Federal Debt Out Of Control: A 'New' Economic Paradigm?

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by: John M. Mason
Summary

The yearly federal deficit is approaching $1 trillion and is projected be at this level or above for the next ten years.

These levels are not being achieved as the economy is leaving a recession, but are being achieved as the current recovery reaches, the age of ten years.

Since there is no one fighting to control this situation, we must ask how this lack of discipline and continuing deficits will impact the economy and markets in the future.

The Congressional Budget Office has released new projections for the federal deficit.

For the next decade, the CBO is forecasting that federal deficits will average 4.4 percent of nominal Gross Domestic Product.

This is up from a 2.9 percent average, which was achieved over the past 50 years.

Over the past four months, from October 1, 2018 through January 31, 2019, the federal deficit came in at $310 billion, up from $176 billion in the same time span from one year ago.

This represents a 77 percent increase.

Note, however, according to the Treasury Department, that in the first four months of fiscal 2018 experienced a shift in the timing of certain payments, which made the deficit appear smaller.

Without these timing sifts, the deficit would have risen by 40.2 percent in this fiscal year!

Furthermore, it should be noted, that these deficit numbers are being achieved after almost ten years of economic recovery. This is not the usual historical picture.

Therefore, it seems that we are entering a period of time where the economic paradigm is changing. We don't know what to call it yet, but new dislocations will be building and we have no idea at this time what that will mean for the economy.

Let's look back at the last 50 years, mentioned above. That means going back to 1969.

As I have tried to document many times in this blog and as I am presenting in my book about this time period, the 1960s really represented the beginning of what I now call the period of "credit inflation,"

The period began in the Kennedy-Johnson years where deficits were promoted as the way to combat economic recessions. But, in the sixties, the Phillips Curve became the excuse to run deficits all of the time so as to spur on economic growth. Added on to these ideas was the move to support housing through numerous programs that would spread credit to the middle classes.

Richard Nixon became president in 1969 and stated that he was entirely supportive of this approach to stimulating economic growth over time.

By the early 1970s we began to see the consequences of this philosophy as the sustained push to expand credit resulted in more and more money going into assets like housing, gold, art and other commodities.

Added on to this continual effort to provide more and more credit to the economy, we saw greater and greater amounts of risk taking and greater use of financial leverage. On top of this, the 1980s and 1990s was a peak time for financial innovation.

And in the 1990s we saw more and more asset price bubbles, something that continues to this day.

However, these results were connected to the fact that as the government provided more and more fiscal and monetary stimulus to credit inflation, less and less money went into physical economic growth and more and more money went into chasing assets.

The economic growth of the American economy slowed down. And, these practices continued on after the Great Recession with economic growth, for the almost ten years of the current expansion, came in at a modest 2.2 percent compound rate of increase, the worst on record.

Price inflation, consumer price inflation, has remained very low during the current expansion, while asset prices have shown substantial rates of increase. Stock prices have traded at all-time highs, commodity prices has been very buoyant, as has the value of many other assets.

Now, we have rising government debt, rising consumer debt, rising corporate debt and at this late a date in the economic recovery. And, more debt is in the forecast.

The Federal Reserve is holding massive amounts of government debt on its balance sheet…and, it holds a massive amount of private debt on its balance sheet in the form of mortgage-backed securities.

The question is, where do we go from here and how do we finance the piles of debt now predicted for the future? Is this a new stage of credit inflation, one where financial markets are just flooded with debt issues and liquidity is floating all over the place, not only here, but all over the world?

The European Central Bank, for example, just ended its flooding of the European banking system with quantitative easing, but now is faced with the problem that with Italy in recession, Brexit on the horizon, and with slowing growth rates elsewhere in the European Union that it must return to some kind of liquidity provision in order to face Europe's slowdown in economic growth.

China is moving to provide greater stimulation to its economy after slower growth rates have been posted there.

Economic growth, as I have written, does not seem to be dependent anymore upon demand side economic stimulus like deficit-creating fiscal programs or loose monetary policy. The supply side seems to be determining how fast the economy is growing. And this, I continue to argue, is due to the assumption of credit inflation that is now built into the investing and speculating efforts of businesses and individuals.

But, asset bubbles cannot be sustained forever by creating more and more debt.

If economic growth is low or non-existent, the debt cannot continuously be sustained. Ultimately, there must be something "real" behind the debt, something that produces "real" wealth.

The environment we have right now is not producing this "real" wealth to sustain the credit inflation that is taking over.

The paradox the United States faces is that its credit inflation is less than that of most of the rest of the world. This is a good part of the reason that the value of the US dollar is so strong.

So, I would argue, that we are entering a strange new world where the economic expansion is long, yet still going on, but the credit inflation created by the government is also expanding creating many, many dislocations in the world of asset prices.

We do not know how this will play out because the paradigm seems to have changed.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.