Fast & Furious Business Cycle

The current business cycle has been unprecedented. It has been fast and furious so far. Last year’s recession was among the worst in US history, but it lasted just two months. The V-shaped recovery in real GDP has been one of the fastest on record, with real GDP likely to surpass its previous Q4-2019 record high during the current quarter. That means that the full recovery in real GDP lasted five quarters, with the economy now in the expansion phase of the business cycle.

Not surprisingly, this remarkable performance has been reflected in the unprecedented V-shaped recovery in corporate earnings, also to record highs, in recent months. That's propelled stock prices to record highs so far this year.

Meanwhile, policymakers continue to step on their growth accelerators, hoping that inflation and financial stability remain under control. Monetary policymakers are still purchasing $120 billion per month in fixed-income securities. Some of them are starting to talk about talking about tapering these purchases. Tapering may be months away, and hiking the federal funds rate won't start until at least a few months after tapering is done. The Biden administration is pushing for more spending that will result in trillion dollar annual deficits in coming years even if taxes are raised to cover some of the spending.

Here are some of the most recent fast and furious consequences of all the high-octane fuel provided by the policymakers:

(1) Prices-paid and prices-received indexes. The prices-paid index included in May’s national survey of manufacturing purchasing managers (M-PMI) remained near April’s reading, which was the highest since July 2008 (Fig. 1). That’s not a surprise since the average of the May prices-paid indexes reported in the regional business surveys conducted by five Federal Reserve Banks jumped to the highest reading on record (Fig. 2). The average of the five regional prices-received indexes also jumped to a record high in May. All 10 regional prices-paid and prices-received indexes are at or near record highs (Fig. 3). (The data for the regional surveys start in 2005.)

(2) Backlogs for the record books. May’s national M-PMI survey showed that supplier deliveries and backlog of orders rose to record highs last month (Fig. 4). In addition, the customer inventories index fell to another record low (Fig. 5). The average of the five regional indexes for either unfilled orders or delivery times rose to a record high in May (Fig. 6).

(3) Capital spending. The good news is that the inflationary economic boom is great for corporate profits, which is great for capital spending. The y/y growth rate in weekly S&P 500 forward earnings is an excellent coincident indicator of the y/y growth rate in nondefense capital goods orders excluding aircraft (Fig. 7). Sure enough, the latter measure of capital spending on equipment and machinery jumped 0.9% m/m and 22.0% y/y to a fresh record high during April (Fig. 8).

(4) Bottom line. What the economy is experiencing may simply be a business cycle set to “fast forward” by the insanely stimulative combination of fiscal and monetary policies. We had a terrible recession last year that lasted only two months. Twelve months later, the economy had fully recovered, based on most macroeconomic indicators. Booms usually occur at the tail ends of expansions. This time, one started during the tail end of the recovery and continues at the beginning of the expansion.

That’s all great until it isn’t—because, as we all know, booms are followed by bananas. Economist Alfred Kahn, an economic adviser to former President Jimmy Carter, warned lawmakers in the ’70s that if they didn’t get inflation under control, the nation was heading for a recession or a depression. To avoid scaring the public during his testimony at the Capitol, instead of saying “recession” or “depression,” he simply said “banana.”

Lots of Liquidity

While the debate rages on over whether inflation is transitory or long lasting, there’s no debating that an enormous amount of liquid assets has piled up since the start of the pandemic.

The accumulation began with a mad dash for cash by panicked individuals and businesses. But since “Modern Monetary Theory Week” (March 23-27, 2020), when the Fed and the Treasury (a.k.a. “T-Fed”) joined forces, the huge accumulation of liquid assets has been mostly attributable to “helicopter money.” Actually, “helicopters” don’t do the situation justice: It’s been more like T-Fed loaded up B-52 bombers with cash and has been carpet bombing the economy and financial system since then. How much cash has been dropped from the B-52s, so far? Let’s count it up:

(1) T-Fed’s B-52 money. Since February 2020, the Fed’s balance sheet has increased $3.6 trillion to a record $7.7 trillion through April (Fig. 1). Over that same period, the Fed’s holdings of Treasuries increased $2.5 trillion (Fig. 2). So the Fed purchased 54% of the $4.6 trillion increase in the Treasury’s publicly held debt from February of last year through April 2021 (Fig. 3). The Fed now holds a record 25.7% of the Treasury’s outstanding publicly held debt (Fig. 4).

Just as significant, the 12-month sum of federal government’s outlays increased $2.1 trillion y/y to a record $7.3 trillion during April (Fig. 5). This extraordinary jump was led by a $1.2 trillion increase in federal outlays on income security, which includes the Economic Impact Payments, i.e., the three rounds of checks sent to most Americans since the start of the pandemic (Fig. 6).

(2) M2 & velocity. Total deposits at all commercial banks in the US rose a whopping $3.5 trillion from the March 18, 2020 week through the May 12 week of this year to a record $17.1 trillion (Fig. 7). The monetary aggregate, M2, is up $4.6 trillion since February 2020 through April to a record $20.1 trillion.

Many economists track M2 velocity, which is the ratio of nominal GDP to M2. It remains near the record lows of the past year. We prefer to track the inverse of this ratio. It shows that over the past year, M2 has been equivalent to 89% of nominal GDP, a record high (Fig. 8). The potential for all this money to fuel higher consumer price and/or asset inflation is hard to ignore.

(3) Who is liquid? Then again, it’s possible that the pandemic spooked lots of people, who’ve decided to hold more precautionary balances in liquid assets as a result.

The Fed’s Distributional Financial Accounts shows that liquid assets held by households jumped by $3.3 trillion from Q4-2019 through Q4-2020 to a record $15.9 trillion (Fig. 9). This category is the sum of currency, checkable deposits, other deposits, and money market mutual funds. Over this same period, here are the increases and latest levels of liquid assets held by the bottom 50% wealth percentile group ($154 billion to $549 billion), the 50%-90% group ($0.9 trillion to $5.0 trillion), the 90%-99% group ($1.2 trillion to $6.0 trillion), and the top 1% group ($1.1 trillion to $4.4 trillion) (Fig. 10).The bottom half of households in terms of wealth undoubtedly needed to spend the cash they received from the government for pandemic relief, so they didn’t accumulate much in liquid assets. The top half might actually have raised some cash at the start of the pandemic by selling other assets. Much of the cash they received from the government was probably saved.

The question is: What will these households do with all that cash they've accumulated since last year? Odds are they will continue to spend it on goods and services and to invest in financial assets.