Public Construction Spending Will Prove Stagflationary

Includes: CEF, GLD, SLV, SPY
by: Jason Tillberg

Stagflation is when there is high inflation coupled with little to no economic growth. This usually implies high unemployment levels as well.

Allow me to define economy.

Economy: The wealth and resources of a country or region, especially in terms of the production and consumption of goods and services

So to grow an economy on a per capita basis, you want to increase the production and consumption of goods and services.

The best way to do that is by increasing the productivity or output per hour.

The greatest example of an infrastructure project that benefited economic growth in America was the Erie Canal.

The Erie Canal was built between 1817 and 1825 at a cost of $6 million. It was funded through selling bonds to private investors. It stretched 363 miles from Albany to Lake Erie.

Before it was completed, it would cost $100 to move a ton of freight, be it flour or materials, from Albany to Buffalo. It would also take about 32 days.

Upon the completion of the Erie Canal, the cost of the toll would be just $2.50 for the entire route and take just 6 days.

Economists today might consider this to be massively deflationary. On the contrary to the price collapse being due to a collapse in aggregate demand, aggregate demand soared.

Traffic exploded on the Erie right from the start. Toll revenue in 1826, its first full year of operation was $500k, which was 5x the interest due on the bonds. The bonds were paid off in 1837 and by 1882, the tolls were eliminated.

Production soared and so did consumption bringing about massive economic growth and giving birth to New York being the Empire State. (Source: Peter Bernstein's "The Wedding of The Waters")

That was then, this is now.

Today, most infrastructure projects are Government financed backed by tax payers, 90% at the state and local level.

The economics of new infrastructure are not as beneficial to adding productivity anymore. On the contrary, the economics of adding new infrastructure are actually more costly and will reduce economic growth as it will reduce consumption due to the higher costs that will be incurred leaving folks with less disposable income to spend on other goods and services.

I have two examples that relate to public construction spending in the U.S. that demonstrate exactly what I'm referring to.

Ever so notably, the pace of public construction spending has been in decline since mid 2009.

Here is a chart of public construction spending:

Public construction spending is spending that consists of the following areas per May's construction report:

Note: These are annualized figures in millions of $

An up to date infrastructure is critical to help us be as productive and efficient as we can be in the most cost effective manner.

These two examples of public construction projects that will soon be underway show how they will cost us dearly.

Baltimore Water Projects and Hefty Price Increases

The city of Baltimore plans to build a new water treatment plant, replace open air city reservoirs with underground storage tanks, install high tech water meters and rebuild 40 miles of pipeline per year.

The Baltimore water bureau chief, Rudolph Chow was cited as saying:

"We have been deferring, non reinvesting, for years. The question is, do we pay now when we have control over the system or do we wait until the whole thing collapse."

To pay for these projects, the city wants to increase water rates over a 3-year period beginning this month for their fiscal year 2014 with a 15% hike. Then an 11% hike the following year and an 11% hike the year after that. That would be a total of 41.7% in two years time!

An average quarterly water bill for a household with 2 adults that uses about 170 gallons of water a day will see their bill go from $157 to $223 by the second half of 2015.

Inflation in water, sewer treatment and trash collection services have already been skyrocketing at a faster rate than overall inflation.

This chart below is indexed to compare the two:

The year over year percent change in the cost of the water and sewer and trash collection services looks like this:

That's stagflation: inflation is high and economic growth is much lower.

Tappan Zee Replacement Bridge

The next example is NY State's Tappan Zee Bridge, located about 20 miles north of Manhattan. It was completed on December 15th, 1955 and is now in a condition where it needs to be replaced with a safer bridge.

Infrastructure expert Barry LePatner refers to the Tappan Zee bridge as the "scary of scaries" in terms of its condition.

The current round trip toll over the Tappan Zee Bridge is $5.00 cash and $4.75 with the EZ pass.

A new bridge is expected to be completed by 2017 at a cost of $3.14 billion, which was the cheapest of the 3 plans presented.

The new round trip toll is expected to be between $12-$15.

That folks, will also prove to be stagflationary.

America is already very productive and efficient, so becoming even more productive and efficient is not going to be easy I admit. Just maintaining the level of productivity and efficiency at the current costs would be good actually. We just don't want to go backwards.

What we would want to see is a high speed rail network that reduces the time it takes us to get from city A to city B at a lower cost than either driving or taking the trains we have today. I don't see that happening anywhere.

Ultimately, we are headed for more stagflation and that could prove to make the next recession more pronounced again.

The S&P 500 (NYSEARCA:SPY) does not like recessions, especially pronounced recessions like the last one we had.

Here is a chart of the S&P 500 year over year percent change with recessions highlighted:

It may make sense to lighten up on stocks before we head into the next recession.

As for timing, just based on the two infrastructure examples above, and I'm sure there are many more all accross America, 2015-2017 may prove to be painful years for the U.S. economy as we adjust to higher costs that are coming.

Another concern for stagflation is the effects on inflation and especially inflation expectations.

If I'm a Baltimore resident who uses water, my inflation expectations just went up. As a driver who uses the Tappan Zee Bridge to cross the Hudson, my inflation expectations did just go up.

I think as inflation expectations rise, that's going to be what will drive gold and silver (NYSEMKT:CEF) higher.

Here is a 10-year chart of Central Fund of Canada, which holds both gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) bullion. It rallied both into 2008 and in 2011 when inflation expectations were spiking.

It is under this logic that when we see inflation expectations picking up again, that's when we could see gold and silver rally once more. It might take until 2015 before we see those expectations rise, but for now, the writing is on the wall.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CEF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.