A Quick Note on Profligate Government Spending…

To stimulate or to crowd out, that is the question

Summary:

• The federal deficit as a percentage of GDP is comparable to levels during the Global Financial Crisis (GFC), which should typically be interpreted as stimulus. However, California tax collections are playing havoc with the already shoddy data.

• The author disagrees with Warren Mosler's view that rate hikes are stimulative in a highly indebted economy. While rate hikes do not efficiently combat inflation in such economies, they create “breaking point” dynamics where real-world corporate and household solvency constraints lead to disruption.

• Albert Edwards' data showing that rate increases aren't working appears to be based on flawed data and has too many variables involved in the analysis to be helpful.

• This is reinforced by the opposite effect in the household sector, which holds more cash than it borrows short-term, and historically benefits from rising interest rates. While corporate interest payments have plunged, interest income has stagnated for households.

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Top Comment:

John Taylor: The teaser rates and low down payments offered by the big homebuilders are a cost for them, equivalent to selling the houses at a lower price. The difference is that the sales are recorded at the purchase price, ignoring these subsidies, so people don’t see the values of homes decline. Good for the builders because their inventory isn’t marked down to lower values.

For resales, homeowners generally lack the ability to offer low rates and low down payments, its based on what the bank offers. As a result, many are pricing their properties above the prevailing market rate without realizing it.

Thus home sales are shifting to new homes because new homes are selling at the market rate, after accounting for financial discounts, while existing homes remain stubbornly overpriced.

MWG: I don’t think this is quite right. New home sales in aggregate are still quite low. At 697K annualized we’re running about 30% below the population-adjusted average of the last 70 years. I agree that the subsidy lowers the cost so that they are more competitive, but my hunch is that new buyers are being seduced by a lower payment rather than a lower price in total. A 2yr teaser rate is roughly akin to a 2% price cut even as it lowers payments over the 2yr period by 20%. The challenge will come in refinancing that teaser rate with a 3.5% down payment if further price declines occur, even if rates are lower.

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The Main Event

Quite a bit of ink has been spilled on the soaring federal deficit. As my friend Warren Mosler points out, the current deficit as a % of GDP is roughly on par with the depths of the GFC:

In previous commentary, I highlighted that a massive increase in government deficit spending is a concern for any bearish interpretation of economic outcomes. Governments can, of course, spend us into a nominal boom (destroying the currency in the process). In part, Warren is highlighting what I’ve been screaming about for almost exactly a year — rate hikes in a highly indebted economy do not work for fighting inflation as they add to the fiscal impulse even as they slow investment faster than consumption. I'm afraid I have to disagree with Warren that they are “stimulative” due to the fallacy of composition. Those receiving income from higher interest rates are not the same agents paying the higher interest expense and this leads to “brittle” outcomes where business insolvencies can rapidly change economic conditions. In fact, every recession has been characterized by this dynamic of rising outlays and falling revenues:

To Warren’s credit, every recession also ends with deficits approaching these levels as government expenditures slowly refill household and corporate income streams while government revenues take less of the economic pie. We can certainly see elements of this today, as most readers are likely enjoying substantially higher yields on their cash assets than they were last year, even as their mostly fixed-rate interest obligations have not increased. This is the source of the recently famous Albert Edwards’ chart showing that “rate increases are not working!” because net interest is falling:

I personally hate this chart, as there are simply too many variables at play. There are two variables in “net interest” — interest paid and interest received. In the data series presented by Edwards, there is a third variable “miscellaneous payments” which is largely tied to property licensing from the US government. And finally, he adds a fourth variable, corporate profits, to convert it into a ratio. The interest paid and interest received sub-variables are not available except on an annual basis which further complicates the analysis. I believe the chart is wrong.