Nothing in the economy is more "fundamental" than the actions of the US Treasury. Nothing.
In this piece, we point out both the wide-spread misunderstanding surrounding the Federal deficit and the resulting Federal debt, as well as the importance of the Federal deficit to the performance of the stock market.
Most market analysts, if they don't ignore it entirely, fatally misrepresent the Federal deficit and the resulting "debt" by repeating the BIG LIE; that there is a Federal debt "time-bomb" on the verge of exploding because the federal government will be unable to sustain the so-called federal "debt". This lie has been repeated (hundreds of times per day) for 80-years.
We'll let Rodger Malcolm Mitchell from Monetary Sovereignty explain the truth (reality).
...that so-called federal "debt," is nothing like your debt. Federal "debt" is the total of deposits into Treasury Security accounts. It's paid back, not with tax dollars, but simply by returning the dollars in those accounts to the account owners.
The federal "debt" (deposits) is no burden on the government, on taxpayers or on the economy, nor does the federal "debt" (deposits) cause inflation, recession, difficulty in borrowing, or any other myths and fables being foisted on the innocent American public.
In fact, since the federal debt evolves from the federal "deficit" (economic surplus), increases in the federal debt are necessary for long-term economic growth.
The last line is key. Deficit spending by the Federal government (currency creator) is necessary for long-term growth of the economy. It is not "debt" at all, it's how growth in the economy is "funded". It should be called the Federal government's "funding of the economy", and when viewed correctly, nobody would insist that funding should be pulled from the economy because the Treasury is about to run out of dollars. The Treasury can never run out of dollars. It always has, and always will have dollars to pay for whatever needs to be funded--from fighter jets to food stamps--regardless of the size of the "debt"...and there is 80-years of evidence to back this up.
The Federal government is on schedule to add one trillion dollars more into the economy than it has pulled out in fiscal 2019, and it will add a further $1.2-$1.3T in funding to the economy in fiscal 2020. Recessions happen when Federal deficits have been decreasing for some time, not when they are increasing.
We have pointed out to our subscribers several times in the past few weeks, that when it comes to the 10y-2y differential and the Fed funds rate, the present situation is very similar to that of the mid-to-late 1990s ( blue ovals on chart below). In the 1995-2000 time-period, the Fed funds rate was lower-to-steady, and the 10y-2y rate differential dropped down and flirted with inversion, just like it is doing today. Amazingly, during that same period the SPX increased 200%!
There is, however, one big difference. Throughout that time-period, Clinton was reducing the deficit, all the way up to a surplus (chart below).
In order to have a budget surplus, the Treasury must remove more funds from the economy than it adds. This forces the private sector to borrow in order to keep the economy expanding and maintain the government surplus (chart below).
Since private (non-government) debt must be paid back, the growth of the economy through private deficit spending (borrowing) is dependent on keeping "increasingly more balls in the air", i.e. more new loans being made, than are being paid back. And, in the Clinton case, some of the private loans had to go to the government just so it could have a surplus. Now that kind of debt truly is unsustainable--the private sector really can and does run out of dollars with which to maintain its debt. Government deficit spending, however, is more like a helium balloon than it is like juggling balls in the air; the helium balloon remains in the air and is not required to return to earth and be cancelled like private debt is required to do. (It should be noted that, although there is no requirement for the funds that are added by deficit spending to be paid back to the Federal government, the government can choose to take them out of the economy through taxation.)
The situation we find ourselves in, since the GFC, is much different from the Clinton era with regards to government deficit spending and private borrowing. The private sector reduced its debt from 170% of GDP, to less than 150% of GDP in the wake of the GFC, and has remained near that level to this day. The Federal government in the meantime, starting in 2010, steadily reduced its deficit spending until a brush with recession in 2015 forced it to start increasing its deficit spending once again, and is set to accelerate the increase in deficit spending as it goes into an election year.
So, while the situation today is similar to 1995 when it comes to Fed funds rates and the inverting yield-curve situation, the Federal deficit spending situation, and the private debt situation is much more favorable than it was then. Considering that the SPX increased 200% during that time, and since we now have more favorable government funding conditions than we did then, it is not unreasonable to expect a sizable rally in the SPX over the next year or two. Buying index ETFs such as DIA, SPY, QQQ, IWM, or any number of good quality stocks should be a hugely profitable investment, and a surprise to all those talking-heads that keep repeating the big lie about Federal deficits and debt.
During the 2018 correction, our analysis showed that we were not at the start of a new bear market and that the bull market was not in the process of ending. As a result, our subscribers avoided the herd mentality of panicked-selling and the losses it created.
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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.