The latest Contrary Investor Subscriber Report contains an interesting set of charts and commentary that shows just how misguided Fed and Obama administration focus on supporting consumption as the means to improve GDP.
Their analysis is always well written, so inquiring minds may wish to take a closer look.
I have permission to do occasional clips so please consider this clip from Looking For Love In All The Wrong Places?
Looking For Love In All The Wrong Places?…You are all very much aware of the change in market tone and sentiment over the last four months. Strategists and investors fretting over rapidly deteriorating macro leading economic indicators (remember the ECRI reaching levels always consistent with recession?) and contemplating the possibility of a double dip has given way to these same folks now trying to one up each other in putting forth ever higher domestic GDP growth estimates for the new year. Goldman (Jan Hatzius) has been a poster child example of this about face, but they have plenty of company. The transition is not hard to understand. With the heavy POMO started in September, followed up by QE2, and now the tax cut extension legislation that should add about $400 billion of “new” fiscal stimulus in 2011, we better have an improved outlook. Certainly THE issue as we move into 2011 is the potential for organic economic growth, or otherwise. Personally, we just can’t put a big “multiple” on marginal stimulus (read borrowed money) additions to macro near term economic expansion. But this issue will not become relevant until 2011 is well underway.
As we see it, one of the really big keys for economic and we believe ultimately financial market performance in the new year will be first, whether corporations spend their currently amassed “savings”. It’s more than well known that through both operations and borrowing in a generationally low interest rate environment, corporations are sitting on top of a boatload of cash at the moment. We’re already seeing the M&A; deals primarily in tech and health care sectors taking place. Secondly, again if QE2 is to be effective, corporations must spend their cash domestically, and not let that cash “leak” into foreign direct investment and/or capital markets. Preferably, corporations would spend their cash domestically on productive investment. Even we’ll admit, that would be bullish. And crazily enough, it would be in stark contrast to what we believe are the misguided policies of the Fed and US government over the last three years.
Right to the key point of this portion of the discussion that happens to be a question and will hopefully become clear as we look at a few longer term data points. Why has the Fed and Administration focused their monetary and fiscal policies virtually exclusively on consumption when it is productive investment that is the key to longer term sustainable economic health and ultimately growth?
The Fed and Administration are carrying out a failed longer term policy of focusing virtually exclusively on trying to stimulate consumption. Unless they change their ways, and fast, it will only be the corporate sector that can truly save the day for the longer term sustainable health of the US economy. Keep an open mind and let’s walk through a bit of history.
The top clip is self explanatory. You may also remember, and we will not drag you through it again, that US credit market debt relative to GDP began a three decade acceleration in the early 1980’s leading up to the recent peak of a generational credit cycle.
We believe the message of the combo chart above is as clear as a bell. As consumption became an ever larger piece of US GDP over time, the ten year rolling average of US GDP growth went into longer term rate of change decline.
The point is that debt financed consumption pressured the longer term growth rate of US GDP over time as consumption adds nothing back to the longer term infrastructure and productive capacity of the economy itself.
Now, remember that disposable income can either be consumed or saved. And it’s that very savings that ends up as productive economic investment over time. So next up is a look at the US savings rate relative to the 10 year rolling average of US GDP growth over the last half century. Notice anything? Of course you do.
From the late 1950’s through to the early 1980’s, the US savings rate reached ever higher highs, as exactly did the rolling ten year average of US GDP growth. But once the decline in the savings rate began, so did the decline in the longer term growth rate in US GDP. Directionally these two data points are twins.
Below we’re looking at the year over year change in nominal US GDP. About as simple as it gets. Alongside is the year over year change in non-residential US fixed investment. A very broad proxy for productive investment/corporate capital spending. These two data points are about as highly directionally correlated as they come. And what this clearly implies is that the longer term rhythm of the US economy is integrally tied to productive investment. Not consumption, but productive investment.
So stepping back just a bit, why have the Fed and Administration been focusing their efforts on consumption when it’s clear that productive investment is the driver of longer term US economic growth? Is it consumption that allows China to grow its economy at double digits, or productive investment? Again, we know there has been over investment in China and we have too much productive capacity globally for now, as this is really a story for another complete discussion. But China never could have “arisen” economically without an important investment in long lived productive assets. You know the fiscal remedies so far stateside. Cash for clunkers, home buyer tax credits, appliance purchase rebate credits, the recent one year drop in the employee side of payroll tax rates, etc. – every single initiative focuses on consumption as opposed to investment. Again, maybe we’ll look like nut balls before the current cycle is over, but Fed and Administration policies are not going to put the US on a longer term firm economic footing, especially within the context of a globalized economy. The US is not going to borrow and consume its way to prosperity. That only enriches the nations doing the actual production. We did that over the last thirty years and the rolling ten year US GDP growth report card is our reward.
Unfortunately, as opposed to supporting and encouraging this transition from reliance on consumption (in a still highly levered economy) to increasing focus on productive investment, the Fed and Administration are acting in contravention. They appear blind to the messages of history. We’re scratching our heads. To be honest, we have only one answer as to why this is happening, and we sound like conspiratorial maniacs when we voice it. Consumption favors the financial sector, especially if that consumption is even partially financed.
It’s simply out in the open these days that the Fed and Administration have done everything in their power to protect the financial sector in the US, even at the expense of the taxpayers and small business. The same thing is happening in Europe. Could it really be that this misguided and myopic focus on consumption as our current savior is simply an extension of that blanket of “protection” to the financial sector? Let’s hope not. Let’s just hope it’s ignorance, ok?
Explaining Fed Actions
The Fed is clearly beholden to the banks, especially large too-big-to-fail (TBTF) banks. Certainly the Fed may sound concerned about unemployment, but it’s safe to assume the Fed’s overriding concern is borrowers’ ability and willingness to pay back the banks.
History shows Bernanke’s idea of inflation targeting at 2% ignoring asset bubbles that build along the way is economically stupid. So why does he do it?
For the sake of argument and in deference to Occam’s Razor , let’s assume that all of the Fed’s mistakes are out of ignorance as opposed to some conspiracy by the Fed to transfer wealth to the financial sector. Simply put, never ignore stupidity when it is a plausible answer to why something happened.
Regardless of why, nothing changes from the perspective of the Bank CEO. The TBTF banks know full well they can take enormous economic risks, secure in the knowledge the Fed will bail them out if they get into trouble.
The latest twist is Citigroup’s chairman now brags that Citigroup is “Too Interwoven To Fail”. Please see 98 TARP Recipients Close To Failure; Citigroup’s Chairman Gives Reasons Citigroup Should Be Broken Up for details.
When profits are rising CEO and executive compensation soars. When the banks fail, taxpayers bail out the banks and shareholders take the hit. However, the CEO gets a golden parachute worth hundreds of millions of dollars. Thus, from the perspective of TBTF banks, the right thing to do is take enormous risks.
The same thing is happening in Canada right now. Please see Canadian Borrowing Gone Mad: A Look at BMO’s Misguided Balance Sheet Theory and the Keep on Dancin’ Market Share Theory of Toronto-Dominion for further discussion.
This process explains the massive boom bust cycles we have seen and how wealth gets increasingly concentrated into fewer and fewer hands over time.
Mike “Mish” Shedlock
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