What the Federal Reserve has failed to grasp is that monetary policy is deflationary when debt is required to fund it.

How do we know this? Monetary velocity tells the story.

What is “monetary velocity?” 

“The velocity of money is important for measuring the rate at which money in circulation converts into purchasing of goods and services. Velocity is useful in gauging the health and vitality of the economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.” – Investopedia

With each monetary policy intervention, money velocity has slowed along with the breadth and economic activity strength.

 

 

US Economy

 

  • Market-based inflation expectations continue to signal higher consumer inflation ahead.
  • Used car prices climbed by most in recent history, as Americans move to the suburbs and avoid public transportation.
  • The latest apartment rental vacancy data show the extent of the rental price drop as people get out of downtown areas.
  • Medical care CPI is moderating as gains in health insurance prices slow.
  • Housing affordability declined in August, as rising prices offset lower mortgage rates.
  • Soybean meal futures continue to rally, partially due to higher feed demand for China’s rising pig population.  Here is Bloomberg’s grains index.

 

 

How much will business insolvencies increase next year?

 

 

When will bankruptcy filings peak?

 

 

Some updates on commercial real estate:

  • CMBS loans delinquency status:

 

 

  • Loans in foreclosure:

 

 

  • Multifamily housing loans:

 

 

  • US factory activity remained robust this month.
  • The NY Fed’s manufacturing index showed continuing growth in October.
  • Factories expect to keep hiring.
  • The Philly Fed’s report was even stronger.
  • Growth in new orders and shipments accelerated.
  • Employees are putting in more hours.
  • CapEx expectations have rebounded.
  • The US dollar’s weakness continues to put upward pressure on import prices.
  • New unemployment applications are holding above one million per week.
  • US mortgage rates hit another record low this week at 2.81%.
  • US retail sales continue to power on, exceeding economists’ expectations.
  • Vehicle purchases have been especially strong since the end of the lockdowns.
  • This chart shows debit- and credit-card spending vs. 2019:

 

 

  • US freight activity has nearly recovered.
  • The federal deficit exceeded $3 trillion in fiscal 2020.

 

Global Economy

 

Which countries have the highest twin deficits?

 

 

This chart shows each central bank’s balance sheet as a percentage of the GDP.

 

 

Our political process can’t (won’t) reduce spending and/or raise taxes enough to balance the budget, so the debt grows and grows. As it does, paying the interest plus the accumulated debt load pulls more capital away from more productive uses. This depresses economic growth, thereby generating even more spending and debt.

Why are rates so low?

Our aggregate debt burden reduces growth, which reduces demand for credit while also increasing the supply of credit. Lower demand + higher supply = lower prices. Interest rates are the price of money. The low interest rates are not a potential benefit for the economy, they are a result of the overuse of debt. At some point, you would think interest rates will have to rise. And in a totally free market that would be the case. But you can bet (as the market does) that the Federal Reserve will step in and implement yield curve control, further distorting the market and hurting savers. This financial repression has severe negative consequences on retirees.

 

 

Central Banks have created this unprecedented divergence between the G20 debt-to-GDP ratio and long-term rates. This can continue far longer than most people think. Japan is now at 237% of debt to GDP. Europe and Japan both have low or nonexistent GDP growth. The explosion of US debt means the US will soon join them. The answer from almost every economist of any stripe about how to fix the debt problem is to “grow our way out of it.” The problem is, we have passed the point of no return.

 

 

We can’t stop growing debt. That would bring down the system in a true greater-than-the-Great Depression crash. What do you cut? Social Security? Medicare? Military pensions? Education? Interest payments on the debt? The State Department? The only way to maintain that spending is to keep adding debt, which sends us further into the debt trap.

At some point, this will simply stop working.

I am often asked exactly when it will happen. The simple fact is I don’t know. My best guess is toward the latter part of this decade. I simply believe/know we will reach a point where everything has to change, and so it will.

 

The Fed’s Mistake

 

The Fed continues to follow the Keynesian logic, mistaking recessions as periods of falling aggregate demand. They believe lower rates and asset price inflation will stimulate demand and increase the rate of consumption.

However, these policies have all but failed to this point. From “cash for clunkers” to “Quantitative Easing,” economic prosperity worsened. Pulling forward future consumption, or inflating asset markets, exacerbated an artificial wealth effect. This led to decreased savings rather than productive investments.

 

 

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, is wrong. It has not happened in 30 years. Despite the short-term benefit of policies like tax cuts, or monetary injections, they do not create economic growth. Debt-driven policies merely reschedule future growth into the present. The average American may fall for a near-term increase in their take-home pay. However, any increased consumption in the present will be matched by a decrease later when the tax cut is revoked.

The Fed’s interventions have also led to a massive leveraging of U.S. corporations, which has led to lower defaults via cheap corporate debt.

 

 

Unfortunately, it has also created an economy with a record level of “zombie companies.” 

“‘Zombies’ are firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing. 

Such is a macroeconomic problem because zombie firms are less productive, and their existence lowers investment in and employment at more productive firms. In short, one side effect of central banks keeping rates low for a long time is that it keeps more unproductive firms alive, which ultimately lowers the long-run growth rate of the economy.” – Axios

 

 

Demographics and Trends Regarding Aging

 

First, in the United States, the private and public sectors will finally come to grips with their age bias, as soon as 2022. The increasing shortage of talent will force venture capitalists and employers to reconsider their age bias. Other trends such as the reshoring of American manufacturing, restrictions on immigration, and the prevalence of automation will all favor recruitment and retention of older workers. Similarly, with both Boomers and Xers perceiving “bias,” political pressure will mount. This will create new opportunities especially for talented Gen-Xers who have always been squeezed between Boomers and Millennials.

Second, employers, educators, and individuals will increasingly adopt practices aimed at continuous learning and skills acquisition. Businesses in the 2020s will be characterized by a wave of new technologies and business models. Every worker will need to be continuously retrained to avoid obsolescence. Fortunately, distance learning is finally advancing to the point where anyone with a smart- phone can get training and assistance anywhere, anytime. Augmented reality, enhance by AI and live tech support, will dramatically reduce the learning curve for many jobs.

Third, all of the research on anti-aging molecules will finally pay off with human trials of multiple treatments by 2025. Once any of the candidates succeeds it will validate the idea that it’s possible to attack certain illnesses by intervening in natural aging processes; in other words, by treating aging itself we can slow the contributing causes of disease. Scientists envision anti-aging drugs eventually delaying older people becoming frail and disabled and vulnerable to one illness after another. Some of these promising compounds have already dramatically extended the life span of yeast, worms, and rodents, but we still haven’t achieved documented results in humans. As Leonard Guarente, an anti-aging pioneer at MIT says, “The most important thing is extending the healthy life span.” We’re confident that anti-aging breakthroughs are coming, but the commercialization timeframe is unclear. Healthy, active oldsters will be a boon to the economy both as producers and consumers.

Fourth, good health, a shortage of skilled replacements, and an unwillingness to “retire quietly” means that Baby Boomers will remain in the workforce far longer than previous generations. Both of the 2020 presidential candidates are already older than the previous oldest President was when he left office. This simply illustrates the fact that a large share of talented and satisfied Boomers won’t be leaving the workforce until at least 2030.

Fifth, across the OECD, an automation revolution enabled by artificial intelligence will reenergize economic growth, in spite of retirements. Like steam engines, electricity, and the assembly line, artificial intelligence is a general-purpose technology that can be applied to make myriad applications dramatically more efficient and effective. When these other technologies were introduced, the society asked, “What do we do with all the excess people, now that their jobs can be done by machines?” This time, society is asking “How can we grow if we don’t have enough people working?” Ironically, the answer is the same: innovate. Artificial intelligence is the first general-purpose transformative technology that’s more useful in services than in agriculture or manufacturing. The AI-driven productivity revolution, running from 2017 to 2035, is just now beginning to surge. And that’s exactly when the Boomers and Xers will be at their most productive and millennials will finally get their chance to shine. From eldercare to e-commerce, to autonomous vehicles and 5G smart homes, the best is yet to come.

 

China has a PR problem.

 

 

COVID Update

 

How soon would you be comfortable…?

 

 

As you can see from the chart below, “more cautious” doesn’t begin to describe the gap between how Democrats and Republicans view the virus:

 

 

Why this colossal difference? Gallup doesn’t say. But it might have something to do with where we’re getting our information.

 

 

All Content is the Opinion of Brian J. Decker