More Of The Same

February 13, 2013

Opinion

The President's message last night was, as expected, simply more of the same: More spending and more taxes.

It was expected because the presumptive opinion in America (as defined by politicians, economists and the media) is that the government will find a way to deal with our problems -whatever they are- and that we do not need to worry.

This view, made popular during FDR's reign and reinforced and expanded since by both political parties, believe that the government can and should inject itself into the economy because the economy needs to be managed. That market forces cannot do the job.

The president said we need to do more. I interpret that to mean we need to take more money from the people who earned it, the producers, because the 50-60+% percent being taken now isn't enough or even fair. And besides, the government knows how to spend this money better than the people who earned it.

You may think differently but right now we live, work and invest in this Keynesian world; therefore, going forward we can expect the following:

1. Governments (all levels) will continue to spend excessively and borrow or print more money because there is no incentive to stop (see ZIRP below.) When the States get into trouble, they believe the Federal Government will bail them out.

2. The Federal Reserve will continue their Zero Interest Rate Program (ZIRP) for as long as they can to help banks (it's their job); and to keep interest rates low to "help" people buy/refinance their homes. And maybe one other thing, the Federal Government can't afford to have rates rise because every 1% rise in interest rates will cost the government over $150 billion per year in additional interest.

3. Currently, the Federal Government is running close to $100 billion per month in deficit spending and the Federal Reserve is printing and pumping in another $105 billion per month. The results so far are not too good however. Preliminary Fourth Quarter GDP decreased at an annual rate of -0.1%. But, it's only been four years.

4. Normally, increasing money supply causes inflation. However, even with the trillions of dollars injected into the economy, we do not see inflation as measured by the Consumer Price Index (CPI.) One reason is of course the way CPI is calculated. The other is that the money being injected by the Fed is going directly into the banks. The banks are not lending the money because they can make more money by buying assets (stocks, bonds, currencies, foreign investments, etc.)  

4. Therefore, we have a kind of stealth inflation because real inflation is not visible in the usual places. However, inflation is visible in asset prices (stocks, bonds, metals, etc.) because that is where the banks are "investing" their free or almost free money from the Fed.

5. This kind of malinvestments will eventually cause "cost-push inflation" (increased costs of materials including energy and labor will force prices up and thereby reduce supply.) Reduced supply then causes prices to increase.

6. Today, the government cannot raise rates to combat rising prices (remember Paul Volker) because U.S. debt is too large and interest on the debt would become unaffordable. Nominal rates on the 10-year Treasury of 5% would increase interest payments close to the size of the Defense budget.

So what do we know after the President's speech? The government is going to keep pumping money into the economy raising nominal GDP, asset prices (including the markets) and inflation. We will need to continue investing like a Keynesian whether you believe in this dogma or not, but keep an eye out for the black swan.