By David Stockman as originally published on Contra Corner and reprinted here with permission
This morning we heard one of the usual bubblevision suspects, a Keynesian street economist by the name of Ian Shepardson, giving the all-clear signal to buy stocks.
He claimed business cycles don’t die of old age, and implicitly, therefore, that the Fed has your back and will keep GDP and earnings chugging ever higher. And, besides, there is huge pent-up demand for CapEx, which is purportedly going to trigger a new leg of strong GDP growth.
That proposition is so ridiculous, of course, that we could dismiss it as typical Wall Street baloney, bilge, bosh and bunkum, and be done with it. After all, here are the 28 previous business expansions since 1879, and they all assuredly died of something. And 10 of them occurred before the Fed opened for business in 1914.
So you can’t say that all which transpired before June 2009, when the current so-called recovery incepted, is pre-history; and that the US economy is now under the awesome tutelage of Keynesian minders at the Fed who have unlocked the secret of maintaining unbroken full-employment forever, world without end.
At least, you can’t say that if you have an ounce of common sense and are not jiggy with the misplaced arrogance of Keynesian PhDs who actually think they can predict and prescribe how to keep a $19 trillion economy on the straight and narrow.
In fact, the Ian Shepardsons of the world are just the auxiliary posse of the Keynesian PhDs and apparatchiks who run the Fed and other central banks based on the same anti-market arrogance.
They have spent the last 10 years blocking, nullifying and suffocating market forces in the financial system. So doing, they have drastically falsified any and all financial asset prices—from overnight carry trade funds, to the FAANG stocks, the 10-year UST, shale-patch junk bonds and the 100-year debt issued by Argentina (of all places) last June, among countless others.
The result is a financial system fraught with incendiary bubbles, excesses and booby-traps, such as the hundreds of billion of ticking time-bombs in the risk parity trades or in the momo roach motels of the stock market like Amazon, Netflix or high fliers in the tech space like Nvidia and Broadcom. During the last 5 years, the latter two have posted 17X and 12X gains in market cap, respectively, compared to net income growth of just 5X and 4X.
Moreover, these distortions and metastases have spilled over into the real economy big time.
The Fed’s Bubble Finance regime on Wall Street, in fact, is a predator on main street. It incentivizes the corporate C-suites to strip-mine cash flows and balance sheets in order to fund massive financial engineering maneuvers, thereby shrinking investments in productive assets, new products, more efficient and skilled employees and other entrepreneurial ingredients of capitalist growth.
Consequently, like in the case of an aging human, where weakened defenses and impaired resilience cause it to succumb to infections and other exogenous threats, the main street economy is exceedingly vulnerable. As Lance Roberts cogently pointed out in a post of this very topic:
While a 100-year old male will likely expire within a relatively short time frame, it will not just “being old” that leads to death. It is the onset of some outside influence such as pneumonia, infection, organ failure, etc. that leads to the eventual death as the body is simply to weak to defend itself. While we attribute the death to “old age,” it was not just “old age” that killed the host.
What the majority of mainstream analysis fails to address is the “full-cycle” of markets. While it may appear that “bull markets do not die of old age,” in reality, it is “old age that leaves the bull defenseless against infections.”
In a word, the US economy is now riddled with infections and debilitating impairments; and having expanded for 106 months or 2.5X the average historical cycle, it is well past the octogenarian point on the age scale.
At the same time, the economic doctors domiciled in the Eccles Building are completely lost and dangerously experimental. After trying the radical cure of ZIRP and QE experiments for upwards of ten years, which didn’t restore vigorous capitalist growth and rising living standards, they have now lurched in the opposite direction, pretending they know the correct time and dosages for QT (quantitative tightening).
We beg to differ. They are making it up as they go along.
The radical step of draining upwards of $2 trillion of cash from the bond markets over the next several years is the monetary equivalent of the bleeding cure. No one in their right mind would be trying it— had not the Fed’s balance sheet been hideously expanded by $3.5 trillion during the past 123 months.
Nor would anyone not drinking the Keynesian Cool-Aid, think that the monetary bleeding cure can be pulled off with nary a hiccup in the expansion of GDP and profits. That assurance from street economists like Shepardson bespeaks pure arrogance and willful blindness to the manifold headwinds and threats at hand.
So hence begins a discourse in the obvious. Wall Street got slightly jiggy about the first quarter GDP “beat” based on the 2.3% growth rate posted by the BEA, and the completely irrelevant canard that there is an alleged “residual seasonality” in the Q1 numbers, thereby making the numbers even stronger than they appear.
As to the latter, we’d guess there is nothing of the sort—just a X-mass shopping binge every year and a morning-after payback in Q1.
More importantly, the report contained numerous signs that the main street economy is riddled with deeply embedded impairments, distortions and deficiencies that make it especially vulnerable to the Fed’s new regimen of interest rate normalization and QT. For instance, the CapEx figures were nothing to write home about, and show no escape from their long-running stagnation.
In fact, the March number for nondefense CapEx excluding aircraft orders came in at $67.2 billion, and that still below the $68.3 billion number posted way back in June 2000. Not only has there been no net gain in 18 years, but as the chart below cogently documents, there appears to be an impenetrable ceiling at that level.
Actually, the story is far worse. That’s because these are nominal numbers, and even be the Commerce Department sawed-off inflation figures, the GDP deflator has risen by 27% in the interim.
This means, of course, that constant dollar CapEx orders are down by more than one-fourth from their turn of the century level. Surely that qualifies as a structural vulnerability that needs some splainin’ and which is hard to reconcile with the current sell-side meme per Ian Shepardson that CapEx is fixing to suddenly go booming higher.
The Wall Street rejoinder, of course, is never mind because what really matters is consumer spending, which accounts for 70% of GDP. And by the lights of our Keynesian wise men, it’s consumer spending which makes the world go round.
But surely that depends upon where they get the wherewithal to shop until they drop. That is, over any reasonable period of time it would seem to matter whether it was earned, borrowed, robbed from rainy day funds or stolen.
That gets us to the striking anomalies in the chart below. Using the pre-crisis peak (Q4 2007) as a common starting point, it turns out that as of Q4 2017, real consumption spending for durable goods was up by 53%—-compared to real compensation per hour gains of 4.0% and total hours worked were up by just 5%.
That’s right. The latter two figures are not per year—they are cumulative for an entire decade and are presented on a peak-to-peak basis, not from the June 2009 trough of the so-called Great Recession.
So how in the world did spending on durables at 53% grow nearly 6X faster than the implied gain in aggregate real wages (hours plus real wage rate equal a 9% aggregate gain)?
The answer in part is that rainy day funds got raided as real savings collapsed to all-time lows of 3.0% or under. Yet as the chart makes clear, the steadily declining lower lows have invariably given rise to a temporary snapback when consumer confidence is clobbered by a renewed cycle of stock market collapse and recession.
Indeed, during the X-mass spending binge, the personal savings rate plunged to 2.4%, which is a screaming sign of financial distress and desperation, not evidence of an economic cycle in its old age possessed of youthful resilience.
Equally importantly, real consumption expenditures for goods—both durables and nondurables—have been sharply boosted in GDP accounting by the lack of inflation as measured by the Commerce Department. In fact, the price level for durables has declined by 17% over the past decade, and even for durables including energy, the annualized gain has been only 1.1%.
Accordingly, real GDP has been given an enormous statistical boost by the forces of global deflation. And as we will elaborate more in Part 2, that’s a function of global monetary repression and asset price falsification by the central banks.
The latter have, in fact, made capital so cheap that the world economy has been flooded with excess capacity and malinvestment that has caused measured prices of tradable goods to be far lower than would be the case under a regime of honest money and market-priced capital goods.
Then there is the most telling anomaly of all. It seem that real consumption spending is up by 35% from the pre-crisis peak whereas industrial production has expanded by only 2%. The plain fact is, that can’t be. There is something drastically wrong under the hood, as we will explore in Part 2.