Legendary investor Jeremy Grantham said, “Remember that history always repeats itself. Every great bubble in history has broken. There are no exceptions.”
President Biden is doing his best to bring that forecast about. President Trump was no fiscal conservative, but Biden is making him look like a piker. Biden’s stimulus package, infrastructure proposal, and proposed budget total about $6 trillion. That is problematic. What follows are broad concepts that may be seemingly unrelated. I don't have space to fully explain each concept, so bear with me.
Deficit spending has caused national debt to rise from $5.7 trillion in 2001 to $28 trillion today. This doesn’t consider Biden’s new spending, which will cause debt to rise to about $31 trillion. Government has perverted tax spending to now be “investment.” And infrastructure is now whatever the spenders want it to be. There is a concept of velocity of money, where a dollar spent in one place will cause other dollars to be spent elsewhere, stimulating the economy in a multiplier effect.
That concept works in the private sector with banking being the key starting point. It doesn’t work with government spending.
Harvard economist Robert Barro looked at government spending versus Gross Domestic Product (GDP) after every war since World War I. The multiplier effect resulted in the same multiplier, 0.8. That’s right, for every dollar the federal government forcibly extracts from you and “invests” they lose 20 cents. Yet the myth persists that government spending stimulates the economy, in part responsible for our current national debt.
Any revenue not extracted from taxes comes from U.S. Treasury Bond sales. Foreign investors once were huge buyers of these bonds, but no more. China, Russia, and Japan, the three largest buyer/lenders to us, are reducing bond holdings. No one else is showing up to buy. The rate and yield on these bonds is simply not high enough. That leaves the Federal Reserve as the main buyer/lender, of about $120 billion per month, in order to keep interest rates at present levels. They added almost $4 trillion in bonds to their balance sheet in the previous year.
Bond yields are becoming volatile. The yield is different than the face rate and reflects investor expectation of return. When yields become volatile it is a sign that rates are too low and investors are nervous about economic stability.
Interest rates have a huge effect on economic growth. Of greatest concern is their effect on the stock market. Most of the larger, and many small, investors buy on what is called margin accounts. The brokerage lends them money to buy stocks, for which they must maintain an equity, or margin, over their debt amount. If interest rates rise, it becomes more difficult to meet interest payments. That often triggers selling to reduce debt or meet payments. In today’s computer-generated trading systems, a market drop due to increased selling often triggers other sell signals, which causes further declines which in turn triggers more selling. It is a precarious situation where a rapid stock market decline could result.
Biden’s solution is to raise taxes on the rich. History has repeatedly proven this to be the wrong approach. 20 percent of taxpayers pay 95 percent of income tax collected. If you make $60,000 per year you are part of the 20 percent. When taxes increase, tax revenue drops. Harding, Reagan, and Trump proved beyond a doubt that lowering tax rates increases tax revenue. They correctly understood that the velocity of money concept must come from the private sector. I suggest you look up Laffer’s Curve to understand this concept.
Now to the hidden tax, inflation. Interest rates are used by the Fed as a tool to curb inflation. The government insists that inflation is below 2 percent, and the status quo must be maintained. The consumer knows this to be a fallacy. Since January, gasoline has increased 182 percent, crude oil 163 percent, grains about 80 percent, and lumber 265 percent. If that isn’t inflation, I don’t know what is. But the Fed and government keep blinders on, insisting their interest rate, tax, and spending policies are necessary.
Where does all of this lead? Individually, perhaps not significantly. Collectively, it is a sign our economy may be headed for disaster. If Biden keeps spending prolifically and raising taxes he is hastening disaster. Prepare for anything to happen. I don’t know how, what, or when, but be ready. Our house of cards is shaky.