Sunday, February 11, 2018

The Federal Reserve and Trump Intent on "Squeezing Blood from a Turnip"...Or Why Most Americans Are in a No Win Scenario

According to conventional economic wisdom, growth is the increase in the capacity and production of goods and services, compared from one period to another.  This view deems that the greater the growth in capacity and utilization of that capacity, the greater the economic growth.  Strangely, what this school of thought fails to account for is the basis of the US consumer economy...the quantity of growth among the US population (aka, consumers)?  Or how a population growing ever more slowly can consume a capacity that (thanks primarily to innovation, technology, and ever cheaper and greater debt) is allowing for ever greater production?

The chart below shows three variables from 1790 to present;
  1. Columns are US debt to GDP
  2. Black line is annual total US population growth (%)
  3. Yellow line is annual under 65yr/old US population growth (%)
Given the US is a nation of immigrants, the US has had a naturally high rate of population growth due to this net inflow of immigrants.  However, annual population growth has consistently decelerated from an annual growth rate of 3.1% in 1790 to just 0.6% in 2017 (an 80% deceleration, with all growth now dependent on immigration).  The substitution of more and cheaper debt (likewise corporately and personally) to maintain an unnaturally high rate of economic growth while population growth decelerated is plain.  Also noteworthy is the abandonment of the Bretton Woods agreement in 1971 and the simultaneous shift from net exporter to net importer at progressively higher levels.  ***BTW, the sharp waterfall in population growth in 1918 was tied to the global H1N1 influenza pandemic.However, gauging potential growth by the under 65yr/old population (yellow line in above chart), the organic basis of growth has nearly ceased (a 95% deceleration).  Why is the lack of under 65yr/old growth important?  Only this population is capable of child birth, this population makes up 90%+ of the work force, and this population (at its peak in earnings from 45 to 55yrs/old) earns and spends double the average 75+yr/old.  It is the under 65 population that utilizes credit while 65+yr/olds are credit averse (for good reason).  This is the segment that traditionally drives the economy but is now absent...and ever more and cheaper debt is the sad substitute.

The decelerating population and real wage growth coupled with accelerating trade deficits correlate nicely with the Federal Reserve interest rate cycles since 1981 (chart below tracks the duration in years and % rate from initiation of rate cuts to rate hike completion).  Each cycle has taken the cost of credit lower for longer and the subsequent rate hikes have been slower and shallower.  The implementation of ZIRP, the duration of ZIRP, and the most timid of rate hikes in the most recent cycle speaks to the ongoing deceleration of the growth among consumers alongside the truly dubious state of the American economy.And the chart below is a peek at just the hiking portion of each cycle since 1955.  Gauging the strength of each "recovery" from peak accommodation (in the most recent cycle, peak QE of $85 billion a month until January, 2014).  Since 1955 by the duration, pace, and total increase of the rate hikes...the most recent period is clearly nothing like any of its predecessors and questions the premise underlying the current recovery.
Concurrent to the implementation of the longer, lower, and slower workout from ZIRP...the Fed essentially sold $0.7 trillion in short duration debt and took on $4.4 trillion in mid and long term Treasury and MBS debt, the federal government drove deficit spending as a % of GDP to unprecedented post-war levels, resulting in a massive increase in federal debt outstanding and debt to GDP.  While the federal deficit (as a % of GDP) has presently been significantly reduced...the Fed's selling of its assets simultaneous to hiking rates with minimal deficit spending is far more than the tenuous post GFC cobbled system can handle.  Of course, Mr. Trump is doing everything in his power to rekindle deficit spending but even this will likely not be enough to avoid the next slowdown.
The US economy (70% driven by consumption) is facing the least population growth and smallest resultant growth in household formation in the nations history (chart below).  An economy so dependent on housing creation to drive its economic activity now reliant on the migration of rural young adults (and the resultant rural depopulation) into urban centers (in search of opportunity) to maintain the urban growth.A consumer driven economy with record low savings rates and sporting near record trade deficits will have the least potential organic growth in US history among the consuming population (and I explain HERE why population growth will only continue down).  The red line in the chart below shows the savings rate is back to record lows (what consumers have left to save or invest after expenses) versus record high household net worth (value of all assets; RE, stocks, bonds, etc.) as a percentage of disposable income (all sources of income remaining after taxation).
Now the White House is communicating that over the next decade that GDP will grow at 3% annually versus the sub 2% estimate from the CBO.  The WH assumes (in large part thanks to the recent tax cuts) America will grow at the same rate as the US did in the 1990's when total population growth (growth in consumers) was more than double what it currently is (and will be over the next decade)...but again, nearly all the existing current population growth is among the elderly as the under 65yr/old segment has decelerated to essentially zero.  The chart below shows real GDP versus total population growth and under 65yr/old population growth with White House and CBO future GDP estimates (luckily America has sworn off recessions indefinitely).  As for that "repatriation of overseas cash", Mish does a nice job summarizing why this is likely little more than myth (HERE) and why little to no investment boom is likely.

What is "growth"?  The chart below shows the annual change in gross domestic product after subtracting the annual federal deficit spending essentially included as part of that GDP figure.  The US hit peak growth in 2000, adding a half trillion in economic activity above and beyond the deficit spending incurred that year.  Since then, the wheels have fallen off and economic activity (subtracting the annual deficit incurred) has been spectacularly negative.  Said otherwise, there is no growth but the growth of debt.  And this takes no account of the far larger and more pernicious unfunded liabilities.

The above chart also shows estimates through 2025.  This is based on 2.5% annual GDP growth through 2025 (splitting the difference between WH versus the CBO's sub 2% GDP growth estimates) minus CBO annual deficit estimates.  However, the annual deficit estimates through 2025 show the CBO's baseline from June 2017...prior to the tax cuts and spiking interest payments.  The resultant updated deficits are likely to be double what is shown in the chart above.  And this assumes no recessions from 2009 through 2025...a period of "growth" unlike the nation has ever seen while the nations populace (consumptive force) grows at the lowest levels.

Of course there are a few winners but mostly losers from the creation of ever more debt.  As the chart below from the Fed's own Survey of Consumer Finances shows, all the record growth in household net worth has gone to the top 20% of income earners since 2007.  In the "best of times", the vast majority have only seen declining "wealth".  Asset holders are rewarded with skyrocketing valuations (absent merit) while wage earners are penalized with minimal wage growth opposite far faster rising costs of living.

Even in the happiest of scenarios, America will continue moving backward...while more realistically, America is almost sure to face economic, financial, and social calamity in the near term.  But this is not simply an American is truly global in its scope (detailed HERE).

Many noted when Trump was elected that his greatest asset may be his knowledge of bankruptcy and reorganization...and the time is coming soon (whether America recognizes this or not quite yet) where this skill set will be put to the test.

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