Starting-out note: there’s an investment idea in here eventually.
I’ve been going through Macroeconomics for Professionals: a Guide for Analysts and Those Who Need to Understand Them, written by two IMF professionals, with the intention of giving it, or something like it, to one of my children who’s getting more interested in stock market investing. I’m not finished with the book, but so far, so good.
counter-cyclical government policy
The initial chapter of MfP is about counter-cyclical government policy, a topic I think is especially important right now.
Picture an upward sloping sine curve. That’s a stylized version of the pattern of economic advance and contraction that market economies experience. Left to their own devices, the size of economic booms and subsequent depressions tend to be very large. The Great Depression of the 1930s that followed the Roaring Twenties–featuring a 25% drop in output in the US and a decade of unemployment that ranged between 14%-25%–is the prime example of this. National governments around the world made that situation worse with tariff wars and attempts to weaken their currencies to gain a trade advantage. A chief goal of post-WWII economics has been to avoid a recurrence of this tragedy.
The general idea is counter-cyclical government policy, meaning to slow economic growth when a country is expanding at a rate higher than its long-term potential (about 2% in the US) and to stimulate growth when expansion falls below potential.
applying theory in today’s Washington
Entering the ninth year of economic expansion–and with the economy already growing at potential–Washington, which had provided no fiscal stimulus in 2009 when it was desperately needed, decided to give the economy a boost with a large tax cut. Although pitched as a reform, with lower rates offset by the elimination of special interest tax breaks, none of the latter happened. Then, just a few days ago, Washington gave the economy another fiscal boost. Mr. Trump, channeling his inner Herbert Hoover, is also pressing for further interest rate cuts to achieve a trade advantage through a weakened dollar.
This is scary stuff for any American. The country faced a similar situation during the Nixon administration, which exerted pressure on the Fed to keep rates too low during the early 1970s. Serious economic problems that this brought on didn’t emerge until several years later, when they were compounded by the second oil shock in 1978 (that was my first year in the stock market; I was a fledgling oil analyst).
Why, then, is Mr. Trump trying to juice the US economy when he should really be trying to wean it off the drug of ultra-low rates?
I think it’s safe to assume that he doesn’t understand the implications of what he’s doing (the thing Americans of all stripes recognize, and like the least, about Mr. Trump, a brilliant marketer, is how little he actually knows). If so, I can think of two reasons:
–as with many presidents a generation ago, he may see ultra-loose money as helping his reelection bid, and/or
–the “easy to win” trade wars may be hurting the US economy much more deeply than he expected and he sees no way to reverse course.
If I had to guess, I suspect the latter is the case and that the former is an added bonus. I think the main counter argument, i.e., that this is all about the 2020 election, is that the administration seems to be systematically eliminating any parties/agencies that want to investigate Russian interference in domestic politics.
Either would imply that software-based multinational tech companies that have led the stock market for a long time will continue to be Wall Street winners–and that the weakness they are currently experiencing is mostly an adjustment of the valuation gap (which has become too large) between them and the rest of the market.
In any event, interest rate-sensitives and fixed income are the main areas to avoid. If the impact of tariffs is an important motivating factor, then domestic businesses that cater to families with average or below-average incomes will likely be hurt the worst.
I saw Ken Rogoff on CNBC today, and surprisingly, he didn’t seem concerned about size of deficit or a ONE TIME drop in interest raters by the Fed. His concern was that the government was financing too much of the debt by short term rather than longer term debt instruments.
Thanks for your comment. This is way outside my area of expertise. As I understand it there are three issues about short-maturity government borrowing. One is that we seem to be reaching the limits of financial markets’ ability to absorb new short-term government issues. The second is that spreads favor issuing longer-term debt (today’s yield on the one-month bill and the 10-year note are identical at 2.02%). Third, if rates are indeed at rock-bottom now, any borrower should be locking them in by extending maturities. On the other hand, the whole point of quantitative easing has been to lower the cost of long-term borrowing. Mr. Trump has also been railing against the Fed running down its longer-term Treasury holdings, apparently wanting further yield suppression–which, I think, makes it harder for Treasury officials to offer an increased supply and risk a rise in yields as a result.
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