Aug 19, 2022
By Steve Blumenthal
“The Federal Reserve Acts were created to make the central bank of the United States a lender of last resort, not spender of last resort, a role Chair Powell confirmed in announcing the pandemic response program April 9, 2020.”
– Dr. Lacy Hunt, Hoisington Research Q2 2022 Quarterly Letter
No one knows the Federal Reserve Act better than Lacy Hunt. His intro continued, “Constructed to prevent the central bank of the United States from acting like a banana republic central bank, the logic of the Federal Reserve Acts writers was impeccable. Converting Fed liabilities into a medium of exchange was well understood to be highly inflationary. Paying the U.S. government’s fiscal obligations with Fed liabilities sends demand for goods and services higher without an increase in the supply of goods and services to consume, the very definition of inflation.”
During the Great Financial Crisis and following it, the money created by the Fed went to the banks (their normal transmission mechanism). With consumers’ bellies already full with debt and the housing market imploding, there was little appetite to borrow and little appetite to lend, so the banks took the lifeline from the Fed and simply put the newly created dollars back on the books at the Fed. Think of it this way, I go to my basement and print up new dollars. I send those dollars to you, and you immediately send them back to me. I deposit the money in your name, and I pay you interest on the money. But that’s not how it works most of the time.
Normally, I’m encouraging you to lend the money to your friends and clients, and that’s the primary way newly printed money gets into the system. This time, your friends didn’t want to borrow money, and your balance sheet was in distress, so you didn’t lend it out and deposited the money back to me, and I paid you a small amount of interest. Then, the Fed Funds rate was 0% to 0.25%. Today, the Fed Funds rate is 2.25% to 2.50%. A good gig if you can get it and the banks got it.
Then came the pandemic; the Fed printed more and helicoptered the money directly to you and me.
Here is the summary of key U.S. policy responses as of June 2021:
- $8.3 billion Coronavirus Preparedness and Response Supplemental Appropriations Act and a second $192 billion package. They together provide around 1% of GDP for:
- (i) Virus testing; transfers to states for Medicaid funding; development of vaccines, therapeutics, and diagnostics; support for the Centers for Disease Control and Prevention responses. (ii) 2 weeks paid sick leave; up to 3 months emergency leave for those infected (at 2/3 pay); food assistance; transfers to states to fund expanded unemployment insurance.
- (iii) Expansion of Small Business Administration loan subsidies. And (iv) US $ 1.25 billion in international assistance. In addition, federal student loan obligations have been suspended for 60 days.
- $2.3 trillion (around 11% of GDP) Coronavirus Aid, Relief and Economy Security Act (“CARES Act”). The Act includes;
- (i) $293 billion to provide one-time tax rebates to individuals;
- (ii) $268 billion to expand unemployment benefits;
- (iii) $25 billion to provide a food safety net for the most vulnerable;
- (iv) $510 billion to prevent corporate bankruptcy by providing loans, guarantees, and backstopping Federal Reserve 13(3) program;
- (v) $349 billion in forgivable Small Business Administration loans and guarantees to help small businesses that retain workers;
- (vi) $100 billion for hospitals,
- (vii) $150 billion in transfers to state and local governments, and
- (viii) $49.9 billion for international assistance (including SDR28 billion for the IMF’s New Arrangement to Borrow).
- $483 billion Paycheck Protection Program and Health Care Enhancement Act.
- On December 28, 2020, President Trump signed an $868 billion (about 4.1% of GDP) coronavirus relief and government funding bill as part of the Consolidated Appropriations Act of 2021. The act includes enhanced unemployment benefits of $300 weekly Federal enhancement in benefits through March 14, direct stimulus payments of $600 to individuals, another round of PPP loans, resources for vaccines, testing and tracing, and funding for K-12 education.
- On March 11, 2021, President Biden signed into law the American Rescue Plan, which provides another round of coronavirus relief with an estimated cost of $1,844 billion (about 8.8% of 2020 GDP).
That is a lot of dinero. MMT, the Magic Money Tree, aka Modern Monetary Theory… the cat is out of the bag.
Approximately half the dollars ever created in the history of the United States were printed in the last several years. Too much money chasing too few goods. Inflation.
The above is from the IMF. I only highlighted the U.S. response. Here you can find the summary of policy responses by country.
More from Lacy:
- Considering that the average age in the United States is 38, more than half of U.S. citizens were not alive at the time of the last such crisis. No wonder the most properly constructed of all the consumer attitude surveys (University of Michigan) reports that sentiment is at a record low for readings that go back to 1952.
- The Fed’s most pressing concerns are to not only reverse its monetary excess and misjudgment of inflation, but also to instill confidence that they will follow important provisions of the Federal Reserve Acts.
- These Acts were set up with the clear intent to keep the Fed free and independent with regards to fiscal policy.
- Now, like in the early 1970s (when Nixon closed the gold window), the Fed alone must unwind a combined monetary/fiscal policy failure.
- Thus, once again, the architects of the Fed Acts showed their wisdom when they tried to establish the Fed’s independence, an insight apparently lost by today’s practitioners.
SB here again with a couple quotes from heavy hitters:
“You have avalanches, but they don’t happen in minutes. They happen in years.” – Jim Richards, Video Interview with Danielle DeMartino Booth, Bretton Woods, NH.
What happens next? The market is betting the Fed will soften and slow its inflation fight. The market expects another Powell Pivot. The market has been trained to believe in the Fed put. Inflation is different. Inflation is the kryptonite to easy money. I think Powell will hike rates higher than what the market is pricing in. Inflation is his giant to slay. He’ll hike until something breaks.
Boomed Booms and Slumped Slumps
More from Lacy:
- As much as the Fed would like to think that their actions during the pandemic have stabilized the business cycle, the long historical record indicates that massive policy swings have often aggravated the magnitude of business cycles.
- For the Nobel Laureate Milton Friedman, the two key metrics were the degree of acceleration in monetary growth from the cyclical trough to the cyclical peak and the ensuing deceleration from the peak to the trough. (bold emphasis mine)
- As such, the Fed has often boomed booms and slumped slumps. They have made expansions more inflationary and recessions deeper and longer lasting.
- To correct these failures, Friedman advocated that monetary growth should be contained in a relatively narrow range that allows for population growth and technological change. Friedman argued that there is an optimal range for monetary growth based upon the aggregate production function, which relates real per capita GDP growth to technology interacting with the three factors of production – capital, labor, and natural resources.
So what is the range for appropriate growth in the money supply over time?
- Friedman calculated that the broad money stock should be limited to a growth rate range of 4% to 6%.
- Since the late 1990s, real GDP per capita has risen by 1.4% per annum.
- The upper ceiling of monetary growth based on Friedman’s work suggests that annual growth should be 5%, with the lower range at 3%.
- Over 2020 and 2021, the pace of M2 quadrupled the ceiling rate, posting an 18% two-year average rate of increase. Chart 1
- As the 2020-21 episode demonstrates, the poor results of the Fed’s stewardship have continued. Ostensibly, this is confirmed by the Fed’s absolute refusal to allow for audits of monetary policy operations. Ironically, the argument is that this would impinge on their independence, which they surrendered in the Pandemic for two long years.
- Reversing the massive deposit growth of 2020-21 will add to the list of policy failures because of the largely unprecedented degree to which deposits grew in these years and the needed magnitude of the deceleration that is already becoming apparent.
- By Friedman’s evidence, the likelihood for a successful outcome of a soft-landing for the Fed and thus the United States is low.
Put your quant geek goggles on and further your economics education… you can find the link to the entire Hoisington letter here.
“Monetary considerations coupled with these real side indicators point to recession and a reduction in inflation and long-term Treasury bond yields. If the Fed stays within the scope of the Federal Reserve Acts, they will have difficulty in containing the recession and fostering recovery. But that situation puts us on alert to the possibility that the Fed returns to a pandemic type of response that generated an inflation rate far above their target, as the experience of the past two years has so painfully taught. The economy might recover temporarily, but the expansion would be interrupted by another cost-of-living crisis and the Fed would not achieve either of its mandates for employment or inflation.”
My point isn’t to say things are going to turn out bad. No one really knows for sure. My point is to emphasize the imbalances that exist due to prior decisions and do our best to gauge what that means in terms of risk. Sometimes the systemic risk is low. Sometimes the systemic risk is high. Today, the risk is higher than I’ve seen in my more than 35 years in the business. More defense than offense. Recession? Yes. Stagflation? Yes.
Boomed Booms and Slumped Slumps. Essentially, more extremes up and down. Makes sense to me. I share a few basic investment concepts in the personal section below.
Grab your coffee and find your favorite chair. Head up, stay positive, ever forward!
Trade Signals: Short-term Trading Top?
August 18, 2022
S&P 500 Index — 4,207
Notable this week:
This Is What Overbought Looks Like,
I’m a subscriber to StockCharts.com and from time to time share a chart or two I find timely.
The following is by|
“It occurred to me that some of our primary indicators have created a teachable moment. Specifically, our short-term and intermediate-term indicators are both at fairly extreme overbought levels, and now is a good time to talk about what that means.
The Swenlin Trading Oscillators for breadth and volume (STO-B and STO-V) are near the top of their normal range, and that usually coincides with short-term price tops. The Intermediate Term (IT) Breadth and Volume Momentum Oscillators (ITBM and ITVM) are also near the top of their normal ranges, and that normally coincides with intermediate-term price tops. With indicators from both time frames at overbought levels, there is strong technical pressure for prices to make a noticeable decline.”
SB here: Focus on the vertical dotted green and dotted red lines. Bottom line: The SPY is near an intermediate term overbought peak.
Conclusion: This condition occurs about every two to three months (see the red, downward pointing arrows for previous events), and it is fairly reliable as a top warning. While all four indicators are still rising, they are quite extended, so I would expect a price top soon, probably this week. Not guaranteed, just likely. DecisionPoint is not a registered investment advisor. Investment and trading decisions are solely your responsibility. DecisionPoint newsletters, blogs or website materials should NOT be interpreted as a recommendation or solicitation to buy or sell any security or to take any specific action.
Overall, caution and downside risk management are advised…
High Yield just turned bearish again. Red arrow bottom right.
The Dashboard of Indicators follows next. Stick to the risk management drill. None of this is a perfect science. We are attempting to identify primary market trends focusing on downside risk management.
Click HERE to see the Dashboard of Indicators and all the updated charts in Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon, and risk tolerances.
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Personal Note – Detroit, Salmon Fishing in BC and Living to 130
Depending on the lens through which you read today’s OMR, the above could be “it is what it is,” it could be depressing (I get that), or it could signal opportunity. I’m in the is what it is camp and we’ll have to adapt to the consequences.
In the “what you can do” category, find funds that generate unique return streams. For example, we allocated about $26 million to a fund that writes a certain type of short-term Chapter 11 bankruptcy insurance protection. Let’s say you are a perfume company and have an order from Neiman Marcus to sell them one million units of your product for $10 million. You ship your product, and Neiman Marcus agrees to pay you within 60 to 90 days. Your risk is they don’t pay you, and if they go bankrupt, you go bankrupt too. So you offload that risk to a third party who will take your receivable if the department store “files” for Chapter 11 bankruptcy. For that protection, you pay 1% per month for three months. The specialty fund we allocated to is taking a short-term risk, doing the credit work on Neiman Marcus, and determining the potential they file for bankruptcy protection in the 90-day window. The odds are not zero, but they are very low if you know how to do your credit research. We anticipate that the fund will distribute more than 3% per quarter to our clients. That totals 12% per year, assuming no bankruptcy filings. There is risk in everything, so no guarantees can ever be made, but I like the risk/reward odds. What is the probability of any company filing Chapter 11 in the next 90-days? It’s not zero, but it’s not very probable if you do your due diligence and keep in close contact with Neiman’s CFO. This is a better risk than 2.8% 10-year Treasury bonds and 6.5% high yield junk bond funds, in my view.
The message is that all is not bad on the investment horizon. Just think differently: Agriculture, farmland, commodities, residential housing, metals, long/short absolute return, and trading strategies. A stay-rich endowment-type investment model. Ok, enough on that.
I just pre-ordered Dr. Michael Roizen’s new book titled, The Great Reboot: Cracking the Longevity Code for a Younger Tomorrow. Roizen founded the Cleveland Clinic’s Wellness Center. Here is the teaser to the book:
As the human lifespan expands and more people live to 100 years and beyond, New York Times best-selling author Michael Roizen, M.D., explains how to prepare for a longer, healthier future. Over the next decade, people living to 100, 120, or even 130 years old will become increasingly common–and life past 100 may not look like what you expect. In this groundbreaking narrative, best-selling author Michael Roizen reveals how current science and technology will revolutionize our ability to live longer, younger, and better.
SB here: Medicare and Social Security anybody… “Anyone, Bueller Bueller anyone?” We’ll have to figure it out.
Ok, except for that “Ferris Bueller’s Day Off” flashback, put Roizen’s outlook in the positive bucket! What types of investment opportunities will this present? Healthier, stronger, for longer. A glass of fine red wine (Cab, Zin, Bourdeaux… or white – you pick) toast to that.
Next Tuesday and Wednesday, CMG’s Avi and I are traveling to Detroit, where good friend and client John Chirikas and his wife Catherine have invited us for golf. Then, on Saturday, August 27, I fly to Vancouver, where I meet up with John Mauldin and Jim Tosti for four days of Salmon and Halibut fishing in British Columbia. I’m told it is a bucket list experience, and since I’m going to be living to 120 or 130, I better add more to the list. Thank you, Dr. Roizen! (Hey Doc, is red wine on the longevity plan?)
Thanks for reading!
Wishing you a great week,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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