Leading cryptocurrency Bitcoin doesn’t come out of nowhere. It is “mined” by solving large, complex math equations. The computers that solve them need electricity—and not just a little of it. This GZero electricity usage chart shows Bitcoin mining as if it were a separate country. On that basis, it’s more than some significant economies like the Netherlands and not far behind Ukraine and Sweden.

 

 

Bitcoin is starting to become systemically important even if its financial uses are still limited. All that electricity shows up in fuel consumption. Moreover, Bitcoin-related computing demand may be aggravating global microchip shortages. At some point, this should be self-limiting since other cryptocurrencies use less energy intensive techniques. But for now, Bitcoin is burning a lot of gas.

 

Debt

 

Total domestic debt is the total outstanding debt owed by all domestic sectors (households and nonprofit institutions, financial and non-financial corporations, farms, state and local governments, federal government) and includes government bonds, corporate bonds, bank loans, other loans and advances, mortgages, and consumer credit.

Total Domestic Debt as a Percent of GDP – data as of 12-31-2021 (select countries) Source: Haver Analytics

Canada: 367.2%
Eurozone: 483.6%
UK: 513.4%
France: 589.0%
Germany: 319.9%
Ireland: 898.1%
Italy: 382.8%
Japan: 654.1%
South Korea: 384.8%
United States: 361.7%

Debt is a drag on future growth. Reinhart and Rogoff did an excellent review of history. The bottom line––plain and simple––is that economies get into trouble when debt-to-GDP is north of 100%. Debt is our number-one problem. It is why the economists I respect the most believe deflation will continue to be the dominant force. In the end, we will monetize the debt and the path to that end game will be volatile. We will solve the problem, but it will require political will, global coordination, and probable financial pain. It is why William White believes, “In the end, there will be inflation.” We do not yet know what the solution will look like. And we’ll all be fine. And our finances will be fine too if we adapt accordingly.

 

COVID Update

 

COVID-related hospitalizations:

 

 

The US is nearing herd immunity

 

 

The COVID recovery won’t proceed at the same pace everywhere. It depends on the prior trends, virus conditions, vaccinations, and other factors. But in any case, the US will probably be first to regain its pre-pandemic trend.

 

 

Note the UK, which is relatively ahead of most others in vaccinations, isn’t in the same position economically. Even Brazil is slightly ahead. That speaks to the continuing Brexit turmoil and trade uncertainty the country faces.

 

Jobs

 

A rising “quit rate” is typically a good sign. It means the economy is strong enough to give workers more opportunities and the confidence to follow them. But digging into the data shows a big difference between sectors.

 

 

The above-average “quits” are happening mainly in the Leisure/Hospitality and Retail sectors, both of which were hit hard last year and are now finding it hard to attract new workers. The workers who quit presumably believe they can find better pay and job conditions elsewhere—and maybe in a whole different sector.

In a March 2021 survey, Prudential Financial asked workers if they were planning to look for a new job once the pandemic is no longer a concern. A remarkable 26% said yes. This seems to correlate with age: Boomers are more likely to stay in place while Millennials are more interested in leaving. If these workers succeed in finding new jobs (and the rising quit rate suggests they will), then employers are about to face a lot of turnover. This will be initially disruptive, but may be beneficial later. Both individual workers, and the economy overall, tend to be more productive when they can use their talents most effectively. Reshuffling the deck might be great for everyone.

 

 

Summer jobs, once a teenage rite of passage, are increasingly rare. This chart shows the monthly labor force participation rate, not seasonally adjusted because it’s already seasonal. The spikes in the purple line are the summer months, and the dashed line is the annual average.

 

 

Some 60% of teens had summer jobs, or were at least looking, from 1950 through around 2000. What explains the decline? Multiple factors are probably at work. The timing coincides with China’s WTO entry and accelerated globalization, which also affected adult employment. Maybe laid-off factory workers took some of the jobs that teens once sought. Another reason might be parents placing higher priority on academic education, athletics, and other non-work activities. And maybe some of it is just the allure of video games over working. This year’s labor shortage is raising pay levels and may change some of these incentives, but we don’t see it in the data yet.

 

The Fed

 

This week the Federal Reserve’s policy committee kept its strategy unchanged, and will continue making huge asset purchases. The members appear unconcerned about inflation risk. We think they are simply cramming more debt into a financial system that is already choking on it.

Key Points:

  • The Fed believes its asset purchases “help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”
  • Households and businesses aren’t starved for credit. The Fed is forcing it on them.
  • Encouraging more debt keeps zombie corporations alive and supports bubble-like asset prices.
  • QE is not having the desired effect on business investment or consumer spending.
  • Fed policy is raising inflation, but in ways the indexes don’t measure.

The Treasury yield curve, while not flat, is definitely trending flatter. That suggests the market doesn’t expect much inflation and the economy may be weakening. That’s what unproductive debt produces.

 

Home Price Appreciation

 

According to the National Association of Realtors (NAR), home prices are up 19.1% from April 2020 to April this year, as every region in America recorded price increases. “This is a record high and marks 110 straight months of year-over-year gains,” it stated. The NAR also explains that much of this price rise can be attributed to low inventory. At the end December, housing inventory stood at just 1.07 million homes for sale on a national level, marking the lowest number of available homes in 39 years. And though inventory has rebounded somewhat, rising to 1.16 million units in April, it’s still down 20.5% from last April. These realties, coupled with low interest rates that make home buying more affordable, can be attributed to traditional market forces. But what if the market is being artificially manipulated?

In a Wall Street Journal article titled, “If You Sell a House These Days, the Buyer Might Be a Pension Fund,” columnist Ryan Dezember explains that pension funds and other investors looking for higher returns on their capital investments are not just buying single houses but entire neighborhoods.

“D.R. Horton Inc. built 124 houses in Conroe, Texas, rented them out and then put the whole community, Amber Pines at Fosters Ridge, on the block,” Dezember writes. “A Who’s Who of investors and home-rental firms flocked to the December sale. The winning $32 million bid came from an online property-investing platform, Fundrise LLC, which manages more than $1 billion on behalf of about 150,000 individuals.”

Far more important, Dezember added that the home builder “booked roughly twice what it typically makes selling houses to the middle class — an encouraging debut in the business of selling entire neighborhoods to investors.”

Encouraging to whom? Real estate consultant John Burns, whose firm estimated that approximately 20% of homes are being bought by someone who never moves in, sees the writing on the wall. “You now have permanent capital competing with a young couple trying to buy a house,” he warned. “That’s going to make U.S. housing permanently more expensive.”

Dezember also recounts similar stories in his book, Underwater: How Our American Dream of Homeownership Became a Nightmare. He reveals that the world’s largest real estate investor, Blackstone Group, has bought other corporations such as Invitation Homes, which is on what he called a “buying spree.”

It is a spree fueled by $10 billion being used to buy $150 million worth of houses — per week.

The genesis of these sales was the real estate crash of 2008. Three years later, corporations began buying large amounts of foreclosed homes at steep discounts, even as banks were making it harder for regular home buyers to get a mortgage. When that proved enormously successful, they moved from buying foreclosures to buying on the open market, snapping up suburban houses and renting them out, often charging those renters more than they would have otherwise paid in rent or a mortgage.

And while this phenomenon didn’t exist a decade ago, by 2018, corporations were purchasing up to one in 10 suburban homes. The result? “Between 2006 and 2016, when the homeownership rate fell to its lowest level in fifty years, the number of renters grew by about a quarter,” Dezember writes.

Unfortunately, he believes this is just the beginning, as he says these corporations are both wealthy and technologically proficient enough to manage “multiples more” with “ruthless efficiency” — and eviscerate the nation’s middle class in the process.

Main Street is still competing with Wall Street. “Since the government quietly taxes away your savings through inflation, people and institutions who want to put money away for future use, or just grow their assets, are forced into riskier and more distortive behavior,” explains columnist Joy Pullmann. “Thus mega-dollar money asset managers and private equity firms are snapping up millions of homes at inflated prices because government profligacy has made it harder for them to secure a yield.”

“Home-price appreciation has historically been how Americans achieve financial prosperity,” Dezember writes. “Unlike stocks and bonds, ownership of which is concentrated at the top, houses are widely held. Roughly half of housing wealth is owned by America’s middle class.”

If this trend continues, entire generations of Americans will literally be priced out of prosperity. There’s no surer road to serfdom than that. Tragically, for a nation looking more and more like a corporate-controlled oligarchy instead of a constitutional republic, that may be precisely the intention.

 

The US Dollar

 

We have been living in a long USD regime off and on since about 2013, and we have just shifted to a weak USD regime.

A few months ago, we were talking about dollar shortages; a few months from now, we will be talking about how the dollar is a threat to the global financial system.

Here is a chart of the dollar index, if you had any doubt:

 

 

A currency is a medium of exchange, a unit of account, and a store of value. We are concerned with the last part.

Of course, we’ve had quantitative easing before, so that’s not new. What’s new is the unprecedented level of fiscal stimulus, which is ongoing, and likely to get much bigger.

This presents us with a bit of a problem.

As the federal government goes further and further into debt, the assumption right now is that the Fed will end up buying all of it, as part of Yield Curve Control, or MMT, or whatever. We are, more or less, at the direct monetization phase, and the government has learned that it can issue more and more debt without consequence, which is to say, without interest rates rising.

This results in the money supply getting bigger and bigger:

 

 

There are two possible scenarios here:

  1. The Fed buys all the debt with printed money, and we become Japan (or worse).
  2. Inflation begins to rise, which spooks Treasury bond holders, who sell and overwhelm the Fed’s efforts to control the yield curve.

It is the second scenario that I am worried about.

A lot of people (myself included) were worried about inflation in 2008. There were a lot of inflation trades back then—some worked, some didn’t. But we never got inflation.

There’s a reason to think things are different this time.

Last time, we had inflation in asset prices (but nothing else), which caused all sorts of inequality and led to some of the civil unrest that we are seeing today.

This time, we are getting a fiscal response as well as a monetary response, in the form of the stimulus checks and the additional unemployment benefits, as well as the PPP loans. This money is going to people who have a higher marginal propensity to consume. Sorry for the economist-speak—that means they are more likely to spend the money, which will push up prices.

The Fed has been jawboning interest rates lower for a few months, threatening to do Yield Curve Control, and then not doing it. If they do it, they will probably only do it in short maturities, out to three or five years.

This leaves the potential for the yield curve to steepen dramatically, with 30-year bonds being most sensitive to a rise in inflation expectations.

The rates market has been downright somnolent in recent weeks, but that could change if inflation begins to rise rapidly. I’ve seen some claims that inflation could rise as high as 4% in 2021.

Of course, this is essentially what the Fed wants, so they’re not likely to do anything about it. They want inflation to overshoot the 2% target, perhaps by a lot.

It’s hard to say what level of inflation would actually compel the Fed to tighten policy. Perhaps there is no level. Hence, the decline in the dollar.

Dollar decline is good for Gold and Silver.  Hence, the hedges that we have in place.

 

Hotels in the US

 

Americans—or at least some of them—are travelling again this summer. This chart of hotel occupancy is a look at how it’s going. The red line is this year, and you can see it’s considerably higher than the same point in 2020 (black line) and 2009 (dashed blue line), which was a terrible year for the industry.

 

 

On the other hand, 2021 hotel occupancy is running lower than the 2000–2020 median rate (solid blue line) and is well below the last pre-pandemic year of 2019 (dashed purple line). Now, it’s possible people who travel are finding other places to stay: with relatives or at campgrounds, for instance. Many may perceive those as safer. But it’s still bad news for the battered hotel industry, which needs to maximize cash flow from its expensive fixed assets. Recovery will come but maybe not this year.

 

China

 

You may have seen that China just recently lifted its “child limit” to three. The whole iconic “one-child policy”, which became a universal two-child policy in 2016 and is now a three-child policy for married couples, was totally misguided to begin with, if the country really wanted sustained economic growth.

For all your life, and likewise, for anyone who has been born within the past 2,200 years, China has had more people than any other country in the world. China’s population has been a point of pride, for one, and a key driver of the country’s economy, and thus, the world’s.

But within the next few years some people think it’s happened already; China is going to be demoted to the world’s No. 2 in population. India, which over just the past 20 years has added the equivalent of the entire population of the U.S., is moving into the top position.

China, with roughly 1.4 billion people, losing the top slot is little more than the answer to a trivia question. (The U.S. ranks third globally in population, but remarkably China has four times the number of people.)

But this reshuffling of the world’s population rankings is quite significant. It highlights China’s demographic headwind, which will soon become a gale-force challenge.

Productivity, the structures, and incentives in an economy to increase production per hour worked, is a key driver of economic growth. If more people in a country are doing economically productive things like building cars, rolling burritos, or selling windows, and they’re doing it more efficiently than they did in the past, the overall economy will grow.

The other main ingredient of economic growth is a rising population. It’s a necessary, though not sufficient, ingredient for sustainable long-term economic growth. Even a country that gets everything else right, smart policies, sound macroeconomics, and strong leadership, for starters, will in time struggle to grow if its population isn’t increasing in size.

And that’s where things are starting to look tricky for China. In early May, China released the results of its once-a-decade 2020 census, which showed the slowest rate of population growth since the 1950s.

The release of the census figures was delayed by more than a month. Demographers around the world speculated that the data was being “fixed” to avoid the political embarrassment of showing a year-on-year population decline, as opposed to just slowed growth. Taken at face value, the [reported] population increase in 2020 when compared with annual birth figures suggested that, miraculously, no one died last year.

A drop in China’s population would have been the first decline since China’s tragic Great Leap Forward economic campaign of the late 1950s, which resulted in as much as tens of millions of people dying of starvation.

The fertility rate, that is, the average number of children that women give birth to, is what I call the “economic skeleton key” because it’s the most important indicator of the future size of the working age population and thus, long-term economic growth.

Globally, fertility has been falling for decades. The average woman in 1960 gave birth to five children in 1960, and just under half that, at 2.4, in 2019. That’s barely above the “replacement rate” of 2.1 children per woman (to “replace” those kids’ parents).

In much of Europe and Asia, including Spain (1.2), Germany (1.5), Japan (1.4), and South Korea (0.9), according to World Bank numbers, the birth rate is already below the replacement level. And recent estimates suggests that China’s is between 1.3 and 1.5. (The uncertainty stems from the possibility of data manipulation, and the fact that births are not always officially reported.)

China’s government sees the writing on the wall. Just three weeks after the release of census figures, lightning-fast by the standards of any bureaucracy, the Chinese government announced that it would officially loosen its family-planning policies, to allow couples to have three children.

It’s a significant change and comes just six years after the country allowed families to have two kids.

Back in 1980, the Chinese government officially limited couples to only one child. But over the previous decade, a brutal and coercive government campaign to limit childbearing had already, incredibly, reduced fertility by half, to just under three children per couple. Part of the rationale was that China’s impatient reformist leaders were desperate to find ways to increase the economic growth rate per capita the government recognized that China was falling ever further behind its dynamic neighbors in East Asia, and they also saw that by promoting economic growth and raising living standards, they could improve the party’s authority and image. They desperately wanted to avoid having future economic gains diverted to feeding more people instead of raising living standards.

At the time, China’s economy was heavily agricultural. Policymakers were strongly influenced by the idea, first advanced by English economist Thomas Malthus in 1798, and reinforced by prominent western thinkers in the late 1960s, that population would grow faster than the food supply over time, triggering mass starvation and crisis.

Advances in agricultural technology and food production, including chemical fertilizer, mechanized farming, irrigation, and seed breeding, have proved Malthus and his fellow doomsday prognosticators completely wrong.

But China’s government didn’t get the memo and figured that they could tackle the challenges of low per-capita GDP, and the worry of not being able to feed everyone, simply by reducing the number of mouths to feed (apparently not thinking through the long-term implications that reducing the number of working people would have on the economy.)

The solution to overpopulation is not to force people to have fewer children. China’s one-child policy showed the futility of that experiment. It is to raise the poorest nations out of poverty through democratic governance, free trade, and the education and economic empowerment of women.

The Chinese government’s latest family-planning policy change is an implicit admission that the country’s one-child policy was a monumental mistake.

What’s more, China’s economy is the world’s second largest. But it’s at least 60th in the world in terms of per-capita GDP, trailing the likes of Romania and Panama. And it’s less than one-sixth that of the U.S., according to World Bank data.

China has succeeded in bringing down its population growth, and can better feed its people, but, ironically, it still lags far behind in economic output per person.

Fertility rates are like giant, ocean-going supertankers, once they’re moving in one direction, it’s close to impossible to alter the course.

After China’s one-child-per-couple limit was lifted in 2015, the birth rate hardly changed over the next several years.

The government has said it will provide support to promote bigger families, such as childcare and paternity leave. But that won’t make much of a dent in the cost of raising another child, from schooling to shoes to housing, for the average family in China.

The government didn’t remove the children limit altogether because it would look like an admission that its family-planning policy was a colossal failure. What’s more, it would put the entire national bureaucracy responsible for enforcing those policies out of work.

Around the world, wherever economic development occurs, the trends of rising urbanization, incomes, and educational levels lead to declining fertility rates, as parents invest more resources in their own consumption and a smaller number of children.

In India, where, like nearly everywhere else, the government isn’t involved in family planning, total fertility was nearly equal to China’s in 1970. And while India’s fertility rate has steadily fallen, to 2.2 births per woman today, it is still above the replacement rate. While the graph of China’s decline looks like a cliff. And that difference makes all the difference.

As life expectancy in China continues to increase, the average person lives to 77, and births decline, China’s population is getting older fast. In fact, the only country that’s aged faster is Japan, the poster child of demographic collapse. Today there are 80 million more Chinese people aged 60 and older than there were just a decade ago.

Meanwhile, over the same period, the country’s workforce shrank by 45 million people. That spells trouble for the pension-fund system, which is forecast to run out of money by 2035.

And immigration, which, apart from home-grown population growth, is the only other source of workers, won’t bail China out. There are just 1 million people living in China who were born elsewhere, or around 0.07% of the population, lower than any other country on earth. (That compares to 14% of the U.S. population.)

That’s not to say that China’s economy, which grew 2.3% last year and averaged 7.7% per year over the 2010s, is about to come to a standstill. China can wring out more improvements in productivity than in countries where productivity is already high. China will likely continue to post solid growth for years to come.

But if an economy can only rely on productivity improvements to generate growth, growth inevitably slows. And that will also be a problem for China’s economy, and for the world.

In the 10 years through 2019, China, on average, accounted for about one-third of global economic growth, larger than the combined share of global growth from the U.S., Europe, and Japan. In 2020, China most likely accounted for almost all the world’s economic growth, as was the case during the global financial crisis.

In 221 B.C., a brutal emperor named Qin Shi Huang unified numerous warring states to create a unified China, to create the world’s most populous country.

Chinese President Xi Jinping will within the next few years be forced to tell the Chinese people that the country lost that title.

Perhaps the looming demographic reality that faces China will provoke a renewed sense of purpose and spur innovation. But there’s no question about this.

The slow changes in China’s demographics will be one of the biggest stories of the global economy for decades to come, and there will be risks, and potential opportunities, as the country wrestles with seismic population shifts.

 

Market Data

 

  • With the release of household finances for the first quarter, the Federal Reserve suggests that households are holding record allocations to stocks in terms of their total financial assets, and relative to the country’s output. There is a strong negative correlation between this and future returns.
  • This week, we saw a return of speculative options traders, nearing their previous extremes. There is very little hedging activity happening right now and a few breadth divergences have popped up. Several commodities are looking vulnerable over the summer months.

 

US Economy

 

  • The U. Michigan consumer sentiment index strengthened this month.
  • Americans are increasingly confident in the jobs market.
  • Inflation expectations pulled back, as the “food at home” CPI component eased.
  • Buying conditions for vehicles tumbled amid shortages and rapid price increases.
  • By the way, the May Conference Board’s report also showed consumer unease with purchasing a vehicle.
  • Goldman’s US financial conditions index shows an extraordinary level of accommodation.
  • The US dollar jumped on Friday as traders lighten up on their bets against the greenback ahead of the FOMC meeting.
  • Household net worth has been surging.
  • US consumers now view the buying conditions for houses as worst in years, as prices surge
  • Google searches for apartments have cooled as rental prices rise from low levels.
  • Wages have decoupled from the monetary policy.
  • However, the Atalanta Fed’s wage tracker is yet to show an acceleration in pay increases.
  • US households expect to spend substantially more over the next 12 months.
  • CEO business confidence is the highest on record.
  • May retail sales were below market estimates, but there was a significant upward revision for April.
  • Manufacturing output rose in May and is now close to pre-COVID levels.
  • Industrial capacity utilization continues to climb.
  • The NY Fed’s May manufacturing report (first regional survey of the month) was weaker than expected.
  • Supplier delays worsened this month, which has been a national trend.
  • The region’s factories are quite optimistic, expecting to further boost hiring in the months ahead.
  • US inventory rebuilding paused in May (mostly due to supplier delays).
  • Retailers’ inventory shortages are becoming more acute.
  • The PPI print surprised to the upside.
  • Used-car dealers are gouging customers amid automobile shortages.
  • Supply chain disruptions have been unprecedented.

 

Thought of the Week

 

“What a wise man does in the beginning, a fool does in the end.”

– Warren Buffett,

Chairman and CEO of Berkshire Hathaway, Investor, and Philanthropist

 

Picture of the Week

 

 

 

All content is the opinion of Brian J. Decker