At one point yesterday it looked like President Trump would win re-election. Then the US went to bed. He was ahead in the key swing state of Michigan and Wisconsin. But when the country woke up, he was marginally behind.
The Federalist reports:
‘Then, something strange happened in the dead of the night. In both Michigan and Wisconsin, vote dumps early Wednesday morning showed 100 percent of the votes going for Biden and zero percent—that’s zero, so not even one vote—for Trump.
‘In Michigan, Biden somehow got 138,339 votes and Trump got none, zero, in an overnight vote-dump.
‘When my Federalist colleague Sean Davis noted this, Twitter was quick to censor his tweet, even though all he had done was compare two sets of vote totals on the New York Times website. And he wasn’t the only one who noticed—although on Wednesday it appeared that anyone who noted the Biden vote dump in Michigan was getting censored by Twitter.’
Something fishy is going on, folks. You simply don’t find 140,000 votes to zero in a swing state. Or any state for that matter.
We won’t know the outcome of this election for a while. Not that the market seems to care. The major US indices surged overnight, with the NASDAQ up just over 4%. Go figure!
But as I said yesterday, this election is just short-term noise. It won’t change the longer-term economic trajectory of the country.
So let’s continue with our investigation into why this is the case. This is especially relevant given the market’s desperation for more fiscal stimulus in the US. If you missed part one from yesterday, click here.
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Why fiscal stimulus will only deliver a short-term economic boost, and leave the economy in a deeper hole when it washes through the system
You’ve probably noticed that QE and central banks are getting less attention these days outside of periods of acute crisis. The ball is now in fiscal policy’s court.
To give you some sense of the widespread nature of this, have a look at the chart below. It shows the fiscal stimulus packages in response to the ‘rona virus as a percentage of GDP.
Surely you’d think this amount of spending will kick-start the global economy and generate solid growth?
Let me introduce you to Lacy Hunt. He has been managing a Treasury-only bond fund at Hoisington Asset Management for 40 years. The longevity of the fund and its performance, and Lacy himself, are legendary in the world of finance.
Lacy is one of the best monetary economists in the world. His training and research credentials are impeccable.
The following excerpt from Hoisington’s recent third-quarter investment update explains why you shouldn’t get too excited about all this fiscal stimulus:
‘Debt financed fiscal policy can provide a short-term lift to the economy that lasts one to two quarters. This was the case with the debt financed stimulus packages of 2009, 2018 and 2019. However, the benefit of these actions in 2009, 2018 and 2019, even when the amount of the funds borrowed and spent were substantial, proved to be very fleeting and the deleterious effects of the higher debt remain. Substantial econometric evidence indicates that government debt as a percent of GDP in all of the major economies are well above the levels where these detrimental effects occur. The multi-trillion dollars borrowed for pandemic relief in the second quarter encouraged the beginnings of a “V” shaped recovery, but this additional debt will serve as a persistent restraint on growth going forward. When government debt as a percent of GDP rises above 65% economic growth is severely impacted and becomes very acute at 90%.’
Hunt points out that all the world’s major economies, the US, Japan, Europe, the UK and China are all heavily indebted.
Expect the recovery to be over soon
In Australia’s case, we have relatively low government debt-to-GDP, but we are amongst the highest in the world when it comes to household debt-to-GDP levels.
That’s a concern when it comes to considering the marginal productivity of debt. As Hunt writes (in relation to the US):
‘Total public and private debt jumped from 167.2% of GDP in 1980 to 364.0% in 2019, with an estimated record 405% at the end of this year. Gross government debt as a percent of GDP accelerated from 32.6% in 1980 to 106.9% in 2019 to an estimated 127% by the end of this calendar year.
‘As proof of this connection, each additional dollar of debt in 1980 generated a rise in GDP of 60 cents, up from 54 cents in 1940. The 1980’s [sic] was the last decade for the productivity of debt to rise. Since then this ratio has dropped sharply, from 42 cents in 1989 to 27 cents in 2019.’
So every dollar of new debt created in the US only creates 27 cents of economic output (or income). According to Hunt, these diminishing returns all but guarantee lower future interest rates (emphasis added):
‘Diminishing returns occur when a factor of production, such as debt capital is overused. This observation is confirmed by the decline in the marginal revenue product of debt. Economic theory demonstrates than when the MRP of a factor declines, the price received for that factor also declines. If, for example, labor is overused to the extent that its MRP declines, so do wages, the price of labor. Thus, the decrease in MRP of debt due to its overuse, indicates that interest rates, the price of debt, should fall. This is exactly what is happening in all the major economies of the world that are suffering from a debt overhang. Thus, considering decreasing interest rates as an inducement for governments to spend more borrowed funds will add to the severity of the debt spiral. If policy makers are incentivized to borrow more because interest rates are low, then the MRP of debt will fall, leading to even weaker growth.’
So fiscal stimulus in highly indebted economies due to the declining productivity of each additional dollar of debt will only have a short-term impact on economic growth.
In Australia’s case, the recently announced fiscal measures are likely to result in relatively good growth for up to two quarters, or perhaps a little longer. Our debt levels are smaller than other nations and a good chunk of the stimulus promotes private sector spending (income tax cuts and tax breaks on investment), rather than direct government spending.
Still, Australia is highly dependent on trade and unless there are more stimulus measures announced soon, you’ll see the global slowdown that was underway before the virus hit resume in 2021.
To sum up then, expect the recovery to be over soon after it began.
I’ll have part three for you tomorrow, which includes crucial analysis of the ‘shadow banking system’.
The above perhaps explains why the market surged overnight. The market is betting on a Biden victory. The Democrats will approve a massive stimulus bill. It will work in the short term. And right now, that’s all the market cares about.
But as I just explained. It will wash through the system and leave the economy in even worse shape…
Editor, The Rum Rebellion