We have been
discussing for years how the growth of the Fed’s balance sheet from $800bn to
$4.5tn from 2009 to thru 2014, and near zero interest rates (ZIRP) have caused
all forms of mal-investment that in the
final analysis will bring down the “house of cards” that is the stock and bond
markets. But it gets even more
interesting, in terms of the central bank “insanity”. That the ECB, BOJ, and the BOE upped the ante
even more by instituting negative interest rate policies (NIRP) will prove to be even more detrimental, in the
long run, than ZIRP. (We did not include
the PBOC (Peoples Bank of China) in this, the reason being that China is not a
fully opened economy, given the fact that currency cannot flow freely across
its borders. But they take a second seat
to no one when it comes to over-leverage and debt. The downside of that story will surely come in
the future as well.)
balance sheet of the Fed has gone basically sideways for the past 3 years, the
ECB, BOJ, and BOE were adding just under $5tn collectively, to theirs. And given the fact that foreign exchange
markets are very liquid and well developed, it should be of no surprise that
much of that non-US central bank stimulus found its way here to further inflate
U.S. stock and bond prices. Now the Fed
is reducing its balance sheet, albeit quite slowly. If all goes according to plan, however, the
combined balance sheets of the big four will still increase by about $235bn
this year, according to data from J.P. Morgan and the banks themselves. It is not until 2019 that the net of the
balance sheets result in a reduction.
But there is no doubt about that after ten years of central bank balance
sheet expansion, the reversal of the process is a ”giant elephant” in the room
for stocks and bonds.
elephant” in the room is the tremendously large and growing Non- Financial Debt
to GDP ratios that exist in the developed world. We, and others of a similar persuasion, have
said for years that excessive debt slows growth as increasing resources are
consumed by debt service. According to a
report in October 2017 by David A. Rosenberg, at Gluskin Sheff +Associates
Inc., these ratios now stand at 250% for the U.S., 372% for Japan, 257% for
China, 180% for Germany, and 240% for the G20 as a whole. All but Germany are up substantially over the
past ten years. Does anyone think these
numbers are coming down? Does anyone
think that the Trump tax cut and infrastructure plan, assuming it gets through,
will result in lower deficits and less borrowing? We believe a substantial extended growth in
GDP, even once the effect of the tax cut and repatriation are factored in, is a
elephant" in the room is the state of employment, labor force demographics, productivity,
entitlements, and how they all relate.
The growth rate in GDP can be viewed as the change in hours worked
multiplied by the change in output per hour.
With the economy at or near full employment, it is hard to see how there
can be a large increase in hours worked.
In addition, the Trump Administration immigration policies have the
potential to cause a reverse migration of the workers, particularly Central American,
that have been here. While there are
arguments as to the wisdom of those policies on both sides, we see a reverse
migration as being highly wage inflationary as individuals in the social safety
net will need financial incentives to enter the work force and take those
vacated jobs. That leaves output per
hour, i.e. productivity, to do the heavy lifting. Productivity growth has been anemic, (under
1%per year). In the absence of some
unforeseen leap in technological innovation there is nothing on the horizon
that portends a resurgence of productivity.
In fact, it’s just the opposite.
than the “Old Maestro” himself, Alan Greenspan has been sounding the alarm on
growth of entitlements as it relates to both debt and productivity. His thesis, which we subscribe to, is that
entitlement dependency discourages savings, which is the lifeblood of
investment. And it is investment in
plant, equipment, and human capital that increases productivity. And of course, given this as a backdrop, what
are some of our leading politicians doing?
According to a Wall St Journal editorial of 2/28/18 titled “A New GOP
Entitlement”, a new family leave benefit is being proposed and would be
financed by a present day raid on the Social Security Trust Fund. As the editorial points out, “every
entitlement since the Revolutionary War Pensions has skidded down the slope of
So these are
just three of the “elephants in the room”, that we believe will provide
significant headwinds to economic growth. They are very detrimental in the long term, and
are a large part of the reason we have been so negative on the stock market,
and remain so.
P.T. Barnum’s elephants once thrilled and
amused tens of thousands of people around the world every year. Millions of investors around the world will
have quite the opposite reaction when the aforementioned "elephants" bring down
the stock and bond markets!