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American capitalism, as we know it, has changed. And with only three months left in 2020, it is time to rethink your capital plan. We are living in an era where policymakers have changed the game. No longer is the Federal Reserve only using interest rates as a lever to spur or temper economic growth. With interest rates at all-time lows, they are now using more radical tools at their disposal. Monetary policy (the Federal Reserve’s actions) is having a more direct influence on economic growth. The YTD money supply in the US is up nearly 20%. The Fed’s balance sheet has increased by 70% during this same period.
During the COVID slowdown, fiscal policy (government spending and tax policies) has also implemented extreme measures this year, though it was mostly necessary due to economic shutdowns. The COVID recession would likely have been much worse without intervention. These measures, though, come at a price.
A government issues additional debt when its net revenue does not fully cover its spending and the interest it owes on existing debt, creating a deficit. The year-end deficit is projected to be $3.3T, triple the shortfall recorded in 2019. Of course, this deficit is added to the country’s debt, and who knows when we will pay this debt down.
According to the Congressional Budget Office, Federal Debt held by the public is projected to be 195% of GDP in 2050.
Modern Monetary Theory (MMT)
This activity resembles money printing, and some liken it to Modern Monetary Theory (MMT), an alternative to mainstream macroeconomic theory. MMT states that because the US government controls the money supply, the government can spend freely as they can always create more money to pay off their debts.
MMT has become an increasingly popular economic theory in some left-leaning circles in recent years, in part due to its extreme change from our current policy. Progressive politicians like Senator Bernie Sanders of Vermont and Representative Alexandria Ocasio-Cortez of New York are among the most vocal MMT supporters. However, the single biggest problem with MMT is the devaluation of the USD and the subsequent inflation. If the government will print more money to meet it’s spending needs, how is this strategy sustainable?
Deficit Spending to Continue
Deficit spending will likely continue past this COVID crisis. Policymakers no longer feel compelled to allow the free market to determine asset prices, but instead are determined to guide it themselves. Capitalism, as we know it, has changed.
Furthermore, depending on the election outcome, taxes will likely rise next year, further complicating this new environment.
A New Game
What does this mean for you all? We think there is a new game afoot and the rules have changed.
The direct influence of both fiscal and monetary policymakers will benefit equity prices going forward, especially on a relative basis.
However, with interest rates near all-time lows, we have a hard time believing that money printing will keep interest rates low and bond prices high. The risk/reward ratio for most bonds look meek at best. The question is, “When will rates rise again?” Your guess is as good as mine. Inflation drives interest rates and trying to predict inflation is near impossible. Inflation levels can rise next year, in three years, in five years, or even longer. While Money Supply is increasing, price discovery via online companies like Amazon has helped to keep inflation levels low. So, it is a battle between these two powerful forces.
More importantly, though, is that the Federal Reserve can remain solvent much longer than any of us. Trying to ‘trade’ off of these developments is risky. Though, what we do know is that interest rates cannot go much lower. Adjust your portfolio accordingly.
While asset prices are high and tax rates are low, we urge you to devote time to your planning ahead of the year-end. We are here to assist, as always.