They're going to find me out They're going to find me out http://www.federatedinvestors.com/texPool/static/images/texpool/texpool-logo-amp.png http://www.federatedinvestors.com/texPool/daf\images\insights\article\worry-woman-laptop-small.jpg April 24 2020 April 3 2020

They're going to find me out

As she adjusts to working from home, Linda wonders what happens when all the bills come due.
Published April 3 2020

With my iPad, iPhone and shoe collection, I have been doing just fine in my job. But now we’re working from home, and I better figure out Skype fast. Seems my iPad is incompatible with the company’s Skype, I learned 15 minutes into Monday’s morning meeting. Panicking, the Mister let me borrow his computer and left the room. “Whoever is not on mute, please turn it on, it’s very distracting,” said one of my colleagues to the group of about a dozen. I sat frozen. “Linda Duessel, are you on mute?” Gulp. “Sorry, this is not my computer.” “Just find the blue circle on the bottom left of your screen, Linda.” However did they know it was me? Oh well, I’ll be on TV soon using Skype. My shelves are ready to go as background with lots and lots of smart-looking books. I wonder what jacket I’ll pair with my sweat pants as my shoes collect dust. As we all adjust to this new work environment, is it cool to start thinking about how we pay the bill? As we suggested in our last weekly, the U.S. looks to be spending about 20% of its GDP on Phase 3 stimulus and massive Fed balance-sheet expansion. And talks have started on a likely Phase 4 with a price tag of another $2 trillion (BTW, a trillion is a million million.) Deutsche projects this year’s deficit will hit $3 trillion, pushing debt-to-GDP to near 100% for the first time since the mid-1940s. No one seems to care right now—especially not politicians with the election seven months away. When asked about all the spending a week ago, President Trump suggested it’ll be no problem because of who we are and how strong we are. I took this as a reference to the strength of our currency. One of my colleagues, sharing an article with me on this subject, suggests the dollar’s status as the world’s reserve currency only works if other countries “go big” as well, leaving the U.S. as the “last dirty shirt.” Unprecedented. Meanwhile, virus-related stimulus in China has totaled just 2% of GDP. Some suggest its future has weakened substantially given what has happened to its economy and its response to the virus relative to the rest of the world where it spread. I wonder, however, what will happen to currencies when the bills for Phase 3 and Phase 4 and maybe more come due while China and its command economy have spent so little?

All of this dramatically ramped-up government intervention due to the coronavirus loosely resembles Modern Monetary Theory-style policies favored by the Far Left. The problem is once such “temporary” policies are introduced, they’re likely to become more or less permanent. If true, this means that the world could be looking at ongoing Fed purchases of newly issued U.S. government debt. Sooner or later, this should prove to be inflationary (a subject I will explore next week). Barron’s says the best way to understand MMT is to think of it as a peacetime version of wartime economic management: governments can do whatever is necessary to satisfy the public purpose as long as they maintain their authority over the populace. The U.S. was able to run budget deficits worth more than 20% of GDP during World War II without risking either inflation or its own creditworthiness—but used rationing, wage and price controls and financial repression to do so. In this crisis many are likening to war, social distancing and stay-at-home orders are the constraints. MMT differs in many ways from mainstream economics. It believes the Fed’s benchmark rate should always be 0% because bond sales are unnecessary. The government can just print money and use either cuts in government spending or increases in taxes to fight inflation. This gets to two essential MMT tenets: money is a creation of the state—a sovereign cannot run out of money or default on any obligation in its own currency—and fiscal spending is disconnected from its financing. The only constraint on government deficits is the economy’s productive capacity, with inflation occurring when resource constraints are met or exceeded. That’s why with inflation so low, deficits aren’t a concern to the MMT crowd.

Even some mainstream economists are starting to conclude deficits may not be a drag as long as global rates stay low. But is it feasible to disconnect deficits and government spending from financing? Only if spending could be restrained by politicians, an idea Bernstein doesn’t find credible. It sees spending moving inexorably higher in an MMT world and scoffs at MMT’s presumption that politicians would be willing to raise taxes to fight inflation. Even if they would, if the rest of the world doesn’t convert to MMT, it’s difficult not to envision a massive carry trade in which investors would borrow from a low-rate U.S. and invest elsewhere, fueling capital flight as cash rates are pegged inappropriately low and/or debt is spiraling ever higher. Theoretically, this would cause a downward spiral in the dollar, for which MMT has no solution. True, MMTers would argue that a government can afford to buy anything that is priced in its own currency. But as post-Keynesian economist Hyman Minsky puts it, “anyone can create money; the problem lies in getting it accepted.’’

Positives

  • The country went into this in a strong position The free cash flow of both businesses and consumers, going into this crisis, was higher than at any time going back to the early 1950. The icing on the cake is fast and aggressive policy response.
  • It should get better Fundstrat looked at stock market behavior after 35% declines since 1900 and found that, with the exception of 1929, the Dow was positive 95% of the time nine months forward with an average gain of 22%. My CIO Steve Auth takes a deeper look into this in his latest piece.
  • It should get better The 17% rally in the S&P 500 off its March 23 low was the second-biggest 5-day up-move ever. In looking at data back to 1970s, Strategas Research says returns after such big rallies are remarkably strong six to 12 months out, with average returns of 9.8% and 24%, respectively.

Negatives

  • Earnings estimates are all over the map The most common 2020 estimate in a Cornerstone Macro survey was $125, down 23% from 2019. Companies are pulling guidance and throwing in the kitchen sink to set up a clean slate for 2021. After the financial crisis, it took four years to get back to peak earnings. Conditions are more favorable today, with a less GDP-sensitive S&P. For example, software contributes 2 times the earnings of energy, vs. a third in 2008.
  • ‘Recovery’ talk is relative All China PMIs rose sharply in March, if the numbers are to be believed, but this was because February was a washout, with much of the economy closed. A similar story is likely to play out in the U.S., where Q3 GDP may look good off what’s certain to be an unprecedented Q2 collapse. The key comparison will be levels prior to the virus, and by that count, Deutsche Bank thinks many numbers will disappoint up to a year out.
  • Domino effect Dun & Bradstreet reports 938 of Fortune 1000 companies have at least one key supplier whose operations have been disrupted by the virus. Many are in China or depend on China for supplies.

What else

Toilet paper is gold, Jerry, gold! Idaho-based Clearwater Paper, the largest supplier of private label toilet paper to retail grocery chains in the U.S., shipped more toilet paper so far this month to a Costco client then it did for the entirety of 2019. Georgia-Pacific estimates toilet paper usage will jump 40% to houses on virus-lockdown homes.

‘Data centers are the new toilet paper’ So says the founder of Australia’s largest independent data center. Usage has surged amid increasing stay-at-home orders across the globe. Microsoft reported a 775% increase in cloud services in Italy in the last month and the U.S. government’s use of analytics jumped 42% last week alone, before the worst of the crisis has even hit here.

What am I supposed to do with all these shoes?? Walmart is selling work shirts but not so many pants, the Washington Post reports. And the Wall Street Journal notes many news anchors and reporters working from home are dressing up only from the waist up, with jeans or pajama bottoms below the camera shot.

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Tags Coronavirus . Equity . Markets/Economy . Fiscal Policy . Monetary Policy . Politics . Volatility .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Dow Jones Industrial Average ("DJIA"): An unmanaged index which represents share prices of selected blue chip industrial corporations as well as public utility and transportation companies. The DJIA indicates daily changes in the average price of stocks in any of its categories. It also reports total sales for each group of industries. Because it represents the top corporations of America, the DJIA's index movements are leading economic indicators for the stock market as a whole. Indexes are unmanaged and investments cannot be made in an index.

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