The US economy is in transition. It is leaving a period of rising stock and bond prices and entering a period in which, we believe, they are falling…in real terms.
The transition is a mess thanks to the confusion of a deflationary monetary policy mixed with an inflationary fiscal policy. The Federal government continues to run large deficits, while the Fed is raising rates…and letting its portfolio of bonds expire (reducing the nation’s monetary footings.)
Reuters reports, ‘Powell signals no retreat, no surrender’:
‘…crucially, Fed Chair Jerome Powell has once again reinforced the “higher for longer” mantra that has underpinned most of his, and his officials’, communications this year, no matter how much market participants have bet otherwise.’
Stocks have held more or less steadfast near the top of their range.
Strapped for cash
But in the early part of this transition, where we are now, the major risk to investors is still a stock market crash. The Fed is no longer supporting the market with EZ credit. Instead, it is withdrawing credit. So, there is the danger of a credit crisis that will whack asset prices.
The crisis could enter the stock market from two different directions. For example, it could stagger in the front door after trying to refinance its debt. Households are paying twice as much to refinance their mortgages. Business debt, too, is much more expensive to roll over. We’ve already seen the second, third, and fourth largest bank failures in US history. It wouldn’t be surprising to see more.
Or, like an old reprobate sneaking into a church and taking a seat in the back row, it could go almost unnoticed as consumers run out of money. They’ve gone through their stimmies. They’ve exhausted their savings. They’re facing over US$1 trillion of credit card debt — at 20% interest! What’s left?
Here’s DNYUZ, ‘US Consumers Are Showing Signs of Stress, Retailers Say’:
‘Now there are signs that some shoppers are becoming more cautious, as Americans’ savings erode, inflation continues to bite and other factors tighten their wallets — namely, the resumption of student loan payments in October. Financial reports from retailers — including Macy’s, Kohl’s, Foot Locker and Nordstrom — that landed this week suggest a shift is underway, from consumers buying with abandon to spending more on their needs.’
Debt stress mounting
And here’s Business Insider, ‘America’s consumer-debt stress is mounting — mortgage rates top 7%, credit-card liabilities hit US$1 trillion, and now auto-loan defaults are on the rise’:
‘The early-stage past-due rate for auto loans — which measures outstanding payments from 30 to 89 days — has climbed above pre-pandemic levels, representing worse credit conditions for Americans, according to the Federal Deposit Insurance Scheme’s 2023 risk review.
‘The rise in auto loan defaults is yet another worry for the American consumer — who must contend with mortgage rates hitting over 7% and an alarming increase in unsecured personal debt to US$225 billion in 2023, per TransUnion. US consumer credit-card debt topped US$1 trillion last quarter for the first time ever, according to Fed data.’
The early stages of this kind of transition are usually deflationary. Prices tend to go down as people have trouble keeping up with current expenses and past debt. They look at the boat in the driveway and say: ‘What do I need that for?’
Inflate or die
Over the longer term, prices can remain more or less constant…and still fall in real terms. That’s what happened in the 1970s. Taking inflation into account, stocks are down (using the Dow as a benchmark) by about 10% from their 2021 top already.
Even at a fairly modest rate of 4% per year…10 years of inflation would reduce the value of debt outstanding by more than a third.
The trouble is that US Government debt is now increasing at about the same rate. What inflation taketh away, Congress and the Biden Administration giveth back, adding new debt at a rate of around US$5 billion per day.
The level of debt must go down or there remains a problem to be resolved. How? There are only two choices, neatly seated on the two ends of the teeter-totter, either ‘inflate or die’. Either inflation reduces the debt…or the debts die, by defaults, bankruptcies, write-offs, etc.
It’s a policy decision, typically made under the influence. Our inquiries into the nature of government — to which we will return anon — are just attempts to understand which way it will go.
For The Daily Reckoning Australia