America is hell-bent on continuing the monetary and fiscal policies eroding its economic and geopolitical hegemony. The so-called “thinking classes” that shape policy are trapped in ideologies that keep them repeating the same mistakes over and over – spending too much money with no prospect of paying it back, mismanaging our foreign affairs by imagining a world that doesn’t exist, and prioritizing false concepts of equality and liberty. The result is a weaker economy, weaker global standing, and an angry and divided citizenry. Things always “move on” and that is precisely the problem – in the world of governance, they “move on” by limiting our ability to offer freedom and prosperity to all but the privileged few.
The Federal Reserve has led the retrograde charge for years. Its latest policy error, which it forecast to the world at Jackson Hole on August 23rd, will launch in September when it starts cutting interest rates with housing, rental, food and stock prices at or near all-time highs. Leaving aside last week’s 800,000 downward adjustment in payrolls, which wasn’t particularly surprising, the economy does not need lower rates. Certain sectors like commercial real estate (CRE) and leveraged finance, which caused their own problems by buying assets at ridiculous prices during the ZIRP/QE years, are pressuring the government for lower rates, but they don’t need or deserve them. There is no compelling policy reason to lower the cost of capital for industries that engage almost exclusively in speculative (and in the case of leveraged finance, often rapacious and unethical) rather than productive activity; they made their beds and should be made to lie in their own dirty sheets. They already enjoy egregiously favorable tax treatment of their income (carried interest, 1031 exchanges, interest deductibility, etc.) and lowering rates closer to or back below the rate of inflation is just another sop to the rich.
Talking heads are debating whether the September cut will be 25 or 50 basis points. Since I don’t think the Fed should be cutting at all, I certainly hope it won’t compound its error by doing more than the minimum. Markets are pricing in cuts of 100 basis points through December which would be grossly excessive. The Fed should leave real (inflation-adjusted) rates where they are. Government inflation statistics are as reliable as job statistics – in other words, not reliable at all. Product and services prices are very high and financial asset prices are “to the moon” as they like to say and lower rates will only push them higher. The economy needs the discipline imposed by positive real rates that was missing for all of the post-GFC period until very recently. Even if one concedes that real rates are now positive, they aren’t positive by much and certainly not by enough to suppress speculative financial activity. And there is absolutely no discipline coming from fiscal policy that’s running ~$2 trillion deficits as far as the eye can see. The Fed is doing little to shrink a balance sheet that was only 7% below its peak at the end of July, leaving monetary conditions pretty loose (M3 was only down 3% at the end of July). Lowering rates with prices high while moving like a tortoise to shrink its balance sheet is not going to convince anybody that the Fed is serious about monetary discipline. Instead, it confirms that our central bank is reacting to political pressure to ease and places a low priority on long-term financial stability. It can try to hide behind its mandate all it wants but it isn’t fooling anybody who doesn’t want to be fooled.
Lax monetary conditions are contributing to record stock prices and what can only be called a boom in credit markets that are keeping the leveraged finance business afloat while private equity firms hold on to overvalued merchandise purchased when rates were much lower. The main action today in private equity is borrower-on-creditor and creditor-on-creditor violence where borrowers spend their time figuring out how to screw their lenders or lenders spend their time figuring out how to screw each other. The real pressure on the Fed to lower rates comes from powerful interests in the financial sector who want to be able to sell their overvalued assets. An intellectually, politically independent, and strong-minded Fed would leave rates alone until next year. But instead the Fed is going to relieve the pain of the people who need and deserve it the least – the private equity and private credit industries and the institutional real estate business. Remember what Jay Powell did for a living before he became a central banker.
Policymakers believes they have no choice but to continue stimulus – the alternative is either a steep recession or depression. But a severe flush of the system is the only honest way to deal with the mire of debt and deficits that built up over the last 25 years. Politically, however, the American people won’t stand for anything of the kind, which leaves us on the path to destruction (and which is why the lack of term limits in our Constitution is one of the document’s worst deficiencies). Taxes are already too high when you include not merely federal but state and local taxes and all the other fees that government imposes. It’s very expensive to support an overbearing and intrusive state that seeks to redistribute income from its most to its least productive citizens without providing the latter with the skills and self-respect to shed the burdens of dependency that government encourages.
America relies on government spending to make it through the day. The deficit represents more than 20% of total federal spending. We should no longer think in terms of Gross Domestic Product but Government Domestic Product. Without government spending and government hiring, GDP by whatever name as well as employment would sink to depression levels. And don’t think the people in Washington don’t know this. Even after the economy recovered to pre-pandemic levels by the end of 1Q21, Congress passed $1.9 trillion in new spending in March 2021 in the form of additional Covid relief. State and local governments received $350 billion in direct aid, K-12 schools were doled out $122 billion (even though many of them were still closed and most of them were teaching bullshit), and mass transit systems were granted $30 billion. Insolvent union pension plans were bailed out to the tune of $86 billion (without any effort to determine what rendered them insolvent in another example of letting off the hook the large investment firms that produce poor-to-mediocre returns while earning enormous fees and claiming to be fiduciaries). The so-called Covid spending plan also involved huge transfer payments to individuals that discouraged work and increased dependency while also fueling unproductive consumer spending (not to mention hundreds of billions of dollars of outright theft by our fellow citizens, making a mockery of all of the political slogans about how we are “all in this together” unless by “this” people mean the ongoing government Ponzi scheme). By mid-2021, consumers were sitting on $2.3 trillion of excess savings that they spent over the next 2-3 years (on unproductive consumer items), fueling CPI inflation that peaked at 9.1% in June 2022. But Congress kept spending with another $1 trillion spending bill in November 2021 with climate spending and more money for the states, then the $280 billion Chips Act, and finally the Inflation Reduction Act that Goldman Sachs estimates will cost $1.2 trillion over ten years. While some of this money will be spent on new factories and other productive purposes, much of it will not. Overall fixed investment and manufacturing output are growing at lower rates than before the pandemic. Rather than create effective incentives to stimulate productive activity, the government just printed money to little positive long-term effect.
Neither party has plans to fix the problem. The quality of economic debate in this election is doing little to enhance America’s standing in the world. Kamala Harris’s initial economic proposals would produce precisely the opposite of what they seek to achieve. Price controls will produce higher prices and more inflation while housing subsidies will raise housing prices (and remember, houses are unproductive assets). And her proposed wealth tax is confiscatory, unconstitutional, unworkable and anti-American (i.e., socialist) – other than that it’s a great way to appeal to progressives. Donald Trump’s tariffs are also a very bad idea that would raise prices on consumers and feed inflation. As I’ve written on Substack (please check my Notes), while economists are normally the last people you want to ask about the economy (except my brilliant friend David Rosenberg and a few others), the candidates are flouting some legitimate economic ideas to make some very unwise economic proposals. Whoever is advising them is driven by political rather than economic ideology. In the meantime, the fiscal and monetary policies that are the underlying causes of structural inflation go unaddressed in the election.
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