For The World’s Largest Economy: Two Possible Futures

For The World’s Largest Economy: Two Possible Futures

On Friday, Goldman suggested that Joe Biden’s tax plan has the potential to accelerate any outperformance seen in cyclicals and value stocks as a result of good news on the vaccine front.

“While focus has been on the increase in the statutory rate, Vice President Biden’s plan includes other provisions such as a minimum tax rate and an increased tax on global intangible low-tax income”, the bank’s David Kostin wrote, adding that “the potential earnings impact of tax reform appears largest for popular secular growth sectors Comm Services, Health Care, and Info Tech”.

Of course, that’s not the only reason to believe a Democratic sweep in November would add to a pro-cyclical impulse that favors perennial laggards at the expense of secular growth favorites. As Kostin went on to say, “Biden has also proposed substantial fiscal expansion, which could lift economic activity and in turn support the relative performance of Value stocks and Cyclicals”.

Read more: Valuing A Vaccine

While the Trump administration is generally in favor of more fiscal stimulus, the ramifications of spending another four years operating under supply-side economics thinly disguised as populism should be obvious.

Leaving aside the distinct possibility that the pandemic’s legacy could be inflationary over the longer-run in the event re-shoring, protectionism, and other supply chain disruptions conspire to push up domestic prices, in the near-term, COVID-19 was a deflationary supernova. It also served to exacerbate inequality.

While the Fed tweaked its framework for achieving the dual mandate in August, we know from the post-financial crisis experience that monetary policy operating on its own (i.e., without a concurrent, sustained fiscal impulse) almost certainly will not bring about robust growth, probably will not engender much in the way of inflation, and will surely widen the wealth gap by inflating the value of financial assets which are disproportionately concentrated in the hands of the rich.

There is, frankly, only one way out of this. As regular readers are apprised, I’ve run fresh out of patience this year with supply-side gimmickry and also with the idea that the Austrian “cure” is viable. Those notions are entertaining and serve as good sparring partners in normal times, but when tens of millions are jobless, they are useless at best, and pernicious at worst.

Supply-side economics has never worked — not really, anyway. The notion that economic prosperity can be created by doling out financial incentives on a grand scale to the already prosperous flies in the face of common sense. If one wanted to help Christopher, a hypothetical fifth grader born to a low-income family in West Virginia, one wouldn’t write Jamie Dimon a check for $1,000.

You might be inclined to call that a straw man argument, to which I would simply say that you cannot make an absurd idea plausible simply by scaling it up. Just ask any of the structured products that imploded during the financial crisis due to the faulty underlying logic that said even though one bad loan is… well, just bad, 1,000 bad loans bundled together are somehow AAA.

As for the creative destruction “cure”, it’s absurd for advanced economies. Anybody who suggests otherwise is a charlatan. When it comes to the feasibility of the great “reset”, I often quote Robert Skidelsky. “On the Austrian analysis, recessions give a chance to re-allocate ‘mal-invested’ productive factors to efficient uses [and] they should therefore be allowed to run unhindered until they have done their work”, he wrote, in Money and Government. Skidelsky then reminded his audience that “economists whose common sense had not been completely destroyed by their theories rejected the drastic cure of destroying the existing economy in order to rebuild it in the correct proportions”.

The above underscores yet another way in which the November election is not just crucial, but in fact existential. Deutsche Bank’s Aleksandar Kocic alludes to this in his latest note.

On Friday, in “Tragically Apt“, I quoted Kocic as saying that monetary policy at this point is “not the most decisive factor”. Kevin Muir, of “Macro Tourist” fame, made similar remarks last week. It is fiscal policy that matters from here.

“Apart from the near term uncertainty that they are practically guaranteed to deliver, depending on their outcome, the 2020 Presidential elections could lead to materially different economic paths in the long run”, Kocic writes, describing “two main election outcomes that capture two distinct modes of fiscal policy and two different futures of the economy”. Here are those two distinct modes and different futures, as expounded by Kocic:

  1. Republican victory is associated with a less comprehensive distribution of fiscal stimulus and is, therefore, less stimulative for growth; it could require a longer monetary policy accommodation causing lower rates and flat curve for a long period of time.
  2. A Democratic sweep, on the other hand, means more egalitarian distribution with possibly more deficit spending and stronger impact on growth. As such, it implies a possibility of a shorter period of financial repression and emergence of an active Fed on the horizon as rebound of growth accelerates reflation and frees Fed’s hand to adjust policy to the new realities.

Let’s take those one at a time. We know, without a doubt, what “longer monetary policy accommodation causing lower rates and flat curve for a long period of time” will entail for society. We’ve just spent nearly a dozen years in that regime.

What will result from monetary policy operating on its own, without a sufficiently powerful fiscal impulse, is the perpetuation of inequality via the asset price channel. The rapid ascent of the red line (figure below) is in no small part due to the fact that the Fed (and other central banks) have spent the last decade mashing their foot on the gas pedal while fiscal retrenchment serves as a heavy boot on the brake.

When you toss in corporate tax cuts, and breaks for the wealthy (e.g., the notion of indexing capital gains to inflation) you’re left with a system that is destined (and I do mean destined) to impoverish virtually everyone.

On top of that, lower rates, a flatter curve, and the “duration infatuation” in bond land lead directly to parabolic rallies in secular growth stocks, which, in turn, create unfathomable wealth for founders and CEOs.

The figure (below) illustrates what happened on September 1, when blockbuster quarterly numbers from Zoom conspired with the underlying dynamics of an options mania in US tech shares to catalyze a cartoonish rally in the stock.

Turning to the alternative scenario posited by Kocic, a Democratic sweep would result in a more redistributive tax code, and a more sustained fiscal impulse.

As Kocic suggests, that would have a “stronger impact on growth”, leading to higher rates and a reflationary backdrop. In turn, fiscal policy would short-circuit many of the dynamics that have made 2020 a year during which the top-10 richest people on the planet saw their net worth balloon by nearly a quarter-trillion over eight months, while the rest of the world starved (literally in the case of some 30 million Americans who told the Census Bureau they were experiencing some form of food insecurity in late July).

With rising rates and faster inflation comes (to quote Kocic) the “possibility of a shorter period of financial repression”, which would translate into higher rates on savings, money market funds, and Treasury bonds.

These are your choices. And while it won’t surprise me (even a little bit) if large swaths of the electorate decide to once again vote against their own self-interest for fear of the Venezuela ghost story or some other absurd canard, don’t say you weren’t warned. And don’t act incredulous when you look up in 2023 and Mark Zuckerberg’s personal net worth is higher than the “total deposits” line item in Bank of America’s quarterly earnings.


15 thoughts on “For The World’s Largest Economy: Two Possible Futures

  1. Another aspects of possible fiscal plans if the Democrats sweep is the use of industrial policy. Aside from the obvious investment in the electrical grid, policy could use MMT to invest in the future productivity of the economy while putting people to work now. Grid, plus roads and bridges are easy wins. We need new industries, we need to increase the productivity of our labor force. MMT for use toward AI, nanotechnology, biotechnology, robotics, and rebuilding a sinking Naval Station Norfolk, to name just five areas.

    I’ve been seeing just looting of America by oligarchs. We are living on the fumes of investment and infrastructure from two, three and four in some cities, generations ago. Even the most critical, Hudson River Tunnel, hasn’t gotten their attention. OECD countries organize their government help for companies in this way like we give tax breaks to ours. It’s an opportune time for us to adopt this type of economic-furthering policy in America. Supply side is failed as also is “public-private partnership.”

    Industrial policy is a secret weapon that could be deployed…I hope the Democrats just call it something else, like the “The Patriotic Jobs of Rebuilding Roads Getting America Working Act of 2021” or something, to throw supply-siders, neo-liberal “thinkers,” and the nativist-first blogosphere, off the scent.

  2. I’m going to start passing the hat among Heisenberg fans/readers who want to see you debate this issue on Squawk Box with Kernan, Santelli, and Art Laughable.

  3. If you want to confiscate and stimulate then go UBI. Whatever the detractions, this President kept us out of wars on foreign soil and sees the USA as a union of 50 States. I object to confiscation that is doled out to 50 subordinate state governments. It simply entrenches Central Control.

    The greatest market problem may be the day after the first debate

  4. To help raise the lower band, Walmart just upped their salary bands. i’m Surprised at the continuous easy pitches at the inequality target and promoting socialist redistribution solutions. What about education, business opportunity, and techs ability to support Person Inc (individual driven businesses with low upfront capital)? Let’s focus on stimulating vocational businesses, teaching entrepreneurship, and championing people capitalizing their God given talents and skills.

    1. The challenge is that the same dynamics driving individual inequality are driving business inequality. It’s harder and harder to start a business because the biggest players eat up more and more of the pie. Walmart can afford to up their salary bands, but that just makes it harder for Joe Blow small business owner to compete.

      As for your point about vocational training and entrepreneurship, there is only so much personal consumption to be had, especially given the income dynamics frequently discussed here, before you need to look to government investment in things like infrastructure, education, and healthcare. If you push a bunch of people into vocational businesses, that doesn’t change the demand side of the equation and only pushes wages down.

      The last thing I’d note is that we’ve had redistributionist policy for the past 40 years and it’s all being redistributed to the wealthy under the guise of supply-side economics. These “socialist” policy proposals are just an attempt to rebalance those huge giveaways to the donor class.

      1. Send me your TPS report… You perspective has not been my personal experience. If you cut out the MAN, individuals can capture the corporate profit into their pocket. Over the last 40 years, many individuals with modest capital have pursued good ideas and scored big. We can go ahead and moan about the system, or make smart choices and build a bright future. This site is a perfect example of how mr H can make a living and carve a niche underneath the big media players.

        1. Moaning about the system and making smart choices personally are not mutually exclusive and anecdotes are not sufficient when it comes to policy decisions. To the first point, I’ve been working in startups almost my entire career so I understand how people, including myself, can overcome challenges to be successful. The policies I advocate would be beneficial to me only in their secondary effects (stronger economy, happier society, etc.).

          Since you are seemingly a regular reader, you can’t have missed what’s happening out there in the real world, but to remind you, small businesses are closing down left and right (happy to dig up an endless number of anecdotes about small businesses struggling or you can just google the data Yelp produces on permanent business closures or small business formation from the past two decades) while the big companies are taking up a larger and larger share of economic profits. Apple recently surpassed the market cap of the Russell 2000 single-handedly (although it is down since) and the trend only gets worse as you go down the ladder to even smaller businesses. This has all happened as we’ve handed out trillions of dollars through Fed policy and tax cuts to people and corporations who were already awash in cash.

          If we really wanted to encourage small businesses, build a safety net. Remove health insurance from the employment equation as the two should have nothing to do with each other. Set up UBI so entrepreneurs have a small income they can rely on while they launch a new venture. And yes, we could do a better job of encouraging people to pursue vocational training instead of college, but we can’t all be independent plumbers.

          I’d print that all out in a TPS report, but my printer is broken…

  5. H

    Thank you, sir, for this clarification I wish the loyal opposition had done a better job explaining over the last six months. What you are describing is actual policy for the country not the endless rhetoric promulgated by both sides of this debate. There was a great line from Jimmy Cagney in a fun movie entitled “Never Steal Anything Small.” He said: “The bigger thief always gets away.” Don’t they always?

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