New Year’s Resolutions, Infrastructure And Drunken Darts

While regular people are still sorting out how to allocate their “stimmy” (and I’m still chuckling at the extent to which America speaks almost exclusively in memes now), Wall Street has turned its focus to the forthcoming infrastructure bill.

Revitalizing American infrastructure is a lot like that New Year’s resolution you make every January, but never keep. Politicians are usually fine with paying lip service to the desirability of infrastructure initiatives, which have some bipartisan appeal by virtue of representing an investment in the country’s future. Nobody likes to ponder the possibility that they may one day find themselves stuck in traffic on a rickety bridge. And “unsafe drinking water” makes for bad press, not to mention sick constituents.

The “problem” (and it’s not really a problem, as I’ll emphasize below) is that building things and improving existing structures costs money. And then there’s the thorny question of whose constituents “deserve” to have their bridges rebuilt, their roads repaved, and their piping re-… I don’t know, “re-piped,” maybe. Further, implementation poses a daunting logistical hurdle, something JPMorgan’s John Normand underscored in a recent note.

The government values the nation’s transportation, power, highways, streets, sewage and water assets at roughly $6 trillion, but as Normand wrote, “about 90% of these government assets are owned by state and local authorities rather than the federal government.”

I won’t assume to be an expert on such matters, but JPMorgan’s contention that “the concept of shovel-ready projects [is] a misnomer in a decentralized system where funding, regulation and some permitting is handled in Washington, but execution is spread over hundreds of municipalities,” seems like a generally accurate characterization of the challenge.

(As an amusing aside for regular readers, sandwiched in-between my master’s studies in political science and business school was a brief stint in an MPA program. Suffice to say it’s probably better for the world that I aborted that academic adventure two semesters in. I’m not sure city hall would have been amenable to my temperament earlier in life.)

It’s not as if the logistical hurdles haven’t occurred to the Biden administration, so one can assume that with a Democratic Congress, some kind of infrastructure plan will end up becoming law. This time, the New Year’s resolution will be kept, even if the final legislation ends up being so watered down as to be unrecognizable when considered alongside campaign promises.

Bloomberg’s lead story Monday centered on the prospect of higher taxes to help “fund” the push. “Key advisers are now making preparations for a package of measures that could include an increase in both the corporate tax rate and the individual rate for high earners,” Nancy Cook and Laura Davison wrote, citing people familiar.

You can absolutely expect everyone involved — from Republicans to Democrats to Janet Yellen to Jerome Powell — to insist that it’s necessary to either borrow or tax in order to “fund” an ambitious longer-term economic recovery package. That’s simply not true. That isn’t the way it works. And all of the people mentioned there are acutely aware of that, even if they can’t seem to wrap their minds around the implications. Obviously, the US government doesn’t preemptively “source” the dollars it spends. Rather, the government spends what it needs (or wants) to spend, then borrows and taxes later. Politicians and economists then point at those taxes and that borrowing to claim that spending has been paid for. That’s clearly ridiculous. The US government is the only legal issuer of US dollars in the universe, so it can’t be the case that anyone “provided” the US government with “new” dollars. Where would those new dollars come from? Nobody else can legally issue them.

The public is now coming around to that charade. Some suggest a mass awakening to the simple reality I’ve just described could be catastrophic for a number of reasons, not least of which is that citizens will begin to demand more and more from the government once it occurs to them (citizens) that their own capacity to pay taxes or China’s appetite for Treasurys aren’t binding constraints on government spending.

Another concern is inflation, but there’s a problem with that argument. Namely, the “lines” stopped matching up decades ago.

“Market relics plus younger investors who happen to study history may remember the 1960s and 1970s, when loose fiscal policy and accommodative monetary policy delivered a positive correlation between deficits and inflation,” JPMorgan dryly remarked, in the same note cited above, adding that “the emerging US fiscal/monetary mix samples from that era, though by policymakers who say they have the tools to do the right thing at the right time to deliver price stability.”

Critics scoff at the notion that policymakers can be trusted in that regard. JPMorgan said simply “We’ll see.”

Over the course of the last several months, I’ve variously tried to strike a balance between playing down absurd inflation hyperbole and noting the obvious, which is just that when consumers are bombarded every, single day with inflation ghost stories, that can affect expectations which, in turn, can become self-fulfilling. In addition, I’ve repeatedly noted that, in the event the US economy does reopen and herd immunity is achieved, the conjuncture could end up resembling a turbo-charged version of early 2018. That is: Fiscal stimulus piled atop an economy already poised to do well, only this time, it’s demand-side stimulus (more potent) and it will hit amid a kind of “grand” reopening in which tens of millions of Americans suffering from cabin fever descend on a suddenly open services sector. That could be inflationary.

“It’s still very early days in the inflation process, given that the service sector will be the source of both a demand surge due to reopenings and supply bottlenecks,” JPMorgan’s Normand went on to say, before suggesting that “there’s been nothing to see so far because so many doors are still closed or just half-ajar [but] that backdrop will change significantly this spring and summer due to both economic reopenings and household drawdown of their extraordinary savings.”

As far as what all of this means for asset prices, the truth is nobody knows. Even before the virus, the playbook was wrong at least as often as it was right. In that sense, forecasting during the pandemic was a lot like forecasting in any other year: Just a drunken game of blindfolded darts. The difference in the COVID era is that everyone is drinking Everclear instead of Sam Adams.

JPMorgan isn’t quite that colorful, but the bank expressed the same general sentiment. “For anyone who hasn’t yet figured out what $1.9 trillion of stimulus means for the fair value of markets over the next couple of years, it’s a work in progress here too… and an upcoming Biden infrastructure bill will increase the challenge,” Normand remarked.