by William Levin
Nothing in U.S. history matches the radical acceleration into the abyss being pushed upon us now.
At
the Federal Reserve semi-annual testimony before Congress this week,
Chair Jerome Powell should have been asked whether the Fed has become
the national Reddit.
The Reddit stock frenzy created a pool of motivated buyers, irrespective of the value of the underlying company.
For
more complicated reasons, the federal government is the biggest
Redditer of all, Reddit on crack cocaine. Instead of billions, the
government plays in the trillions. Instead of a handful of small cap
stocks, it has hijacked the entire stock market. But the mechanism is
the same. Flood the market with funds, and for good measure force
interest rates to zero, eliminating alternative investments. The recent
congressional Reddit hearings are parody in comparison to the
government's role in driving market prices, in particular the Fed.
Let's
make it specific. When Joe Biden promises to spend $1.9 trillion,
where exactly does that money come from? Beyond that, even excluding
the $1.9 trillion, how does the government finance four years of
deficits, which the Congressional Budget Office recently estimated at $5.9 trillion? That's an expected one-term cumulative deficit of $7.8 trillion. Where indeed does this money come from?
The
wrong answer is tax receipts. In FY2020, federal budget revenues —
i.e., tax receipts — totaled $3.4 trillion — $1.6 trillion from income
taxes; $1.3 trillion from payroll taxes; $0.2 trillion from corporate
taxes; and the balance of $0.3 trillion from excise, custom duties,
estate taxes, and miscellaneous. Spending, on the other hand, totaled
$6.6 trillion, versus the pre-COVID budget of $4.8 trillion. The result
is a record $3.1-trillion deficit.
Scale
matters here. One point nine trillion dollars is 40% more than the
total regular spending of the entire U.S. government. And that is on
top of $3.5 trillion in COVID spending already committed, of which some
$1.0 trillion has yet to be spent. Put another way, Biden could triple
income tax receipts in 2021, from all taxpayers, and still not pay for
this year's forecasted $4.2-trillion deficit, including his
plan. Taxing the wealthy does not work, either, as a 1% rise in the
highest two tax brackets raises, by these standards, a mere $120 billion
over 10 years, an amount that will decline as higher rates change behavior.
Bottom
line: There is no money in tax receipts to pay $1.9 trillion, or indeed
any of the $7.8-trillion unfunded spending coming our way.
The
next option is to borrow the money from third parties. Here the
problems begin to multiply. We as a country have already been tapping
this well aggressively. We have to pay interest on this debt. Over
time, the interest payments, which already approximate $350 billion
annually, will swallow the discretionary budget. It addicts this
country to maintaining artificially low interest rates. If rates were
to advance back to historic norms, the country would immediately enter a
deficit death spiral.
Lastly,
and perhaps most problematically over the longer term, who will
buy? Excluding the federal government as owner, foreigners already own
more than 30% of our public debt, including China which holds in excess
of $1 trillion currently. Will China continue to buy our debt so we can
increase military expenditures to wage war with China? That sounds
absurd now.
That leaves the final option of printing money.
From
time immemorial, the printing press has been the preferred choice of
weak governments. Easy money has no immediate or obvious cost since
inflation and currency devaluation can take time to materialize. It
does not require a willing buyer.
In
a modern economy, printed money has a third virtue. The Federal
Reserve increases the money supply by purchasing debt securities, with
printed money, from banks or private parties. When the purchases are
big enough, it dramatically increases the competition for
interest-bearing assets, raising their price, which in turn lowers their
yield. In 2020, the Fed used printed money to reduce interest rates
from the 1.4% range to zero.
The stock market zoomed to historic highs on the back of this easy-money, zero-interest-rate nirvana.
Correlation between the Fed balance sheet and the U.S. stock market.
Source: Preston Pysh.
Historical
perspective is needed here. Congress created the Federal Reserve
system in 1913. In all those years, until very recently, the Fed's
balance sheet was restricted to influencing the Federal Funds rates as
the reference marker for all interest rates. As a result, the balance
sheet expanded when the Fed purchased assets and shrank when it sold
those assets, but it always remaining quite small as a percentage of
GDP. Even as late as 2007, the Fed balance sheet was a mere $870
billion.
Then
the 2008 financial crisis hit. It was only then that the Fed announced
a new tool, usually referred to as Quantitative Easing, though the more
precise term preferred by the Fed is Large Scale Asset Purchases. This
was the first time the Fed aggressively pumped printed money into the
economy via enormous asset purchases. By 2015, the Fed balance sheet
peaked at $4.5 trillion.
With
the crisis past, the Fed announced its intention to restore normality
by selling assets. But as with all things governmental, norms once
broken never are restored. The balance sheet went as low as $3.8
trillion in 2019, but the Fed balance sheet currently stands at a
hard-to-fathom $7.5 trillion, which sets several dubious records.
It
is the greatest one-year increase in the Fed balance sheet in U.S.
history. It means that all COVID expenditures to date have been
financed with printed money. And, given $2.3 trillion in expected
FY2021 deficits, apart from $1.9 trillion in supplemental spending, the
Fed balance sheet by year-end 2021 is expected to reach or exceed $10
trillion.
So
there is the answer. All of the $1.9 trillion in proposed spending,
and much more, will be funded with printed money, via asset purchases by
the Fed.
The
Fed does not explain what constitutes a normal balance sheet. Nor has
there been candor with the American people that the COVID spending, all
of it, has been, and will continue to be, paid for with printed money.
Rather,
Treasury secretary, and former Fed chair, Janet Yellen cheerleads for
$1.9 trillion in spending, without regard to its funding; inflationary
pressure; waning need ($1 trillion unspent, a working vaccine; an
underway recovery; the scientific prospect for herd immunity by this
summer); and sheer political looting ($465 billion directly to
individuals versus blue-state payoff money of $350 billion, $170 billion
boondoggle for schools and colleges, $200 billion in leftover slush
fund expenditures, and on and on). All this as the administration
readies yet more trillions in spending in March for "infrastructure."
As
a postscript, the Fed balance sheet explains when the stock market boom
will end. The answer is 2022, and sensibly far sooner based on
rational expectations. The unthinkable tsunami-like growth in
the Federal Reserve balance sheet to $7.5 trillion has fueled the
present record market highs. It is the huge pool of money that has led
to relentless buying regardless of valuation, AKA Reddit on the grandest
scale ever seen.
Wall
Street takes comfort that ballooning the Fed balance sheet to $10
trillion in 2021 will support further market advances. Maybe so. But
small comfort ought to be taken here. Unless the Fed is committed to
owning these securities forever, and growing them further, the day will
come when the Federal Reserve, at a minimum, stops growing its balance
sheet. The Fed cannot permanently increase the money supply in excess
of the demand for money without reintroducing stagflation to the
national vocabulary.
If
and when the Fed starts selling down aggressively, or that expectation
becomes clear, markets will fall. Beginning in 2022, the deficit is
forecast at "only" $1.2 trillion, which is not enough new juice into the
system.
In
the longest run, the unhinged spending-deficit–new money grift works
only because the U.S. is the world's reserve currency. China
understands this. As much as anything else, a prime Chinese agenda is
to displace the dollar as the world's reserve currency with an
"international" — i.e., non-U.S. — medium of exchange. Blockchain
technology will make this possible even as reckless spending with
printed money hastens our collapse.
Trust
is the true coin of the realm. That trust is gradually but
relentlessly eroding, as it should be when no one cares about a
$10-trillion Fed balance sheet, a $1.9-trillion political payoff scheme
long after COVID peaked, and the prospect of a one-term $7.8-trillion
deficit, with more on the way, as far as the eye can see.
The CBO 2020 Long-Term Budget Outlook
Source.
If
money on this scale is an unhelpful abstraction, then consider the
truly hazardous cost of excess government spending. The U.S. has
emptied its toolbox for future emergencies. Interest rates are at zero,
the Fed cannot print more money with impunity, Social Security and
Medicare are bankrupt, tax increases cannot remotely fill the gap, and
the deficit forecast has already swallowed us whole.
This
unnerving state of affairs has been long in the making and has many
parents, Republicans and Democrats alike. But nothing in our history
matches the radical acceleration into the abyss being pushed upon us
now, exclusively by one party, and just as we should instead be
repairing our finances.
William Levin is the founder and managing director of a New York investment banking firm.
Source: https://www.americanthinker.com/articles/2021/02/the_federal_reserve_is_taking_us_into_uncharted_and_deadly_waters.html
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