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Authored by Peter Cook via RealInvestmentAdvice.com,

Most people are aware that GDP growth has been lower than expected in the aftermath of the Global Financial Crisis of 2008 (GFC).  For example, real GDP growth for the past decade has been closer to 1.5% than the 3% experienced in the 50 years prior to 2008.  As a result of the combination of slow economic growth and deficit spending, most people are also aware that the debt/GDP ratio has been rising.

However, what most people don’t know is that, over the past ten years, the dollar amount of cumulative government deficit spending exceeded the dollar amount of GDP growth.  Put another way, in the absence of deficit spending, GDP growth would have been less than zero for the past decade.  Could that be true?

Let’s begin with a shocking chart that confirms the statements above, and begins to answer the question.  The black line shows the difference between quarterly GDP growth and the quarterly increase in Treasury debt outstanding (TDO).  When the black line is above zero (red dotted line), the dollar amount is GDP is growing faster than the increase in TDO.  From 1971 to 2008, the amount of GDP typically grew at a faster rate than the increase in TDO, which is why the black line is generally above the red dotted line.

Chart 1

During the 1971-2008 period, inflation, budget deficits, and trade deficits varied widely, meaning that the relationship between GDP growth and TDO was stable even in the face of changes in other economic variables. Regardless of those changing economic variables, the US economy tended to grow at a pace faster than TDO for four decades.  The only interruptions to the pattern occurred during recessions of the early 1980s, early 1990s, and early 2000s when GDP fell while budget deficits did not.

The pattern of GDP growth exceeding TDO changed after 2008, which is why the black line is consistently below the red dotted line after 2008.  A change in a previously-stable relationship is known as a “regime change.”  Focusing first on 2008-2012, the increase in TDO far exceeded GDP growth, due to an unprecedented amount of deficit spending compared to historical norms.  Focusing next on 2013-2017, the blue line has been closer to the red dotted line, meaning that the dollar amount of GDP growth was roughly equal to TDO.

If the pattern of the past was in effect, the black line should have been far above the red dotted line for most of the entire period of 2009-2017, because it would be expected that a recovering economy would have produced an excess of GDP growth over TDO.  But that didn’t happen.  This article will not speculate on why there was a regime change.  Instead, this article is focused strictly on identifying that a regime change occurred, and that few people recognize the importance of the regime change, which is probably why it persists.

Taking a quick detour into the simple math of GDP accounting, the level of GDP is calculated by adding up all forms of spending:

GDP = C + I + G + X

In the equation above, C is consumer spending; I is investment spending by corporations; G is government spending; and X is net exports (because the US has become such a heavy net importer, X has been a subtraction from GDP since 2000).

For context, at the end of 2017, the level of US GDP was $19.74 trillion, per the Bureau of Economic Analysis (BEA).  Of that $19.74 trillion, the Congressional Budget Office (CBO) calculated that the US government spent $3.98 trillion, all of which counts toward GDP. In 2017 the government borrowed $516 billion, meaning that the government spent more than it received via taxes and other sources.  The main insight in understanding how the government calculates GDP is that all government spending counts as a positive for GDP, regardless of whether that spending is financed by tax collections or issuing debt.

Because deficit spending is additive in the calculation of GDP, it makes sense to compare the amount of deficit spending to the amount of GDP growth produced each year. The first four columns in the table below show the annual GDP, the annual dollar change of GDP, the total amount of Treasury debt outstanding (TDO) and the annual dollar change of TDO.  Comparing the second and fourth columns, it is easy to see that the annual increases in TDO regularly exceed the increases in GDP.

Chart 2

The final column to the right shows the increase in TDO as a percentage of the annual change in GDP growth.  When the ratio is greater than 100%, the increase in TDO is responsible for more than 100% of annual GDP growth.  Reinforcing the message of Chart 1, the annual increase in TDO exceeded annual GDP growth in each of the years from 2008-2016. The only year in which annual GDP growth was greater than the increase in TDO was in 2017, possibly due to the debt ceiling caps, which have now been lifted.

The cumulative figures are even more disturbing.  From 2008-2017, GDP grew by $5.051 trillion, from $14.55 trillion to $19.74 trillion.  During that same period, the increase in TDO totaled $11.26 trillion.  In other words, for each dollar of deficit spending, the economy grew by less than 50 cents.  Or, put another way, had the federal government not borrowed and spent the $11.263 trillion, GDP today would be significantly smaller than it is.

It is possible to transform Chart 1, which shows annual changes in TDO and GDP from 1970-2017, into Chart 3 below, which shows the cumulative difference between the growth of TDO and GDP over the entire period from 1970-2017. The graph below clearly shows the abrupt regime change that occurred in the aftermath of the GFC.  A period in which growth in GDP growth exceeded increases in TDO has been replaced by a period in which increases in TDO exceeded GDP growth.

Chart 3

Unfortunately, extending the analysis forward tells us the problem will only get worse.

Chart 4

Over the entire period from 2008 to 2021, the increase in TDO will exceed GDP growth by $7.531 trillion ($15.843 trillion of TDO compared to $8.312 trillion of GDP growth).  While most people would accept that deficit spending is required for short periods to offset economic disturbances, even John Maynard Keynes wouldn’t expect it to become the norm.  Nor would he expect that a dollar of deficit spending would produce less than a dollar of GDP growth.

Investment and Policy Implications

The purpose of this article is to clarify the changing relationship between the dollar amounts of GDP growth and budget deficits, which are funded by TDO.  If indeed GDP growth has become reliant on budget deficits post-2008, there are many implications for investment policies across all asset classes. For example, might poor organic growth in the private sector explain the unexpectedly-low inflation environment and historically-low capital investment?  If so, what are the implications for stocks and bonds?

Also, government policy should acknowledge the regime change and adapt policies accordingly. If massive deficit spending is required to produce a “positive” sign for GDP growth, is it possible that the private sector of the economy is not growing but shrinking?  Is the private sector’s health now completely reliant on continued government deficits?  If so, is there a limit to the government’s ability to run deficits by issuing bonds?  If a dollar of increase in debt leads to less than a dollar of GDP growth, should the US continue to borrow?  Should the Fed raise rates because of increased fiscal stimulus if the link between deficit spending, GDP growth, and inflation has experienced a regime change?  Can any economic theory explain what is going on?

These questions will be addressed in upcoming articles.

Conclusions

• All government spending boosts GDP calculations, regardless of whether government spending is financed by tax collections or deficits financed by debt issuance.

• Isolating the interaction between increases in TDO and the dollar amount of GDP growth, the data show a regime change post-2008 compared to the period 1971-2007.

• In the period 1971-2007, the dollar amount of GDP growth exceeded increases in TDO except in years in which the economy was in recession.

• In the period 2008-2017, annual increases in TDO regularly exceeded the dollar amount of GDP growth, which remarkably occurred during years that GDP was calculated to be growing.

• In the period 2008-2017, the cumulative increase in TDO was a multiple of cumulative GDP growth. The dollar amount of GDP growth was completely dependent on deficit spending.

• The efficiency of each dollar of deficit spending is declining, because the dollar amount of TDO is greater than the dollar amount of GDP growth.

• In the period 2018-2021, the increase in TDO will continue to exceed GDP growth, per forecasts made by the BEA and CBO. That is, GDP growth will be dependent on continued deficit spending.

• Importantly, if the economy slips into recession, it is possible TDO will grow at well over $2 trillion per year, meaning that the gap between TDO and GDP will get much larger.

* * *

“Peter Cook is the author of the ‘Is That True?’ series of articles, which help explain the many statements and theories circulating in the mainstream financial media often presented as “truths.” The motives and psychology of market participants, which drives the difference between truth and partial-truth, are explored.”

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We had been wondering for the past few months why SocGen, which last year was one of the most bullish banks, turned surprisingly sour on the S&P in late 2017 and early 2018 (here and here and any Albert Edwards note of course). We now may know the answer: Societe Generale has cut bonuses for its traders by as much as 25%.

According to Bloomberg, “the reduction in the bonus pool was communicated to the employees in recent weeks” which certainly did not boost morale, or the optimism of the bank’s strategists who earlier this week released a note titled simply “Bulls Beware” .

The sharp reduction in comp is not surprising: it comes amid a poor performance at the Paris-based lender’s trading activities, with revenue from fixed income, currencies and commodities falling about 7% to €515 million euros in Q4. And just like all of its peers from Goldman to Morgan Stanley, the bank cited “historically low volatility” and the reduced client activity as a reason for the underperformance.

What is odd, perhaps is that not more banks have done the same as SocGen which will now certainly suffer an exodus of its most profitable traders, who will get poached by Socgen’s better paying peers.

The bonus cuts also come after CEO Frederic Oudea warned comp would “follow the performance” of the trading activities, which while bad was hardly terrible.

SocGen is also battling overhangs from long-running regulatory probes; it is currently in talks to settle a US investigation into the alleged manipulation of the Libor interest rate, as well as a probe into accusations of bribery in Libya. Earlier this week, Deputy CEO Didier Valet left the company after a disagreement over a case that sees the bank accused of manipulating Libor, Bloomberg also reported.

* * * 

Meanwhile, as SocGen is slashing bonuses to punish its traders for being unable to navigate centrally planned markets in which nothing makes sense, Deutsche Bank – whose earnings were “abysmal” with a 29% plunge in Q4 FICC trading revenue – is rewarding them, and today announced it would boost 2017 bonuses four-fold to €2.2 despite posting its third annual loss in a row.

The increase in rising pay was disclosed in Deutsche’s 2017 annual report which was published on Friday morning, and reflects the lender’s decision to return to its “normal system of variable compensation” in 2017, after an 80% cut in bonuses to €500m in 2016, which also was expected considering Deutsche Bank’s stock hit record lows that year, sinking below the depths of the financial crisis.

The bank also announced that less than half of the 2017 bonuses will be deferred to future years.

Which is good news for those Deutsche Bank employees who were not fired: last month the bank announced the layoff of another 500 in its corporate and investment bank units. The German lender has also suffered a sharp drop in graduate hires, which fell by a quarter to just 619 people in 2017. The overall number of employees fell by 2.2% of 97,535.

Furthermore, not everyone will share in the bonanza: CEO John Cryan and the other members of the management board waived their variable pay. Still, total comp for the 12 most senior top executives at Deutsche still rose 13% to €29.2MM. Cryan, however, took a pay cut of €400,000 and earned €3.4m last year.

As the FT recalled, during DB’s annual press conference in February, Cryan went so far as to call the higher 2017 bonuses a “one-off investment” necessary “to secure our franchise and to strengthen our position in key sectors”, adding that “in the coming years, these kind of bonus payments will only be justified if the bank performs correspondingly”.

Sadly for its employees, SocGen did not quite share this view the relationship between variable comp and capex as one to one.

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In sleepy upstate New York, one small post-industrial city has adopted what’s widely believed to be the first bitcoin mining ban in the US. On Thursday evening, the city council in Plattsburgh New York voted unanimously to impose an 18-month moratorium on bitcoin mining, per Motherboard.

As we pointed out earlier this month, two large-scale bitcoin mining operations in the town had become a tremendous drain on the local utilities. This is a problem because,according to the Municipal Electric Utility Association, since the 1950s, the city is allotted a certain amount of inexpensive hydropower generated on the St. Lawrence River. Bitcoin miners are often drawn to areas with inexpensive hydro-power, like the Columbia River basin in the Pacific Northwest.

Mining is the extremely energy-intensive computational process that secures the Bitcoin blockchain and rewards miners with bitcoins, and increasingly, environmentalists are worried that the tremendous amount of energy required to power the bitcoin network could adversely impact the environment. Already, the bitcoin network uses more energy on a daily basis than many countries, including the Republic of Ireland…

The Bitcoin moratorium was proposed by Plattsburgh’s Mayor Colin Read earlier this month after local residents began reporting wildly inflated electricity bills. But unfortunately for residents, the moratorium affects only new commercial Bitcoin operations and will not affect companies that are already mining in the city.

“I’ve been hearing a lot of complaints that electric bills have gone up by $100 or $200,” Read said. “You can understand why people are upset.”

Thanks to a hydroelectric dam on the St. Lawrence River, Plattsburgh has some of the cheapest energy in the US – its mayor claims it’s among the cheapest electricity in the world.

To wit, residents pay only 4.5 cents per kilowatt-hour (the US average is a little over 10 cents). Industrial enterprises, including Bitcoin mines, pay even less, often just 2 cents per kilowatt-hour.

But there’s a catch: The problem is that Plattsburgh only has an allotment of 104 megawatt-hours of electricity per month. The biggest Bitcoin mining operation in Plattsburgh, operated by a Puerto Rican company called Coinmint, uses roughly 10% of the city’s total power budget.

The heavy power use forced city employees to purchase electricity on the open market in January at far higher prices. Those prices could be as high as 37 cents per kwh. That cost was distributed among city residents, with some paying between $100 and $200 more for their electricity that month. While this does occasionally happen during the frigid winter months, this year’s winter has been relatively mild.

“We could use 100 megawatts in two months’ time if we opened up the floodgates,” Read told Motherboard. “And then there would be no cheap power left for our residents. Some of the proposals we’ve been seeing, they want to take 20 or 30 megawatt bites of power, and we don’t have that.”

In the next 18 months, city officials promised to work with locals and newcomer miners to develop a solution. Read suggested a number of possible solutions, such as making miners pay for any overages, or increasing the rate for miners.

According to one miner, either of these arrangements would be welcomed by the mining community, which includes a few locals.

“It would never cost the Plattsburgh citizens any more money to let more miners come in here because the miners are willing to pay for those overages when it’s super cold,” Tom Pillsworth, a Plattsburgh local and partner at the second largest Bitcoin mine in the city, told Motherboard. “The miners are more than willing to pay.”

Now that China’s crackdown on miners has created an exodus to other parts of the world, clashes between locals and miners in areas where hydro-electricity makes power cheap are bound to become even more common. Case in point: Miners in one Washington State town near the Columbia River are waging a kind of guerilla war against locals over their power usage.

But perhaps the Plattsburgh solution will become a template to help the two sides equitably distributed electricity resources before miners are banned from the US, too.

* * *

The State of New York is already fighting back. Case in point: the New York Public Service Commission on Thursday took action to stop miners from taking advantage of the cheap hydroelectric power found in several places upstate, according to Bloomberg.

“If we hadn’t acted, existing residential and commercial customers in upstate communities served by a municipal power authority would see sharp increases in their utility bills,” Commission Chair John Rhodes said in a statement.

The agency is made up of 36 municipal power authorities in the state. In some cases, the miners, which require huge amounts of electricity for data processing, accounted for a third of a municipal utility’s demand, the commission said.

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Authored by Charles Hugh Smith via OfTwoMinds blog,

Alas, fakery isn’t actually a solution to fiscal/financial crisis…

This chart of “debt securities and loans”–i.e. total debt in the U.S. economy–is also a chart of the creation and distribution of new money, as the issuance of new debt is the mechanism in our financial system for creating (or “emitting” in economic jargon) new currency: when a bank issues a new home mortgage, for example, the loan amount is new currency created out of the magical air of fractional reserve banking.

Central banks also create new currency at will, and emitting newly created money is how they’ve bought $21 trillion in assets such as bonds, mortgages and stocks since 2009. Is there an easier way to push asset valuations higher than creating “money” out of thin air and using it to buy assets, regardless of the price? If there is an easier way, I haven’t heard of it.

Which brings us to the question: how much longer can we get away with this travesty of a mockery of a sham? How much longer can we get away with creating “money” by issuing new debt/liabilities to grease the consumption of more goods and services and the purchases of epic bubble-valuation assets?

Since humans are still using Wetware 1.0 (a.k.a. human nature), we can constructively refer to the Roman Empire’s experience with creating “money” with no intrinsic value. The reason why the Roman Empire (Western and Eastern) attracts such attention is 1) we have a fair amount of documentation for the period, something we don’t have for other successful empires such as the Incas, and 2) we’re fascinated by the decline and collapse of the Western Empire, a structure so vast and successful that collapse seemed impossible just a few decades before the final unraveling.

One of the books I’m currently enjoying is The Fate of Rome: Climate, Disease, and the End of an Empire, a new exploration of the impact of climate change and pandemics on the Roman Empire’s final few centuries.

The key takeaway is that climate change undermined the production of grain while the arrival of previously unknown diseases via trade routes stretching from Rome to China, India and the interior of Africa decimated the productive populace. Add in the rise of well-organized “barbarians” and the political instability born of a self-serving, ossified elite and voila, you have an excellent recipe for crisis.

Crises tend to reduce tax collections and increase government/Imperial costs, and this creates a fiscal/financial crisis. The Romans didn’t have a fiat currency that a central bank could create out of thin air, so they did the next best thing which was to replace their mostly-silver coinage with new base-metal coinage that had been washed in silver. That is, they debased/devalued their money, replacing coinage with an intrinsic value of silver with coinage with little to no intrinsic value.

They got away with this debasement/ devaluation for quite a few years, and so naturally they reckoned they could get away with it forever. But alas, debauching the currency is not a permanent solution to insolvency; it is a one-time trick that fools the market and populace for a time but soon enough people catch on and bad money drives out good money (Gresham’s law) as people hoarded the old silver coins and tried to trade the worthless new coins for anything but more worthless “money.”

In the present, we see this process at work in Venezuela, where the government has debauched the nation’s currency, the bolivar, to the point that inflation (i.e. loss of purchasing power) is running around 7,000% annually.

So how long can we get away with creating “money” out of thin air and using it to pump up asset prices? The Roman leaders who in desperation debased the Empire’s currency/coinage must have been chortling at the fast one they pulled on the Empire’s merchants, markets, farmers and soldiers, and we must forgive their avid willingness to believe that they could get away with it essentially forever.

Alas, fakery isn’t actually a solution to fiscal/financial crisis. At this moment in time, our “leadership” is basking in the hubris-soaked confidence that we can get away with it if not forever then for decades to come: we can borrow currency into existence in as many trillions as we desire, and inflation will remain dormant, consumption will remain robust and everyone will accept the debauched currency as having value.

Until they don’t. This is typically a sudden and unexpected event, as this chart of the exchange rate of the bolivar to the US dollar shows: the slide from 10 bolivars to the USD to 25 bolivars to one USD was gradual, but the implosion to 200,000 bolivars to the USD was frighteningly rapid.

No doubt the Romans said, “it can’t happen here”–but they were wrong.

*  *  *

My new book Money and Work Unchained is $9.95 for the Kindle ebook and $20 for the print edition.Read the first section for free in PDF format. If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.

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Stocks went into reverse this week…

All major US equity indices were lower this week (despite a late-day, OPEX-week, panic bid ramp)…

 

Chinese stocks were also broadly lower on the week…

 

Most of European majors were higher on the week, except UK’s FTSE…

 

*  *  *

Nasdaq underperformed notably on the day…Futures show the overnight dip when McMaster headlines hit… (NOTE – look at the idiotic panic bid, then puke into the close!!)

 

The Dow is back in the red for March…

 

The Dow managed to scramble back above its 50% retracement level today, but the jaws of the trendlines are closing in one way or the other…

 

Bank Stocks were all down on the week (led by a 3% drop in Citi) but of most note is the roundtrip from Friday’s payrolls spike…

 

VIX ended the week higher (but drifted lower the last couple of days into OPEX)…

 

Investors sold the short-end of the Treasury curve this week (2y Yield up 3bps) but the rest of the curve was bid (with some selling on Friday after IP beat)…

 

Breakevens fell notably on the week also…

 

While the yield curve steepened a little today, on the week it flattened dramatically to a fresh cycle (Oct 2007) low…the 12bps flattening in s2s30s is the 2nds biggest in 4 months…

 

The Dollar Index managed to scratch out its 4th weekly gain in a row (reversing as China’s new year holiday ended)…

 

The Russian Ruble fell notably – 2nd biggest weekly drop since July 2017…

 

The gains in the dollar weighed on gold, silver, and copper but crude snapped higher today (for no good reason), jumping into the green for the week…

 

Quite a stop-run in the energy complex…

 

Another ugly week for cryptos, though today saw brief buying-panic…

 

Finally, we note that Gold remains the only asset-class to have normalized post-Feb-Fiasco…

 

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Authored by Patrick Buchanan via Buchanan.org,

After the victory of Donald Trump in 2016, the GOP held the Senate and House, two-thirds of the governorships, and 1,000 more state legislators than they had on the day Barack Obama took office.

“The Republican Party has not been this dominant in 90 years,” went the exultant claim.

A year later, Republicans lost the governorship of Virginia and almost lost the legislature.

Came then the loss of a U.S. Senate seat in ruby-red Alabama.

Tuesday, Democrats captured a House seat in a Pennsylvania district Trump carried by 20 points, and where Democrats had not even fielded a candidate in 2014 and 2016.

Republicans lately congratulating themselves on a dominance not seen since 1928, might revisit what happened to the Class of 1928.

In 1930, Republicans lost 52 House seats, portending the loss of both houses of Congress and the White House in 1932 to FDR who would go on to win four straight terms. For the GOP, the ’30s were the dreadful decade.

Is the GOP staring at another 1930?

Perhaps.

Unlike 1930, though, the nation has not endured a Great Crash or gone through year one of a Great Depression where unemployment hit 10 percent in June, when the Smoot-Hawley tariff was passed.

Today, the economy is moving along smartly. The labor force is larger than it has ever been. Workers are re-entering and seeking jobs. Black and Hispanic unemployment are at record lows. Confidence is high. Our Great Recession is 10 years in the past.

The problem for Republicans may be found in a truism: When the economy is poor, the economy is the issue. When the economy is good, something else is the issue.

A good economy did not save the GOP in the 18th Congressional District of Pennsylvania, where the party’s tax cut was derided by Democrat Conor Lamb as a wealth transfer to the rich. Nor did Lamb hurt himself by implying Republicans were planning to pay for their tax cut by robbing Social Security and Medicare.

Republican candidate Rick Saccone reportedly stopped using the tax cut as his major issue in his TV ads that ran closest to Election Day.

Other factors point to a bad day for the GOP on Nov. 6.

Republican retirees from Congress far outnumber Democratic retirees.

Democratic turnout has been reaching record highs, while GOP turnout has been normal. And even in the special elections Democrats have lost, they are outperforming the Democrats who lost in 2016.

Relying upon hostility to Trump to bring out the resistance, savvy Democrats are taking on the political coloration of their districts and states, rather than of the national party of Hillary Clinton, Barack Obama and Bernie Sanders.

There is, however, troubling news from Pennsylvania for Nancy Pelosi.

Lamb promised voters of “Deerhunter” country he would not support San Francisco Nancy for speaker. Look for Democrats in districts Trump carried to begin talking of the “need for new leaders.”

Trump seems fated to be the primary target of attack this fall, and not only in districts Clinton carried. For an average of national polls shows that disapproval of his presidency is 14 points higher than his approval rating. And this is when the economy is turning up good numbers not seen in this century.

At the national level, Democrats will turn 2018 into a referendum on the Trump persona and Trump presidency. For while the Trump base is loyal and solid, the anti-Trump base is equally so, and appreciably larger.

Lest we forget, Hillary Clinton, not the most charismatic candidate the Democrats have put up in decades, beat Trump by nearly 3 million votes. And while Trump pierced the famous “blue wall” — the 18 states that voted Democratic in every presidential election between 1992 and 2012 — the demographic trend that created the wall is still working.

White voters, who tend to vote Republican, continue to decline as a share of the population. Peoples of color, who vote 70 to 90 percent Democratic in presidential elections, are now nearly 40 percent of the nation.

Mass migration into America is re-enforcing that trend.

Moreover, millennials, who have many elections ahead of them, are more liberal than seniors, who have fewer elections ahead and are the GOP base.

But if Republicans face problems of demography, the party of “tax and tax, spend and spend, and elect and elect” appears to be reaching the end of its tether. Federal deficits are rising toward trillion-dollar levels.

The five largest items in the budget — Social Security, Medicare, Medicaid, defense, interest on the debt — are rising inexorably. And there appears no disposition in either party to cut back on spending for education, college loans, food stamps, housing assistance or infrastructure.

If the Fed did not retain the power to control the money supply, then the fate of New Jersey and Illinois, and beyond, of Greece and Argentina, would become our national destiny.

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