Wednesday, March 10, 2021

The Last Sugar High

The cyclical heavy Dow made a new all time high today unconfirmed by every other major index. This is setting up to be the largest and most unexpected crash in history. Overbought and overbelieved by a society of stimulus addicts high on monetary and fiscal heroin running at a combined 30% of GDP. Easily enough to kill someone...

First off, I revisited my 2021 predictions last night, and aside from the fact that this rolling crash has not yet taken down the Dow and S&P, my predictions are right on track. Since I wrote that prediction back in early December, the Democrats have taken full control of Congress, TWO massive stimulus bills have passed, and the vaccine is now in widespread distribution. 

Had someone told me that all of those reflationary events would occur, I would surely have predicted extreme reflation at this point, absent the larger crash. However as of this writing I am even more convicted of impending deflation. The final crash will be the last nail in the deflationary coffin. 

The U.S. is now Japan in the economic sense, which means that absent major structural changes to the economy, no amount of fiscal and monetary stimulus is going to create lasting reflation. Even this most recent stimulus package won't give more than a few weeks of economic sugar buzz. From a markets standpoint, it's already priced in several times over. 

There are several problems with the economy right now, in addition to the obvious COVID lockdown hangover. It's becoming abundantly clear that U.S. government stimulus is no longer stimulating the economy. As I've pointed out, the U.S. is borrowing 20% of GDP to have a 4% growth rate. That implies that the Keynesian economic multiplier is now negative in absolute terms and fractional in relative terms. Historically, the fiscal multiplier as one can discern from its name, was expected to create GDP in excess of the amount that was being borrowed. 

There are many reasons why this could be happening, but the most obvious reason is that the government is merely replacing activity that has been lost in the private sector with essentially subsistence welfare checks that represent consumption absent production. COVID erased five years of job growth, and fiscal stimulus is attempting to paper over it. 

Below we see what I call "Honest GDP", it's nominal GDP - the deficit. Stripping out unemployment checks and one time stimmy payments, economic activity is back where it was five years ago. Meanwhile, a 20% budget deficit implies that much of this borrowed money is now going to foreign imports where it will do nothing for GDP:

According to the Krugmanite doctrine, budget deficits never matter. And according to Republicans, deficits only matter when Democrats are in office. One thing they both share in common is that they have been assiduoualy ignoring the Faustian bargain that comes along with a reserve currency. Because if they admitted it existed, they would have been duly discredited a long time ago. 

The assumption that deficits don't matter, is predicated on the belief that interest rates will never rise and the economy will remain in a perpetual state of deflation. If interest rates rise significantly and worse yet permanently, then the U.S. budget would be crowded out by debt service. Currently, the U.S. is borrowing 400% of its GDP "growth", so making the interest payment is easy, since it's all borrowed money. Imagine what would happen if interest rates rose sharply AND the government could not repay its lenders by borrowing more money? As long as the real economy never recovers we don't have to worry about this accelerating debt load, we can remain in deflationary purgatory and rejoice like idiots that deficits don't matter. 

One of the consequences of all this debt is that now the economy is hyper-sensitive to inflation. THIS (1.7%) is the runaway inflation that the majority are currently worried about.

Soon it will be time to raise the Fed funds rate and be glad that honest GDP never went positive. This is how Japan ended up tethered to the zero bound:

All of which is also why dollar destruction is NOT imminent. Below we see that the velocity of money has collapsed, which is another sign that the economy is structurally damaged:

"The velocity of money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to another...Simply put, it's the rate at which consumers and businesses in an economy collectively spend money...High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions."

The other major factor impinging on this recovery is the fact that COVID accelerated the automation of the economy. People are now used to online shopping, takeout dining, online dating, online classes, working remotely. Go into stores and you can have contactless shopping via self-checkout. All those people who used to work in restaurants and retail can now sit at home, smoke pot, and play Xbox, while collecting stimmy checks. Because what other choice do they have? We are facing a potential lost generation in the aftermath of the virtualization of the economy. The inevitable consequence of "free money". 

Getting back to the casino:

Two things happened today, first deja vu of the first House vote, Tech stocks opened higher today and then rolled over closing at the lows of the day. One should be asking why were Tech stocks up at all today given the impending stimulus vote? Clearly Tech shorts were covering ahead of the vote, knowing that if it failed, Tech would have screamed higher, and cyclicals would have exploded. Crisis averted.

Ironically, the Tech trade would be the right trade for the deflationary times to come, IF it were not already a collapsing bubble:


I maintain that the Dow's new all time high today is setting up to be an historically massive headfake, as this current divergence with the Nasdaq is deja vu of Y2K:

"In early 2000, the view, like today, “was that equities were not interest rate sensitive any longer and that the business cycle had been repealed”

“The lesson here is that near or at market peaks, it is common for the Nasdaq to first succumb to the overhyped inflation fears and the rise in bond yields, and after the mega caps slip, the Dow follows with a lag”

Contrary to what we are told by Wall Street this is not "early cycle".

The comedown from this last sugar high, will be biblical.