Market Slice: Business as Usual?

 

No Such Thing as Broke

Most Americans understand there is a fundamental relationship between income and expenses. Whatever your income level, chances are you manage to live more or less within the means you have at your disposal. Sure, an occasional major purchase might go on a credit card, or you buy a new car that costs more than you can afford. But those bills have to be paid, and you know there’s a limit to how deep into the hole you can go.

 
Tee shirt offered on eBay.

 

This is not a problem faced by our politicians. Through the miracle known as Modern Monetary Theory, serious economists now believe it is literally impossible for the U.S. government to go broke. Why? Because they control the (metaphorical) printing press. They can always create more money to service any amount of debt… so why stop borrowing?

Not only that, but this unlimited money creation can take place without inflation – the theory goes – because total control of the nation’s currency means prices can be kept low by making more dollars available to consumers, creating a manipulated balance between supply and demand. While money supply has been expanding steadily since the dotcom crash at the turn of the century, the pandemic stimulus programs represented a blow-off phase, when money creation went parabolic:

As shown on EconomicGreenfield.com, here is the “M2 Money Stock” (seasonally adjusted) chart, updated on May 24, 2022, depicting data through April 2022, with a value of $21,728 Billion:

Chart courtesy https://fred.stlouisfed.org

What this chart tells us is nothing new. Money supply has exploded upward, and while initially this flood of new money mostly found its way into asset markets – creating the Everything Bubble we are now witnessing – over the past year it has finally started to show up in consumer prices, as well.

This might have been worse, except there were simultaneous deflationary pressures working to keep prices down, even as money supply expanded. These deflationary forces, including new technologies and offshore production with radically lower labor costs, created the illusion of “no inflation.” Monetary and fiscal policy makers were so taken by this mirage that they openly bemoaned not being able to get inflation over 2%… a level deemed necessary for continued growth. Just as they missed the evident signs of inflationary pressure for so long, even dismissing the evidence as “transitory” long after it had taken hold in the economy, these incompetent politicians are now oblivious to the fact that the U.S. economy is slowing down drastically.

Not convinced? Take a look at these items:

What we’re seeing now is rapid, significant interest rate hikes at a time when the economy is entering recession. This will have the effect of further reducing economic activity, threatening an economic free fall into deeper hardship. We are already hearing whispers of the word “depression.” And while few alive today have much of an idea what really means, those who do remember – or were raised by parents scarred by the experience in the 1930s – know that, when it comes to hard times, it’s very possible “we ain’t seen nothin’ yet.”

 

Will the Fed Pivot?

When the market responded favorably to last week’s 75 basis point increase in the Fed Funds rate, many commentators took it as a sign on the market calling bull on Powell’s tough inflation talk. To be sure, there was some “soft” language in his remarks, about being “led by data,” meaning if the data shows signs of a slowdown, the Fed might back off its aggressive tightening.

But there’s a rub. Two, actually.

For one thing, this rapid increase in the rate is painfully obviously too little, too late. This should have been done months ago… even with rates now at 2.25%, considering inflation is over 8%, monetary policy is still very loose. As long as the cost of money is substantially lower than the inflation rate, it will be hard to rein in inflation. That’s why Paul Volker raised rates all the way to 20%, almost 900 bps, in 1980-81. Over a period of about 18 months, the Fed chair imposed extreme tightening, provoking a recession that finally did succeed in cooling off inflation and ending the stagflationary recession.

The other rub is the data Powell wants to be led by is manipulated… the official figures on everything from unemployment to GDP to, yes, the rate of inflation, are totally doctored. Not only that, but these data are what we call “trailing indicators”… they don’t show where we’re going, but rather where we’ve been. This is what we’ve called “driving by the rear-view mirror.” Here’s how we described it back in June:

Imagine trying to steer your car based on what you see when you look in the rear-view mirror. Well, that’s how the Fed sets monetary policy… and it’s working about as well as you’d expect.

What we’re seeing currently is the Fed is pursuing a tightening monetary policy. Their controlled demolition of the stock market is proceeding more or less as planned. As we suggested in January and again in May, a slow disinflation of the crazy stock market bubble has been the Fed’s goal since the start of the year.

And as if that wasn’t hard enough, they have to accomplish this without causing a panic in the bond markets.

Realizing too late they had overheated the markets with a bottomless punch bowl of free money, Powell et al set the intention of bringing down inflation by slowing the economy, which they mistakenly equate to the stock market.

Now, as they look backwards and realize the object in the mirror (inflation) is closer than it appears, they are continuing to tighten.

 

What seems most likely is that sometime this fall, the Fed will realize – too late, as always – they are choking out the patient, and stop tightening. The problem is that inflation will still be well above their 2% target, and once the punchbowl is restored, we are likely to see another stock market frenzy… until the final collapse hits in 2023.

Image courtesy of Bob Rich of app.hedgeye.com

 

Politicians Gonna Politician

This week, a bipartisan Congress passed the Inflation Reduction Act, a $480 billion dollar spending measure that purports to reduce inflation, uh… eventually?

Unlike Biden’s failed Build Back Better Act, this one is structured to provide long-term deficit reduction. However, there appears to be two significant tax provisions in the bill… a 15% minimum tax on corporate book income, and a whopping $125 billion allocation for I.R.S. enforcement, obviously designed to squeeze taxpayers who may be underreporting or failing to pay taxes.

Courtesy of www.zerohedge.com

Since struggling small businesses often use tax set asides to cover operating expenses, this clause is likely to hit the already-beleaguered SMB sector (small and medium businesses) especially hard.

This is just business as usual in Washington. Using showboat policies around supporting green energy and helping injured military vets, the Congress critters have passed a pork-stuffed tax and spend bill, and – putting lipstick on the pig – called it “inflation reduction.”

If you’re inclined to put your confidence in the politicians and trust this bill will do what it says, Goldman Sachs analyst Alec Phillips has another idea for you to consider. ZeroHedge explains his assessment:

“[T]he fiscal deal that already looked likely to pass now looks likely to be a bit broader than expected: the potential Senate deal now includes a version of the corporate minimum tax the House passed late last year, as well as a package of energy provisions similar in size to the House-passed bill. However, and this is the punchline, the Goldman strategist finds “the fiscal impact remains limited” and warns that “over the next few years, it looks unlikely that this bill would change the fiscal impulse by more than 0.1% of GDP, as new spending and new taxes roughly offset and, in any case, both are fairly small in absolute terms.”

As the bill stands, hundreds of billions more will be spent, with tax collections and drug price manipulations – which are likely to get watered down or even removed from the final version — “offsetting” the spending increases.

In other words, it’s tax and spend. Shocking. Yup, it’s business as usual for our elected “leaders,” who are fiddling as Rome burns.

Musee des Beaux-Arts Andre Malraux, Wikimedia Commons

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