Thursday, September 24, 2020

The Glass Is More Than Half Full

We didn’t know how good we had it in 2019. Then the pandemic hit in 2020, and we all concluded that it will take many years before life will be as good as it was in 2019. Perhaps we’re too pessimistic. After all, 2019 was better than we realized at the time; perhaps we’ll return to the good life sooner than we realize now. Let’s examine that notion, starting with how good it was in 2019, then considering how we might rebound to the good old days sooner than widely anticipated:

(1) Household income rose to record high in 2019. My attitude toward any data series that doesn’t support my story is that either it is flawed or it will be revised to support my story. That’s been my strongly held attitude toward median real household income, the annual series compiled by the Census Bureau and used to measure poverty in America. It’s been a big favorite with economic pessimists and political progressives in recent years because it confirmed their view that, for most Americans, the standard of living has stagnated for years.

My view has been that lots of other, more reliable indicators of income confirm that the standard of living has been improving for most Americans for many years. Now even the Census series confirms my story. So it’s back on the right track after misleadingly showing stagnation from 2000 through 2016 (Fig. 1). The median household series, which is adjusted for inflation using the CPI, is up 9.2% from 2016 through 2019 and hit new highs during each of the last three years (2017-19) after remaining flat from 2000 to 2016.

Also up over the past three years to new record highs are the Census series for median family (up 11.0%), mean household (10.7%), and mean family (12.5%) incomes. Almost everyone was doing better than ever before last year.

(2) Personal income data refute stagnation myth. While the Census data make more sense to me now, they still have lots of issues. Most importantly, the Census data are based on surveys asking a sample of respondents for the amount of their money income before taxes. So Medicare, Medicaid, food stamps, and other noncash government benefits—which are included in the personal income series compiled by the Bureau of Economic Analysis (BEA)—are excluded from the Census series. In addition, the BEA data are based on “hard” data like monthly payroll employment statistics and tax returns. BEA also compiles an after-tax personal income series reflecting government tax benefits such as the Earned Income Tax Credit.

The BEA series for personal income, disposable personal income, and personal consumption expenditures—on a per-household basis and adjusted for inflation using the personal consumption expenditures deflator (PCED) rather than the CPI—all strongly refute the stagnation claims of pessimists and progressives (Fig. 2). All three measures have been on solid uptrends for many years, including from 2000 through 2016, rising 25.1%, 27.9%, and 25.9%, respectively, over this period. They often rose to new record highs during this period. There was no stagnation whatsoever according to these data series. Instead, there was lots of growth!

The standard critique of using the BEA data series on a per-household basis is that they are means, not medians. So those at the very top of the income scale, the so-called “1- Percent,” in theory could be skewing both the aggregate and per-household data. That’s possible for personal income but unlikely for average personal consumption per household. The rich can only eat so much more than the rest of us, and there aren’t enough of them to substantially skew aggregate and per-household consumption considering that they literally represent only 1% of taxpayers, but almost 40% of the federal government’s revenue from income taxes, as discussed below.

(3) Real hourly wages belie stagnation myth too. Another data series that refutes the stagnation claim of pessimists and progressives is average hourly earnings (AHE), reported in the monthly employment report and reflected in the BEA income data. Adjusting it for inflation using the PCED shows that it soared during the second half of the 1960s through the early 1970s (Fig. 3). It then stagnated during the rest of the 1970s through mid-1995 as a result of what was then called “de-industrialization.” Since December 1994, it has been rising along a 1.2%-per-year growth path. That’s a significant growth rate in the purchasing power of consumers, as real AHE compounded to an increase of 37.2% from December 1994 through July of this year. That coincides with the High-Tech Revolution, which I’ve been writing about since 1993!

By the way, the hourly wage series I am using here is for production and nonsupervisory workers, which obviously doesn’t include the rich. Furthermore, these workers have accounted for between 80.4% and 83.5% of total payroll employment since 1964 (Fig. 4). So the real AHE series includes lots of working stiffs and isn’t distorted by the 1-Percent, let alone the top 20%-or-so of earners.

(4) The CPI is very misleading. It is well known that the CPI is upwardly biased, especially compared to the PCED (Fig. 5). Since January 1964 through July of this year, the CPI is up 838.5%, while the PCED is up 646.3%. As a result, while the PCED-adjusted AHE has been rising in record high territory since January 1999, the CPI-adjusted version didn’t recover to its previous record high during January 1973 until April 2020, which makes absolutely no sense (Fig. 6)! (An extremely flawed August 2018 study by the Pew Research Center concluded that Americans’ purchasing power based on the CPI-adjusted AHE has barely budged in 40 years!)

The Fed long has based its monetary policy decision-making on the PCED rather than the CPI. A footnote in the FOMC’s February 2000 Monetary Policy Report to Congress explained why the committee had decided to switch to the inflation rate based on the PCED.

(5) Adjusting for household and family sizes makes a difference. The fun of making fun of the funny-looking Census income data series continues when I adjust them for the average size of households and families in the US (Fig. 7 and Fig. 8). Both series have been on downward trends since the 1940s, especially the average size of households. Households have always been smaller than families, and earned less, since the former include single-person households, which have increased significantly in recent years because young adults have been postponing marriage and older folks have been living longer, resulting in more divorced and widowed persons.

Furthermore, data available since 1982 through 2019 show that the percentage of nonfamily households has increased from 25.1% to 35.7% over that period (Fig. 9 and Fig. 10). So there are more of these households that tend to earn less than family households. No wonder that the Census data adjusted for household size and for inflation using the PCED shows less stagnation and steeper uptrends since the start of the data (Fig. 11 and Fig. 12).

(6) The rich aren’t like you and me. What about the 1-Percent, who earn too much money, have too much wealth, and don’t pay their fair share of taxes? The total number of all the tycoons on Wall Street, in Silicon Valley, and in the C-suites of corporate America—including everyone with adjusted gross income (AGI) exceeding $500,000 a year—was 1.5 million taxpayers in 2017, exactly 1% of all taxpayers who filed returns that year, according to the latest available data from the Internal Revenue Service (IRS) (Fig. 13).

Collectively, during 2017 the 1-Percent paid $625 billion in income taxes, or 26.7% of their AGI. That amount represented 38.9% of all federal income tax paid by all taxpayers who paid any taxes at all (Fig. 14, Fig. 15, and Fig. 16). The rest of us working stiffs, the “99-Percent,” shelled out $980 billion, or 61.1% of the total tax bill. What should be the fair share for the 1-Percent? Instead of almost 40% of the federal government’s tax revenue, should they be kicking in 50%? Why not 75%? They would be less rich, but everyone else would be richer—unless the 1-Percent decided to work less hard or to leave the country, having lost their incentive to keep creating new businesses, jobs, and wealth.

(7) Can you Trump this? Love him or hate him, the standard of living did increase significantly during Trump’s first term (until the pandemic hit), as it has done under many previous presidents, especially those who have championed pro-growth and pro-business policies, including tax cuts and deregulation.

(8) Time for progressives to declare “mission accomplished?” Progressives continue to claim that government policies need to be more progressively focused on raising taxes and redistributing income. Until recently, they’ve relied on the Census income series to prove their point, though these measures clearly leave out the positive impact that past progressive policies have already had through Medicare, Medicaid, food stamps, tax credits, and other noncash government social benefits.

Progressives long have promised that their policies will create Heaven on Earth. Arguably, they have succeeded in doing so for many Americans with their New Deal, Great Society, and Obamacare programs. These programs have reduced income inequality by redistributing income, which has been growing faster than progressives concede thanks to America’s entrepreneurial spirit and capitalist system. Progressives, who never seem satisfied with the progress they have made, run the risk of killing the goose that lays the golden eggs to pay for their programs. Incomes can always be made equal by making everyone equally poor.

As confirmed by the latest available IRS data, there is no denying that the rich got richer during 2017 and earned more taxable income than ever before. They undoubtedly continued to do so during 2018 and 2019. But now even the Census data show that real median household income rose to a record high last year. Most Americans were more prosperous last year than ever before, though some more so than others. Why does anyone have a problem with that?

The bottom line is that just before the pandemic, American households enjoyed record standards of living. Income stagnation was a myth. Income inequality isn’t a myth but an inherent characteristic of free-market capitalism, an economic system that awards the biggest prizes to those capitalists who benefit the most consumers with their goods and services. Perversely, inequality tends to be greatest during periods of widespread prosperity. Rather than bemoaning that development, we should celebrate that so many households are prospering, even if a few are doing so more than the rest of us.

(9) Housing-led recovery. So how do we bring back the good times once the pandemic is over so that we can enjoy widespread prosperity again? We may not have to wait that long. The pandemic has triggered a housing boom that could offset many of the ongoing woes in industries still plagued by the pandemic. De-urbanization is certainly weighing on urban economies, but suburban ones are booming because more and more city apartment dwellers are moving to homes in the burbs. There’s increasing anecdotal evidence that Millennials who’ve been renting apartments in urban areas are responding to the pandemic by buying houses in the burbs. Housing-related retail sales of furniture, furnishings, and appliances have rebounded to record highs as both existing and new home sales are surging.

Among the industries that are most likely to face a challenging recovery are the ones covered by the following categories of personal consumption expenditures: air transportation, hotels & motels, food services, amusement parks & related recreation, admission to special spectator amusements, and gambling. Altogether, these categories added up to $996 billion (saar) during July, while housing-related construction and consumption totaled $862 billion. While the recent recovery in the former could stall until a vaccine is available, the latter is likely to boom in coming months (Fig. 17).

Furthermore, Americans have $10.6 trillion in home mortgages. Thanks to the Fed’s ultra-easy monetary policies, many are refinancing their loans at record-low mortgage rates, providing a significant boost to monthly household incomes. Those record-low mortgage rates are also helping to keep home buying affordable even as home prices continue to rise. In addition, Americans have a record $20.2 trillion in home equity. If they need it, they can use it to raise some cash through home equity loans or by selling their homes at record-high prices. The glass is at least half full.

Monday, September 21, 2020

What In the World Is Going On? A Recovery from the Global Lockdown Recession Is Underway.

There has never been a recession like the one that hit the global economy earlier this year. It was truly global because every country in the world experienced an economic downturn as almost all governments around the world responded to the pandemic by imposing lockdown restrictions to slow the spread of the virus. China (in late January) and Italy (in early March) did so before the World Health Organization (WHO) officially declared the pandemic on March 11. Almost everyone else followed suit immediately after the WHO declaration. While the pandemic continues to plague the world with new outbreaks and waves of infection, the global economy has recovered in recent months. Let’s take a world tour to assess the strength and sustainability of the recovery:

(1) Global PMIs and leading indicators. It’s been a V-shaped recovery according to the global PMIs (purchasing managers indexes) for both advanced and emerging economies as well as for both manufacturing and non-manufacturing around the world (Fig. 1 andFig. 2). The global composite PMI—which combines the global manufacturing indexes (M-PMIs) and non-manufacturing indexes (NM-PMIs)—rebounded from a record low of 26.2 during April to 52.4 during August, the best reading since March 2019. That’s certainly a V-shaped recovery.

Not surprisingly, leading on the way down and on the way up was the NM-PMI for advanced economies. As a result of social distancing, this has been the first-ever global recession led by services-producing industries. It hit the global economy hard during March and April. The gradual easing in lockdown restrictions led to a solid rebound in both non-manufacturing and manufacturing industries since the April bottom.

The index of OECD leading indicators confirms the V-shaped recession and recovery for the advanced economies. It plunged from 99.4 during January to a record low of 93.2 during April, and rebounded to 98.3 during August (Fig. 3). Here are the three readings for January, April, and August for the US (99.3, 92.6, 97.6), Europe (99.5, 90.7, 98.3), and Japan (99.5, 98.3, 98.9). The OECD also compiles leading indicators for the BRIC countries. Here are their three readings for January, April, and August: Brazil (103.1, 93.3, 100.4), China (98.1, 94.9, 98.8), India (100.1, 87.1, 97.1), and Russia (99.7, 91.0, 98.7) (Fig. 4).

(2) Global production and exports. So far, we have data only through June for global industrial production and world exports (Fig. 5). They both show steep declines from December through April of 13.0% and 18.2%, respectively, and have rebounded 5.7% and 8.0% since then, through June.

The most current, and among the most relevant, export series for gauging the global economy is the one reported by China. The data we track are seasonally adjusted and available through August. Chinese exports (in yuan) plunged 42.1% from January through February, then rebounded through July to a record high; it dipped slightly in August, though still exceeded January’s reading by 9.1% (Fig. 6). That’s impressive.

(3) Commodity prices. Also impressive is the rebound in the CRB raw industrials spot price index, led by the price of copper (>Fig. 7). Since March 23—when the Fed announced its policy response to the pandemic, which we call “QE4ever”—through Friday, September 11, the former is up 10%, while the latter is up 43%. The price of copper has rebounded from a low of $2.12 per pound on March 23 to $3.03 on Friday, September 11, holding near September 4’s $3.05, which was the best reading since June 20, 2018, i.e., when Trump started to escalate his administration’s trade wars.

My colleagues and I created a Global Growth Barometer (GGB), which simply averages the CRB index of industrial commodity prices with the price of a barrel of Brent crude oil (Fig. 8). It is very similar to the S&P Goldman Sachs Commodity Index (GSCI), which gives energy commodities a combined weight of 61.71%; that compares with the 50.00% weight that our GGB gives to oil. Recently, the price of oil dropped a bit on concerns about a slowdown in the global economic recovery, which hasn’t been confirmed by either the CRB index or the price of copper. Our GGB and the GSCI are up 19% and 29%, respectively, since March 23.

(4) Currencies. By the way, there continues to be a strong inverse correlation between commodity price indexes (using either our GGB or the GSCI) and the trade-weighted dollar (TWD) (Fig. 9). The relationship between the dollar and commodity prices is quite a bit easier to see on a chart than the relationship between the dollar and US fiscal and monetary policies relative to those of other major economies.

The TWD has dropped 7.5% through September 11 since peaking this year on March 23. That coincided with the rebound in our GGB. It also nearly reverses the 9.4% surge in the TWD since the start of this year through its recent peak, which coincided with the pandemic-related plunge in commodity prices.

I’ve often observed that the dollar tends to weaken when overseas economies are showing strength relative to the US economy. Rising commodity prices suggest that’s the case relative to countries that are commodity producers. The inverse correlation between the dollar and commodity prices is partly attributable to the strong correlation between commodity prices and the currencies of commodity-producing countries such as Australia and Canada (Fig. 10).

China’s economy fell into the pandemic-related recession earlier this year before the US did the same, and China’s recovery started a couple of months sooner than the recovery in the US. China also seems to have made more progress in ending the spread of the virus than elsewhere in the world. That helps to explain why the Chinese yuan is up 4.7% since May 28 through Friday, September 11 (Fig. 11).

For a few weeks during the summer, it seemed that Europeans were also making more progress in dealing with the pandemic than have Americans. That explains some of the 9.8% bounce in the euro since May 7 through Friday, September 11 (Fig. 12). But now that Europeans are returning from their long summer vacations, another wave of infection is hitting Europe.

However, the euro may continue to benefit from the perception that the pandemic has reduced, rather than increased, the likelihood of the disintegration of the European Union (EU) and the Eurozone. On July 20, the 27 EU governments reached a breakthrough agreement authorizing the European Commission, the executive branch of the EU, to raise €750 billion to provide grants and loans to help member countries cover the costs of dealing with the pandemic.

This deal marks a precedent for common debt borrowing at the EU level, something that many countries, including Germany, opposed for a long time. But this oppositional stance had softened in the wake of the COVID-19 crisis.

Wednesday, September 2, 2020

The Future Is Coming: The Technology Revolution of the Roaring 2020s

In my August 12 newsletter, I discussed the technological innovations that drove the prosperity of the 1920s. Then I discussed the ones that are likely to do the same during the current decade:

“The awesome range of futuristic ‘BRAIN’ technological innovations includes biotechnology, robotics and automation, artificial intelligence, and nanotechnology. There are also significant innovations underway in 3-D manufacturing, electric vehicles [EVs], battery storage, blockchain, and quantum computing.”

In my 2018 book, Predicting the Markets, I observed:

“In the past, technology disrupted animal and manual labor. It sped up activities that were too slow when done by horses, such as pulling a plow or a stagecoach. It automated activities that required lots of workers. Assembly lines required fewer workers and increased their productivity. It allowed for a greater division of labor, but the focus was on brawn. Today’s ‘Great Disruption,’ as I like to call it, is increasingly about technology doing what the brain can do, but faster and with greater focus.”

The future is always coming, of course. However, the future is already here to a large extent. Consider the following awesome technologies that are just starting to proliferate in ways that should boost productivity and prosperity:

(1) Home-based work, education, and entertainment. The pandemic has transformed the way many people work, pursue an education, and get entertained. They can do all these activities from home because of technologies that allow them to carry on their lives over the Internet. When the pandemic is finally over, many people may go back to their old normal routines. Employers, however, may tell their employees to continue to work from home or closer to home in the suburbs. Reducing or eliminating commutes to work certainly increases productivity. It also cuts the costs of urban office space.

A recent study by the National Bureau of Economic Research compared employee behavior over two eight-week periods before and after shelter-in-place mandates were implemented. Looking at email and meeting metadata, the group calculated that the workday lasted 48.5 minutes longer, the number of meetings increased about 13%, and people sent an average of 1.4 more emails per day to their colleagues.

(2) Telemedicine. Telemedicine allows patients to visit with clinicians remotely using virtual technology. Innovative uses of telemedicine are increasing with advances in telehealth platforms and remote patient-monitoring technology. New mobile health apps and wearable monitoring devices help track a patient’s vitals, provide alerts about needed care, and help patients access their physician. Over the last few months, millions of people have relied on video or telephone calls to talk to their doctors.

During the coronavirus pandemic, the Centers for Medicare and Medicaid Services (CMS) has taken unprecedented action to expand telehealth for Medicare beneficiaries. On March 13, 2020, President Trump made an emergency declaration under the Stafford Act and the National Emergencies Act empowering CMS to issue waivers to Medicare program requirements to support healthcare providers and patients during the pandemic. One of the first actions CMS took under that authority was to expand Medicare telehealth on March 17, 2020, allowing all beneficiaries to receive telehealth in any location, including their homes.

Before the public health emergency, approximately 13,000 beneficiaries in fee-for-service Medicare received telemedicine in a week. In the last week of April, nearly 1.7 million did so. In total, over 9 million beneficiaries have received a telehealth service during the public health emergency, mid-March through mid-June, according to a July 15 HealthAffairs blog post.

(3) 6G. An August 21 article in SingularityHub, titled “6G Will Be 100 Times Faster Than 5G—and Now There’s a Chip for It,” reports the following:

“Though 5G—a next-generation speed upgrade to wireless networks—is scarcely up and running (and still nonexistent in many places) researchers are already working on what comes next. It lacks an official name, but they’re calling it 6G for the sake of simplicity (and hey, it’s tradition). 6G promises to be up to 100 times faster than 5G—fast enough to download 142 hours of Netflix in a second—but researchers are still trying to figure out exactly how to make such ultra-speedy connections happen.”

However, this technology probably won’t be available for prime time until 2030. For now, we’ll have to settle for 5G. The pandemic has slowed the rollout of 5G at the same time as it has increased the demand for the technology to facilitate working remotely by boosting data transmission speeds. Nevertheless, the rollout should continue during the second half of this year into 2021. When it becomes truly accessible, it promises to be more than 30 times faster than the average 4G download speed and to revolutionize self-driving cars, augmented reality, and the Internet of Things.

(4) Robotics, automation, and 3D manufacturing. The August 18 issue of National Geographic featured an article titled “The robot revolution has arrived.” The COVID-19 pandemic has significantly boosted the interest in having robots do more of what humans did before the health crisis. In many instances, it is simply the medically wise alternative to using infection-prone humans. The article reports:

“Already, in 2020, robots take inventory and clean floors in Walmart. They shelve goods and fetch them for mailing in warehouses. They cut lettuce and pick apples and even raspberries. They help autistic children socialize and stroke victims regain the use of their limbs. They patrol borders and, in the case of Israel’s Harop drone, attack targets they deem hostile.”

The pandemic disrupted global supply chains. One likely outcome is that manufacturers will increasingly explore ways to work with suppliers closer to home. Instead of just-in-time inventories, companies will be looking for ways to have just-in-case inventories available in the event of future supply disruptions. They are increasingly using 3D printers to produce parts on demand to the exact specification and in the exact numbers required—reducing wait time and safeguarding against external disruptions.

Robots, automation, and 3D printers are revolutionizing manufacturing. An August 21 article in reports:

“Mighty Buildings claims to increase the efficiency and reduce the waste in building modern homes. Drawing from foundations in robotics, manufacturing and sustainability, Mighty Buildings’ goal is no less than the reimagination of the construction sector. The company uses a combination of 3D printing and prefab techniques to automate up to 80 percent of the building process for greater productivity. … According to the Oakland, Calif.-based startup, they can build a 350-square-foot studio unit in under 24 hours while using 95 percent fewer labor hours at twice the speed of traditional manufacturing methods.”

If one of the consequences of the pandemic is de-urbanization, there will be more suburbanites who will need to buy one or more cars to get around their small towns. The August 7 Forbes reports:

“A mass shift to single-occupancy vehicles is occurring nationwide according to new research from Cornell University, which poses a major traffic and pollution problem in many cities. The solution, according to today’s most influential automakers, is to accelerate the development of electric, driverless cars programmed by artificial intelligence.”

Volkswagen AG pledged more than a fifth of its vehicles will be electric by 2025, while investing 44 billion euros ($52 billion) on autonomous driving and “mobility services” by 2023.

By the end of the 2020s, autonomous drones carrying passengers and cargo could be as ubiquitous as in the old television cartoon The Jetsons. EHang, a Chinese company, reportedly is ahead of the pack with its autonomous aerial vehicle, or AAV. A user can summon an EHang drone using an app. The drone lands at a predetermined spot near the requested pick-up location. It can carry up to two passengers with a combined weight of under 440 pounds and travel up to 32 kilometers (22 miles) on a single charge.

(5) Batteries. The outlook for EVs and drones depends largely on progress made in increasing the capacity and service lives of large batteries while reducing their weight, as Jackie and I have often discussed in the past. The future may belong to solid-state batteries, which reportedly could be available by 2025. That’s the same year that the world’s biggest automakers plan to launch an array of new electric models.

Wednesday, August 12, 2020

Another Roaring Twenties May Be Ahead

We seem to be living in unprecedented times. We always seem to be living in unprecedented times, according to conventional wisdom, mostly because we don’t spend enough time studying history. There’s certainly a precedent for our current times in the past, one that was truly unprecedented back then.

World War I was followed by the Spanish Flu pandemic of 1918, which infected an estimated 500 million people and killed as many as 50 million. Given that the world population was 1.8 billion back then, that implied a 28% infection rate and nearly a 3% death rate. Both stats are currently significantly lower for the COVID-19 pandemic. Today, the global population is 7.5 billion. There have been 20 million cases and 735,000 deaths worldwide as of yesterday.

The good news is that the bad news during the previous precedent was followed by the Roaring Twenties. So far, the 2020s has started with the pandemic, but there are plenty of years left for the prosperous 1920s to become a precedent for the current decade. If so, the driver of the coming boom will be technology-enhanced productivity, as it was during the 1920s.

Before we go there, let’s go back to the late 1700s and recall the grim forecasts of Thomas Malthus. He was the first economist, and he was a pessimist. In other words, he was the first Malthusian. During the late 1700s, he predicted that populations would grow faster than food production; the result would be a regular cycle of starvation and death. He was dead wrong. Agriculture was among the industries that benefited the most from the Industrial Revolution of the 1800s. Technological progress always confounds the pessimists by solving scarce-resource problems. It also fuels productivity and prosperity, as it did in the 1920s and could do again in the 2020s. Consider the following:

(1) Technology during the 1920s. In 1920, 51% of the US population lived in cities, up from 23% in 1870. This remarkable urbanization was enabled by innovations in electricity and plumbing. Electric grids provided clean, bright light without emitting smoke. Urban water networks supplied clean water, and sewer systems removed waste without the pungent odors of chamber pots and outhouses. Telephones allowed people to converse with distant friends.

Henry Ford’s Model T, built between 1908 and 1927, was the first car invented and helped people to live an easier life by making transportation easier and faster. In 1900, just 8,000 motorcars were registered in the US, but there were 9 million in 1920 and 23 million in 1929. Streetcars and subways, unheard of in 1870, were in all the major cities by 1920. Intercity trains were becoming steadily faster and more reliable. Detroit Police Officer William Potts came up with the idea of traffic lights, taking inspiration from railroad traffic signals. General Electric bought the idea for $40,000, and traffic lights soon were everywhere.

Ford’s assembly line innovation boosted productivity in many manufacturing industries, including the processed food industry. National food brands—including Heinz, Campbell’s, Quaker Oats, Jell-O, and Coca-Cola—began to fill cupboards. Refrigerated railroad cars and in-home iceboxes meant that vegetables were available in winter. Restaurants began to proliferate early in the 20th century. When people out and about in their Model Ts got hungry, their options were few, but the first fast-food chain opened its doors in 1919, an A&W (better known today for its root beer). White Castle hamburger stands opened in 1921, and the first Howard Johnson’s restaurant in 1925.

Increasingly, anything not available in a local store could be obtained by a mail-order catalog. The Montgomery Ward catalog was first issued in 1872, the Sears catalog in 1894. By 1900, Sears was fulfilling 100,000 orders a day, and its catalog featured fur coats, furnaces, furniture, and much more—including homes. Sears sold more than 70,000 mail-order homes between 1908 and 1940. The catalog business was helped along by Parcel Post, which arrived in 1913.

Penicillin is considered one of the most important inventions to come out of the 1920s. It was created by Sir Alexander Fleming, Professor of Bacteriology at St. Mary’s Hospital in London, after studying bacteria in 1928. The antibiotic kills or prevents the growth of bacteria.

The bulldozer—used today in all kinds of construction the world over—was invented in 1923 by James Cummings and J. Earl McLeod, originally to dig canals.

Another popular invention found in almost every home by the mid-1900s was the radio. Listening to the radio became a national pastime, and many families gathered in their living rooms to listen to sports news, concerts, sermons, and “Red Menace” news. The phonograph—invented in 1877 and widely used by the 1920s—offered another entertainment option: listening to professional-quality music at home, unheard-of in earlier generations. Outside the home, going to motion picture shows—which were silent until 1927—was a very affordable and popular pastime.

(2) Technology during the 2020s. Today’s doomsters could be confounded by biotechnological innovations that deliver not only a vaccine for COVID-19 but for all coronaviruses. Scientists are investigating a dizzying array of approaches to fight COVID-19. Hopefully, beyond finding a cure or a vaccine, one of beneficial outcomes of all this research will be that scientists learn many more ways to combat illnesses in general and viruses in particular. Typically, it takes roughly a decade for a new vaccine to go through the various stages of development and testing. However, the urgency of the pandemic has mobilized global medical resources as rarely seen in human history. Billions of dollars, provided by both the public and the private sectors, are funding the global campaign to develop tests, vaccines, and cures for the virus.

My colleague Jackie Doherty and I have been writing about disruptive technologies for some time, usually in our Thursday commentaries. (See our archive of Disruptive Technologies Briefings) The awesome range of futuristic “BRAIN” technological innovations includes biotechnology, robotics and automation, artificial intelligence, and nanotechnology. There are also significant innovations underway in 5G for cellular networks, 3-D manufacturing, electric vehicles, battery storage, blockchain, and quantum and edge computing.

As I wrote in my 2018 book Predicting the Markets:

“Economics is about using technology to increase everyone’s standard of living. Technological innovations are driven by the profits that can be earned by solving the problems posed by scarce resources. Free markets provide the profit incentives to motivate innovators to solve this problem. As they do so, consumer prices tend to fall, driven by their innovations. The market distributes the resulting benefits to all consumers. From my perspective, economics is about creating and spreading abundance, not about distributing scarcity.”

Now consider the follow stats on technology capital spending in the US: High-tech spending on IT equipment, software, and R&D rose to a record $1.32 trillion (saar) during Q2-2020 (Fig. 1). It jumped to a record 50.1% of total capital spending in nominal GDP during the quarter (Fig. 2). Equipment and software accounted for 31.1%, while R&D accounted for 19.1% of capital spending in nominal GDP (Fig. 3).

The 1920s ended with a stock market meltup followed by a meltdown. The 2020s may already be seeing a meltup, begun on March 23. We live in interesting, though not unprecedented, times. The Roaring 1920s could be a precedent for the Roaring 2020s. As Mark Twain observed: “History doesn’t repeat itself, but it often rhymes.”

Friday, August 7, 2020

May the Bond Vigilantes Rest in Peace

Bonds I: Eulogy. Let me begin my eulogy for the Bond Vigilantes with apologies to William Shakespeare. The emotional eulogy for Julius Caesar that Shakespeare penned for the character Marc Antony in his play Julius Caesar inspired the words that I would like to share with you on this solemn occasion:

Friends, countrymen, citizens of the world, lend me your ears. I come to bury the Bond Vigilantes, not to praise them. The noble Fed killed its rival, the Bond Vigilantes, because they were too ambitious. If it were so, it was a grievous fault. The Bond Vigilantes sought to marshal market forces to counter the ever-growing power of the government. That cause is noble and good. But while the evil that men do lives after them, the good is oft interred with their bones—so let it be with the Bond Vigilantes. Their well intentioned efforts were doomed to failure. The Fed meant well too, as did Caesar’s assassins. Both comprise honorable men. But men have lost their reason. Bear with me; my heart is in the coffin there with the Bond Vigilantes, and I must pause ’til it come back to me.

Bonds II: Requiem. My friends, I still fondly recall the days when the Bond Vigilantes rode high and mighty. The July 27, 1983 issue of my weekly commentary was titled “Bond Investors Are the Economy’s Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

To this day, every time bond yields rise significantly almost anywhere in the world, I get asked to appear on at least one of the financial news TV networks to discuss whether the Bond Vigilantes are back. Having popularized “hat-size bond yields” and “Bond Vigilantes,” I’ve learned to appreciate the power of coining pithy terms to brand my economic and financial forecasts. Coin a good phrase that accurately describes future developments, and it will appear in your obituary, if not on your tombstone.

The Bond Vigilantes Model tracks the rise and fall of the Wild Bunch. It simply compares the bond yield to the growth rate in nominal GDP on a year-over-year basis (Fig. 1). My model shows that since 1953, the yield has fluctuated around the growth rate of nominal GDP. However, both the bond yield and nominal GDP growth tend to be volatile. While they usually are in the same ballpark, they rarely coincide. When their trajectories diverge, the model forces me to explain why this is happening. On occasions, doing so has sharpened my ability to see and understand important inflection points in the relationship. Here is a brief nostalgic walk down Bond Street:

(1) Getting whipped by inflation. From the 1950s to the 1970s, the spread between the bond yield and nominal GDP growth was mostly negative (Fig. 2). Investors underestimated the growth rate of nominal GDP because they underestimated inflation. Bond yields rose during this period but remained consistently below nominal GDP growth. Those were dark days for bond investors.

(2) Keeping law and order. The Bond Vigilantes were increasingly in command during the 1980s and 1990s. They fought to bring back law and order in the fixed-income markets to the benefit of bond investors. There were several episodes when rising bond yields slowed the economy and put a lid on inflation.

The Bond Vigilantes’ heyday was the Clinton years, from 1993 through 2001. Placating them was front and center on the administration’s policy agenda. Indeed, Clinton political adviser James Carville famously said at the time, “I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

(3) Long siesta. After the mid-1990s, the Bond Vigilantes seemed less active, because they no longer had to be as vigilant. As inflation fell, the spread between the bond yield and nominal GDP growth narrowed and fluctuated around zero. While today the US government faces the problem of persistently big federal budget deficits, it’s interesting to recall that at the start of 2001, a major topic of discussion was how big the coming surplus in the federal budget might get.

During the early 2000s, after the 9/11 terrorist attacks, the Fed kept the federal funds rate too low, and a global savings glut kept a lid on bond yields and mortgage rates. They remained relatively flat even as the Fed started raising the federal funds rate “at a measured pace” of 25bps moves, from 1.00% to 1.25% on June 30, 2004 up to 5.25% through June 29, 2006 (Fig. 3).

(4) Long good buy. The Great Financial Crisis (GFC) of 2008 caused the Fed to implement ultra-easy unconventional monetary policies. The federal funds rate was pegged in a range of 0.00%-0.25% from December 16, 2008 through December 16, 2015. The Fed’s three QE (quantitative easing) programs caused the Fed’s holdings of bonds to balloon from $0.48 trillion during the final week of November 2008 to $4.19 trillion by the start of October 2014 (Fig. 4). Inflation remained remarkably subdued after the GFC. Starting January 2012, the Fed targeted core PCED (personal consumption expenditures deflator) inflation at 2%, but it has remained below that pace during all but 13 months since then (Fig. 5).

The Fed’s QE3 was terminated near the end of 2014, and the federal funds rate was raised for the first time since the GFC on December 16, 2015. Fed officials continued to ratchet rates higher up to 2.25%-2.50% on December 19, 2018. They were expecting to normalize monetary policy (Fig. 6).

Nevertheless, investors, reaching for yield, poured money into bonds. The 10-year US Treasury bond yield fell to 1.92% at the end of 2019 (Fig. 7). It was a long good buy from the peak in its yield of 15.84% back on September 30, 1981 (Fig. 8).

(5) Last rites. The bond yield fell below 1.00% for the first time on March 5, 2020, and has been consistently below since March 20. The World Health Organization declared a pandemic on March 11. The Fed responded to the Great Virus Crisis (GVC) by lowering the federal funds rate by 100bps to zero and implementing QE4 on March 15. On March 23, QE4 was turned into QE4Ever. The bond yield fell to a record low of 0.55% on Friday. The Bond Vigilantes have been buried by the Fed.

Bonds III: The Inflation Scenario. Many investors who profited from the long good buy are now saying “you are dead to me” to the bond market. They are rebalancing more of their portfolios into other assets, such as US stocks, SPACs (special-purpose acquisition companies), precious metals, and overseas assets including currencies, stocks, and bonds.

The end of the long-term bull market in bonds has been declared, erroneously, by market prognosticators for many years. It may not be over just yet. The yield on the 10-year Treasury could still fall to zero. It could even turn slightly negative, as have comparable yields in Germany and Japan (Fig. 9).

Then again, what if a vaccine and effective treatments are discovered to end the pandemic early next year? Never before has the drug industry received billions of dollars to develop such medicines at warp speed. In this scenario, the global economy could recover quickly next year. Inflation could finally jump above the Fed’s 2.0% target as demand for goods and services outstrips supply, especially if global supply chains have been significantly disrupted by the pandemic and by the worsening Cold War between the US and China.

Would rising inflation cause bond yields to soar? I don’t think so. Both monetary and fiscal officials know that rising interest rates could abort the post-GVC recovery. They also realize that a rebound in interest rates would significantly balloon federal deficits and the debt. Net interest paid by the federal government totaled $346.9 billion over the 12 months through June, down from a record high of $384.8 billion during March (Fig. 10).

I believe that the Fed publicly would welcome inflation in a range of 2.0% up to 4.0% as a long overdue offset to inflation running below 2.0% for so long in the past. In this scenario, the Fed might announce that the federal funds rate will be held at zero and that the bond yield will be pegged below 1.00%. In other words, any sign that the Bond Vigilantes might rise from their graves (along with inflation) would be met by the Fed with whatever it takes to keep them buried. This would be wildly bullish for all of the alternative assets to bonds mentioned above, especially growth stocks and precious metals.

My view that the Fed’s attitude toward rising inflation is evolving into one of benign neglect was confirmed by an important August 2 article by Nick Timiraos, the WSJ’s ace Fed watcher, titled “Fed Weighs Abandoning Pre-Emptive Rate Moves to Curb Inflation.” Timiraos reports that the Fed “is preparing to effectively abandon its strategy of pre-emptively lifting interest rates to head off higher inflation, a practice it has followed for more than three decades.”

The Fed first formally targeted inflation in a January 25, 2012 press release titled “Federal Reserve issues FOMC statement of longer-run goals and policy strategy.” It stated: “The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate.” The widespread interpretation was that once the target was achieved, it would be a ceiling.

Timiraos reports that some Fed officials wouldn’t mind if inflation were to run hot above 2% for a while since it has run cold for so long. They want to offset previous deviations on the downside with a stretch of inflation overshooting the 2% target for a while.

Might all of this eventually lead to hyperinflation? I am not in the hyperinflation camp. But if that’s the ultimate endgame of Modern Monetary Theory (MMT), then all bets are off.

Bonds IV: The Dollar Vigilantes. Of course, the death of the Bond Vigilantes could lead to the emergence of other vigilantes in the financial markets. The Dow Vigilantes got what they wanted in response to the freefall in stock prices from February 19 through March 23. They got QE4Ever plus the CARES Act. The result has been trillions of dollars printed and spent by Fed Chair Jerome Powell and Treasury Secretary Steven Mnuchin.

The Gold Vigilantes are certainly expressing their fear and loathing of this unholy alliance between fiscal and monetary policies. But they don’t have the kind of power that the Bond Vigilantes once had to rein in policy excesses. The only market players left with any power are the Dollar Vigilantes. They have lots of fear and loathing of MMT and can do something about it.

They can devalue the dollar relative to other currencies, thus putting upward pressure on import prices, which could revive inflation. Even the Wizards of MMT acknowledge that they should at least think about tapping on the brakes if inflation makes a comeback.