The Investor September 2021

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ShareFinder’s prediction for Wall Street for the next five months


South Africans are taxed to death …and fleeing

By Richard Cluver

South Africans are, according to a study by trade union Solidarity, now among the most highly taxed people in the world…and they are fleeing our shores in record numbers. As an ANC “lekgotla” was this month trying to dream up more unaffordable inducements to dangle before the voting public ahead of the up-coming municipal elections, it is becoming increasingly clear that the source of all of its largesse is exhausted and dwindling by the day.

What the ANC clearly fails to grasp is the simple fact that if you take too much money out of a business it will die! And as the party leans increasingly towards its latest dream of a Basic Income Grant, the fact that it will very likely bankrupt the country hardly seems to trouble a party which senses its imminent demise at the polls if it cannot do something dramatic! Worse, the EFF seems set to gain at the polls with it’s new inducement of “Free electricity for the masses.”

Business Practice 101 recognises that you need to spend a significant portion of your business revenue on renewing plant and machinery, educating your staff so that they are better than your opposition, and putting aside a portion for the inevitable rainy day. Nations are no different from spaza shops in this regard. Diverting

C:\Users\User\AppData\Local\Microsoft\Windows\INetCache\Content.Word\$5 Book AdFinal.JPG too much of your income as a nation towards civil service salaries and welfare projects might win you votes but in the end your best workers will be gone and bankruptcy will stare you in the face. That’s why, as a nation, we are drowning in debt and have the world’s highest unemployment rate.

As the party that came to power on a promise of putting its people first, the ANC has miserably failed ALL of its people and even the poorest of the poor are now paying the price!

Relative to Gross Domestic Product South Africa is now extracting total taxes three times greater than the 10 percent which economists believe developing nations should realistically be able to sustain. Our rate of 29.1 percent compares very unfavourably with the richest nations: In the USA the total tax burden is only 10% of their GDP.

In fact there are 137 countries a South African can move to if he would like to reduce his tax burden. The list includes Switzerland, Australia, Saudi Arabia, South Korea, Algeria, Ireland, Turkey, Russia, Mauritius, Colombia, Kenya, India, the Bahamas, Ghana, Thailand, China, Ivory Coast, Malawi, Egypt, Jordan and the Philippines to name just a few.

So it should be no surprise that South Africa’s workers are understandably leaving in droves for destinations where they are able to hang on to a greater proportion of the sweat of their labour! As a result of emigration, the country has over the past two years seen a sharp decline in the number of its “Top Ten Percent,” taxpayers who earn R750,000 or more annually.

Recently, a study by the University of Cape Town disclosed a catastrophic 55.73 percent decline in the numbers of the top three categories of taxpayers: from 6.1-million to 2.7-million while simultaneously the ultra-poor who earn less than the minimum wage has grown by 54 percent.

Eunomix’s analysis of the SA Revenue Service’s (SARS) personal income tax data also paints a serious picture. It finds that since peaking in 2012 at 6.4-million taxpayers, the number had fallen to just 4.3-million people by 2019 — a 32% decline.

And according to the CEO of the Professional Provident Society, Izak Smit, between 20 percent and 25 percent of professionals exiting PPS’s insurance business and the professional medical scheme Profmed which PPS administers, cite emigration as their reason for doing so. Last year, across PPS’s life insurance business, which covers about 130,000 professionals, about 600 of the 2,500 members exiting listed emigration as a reason for leaving.  

Speaking to Business Day journalist, Lynley Donnelly, Izak Smit said that the emigration of SA’s skilled professionals is a major risk for job-creation efforts. He warned that the dwindling tax base cannot be ignored by policymakers as the country battles the aftermath of Covid-19 and one of the highest unemployment rates in the world.

Noting global studies that constantly show that around 65 percent of new jobs created in the average economy are the result of the efforts of professionals and small business entrepreneurs, it is clear that the ANC’s unfriendly attitudes towards business, our high borrowing costs which are a direct result of excessive government borrowing, together with the recent riots which have been attributed to ANC factional battles, are the major reasons why skilled South Africans are emigrating.

Izak Smit’s comments come in the wake of a new study by trade union Solidarity which has added up “all the hidden taxes” South Africa’s taxpayers are saddled with. As a result, even those who for all practical purposes live beneath the breadline with a gross monthly income of R640, face an effective tax rate of approximately 7 percent.

But that percentage pales into insignificance against the effective 42.5 percent paid by the top ten percent who earn R70 000 or more a month. This implies that people in ‘decile 10’ work only 4 hours and 36 minutes for themselves in a normal working day of 8 hours – for the other 3 hours and 24 minutes, they actually work for the state. It means that people who are in their office at 08h00 only start working for themselves at 11h24.”

The union used Statistics South Africa’s division of society into ten equal parts called deciles. It then compared these with housing, food, transport and other costs – and the tax payable on each of these. Below, is how it sets out the living costs, and taxes paid by our top-income people.

https://businesstech.co.za/news/wp-content/uploads/2021/09/High-Income.png

At the opposite end of the scale are 20-million poor which is a big reason why South Africa is now ranked at position 114 out of 189 countries on the Human Development Index; a measurement of equality developed by the UN which ranks countries by analysing their quality of life against the backdrop of their industrial development. 

https://businesstech.co.za/news/wp-content/uploads/2021/09/Low-Income.png These are folk living on less than R640 a month who spend 64 percent of their income on the provision of food and housing. Of what remains, the biggest single bite is taken by the Government with an average of R44.78 a month, nearly twelve times what they can afford to spend on education and three times what they spend monthly on transport.

Turning to the average SA citizen who enjoys a monthly income of R8,746, people in ‘decile 9’ he is already better off than 80% of the country’s people, Solidarity said. Though this group is in large part exempt from direct taxation and spends the largest percentage of their income on accommodation (27.7%) and food (16.9%), the State still represents their single largest living expense. They contribute 16 percent to the fiscus in the form of indirect taxation to the tune of R1 401.31. This implies that in a traditional 8-hour workday, people in decile 9 work only 6 hours and 43 minutes for their own income. They actually work the other 1 hour and 17 minutes for the state.”

The fact that the petrol levy is now 40% of the fuel price implies that on average, people in this decile pay more tax in the form of petrol levies than income tax, Solidarity said.

https://businesstech.co.za/news/wp-content/uploads/2021/09/Middle-Income.png


New Books AD copy Where most other countries limit their income streams to a few categories, the South African government has decided to extract taxes from its citizens in every possible way, Solidarity said. In addition to the above direct charges, the trade union said that South Africans could also expect to be taxed on everything from interest earned to TV licences.

https://businesstech.co.za/news/wp-content/uploads/2021/09/Other-taxes.png

 

Drilling down for the economic reasons why South Africa’s top earners are fleeing the country in such high numbers, the Solidarity tax burden calculation makes it clear that only France with 46.2 percent, Denmark with 46 percent, Belgium with 44.6 percent Sweden with 44 percent and Finland with 43.3 percent are extracting more cash from their top citizens than South Africa does.

However, in these countries the State is primary service provider for most public services such as pension systems which allow people to retire with a good standard of living with a pension linked to their salaries in addition to grants and training programmes for the unemployed, the trade union said.


Comparing the sum of all taxes collected relative to those collected elsewhere, South Africa extracts 29.1 percent of Gross Domestic Product whereas economists believe developing nations should not realistically be able to sustain an extraction rate greater than ten percent. A more realistic comparison might be that relative with the rest of sub-Saharan Africa where the effective tax burden to the GDP is about 18.6% compared to the world average of 15.3%.

https://businesstech.co.za/news/wp-content/uploads/2021/09/GDP-2.png

“In the USA – which is comparable to South Africa on many levels because the same economic activities occur there, but on a much larger scale – the total tax burden is only 10% of the GDP.

“South Africa does still have a lot of infrastructure development to do; therefore, an overall average tax burden of 10% may not be feasible any time soon.”






The Return of Stagflation

By John Mauldin

I have been writing this letter for 22 years. Sometimes I look into the future and other times merely try to explain the present. Today I’John Mauldinm going to look at several possible futures. There are forces at work in both Congress and the Federal Reserve that could take us down radically different paths. There are also changes in the Zeitgeist, the way we act and think both in and as a society, that are going to have major impacts.

What I am not doing today is predicting the future. I am looking at events and saying if “this” happens we need to be prepared for it. I’m increasingly concerned we are in an economic situation with almost no wiggle room. We had serious issues before the pandemic which haven’t gone away. Massive fiscal and monetary stimulus obscured this reality, but can’t do so forever.

The late 2020 and early 2021 recovery was exactly that: a recovery from an exogenous event. It wasn’t new, organic growth—or at least not most of it. Moreover, the “exogenous” event is proving less than exogenous. We have wonderful vaccines, very effective in preventing severe disease and death. They help protect the people who get them, but the macro benefit is limited because they aren’t being administered widely enough and quickly enough. This limits global trade and travel, without which sustainable recovery is difficult.

Yes, we’ve learned to cope. We’re making adjustments but still a long way from normal. Much like the COVID-19 disease itself, the economy endured a severe acute phase followed by a chronic “long COVID.” The ongoing symptoms are less severe but still problematic.

Today we’ll explore all this and consider the possibilities. Long-time readers know I call the shots as I see them. Maybe I’m wrong but I fear we have consumed all the wiggle room. Now we need everything to go exactly right… and I have serious doubts it will.

Weaker Expansions

This year’s economy is built on top of last year’s, which was on top of the year before, and on back. It’s an iterative process. Nothing, not even COVID, wipes out the past. We keep feeling its effects.

So before we talk about future growth, let’s look back. I have said many times GDP has serious flaws as a growth measure, but it’s what we have. The bars in this chart are real GDP growth by quarter back to 1990, at a seasonally adjusted annualized rate. The gray vertical bars are recessions, of which there were 4 in this period.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_1_20210910_TFTF.png
Source:  FRED

I want you to look at the periods between recessions, what business cycle theorists call the “expansion phase.” Looking only at those (omitting the recession quarters), here is the average quarterly GDP (annualized rates) for the last three expansions.

  • 1991–2001: 3.6%
  • 2001–2007: 2.8%
  • 2009–2019: 2.3%

The last three expansion/recovery phases were each weaker than the last. Maybe that’s coincidence, but it matches a lot of other data showing “growth” isn’t what it used to be.

Remember how this is supposed to work. If you want, say, 3% average GDP growth over long periods, which you know will include recessions in which growth is zero or negative, math says the expansion phases need to average well above 3%. They didn’t do so over the 2 years before COVID struck. The last 21 years have seen sub-2% growth for the entire period.

However, in the four quarters since the COVID recession, growth averaged a stupendous 12.8%. If you go back another quarter and include Q2 2020 (which was -31.2%), it’s still 5.8%. In either case, GDP says we are now experiencing the most gangbusters expansion in decades.

Does that really make sense? Is it where the economy would be right now if COVID had never happened, and the 2019 trends continued? That’s just not plausible. Growth was only 1.9% in Q4 2019 and prospects for more looked pretty bleak at the time.

I and others were saying the mild growth was a consequence of Federal Reserve policy and would only get worse unless the Fed changed course. This is from my December 20, 2019, Prelude to Crisis letter. It’s doubly haunting to read now.

The Fed began cutting rates in July. Funding pressures emerged weeks later. Coincidence? I suspect not. Many factors are at work here, but it sure looks like, through QE4 and other activities, the Fed is taking the first steps toward monetizing our debt. If so, many more steps are ahead because the debt is only going to get worse…

Just this week Congress passed, and President Trump signed, massive spending bills to avoid a government shutdown. There was a silver lining; both parties made concessions in areas each considers important. Republicans got a lot more to spend on defense and Democrats got all sorts of social spending. That kind of compromise once happened all the time but has been rare lately. Maybe this is a sign the gridlock is breaking. But if so, their cooperation still led to higher spending and more debt.

As long as this continues—as it almost certainly will, for a long time—the Fed will find it near-impossible to return to normal policy. The balance sheet will keep ballooning as they throw manufactured money at the problem, because it is all they know how to do and/or it’s all Congress will let them do.

Nor will there be any refuge overseas. The NIRP countries will remain stuck in their own traps, unable to raise rates and unable to collect enough tax revenue to cover the promises made to their citizens. It won’t be pretty, anywhere on the globe…

Crisis isn’t simply coming. We are already in the early stages of it. I think we will look back at late 2019 as the beginning.

COVID was nowhere on the radar screen when I wrote that. A few weeks later it made the Fed intensify an already-loose policy stance while Congress passed gargantuan spending bills that sent the debt even further skyward.

These had initially beneficial effects, as seen in recent GDP numbers. The question now is how long those effects will last.

Back on Its Own

Hindsight is always 20/20. It’s easy to look back and say governments overreacted in the initial COVID crisis, both with economically harmful protective measures and added spending to mitigate that harm, but there was much we didn’t know at the time. I think they were right to err on the side of caution. The first massive stimulus was necessary; subsequent rounds were more questionable.

Necessary or not, the spending was truly staggering. Here’s a chart comparing the inflation-adjusted per-capita spending with two previous crises. In fiscal terms, we just lived through the equivalent of two New Deals. And instead of 10 years, it happened in less than two.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_2_20210910_TFTF.png
Source: The Washington Post

The scale and speed of this spending explains much, if not most, of the recent GDP growth. Putting an extra $14 trillion on top of normal government spending into a $20 trillion economy is a massive sugar high. It wasn’t a free lunch by any means; the national debt went up accordingly. But it still had a short-term stimulus effect.

The stimulus effect is now ending. The last round of $1,400 payments is either spent or banked. The extended and enhanced unemployment benefits ended this week in the states that hadn’t already canceled them. The small businesses who received payroll support are reaching the end of their rope.

Yes, Congress is considering a pair of infrastructure bills whose price tags, if they pass in the proposed form, will outweigh the prior COVID bills. But passage is increasingly dubious. (More below.) Even if they do, the spending will be spread over many years. It won’t come close to replacing the other programs that have ended, or will end soon.

For all intents and purposes, without more stimulus the economy is back on its own as the fourth quarter approaches—and basically where it was in late 2019. It may even be worse, considering changes to the workforce. Millions have died, become disabled, retired early, or are retraining for career changes. While this may be long-term positive in some cases, it’s not necessarily positive for the next quarter’s GDP.

Danielle DiMartino Booth at Quill Intelligence looked at data from Burning Glass Technologies, which analyzes almost every job posting in the country. It is amazingly comprehensive. I will quote one paragraph and then ask that you look at the data. But the point is the total job postings are essentially unchanged from January 2020. Danielle did highlight a few details.

Lucky for us, unlike some real-time data sets started after the pandemic, Burning Glass also provides weekly data job postings baselined in January 2020. That gets us from the JOLTS July data to The Conference Board’s August data to the week ended September 3rd, depicted in the bottom two charts above. In the aggregate, job postings are UNCH, up 0.1% (light blue line). But it’s the slicing and dicing by industry and educational attainment that’s most edifying. After peaking at +34.1% in the week ended June 11th, postings in Financial Activities (red line) are up a scant 0.7%. Meanwhile, after peaking in the week ended May 14th, openings for those with Extensive education (yellow line) are down by 17.7%, a level last seen in February. At the opposite end of the spectrum, postings for those with Minimal education (purple line) are still up 30.1%; but they’re well off their July 16th peak of +75.1%. Leisure & Hospitality openings (orange line) peaked that same week at +46.5%; they’ve since fallen to +13.4%.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_3_20210910_TFTF.png


Source: Quill Intelligence

I find this simply astounding. Job postings requiring extensive education are down 17% and job postings requiring minimal education are up 30%. This isn’t the world we told our children about when we urged them to get college degrees. Other statistics show there is a great deal of complacency in the job search market among the unemployed. This is most strange given the higher wages being offered, etc.

Workers are clearly looking not just for higher wages but for better working conditions and higher wages. I’m not sure that will change for quite some time. We are in a wage-price spiral. Every region in this week’s Federal Reserve Beige Book highlighted the increased cost of labour. One line stuck out to me: A hotel firm raised the wages for their cleaning staff to $15 an hour. They noted the current staff was very pleased with the raise but it attracted no new workers.

Dangerous Assumptions

One serious downside risk is inflation. Economists talk about “nominal” and “real” GDP, the latter of which is adjusted for inflation. Higher inflation pushes real GDP lower. An economy showing 4% nominal growth and 1% inflation would have 3% real growth. Not so bad. But if nominal growth stays exactly the same but inflation rises to 4%, real growth would be 0%.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_4_20210910_TFTF.png It gets worse. If nominal growth falls just a little, say from 4% to 3%, then a 4% inflation rate would push real growth down to -1% recession territory. A little bit of inflation can amplify a mild setback into a serious one in real terms. I mentioned the 4% inflation rate because that is exactly where we are when we look at PCE (Personal Consumption Expenditures) inflation, the Fed’s favourite measure.

Despite that, the FOMC projects inflation falling toward 2% within just a few months, and below 3% today. Oops:

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_5_20210910_TFTF.png


Source: FRED

CPI has run well north of 5% over the last six months. The Atlanta Fed’s wage growth tracker is now at 3.9% on its way to 4%. Newsweek reports national average apartment rents rose about 9.2% in this year’s first half. The average apartment in the US now costs $1,200 per month.

These things aggravate each other, too. Inflation pushes input costs (wages, materials, rent, etc.) higher. This can reduce output, and result in lower nominal GDP if common across the economy. With the Fed likely to reduce its asset purchases slowly, if at all, extended inflation in the 3% or higher range is entirely possible, and maybe likely, at least for the next year or so. (I am still in the long-term deflation/disinflation camp, but I also optimistically assumed the Federal Reserve would lean into inflation and take its foot off the gas pedal.)

This is only now beginning to show up in growth forecasts. We see it first in the non-subjective models that react faster than human forecasters. Here’s the Atlanta Fed’s GDPNow forecast as of Sept. 2. Notice how the green line (their model) turned down in late August. I expect it to turn down even more by the end of September. The Blue Chip consensus runs a little behind but I doubt it will retreat as fast. Then again, they are more often wrong than not, nearly always to the upside.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_6_20210910_TFTF.png


Source:  Federal Reserve Bank of Atlanta

Last week’s Human Capital Losses letter outlined why as many as 4 million people may no longer be considered part of the labour force, at least for now. That is almost 3% of the total labour force and since GDP is the number of workers times productivity it can be expected to be a 3% drag on GDP starting with the fourth quarter, unless an enormous amount of people come back to work. It’s certainly not in the data yet.

COVID has had labour force effects we are still struggling to understand. Whether it’s early retirements, health concerns, long COVID disability, a doubling of the number of homeschooling families, excessive government benefits, or (more likely) some blend of all those and more (like pre-existing demographic trends), worker shortages limit output. Rising productivity can offset some of this, but not all. And maybe not fast enough to avert another recession.

Other things could help, too. We see significant new demand for certain products and services, as well as desire to rebuild inventory. Those would be positive for GDP. But they’re not assured and it is not clear how much they would help. Businesses are struggling to adjust.

The Human Infrastructure Wrench in the Gears

This is where I will get into trouble. The current $3.5 trillion infrastructure bill if passed as proposed would be a massive blow to the economy. You can’t raise taxes to the extent this proposal would and not expect a negative impact. And those are just the major tax increases. There are hidden cost increases all throughout the legislation.

Senator Manchin has said he will not support a bill of that size. Senator Sinema has also indicated she will not. My Washington sources say there is a number somewhere between $1 trillion and $1.5 trillion they might accept, which would raise capital gains and corporate taxes (along with personal taxes on higher incomes) to pay for the expenditures.

To further the plot, the government will run out of borrowing authority in the next month or two unless Congress raises or suspends the debt ceiling. It may end up being part of the infrastructure reconciliation bill. I have no idea how that would work out, but we will know soon.

I’m not really making a prediction here. These labour issues, inflation, and legislative manoeuvring create a great deal of uncertainty. COVID and so much more will all be impacting the economy over the next few months. The market is currently priced for perfection. And admittedly, S&P 500 profits are through the roof. A lot of good is happening at the same time all of these issues are coming into play. If the problems I highlighted above are resolved in a positive manner, we could see the market explode to the upside.

My point is it’s exceedingly dangerous to assume the recent strong growth will continue into 2022 and beyond. COVID’s economic impact will remain significant but diminish as we all learn to deal with it. We are either going to return to the previous trends, which weren’t great, or see new trends form. If the latter, they could be different but not necessarily better.

These potential problems could develop into actual problems and recessionary conditions. The economy is way too close to stall speed. If the engines stop turning, your portfolio needs to be ready.

I am increasingly concerned that the Fed is toying with inflation and the economy could slow down more than they currently project. They are roughly projecting 2–3%+ growth and slightly above 2% inflation. That would be a very good outcome. I am more worried they are wrong, as they have often been in the past, and we’ll get the worst of both worlds: higher inflation and lower growth—in a word, stagflation.



Redistribution without growth is wishful thinking
.

By Brian Kantor

There is a recognition in SA that developed economy welfare benefits (basic income grants) are impossible without developed economy social security taxes — of the order of a 10%-15% salary sacrifice imposed on the formally employed.

However, higher taxes discourage growth by discouraging enterprise and encouraging the emigration of scarce skills and capital. Redistribution can also lead to slower growth by reducing the incentive to work, to be economically active.

The number of people in SA who are not economically active has been rising as disturbingly fast as the estimated unemployed. Many of those classified as unemployed are in fact not economically active. They say they would be willing to work when asked, but only for what are unrealistically high rewards for work that is simply not available, particularly in the rural areas where unemployment is double that of urban areas.

It is striking how little income from work is earned by the poorest South Africans. Of the 16.3-million in the lowest fifth of the income distribution in 2016 (31% of the population), only 15.9% were employed, the unemployment rate was more than 60%, and 53% were economically inactive. The average monthly wage was just R1,017, as reported by the panel that recommended a national minimum wage of R3,500 per month.

Among adults of the second poorest 20% (25% of the population), 42.2% were not economically active. Of the third quintile, the middle-income group, only 52.5% were then employed (33% were economically inactive) for an average monthly wage of just R2,651. The minimum wage is only exceeded by workers in the fourth and fifth quintiles of the income distribution (25% of the population).

Cash grants, subsidised housing and utilities, and free education and primary health care have all helped meaningfully to relieve absolute poverty. They have allowed many of the poor to survive without work. It has also raised the wage that makes it sensible for many to work.

Unemployment of the order of 40% — far higher for the youngest cohorts of potential workers — cannot be explained by a lack of demand for labour, the result only of slow growth and the host of regulations, including the minimum wage, the influence of unions and the Commission for Conciliation, Mediation and Arbitration (CCMA), which discourage demand for low-skilled labour.

Nor is it plausible to think regulations are strictly observed by informal hirers and suppliers of labour, which include the large number of immigrant workers employed informally who will not answer phone calls from Stats SA. Foreign workers undoubtedly depress wages for informal employment.

The relationship between GDP (growing slowly) and the numbers employed outside of agriculture has become much weaker since around 1990. Each percentage point of growth in GDP now results in fewer jobs. Much improved poverty relief helps explain this trend.

Graphic: RUBY-GAY MARTIN

Graphic: RUBY-GAY MARTIN

Yet the share of the economy received as wages and salaries has increased significantly in recent years, while the share of operating surpluses of the firms providing employment has shrunk.

To describe this dual labour market as unintended would be inaccurate. Worryingly so, given the importance of profits for growth-enhancing investments in equipment and people. Those with better paid jobs are the favoured and well protected insiders of the developed sector of the SA labour market. Nor has the observed unemployment affected the active competition for skilled, better paid workers.

Graphic: RUBY-GAY MARTIN

SA has chosen to tackle poverty with welfare rather than with jobs.

 Further redistribution without growth is wishful thinking.

It cannot solve the poverty problem and will exacerbate the employment problem.

Educating and training the many potential entrants to the labour force so that they could command the rewards that make it sensible for many more to work, and sensible to hire more productive workers, would raise incomes and employment. Privately and competitively supplied education and training, funded expensively as they are now by the taxpayer, would deliver both. But alas, this is also wishful thinking.

• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.



The Path of Least Embarrassment

By Jared Dillian

Jared Dillian The Federal Reserve is a government institution. Sort of. Technically it is a private bank, and it makes or loses money, but its P&L is incidental to its mission. But for the purpose of this analysis, let’s say that the Fed is a government bank, and that its inhabitants are government employees.

Now, I used to work for the government. And I can tell you from nine years of working for the government that the one thing that motivates government employees more than anything is fear of embarrassment. There’s no profit or loss, but if journalists start sniffing around and news gets out that you were negligent in some way, that’s how careers end. But not because you were negligent—only because word got out!

Among the Fed’s many functions is to serve as some kind of economic oracle. It employs well-educated economists who gather data and make forecasts about the economy. And the best economic minds in the world have determined that the inflation we are experiencing, while uncomfortable, is transitory. It won’t last long. It will simply go away.

But that hasn’t happened. In fact, it is getting worse.

At some point, the Fed is going to have to acknowledge that its forecasts were wrong and that the inflation is not transitory. But it will postpone doing this as long as possible. Because the Fed, as a government institution filled with government employees, does not want to be embarrassed. Admitting it was wrong about inflation would cause it to lose face. And then people would question its oracular abilities.

So, when will the Fed hike rates? It will wait as long as humanly possible.

Political Concerns

In my view, the Fed won’t hike rates until inflation becomes a political concern. Until the Biden administration starts looking at the polls and figures out that people are pissed about inflation and might pull the lever for the opposing party.

Now, Joe Biden has no clue how to stop inflation. He has stated that his $3.5 trillion spending plan will actually fight inflation, which is absolutely ludicrous. And his instincts around inflation are bad—he blames high prices on profiteering, and rather than pursuing a supply-side solution, he’ll attack producers for price-gouging, which will have the opposite effect. But I assure you that when inflation reaches double digits—which it will—Biden will phone Powell and ask for help fighting inflation.

One thing I’ve noticed from watching markets every day is that stocks are very squirrelly about the prospect of any Fed tightening. The conventional wisdom around this is that the Fed will taper asset purchases slowly (if it ever gets around to it at all), and then raise rates even more slowly. But if inflation prints 10%, and Biden panics, and the Fed panics, we’re talking about the mother of all crashes in our future. I have been trading accordingly.

Is Biden to blame for inflation? Mostly, but not entirely. Much of the blame rests with the Fed, and also with Trump, who started the PPP loans and stimulus checks. Inflation literally started rising the day that Biden was inaugurated, and people have noticed, so Biden will get the blame. He owns it. And he’ll be wearing it next November.

But I’m not so sure the Republicans know how to stop inflation either.

Tough Love

An observation on social psychology:

Nobody wants to do the hard thing. I was watching the nightly news a few weeks ago, and they were doing a piece on expiring unemployment benefits. It was a sob story. They interviewed a young woman who said she had been looking for a job but couldn’t find one. She had bills to pay, and she was going to starve.

There are more than 10 million job openings! The most ever!

Back in the early 1990s, one of the most incredible things happened—we threw millions of people off of welfare, under a Democratic president. What about the poor people? It’s a little tough love—they need to hustle and go find a job. They will figure it out. And they did. 

Politically, that was a very hard thing to do, but it was part of the zeitgeist at the time—the population was very fiscally conservative back then.

At different points in history, a president or Fed Chair had to do the hard thing—the unpopular thing. Paul Volcker did it in 1979, when he was Fed Chair. But again, it wasn’t so much that Volcker was a genius or hero—he was the right man, in the right place, at the right time. But the country demanded it—they were sick of inflation, and they were willing to do the hard thing and take the pain.

Nobody is willing to do the hard thing and take the pain these days. The Fed will hike interest rates someday, the government will do austerity, but not until people are so miserable that they are ready for it. And we are a long way away from that.

In the meantime, the government stupidity will continue, and it will continue to create profitable opportunities. That is the part I choose to focus on—making money. At the end of the day, I am an investor, so that is what matters.

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Jared Dillian



 


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