Road to Argentina

Politicians and the public are enamored with stimulus.  They are popular.  It feels like a free lunch.  Every time the government goes on a massive spending and/or tax cut binge, the economy gets stronger.  It happened after the Trump tax cuts in 2017, and it happened after the ridiculously huge Covid stimulus in 2020/2021.  During the period from 2014 to 2020, when the price of crude oil went from $110 to $40, and when the US budget deficits were regularly breaking $1 trillion annually, the MMT crowd were running amok, telling the public that deficits don't matter, that the government can keep spending and cutting taxes to maximize the economy without increasing inflation.  Of course, what these academics don't factor in is the psychology of money and inflation.  

Take a look at the year over year change in the money supply/CPI index ratio.  This is a measure of how much money supply changed vs the CPI.  The higher the number, the more money supply increased vs CPI.  The lower the number, the less money supply increased vs CPI.  This is a great look into the psychology of inflation and inflation expectations in the economy.  When money is viewed as a store of value, the M2/CPI ratio should go up.  If money is viewed as a depreciating asset, it should go down. 

 

The only precedents for such a low year over year change in the M2/CPI ratio was the stagflationary 1970s era, when inflation expectations kept pushing inflation higher even more than the supply of money.  The shaded areas are recessions, and each spike lower in the M2/CPI ratio in the 1970s was during a recession.  This speaks to the insidious nature of inflation expectations, which fuel higher wages, which lead to higher cost of goods, which lead to higher CPI which then results in even higher wages.  The fuel for this wage price spiral are the massive government budget deficits which pump trillions of new dollars into the economy every year.  

The big plunge in the M2/CPI ratio speaks to the loss of trust among the public in the authorities in regards to inflation.  The tide has shifted from a deflationary mindset in the 2010s, where people kept money in the bank collecting 0% interest, to an inflationary mindset, where people are now seeking yield on cash, to keep up with inflation.  The consequences of the government going deep into debt to keep recessions at bay have resulted in stagflation.  

Nominal retail sales are up big over the last 2 years, but real retail sales are actually down from 2 years ago.  That is the definition of stagflation.  And it tricks the public into thinking the economy is strong when nominal numbers keep going higher (revenues), even though volumes are shrinking.  No wonder crude oil is trading so weak.  

Nominal Retails Sales

 

Real Retail Sales

When you've squeezed so much out of the economy with low rates and financial repression over the past 15 years, monetary policy becomes impotent in stimulating the economy.  Unlike what most investors think, fiscal policy is now the bazooka.  Monetary policy is the pea shooter.  And with budget busting fiscal policy, the Fed is fighting a losing battle over inflation.  As much as I view Powell as being incompetent, he's not the one who caused the inflation problem.  Its the White House and Congress, with their egregious multi-trillion dollar spending packages during Covid, the child tax credits, the ridiculously long pause on student loans, etc.  And they have no interest in doing anything tangible to reduce inflation, such as cut spending and raise taxes, as it is politically toxic for their base.  Instead, you get gimmicks like SPR releases to lower oil prices or states issuing stimmy checks to cover the rising cost of food and energy.  Fighting inflation with cash stimmies!  Only politicians could come up with such asinine solutions.  When these policies fail, you just get the blame game from these politicians, pointing fingers at anyone but themselves.  And these inflationary, populist policies continue, as the public doesn't care about deficits. They just want their Social Security checks and other handouts. 

The debt ceiling "crisis" could have been an opportunity for both sides to do something about the inflation problem by reducing spending.  But it was clear to see during this debt ceiling debate that Republicans were more worried about preventing defense spending from going lower than they were about the number of years of spending caps.  And Democrats were half hearted in their attempt to raise taxes, and were steadfast in keeping spending caps as short as possible.  In the end, the deal had almost no effect on future spending. 

The long term side effects of these budget busting policies have not fully come to bear.  The US is slowly becoming the rich man's Argentina.  If it were not for the exorbitant privilege of having the reserve currency, the US would be dealing with a situation like the UK in fall of 2022, where there was a revolt in the bond market, as investors no longer wanted to buy the debt of a country that spends and borrows so rampantly even in the face of high inflation.  

When you abuse the reserve currency by running absurd budget deficits as a % of GDP, you risk losing that privilege.  The US government is doing its best to try to speed up the process of losing reserve currency status.  It probably happens within 20 years.  I don't expect another country to become the reserve currency.  The mindset will shift from keeping money in the bank to keeping gold bars in a vault.  Instead of holding cash, investors will have to hold stocks/gold/real estate as a store of value.  Financial repression will continue, as interest rates will be held below the rate of inflation to keep the economy from falling apart in stagflationary times.  Anything to lessen pain, to kick the can, and to keep the drugged up economy from crashing.  

The AI hype has taken over the stock market.  The put/call ratios are plunging, as call speculation in the big cap tech names and QQQ continues.  One of the worst performing ETFs out there, NOPE, is now long 90% QQQ.  That fund manager was long a bunch of gold miners right before they got smashed heading into the debt ceiling.  The energy is building for a substantial drop.  I don't expect it to come until after the market is confident that the Fed is done with rate increases, which could come as soon as June with weakening economic data.  Once you get the celebratory buying on a Fed that is done with the economy weakening, the market will come back to the ironic reality that there will not be rate cuts until the stock market goes down.  That reality should hit sometime this summer.  Tops are always difficult to time, but you can still profit if you are close enough and give yourself room for error by using proper sizing.  Still short individual stock names, but not big positions, so I will be looking to add soon.  Staying away from shorting NVDA for now, but it is definitely on my radar.