the fight over unemployment benefits

My cartoon version of US politics:

A generation ago the Democrats were the party of the working people and the Republicans the party of the wealthy, especially of inherited wealth.

The Democrats’ goal was to push for strong wage gains, to improve the lot of their supporters. They were also for wealth redistribution–taxing the rich to get the money for social welfare programs like Medicare or Social Security. High wage gains would also eventually create inflation, eroding the value of the assets supporting hereditary wealth–an added plus.

The aim of the Republicans was to defend the status quo, the value of their bonds and their industrial operations, by advocating low wages, low taxes (no redistribution) and low inflation.

Even though both parties have strayed far from their roots, this old picture has some relevance in explaining economic forces at work in the US today.

The Congressional Budget Office estimates that the federal budget deficit for 2020–the amount that government spending will exceed income–will come in at $3.7 trillion.

This is where the current debate on extension of unemployment benefits comes in. Democrats are calling for another $3 trillion in aid to out-of-work Americans; Republicans are arguing for $1 trillion. In simple terms, the difference is between continuing $600 a week in extra benefits vs. reducing that to $200.

In the former case, the federal deficit would come in at about $7 trillion and total government debt would rise to just under $30 trillion. This compares with GDP of about $19 trillion this year–with real GDP growth (even before the pandemic) reduced to close to zero due to Trump’s epic incompetence. That would put us higher than perennial poor soul Italy in terms of debt/GDP and into the same bracket with Greece and Lebanon. Only Japan, with debt of 2.5x GDP would be out of our reach–for now, anyway.

(An aside: hard to believe one man could do so much damage so quickly–and that’s not considering his white racism, environmental recklessness, the secret police roaming Democratic cities…)

Anyway, the question wealthy Republican backers seem to be asking is at what point will creditors balk at continuing to fund the Federal government. Their answer can be seen in the Republican negotiating stance–we’re already there. In my view, a lot depends on whether Trump is reelected despite his devastation of US aspirations and value. I think we’re already seeing the first indications of the world’s worries in the decline of the dollar vs the euro. For wealthy holders of dollar-denominated assets–real estate, industrial plants, fixed income securities–losses could be very large.

debasing the currency

what debasing is

“Debasing” is goldbug-speak. In past centuries, when gold was actually used as money everywhere, when countries minted gold coins and kept reserves of the yellow metal as symbols of their ability to repay borrowings, governments in trouble would sometimes dilute their gold by blending in inexpensive base metals. So they would repay creditors substantially less than they’d borrowed. That’s debasing.

The modern equivalent of physical debasement is running a highly stimulative money policy, the idea being to create lots of inflation, which would allow a government to repay borrowings in inflation-debased currency.

A report from Goldman Sachs strategists came out this week suggesting that this process is at work in Washington right now, as a consequence, intended or not, of pandemic-fighting fiscal and monetary stimulus. Its conclusion: buy gold.

relevance for us as investors

I haven’t seen the report itself. I’ve only seen coverage in the financial press. (I’m not a Goldman client. For what it’s worth, I think the firm does top-notch factual research but struggles to find interesting investment conclusions from what it unearths. For you and me, Merrill Edge is the best I’ve found.)

I wrote about the gold issue in May. Except for China and India, where gold is still money, I don’t think holding gold achieves much of anything. The fact that a major brokerage house, typically a stronghold of Republican political sentiment, is willing to suggest–and seek publicity for–this idea, with its implied criticism of Trump’s dumpster-fire handling of the economy, is the most interesting aspect of its publication.

I think inflation is the least of our worries. Last year the federal government took in $3.5 trillion in taxes. Pre-pandemic, Washington was thought to be on course to spend about $1 trillion more than in 2020, due in large part to Trump’s failure to offset tax cuts with removal of special interest tax breaks for politically connected swamp creatures. The actual deficit will more likely be around $8 trillion. This would mean a total federal debt of, say, $28 trillion, or about 135% of GDP. That would place us up there with Italy among the most indebted nations in the world.

Yes, debt this high creates worries about devaluation as a way of not paying creditors back in full. Historically, however, such high levels of government debt are also associated with much slower GDP growth and emigration of the best and the brightest to make a life where economic opportunities are greater.

From a purely financial point of view, Trump’s threats to renege on government debt held by foreigners (basically making us look like Argentina) and his use of the banking system to attack political enemies are also giving new impetus to the search for alternatives to the dollar as the go-to currency for international trade and as a store of value.

I could go on about the other ways Trump continues to severely damage the US, while failing to provide any support for the left-behind rural citizens who support him. But I think the key question for the rest of the world is whether the US electing a white racist incompetent was a disastrous mistake or whether he really represents what the country stands for. If the latter proves true in November, the currency and securities markets reaction will likely be strongly negative.

playing cyclical recovery

Yet another slow-motion human catastrophe seems to be starting to play itself out in the US. Yes, Trump’s strange attempt to undermine the finances of the American university system, one of our crown jewels, by barring its highest-paying students from attending, disappeared almost as soon as it was unveiled (to be fair, my guess is Trump had no idea what he was doing; he just wanted to burnish his xenophobe credentials). But the real economic/social issue is the rolling start to the national school year next month. Just as with mask wearing, Trump appears to be insisting on resuming school in person and on schedule, which seems to me to be a recipe for another surge in coronavirus cases, similar to the one resulting from Trump’s urging southern and western states to reopen too early.

I think the stock market reaction to this will be twofold: to stop the rotation away from secular growth to domestic cyclicals, and to reconsider whether or not the latter’s current prices are too high.

What I have tended to forget is that, possibly ex the UK, the US response to the coronavirus has been by a mile the worst in the world. Europe and Asia are already starting to rebound at the same time equity investors are coming to grips with the fact that Washington–and a number of state governors–are about to inflict another round of damage to GDP.

Anyway, my thought is to reduce my exposure to what I see as very expensive tech names and build up cyclical exposure–in the EU and Asia.

thinking about the US stock market

tactics

There’s a struggle going on in the market between secular growth stocks and business-cycle sensitives. This contest has two parts: valuation and concept.

valuation

If we look at the performance of NASDAQ vs. the Russell 2000 over the past 2 1/2 years, the former has outperformed the latter by an almost unheard of amount for a developed country. Relative valuation alone argues that the R2000 should have its day in the sun.

One would expect balance to be restored by some combination of NASDAQ losing relative ground and R2000 going up. The immense money and fiscal stimulus coming out of Washington suggests the central tendency of stocks will be up, so NASDAQ could conceivably do its part to restore valuation balance by simply standing still.

concept

On the other hand, this performance differential is arguably justified. Thanks to Trump’s epic incompetence, the domestic economy has been increasingly weak–both vs our own history and results in most other places (not the UK) since the effects of the 2017 tax cut have warn off. And the R2000 is much more closely tied to the US than the more global NASDAQ. Every recent rally attempt by the R2000 has petered out in short order–although the one now underway may have more legs than its predecessors.

Then there’s the pandemic. Washington has spent trillions of dollars, correctly so in my view, to prop up a country being ravaged by a deadly disease. Unfortunately for us, with his usual blend of insight and judgment, Trump has armtwisted states like Florida, Texas, Arizona et al into lifting quarantine restrictions much too soon. The result has been that while Canada and the EU have Covid under control and are revving up their economies, we’re seeing the virus flare up again with huge increases in new cases and red-state hospitals and funeral homes overwhelmed. He’s now, in inexplicable fashion, compounding his error by pressuring schools to reopen shortly, amplifying the risk of disease to both students and teachers.

All this implies both that another round of aid from Washington may be necessary to offset Trump’s gaffe and that the domestic economy will be relatively weak for longer than hoped–and longer than any other OECD country. (The financial press has begun to link Trump’s handling of the coronavirus with his disastrous foray into Atlantic City gambling, even though the fact that he’s done this sort of thing before isn’t a great explanation for why he should be doing it again.)

Other worries: the national debt is now higher as a percentage of GDP than it was at the end of WWII, and the budget deficit is already approaching $4 trillion.

Concept, then, argues that investors should continue to do what they’ve been doing for the past couple of years–stay as far away from the domestic economy as possible.

strategy: i.e., what happens next?

I think we muddle along for a while. But the two big questions that I see eventually coming to the forefront of the market’s consciousness are:

–in November, will the US reelect a white racist economic illiterate who has crushed GDP growth, who’s a fanboy of corrupt dictators, who seems to revel in the suffering of others and who appears to be unraveling mentally before our eyes? It says something about the parlous state of domestic politics that the answer is not clear.

–how/when/at what cost does the country begin to clean up the gigantic mess Trump, his administration and his enablers in Congress have created?