Saturday, December 12, 2020

Inflation Was Sooo 1970s! Will It Roar Back in the 2020s?

Inflation I: Post-Pandemic Worry. I was an early believer in “disinflation.” I first used that word, which means falling inflation, in my June 1981 commentary titled “Well on the Road to Disinflation.” The Consumer Price Index (CPI) inflation rate was 9.6% that month. I predicted that Federal Reserve Chair Paul Volcker would succeed in breaking the inflationary uptrend of the 1960s and 1970s, which he did.

Nevertheless, throughout my career, I’ve often fielded questions about the likelihood of a rebound in inflation from accounts who were worried that it just might make a comeback. After all, the Fed chairs who followed Volcker tended to favor stimulative monetary policies. This year, as a result of the unprecedented monetary and fiscal policy stimulus provided by governments around the world to offset the adverse financial and economic consequences of the Great Virus Crisis (GVC), I’m hearing more concern that inflation could come roaring back once the pandemic is over.

In this widely feared scenario, interest rates might soar. That would create all sorts of trouble. The mountains of debt accumulated by the public and private sectors would compound at a faster pace. The credit markets could seize up, causing a credit crunch and a recession, possibly worse than those of the Great Financial Crisis (GFC). Stock markets would fall into bear markets as earnings declined and valuation multiples tumbled. If inflation were to come roaring back, my upbeat Roaring 2020s outlook would be its biggest casualty.

Given the consequences of getting their expectations for inflation wrong, it’s no wonder investors are worried about this bad-case scenario even if they aren’t ready to do anything in response to it, other than talk about it more often. In any event, while I’m still a disinflationist, our YRI team is focused on watching out for signs of trouble on the inflation front. Before I review what we are seeing, let’s briefly recount what happened during the Great Inflation of the 1970s.

Inflation II: A Brief History of Inflation in the 1970s. Almost everything that could go wrong did so back then. I reviewed what happened in my 2020 book titled Fed Watching for Fun and Profit. For starters, on August 15, 1971, President Richard Nixon suspended the convertibility of the dollar into gold, which ended the Bretton Woods system that had kept the dollar’s value at a constant $35 per ounce of gold since the system was established in 1944. The value of the dollar in foreign exchange markets suddenly plummeted, causing spikes in import prices as well as the prices of most commodities priced in dollars.

During the summer of 1971, Nixon imposed wage and price controls. They didn’t work, and the controls were lifted in 1973. During 1972 and 1973, for the first time since the Korean War, farm and food prices began to contribute substantially to inflationary pressures in the economy. Also, there was a major oil price shock during 1973 and again in 1979 (Fig. 1).

Together, the two oil price shocks of the 1970s caused the price of a barrel of West Texas crude oil to soar 11-fold from $3.56 during July 1973 to a peak of $39.50 during mid-1980, using available monthly data (Fig. 2). As a result, the CPI inflation rate soared from 2.7% during June 1972 to a record high of 14.8% during March 1980. Even the core inflation rate (i.e., the rate excluding food and energy) jumped from 3.0% to 13.0% over this period as higher energy costs led to faster wage gains, which were passed through into prices economy-wide. During the 1970s, strong labor unions in the private sector succeeded in quickly boosting wages through cost-of-living clauses in their contracts. The result was an inflationary wage-price spiral (Fig. 3).

It’s my view that the 1970s were uniquely inflation prone. Paul Volcker stopped the inflationary wage-price spiral by tightening monetary policy significantly during the late 1970s and early 1980s, causing a severe recession. However, inflation continued to trend lower since then through today, mostly because of the four deflationary forces (i.e., the “4Ds”), which we have discussed many times along the way. (For a summary, see the excerpt from my 2020 book titled Four Deflationary Forces Keeping a Lid on Inflation.)

Inflation III: Will the 4Ds Drown in M1’s Tsunami? The question for us today is whether the 4Ds are still relevant or whether they’ve met their inflationary match in the extraordinary monetary and fiscal policy responses to the pandemic. The 12-month federal deficit rose to a record high of $3.3 trillion through October, while the Fed’s purchases of Treasury securities totaled a record $2.4 trillion over the same period (Fig. 4). Most of those expansions occurred since the week of March 23, when the Fed and the Treasury essentially embraced Modern Monetary Theory and morphed into “T-Fed” in response to the GVC.

Contrary to Milton Friedman’s claim that inflation is essentially a monetary phenomenon, it has remained subdued ever since the GFC notwithstanding the ultra-easy monetary policies of the major central banks. We soon should find out if money matters to the inflation outlook given that the GVC has resulted in ultra-easy monetary policies on steroids and speed combined! In the US, M1 has increased by $2.3 trillion since the last week of February to a record $6.2 trillion during the week of November 23 (Fig. 5). It is up an astonishing and unprecedented $498 billion during the latest week and 57% y/y! MZM and M2 are up 28% and 25% y/y (Fig. 6).

Our money is on the 4Ds. They should continue to keep a lid on inflation. Here is our current bottom lines on each of the 4Ds:

(1) D├ętente. In the grand sweep of economic history, inflation tends to occur during relatively short and infrequent episodes, i.e., during war times. The more common experience has been either very low inflation or outright deflation during peacetimes.

Periods of globalization follow wartimes. During peacetimes, national markets become increasingly integrated through trade and capital flows. The result is more global competition, which is inherently deflationary. The worsening Cold War between the US and China is a threat to globalization, but probably won’t heat up to the point of causing inflation now that a regime change is coming to Washington. In any event, China’s exports during November edged back up to the record high hit during July notwithstanding Trump’s trade war with that country (Fig. 7).

(2) Technological Disruption. Nevertheless, recent global trade tensions and the pandemic are likely to cause businesses to diversify their offshore supply chains away from China and to onshore more of them. That could be costly and inflationary. It could also be cost effective now that labor shortages attributable to global demographic trends are stimulating technological innovations in automation, robotics, artificial intelligence, and 3D manufacturing. These all enable onshoring and boost productivity to boot.

Nonfarm productivity jumped 4.0% y/y during Q3, the fastest pace since Q1-2010. We are expecting a secular rebound in productivity growth during the Roaring 2020s. So far, so good: The 20-quarter growth rate of productivity (at an annual rate) is up from a recent low of 0.6% during Q4-2015 to 1.7% during Q3 (Fig. 8). I believe that the pandemic accelerated the pace of applying new technologies to boost efficiency and profit margins, as we will discuss more fully tomorrow.

(3) Demographics. Fertility rates have plunged below population replacement in recent decades around the world as urbanization has changed the economics of having children. Instead of being an important source of labor and elder care, as they were in agrarian communities, children are all cost in urban settings. Nursing homes have few vacancies, while maternity wards have plenty. Increasingly geriatric demographic profiles are inherently deflationary.

4) Debt. During the 1960s through the 1980s, debt was stimulative; more of it stimulated more demand and added to inflationary pressures. Now, easy credit conditions aren’t as stimulative to demand as in the past because so many consumers have so much debt already. However, easy monetary conditions are a lifeline to zombie companies, enabling them to raise funds to stay in business and add to global supplies of goods and services, which is deflationary.

Inflation IV: By the Numbers. Now let’s review the latest inflation data around the world. Inflation remains remarkably subdued, as it has been since the mid-1990s. Consider the following:

(1) G7. The core CPI inflation rate among the seven major industrial economies has fluctuated in a flat range between a high of 2.2% and a low of 0.7% since 1997 (Fig. 9). The core rate was only 1.1% during October. Here are the latest core CPI inflation rates for the US (1.6%), Eurozone (0.2), and Japan (-0.4) (Fig. 10).

(2) China. While China’s economy has staged a significant recovery from its lockdown recession at the start of the year, the CPI inflation rate dropped from a recent peak of 5.8% during February to only 0.5% during October. The Producer Price Index was down 2.1% y/y during October.

(3) US. The pandemic has had a dramatic inflationary impact on only one component of the CPI: Used car and truck prices are up 11.5% y/y through October (Fig. 11). (They are up 14.4% in the PCED, or personal consumption expenditure deflator, measure.) This is a category with little weight in the CPI.

Rent of shelter has a much bigger weight, and its inflation rate has been falling sharply as a result of the pandemic because of two phenomena: people unable to pay their rent and renters becoming homeowners. This CPI item’s inflation rate is down from 3.4% at the start of the year to 2.1% during October (Fig. 12). It does include hotel and motel fees, which should reflate once a vaccine is widely distributed.

Inflation V: Bonds, the Dollar & Commodity Prices. Notwithstanding all the above, the financial markets seem to be signaling that inflationary pressures are making a comeback of sorts. More likely, in our opinion, is that they’re simply signaling that the deflationary pressures initially unleashed by the pandemic are abating as the global economy continues to recover. Consider the following:

(1) Expected inflation rebounds. The 10-year US Treasury bond yield has been relatively flat just below 1.00% recently, while the comparable TIPS yield has been edging lower again following a smallish and shortish rebound from its fall earlier this year (Fig. 13). As a result, the yield spread between the two, which is widely used as a proxy for the average annual 10-year expected inflation rate, has rebounded from this year’s low of 0.5% on March 19 to 1.9% on Monday (Fig. 14).

(2) Copper is red hot. The price of copper has rebounded dramatically along with China’s economy as auto sales in China rose for a fourth straight month in October. The price of the red metal is up 65.5% since the year’s low on March 23 from $2.12 per pound to $3.51 on Monday (Fig. 15). The two previous rebounds that exceeded the current one since 2004 were not associated with rising CPI inflation.

Meanwhile, the ratio of the nearby futures prices of copper to gold continues to signal that the bond yield should be closer to 2.00% than to 1.00% (Fig. 16). There’s been a tight fit between the ratio (multiplied by 10) and the yield since 2004. Without the Fed’s open market purchases of Treasury notes and bonds, the yield would probably be higher, boosting the expected inflation proxy over 2.00%.

By the way, the reason why the copper/gold ratio tracks the nominal yield so closely is that the price of copper is highly correlated with the yield spread inflation proxy, while the price of gold is highly correlated with the inverse of the 10-year TIPS yield (Fig. 17 and Fig. 18).

(3) The dollar’s descent. Yet another interesting set of correlations is the ones between the inverse of the dollar versus the price of copper and versus expected inflation (Fig. 19 and Fig. 20). All three variables are consistent with rising inflation pressures. However, similar past episodes in recent years signaled that deflationary pressures were abating rather than inflation rebounding.

Saturday, December 5, 2020

The Carrie Trade: From Bond Vigilantes to Bond Zombies

Carrie is a horror novel by Stephen King. It was his first published novel, released on April 5, 1974. It was turned into a movie in 1976 starring Sissy Spacek and John Travolta. Carrie is a misfit bullied in her high school and dealing with an abusive, religious fanatic mother at home. She finds that she can channel her angst into telekinetic powers, which she uses to exact revenge on her tormenters. Much blood is spilt along the way, including Carrie’s. In the final scene, she seems to rise from the dead but that’s just a bad dream.

The Bond Vigilantes have been buried by the Fed. However, in our nightmare scenario, they could rise from the dead like Carrie. It isn’t likely to happen if inflation also remains buried, as I expect.

Meanwhile, there are other vigilantes in the financial markets. The Dow Vigilantes sent out a blood-curdling scream when the S&P 500 plunged 33.9% in 33 days earlier this year (Fig. 1). The Fed responded with QE4ever on March 23. The Dollar Vigilantes are threatening a crash in the currency if US fiscal and monetary policies continue to placate the Dow Vigilantes by swelling the federal budget deficit and the money supply (Fig. 2, Fig. 3, and Fig. 4). A plunge in the dollar could revive inflation and unleash a plague of Bond Zombies.

It’s hard to get a clear signal from the financial markets since their price mechanisms have been so distorted by the Fed and the other major central banks. The one clear signal may be coming from the commodity markets. Consider the following:

(1) CRB raw industrials. The CRB raw industrials spot price index continues to signal rebounding global economic activity (Fig. 5). It is highly inversely correlated with the trade-weighted dollar. The rising CRB index is bullish for the Emerging Markets MSCI stock price index, the Australian and Canadian dollars, and the S&P 500 Materials sector. (See our Market Correlations: CRB Raw Industrials Spot Price Index.)

The CRB index is also highly correlated with expected inflation as measured by the yield spread between the 10-year nominal Treasury bond and the comparable TIPS (Fig. 6). This spread has rebounded from this year’s low of 0.50% on March 19 to a range of 1.6%-1.8% in recent weeks.

(2) Copper. The price of copper is one of the 13 components of the CRB raw industrials spot price index (Fig. 7). (Petroleum and lumber products are not included in the index.) The copper price has been leading the overall CRB index higher since this year’s bottom. On Monday, copper closed at the highest price since January 2, 2014. Driving the price of the red metal higher has been China’s M-PMI, which has recovered solidly over the past six months through November (Fig. 8).

(3) Copper/gold ratio. When I multiply the ratio of the nearby futures prices of copper to gold by 10, the resulting series has shown a remarkably close fit with the 10-year Treasury bond yield since 2004 (Fig. 9). The ratio currently suggests that the bond yield should be closer to 2.00% than to 1.00%. As I discussed on Monday in my Morning Briefing, the yield has remained under 1.00% since March 20, as the Fed has been buying Treasury notes and bonds faster than the Treasury has been issuing them:

“From the last week of February through the last week of October, the Fed’s holdings of Treasury securities increased $2.1 trillion as follows by maturities: One year or less ($421 billion), 1-10 years ($1,281 billion), and over 10 years ($351 billion) (Fig. 9). From the end of February to the end of October, the Treasury increased its outstanding marketable debt by $3.4 trillion as follows: bills ($2,420 billion), notes ($735 billion), and bonds ($284 billion) (Fig. 10). In other words, the Fed financed 62% of the Treasuries financing needs across all maturities, and purchased $613 billion more notes and bonds than were issued over that period!”

That’s the “Carrie trade.” As long as it continues, the Bond Vigilantes will remain buried.

(1) 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. During the 1980s and 1990s, there were a few episodes when rising bond yields slowed the economy and put a lid on inflation.”

Tuesday, December 1, 2020

Comparative Roaring '20s

This should be the first and last holiday season requiring us all to socially distance from one another. Apparently, we will have a cornucopia of vaccines and treatments available for mass distribution early next year. If so, then 2020 may mark the beginning of the Roaring 2020s, as I've discussed in previous LinkedIn articles. Let’s compare the current situation to the one before and during the Roaring 1920s:

(1) World War I. Recall that the years leading up to the Roaring 1920s included World War I from July 28, 1914 through November 11, 1918. The total number of military and civilian casualties in World War I was about 40 million, with estimates ranging from around 15-22 million deaths and about 23 million wounded military personnel—ranking World War I among the deadliest conflicts in human history.

(2) Spanish flu. That was followed by the Spanish flu pandemic from February 1918 through April 1920. It infected 500 million people—about a third of the world's population at the time—in four successive waves. The death toll is typically estimated to have been somewhere between 17 million and 50 million, and possibly as high as 100 million, making it one of the deadliest pandemics in human history.

(3) Depression of 1920–21. There was a severe deflationary recession in the US, the UK, and other countries beginning 14 months after the end of World War I. It lasted from January 1920 to July 1921. How depressing! The Great War (as it was called back then) and the pandemic of 1918-20 killed between 32 million and 72 million people. That was followed by a global depression (as recessions were called back then). No one at the start of the decade could have anticipated the technology-led revolution of the Roaring 1920s or the resulting prosperity of that period. Thanksgiving during 1920 must have been extremely depressing indeed.

(4) The high-tech revolution of the 1920s. As I reviewed in my August 12 article, the 1920s was a decade of amazing technological innovations. Some of them sped up activities that were too slow when done by horses and automated activities that required lots of workers. Assembly lines required fewer workers, and their productivity increased. The revolution allowed for a greater division of labor. The focus was mostly on brawn.

The automobile produced on assembly lines revolutionized transportation. The bulldozer did the same for construction. The standard of living improved dramatically for everyone as 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. National food brands proliferated, as did restaurants. Department stores and mail order retailers provided goods to a rapidly growing consumer market. Penicillin was discovered.

(5) The trade wars of 2018-19. The 2020s were preceded by a trade war between the US and China. President Donald Trump started and escalated it during 2018 and 2019. The Biden administration is likely to deescalate the resulting Cold War. Nevertheless, as a consequence of both ongoing tensions between the two countries and the pandemic, manufacturers are likely to move more of their operations and supply chains to the US. That could be inflationary. More likely is that some of the technological innovations discussed below will boost productivity and reduce energy and transportation costs.

(6) The pandemic of 2020. So far, the Covid-19 virus has killed 1.5 million people worldwide including 276,000 in the US. That’s a terrible outcome, but nowhere near the Spanish flu’s lethal toll. The biotech revolution is likely to deliver effective vaccines against the Covid-19 virus this time.

(7) The high-tech revolution of the 2020s. Today’s “Great Disruption,” I like to call it, is increasingly about technology doing what the brain can do, but faster and with greater focus. Given that so many of the new technologies supplement or replace the brain, they lend themselves to many more applications than did the technologies of the past, which were mostly about replacing brawn. Today’s innovations produced by the IT industry are revolutionizing lots of other ones, including manufacturing, energy, transportation, healthcare, and education. My friends at BCA Research dubbed it the “BRAIN Revolution,” led by innovations in biotechnology, robotics, artificial intelligence, and nanotechnology. That’s clever, and it makes sense.

The current pandemic seems to be speeding up the pace at which these and other technologies are proliferating. I believe that productivity growth has been heading toward a secular rebound during the post-pandemic Roaring 2020s. Even before the Great Virus Crisis (GVC), companies had been moving to incorporate into their businesses a host of state-of-the-art technologies in the areas of computing, telecommunications, robotics, artificial intelligence, 3-D manufacturing, the Internet of Things, among others. The GVC is accelerating that trend as companies rethink how to do business ever more efficiently in the post-pandemic era. See my September 2 article titled “The Future Is Coming: The Technology Revolution of the Roaring 2020s.”

(8) One major difference. The one major difference between the 1920s and the early 2020s (post the November 3 election) is the political persuasion of the presidency. During the 1920s, the White House was occupied by two very conservative Republican presidents: Warren G. Harding (March 4, 1921–August 2, 1923) and Calvin Coolidge (August 2, 1923–March 4, 1929). Coolidge advocated smaller government and laissez-faire economics.

Andrew Mellon was secretary of the Treasury from March 9, 1921 through February 12, 1932. One of his achievements was the Revenue Act of 1926, which reduced the top marginal rate to 25%. In addition to cutting taxes on top earners, the act raised the personal exemption for federal income taxes, abolished the gift tax, reduced the estate tax rate, and repealed a provision that had required the public disclosure of federal income tax returns.

The incoming Biden administration has promised to raise numerous taxes including on corporations and on taxpayers earning more than $400,000 annually. I remind the incoming administration that trickle-down economics works both ways: Higher taxes on the rich and on corporations inevitably trickle down to everyone else.

Sunday, November 22, 2020


The following is the Introduction to our latest study in our "Predicting the Markets" series. The paperback and e-book are available on Amazon here. The other studies in this series are available on my Amazon author's page here.

I started my career on Wall Street in 1978. I spent the prior year at the Federal Reserve Bank of New York in the economics research department after receiving my undergraduate degree in economics and government from Cornell University in 1972 and my PhD in economics from Yale University in 1976. Over the past 40-plus years, I’ve worked as both the chief economist and the chief investment strategist at several firms on Wall Street. Since January 2007, I’ve been the president of my own consulting firm, Yardeni Research, Inc.

My job continues to be to predict the financial markets, particularly the major stock, bond, commodity, and foreign exchange markets around the world. I’ve learned a lot about these markets over the years. I recently started sharing what I’ve learned in a series of books and studies.

In this study, I will focus on the S&P 500 stock price index, examining how it is determined by the earnings of the 500 companies that are included in the index and the valuation of those earnings by the stock market.

Why pick the S&P 500?

The S&P 500 is a stock market index that measures the stock price performance of 500 large companies listed on stock exchanges in the United States. It is one of the most widely followed equity indexes. The stocks in this index are a representative sample of leading companies in leading industries. Many equity managers benchmark the performance of their portfolios to the S&P 500. Among the largest exchange-traded funds are those that track the S&P 500. The S&P 500 represents more than 83% of the total domestic US equity market capitalization.[1]

The widely followed Dow Jones Industrials Average (DJIA) has only 30 companies. It was launched in 1896 and was a spin-off of the Dow Jones Transportation Average, which was first compiled in 1884 by Charles Dow, the co-founder of Dow Jones & Company. The S&P 500 dates back to 1923. That year, the Standard Statistics Company (founded in 1906 as the “Standard Statistics Bureau”) developed its first stock market index, consisting of the stocks of 233 US companies and 26 industries, computed weekly. (The company also began rating mortgage bonds in 1923.) In 1926, it developed a 90-stock index, computed daily. In 1941, Poor’s Publishing merged with Standard Statistics Company to form Standard & Poor’s (S&P). On March 4, 1957, the index was expanded to its current 500 companies and was renamed the “S&P 500 Stock Composite Index.”

The components of the S&P 500 index and other S&P indexes are selected by the firm’s US Index Committee, which meets monthly. All committee members are full-time professional members of the firm’s Indices staff. At each meeting, committee members review pending corporate actions that may affect the indexes’ constituent companies, statistics comparing the indexes’ composition to the broad stock market, candidate companies under consideration for addition to an index, and the bearing of any significant market events on the indexes.

The committee identifies important industries within the US equity market, approximates the relative weight of these industries in terms of market capitalization, and then allocates a representative sample of stocks within each industry of the S&P 500. There are 11 sectors according to the Global Industry Classification Standard (GICS): Communication Services, Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Information Technology, Materials, Real Estate, and Utilities.[2] These sectors are further divided into 24 industry groups, 69 industries, and 158 subindustries.

Candidates for inclusion in the S&P 500 index must meet specific criteria in eight areas: market capitalization, liquidity, domicile, public float, GICS, financial viability, length of time publicly traded, and stock exchange listing. The index is reconstituted quarterly, though changes are made infrequently.

The S&P 500 index is a free-float, capitalization-weighted index. That means that companies are weighted in the index in proportion to their market capitalizations. To determine the market-capitalization weight of a company, only the number of shares available for public trading (free float) is used. Shares held by insiders or by controlling shareholders that are not publicly traded are excluded from the calculation. The largest companies (based on market capitalization) in the S&P 500 account for a substantial portion of its total market capitalization. Since the index is market-capitalization weighted, these companies have the greatest influence on the index’s price performance.

Notwithstanding occasional bear markets, the S&P 500 has been a great investment over the years—so much so that “S&P” could stand for “Success & Profit.” Since January 1, 1955, through September 2, 2020, the index has been down in bear markets during 3,029 of the 16,535 trading days—i.e., just 18.3% of the time. It has risen at a compounded annual rate of 6%, a rate that doubles the value of this portfolio every 12 years. And that doesn’t include the dividend return provided by many of the S&P 500 companies.

The first chapter in our study covers the various measures of earnings for the S&P 500 and why we favor forward earnings among them. The second chapter discusses various models of valuation, again focusing on the S&P 500. The final chapter uses the resulting analytical framework to review how it has worked in good times and bad, focusing on the Great Financial Crisis and the Great Virus Crisis.

[1] See S&P Global, S&P 500: The Gauge of the Market Economy and S&P U.S. Indices Methodology, August 2020. See S&P Dow Jones Indices.

[2] The Global Industry Classification Standard is jointly developed and maintained by S&P Dow Jones Indices and MSCI.

Saturday, November 14, 2020


A large team of the Fed’s researchers have been busy constructing a new database containing quarterly estimates of the distribution of US household wealth since 1989. They launched it with the release of a March 2019 working paper titled “Introducing the Distributional Financial Accounts of the United States.” The Distributional Financial Accounts (DFA) is an impressive accomplishment combining quarterly aggregate measures of household wealth from the Financial Accounts of the United States (FA) and triennial wealth distribution measures from the Survey of Consumer Finances (SCF).

I. A much more comprehensive database. We believe that the new database can be used to resolve lots of controversial issues about wealth distribution in the US. The DFA’s balance sheet of the household sector is much more comprehensive and timely than previously existing sources. The Fed’s researchers observe that their “approach produces rich and reliable measures of the distribution of the Financial Accounts’ household-sector assets and liabilities for each quarter from 1989 to the present.” The data can be used to study the distribution of wealth in America by wealth and income percentiles, education, age, generation, and race. Melissa and I intend to do just that in coming months with the goal of assembling a comprehensive study tentatively titled “Income & Wealth in America: Myths & Realities.”

II. Who owns equities in America, according to FA? Aggregate data are available in Table L.223 in the FA for corporate equities held by each of the major sectors in the accounts. Unlike the DFA, the household sector in the FA includes nonprofit organizations, and this sector’s data are calculated residually from the other accounts. Let’s review our findings:

(1) The supply side of equities. The total market value of equities held in the US during Q2-2020 was $52.0 trillion, with domestic issues totaling $43.5 trillion and foreign issues totaling $8.5 trillion (Fig. 1). Domestic issues included $33.5 trillion of nonfinancial issues and $10.0 trillion of financial issues and consisted of $37.2 trillion of publicly traded and $6.3 trillion of closely held equities (Fig. 2 and Fig. 3). The $6.3 trillion of closely held equity consisted of $4.7 trillion in S corporations and $1.6 trillion in C corporations (Fig. 4).

(2) Ownership by sectors. During Q2-2020, of the $52.0 trillion in equities, the major sectors directly held the following amounts and percentage shares: household sector ($19.5 trillion, 37.6%), mutual funds and exchange-traded funds (ETFs) ($14.5 trillion, 27.8%), rest of the world ($8.2 trillion, 15.8%), and institutional investors ($7.0 trillion, 13.4%) (Fig. 5 and Fig. 6).

(3) Directly and indirectly held by households. The FA includes a Table B.101e titled “Balance Sheet of Households and Nonprofit Organizations with Debt and Equity Holdings Detail.” It provides extraordinary insight into the indirect equity holdings of households through life insurance companies, private and public pension funds, and mutual funds. During Q2-2020, households and nonprofits directly held $19.5 trillion (37.6% of all equities) and indirectly held $12.4 trillion (23.8% of the total) (Fig. 7). In other words, their direct and indirect holdings of equities totaled $31.9 trillion, or 61.4% of all equities (Fig. 8). Interestingly, this percentage has been remarkably stable around 65% since the early 1980s.

III. Which households own equities, according to DFA? The link between the household sector in the FA and in the DFA is Table B.101.h titled “Balance Sheet of Households,” which unlike Table L.223 excludes nonprofit organizations from the household sector. On the other hand, this balance sheet shows the household sector’s combined holdings of corporate equities and mutual fund shares, which include bond funds but not money market mutual funds or ETFs. The assets and liabilities in this version of the household balance sheet are the ones for which the DFA provides all the data needed for analyzing the distribution of household net worth. (See “Household Balance Sheet” from our forthcoming study on income and wealth in America.)

Now, let’s analyze the distribution of the DFA’s various series for corporate equites and mutual fund shares held by households, sliced and diced by wealth percentile, generation, and education:

(1) DFA by wealth percentiles. We repeat: The DFA is based on the FA’s Table B.101.h, which is the “Balance Sheet of Households” excluding the assets and liabilities of nonprofit organizations. It shows only annual data and reveals that corporate equities and mutual funds held by households at the end of 2019 totaled $29.1 trillion (Fig. 9). In the DFA, this series is shown on a quarterly basis. By the way, we can derive a similar quarterly series as the sum of corporate equities held by households and nonprofits plus mutual fund shares held by them, as reported in FA Table L.224, which excludes money market funds and ETFs (Fig. 10).

The DFA shows that corporate equities and mutual fund shares held by households was down slightly to $26.8 trillion during Q2-2020, with the following ownership and percentage shares of the total among wealth percentile groups: top 1% ($14.1 trillion, 52.4%), 90%-99% ($9.5 trillion, 35.8%), 50%-90% ($3.0 trillion, 11.2%), and bottom 50% ($0.2 trillion, 0.6%) (Fig. 11 and Fig. 12).

The bottom 50% never owned more than 1.6% of this asset category. The 50%-90% crowd’s share peaked at 21.4% during Q3-2002 and since has fallen to 11.2% currently. The 90%-99% group has held a fairly steady share around 35% since the early 1990s. The top 1% has ranged between a low of 40.2% and a high of 52.8%.

The widespread notion that the very rich own a disproportionate share of corporate equities is true, but their collective share is more like 50% of the total held by households than the urban legend of 80%-90%.

(2) DFA by generations. The DFA allows us to compare the amount of an asset or liability held and the percentage shares by four generations: Silent (born before 1946), Baby Boomer (1946-1964), GenX (1965-1980), and Millennial (1981-96).

Here are the values of corporate equities and mutual funds held by the four generations and their percentage shares during Q2-2020: Silent ($5.1 trillion, 19.0%), Baby Boomer ($14.8 trillion, 55.3%), GenX ($6.3 trillion, 23.4%), and Millennial ($0.6 trillion, 2.2%) (Fig. 13 and Fig. 14).

Since the start of the data in 1989, the percentage share held by the Silent generation has dropped from around 80%-90% to 19% currently, while the percentage share of the Baby Boom generation increased from 10%-20% to 55% currently. The GenX share was close to zero in early 2009 and has been trending up; it’s around 23% currently. The Millennials’ share remains close to zero.

(3) DFA by education. Finally for now, let’s have a look at the impact of education on the ownership of corporate equities and mutual fund shares. The DFA data show that households headed by college-educated persons held 82.9% of corporate equities and mutual fund shares during Q2-2020 (Fig. 15 and Fig. 16). That percentage has been trending higher since Q1-1995, when it fell to a series low of 60.2%. Households with heads who had some college, high school, and no high school owned only 9.9%, 6.3%, and 0.8%. Education is clearly a vitally important determinant of financial well-being.

IV. What's the bottom line? Since the early 1960s, the household sector (including nonprofit organizations) has directly and indirectly held 65% of equities in America. Of the equities held by households (excluding nonprofit organizations), the “1%” hold around 50% of this asset class. Older people with college educations tend to own more equities than younger ones with less education.

Monday, November 2, 2020

Gridlock Is More Bullish Than Blue or Red Waves

I’ve often observed that the US economy has performed remarkably well over the years despite Washington. Presidents like to take credit for the millions of jobs they have created or boast about the number of jobs they will create. Presidential candidates make similar promises about how their policies will boost employment by millions if they are elected or re-elected.

The reality is that it is businesses that create jobs, not politicians. Businesses tend to do a better job of creating jobs when they aren’t burdened by Washington’s meddling in their affairs. Since Washington almost always meddles to varying degrees with the economy, it’s amazing how so many businesses in so many industries continue to be profitable and to expand their capacity and payrolls, with only recessions briefly tripping them up.

This line of thinking leads to the widely held notion that the economy and the stock market do best when Washington’s politicians are stymied from meddling as much as they would like by political gridlock, i.e., when the party of the president doesn’t have majorities in the House and/or the Senate. Divided government is bullish, while unified government is bearish, or less bullish.

Our governing system of “checks and balances” is the core principle that guided the nation’s founders when they wrote the US Constitution. In addition, many of them signed the Declaration of Independence, which declared: “Governments are instituted among Men, deriving their just powers from the consent of the governed.” They were mostly lawyers, and they designed a system that worked best when it didn’t allow any majority party to have too much power for too long.

By the way, Abraham Lincoln, who was a lawyer as well as a president, famously restated the founding principle in his Gettysburg Address: “that these dead shall not have died in vain—that this nation, under God, shall have a new birth of freedom—and that government of the people, by the people, for the people, shall not perish from the Earth.”

Today, many investors fear that a Blue Wave on Election Day could happen, giving the Democrats’ unfettered power to implement their expansive and expensive agenda, including increasing federal spending, raising federal taxes, imposing more regulations, packing the Supreme Court, and so on. Wall Street strategists, including yours truly, countered that the bearish impact of higher taxes and more regulations should be offset by more spending in the Blue Wave scenario.

At my firm, we recently analyze the performance of the S&P 500 under unified and divided government since FDR took office (Fig. 1). We calculated the percentage increases in the index from January-through-December periods during the two alternative regimes. We found that during the previous six Blue Waves, the S&P 500 increased 56% on average. During the previous three Red Waves, the index rose 35% on average. During the seven periods of divided government, the S&P 500 rose 60% on average.

This suggests that gridlock is more bullish than the two unified alternatives, which are also bullish, but less so, with Blue Waves more bullish than Red Waves. Perhaps the market figures that government is less likely to grow much bigger when the government is divided rather than unified. In any event, the government has been getting bigger and more meddlesome for years, as evidenced by ever-widening federal budget deficits and mounting federal government debt (Fig. 2). (The founders generally disapproved of debt and believed that the amount the country owed should be limited.)

Alternatively, could it be that the White House and the Congress don’t matter as much to the stock market as does the Fed? I think so, and so does Barron’s, which chose to run a cover story on Fed Chair Jerome Powell with the title “This Is Jerome Powell’s Moment, No Matter Who Wins” this week. The article, written by Nick Jasinski, observed: “Tuesday’s election will be a critical one for the nation. But for those nervous about the economy, the Fed’s chairman may just be the most important man in Washington.”

I was quoted in the piece as follows: “He’s a pragmatic pivoter. He’s done what he set out to do, and [shown a willingness to] change his mind depending on what the situation demands, but not be totally inconsistent.” Chapter 8 of my book Fed Watching for Fun & Profit is titled “Jerome Powell: The Pragmatic Pivoter.”

I previously have observed that no matter who wins the White House on Tuesday (or before Inauguration Day), he won’t be as important as Powell, whose first term doesn’t end until early 2022. Powell has made it very clear that he intends to keep the yield curve close to zero. The federal funds rate was lowered to zero on March 15 (Fig. 3).

The 10-year US Treasury bond yield has been below 1.00% since March 20 (Fig. 4). From February through September, the Treasury issued $670 billion in notes and $259 billion in bonds (Fig. 5 and Fig. 6). Over the same period, the Fed purchased $1,223 billion in notes and $338 billion in bonds. Previously, I’ve argued that if the bond yield rises above 1.00%, the Fed will most likely announce an official target range below 1.00%, a.k.a. “yield-curve targeting.”

Finally, since Halloween coincided with a full moon this weekend, all the more reason to fear the front cover curse. What could possibly go wrong for Powell?

Wednesday, October 14, 2020

Don't Fight T-Fed

The Fed I: Birth of T-Fed. What a difference a pandemic makes. Prior to the Great Virus Crisis (GVC), Fed officials were either dismissive of Modern Monetary Theory (MMT) or remained silent on the subject since it crosses into the realm of fiscal policy. Fed officials have had a very long tradition of never crossing that line. They do monetary policy. Congress and the White House do fiscal policy. Period! Nothing to see here. Move on.

Since the GVC, Fed officials repeatedly and frantically have been exhorting the fiscal authorities to do much more to support the economy. They’ve made it very clear that they will continue to help finance the resulting federal deficits by purchasing most, if not all, of the Treasury debt issued to pay for more fiscal stimulus. They’ve certainly been doing so since March 23, when they implemented QE4ever, which has already mostly financed the $2.2 trillion CARES Act signed by President Donald Trump on March 27. Consider the following:

(1) Consolidating the Treasury & the Fed. Over the past 12 months through August, the federal budget deficit totaled a record $2.92 trillion (Fig. 1). Over the same period, the Fed’s holdings of Treasuries is up by a record $2.26 trillion. Now that the Treasury and the Fed have joined forces in the MMT crusade to drown the virus in liquidity, we might as well consolidate the two of them into “T-Fed.” The result is that the federal government needed to borrow just $663 billion from the public over the past 12 months through August (Fig. 2)!

(2) The Fed’s portfolio of Treasuries. The Fed held a record $4.45 trillion in US Treasuries at the end of September (Fig. 3). That amounts to 24.2% of the Treasury’s marketable debt outstanding (Fig. 4). The Fed owns 20.0% and 36.9% of US marketable Treasury notes and bonds, respectively (Fig. 5).

(3) Good ol’ Feddie. During the Great Financial Crisis, mortgage giants Fannie Mae and Freddie Mac were placed in conservatorship on September 7, 2008. The Fed rose to the occasion and was transformed by then-Fed Chair Ben Bernanke into “Feddie.” QE1 was introduced on November 25, 2008. In this first round of quantitative easing, the Fed committed to purchase $1.24 trillion in mortgage-backed securities and agency debt (Fig. 6). Since QE4ever, the Fed has purchased $618 billion in such securities, bringing their total to a record $1.98 trillion during September. The result has been record-low mortgage rates, which has contributed to the housing boom caused by de-urbanization in response to the pandemic and mounting urban crime (Fig. 7).

The Fed II: De Facto Yield-Curve Targeting. What if another big round of deficit-financed fiscal spending pushes up bond yields and mortgage rates? That would be a big setback for MMT crusaders. The 10-year Treasury bond yield has averaged 0.68% since MMT Day (March 23) through Friday’s close. It rose to 0.79% on Friday, up from the record low of 0.52% on August 4 (Fig. 8).

Have no fear; the Fed is here with YCT (yield-curve targeting), which it will use if necessary to supplement MMT by keeping a lid on bond yields. Actually, the remarkable stability of the bond yield near record lows since March 23 suggests that the Fed may be capping the bond yield below 1.00% without officially saying so.

Ever since March 23, Powell repeatedly has stated that the Fed intends to keep interest rates close to zero for a very long time. At his June 10 press conference, he famously said: “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.” He reiterated that policy in his July 29 press conference, saying: “We have held our policy interest rate near zero since mid-March and have stated that we will keep it there until we are confident that the economy has weathered recent events and is on track to achieve our maximum employment and price stability goals.”

Remember that the Fed lowered the federal funds rate by 100bps to zero on March 15. No target was set for the bond yield at that time or has been since then—so far. At the June 10 presser, Nick Timiraos of the WSJ asked Powell about the possibility of “yield caps.” Powell revealed that at the latest meeting of the Federal Open Market Committee (FOMC), the participants received a briefing on the historical experience with YCT and said that they would evaluate it in upcoming meetings. Here is the excerpt on YCT from the June 10 FOMC meeting Minutes:

“The second staff briefing reviewed the yield caps or targets (YCT) policies that the Federal Reserve followed during and after World War II and that the Bank of Japan and the Reserve Bank of Australia are currently employing. … [T]hese three experiences suggested that credible YCT policies can control government bond yields, pass through to private rates, and, in the absence of exit considerations, may not require large central bank purchases of government debt. But the staff also highlighted the potential for YCT policies to require the central bank to purchase very sizable amounts of government debt under certain circumstances … and the possibility that, under YCT policies, monetary policy goals might come in conflict with public debt management goals, which could pose risks to the independence of the central bank.”

So how might the Fed be keeping a lid on the 10-year bond yield? Simple: The Fed has been buying all the bonds that the Treasury has been issuing in recent months and then some. From February through September, the Treasury issued $259 billion in bonds with maturities exceeding 10 years. Over that same period, the Fed purchased $338 billion of such bonds.

The Fed III: How To Print Money. Fed Chair Jerome Powell’s important interview on 60 Minutes with Scott Pelley was aired on May 17. Pelley asked where Powell got the trillions of dollars that the Fed spent on purchasing bonds since March 23: “Did you just print it?” Powell forthrightly responded: “We print it digitally. So as a central bank, we have the ability to create money digitally. And we do that by buying Treasury bills or bonds or other government guaranteed securities. And that actually increases the money supply. We also print actual currency, and we distribute that through the Federal Reserve banks.”

Powell also acknowledged that there was no precedent for the scale of QE4ever: “The asset purchases that we’re doing are a multiple of the programs that were done during the last crisis.” Let’s review how T-Fed’s actions since MMT Day have boosted the M2 monetary aggregate:

(1) US Treasury’s deposit account at the Fed. The Treasury has been borrowing at a record pace in the Treasury market to fund the various government support programs aimed at reducing the economic damage and pain resulting from the GVC. The federal budget deficit has totaled a record-shattering $1.9 trillion from March through September. As a result, the US Treasury General Account at the Fed has jumped from $439 billion at the end of February to $1.7 trillion during the October 7 week (Fig. 9).

(2) The Fed’s US Treasury purchases. Over that same period, the Fed facilitated the Treasury’s massive borrowing with massive purchases of US Treasuries, totaling $1.99 trillion. The Fed now owns a record $4.46 trillion in US Treasuries as of the October 7 week (Fig. 10).

(3) Commercial bank deposits and cash. The Fed also facilitated the mad dash for cash that started during February as the viral pandemic triggered a widespread pandemic of fear. The Fed’s purchases of Treasuries and agency securities from the public boosted commercial bank deposits by $2.28 trillion from the end of February through the September 30 week as the public sold securities to raise cash (Fig. 11).

The huge 20% y/y jump in this liability item on banks’ balance sheets was offset on the asset side by “cash” assets, which are basically the banks’ reserve balances at the Fed (Fig. 12). They really aren’t cash per se, since the banks can’t make loans with these deposits at the Fed. They can make more loans by lending out the increase in their deposits less reserve requirements, which were lowered to zero on March 15. When they do so, the banks also create more deposits. That’s the way a fractional-reserve banking system works. (By the way, the answer to the oft-asked question of why the banks don’t lend out all that cash on their balance sheets is that they can’t, because it is a balancing item determined totally by the Fed’s balance sheet!)

(4) Commercial bank loans. The Fed’s MMT maneuvers also facilitated the $781 billion jump in commercial bank loans from the end of February through the May 13 week (Fig. 13). Commercial and industrial loans soared $715 billion over this same period as businesses cashed in their lines of credit, fearing a cash crunch (Fig. 14). The surge in loan demand was easily funded by the increase in deposits. Indeed, the brief surge in borrowing by banks during the weeks of February 12 through March 25 has been more than reversed subsequently (Fig. 15).

(5) Companies issuing bonds and paying down lines of credit. Now many businesses that had rushed to draw their lines of credit during the mad dash for cash earlier this year are paying them down. Nonfinancial corporations raised a record $1.44 trillion over the past 12 months through August at record-low yields, thanks to the Fed’s backstopping the corporate bond market as part of QE4ever (Fig. 16). And what are the banks doing with the cash from the loan paydowns? They are buying Treasuries and agencies to the tune of $527 billion since the start of this year through the September 30 week (Fig. 17).

The Fed IV: MMT Junkies. T-Fed was born on March 23, the day that the Fed adopted QE4ever. Ever since then, Fed officials have been basically saying: “More, more, more!” They want another round of MMT. They don’t call it that, but that’s what they are asking for.

Fed Chair Jerome Powell was asked about MMT during congressional testimony on February 26, 2019. He hated it back then: “The idea that deficits don’t matter for countries that can borrow in their own currency I think is just wrong,” the Fed chair said. The “US debt is fairly high to the level of GDP—and much more importantly—it’s growing faster than GDP, really significantly faster. We are going to have to spend less or raise more revenue.”

Powell rejected the notion that the Fed should enable fiscal spending: “[T]o the extent that people are talking about using the Fed—our role is not to provide support for particular policies,” he said. “Decisions about spending, and controlling spending and paying for it, are really for you.” In effect, he told Congress: “Fiscal policy is your domain. Leave us out of it.”

Again: What a difference a pandemic makes! Consider the following:

(1) March. In his March 3 and March 15 unscheduled press conferences, Powell said it wasn’t the Fed’s “role to give advice to the fiscal policymakers” and that fiscal policy would need to be handled on a “discretionary” basis.

(2) April. Powell’s fiscal pivot occurred during his April 29 press conference Q&A, when he said: “I have longtime been an advocate for the need for the United States to return to a sustainable path from a fiscal perspective at the federal level. We have not been on such a path for some time, which means … that the debt is growing faster than the economy. This is not the time to act on those concerns. This is the time to use the great fiscal power of the United States to … do what we can to support the economy and try to get through this with as little damage to the longer-run productive capacity of the economy as possible.”

(3) June. During his June 10 press conference, in prepared remarks, Powell said: “I would stress that [the Fed has] lending powers, not spending powers. The Fed cannot grant money to particular beneficiaries. … Elected officials have the power to tax and spend and to make decisions about where we, as a society, should direct our collective resources. The CARES Act and other legislation provide direct help to people and businesses and communities. This direct support can make a critical difference not just in helping families and businesses in a time of need, but also in limiting long-lasting damage to our economy.”

(4) July. During his July 29 press conference Q&A, Powell stated: “Fiscal policy … can address things that we can’t address. If there are particular groups that need help, that need direct monetary help—not a loan, but an actual grant as the PPP program showed—you can save a lot of businesses and a lot of jobs with those in a case where lending a company money might not be the right answer. The company might not want to take a loan out in order to pay workers who can’t work because there’s no business.”

(5) September. In prepared remarks at his September 16 presser, Powell said: “The path forward will also depend on the policy actions taken across all parts of the government to provide relief and to support the recovery for as long as needed.” In the Q&A, he warned that “as the months pass … if there isn’t additional support and there isn’t a job for some of those people who are from industries where it’s going to be very hard to find new work, then that will start to show up in economic activity. It will also show up in things like evictions and foreclosures and, you know, things that will scar and damage the economy.”

(6) October. At the National Association for Business Economics virtual annual meeting on October 6, Powell reiterated his call for more MMT: “By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.”

An October 7 WSJ editorial commented: “It’s important to understand how unusual this is. The Fed’s job is monetary policy and financial regulation. Yet here is a Fed chief lobbying Congress, and the public, on behalf of one side of a fiscal debate.”

(7) Other talking Fed heads. And the beat goes on … On Thursday, Dallas Fed President Robert Kaplan said in a Bloomberg Television interview: “I think the Fed can do more, and I’m sure we’ll look at all our options, but those aren’t substitutes for fiscal policy.”

The same day, Boston Fed President Eric Rosengren emphasized in an interview with Bloomberg News: “There’s a limit to how far we can push the 10-year Treasury rate or the mortgage-backed rate down.” He added: “That’s not to say we shouldn’t do it. It just says the magnitude of the impact, when rates are already so low, is probably much less than what we want, which is why I think you’re hearing Federal Reserve speakers call out for more fiscal policy.”

The Fed V: MMT’s Best Friends Forever. The Fed isn’t the only central bank that has embraced MMT. Arguably, the Bank of Japan (BOJ) led the way with its zero-interest-rate policy, which has been in place since the late 1990s. The People’s Bank of China certainly has enabled China’s commercial banks to finance lots of government spending since 2008.

In her September 4, 2019 speech as the new president of the European Central Bank (ECB), Christine Lagarde called on “the other economic policy makers” to do “what they had to do” to stimulate economic growth. And that was before the pandemic. Since the World Health Organization declared the pandemic on March 11, the ECB’s assets have soared by €2.0 trillion to a record €6.7 trillion (Fig. 18). This past July, the European Union approved a €750 billion economic recovery fund, which will be financed by issuing common debt, providing more bonds for the ECB to buy.

On Thursday, September 17, BOJ Governor Haruhiko Kuroda pledged to work closely with the country's new Prime Minister Yoshihide Suga to support the economy. So far, Suga has indicated that he is not focused on the inflation target. Instead, a top priority of his administration is protecting jobs, reported Reuters. Suga’s emphasis on jobs may influence Kuroda to deemphasize the importance of the inflation target, as Powell’s Fed has recently done. Since the last week of February through the September 25 week, the BOJ’s balance sheet has soared 18% in yen (Fig. 19).

The three major central banks are all MMT’s BFFs (best friends forever).Their combined balance sheet has jumped $6.8 trillion to a record $21.2 trillion since the February 21 week through the September 25 week (Fig. 20). Here in dollars are each of their increases over this period and their most current record highs: Fed ($3.0 trillion $7.0 trillion), ECB ($2.5 trillion, $7.6 trillion), and BOJ ($1.3 trillion, $6.6 trillion).

It’s good to have friends.

Friday, October 9, 2020

Tale of Two Economies: Housing-Related Boom vs Pandemic-Challenged-Services Bust

“E pluribus unum” certainly doesn’t apply to our highly partisan political discourse these days. The phrase is Latin for “Out of many, one.” It is a traditional motto of the US, appearing on the Great Seal. Its inclusion on the seal was approved by an Act of Congress in 1782. Another motto is “Novus ordo seclorum,” which is Latin for "New order of the ages.” That doesn’t seem to apply these days either given our political and social disorder.

Then again, we all seem to be united when it comes to shopping. While the country remains bitterly divided politically, we are united in our drive to thrive. That certainly helps to explain the remarkable economic recovery in recent months from the two-month lockdown recession during March and April.

American consumers almost never disappoint us. I often have observed that when Americans are happy, they spend money and when they are depressed, they spend even more money—because shopping releases dopamine in our brains, which makes us feel good. Obviously, the Great Virus Crisis (GVC) is writing a new chapter in the history of consumer behavior. I’m not a virologist, but one widespread side effect of the virus is evident: Most consumers have been suffering from cabin fever, which can be depressing, and weren’t able to seek relief through shopping during the lockdown recession.

In our May 21 Morning Briefing, we predicted that “US consumers will open their wallets and spend once some semblance of normalcy returns.” So far, so good. As the lockdown restrictions were gradually lifted during May, consumers rushed to spend lots of the cash they had saved up during the lockdown.

Housing-related spending has been especially strong, as consumers have decided it’s time to remodel their cabins if they are going to spend more time working, learning, and entertaining at home. They’ve also rushed to buy more new and existing cabins in suburban and rural areas in a broad-based wave of de-urbanization triggered by the pandemic. In addition, the pandemic may have convinced many Millennials (who are currently 24 to 39 years old) that now is the time to buy a house rather than to rent an apartment. The Fed is contributing to the resulting housing-related boom by keeping mortgage rates at record-low levels.

All these developments were confirmed on October 1, when the Bureau of Economic Analysis (BEA) released the August personal income report. The next day, the employment report for September released by the Bureau of Labor Statistics (BLS) suggested that consumers continued to gain purchasing power from their participation in the labor market—i.e., working—which should more than offset the decline in purchasing power provided by the government with pandemic-support benefits.

If Washington provides another round of such support anytime soon, that will unleash even more dopamine, adding to the economic “V is for Victory” victory over the pandemic’s economic impact. Consider the following:

(1) Consumer-led V-shaped recovery. The October 2 update of the Atlanta Fed’s GDPNow model showed that Q3’s real GDP is tracking at a record jump of 34.6% (at a seasonally adjusted annual rate, or saar) following the record 31.4% drop during Q2. That’s certainly a V-shaped recovery so far.

Leading the way up during Q3 is a 36.8% projected rebound in real consumer spending, following the 33.2% drop during Q2. Consumers contributed 24.0 percentage points to the freefall in real GDP during Q2, when lockdown restrictions held them back (Fig. 1). They are likely to contribute more to the Q3 upswing. By the way, spending on consumer services was hit hardest by the lockdown during Q2, as evidenced by the -22.0ppt contribution of this component to the drop in real GDP!

In current dollars, personal consumption expenditures has rebounded 18.6% from April through August (Fig. 2). It is only 3.4% below its record high during January. Interestingly, consumer spending on goods is up 24.0% over this period to a new record high. Spending on services is up 16.1% since April but still 7.4% below its record high during February. During August, consumer spending totaled $14.4 trillion (saar) with services at $9.5 trillion and goods at $4.8 trillion.

(2) A pile of savings to spend. How can it be that consumer spending has rebounded so strongly when millions of workers remain unemployed? During the lockdown recession, personal saving soared from $1.4 trillion (saar) during February to an all-time record of $6.4 trillion in April (Fig. 3) . It was back down to $2.4 trillion during August.

Consumer spending clearly was boosted by the jump in the government social benefits component of personal income from $3.2 trillion (saar) during February to a record $6.6 trillion during April (Fig. 4).

However, government social benefits was down to $4.1 trillion during August. That’s still well above the $3.2 trillion during February. The same pattern is evident in personal saving. So there is still enough “potential” fiscal stimulus left over to provide “kinetic” energy to consumer spending over the next few months, in our opinion.

(3) Earned income rebounding. But don’t we need another round of fiscal stimulus to keep the consumer recovery going until a vaccine is available? Not if wages and salaries continue to rebound along with employment. The former is up 7.6% since April through August, while the latter is up 6.5% from April through September (Fig. 5).

Our Earned Income Proxy (EIP) is highly correlated with wages and salaries in the private sector (as reported in the BEA personal income release). The EIP is up 10% from April through September (Fig. 6). The EIP is based on the monthly BLS payroll data. It is simply aggregate hours worked by all workers—which is up 12.1% from April through September—multiplied by average hourly earnings. Aggregate hours worked reflects payroll employment—which is up 8.8% from April through September—multiplied by the average length of the workweek. This augurs well for the ongoing V-shaped recovery in both consumers’ purchasing power and their spending.

(4) Housing-related spending leading the way. The latest personal income release confirms my view that a housing-related spending boom is underway as a result of de-urbanization and record-low mortgage rates. Spending on furniture & furnishings and household appliances soared 38.9% from April through August to new record highs since June of this year (Fig. 7).

Construction spending on new homes and on home improvements is included in the residential investment component of GDP rather than in personal consumption. The recent jumps in new and existing home sales suggest that both categories of residential construction should be rising to new cyclical highs soon and could be on their way to record highs in coming months (Fig. 8). Together, they totaled $589.4 billion (saar) during August, 13.1% below the record high during February 2006.

Altogether, housing-related consumer and construction spending totaled a record-high $906.4 billion (saar) during August, surpassing the previous record high during February 2006 by 1.3% (Fig. 9).

(5) Spending on autos also strong. Undoubtedly, the pandemic also has boosted the demand for autos along with the demand for houses by people moving out of cities to the suburbs and rural areas. Sure enough, current-dollar spending on new motor vehicles jumped 50.6% from April through August to the highest pace since July 2005 (Fig. 10). Spending on used cars is up 94.5% since April.

(6) Services are on the mend too. As noted above, the services economy also has been recovering, but has a ways to go to regain all that was lost during the lockdown recession. That’s because several important services-providing industries remain challenged by various voluntary and enforced social distancing restrictions.

Initially, the pandemic caused spending on health care services to plunge 34.7% from February through April (Fig. 11). Hospitals suspended elective procedures in anticipation of a huge influx of Covid patients. Since April through August, this category is up 43.5%, which is only 6.4% from its record high during February.

Also taking a big hit from the lockdowns was spending on food services, including restaurants. This category plunged 47.5% from February through April but rebounded 69.4% through August (Fig. 12). It is still 11.2% below its record high during January. It is likely to struggle to climb higher in coming months as winter weather forces restaurants to halt outdoor dining and do the best they can with significant capacity limits on indoor dining.

Among the services-providing industries, the most challenged have been the following (showing the percentage changes from February through April and from April through August, as well as the percentage below the February pace): Air Transportation (-93%, 888%, -36%), Hotels & Motels (-83, 176, -54), Gambling (-80, 320, -18), Amusement Parks, Campgrounds, & Related Recreation (-90, 240, -67), and Admissions to Specified Spectator Amusements (-97, 423, -82) (Fig. 13 and Fig. 14).

(7) Bottom line. Although the recovery from May through September has been V-shaped, there are plenty of challenges ahead. The pace of the recovery is bound to slow in 2021, and there could be setbacks. However, so far, the recovery has been impressive.

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.