More Dope For The Lance Armstrong Economy
- Monetary policy anesthetized fiscal policy over the past decade.
- The economy is not as strong as financial market performance suggests.
- Financial markets are now dependent on monetary stimulus as fiscal policy is impotent.
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I’ve been critical of the Federal Reserve for several reasons over the past five years, but one reason stands above them all. At the depths of the Great Recession, the Fed administered the equivalent of shock therapy to the heart of the economy and financial markets with its crisis-level policies to halt the deflationary spiral in asset prices, stimulate demand for goods and services and restore consumer confidence. It worked, and it was a brilliant move! The problem was it never ended.
As a result, it lulled our policy makers on both sides of the aisle to sleep with year after year of financial wealth creation. After the recovery became a new expansion, fiscal policy never grabbed the baton that monetary policy was handing it by addressing the structural reforms our economy so desperately needs. Instead, monetary stimulus was injected every time there was any hint of economic weakness.
The Lance Armstrong Economy
I called this the Lance Armstrong economy back in 2017, when I wrote:
“This economy reminds me of Lance Armstrong when he was in his prime. In other words, accelerating at a rate of speed far greater than it should be under ordinary circumstances. Our deficit-financed growth is Armstrong’s steroid-induced speed on a bicycle. Neither lasts forever, and both have negative long-term consequences.”
Yet policymakers in Congress and at the Fed don’t see the long-term consequences, and if they do they refuse to acknowledge them. For example, we supposedly have the strongest and fastest growing economy in the world today, but is it really growing at all?
Let us assume that the Fed is accurate in its forecast for U.S. economic growth of 2.4% in real terms for 2019, which would be 4.4% in nominal terms when adding the expected rate of inflation of 2%. The Congressional Budget Office is forecasting the budget deficit to be approximately $1 trillion this year. This means that we will be borrowing nearly 5% of GDP to grow our $20 trillion economy 4.4%. That is not growth!
It only gets worse moving forward, as the Fed forecasts a long-run growth rate of 1.9%, while the CBO indicates our deficits will continue to steadily rise, as the cost to service the outstanding debt will total $7 trillion over the next decade.
Once the Fed started to gradually withdraw monetary stimulus in earnest at the beginning of last year, the fiscal stimulus that replaced it could not have been more irresponsible and untimely. The $1.5 trillion tax cut did little more than boost corporate earnings for one year, as well as fund dividend payouts and stock buybacks. It also dramatically reduced tax revenue, which has led to a larger deficit. There have been no lasting positive impacts on the rate of economic growth and the S&P 500 index is at about the same level as it was at the beginning of 2018.
Now corporate earnings growth expectations for the first quarter of this year have been steadily declining to what is now just 1.8%. A corporate earnings recession is a distinct possibility in the first half of 2019.
More Dope From The Fed?
We can point to many reasons for the 19% decline in the S&P 500 index that started at the beginning of October, but none of them were factors in deterring the Fed from continuing down the path of policy normalization until stock prices began to fall. At that point Chairman Powell abruptly changed his tune. In the span of three months the Fed went from a forecast of four interest rate increases and $600 billion of balance sheet reduction (quantitative tightening) to no more interest rate hikes and flexibility as to how much liquidity will be withdrawn.
The Fed characterized the economy as “ solid” in its FOMC statement this week. Sure, as solid as a pro cyclist powering up a mountain side in the French Alps with dope pumping through his veins. Yet during his press conference, Fed Chairman Powell stated that, “the case for raising rates has weakened somewhat.” More importantly, he said “the normalization of the size of the portfolio will be completed sooner and with a larger balance sheet than in previous estimates.”
This is code for the economy is weakening and fiscal policy is out of bullets, so we must prevent financial asset prices from reflecting this economic weakness or it will result in a negative feedback loop. This effort is no different than what the Fed successfully accomplished 10 years ago, but back then financial asset prices were pricing in Armageddon. Today they are overvalued by all historical measures. The longer the Fed continues to support financial markets as the economic fundamentals deteriorate, the greater the inevitable adjustment will be when values revert to historical means. Additionally, the Fed continues to placate legislators with its market manipulation, resulting in no sense of urgency to address the serious structural problems with our economy.
Lance Armstrong lived a lie that ended up losing him his integrity, medals, fame and what he claims to be as much as $100 million. I think the Fed has allowed us to live a lie, but in the end its member banks will be just fine. They will always have a lifeline to seemingly endless and unlimited liquidity to remain solvent and profitable. I can’t say the same for the majority of investors and American taxpayers who are beholden to the Fed’s misled policies. I hope I am wrong and that the party never ends, but history has shown that it always does at some point. When it does I am quite certain that much like Lance Armstrong, the Fed will have lost its credibility.
Lance Armstrong’s performance was too good to be true, because it wasn’t true. In the end the payback was devastating. In a similar fashion the performance of our economy and our financial markets is too good to be true. What will soon be the longest expansion and bull market on record has been built on wetlands of liquidity and debt-induced consumption rather than on a bedrock of capital investment, savings and wage gains. If the performance-enhancing liquidity is ever withdrawn, or does not continue to increase, market performance will deteriorate, and the payback from this past decade of malinvestment will be very damaging for the majority, while having enriched a minority.
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This article was written by
Lawrence is the publisher of The Portfolio Architect. He has more than 25 years of experience managing portfolios for individual investors. He began his career as a Financial Consultant in 1993 with Merrill Lynch and worked in the same capacity for several other Wall Street firms before realizing his long-term goal of complete independence when he founded Fuller Asset Management. He graduated from the University of North Carolina at Chapel Hill with a B.A. in Political Science in 1992.
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