The Macro Minute Nov 10
THANK YOU FEDERAL RESERVE! – It looks like the Fed might be America’s saving grace after all:
THANK YOU FEDERAL RESERVE! – It looks like the Fed might be America’s saving grace after all:
For the first time in 31 years, inflation is now above six percent. The Consumer Price Index for October was 6.22 percent higher than in October last year.
After three months of price hikes tapering off, inflation is back with full force. Just as I predicted back in June, we are in the Fall of Inflation: the Bureau of Labor Statistics is reporting across-the-board price increases.
This is monetary inflation. As I explained back on October 20, our economy does not have a capacity problem; the constraints that do exist in such areas as trucking are caused entirely by government regulations. A case in point is the California law that prohibits trucks older than 2011 from operating within the state. While the Biden administration is focused on ports, there is a much more pressing problem on the trucking side of the logistics chain. Even a Politi-Fact “fact checker” has had to admit that California’s AB5, the law banning older trucks, is a culprit in the Golden State’s apparently unending supply-chain problems.
With that said, even the government-imposed problems in our logistics industry cannot account for the inflation we have. For the supply-chain problems to impact the economy, there first has to be money on the demand side. Since our economy is operating at a capacity roughly 5.6 million workers short of where it was in 2019, economic theory and common sense prescribe that we should see consumer spending – and by extension business investments – at a proportionately lower level. The fact that we are not is attributable to the very large amounts of cash that Congress has been pumping into the economy through its several stimulus bills.
In short: we are dealing with a bad case of monetized inflation. To make it worse, this monetized inflation is paired with subpar capacity utilization in the economy, which technically means we are in the thick of stagflation.
Figure 1 compares CPI inflation so far for 2021 with the same period in 2019. Again:
While operating at lower capacity, our current economy is – again – plagued by inflation that won’t subside. Figure 1 reports the monthly year-to-year inflation rates (not seasonally adjusted):
The response from relevant government institutions to these high inflation rates have been muted so far. The prevailing talking point is that inflation is “transitory”, a concept that has no meaning in economic theory and serves no purpose in real life: in the long run, all inflation is transitory – even the high inflation we endured during the last stagflation episode. Therefore, it is refreshing to see Federal Reserve Vice Chairman Richard Clarida spell it out: inflation, he says, is “much more than a ‘moderate’ overshoot of our 2 percent longer-run inflation objective”.
Again, as I pointed out yesterday in my review of the latest producer-price inflation numbers, this is the reason why the Federal Reserve decided to start rolling back its Treasury purchase program sooner than it had previously signaled. the roll-back is also more aggressive than expected, with a six-month horizon for completion and a simultaneous tapering for both traditional Treasury securities and Mortgage-Backed securities.
The latter is going to impact on the mortgage-loan market, though it is too early to tell if it will be enough to cool off real estate prices.
To make the point about our inflation in a different format, let me also present the CPI numbers in the year-to-date format I used in yesterday’s PPI analysis. Watching prices rise from January and on through the year, Figure 2 reports that year-to-date inflation is now at 5.74 percent:
The year-to-date inflation rate for October is a high number, the 15th highest on record for the month of October (with data stretching back to 1913) but given that the inflation rate is again accelerating, it is likely that we will end the year somewhere in the bracket where the stagflation era found itself. In the month of December, year-to-date inflation was
I predict that we will be in this bracket by the end of this year. The Federal Reserve’s shift in monetary policy will have an impact on inflation, but not before the turn of the year.
One factor that could dampen inflation is that Congress has ended its unemployment-bonus program across the country. Hopefully, this will lead to some rise in labor supply; if employment increases, the money printing that currently funds deficit-spending on entitlement benefits, will gradually be replaced by tax revenue. Where more value goes into the economy (workers producing value) and less newly minted cash is used to fund expenditures, the monetized inflation gap shrinks. This eases the inflation pressure that otherwise drives up prices across the economy.
These are hopes on my end. I don’t predict any immediate substantial effect of the demise of the unemployment bonus, and I cannot let go of the suspicion that the bonuses inspired creative fraud that, in turn, inflated unemployment numbers. Thereby, the expectations of a boost in employment after the bonus ended in select states, were exaggerated.
Again, this remains to be solidly proven, but the suspicion of widespread fraud is reinforced by the fact that at its height, the unemployment-bonus program on average paid out more than $6,000 per month per unemployed person.
In other words: the responsibility for eliminating inflation lies with Congress and the Federal Reserve. The central bank has how stepped up to the plate and taken its responsibility; when will Congress do the same?
Never Bark At the Big Dog. The Big Dog Is Always Right.
The Bureau of Labor Statistics has released its numbers for the Producer Price Index for October. They confirm the suspicion I had last week when I said:
Inflation is here and it is not going away, with third-quarter GDP numbers showing inflation close to five percent. And let’s not forget that the GDP-based inflation measurement is more conservative than the more widely used Consumer Price Index, the October numbers of which the Bureau of Labor Statistics will publish next week. It is entirely possible, even likely, that the Fed, having a preview of those numbers, got so scared of where inflation is heading that they decided it was reason enough to move faster with their rollback of Treasury purchases. If so, we should expect a bombshell or two on Tuesday and Wednesday when PPI and CPI numbers are released.
And a bombshell it was. Compared to October last year, producer prices are up 22.6 percent. This is in fact an acceleration of PPI inflation compared to the last few months: after reaching 19 percent in May, producer prices stayed virtually still in the sense that they remained roughly at a rate 20 percent higher than last year. This rate, newsworthy in itself, is not the biggest story – that would instead be the fact that the October inflation leapt up as much as it did. By October last year, the economy was moving out of its artificial shutdown, with economic activity coming back online again on a broad scale.
It is sometimes suggested that the high inflation rates this year are due to the recovery from the shutdown. If this was the case, though, the bulk of that inflation would have been visible late last year and early this year; we are now in November 2021, closing in on two years from when the covid-19 epidemic started, and inflation rates are still rising. Furthermore, if inflation was strictly the cause of a rapid return to normal for the economy, there would be little to no difference in inflation rates between this year and 2019, the last year before the artificial shutdown.
A review of two-year inflation rates for the Producer Price Index clearly show that our current price-hiking problems are more than just a return to normal: PPI for October was almost 21 percent higher than it was in October 2019. In fact, we have had 10+ percent two-year PPI inflation since May:
Again, it is highly probable that the decision by the Federal Reserve’s Open Market Committee to start winding down its Treasury security purchases a month earlier than previously expected, was motivated in large part by these PPI numbers. Producer prices were in deflation for most of last year – hardly surprising – but what is often overlooked is that they fell from May to December in 2019 as well. Since that year was a strong one for the economy, with unemployment below 3.5 percent and workforce participation above 60 percent, PPI deflation is not unique to artificial economic conditions.
As mentioned, the 2019 PPI comparison also shows that we have inflation in our economy that has nothing to do with ending last year’s shutdown. There is another way to capture this point: Table 1 reports inflation as a year-to-date figure. For example, in February this year, producer prices were 2.8 percent higher than they were in January; in March the same prices were five percent higher than in January; and so on.
Measured this way, inflation in October was 17.3 percent. This is the fourth highest October figure for year-to-date inflation on record (and the PPI data goes back to 1913). In fact, 2021 is the second-most inflationary year for producer prices, with only one year, 1917, exhibiting faster acceleration of year-to-date inflation:
Again, year-to-date inflation is not the commonly used measure for price hikes. The year-to-year method is a better one for gauging inflation over the longer term. However, the year-to-date numbers tell us how fast inflation is accelerating, and are therefore important indicators of how potentially destabilizing inflation can be. From this viewpoint, Table 1 has some ominous news for us: every year with a higher October Y-t-D inflation rate was associated with a war. In 1946 we had just gotten out of World War II, and 1916 and 1917 were right up in the middle of World War I. The two real peacetime years with Y-t-D inflation comparable to 2021 are not very good company to have: in 1933 the country was struggling with the Great Depression, and in 1974 stagflation was burning through the economy.
Tomorrow we get the Consumer Price Index data. Prepare for more bad news.
The Fed started moving out of the U.S. debt market last week. Was inflation one of its concerns?
The massive spending plan that Congress passed on Friday is not only an open ideological effort to advance socialism by means of expanded economic redistribution, but it is also a fiscal hand grenade thrown right into the federal government’s finances.
For this reason, I predict that the Build Back Better Act will be the beginning of the end of America’s era of big government.
For sure, a lot must go right for that to happen, but ironically the BBBA has actually laid out the landscape for the demise of the very welfare state that it seeks to expand.
The reason for this lies in the items of the bill that increase economic redistribution, primarily
The annual costs of these items are not entirely clear, but according to at least one estimate we are looking at approximately $120 billion per year. However, it is almost a natural law that initial cost estimates for new and expanded entitlement programs under-estimate their cost. The classic examples are Social Security, the tax of which was raised 20 times by Congress in the 40 years from 1950 to 1990, and Lyndon Johnson’s War on Poverty, which caused the perennial budget deficit that is responsible for a large part of our $28.9 trillion pile of debt.
With that in mind, it is worth noting that an estimate by economists the University of Pennsylvania Wharton School points to the BBBA adding as much as $270 billion per year over a ten-year period. Their estimate is based on the realistic premise that all the temporary entitlement expansion are made permanent. What it does not seem to take into account, however, is the depressing effect on economic growth from a welfare state that exceeds 40 percent of GDP. With these new programs, the U.S. economy is slated to permanently cross that line.
As I show in Industrial Poverty with my own estimates, and with citing other studies, the 40-percent threshold is statistically well established. When the package of entitlement programs we know as the welfare state consume more than 40 cents of every dollar of GDP, the combined effect of
depresses growth enough to bring an economy down into de facto perennial stagnation.
In practice, this means that makes itself unaffordable. It creates a permanent budget deficit that only widens with time. In the case of the U.S. economy, this budget deficit already exists – I discussed the reasons for this in my ebook Tax Cuts Don’t Work – and the welfare-state expansion that comes with the BBBA will drastically grow this structural government over-spending. Given how close we are to a fiscal crisis, this expansion will quickly push us to the brink.
In addition to the deficit expansion that Congress itself drives with its new spending programs, there is going to be mounting pressure in the opposite direction from the Federal Reserve. Their decision last week to start early with their tapering of U.S. debt purchases is both a tangible fiscal variable to take seriously, and a policy signal to Congress that they better start actively trying to reduce their budget deficit.
Congress, on the other hand, can’t have it both ways. They cannot balance the budget while maintaining and even expanding entitlement spending, and they cannot keep funding a large deficit without support from the Federal Reserve. Any attempt to force the Fed into compliance will be met with heavy resistance from the sovereign-debt market: the announcement that the central bank will start its debt-purchase tapering already in November has been received positively by Treasury investors. On Wednesday, when the Federal Reserve announced its new monetary policy,
After falling on Thursday and Friday, today on Monday Nov. 8 the yields are as follows:
Any return to quantitative easing of any kind will be met negatively, i.e., with rising interest rates. This means, in turn, that the White House no longer has a choice: it must keep the Fed’s monetary policy leadership – its Federal Open Market Committee – largely intact. They may appoint an FOMC member who is more favorably positioned in terms of quantitative easing than the majority, but there will be no upsetting shift in the composition of the committee.
With the Federal Reserve gradually pulling out of the U.S. Treasury market, the deficit-spending majority in Congress (which, notably, is bipartisan) is now left to fend for itself. It will have to take its case for endless trillion-dollar budget deficits to investors that operate on a global scale; without the central bank as the default buyer, any attempt to sell virtually unlimited debt to the world will inevitably lead to an interest-rate shock and likely credit downgrades for the U.S. government. This, in turn, will send the cost of the debt skyrocketing, but we might not even get there before we hit the trigger point for a fiscal crisis.
As the door slams shut on deficit monetization, Congress is left with only one option: to reform away as much of its entitlement obligations as it can. This will take a structural redesign of the entire welfare state; as I explained in Tax Cuts Don’t Work, a penny-plan approach only delays the fiscal crisis, but will not stop it. The reason is to be found in the very fiscal design of our entitlement programs:
Plainly, in order to balance the budget Congress must hope that the cost of the entitlements they have promised the American people – or selected segments thereof – grows no faster than aggregate personal income (which currently funds 80 percent of all federal tax revenue). The conundrum can be expressed as follows:
To make the equation work, E must never rise faster than Y. Is that possible? No. Let’s look at some graphs to see why. First, Figure 1, which illustrates the cost of benefits rising along a red function; the slope is determined by E, in other words the terms on which Congress will have to put more money into the program to keep its entitlement promises. The dark green “wave” function is the regular business cycle with which Y rises and falls. The dashed dark green function is the long-term average trend of tax revenue.
Figure 1 illustrates the normal relationship between tax revenue and the entitlements it is supposed to pay for. This is why we have a structural deficit in the federal budget, in other words a deficit that does not go away over one business cycle.
What, then, can Congress do about this situation? The option often heard in the debate – as often as proposals for spending reform are heard – is to follow the so-called penny plan. Its principle is simple, though its nuance tends to vary depending on who propose it. Basically, the plan says that Congress should cut one percent of the budget for all entitlement programs every year for ten years, and then let them revert back to normal again.
The problem with this plan is that the entitlements that constitute the program do not change. For example, Medicaid still promises the same package of health benefits to its enrollees under the penny plan as it does before the plan is implemented. The cost of those benefits is not determined by what Congress can afford, but by the overall cost of providing health care; the “E” in Medicaid changes with the cost of medical staff, the production and distribution costs of medical technology, etc. Over time, those costs increase because the science of medicine becomes better and better at curing more and more advanced health conditions. To keep up with those costs, Congress will have to increase the “B” of Medicaid on a regular basis.
Proponents of the penny plan sometimes point out that entitlements are run inefficiently, that the bureaucracy around Social Security, Medicare, Medicaid, TANF, WIC, SNAP, the EITC, etc., can be reduced without impacting benefits. This is true to some extent, but bureaucracy costs usually represent only a few percent of the cost of the programs. The big option for reduction is in the entitlements themselves.
The costs of other programs, such as the Earned Income Tax Credit or even Social Security, are determined by income-eligibility variables. The EITC pays out a refundable tax credit to people making up to a specified threshold; the “B” in Social Security is defined by the beneficiary’s income history. In neither case is the growth of the benefit related to the growth of the tax base. Therefore, the scenario in Figure 2 is possible if, and only if, Congress consistently – and increasingly – defaults on its promises to the eligible population:
Do tax hikes work? In a situation with a structural budget deficit caused by excessive entitlement spending, tax hikes are, to wit, even worse than tax cuts. For two reasons, Congress would have to repeat them over and over again:
Taken together, these points tell us that if we try to close the structural deficit with higher taxes, we will have to not only raise taxes repeatedly, but raise them more each time we try. As we do, we create a need for even larger tax hikes in the future:
There is only one way to solve the deficit problem in a modern, socialist welfare state: to structurally reform away the socialist welfare state. Back in 2012 I collected a set of papers explaining how this can be done; since then the need for structural spending reform has only grown bigger.
It sounds daunting to suggest that Congress might actually resort to reforms that permanently reduced the size of government and even got it out of the business of economic redistribution. However, with the Fed standing firm against more deficit monetization, and with increasingly alarming warning signs of higher inflation, I am cautiously optimistic that Congress will get its act together. It won’t happen now, but it might actually happen after next year’s election.
The only question is: will that be soon enough?
America has been pushed one step closer to becoming a full-fledged European welfare state. On Friday, President Biden and the Democrat majority in Congress had reasons to celebrate when the House of Representatives passed the Build Back Better Act. This bill is an open, unabashed vehicle for expanding socialism in America.
No, this is not a rhetorical point. It is an analytical fact, and it is about time that the conservative movement in America comes to grips with the fact that the American welfare state is indeed socialist in design, intent and function. If, and only if, conservatives recognize that our welfare state is socialist, will they be able to understand why the left continues to expand the welfare state.
That recognition, in turn, is a necessary condition for anyone who wishes to put an end to the growth of the American people’s dependency on government. Or, which is to make the same point from the opposite angle: it is a necessary condition for anyone who wishes to protect and restore the values upon which the United States of America was founded.
This ideological insight is badly needed, not only among the broader community of conservative public policy pundits but among Republicans in Congress as well. While six Democrats refused to support it, 13 Republicans helped Speaker Pelosi bring the BBBA over the finishing line. Reports Breitbart:
The 13 establishment House Republicans who voted to pass the $1.2 trillion “bipartisan” infrastructure bill, which will now go to Biden’s desk to sign, sprung free the far-left framework of the reconciliation package. The reconciliation package is a measure far-left Democrats had been fighting over for months while holding the infrastructure bill hostage
There is no doubt that this Act will leapfrog America closer to a fiscal crisis. Ironically, this may be the very reason why the welfare-state expansion embedded in the bill ultimately fails, but conservatives or libertarians cannot pin their hope of saving America on the self-destructive fiscal mechanics of the Democrats’ latest massive spending bill. The federal government’s already brink-dwelling debt problem is a weak branch to hold on to when the left is so close to fulfilling their ideological dream:
Turn America into a full-scale Scandinavian welfare state.
They won’t stop until a fiscal crisis has destroyed America as we know it. We, on the other hand, can’t wait with defending America until that point. We have to step up and take the ideological fight for our country, and we have to do it now.
The Build Back Better Act is the perfect place to start, but in order to use it as a launch point to save our country from fiscal, economic and social ruin, we first need to understand why the BBBA is a vehicle for advancing socialism.
It is a widespread conventional wisdom, especially among conservatives in America, that socialism begins when government seizes private businesses. This is not the case: the confiscation of private property is merely a special case of socialism. The general case of socialism is economic redistribution:
The reformist version of socialism means that you gradually expand government in order to gradually reduce economic differences between private citizens. We know the reformist version as the welfare state. Its architects, among them Swedish economist Gunnar Myrdal and his American colleague John Kenneth Galbraith, were open about their intent by creating welfare states that took from “the rich” and gave to “the poor”: eventually, with gradual expansion of government, all economic differences would disappear and everyone would have the exact same standard of living.*
It is in view of this ideological agenda, this proper definition of socialism, that we must see the BBBA if we are going to understand its purpose – and how to fight back against this unending growth of government.
The BBBA is filled with tax-and-spend provisions that expand economic redistribution in America. Let us start on the tax side, which is summarized by the Tax Foundation. They did a decent job of studying the bill but they do not mention the ideological profile:
Create a new surcharge on modified adjusted gross income (MAGI), defined as adjusted gross income less investment interest expense, equal to 5 percent on MAGI in excess of $10 million plus 3 percent on MAGI above $25 million.
This is one of the jewels in the BBBA’s ideological crown. Raising taxes on “the rich” is as common under socialist reformism as prayer is in church. Granted, this tax hike has been watered down to moderate its impact on the tax base, but it is still there and will be celebrated by the left. It will also encourage them to seek more tax hikes in the future.
Extend the American Rescue Plan Act (ARPA) Child Tax Credit (CTC) expansion through 2022, and make the entire CTC fully refundable on a permanent basis
I was among the very few analysts who pointed out, when the CTC was created, that it would become a permanent entitlement program. I saw the ideological intent behind it. Now, it is on its way to becoming permanent: barring a major fiscal crisis, come 2025 Congress will secure that the CTC is as permanent as the Earned Income Tax Credit. It does not matter who is elected president in ’24, nor does it matter who controls Congress after that election; no entitlement program has ever vanished without being replaced by another.
Taken together, the CTC and the EITC inject a significant amount of cash into the budgets of low-income families. The CTC has a much higher income-eligibility threshold than the EITC, capping out at $150,000 for a married couple, but that does not change the fact that it adds a major, new cash entitlement program to the package of benefits that the federal government offers to low-income families.
Speaking of the EITC, the Tax Foundation notes that the BBBA extends
the ARPA’s temporary expansion of the Earned Income Tax Credit (EITC) eligibility, phase-in rates, and amount through 2022
With an eligibility cap at $57,414 for 2021, again barring a major fiscal crisis the EITC will become permanent in this expanded form. Given the negative incentives that the EITC comes with – creating an effective marginal income tax comparable to what you pay making eight times the EITC income cap – its expansion will only contribute to trapping low-income workers in the jobs they have; incentives to advance one’s career or start a business will be weaker, especially when the EITC and the CTC are added together.
These disincentives are not new to the expanded EITC, but have been embedded in the entitlement program since it was created almost 50 years ago. The expansion has only reinforced them, but the fact that Congress chooses to expand it is a sign that they prioritize the economic redistribution that the program carries out than the self-determination incentives that come with earning your own paycheck.
Raise the cap on the state and local tax (SALT) deduction from $10,000 to $80,000 and extend this cap through 2030. The $80,000 SALT cap amount would also apply to the 2021 tax year. For 2031, the SALT deduction cap would be set at $10,000.
This is de facto a give-away to states with high income taxes, easing the pressure to lower taxes in those states. Since state income taxes are often progressive in nature, especially in high-tax states, this SALT cap increase reinforces the ideological profile of the U.S. tax system.
There are also some new tax features on the corporate side that could be said to contribute to the socialist ideological profile of the BBBA. They are, however, not nearly as strong, either economically or ideologically, as the changes to the personal-tax side.
The ideological motive behind the BBBA is further highlighted by what the Act does on the spending side of the federal budget.** The Heritage Foundation has the story:
Democrats are proposing the largest increase in means-tested welfare in U.S. history by far. The latest Democrat tax and spend reconciliation bill (also known as the Build Back Better bill), would increase means-tested welfare spending by $756 billion over the next five years.
I am not sure how Robert Rector and Jamie Bryan Hall, the authors of this Heritage report, define “largest in history”, but I would suggest that the very creation of the modern, redistributive welfare state in the 1960s was a bigger increase in means-tested welfare than what the BBBA brings.
In addition, the Biden administration has used administrative action to increase permanently food stamp benefits by 21%, for a cost of an additional $180 billion over five years. Added together, the total cost of the additions to these means-tested welfare programs over five years is $836 billion. The Democrat bill artificially hides the actual cost of the new programs by terminating or severely reducing them after the fifth year.
The expansion of the food-stamp program – also known as SNAP – is fully in line with the ideological push to grow the redistributive welfare state. While I find it curious that the executive branch can constitutionally expand an entitlement program, the main point here is that its expanded eligibility compounds the self-determination disincentives imposed by the CTC and the EITC. Even though SNAP caps out at 130 percent of the federal poverty line – currently $34,452 for a family of four – it cuts right through the income layers where people otherwise would be motivated to move from unskilled to skilled labor.
For this reason, the SNAP expansion adds to the socialist ideological profile of the American welfare state. It is technically independent of the BBBA, but the reason for this is likely just a matter of political tactics; if the Democrats in Congress had been convinced that they could expand SNAP under the BBBA, they would have included it in the bill.
It is noteworthy, as Rector and Hall point out, that the BBBA cuts off expanded benefits after five years. This is, of course, only a budgetary accounting trick; there is no way on God’s Green Earth that they will go back to those who benefit from expanded entitlements and say, five years from now, that “sorry, you are out of luck”. No, we should expect these expansions to be as permanent as the CTC, the larger EITC and every other ideologically driven measure in the BBBA or its immediate vicinity.
Rector and Hall also mention that BBBA
The increases in spending are unprecedented. For example, the bill proposes new spending of some $26 billion per year for low-income housing. This is roughly 50% above the current baseline spending level of $53 billion per year.
They also note that
Each poor family in the United States receives on average—today—roughly $65,000 per year in cash, food, housing, medical care and free education for their children
and that the BBBA
reverses President Bill Clinton’s welfare reform by removing work requirements from large cash-welfare programs. This resurrects a failed policy of paying families not to work. Clinton was elected precisely to eliminate this type of welfare.
They do not call out the BBBA as being a tool for expansion of the socialist welfare state. This is regrettable but understandable. The American right is notoriously uneducated on socialism. Hopefully, that will change with the growing size of the welfare state. But hopefully, that change will also come before the welfare state has permanently destroyed the American economy, which it will do by means of a fiscal crisis. Most major welfare states in Europe have suffered fiscal hardship or explosive fiscal crises, the outcomes of which have been a welfare state that provides badly starved benefits but pays for them with exceptionally high taxes.
*) It is worth noting that Galbraith was the main architect behind Lyndon Johnson’s War on Poverty, and therefore the de facto ideological architect of the modern American welfare state.
**) For odd reasons that defy logic, analysts of government spending tend to treat “refundable tax credits” as something that belongs on the tax side of the budget. Since a refundable tax credit pays out money, and since the payout is not merely the return of excess tax payments, it is by definition a benefit. Benefits are based on codified entitlement criteria and therefore part of an entitlement program. With that said, in order not to add unnecessary confusion to the conversation over the BBBA, for now I stick to the erroneous conventional-wisdom terminology and leave the CTC and the EITC on the tax side of the federal budget.