Money: Recession or Recession?

Last week I wrote about a mountain of money and showed concern that if it is not removed it will eventually cause a problem for the US economy.

Many of you are not convinced. You believe that the Fed should be stimulating the economy after a quarter when the real GDP crashed by 33%. Many of you do not see any signs that all that money is causing problems.

But I am going to be stubborn. The case for keeping that huge chunk of money is not very good, and the fact that no problems have popped up yet doesn’t mean we can ignore some very real risks.

The recession and the rise in unemployment were not the result of people wanting to spend less. Rather, the lack of spending is mostly because COVID-19 regulations shut down many of our purchasing options. Yes, we are opening the economy but so far that is an experiment. As COVID-19 comes back, along with us getting out and spending more, we will have more limits on our spending behavior.

Point? Fed monetary policy is not doing very much. What matters is the course of COVID-19 and the shutdowns that go with that. We don’t need to pile up all that money. What we need to do is tame COVID-19.

The bigger issue is the risks arising from a successful attack on COVID-19. That medical breakthrough is what will get us spending again. With banks flush with money and with us ready to spend our brains out, now we have some problems. Why? Wouldn’t that be good for output, profits, and employment? It sure would. But look back at history. When demand comes roaring back, but supply cannot possibly keep up the pace, it leads to shortages -- and those shortages have consequences.

Think basic economics? When demand rises and supply doesn’t match it, it causes inflation. Real and marked progress against COVID-19 will bring rapidly rising prices, wages, cost of materials, rents, and more. Many companies have gone out of business with little chance of snapping back. Supply chains are in total disarray. Workers may have found alternative uses for their skills and time. Firms will not find it easy to find, hire, and train people. Banks have all that money sitting around and they will want to induce us to borrow it and spend it. And we will want to – demand is not the problem. The risk is that demand soars and supply inches up. The difference results in inflation.

What can the Fed do in such a case? One approach is to ignore the inflation. Think of inflation as a negative but natural side-effect. The good thing is that the Fed would be letting supply restore itself and economic growth would be appreciated. The bad thing is that inflation will rise. It might be worth the risk, but history suggests that once the Fed mounts that pony, it is not easy to get off. We learned that rising inflation often turns into runaway inflation and that causes recessions.

There is ample risk from too much money, but the Fed won’t try to suck it out of the system for fear that interest rates will rise and cap off the national recovery. It sounds like a terrible choice – leave the money in and get inflation and recession, or take the money out and get recession.

My vote is to take the money out. Take it out gradually. After all, it's just sitting around in vaults. We are not using all that money. I doubt that a discernible move in that direction will create much harm at all. If and when the economy recovers there will be plenty of money around to facilitate a supply response. 

Hi honey, why are you playing with that gun? Mom, don't worry, I won't shoot it in the house. Okay sweetie, just be real careful. I will, don't worry Mom. 

 

Is the Fed a Drug Dealer?

The stock market seems to like the Fed’s promise to continue stimulating the economy. There are forecasts that the economy will weaken in the near future – and the Fed believes it needs to keep interest rates at zero to keep the economy afloat.

I win no popularity awards for being a curmudgeon, but I can’t help but point out the damage the Fed is doing.

The best analogy I have seen lately has to do with drugs or pain medicines. The drug analogy helps us to understand the predicament.

Surely pain medicine has its place. We need pain medicine to get us through bouts of intense pain. This pain might come as a direct result of an injury or it might be the expected result of a successful surgery. Whatever its purpose, the medicine is meant to be highly effective and temporary. The bruise or the surgery’s incisions will heal.

The problem comes when the pain goes away but the patient gets addicted to the drug. It might be a mental or a physical addiction but that does not matter. It is real. One needs to keep taking the drug. At some point the addiction will become damaging and something must be done. At some point the drug will have to be withdrawn. This process will be incredibly painful. The wise doctor will help one with the withdrawal, but much depends on the behavior of the patient. Some would rather experience the addiction than the withdrawal.

Larry, you are not a medical doctor. What’s up?

What’s up is that the Fed has just told its patient that it will continue the stimulus. As it injects more and more money into the economy creating imbalances everywhere (I hope you weren’t planning to live your retirement on your interest income), it says nothing about when or if it is going to reverse operations -- and withdraw the money.

But the Fed doesn’t know how to do that. It has zero experience with withdrawing mountains of money. Note that even after the previous recession, it never withdrew the money. The money is sitting as excess reserves in banks doing nothing – doing nothing but waiting to explode like a typhoon at some point down the road. Notice – the Fed spewed trillions into the financial system and it has done nothing to withdraw it.

So if it didn’t do that in all those years since the last recession ended, how can we expect the Fed to withdraw another tranche of trillions of dollars of money? Call it a typhoon or an avalanche. They have no clue what to do.

Doctor, give that man a shot. He just got hit by a bus. Doctor says, okay, but I have no idea how to save him from his injuries. What do I do when the shot wears off? We don’t care. Just give him the shot and then we will pray.

I sound pretty cruel. But the Fed is no different than the doctor. The Covid has caused the problem in the economy. The Covid could go on for many years. Meanwhile the Fed administers more and more pain medicine today with no plan for tomorrow. 

Why don’t they do today what might be sustainable in the future? Funding unsustainable increases in the national debt is not thinking about the future. The Fed sadly is adding to our miseries – only we don’t see the typhoon yet.

False Prophets of Doom and the S&P500

Judging from much of the reporting lately, the stock market is high and rising and simply cannot sustain its lofty position. While I never predict stock prices, I can at least spout off a bit about these people who seems so sure that stock prices have to fall.

On the face of it, the intuition seems easy. The economy is horrible by most current measures (it fell 33% in the second quarter of 2020 when measured by real Gross Domestic Product) without real hope for a lasting recovery so long as Covid rages on. Meanwhile, the stock market has risen lately and has reached some very lofty numbers.

So I thought I would look at some numbers. Below I discuss data for the S&P 500. I use a measure of change in the valuations of 500 major US corporations. I did this comparison on July 29. The value of the S&P on that day was 3258.

3258 looks very impressive when compared to the end of March 2020 when it registered 2611. Wow. That pops your eyes out. In just a few months, the market rose by about 25%. Since March, the S&P rose continuously, though with a lot of variability.

We might forget that March 2020 was a very bad month for the country and the stock market. Just two months earlier in January of 2020, the end of month S&P value was 3284. In those two months, the S&P value fell from 3284 to 2611. Yikes. Ugly.

Notice that the July value of 3258 remains below the January value of 3284. So yes, we had an incredible upward spike since March, but we see that between January and July we had zero growth in the S&P. Does that sound like an unsustainable increase? Or is it simply a rebound. Bouncy ball. Ball went down. Ball came back up?

What about longer periods of time?

At July’s S&P value of 3258:

            It was 1 percent lower than in January of 2020

            It was about 7 percent higher than July 2019

            It had risen by about 8 percent per year between July 2018 and July 2020

            It has risen by about 10 percent per year between July 2017 and July 2020

What do you do with all that?

My take is that the S&P increases mostly happened prior to 2020

The most recent S&P increases still have not gotten us back to January

You might say, okay, the current increases are not remarkable, but still – why hasn’t the S&P fallen commensurately with the second quarter real GDP? Why hasn’t the stock market fully registered the worry about future declines in the economy?

And my answer is this – I don’t forecast stock prices. I don’t know how much the stock market “should have fallen.” I cannot read the minds of the public about future Covid, future real GDP, or future shooting stars.

But I do know that all those false prophets of doom have more to explain about why they are so sure stock prices have to collapse. As for me, I don’t see a sell opportunity. I guess we will see. Meanwhile there is always Jack.

 Note: I wrote this piece on July 29. It is now August 11. The S&P value on August 10 was about 3355. So it is still rising. It is about 100 points higher than the figure I was quoting above, 3258. I am glad I didn't sell in July. What about now? 

Not About Covid

Imagine what it was like in the 1940s during World War II. What did people talk about? Of course, the course of the war and what they had heard about friends and loved ones involved with the war. Today, Covid is our World War II. It’s hard to have a conversation with anyone that doesn’t eventually focus on Covid. What is it? How did it start? How does it spread? How do we stop it?

My title says this is not about Covid so you are probably wondering where this is headed. Where I am headed is to think about the source of our disagreements about it – and about recent racial incidents and about the recession, and so on.

I was walking around Green Lake talking with my friend Barbara and it dawned on us that we live in an incredibly testy world. We wondered why it had to be so ugly and non-productive. I found myself giving my standard answer – our confrontations are about extreme ideologies and the people who follow them.

But as we talked more about Covid disagreements, it seemed pretty obvious that those heated disagreements were not caused by Karl Marx or Adam Smith or Al Gore and Rush Limbaugh. Similarly, racial animosities are not so easy to predict.

So as we sidestepped a lot of goose poop and watched the geese and ducks match their cloaca, we dug deeper into our differences.

We came up with 17 causes of our differences – I know I must be able to find a couple more. Maybe you can help me. 

The truth is that those 17 are not really independent so I guess I won’t worry about the number.

As I rattle these off, keep in mind how these differences might play into your opinions about various issues today. Notice, too, which ones of the 17 come into play for a particular issue but not for others. Thus we might not see the same people lining up together to take positions on any given issue. For example, liberals might not agree with other liberals about a cure for Covid. Some conservatives may have very little in common with other conservatives as they try to resolve racial issues.

These 17 are in no particular order.

1.    Financially Selfish v Generous – you want to keep what you make/you are very charitable

2.    Inward oriented v greater good – you are focused mostly on you and your family and friends/you speak often of the greater good

3.    Philosophical purity v practical/law abiding – you adhere to a philosophical position/you like to think you do things that are efficient or practical including following the law

4.    Empathetic v rule following – you feel strongly about the plight of others/you mostly want people to abide by or not deviate from the laws

5.    Competitive v cooperative – you see much of life as a contest that you want to win/ you work with others

6.    Loyal to people v loyal to ideas – you are loyal to your spouse or your boss or your friends/you prefer to be loyal to ideas or laws

7.    Spiritual v practical – you are driven by the values of a religion/your behavior is mostly driven by practicality

8.    Religious v spiritual – you adhere to a specific religion/you mostly are driven by religious values but not a particular religion

9.    Habitual v free spirited – you are very disciplined and predictable/you are hard to pin down.

10. Rich v poor -- you were born with a silver spoon in your mouth/you were born into poverty

11. Energetic v lazy -- you love to be creative and productive/you love watching Popeye reruns and laying on the couch

12. Smart v not so smart -- biology gave you raw brain power/heredity didn't help you learn 

13. Healthy v Sickly -- you are well and maybe athletic/you are chronically ill and often need medical attention

14. You take recreational drugs v you don't drink alcohol or take drugs -- you are a little wild & crazy/you have empathy for those who need help with chemicals

15. Sloppy v Neat -- you pay attention to details/you let it all hang out

16. Huggy v Standoffish -- you love to be with people and get attached/you dislike close or emotional relationships

17. Bourbon v Scotch – okay this one is for fun and gives me 17. :-)

I am sure there are more of these. What’s missing in my list of 17?

Here’s the trick. Some of these choices put you in the D or R camps. Maybe Rs are financially selfish and Ds are generous? But surely you see that you cannot easily assign a person the same ideology or a party based on each of these very strong character traits.

And that is why I believe that Covid and recent racial tensions are not easy to parse. We are not getting predictable things coming from the mouths and behaviors of our friends and relatives and politicians.

Maybe this is good. Maybe ideological living is not good for us. Maybe we will spend more time thinking and doing less shouting and cheering? Maybe our most vexing current problems do not require an ideological basis for understanding or solution. 

I don’t know but it sure was nice walking around Green Lake in the summer.