 2017 despite the Fed’s money printing and zero rate policy (2008–15).
Even before the new pandemic-related crash, it fell to 1.37 in early 2020. It can be expected to fall even further as the new depression drags on.
As velocity approaches zero, the economy approaches zero. Money printing is impotent. $7 trillion times zero = zero. There is no economy without velocity.
The factors the Fed can control, such as base money, are not growing fast enough to revive the economy and decrease unemployment.
Spending is driven by the psychology of lenders and consumers, essentially a behavioral phenomenon. The Fed has forgotten (if it ever knew) the art of changing expectations about inflation, which is the key to changing consumer behavior and driving growth. It has nothing to do with money supply.
The bottom line is, monetary policy can do very little to stimulate the economy unless the velocity of money increases. And the prospects of that happening aren’t great right now.
But what about fiscal policy? Can that help get the economy out of depression?
Let’s take a look…
Congress is far along in authorizing more deficit spending in 2020 than the last eight years combined. The government will add more to the national debt this year than all presidents combined from George Washington to Bill Clinton.
This spending explosion includes $26 billion for virus testing, $126 billion for administrative costs of programs, $217 billion direct aid to state and local governments, $312 billion for public health, $513 billion in tax breaks for business, $532 billion to bail out major corporations, $784 billion in aid to individuals as unemployment benefits, paid leave, direct cash payments and $810 billion for small businesses under the Paycheck Protection Program.
This comes on top of a baseline budget deficit of $1 trillion.
Moreover, Congress is expected to pass an additional spending bill of at least $1 trillion by late July, mostly consisting of assistance to states and cities. Combining the baseline deficit, approved spending and expected additional spending brings the total deficit for 2020 to $5.3 trillion.
That added debt will increase the U.S. debt-to-GDP ratio to 130%. That’s the highest in U.S. history and puts the U.S. in the same super-debtor’s league as Japan, Greece, Italy and Lebanon.
The idea that deficit spending can stimulate an otherwise stalled economy dates to John Maynard Keynes and his classic work The General Theory of Employment, Interest and Money (1936).
Keynes’ idea was straightforward.
He said that each dollar of government spending could produce more than $1 of growth. When the government spent money (or gave it away), the recipient would spend it on goods or services. Those providers of goods and services would in turn pay their wholesalers and suppliers.
This would increase the velocity of money. Depending on the exact economic conditions, it might be possible to generate $1.30 of nominal GDP for each $1.00 of deficit spending. This was the famous Keynesian multiplier. To some extent the deficit would pay for itself in increased output and increased tax revenues.
Here’s the problem:
There is strong evidence that the Keynesian multiplier does not exist when debt levels are already too high.
In fact, America and the world are inching closer to what economists Carmen Reinhart and Ken Rogoff describe as an indeterminate yet real point where an ever-increasing debt burden triggers creditor revulsion, forcing a debtor nation into austerity, outright default or sky-high interest rates.
Reinhart and Rogoff’s research reveals that a 90% debt-to-GDP ratio or higher is not just more of the same debt stimulus. Rather it’s what physicists call a critical threshold.
The first effect is the Keynesian multiplier falls below 1. A dollar of debt and spending produces less than a dollar of growth. Creditors grow anxious while continuing to buy more debt in a vain hope that policymakers reverse course or growth spontaneously emerges to lower the ratio. This doesn’t happen. Society is addicted to debt and the addiction consumes the addict.
The end point is a rapid collapse of confidence in U.S. debt and the U.S. dollar. This means higher interest rates to attract investor dollars to continue financing the deficits. Of course, higher interest rates mean larger deficits, which makes the debt situation worse. Or the Fed could monetize the debt, yet that’s just another path to lost confidence.
The result is another 20 years of slow growth, austerity, financial repression (where interest rates are held below the rate of inflation to gradually extinguish the real value of debt) and an expanding wealth gap.
The next two decades of U.S. growth would look like the last two decades in Japan. Not a collapse, just a slow, prolonged stagnation. This is the economic reality we are facing.
And neither monetary policy nor fiscal policy will change that.
for The Daily Reckoning
Is the worst of the economic collapse over?
Not really. The economy is off the bottom, but that’s only to be expected after the historic collapse of March–May and the stock market crash in March and April.
The question now is not whether we’re growing again. We are. The questions are how fast is that growth, and how long will it be before we return to 2019 levels of output?
And this question applies not just to the U.S. but to the entire global economy, especially the large producers such as China, Japan and the EU.
Here, the news is not good at all.
Recent data suggests that we may not reach 2019 output levels until 2023 at the earliest, and that something close to full employment may not return until 2025.
A simple example will make the point.
Just Not Enough Growth
Assume 2019 GDP has a normalized level of 100. Now assume a 10% drop (that’s about how much the U.S. economy will decline for the full-year 2020 according to many estimates).
That moves the benchmark to 90 in 2020.
Now assume 5% growth in 2021 (that would also be the highest growth rate in decades).
That will move the benchmark back up to 94.5. Next assume growth in 2022 is 4% (that would also be near record annual growth for the past three decades).
That would move the benchmark up to 98.3. Here’s the problem…
An output level of 98.3 is still less than 100. In other words, back-to-back growth of 5% in 2021 and 4% in 2022 is not enough to recover the 2019 level after a 10% decline in 2020.
But the situation is even worse than I just described.
Worse Than a Technical Recession
China PMI figures have recently been 50.9 (manufacturing) and 54.4 (services).
The Wall Street happy talk brigade is cheering these numbers because they “beat” expectations and they show growth (any number over 50 indicates growth in a PMI index series).
But growth is completely expected. The problem is that growth is so weak.
A strong bounce back from a collapse should produce PMI readings of 60 or 70 if a robust recovery were underway. It’s not.
Here’s the reality: What the U.S. economy is going through right now is far worse than a technical recession.
A recession is defined as two or more consecutive quarters of declining growth along with higher unemployment.
A recession beginning in February has already been declared by the National Bureau of Economic Research (NBER), which is the private arbiter of when recessions begin and end.
If we judge strictly by growth figures, the recession may already be over (although we won’t know for months to come, until quarterly growth figures are available and the NBER has time to evaluate them and make a call).
Most recessions don’t last that long, usually only about six–nine months. But that misses the fact that we’re really in a new depression.
The New Depression
“Wait a minute,” you say. “Growth may be weak, but it’s still growth. How can you say we’re in a depression?”
Well, as I’ve explained before, the starting place for understanding depression is to get the definition right.
Economists don’t like the word “depression” because it does not have an exact mathematical definition. For economists, anything that cannot be quantified does not exist. This view is one of the many failings of modern economics.
Many think of a depression as a continuous decline in GDP. The standard definition of a recession is two or more consecutive quarters of declining GDP and rising unemployment, as I just explained.
Since a depression is understood to be something worse then a recession, investors think it must mean an extra-long period of decline.
But that’s not the definition of depression.
The best definition ever offered came from John Maynard Keynes in his 1936 classic The General Theory of Employment, Interest and Money.
Keynes said a depression is “a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse.”
Keynes did not refer to declining GDP; he talked about “subnormal” activity.
In other words, it’s entirely possible to have growth in a depression. The problem is that the growth is below trend. It is weak growth that does not do the job of providing enough jobs or staying ahead of the national debt.
That is exactly what the U.S. is experiencing today.
The key is a depression is not measured by declining growth but is measured by a combination of actual declines and a below-trend recovery. This happened during the Great Depression.
Depressions Leave Lasting Impressions
There was declining growth and a technical recession from 1929–1932. Then a recovery (from a low level) from 1933–36. Then a second technical recession in 1937–38 and then another recovery from 1939–1940.
The entire period 1929–1940 is known as the Great Depression in part because the stock market and commercial real estate never recovered their 1929 levels even by 1940 (they finally recovered in 1954).
Depressions are also categorized by large behavioral changes including higher savings rates, smaller family size and internal migration. These effects are intergenerational.
Many behavioral changes from the 1930s were still prevalent in the 1950s and early 1960s and lasted until the baby boomers came of age in the late 1960s.
This kind of profound change with lasting impact is happening again.
The Great American Exodus
Due to a combination of COVID-19 spreading in densely populated areas, business failures, urban riots and failing mayors and police departments, Americans are migrating from the big cities to suburban and country areas by the millions.
American families are leaving dysfunctional cities such as New York City, Seattle and San Francisco and heading for Montana, Colorado, Maine and upstate New York in the Catskill Mountains among other safe havens.
Big cities have always offered a trade-off between higher taxes and urban stress in exchange for entertainment, great restaurants, museums and intellectual buzz.
Today the venues and buzz are gone, the crime rates are soaring and all that is left is the stress and taxes. So people are getting out.
Changes like this are not temporary. Once people move out, they don’t return ever. Their children may return someday but that could be 15 or 20 years away.
And those who leave tend to have the most capital and the most talent. This leaves the cities as empty shells populated by oligarchs with personal bodyguards and the poor, who have to deal with the street-level violence.
This shift can be helpful for individuals who move, but it’s devastating for the economics of major cities. And that’s devastating for the U.S. economy as a whole.
It’s one more reason we will be in depression for years even if the technical recession is over soon.
Investors Will Learn the Hard Way
The best case is that it will take years to get back to 2019 levels of output. The worst case is that output will drop even lower as the recovery fails.
We’re not really in a recession right now. We’re in a depression and will remain there for years.
No one under the age of 90 has ever experienced a depression until now. Most investors have no working knowledge of what a depression is or how it affects asset values.
But they’re going to find out, and probably the hard way.
for The Daily Reckoning
How do you invest in a world gone covidiously cuckoo?
In Agora founder Bill Bonner’s take: wandering through life facelessly suspended “between six feet apart and six feet under?”
In a country that locks down its healthy and productive citizens, while refusing even to bother, let alone lock up, crazed mobs of masked arsonists and burglars in the streets?
How do you soldier on without despair in the throes of the doomsday Adventist cult of COVID-19, with its high priest Anthony Fauci on Tuesday trumpeting a “Second Coming” of the virus, as a scourge for sinners in the hands of an angry doctor?
He probably means you and me, folks.
Indignant at Southern and Western states that have apparently unleashed vicious “surges” of viral YouTube porn after opening up their economies, the reverend doctor stormed: “Just look at some of the film clips that you’ve seen! Of people congregating! Often without masks!”
Don’t deny it, you yourself may have taken a dirty peek or two at the shocking scenes of happy faces.
Some of the celebrants are adopting strange new and kinky positions: “Of being in crowds… and jumping over, avoiding, and not paying attention to the guidelines that we very carefully put out.”
Predicting hundreds of thousands of infections a day unless the misbehavior stops, the Doctor seemed shaken by the guideline-scoffers: “We’re going to continue to be in a lot of trouble. And there’s going to be a lot of hurt.”
Don’t say he didn’t warn you!
Much Lower Fatality Rates Than New York
Meanwhile, with the all-cause death rate in this decade still the lowest of the century, death rates plummet around the world, while the spikes and surges affect only test-rates and media spins.
In the index of COVID death rates per thousand people, the Southern and Western rebels remain an order of magnitude behind the lock downers in New York.
Texas’s per capita COVID death rate is just 6% of the death rate of New York; Arizona’s is 16%. William Briggs and David Stockman are both on top of the data.
Intelligent investors will ignore the pandemonium and seek the signal in the noise.
They are always ready to invest in the midst of what economist Joseph Schumpeter called “gales of creative destruction.”
And in the future, they will take solace from understanding the message of time-prices, which gained impressive new momentum and authority with recent research from the anti-doomsday voices of economists Marian Tupy and Gale Pooley.
Time-Price Theory Meets COVID-19
Time-prices are the only true prices. They gauge the number of hours and minutes you have to work in order to buy goods and services.
An index of economic progress, they combine in one number both the rise of incomes and the drop in prices resulting from the advance of innovation.
In the past, Pooley and Tupy have confined their measurements and observations to the relatively halcyon years between 1980 and 2018.
During this period, while world population increased 73%, the prices of 50 key commodities of life, measured in the work hours to buy them, dropped 71% and their abundance grew 518%.
Nowhere was evidence of “peak commodities” or unsustainable resources. As population grew, commodities grew yet more abundant per capita. Human populations do not burden the planet; they proliferate its bounties.
Although an exciting breakthrough in economic statistics, this evidence of surging economic growth and progress fails to offer guidance to investors for a time of economic and social catastrophe such as today.
As Steven Pinker of MIT has documented in several books, the era between 1980 and 2018 has been a time of unprecedented peace, productivity, and increasing longevity.
But now Tupy and Pooley have uncovered a new series of commodity prices going back to 1960 (World Bank).
For the U.S., they also compiled time-prices going back to 1919 (U.S. Bureau of Labor Statistics), 1900 (Canadian economist Davis S. Jacks) and even 1850 (also Jacks).
Since the U.S. was what we now would call a Third World country in 1850, its 19th century ascent is suggestive of the global trend.
This new data covers the U.S. Civil War, the First World War, the Spanish Flu, the Great Depression and World War II. The Spanish Flu in 1918 had a death rate roughly ten times COVID-19 today.
What Pooley and Tupy found was that innovation proceeded with little disturbance through all these disasters. In my Information Theory of Economics, with wealth measured as knowledge, growth as learning, and money as time, wars and plagues could buffet but not balk the process of growth and innovation.
The current and recent COVID-19 lockdowns represent the most egregious public policy blunder of all time, ravaging economies around the world, causing a UN estimated (and probably exaggerated) 260 million starvation deaths in the Third World, with no detectable improvement in healthcare outcomes.
The carnage perpetrated by a clueless political class and its sanctimonious experts is possibly unprecedented in world history. But as long as the human heroics of invention, learning, and creativity are allowed to continue, the prospects for the world economy remain better than ever.
Better and Better
Our time-price chroniclers show that innovation has been accelerating ever since 1850. In the early period in the U.S., time-prices improved on average around two percent a year as workers had to spend ever less time to gain the crucial commodities of life.
Through wars and plagues, time-prices continued to improve, dropping some 3.4% per year compounded through the most recent period.
Innovation is a process of learning, accomplished through falsifiable business and technological experimentation — business projects that can fail and thus yield knowledge regardless of outcome.
The key metric is the learning curve — the tendency of costs to drop between 20-30% with every doubling of unit sales — the most widely documented data in business history.
Tupy and Pooley’s most recent data opens up wide global horizons for investors that dwarf the political botches and blunders of 2020.
What investors have to do is find the most innovative and creative entrepreneurs and support them.
Don’t let the lockdown control freaks control you.
for The Daily Reckoning
Investors are ignoring the worst economic and earnings data since 2008. They’ve piled into risky assets in the hope that conditions will soon be back to normal.
But as much as we all hope for restoration to pre-coronavirus economic conditions, there are many reasons why the environment for stocks won’t be back to normal for much of 2020.
The first reason is that corporate balance sheets were weak going into the coronavirus crash. Large corporations have taken full advantage of the Fed’s emergency actions in March to issue a tidal wave of new corporate bonds in April and May. This raised liquidity and staved off bankruptcy for many companies.
Most companies won’t be using the money they raised from corporate bond sales to expand facilities or hiring. Rather, they’re hunkering down for a long downturn by raising liquidity on favorable terms.
Corporate cash balances may be higher, but so are corporate debt balances. Companies that take such corporate financing actions tend to remain defensive for years afterward as they shift to balance-sheet-repair mode.
A second reason why conditions for risky assets won’t be back to normal for much of 2020 is that a cycle of corporate defaults has begun. Household names like J.C. Penney and Hertz have already defaulted. But more defaults are on the way.
With so many insolvent companies in the oil, retail, restaurant, hospitality, airline and (eventually) high-rise office building sectors, the corporate default rate will remain very high in the months ahead.
This environment warrants lower-than-normal valuations in the stock market. But instead, bull market sentiment is as euphoric as ever, and valuations have ramped up to near all-time highs just as the earnings stream that supports the market has collapsed.
Investors feel bulletproof yet again, extremely confident that the bear market is over because “the Fed has their back.”
But what entity is really supporting investors? What has their back?
- It’s not the Fed directly, because the Fed isn’t buying stocks. The Fed is already walking a political tightrope by buying a small amount of corporate bonds. It’s a show of force to try to rekindle risk appetites. The Fed would rather see private-sector investors buy risky assets than take the political risk of buying risky assets themselves
- It’s not corporate buybacks, which will be hundreds of billions of dollars lighter in 2020 than in 2019
- It’s not foreign investors, who are already stuffed with U.S. stocks after having accumulated them for years on end
- And it’s not institutional investors, most of whom have strict mandates to rebalance out of stocks and into bonds when stocks outperform.
Here is what ultimately “has the back” of bullish investors: the supply of new money that comes from other bullish investors.
Lately, much media attention has been lavished on a new generation of day traders who use modern versions of the 1990s internet “chat boards” to share trade ideas.
The quality of these ideas is extremely low, as shown by the recent frenzy for bankrupt stocks like Hertz that are clearly worth nothing and distressed stocks like American Airlines that could easily be worth nothing by late 2020.
Nonetheless, a temporarily popular idea (no matter how poorly researched) can have outsized effects on market pricing.
Why is that?
I suspect it’s a combination of shallow depth in the order books for many stocks and the high-frequency trading (HFT) shops that are the first to pick up on a retail trader frenzy.
When online brokerages shifted to a commission-free business model, following pioneer Robinhood, the pace of mini-spikes and crashes in individual stocks seemed to multiply. That’s because HFTs pay the no-commission brokerages for “order flow.”
Payment for order flow not only results in HFT front-running of retail investor orders; it also delivers market intelligence to HFT shops and other algorithm-based traders.
This generation of retail day traders might be exerting a much more powerful influence on stock prices than is widely assumed. The buying power of retail traders has been multiplied by the way the trading system has evolved.
Said differently: The market prices of many stocks are being set by the least-informed, least-experienced investors because their buying power is being magnified by HFT buying.
Combine this phenomenon with the passive-investing trend (indexing and ETFs) and we have a market that’s being mostly driven by ill-informed investors.
Take the case of German payment technologies company Wirecard…
A long list of short sellers have argued convincingly for years that Wirecard is an accounting fraud. Yet it took a specific set of catalysts (including Wirecard’s auditor finally doing its job) to reveal the fraud that lay beneath the surface.
The whole time, retail investors, institutional investors, index investors and even German government regulators chose to either not understand the stock they owned or defend it against valid criticisms from short sellers.
At the stock’s all-time high in September 2018, German-listed Wirecard had a market cap of €23 billion. It’s likely to be worth zero in the near future.
I mention this case not to imply that Wirecard-style accounting frauds are everywhere but to highlight this point: When a critical mass of investors are all thinking the same way, a company perceived to be worth billions one day can be perceived as nearly worthless the next.
At its peak, Wirecard could do no wrong in the eyes of its shareholders and defenders. Confidence surely grew when shareholders saw that German financial regulators “had their back” against the claims of supposedly evil short sellers.
The tragic case of Wirecard applies to today’s day trader-driven market for many individual stocks because so many popular stocks have been pumped up by echo-chamber sentiment. A near-universal belief that the Fed “has my back” is part of the echo chamber.
But again, the only real entity that has their back (for now) is the supply of new money that comes from other bullish investors. Yet that supply, which includes buying pressure from HFTs, can turn on a dime once momentum shifts.
This is a message I’ve relayed before, but it bears repeating: Stock market bulls tend to think similarly. They move in sync. So when the mood shifts abruptly and bulls turn cautious, prices can fall sharply.
In his book Aftermath, Jim Rickards explains the concept of “hypersynchronicity.” It’s a state of the market in which most of the players have similar strategies and expectations in the months leading up to crashes.
Groupthink and herd behavior are pervasive near a market’s peak. An unstable number of investors has herded into an asset class. These investors are hoping to sell to other investors who may have a similar philosophy but have an even greater risk appetite.
The stock market environment of mid-February 2020 appeared to be very hypersynchronous. And today’s stock market environment appears very hypersynchronous.
An efficient, stable market for stocks requires a set of actors with diverse philosophies and viewpoints. If most market participants have piled into similar strategies and trades, you can end up with a market that is setting new all-time highs yet becoming increasingly fragile.
“Markets now confront a lethal brew of passivity, product proliferation, automation and hypersynchronous behavioral responses,” Jim writes in Aftermath. “This accumulation of risk factors is entirely new and outside the experience of any trader or quant.”
Traders and quants have no historical analogue that can plug neatly into their automated trading models. Most quants recognize this dearth of historical analogues, so they make up for it by constantly tweaking the inputs to their models to match what worked in recent history.
With so many quants flocking to trends that are “working,” the end result is groupthink on a mass scale. Groupthink reaches a critical state once investors have dangerously similar strategies and expectations.
If some surprising new factor — a second wave of coronavirus cases or a monetary system earthquake like a Chinese currency devaluation — causes expectations to suddenly change in a hypersynchronous market, then we should not be surprised to see a crash.
The seemingly relentless bid under most stocks can suddenly relent. Although it feels wasteful at times to implement bearish trades, I’m confident they will be valuable in hedging your portfolio against losses if a hypersynchronous market morphs from a bubble into a crash.
And that looks increasingly likely.
for The Daily Reckoning
“Great job numbers.”
Here the president refers to June’s unemployment report, out this morning.
The United States economy took on 4.8 million nonfarm jobs last month — a record number.
We are further informed that the unemployment rate has fallen to 11.1%.
As is custom, a Dow Jones survey of economists botched it badly.
These blind soothsayers soothsaid 2.9 million jobs… and 12.4% unemployment.
“Today’s announcement proves that our economy is roaring back,” the president continued. “It’s coming back extremely strong.”
Mr. Trump’s delirium was broadly shared…
“The 4.8 million rise in nonfarm payrolls in June provides further confirmation that the initial economic rebound has been far faster than we and most others anticipated,” gushed Michael Pearce, senior U.S. economist for Capital Economics.
“A second consecutive large upside surprise to hiring relative to consensus confirms our view that the reopening rebound would be much more robust than most expected a couple months ago,” chortled Citi economist Andrew Hollenhorst.
But is today’s report as lovely as these gentlemen claim?
A leading question perhaps. The answer nonetheless follows.
But first… how did the stock market take this morning’s news?
The Dow Jones was immediately up and away 232 points. The other major indexes were also up, also away.
But the gravity of additional news soon tugged them earthward…
Florida authorities announced 10,000 fresh coronavirus infections this morning — a “healthy” number to be certain.
This after the United States reported over 50,000 new infections yesterday. That is a record amount… incidentally.
And so the economic lights that have been winking on in many locations… may once again wink off.
Thus today, stocks that would prosper from a rapid economic recovery absorbed the heartiest slatings.
First among these were airline and cruise line stocks.
The major indexes nonetheless maintained the vertical…
The Dow Jones posted a 92-point gain on the day. The S&P added 14 points of its own; and the Nasdaq, 53.
But can you trust today’s unemployment numbers?
Like June’s, May’s unemployment report was likewise a “blowout.”
Yet the Bureau of Labor Statistics (BLS) itself advised you to look beyond the headline number… and glance the small print.
That is because BLS confessed to a “misclassification error.”
Many workers had been previously listed as unemployed on temporary layoff.
Yet in the May survey these same workers were listed as “employed but absent from work.”
That is, they were listed as employed — though their circumstances may not have changed one jot since March or April.
Sort them into the unemployment column… and BLS conceded actual unemployment may have run three full percentage points higher than the official 13.3%.
Now roll the calendar forward one month…
Buried under many inches of print today — near the very foot of a CNBC article — we learn the following:
The headline unemployment rate was understated slightly due to counting errors at the Bureau of Labor Statistics. Workers who still have jobs but have not been working are being counted as employed and even though they are supposed to be considered unemployed under BLS rules.
And so June’s report features the identical “miscalculation error” as May’s report.
Yet we are assured that June BLS number-counting improved drastically:
However, the BLS said that discrepancy “declined considerably” in June, making the actual unemployment rate only about 1 percentage point higher than the reported level.
Thus June unemployment would read 12.1% — not 11.1%.
In either event… the United States economy has killed nearly 14.7 million jobs since February.
And unemployment remains the highest since the Great Depression.
Nearly half of working age American adults — some 47% — are presently idle, their hands the devil’s workshop.
Says Torsten Slok, Deutsche Bank’s chief economist:
To get the employment-to-population ratio back to where it was at its peak in 2000 we need to create 30 million jobs.
30 million jobs!
Meantime, the Department of Labor reported today that another 1.4 million Americans filed onto unemployment lines last week.
Yet let them eat cake, says the stock market…
Its assault upon its February peaks continues yet, the craggy heights within sight.
The Nasdaq has vaulted 30% this past year — despite the fiercest economic downdraft since the Great Depression.
Never before has the stock market risen so loftily above the economy that supposedly supports it.
We have credited the Federal Reserve with responsibility.
But does the Federal Reserve alone account for the stock market delirium?
Managing editor, The Daily Reckoning
Joel Elconin kicks off our Canada Day editorials with a quick recap of the US markets and gold sector at the end of the 2nd quarter. With US markets resisting a major breakdown it will be the news in the next 6 months that could drive markets down again. For gold there are a couple key data points and news events that will drive prices through the end of the year.
Today we lower our ear to the rail… and report the approach of a rumbling locomotive.
Free and honest markets are roped to the tracks, squirming, writhing, sobbing.
This iron horse is barreling toward them. Mr. Jerome Powell is at the controls…
And murder is on his mind.
What is the Federal Reserve’s latest plot against the remains of free and honest markets?
And will it pull off the caper?
We first look in on the seemingly condemned — squirming, writhing, sobbing on the tracks…
A Quiet Day on Wall Street
The day counted plus and minus.
The Dow Jones lost 39 points. The S&P scratched out a 1.85-point gain today. The Nasdaq, meantime, took the ribbon with a 32-point advance.
A dull affair altogether. Yet tomorrow may bring high adventure of course.
And so we now return to today’s central question:
What is the Federal Reserve’s latest plot against the remains of free and honest markets?
Let us first flip back the calendar to the war year of 1942… where our tale begins.
How the Fed Fought WWII
Wars are costly enterprises. And taxes alone would not purchase the arsenals of democracy.
Uncle Samuel therefore held his cap before the bond market… and went upon the borrow.
But the authorities were hot to keep borrowing costs within reasonable limits.
The Federal Reserve and the Treasury Department therefore signed onto an agreement:
The Federal Reserve would place a cap on the government’s borrowing costs.
This it accomplished by purchasing any government bond with yields above a predetermined level.
These purchases shrunk the yield (purchasing Treasuries hammers down the yield; selling Treasuries ratchets yields higher).
If the 3-month Treasury bill yielded above 0.50% — for example — the Federal Reserve purchased 3-month Treasury bills until yields fell to 0.50% or below.
If longer-dated Treasury yields exceeded 2.5%… the Federal Reserve purchase longer-dated Treasuries until yields dropped to 2.5% or lower.
Thus borrowing costs were clamped to tolerable levels.
The Fed Cedes Monetary Policy to the Treasury
The proper term for the business is “yield curve control” (more on which below).
The Federal Reserve — in essence — ceded monetary policy to the United States Department of Treasury.
The Federal Reserve likewise surrendered control of its balance sheet, notes Jim Rickards:
The cap also meant that the Fed surrendered control of its balance sheet because it would have to buy potentially unlimited amounts of Treasury debt to implement the rate cap. (Such asset purchases had inflationary potential, but in World War II, inflation was managed separately through wartime price controls.)
The monetary base doubled between 1942–45… incidentally.
The Federal Reserve continued to abdicate its responsibility for monetary policy until 1950.
Now come home…
The Fed’s Fighting a New War
It is the year of pandemic. To battle its economic catastrophes, the Federal Reserve has reset its target interest rate to zero.
Thus interest rate policy is… limited.
Might our adventuresome central bank wade into the dense swamp of negative rates?
It may — in these pages we have maintained it will. Yet to date it has heaved the wet blanket upon all speculation of them.
And negative interest rates have not met advertising where attempted — in Japan and parts of Europe primarily.
How then can the Federal Reserve coax the reluctant economic machinery to life… and stuff down borrowing costs?
Yield curve control — the same yield curve control that financed the Second World War.
The Fed Would Take Direct Control of Interest Rates
In reminder, the yield curve plots bond yields across the spectrum — from short-term bonds to long-term bonds.
Yet this you must understand:
The Federal Reserve only fixes the federal funds rate. That is the “overnight” rate banks charge one another to borrow.
That is, the Federal Reserve’s actual control over interest rates is limited.
It influences longer-term rates, nudges them, leans on them, blows against them.
But it does not control them… to its everlasting disappointment.
And longer-term rates unlock the grails of borrowing and consumption.
How can the Federal Reserve seize direct control of longer-term rates?
Yield curve control.
Targeting Longer-Term Yields
Assume a particular Treasury yield exceeds the Federal Reserve’s preferences.
It can then purchase and purchase that particular Treasury until yields sink to its liking.
Explains one Sage Belz — and another David Wessel — they of the Brookings Institution:
In normal times, the Fed steers the economy by raising or lowering very short-term interest rates, such as the rate that banks earn on their overnight deposits. Under yield curve control (YCC), the Fed would target some longer-term rate and pledge to buy enough long-term bonds to keep the rate from rising above its target. This would be one way for the Fed to stimulate the economy if bringing short-term rates to zero isn’t enough.
And that is lovely because:
Lower interest rates on Treasury securities would feed through to lower interest rates on mortgages, car loans and corporate debt, as well as higher stock prices and a cheaper dollar. All these changes help encourage spending and investment by businesses and households. Recent research suggests that pinning medium-term rates to a low level once the federal funds rate hits zero would help the economy recover faster after a recession.
Meantime, the federal government is piling up debt at rates truly fantastic…
Bottling Borrowing Costs
The federal deficit in the current year may well exceed $4 trillion. And trillion-dollar deficits stretch to the farthest horizon.
The authorities are therefore keen to bottle interest rates… lest borrowing costs rise and become a millstone about the neck.
Yield curve control permits the Federal Reserve to throttle borrowing costs.
“Wait one minute,” you say. “Are you not describing quantitative easing? The Fed purchased Treasuries and other assets to drive down yields. What’s so different about this yield curve control?”
Precisely correct you are. But quantitative easing did not grant the Federal Reserve direct control over rates.
Yield curve control — as the title faintly suggests — does.
It’s All About the Yield
The Federal Reserve would purchase the requisite number of bonds to hammer yields to its desired level.
If 100 bonds fails to work the trick, then 1,000 bonds it will be. If 1,000 bonds proves inadequate to purposes, then 10,000 it will be… all the way up to a million or more.
Michael Lebowitz and Jack Scott of Real Investment Advice:
Assume the Fed set a 0.75% target yield on the 10-year U.S. Treasury note. They can then employ QE in any amount needed to buy 10-year notes when the rate exceeds that level. If successful, the rate would never exceed 0.75% as traders would learn not to fight the Fed.
Thus “Don’t fight the Fed” would assume an even greater ferocity.
Is this yield curve control in the offing?
“Whatever It Takes”
The Federal Reserve Bank of New York president — Mr. John Williams — says he and his fellows are “thinking very hard” about it.
We have no doubt they are… to the extent that they are capable of thinking very hard.
Our spies in Washington inform us the Federal Reserve will hatch its yield curve control operation later this year — for what it is worth.
Jim Rickards likewise believes yield curve control is coming:
The Fed and Treasury will reach a new secret accord, just as they did in 1942. Under this new accord, the U.S. government could run larger deficits to finance stimulus-type spending…
The Fed can use open market operations in the form of bond buying to achieve the rate caps. This means the Fed would not only give up control of interest rates, but it would give up control of its balance sheet. A rate cap requires a “whatever it takes” approach to Treasury note purchases.
“Whatever it takes.” We suspect “it” will take much. Then some more.
And so we will have more manipulation. More distortion. More fraud.
Reduce the thing to its core and this is what you will find:
The Federal Reserve attempts to fix the price of the dearest commodity of all — the price of time itself.
What king ever sought such power?
Managing editor, The Daily Reckoning
The war on savers rages into its second decade.
And yesterday Field Marshal Powell vowed indefinite bombing, shelling, machine-gunning and bayoneting… until the white flag rises over enemy lines.
It is war to the knife… and from the knife to the hilt.
The only peace terms he will accept are these:
Complete, undiluted and unconditional surrender.
These hoarding hellcats must be vanquished. And their cities must be sowed with salt… as triumphant Rome vanquished Carthage… and sowed it with salt.
Here is yesterday’s dispatch from headquarters:
We are going to be deploying our tools — all of our tools — to the fullest extent for as long as it takes… We are not thinking about raising rates; we are not even thinking about thinking of raising rates.
Zero Rates Through at Least 2022
Powell and staff indicated they will clamp rates to zero, or near zero… through 2022.
We wager rates will remain clamped to zero longer yet.
Deflation hangs over the battlefield like a thick cloud of chlorine gas. And the Federal Reserve’s 2% inflation target appears more wishful than ever.
We do not expect any rate hikes until it lifts. And we hazard little will lift until 2022 has passed.
Meantime, Marshal Powell reminded us yesterday that the pre-pandemic 3.5% unemployment rate yielded little inflation.
He suggested, that is, that unemployment could sink below 3.5% before inflation menaced.
But it could be a long, long while before unemployment drops to pre-pandemic levels.
As we recently noted:
After the last financial crisis, over six years lapsed before employment fully recovered — 76 months.
If we assume a parallel recovery… pre-pandemic unemployment would return in 2026.
Of course comes our disclaimer: Pre-pandemic unemployment would return before 2026.
We simply do not know. Nor does anyone.
But who can say if pre-pandemic levels of unemployment will ever return?
The Fed Doesn’t Expect a “V-Shaped” Recovery
Even Powell himself is nagged by doubts:
Unemployment remains historically high. My assumption is there will be a significant chunk … well into the millions of people, who don’t get to go back to their old job… and there may not be a job in that industry for them for some time.
The Federal Reserve therefore fears an arduous and protracted recovery. This is the argument of one Joseph Brusuelas, chief economist at RSM:
It is clear that the Fed does not anticipate a V-shaped economic recovery and is positioned to move forcefully to support the economy…
Adds Charlie Ripley, senior investment strategist at Allianz:
The Fed understands we are just in the beginning phases of the economic recovery and making rash changes to policy or forward guidance is premature at this time.
The Federal Reserve’s fears may well prove true…
We have cited evidence recently that each recession is fiercer than the previous. And that additional debt is required to put down each successive menace.
Comparing the 1990, 2001 and 2008 Recessions
Once again, Michael Lebowitz and Jack Scott of Real Investment Advice:
- The [2008–09] recession was broader based and affected more industries, citizens and nations than the prior recessions of 1990 and 2001…
- The 2008–09 recession and recovery also required significantly more fiscal and monetary policy to boost economic activity…
- The amount of federal, corporate and individual debt was significantly lower in 1990 and 2001 than 2008–09…
- The natural economic growth rate for 1990 and 2001 was higher than the rate going into the 2008–09 recession.
“The economic growth rate going forward may be half of the already weak pace heading into the current recession,” these gentlemen conclude.
We in turn conclude that zero interest rates will be with us for years… as will the warfare against savers.
The Fed Will Keep Buying Ammunition
But the enemy of the saver is the ally of the speculator.
The Federal Reserve intends to purchase roughly $120 billion of Treasury notes and mortgage-backed securities each month of the year.
Its balance sheet may swell to 40% of the United States economy by year’s end.
What percentage of the United States economy did it represent in 2007?
A mere 6%… if you can believe it.
These assets represents ammunition in support of Wall Street.
And as long as the Federal Reserve rains down ammunition upon savers… Wall Street can advance under the covering fire.
Powell insists he’s battling for the economy’s life.. If my policies prosper Wall Street, be it so, says he (with a wink and a nod):
We’re not focused on moving asset prices in a particular direction at all — it’s just we want markets to be working, and partly as a result of what we’ve done, they are working.
Just so. But the stock market has evidently advanced too far. And the stock market has evidently advanced too fast.
The Market’s Worst Day Since March
Today the market took to its heels… and fell into panicked and headlong retreat.
The Dow Jones pulled back 1,861 points on the day. Both the S&P and the Nasdaq took similar trouncings.
The S&P did, however, manage to hold the 3,000 line.
The combined rout nonetheless represents the market’s greatest daily plunge since mid-March… at the height of the havoc.
The reasons on offer in the mainstream press reduce to two:
A) Yesterday Powell’s dour comments emptied ice water upon the heads of sunny-siders expecting the “V-shaped recovery.”
B) A resurgence of coronavirus cases following reopenings may delay additional economic progress.
Texas, Arizona, Florida, North Carolina and California — among others — report what the journalists like to call “alarming” increases.
“This Thing’s Going to Linger Longer Than Probably the Market Had Thought Of”
And so, says Mr. Dan Deming, managing director at KKM Financial, reports CNBC:
“You’re seeing the psychology in the market get retested today” as traders weigh the recent uptick in coronavirus hospitalizations and a grim outlook from the U.S. central bank… “The sense is maybe the market got ahead of itself, which makes sense given the fact that we’ve come so far so fast.
“The reality is this thing’s going to linger longer than probably the market had thought of.”
But the stock market should take heart:
The full arsenal of the Federal Reserve is in back of it.
Savers, meantime, must only despair:
The full arsenal of the Federal Reserve is against them…
Managing editor, The Daily Reckoning