This April, the International Monetary Fund (IMF) stated that it is expecting a fiscal deficit of 7.1% for the US next year – monstrous numbers, outranking other first world economies by a factor of 3. As the IMF’s chief economist Gourinchas said, “Something will have to give“.
The true question, however, is not ‘if’ but ‘when’ – in 2 decades, next year, tomorrow? No one does or can know, as only a combination of various exogenous events will lead to a cascade bringing the whole house of cards down. One of the unspoken side effects is the long-term expropriation of private wealth of the citizen by the hidden tax of inflation (Yes, even if it is ‘only’ near the Fed’s target of 2% p.a.). Another is the phony effect on asset prices.
The latest report by the NFIB Small Business Economic Trends (SBET) offered the insight that “Government spending and hiring remain strong, [and will be] the legs of any 4th quarter growth that might occur.” – suggesting that concurrent growth is barely based on the small- and mid-sized business that make up the bedrock of the economy, but on government intervention.
The NFIB July SBET report was even more poignant. “Government spending (labor costs) was about as large as private investment.” A whopping 70k of 206k created jobs constituted government hiring, and another 82k were in healthcare and social assistance, both heavily dominated by government. Thus, 76% of jobs created in July were due to government hiring or in sectors heavily dominated by it. The report further communicated that “an economy dependent on the government sector for growth will not perform well, as markets allocate resources more efficiently than thousands of bureaucrats making decisions about where your money should be spend or invested“. Clearly, an individual cognizant of genuine economics as opposed to Keynesian mania wrote these words, an individual that might get kicked out of their position soon for speaking the truth…
As equally seen in the credit bubble that burst in 2008, corporate earnings, which drive the stock market in aggregate, have been overinflated by the reckless debt growth – this time not mortgages, but government excess debt assumption and spending.
The SP500 is near its all-time high, and largely so due to the ballooning budget deficits – $380B in August, likely to exceed $2T for the fiscal year 2024. The problem is not that the thin trend that the SP500 is sporting cannot go on a while more (following Keynes’ famous quote about markets staying irrational longer than contrarians staying solvent), but that a trend built on debt is built on weak foundations – it is concentrated, not able to exist without being propped up, and will most certainly not last forever.
On the one hand, excess fiscal spending and budget deficits boost corporate earnings in aggregate by making funds available for hiring, wages and money artificially changing hands, even when demand stagnates – and also somewhat by increasing demand for goods and services. These effects can be broad or targeted to benefit specific sectors, such as healthcare or public administration and agencies.
On the other hand, public spending changes bond market dynamics. A fiscal deficit is money spent that is not owned, i.e. debt, and is financed by broad selling of government bonds, typically pressuring interest rates in treasuries to rise into the stratosphere. An inflow of investor money into the latter and away from corporate bond markets is the result, hurting business, corporate earnings and stock prices.
In the 1980s, high deficits led to high yields on treasuries that corporate bonds and stocks had to compete against – yields on treasuries were typically above 8% p.a. and at times exceeded 14% p.a. From 1980-1983, the deficit/GDP ratio grew from 2.6% to 5.7%, while stocks went down or sideways unable to compete with extremely high real rates on fixed income investments.
This however is not the case today, with the Fed monetizing the debt. Nominal treasury yields are locked in a low range from 0 to 5% over the last 2 years, and real rates were negative most of that time due to a historic explosion in inflation rates.
In the current environment, Fed purchases of spent government debt are keeping yields low, which allows money inflows into corporate bonds to translate more directly into rising stock prices, rather than being offset by higher yields as was the case in the past, all while spent ‘phony money’ debt is pressured into the system. Risk assets here remain attractive to the average investor, however overconfidence and over-concentration in mega-cap tech stocks make for thin and wobbly markets.
Of course, fiscal spending is partially politically inspired, to keep nominal GDP growth alive and kicking and markets floating, well throughout Biden’s term. This pace is now about to pick up, with a “significant increase in fiscal year-end spending” to be expected, as stated by Public Admin spokespeople in the September ISM Services Report on Business (NMI). Meanwhile, as the ISM Manufacturing report (PMI) suggests, genuine manufacturing and capital production is and has been in a contraction slump since November 2022:
While the excessive fiscal spending has been able to keep GDP growth well in the positive, it is merely so on the surface. When adjusting for inflation (real GDP), we can see on the difference of nominal and real GDP below that GDP growth over the last quarters was largely attributable to price growth and factors other than productive capacity.
The final question remains – how long can the reckless fiscal deficit be expanded, and how will it proceed in detail after the November US election, depending on the outcome of the election?
