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A few months ago investors – especially those working for risk 60/40 balanced and parity funds – freaked out when the traditional correlation between stocks and yields (or inverse correlation between stocks and Treasury prices) flipped, sliding to the lowest on record, as any hope for diversification of equity risk by hiding into government bonds disappeared. And while the correlation has since recovered some of its normal historical pattern as the following chart from Goldman shows…

… a new and just as ominous decoupling has now emerged: that between stocks and investment grade and junk bonds.

In other words, while the low – or inverse – correlation between stocks and bonds has been one of the core anchors of modern finance, allowing cross-asset traders to diversify excess equity risk into bonds, this “basic premise” of modern portfolio consutrction theory no longer works. The culprit? Who else: the Federal Reserve.

As JPMorgan credit strategist Eric Beinstein writes in his latest Credit Market Outlook note, “in recent months, there have been two interesting trends in total return correlations: HG credit has become more correlated with stocks and thereby also more correlated with the HY bond market.”

What’s behind this rising correlation? According to the JPM strategist, there are several drivers:

• First, the unusual dynamic that stocks are doing very well at the same time that UST yields have declined. This, in JPM’s view, “is the result of so much QE-driven liquidity in the market that investors are buying everything: stocks and bonds.”
• The second, less likely, driver of persistently elevated correlations according to Beinstein, is exceptionally strong corporate earnings which have driven further total return gains this year alongside higher equities.

To JPM, this stands in contrast to what has traditionally been a key investment consideration for HG credit – its diversifying characteristic versus Equities, in the context of a balanced asset allocation portfolio (similar to the inverse correlation between stocks and treasurys). As Beinstein explains for those who have not taken finance 101, “when equities have risen, yields have often as well, leading to losses on the HG side and vice versa.” But not anymore, and here’s why:

The latest ongoing round of Fed QE appears to have broken this basic premise, with total return correlations between HG and Equities reaching their highest since 2008 on a 3yr trailing basis and since 1997 on a 12m trailing basis (of monthly returns in both cases).

The charts below shows these correlation time series over a very long period of time. They show that over time there have been various correlation regimes. Low to negative correlation has prevailed for most of the past two decades, but there have been several long periods of positive correlation in the past, with the most recent from 2009 to 2011, also following a market crisis.

Both charts above show that while there has been a wide range of return correlation regimes over the past 20 years “the increase in the Fed’s balance sheet (shaded area on the charts below) potentially argues for an extended period of higher correlations.”

Some more observations on how this heightened correlation has played out in the past: HG returned -7.1% in March ’20, before the Fed Covid programs fully took effect, while equity markets weakened sharply as well. To JPM, with UST yields so low “there is a risk that this lack of correlation repeats, with spreads widening more than UST yields may be able to fall.” Another takeaway is that the strong correlation between HG and HY returns argues for owning HY for the greater carry; HG and HY have been 75% correlated over the past 12 months, the highest since 2017. To be sure, it is always dangerous to extrapolate trends in correlation too far.

As Beinstein (somewhat sarcastically)concludes, “the potential implications of these developments are interesting” and explains: “traditionally portfolio theory says that bonds are a diversifier for equity market investments. This has not been the case recently, with the risk that it also remains not the case if/when there is an equity market selloff.“

Translation: in the next crash, everything will go down at the same time and there will be nowhere left to hide… Which is also why the Fed can never again allow a market crash.

Authored by Scott Minerd via GuiggenheimPartners.com,

Things Couldn’t Be Better

The COVID Delta Variant’s Looming Threat to Risk Assets.

When asked why Guggenheim frequently comes up with out-of-consensus and sometimes seemingly crazy views, I remind people that our process is driven by data and not opinion which can be affected by emotion or pressures to conform to opinions of others. The consensus is often a warm and fuzzy place where others join, providing the comfort associated with agreement and a sense of community and safety. And if the consensus is wrong at least you have company with whom to lament and console. Nevertheless, none of this pays the bills.

Having opinions outside of the consensus can be a lonely and isolated place without comfort from others while exposing oneself to harsh criticism and moments of self-doubt.  No one can ever be right 100 percent of the time, and there is always some probability that you can misinterpret the data. 

Having just come through the worst pandemic in more than a century, I hesitate to focus on it again. But at the risk of sounding like Chicken Little (as I did in my commentaries from February and March 2020), the evolving data on the Delta variant are extremely disturbing, and dare I add similar to the data we saw last year.

Many of us are unfamiliar with the concept of the Basic Reproduction Number, or R0 (pronounced R naught) as referred to by epidemiologists. R0 is the expression of disease transmissibility that measures how many people will be infected as a result of another infected person’s human interaction. If R0 of an infectious disease is less than 1, the disease will eventually peter out, but if R0 is greater than 1 it will spread.

The R0 for the initial strain of the Coronavirus back in early 2020 was somewhere between two and three, meaning that if someone were exposed to the virus, they would, on average, infect two to three more people. Given that the incubation period for COVID once a person is exposed is about two weeks, multiplying the number of current cases by R0 projects the number of new cases to be expected at the end of the gestation period. For instance, if there were 50,000 new cases of the initial strain of COVID in a population that had never been inoculated, in two weeks one would expect  100,000 to 150,000 new cases. This is exactly the transmission pattern that the pandemic followed last year.

As I have been following the data over the past few weeks, a disturbing pattern has seemed to emerge. The increase in the absolute number of cases on a weekly basis appears to be similar to what we witnessed last summer when COVID infections began to spike going into the autumn. 

How could this be happening when approximately half of all Americans have been vaccinated? If we are experiencing a resurgence shouldn’t the absolute number of new cases be cut in half?  Concerned about what I was seeing, I began researching further by calling various experts in this field.  That is when I discovered the Delta variant had a R0 of six, which is two to three times more transmissible than the initial COVID strain. This means that  in two weeks we should expect the number of new cases for the unvaccinated will be six times that which was observed in the current week. Since 50 percent of the population is not vaccinated, then the Delta variant’s R0 of six is effectively halved and we will have approximately the same number of new cases over the course of the coming months that we would have expected with the original variant if there is no intervention to slow its progression.

Given average daily new cases today of about 60,000, a level that is consistent with what we saw last October when we were deep into lockdown, the number of new cases is projected to be remarkably similar to last autumn. The data are telling us that within six to eight weeks we should see new cases higher than 200,000, consistent with the peak of last December. 

Déjà Vu in the Trajectory of COVID Cases

Source: Guggenheim Investments, Bloomberg. Data as of 7.26.2021.

Today, of course, we have circumstances that many believe will mitigate this outcome. The breakthrough rate of infection is quite low for those who have been vaccinated and those who have the antibodies from having already caught the virus. But we would need to increase the vaccination rate in order to gain further benefits from this condition.

We also know a lot more today about containment measures than we did in early 2020, and we are seeing mask mandates being re-imposed. The Centers for Disease Control and Prevention (CDC) recommended on July 27 that Americans wear masks indoors again, particularly in areas where virus transmission is high, such as in the South and in Southwest states like Arizona, Nevada, Utah, and Wyoming. Cities like Los Angeles and St. Louis are also bringing back mask mandates. Unfortunately, these new mandates are recommended in areas that are probably least likely to follow them.

Given uneven distribution of vaccination rates across the country, the path of the Delta variant will differ by region. The low vax regions, which tend to be areas that make smaller contributions to economic output, like Arkansas and other parts of the South, are seeing a faster rise in cases than high vax regions.

No Matter Where You Live, the Trend Is Not Your Friend

U.S. Daily New Cases Per Million People, 7-Day Moving Average

Source: Guggenheim Investments, Bloomberg. Data as of 7.26.2021.

But even the regions that make larger contributions to economic output, like California, Florida, and Texas, have vaccination rates that are approximately the national average of 50 percent, and they are already sounding the alarm about the rise in cases. For instance, new cases in the state of Florida are at record highs, exceeding the peak of the past year despite having a 50 percent vaccination rate.

COVID Cases Spike in Florida

Florida Daily Hospital Admissions Among 18–39 Year-Olds 7-day average

Source: U.S. Department of Health & Human Services. Data as of 7.24.2021.

There are a few other things that are different this go-around. Policymakers are scared to death that introducing more aggressive containment measures could lead to a full-blown bear market like last March, when risk assets collapsed and credit markets seized up. Therefore investors should expect more support out of Washington, including fiscal stimulus if necessary and a delay in tapering or any monetary tightening on the part of the Federal Reserve. Additionally, the $2.6 trillion increase in savings since the pandemic started should provide a buffer to consumption, as well as help support equity prices even as the Delta variant data turn more negative.

Thinking back to February 2020, when I first started to study the transmissibility of coronavirus, the data scared me. But just as frightening was the cognitive dissonance that prevailed in the markets. People just could not believe that something as bad as a pandemic could possibly happen. Credit spreads were tight and risk assets were priced to perfection, but everywhere you looked there were red flags. Even as I was sounding an alarm on CNBC, the S&P 500 was making a new high.

The cognitive dissonance that we were living with in the winter of 2020 is similar to that of today. Now the risk is that with another surge in new COVID cases, policymakers will either react to it quickly and lock down the economy, or they will not react to it and lock down the economy after the situation is more dire. For the time being, hope appears to be the operative strategy. In all likelihood the reaction function that would keep the Delta variant breakout from turning into something that could become a serious economic problem is not good.

I could be wrong about the outcome, but  if people start to move beyond cognitive dissonance and transition to panic or even simply risk reduction, at current extreme valuations risk assets are in trouble.

The potential resurgence of the pandemic is happening during  a seasonally weak period for risk assets. This increases the probability of downside risk.

Traditionally, August through October are  the worst months for stock market performance, jobless claims are somewhat higher than we were expecting, economic activity like the services PMI is generally slightly lower than we were expecting, and second quarter Gross Domestic Product (GDP) came in below consensus. Normally these data points would not be something that would cause a great deal of concern in terms of the strength and durability of the expansion, but in light of the other data, this could actually be the slow erosion that begins the process of economic deceleration.

At this incipient stage of the spread of the Delta variant and slowing of economic growth, there are enough red flags that prudent investors have to start considering de-risking. Even if the outcome is not as severe as last year, we still can expect significant volatility in the weeks and months ahead as the market prices in a rising level of uncertainty. With the likelihood that COVID will once again adversely affect economic activity, risk assets look extremely vulnerable against this economic backdrop.

The potentially good news is that August traditionally is associated with declines in long-term rates. Our longstanding view that 10-year Treasury rates could continue to decline to 65 basis points or even lower, may prove more prescient than is commonly believed.

Once again we find ourselves outside of the consensus opinion. I fully expect to hear the cat calls and criticism in the coming days, but we have a higher duty to our clients than the fear of public opinion and that is honesty. 
All in all, as far as markets and the economy are concerned, “Things couldn’t be better.” If that’s the case, I guess it’s probably time to sell! 

A liberal judge in Arkansas has ordered the state to resume federal pandemic unemployment benefits just one month after they expired, in yet another glaring example of why there’s a huge gap in unemployment claims between red and blue states (despite Arkansas being a red state).

On Wednesday, Pulaski County Circuit Judge Herbert Wright issued a preliminary injunction so the state can resume participation if the government will “agree to permit the State to do so.”

“If the appropriate federal authorities reject such a reinstatement, the State will immediately provide proof of such communication to the Court,” said Wright.

The decision stems from a lawsuit filed last Friday on behalf of five citizens seeking to enjoin the state from ending pandemic-related unemployment programs, which provided an extra $300 per week on top of state unemployment benefits which average $338 per week. The combined $638 average weekly income is the equivalent of $15.95 per hour for someone working a 40-hour work week, according to the NY Post.

In May, Arkansas Gov. Asa Hutchinson (R) announced that the state would end its participation in the unemployment programs on June 26 – which Hutchinson rightly claimed ‘actually interferes‘ with the ability to fill more than 40,000 vacant jobs in the state. There are some 69,000 unemployed Arkansans.

The plaintiffs in the lawsuit argue that Hutchinson lacked the legal authority to end the state’s participation in the program – which Wright acknowledged was voluntary, but he had “serious doubts that the Governor and the Director of Workforce Services were acting within the scope of their duties” when they canceled the aid.

“Thanks to the ruling, people will now be able to get benefits to help them pay the rent, keep their lights on, have enough food to eat, and see the doctor while they continue their job searches,” said Kevin De Liban, Legal Aid of Arkansas’s director of advocacy.

Half of all US states, largely run by Republicans, have announced plans to end federal unemployment benefits amid massive job shortages.

As the New York Post notes, ‘A recent poll by Morning Consult found that more than 1.8 million unemployed Americans have turned down jobs throughout the pandemic due to the generosity of the unemployment benefits. Of the 5,000 surveyed who were actively collecting the benefits, 29 percent said they turned down job offers, according to the poll.‘

By Michael Every of Rabobank

Big, Bigger,…East India Company

Q2 US GDP was a shocker at just 6.5% q/q annualised vs. 8.5% expected. That was little changed from 6.2% in Q1, when the US hadn’t yet ‘beaten Covid’, and so was a jab to markets expecting jabs to have delivered more. The details can be sliced and diced this way and that and will be revised endlessly, more so given the extraordinary times and that some of the data was probably literally phoned in. Nonetheless, the picture is that without the huge fiscal transfer from the public to the private sector, allowing for personal consumption to be up 11.8% q/q annualized like Q1’s 11.4% print before it, the US economy would have been even weaker. It certainly was not a GDP report that showed any sign of private investment rebounding: not in a V-shape “Roaring 20’s” fashion –remember that idiotic meme, if taken without any historic irony, from all of 6-7 months ago?– nor even to a “rubbish pre-Covid New Normal” – and remember that meme? The last four quarters’ figures for real private sector fixed investment are, starting in Q3 2020, now: 27.5%, 17.7%, 13.0%, and just 3.0%. Where next?

On which note, it appears we are no closer to any fiscal stimulus – or at least that’s the market’s view given 10-year US yields are this morning at 1.27%. Indeed, ‘all of a sudden’ the US debt ceiling looms as a possible fiscal cliff, the complete opposite of the reflation story that pushed up yields in Q1. Further, a White House press conference yesterday left the rhetorical door open to renewed lockdowns if the science (i.e., the CDC) demands it, which is obviously not good for business confidence. Moreover, largely unheralded by the financial media because this kind of thing only happens to other people, the eviction moratorium ends at the end of this month – and a Supreme Court ruling means only action from Congress, not an executive order, will extended it further. Millions of people could be about to lose their homes: do the math on what that means for the economy and, more importantly, for an already bitterly-polarised US society.

While reiterating that this is not an equity Daily, also a shocker to markets –says Bloomberg– were earnings at Amazon, its stock falling 6% as a result, the equivalent of an entire fleet of priapic rocket-ships. That is the headline this morning in Asia, not the hours ticking down to mass US evictions,…unless the two are conflated, and disappointing sales projections for Q3 are due to the fact that lots of customers will not be able to get stuff delivered to “Skid Row”. Please don’t mistake the tone here for flippancy – it should be taken as urgency.

Regular readers know this Daily has never been short on comment about how failing and flailing our global systemic architecture is, despite the rictus smiles we get from the top of it. When even the corporate behemoths our system creates are perhaps being dragged down by its internal contradiction of a lack of final demand, that criticism might become a little more obvious. Full Marx to those who spotted it in advance. But what am I saying? There can always be more QE, right? And QE will obviously stabilize everything,…right? Would you want to bet against the broader market mirroring these thoughts?

On which note, I want to embark on a little voyage with you. First to Europe, where ECB executive board member Panetta has stated: “cinema-lovers, from now on when inflation falls below 2% our monetary policy should take inspiration from ‘Pirates of the Caribbean’, even if some would prefer ‘Sleeping Beauty’.” Was the ECB implying it would act like a drunken pirate with more luck than knowledge? Presuming he meant the first movie, maybe he was referring to a cursed gold standard – but that would imply less QE as well as no fiscal stimulus. So perhaps the message was just “Welcome to Caribbean, love!” – which markets happily echo…until there is no more rum. But on we sail, me hearties, as rum we have a-plenty. For the Americas, with a fair wind at our backs!

The first Pirates film featured the East India Company (EIC), a monopolistic, mercantilist body set up in 1600 to loot and colonize Asia for the British, and which ruled India from 1757-1858, when Queen Victoria decided to do it as Empress. (NB They are the baddies.) Branko Milanovic recently wrote an article asking if Norway is the new EIC. I want to ask a simpler question: how much bigger can big US firms get before they end up stumbling into roles that replicate the EIC experience? I am serious even if *not* talking about colonization or selling opium at gunpoint.

Assume Generic Big Tech Firm (GBTF) keeps growing market cap at 11.2% a year, and the US economy grows 4% in nominal terms (2% real GDP, 2% CPI) to keep the math simple. In that scenario, GBTF doubles its market cap relative to GDP by 2031; again by 2041; and again by 2051. Wall Street/Tech Bro eyes turn green, because who doesn’t like an exponential? Amazon’s market cap is $1.8 trillion, which is 8% of the US. Project that at 16%; 32%; 64%, etc. By 2061, the selection of the CEO of GBTF would be a political event to eclipse that of US president. Or could we see the government merge, in neoliberal fashion – which is how the EIC operated? Here’s another historical snippet: in 1915, diplomat Kurt Riezler proposed to Chancellor Bethmann-Hollweg to make the German Empire into a joint-stock company in which Prussia would hold a majority stake.

Meanwhile, we sail for China. After this week’s hoo-ha over regulatory crackdowns, the Wall Street Journal reports the message to state banks from Beijing is now: “That thing about destroying swathes of the private sector, and stopping US IPOs, and massive political risk? So we didn’t mean it.” Which is reassuring to some. Others are post hoc ergo propter hoc arguing that if you read Xi Jinping’s speeches, he made clear years ago that such crackdowns were inevitable: to which one may ask “What else has been said in said speeches?” Clearly, however, Beijing can project forward using the Rule of 72 and recognize what it means about who rules. Perhaps the US can too, via the July anti-trust executive order? That remains to be seen, mateys. And even more than fleets of priapic rocket-ships are at stake.

Allow me to conclude this week and this month by noting that in his piece, Milanovic quotes a gem from Adam Smith I have also used before, talking specifically about the EIC: “The government of an exclusive company of merchants is, perhaps, the worst of all governments for any country whatever.” But boy, looking around us globally, is there some tough market competition.

Happy Friday!

While most economists were keenly focused on today’s core PCE data in the Personal Income and Spending data, we were far more interested in the spending power left inside the dynamo that is responsible for 70% of US GDP: the US consumer. And unfortunately, there is very little left.

For much of the post-covid recovery period, the most bullish narrative was that the trillions in excess savings (the number $2.5 trillion had been generously thrown about) resulting from the trillions in Biden stimmy checks which Americans ‘prudently’ saved would provide a long enough runway to allow US consumers to offset transitory surging prices with money they had saved up.

There is just one problem: according to the latest data from the BEA, excess savings are almost gone. In fact, as of June, there were just $1.7 trillion in annualized personal savings, a huge drop from the $2.5 trillion average observed for much of the post-covid period when Savings peaked predictable after the 1st, 2nd and 3rd stimulus hit America’s checking accounts. Alas, almost all of that is now gone, and as of the latest data, US consumers have just 30% more savings – or about $400 billion – compared to the pre-covid level of $1. 3 trillion.

Worse, at the current rate that Americans are burning through savings, this means that the entire fiscal stimulus tailwind from Biden’s trillions will be gone by August… just in time for emergency unemployment benefits to end.

This is the worst possible outcome for the US economy because it means that US consumers will be hit by surging rent inflation and commodity pass through costs as well…

… at the end of 2021 and start of 2022, just as they realize they have spent all of their savings accumulated during the covid period, leading to a stagflationary spending depression, as the economy reverses even as prices continue to rise.

And the funniest thing: career economists may not understand any of this (until it is too late), but consumers sure do: as today’s University of Michigan consumer sentiment report showed, spending intentions on houses, vars and large household durable goods has crashed to the lowest level since the soaring inflation of the early 1980s forced Volcker to hike rates to 20%.

There is just one event that could short circuit what appears to be a near-certain recession heading into 2022 and mid-term elections which would be devastating for Democrats faced with an imploding economy: another multi-trillion stimulus, just enough to kick the can by another 4-6 months. But for that to happen, the US economy needs to be shut down again which will only happen only once there is enough covid Delta-variant fearmongering. Which should also explain everything that’s happening right now.

Authored by Isabel van Brugen via The Epoch Times,

Attorney General Merrick Garland on Thursday warned Texas Gov. Greg Abbott to “immediately rescind” a new executive order aimed at restricting the ground transportation of illegal aliens detained by Customs and Border Protection (CBP) agents who may pose a risk of transmitting COVID-19.

“The order violates federal law in numerous respects, and Texas cannot lawfully enforce the executive order against any federal official or private parties working with the United States,” Garland told the Republican governor in a letter.

Garland warned that the Department of Justice (DOJ) will “pursue all appropriate legal remedies” if the Lone Star state refuses to rescind Executive Order GA-37, which he described as “both dangerous and unlawful.”

“In short, the order is contrary to federal law and cannot be enforced,” Garland wrote.

“I urge you to immediately rescind the order.”

The AG’s letter comes just one day after Abbott signed the executive order, which cites a surge in CCP (Chinese Communist Party) virus infections in Texas as the reason for the restriction.

“The dramatic rise in unlawful border crossings has also led to a dramatic rise in COVID-19 cases among unlawful migrants who have made their way into our state, and we must do more to protect Texans from this virus and reduce the burden on our communities,” Abbott, a Republican, said in a statement in issuing his order on Wednesday.

“This executive order will reduce the risk of COVID-19 exposure in our communities,” he said.

A group of more than 350 illegal immigrants waits for Border Patrol after crossing the Rio Grande from Mexico into Del Rio, Texas, on July 25, 2021. (Charlotte Cuthbertson/The Epoch Times)

The order prohibits anyone other than a federal, state, or local official from transporting migrants detained by CBP for crossing the border illegally, who are subject to expulsion under the federal Title 42 order.

Hitting back against Garland’s letter, Abbott said in a statement that the Biden administration “fundamentally misunderstands what is truly happening at the Texas-Mexico border.”

“The current crisis at our southern border, including the overcrowding of immigration facilities and the devastating spread of COVID-19 that the influx of non-citizens is causing, is entirely the creation of the Biden Administration and its failed immigration policies,” the governor added.

“And it is increasingly a matter of grave public-health concern as unlawful migrants enter from countries with lower vaccination rates than the United States.”

Border Patrol agents are apprehending an average of 6,300 illegal immigrants daily along the southern border. Texas is home to the busiest border sector for illegal crossings. Border Patrol agents detained 20,000 illegal immigrants in one week in late July in the Rio Grande Valley sector.

Republicans have blamed Biden’s rollback of Trump-era policies for fueling the border surge, which they insist is a crisis, while members of the administration have sought to portray the spike in illegal crossings as a challenge, driven in part by seasonal factors.

After posting its most recent earnings “beat”, Tesla is taking on two starkly different strategies for its U.S. and its China business. 

In the United States, the automaker is raising prices in an attempt to boost profit margins, while in China it is keeping prices steady in what is likely an attempt to drum up more demand, Reuters reported. 

So far, Tesla has raised the price of its Model 3 and Model Y “about a dozen times” in the U.S. this year, the report notes. At the same time, the company also introduced an affordable version of its Model Y in China.

Tesla isn’t just facing increased scrutiny in China from its citizens and the government, but is also running face-first into a wall of Chinese EV competitors. 

Toni Sacconaghi of Bernstein has questioned demand in China as a result of the introduction of the lower priced Model Y. He has said that the model “may make sustained margin improvement difficult”. Chinese owners were “were less enthusiastic and had lower repurchase intentions than owners in the United States and Europe,” a Bernstein survey recently showed.

Meanwhile in the U.S., Tesla continues to raise the price of its Model Y long range, which is now priced at $53,990. In China, the more affordable Model Y is priced at $42,394.

Roth Capital Partners analyst Craig Irwin told Reuters: “I think Tesla is looking to be as competitive as it can be in China. Lower prices will be a part of that aggressive market positioning. There is a very large difference in battery prices in the U.S. and China, as well as local vehicle manufacturing costs.”

Hargreaves Lansdown analyst Nicholas Hyett added: “It wasn’t so long ago that the group was trimming prices in the U.S. to gain scale and maximize profitability, and it feels like we’re now seeing that in China too.”

Gene Munster at Loup Ventures attests that the lower prices in China could “have a lasting effect” for the company in the country: “Teslas are on average 3x the cost of a typical EV made in China so they have to be priced less than the U.S. to compete. Prices of Teslas in China will be below (the) rest of the world for the next decade.”

Tesla’s market share in China has fallen to 11% in the battery electric vehicle market. China makes up 44% of the global EV market. 

 

 

 

Authored by Lance Roberts via RealInvestmentAdvice.com,

In a recent interview with Business Insider, Paul Krugman’s delusion was evident as the difference between economic theory and reality was on full display.

However, such is always the difference between economists who spent their lives in the “ivory towers” of academia instead of those who created businesses, jobs, and prosperity.

While many economists attempt to make economic theory a science, it is still a function of human psychology and behaviors. For example, the theory is that if the price of beef rises too much, consumers will switch to chicken. However, in practice, individuals often make other choices instead.

Most economists, Krugman included, believe the economy is about to come roaring back to life with economic growth rates that will surpass anything seen in this current century. Such may well indeed be the case momentarily as massive stimulus and spending flow through the system. However, what happens then?

After 12-years of monetary interventions, we now have plenty of evidence to determine if Paul’s view of the world is indeed what he claims it be.

Wages Will Recovery With The Economy

“So there’s basically not much of a downside to having a very rapid economic recovery. If you’re an ordinary American, you can say, ‘look, the odds are that by this time next year, jobs will be plentiful, things will be looking pretty good. Inflation might be a bit higher, but your income will be more than keeping up with it.’” – Paul Krugman

It is correct there will be inflationary pressures if we indeed do have a rapid economic recovery. However, Krugman’s mistake is in stating that wages for “ordinary Americans” will rise commensurately. Since 2007, the inflation-adjusted wage growth for the bottom 80% of Americans has not grown.

We can look at the wage growth of the bottom 80%, compared to economic growth, and see that wage growth has not come close to keeping up with economic growth.

Furthermore, since 1990, wage growth has failed to keep up with the rising cost of the standard of living for the bottom 80% of Americans. The chart below shows the gap between wages, savings, and living costs through the end of 2020. It requires roughly $4000 in debt annually to “fill the gap” between incomes, savings, and the cost of living.

Given that it takes a “full-time” job to support a family, it is increasingly difficult to look at the chart below and suggest that we are anywhere near full employment.

Of course, when Government Transfers make up more than 40% of real disposable incomes, it only further undermines Krugman’s view of American prosperity.

Interestingly, given all government spending was done through debts and deficits, Krugman sees no evidence of any problems.

No, Debt Is A Problem

“We’ve learned two lessons from the past dozen years. The U.S. economy can in fact run a lot hotter than we thought. It is, in fact, okay to have nice things. We can have full employment and it doesn’t mean that that hyperinflation is around the corner. And, the debt doesn’t seem to be a problem at anything near current levels.”

As noted above, we haven’t seen anything close to true “full employment” since Bill Clinton was President. But such also corresponds with the tipping point to where debts and deficits became corrosive to economic growth. As shown, despite continued increases in debt, economic growth has continued to deteriorate, the wealth gap widened, and the calls for socialism rose.

I am not sure how Krugman can conclude that debt at current levels has no consequence. Such is particularly an issue where it now takes more than $5 in debt to create $1 of economic growth.

As we discussed in “Sugar Rush:”

“While the economy may have ‘appeared’ to grow during this period, economic growth would have been ‘negative’ without debt increases. The chart below shows what economic growth would be without the increases in Federal debt.”

Such is why, after more than a decade of monetary and fiscal interventions totaling more than $43 Trillion and counting, the economy remains on “life support.”

(It required roughly $12 in support to generate $1 of economic growth.)

While the claims of a robust economy rely heavily upon a surge in consumer spending, as noted above, it is a mirage of the increase in “social benefits.”

No Historical Evidence

“I’m worried that they’re excessively paid for. In principle, they’re supposed to be fully paid for. But take what we knew about the economy in 2019. We were really kind of in secular-stagnation land with low neutral real rates. We had full employment then, it was only thanks to extremely low interest rates and persistent deficit spending. What the doctor ordered is some sustained moderate deficit spending.”

Uhm…we did that.

After 12-years of “Zero Interest Rate Policies,” and successive rounds of trillions of dollars in monetary interventions, there has been little to show for it.

The only thing we can attribute to 12-years of the most progressive and aggressive monetary experiments in history is a massive surge in the “wealth gap.” The top 10% of income earners own ~90% of the entirety of equity assets.

I am not sure that doing more of the same is going to generate a different result.

Pulling Forward Consumption Isn’t Sustainable.

The problems that both Keynesian and Modern Monetary Theories run into is three-fold:

1. Debts and deficits have an economically negative impact longer-term.

2. Low-interest rates do not promote economic activity but actually detracts from it due to a lack of incentives.

3. Providing short-term incentives does not increase productive economic activity.

The “trap’ that economists, along with the Fed, have fallen into is that “stimulus” only pulls forward “future consumption.” Yet, as we saw after the initial CARES act, as soon as financial supports evaporated, so did economic growth.

The hope over the last decade was the economy would eventually “catch fire” and grow organically. Such would allow Central Banks to reverse monetary supports. However, such has never occurred. Each time Central Banks reduce monetary supports, the economy stalls or worse.

After 12-years it is clear “something has gone wrong.” Despite perennial hopes of “higher growth rates,” such has not been the case. Instead, the only thing that has grown is the debt and deficits which continue to erode economic solvency.

While the U.S. economy will indeed exit the recession in 2021, it may be a statistical result rather than an economic recovery leading to broader prosperity.

The most significant risk of the latest stimulus package is a surge in inflationary pressures, undermining the stimulus’s benefit. That concern will manifest itself as a stagflationary environment where wages remain suppressed while costs of living rise.

Due to the debt, demographics, and monetary and fiscal policy failures, the long-term economic growth rate will run well below long-term trends. Such will only continue to widen the wealth gap, increase welfare dependency, and socialism usurping the “golden goose” of capitalism.