No Recession and No Rate Cuts

July 1st, 2024

ECONOMIC NEWS OF THE 2nd QUARTER, 2024

NO RECESSION IN SIGHT! NO RATE CUTS!

AMERICA’S THREE-LEGGED ECONOMIC STOOL

STATE CAPITALISM VERSUS GOOD ECONOMIC PLANS

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NO RECESSION IN SIGHT! NO RATE CUTS!

There is evidence that the United States is experiencing a slowdown in the economy, but there is no sign that a recession is coming soon. As expressed in previous newsletters, as long as the United States government is not serious about balancing the federal budget and continues to pump 100s of billions of dollars into the economy through budget deficits (stimulating the economy), we should not experience a recession in the short-term!

In December of 2023, most investors had priced in six or seven rate cuts in 2024 (quarter point increments), and the Federal Reserve announced that there would be just three rate cuts for 2024 (also in quarter point increments). In my January 2024 newsletter, I argued that there would be no rate cuts for all of 2024, based upon the conflict between monetary policy (run by the Federal Reserve) and fiscal policy (run by the administration and Congress). On June 12th, 2024 the Federal Reserve announced that there would be only one rate cut in the Federal Fund Rate during 2024 (again a quarter point, probably in December). I still don’t see the need for any rate cuts at all for 2024. But, it is nice to see the Federal Reserve coming around to my way of thinking!!! ??

An interesting economic note is that in April, 2024 there were 8.1 million job openings available in the United States, with just 6.5 million people unemployed. Before 2021, there had never been more than 8 million job openings in the United States; we have had a period now of 38 straight months of job openings over 8 million, peaking at 12.2 million in March, 2022.?

AMERICA’S THREE-LEGGED ECONOMIC STOOL

I believe that there is an argument to be made that the economic wellbeing of the United States now rests on just three macroeconomic factors. These factors are: First, the dollar is the RESERVE CURRENCY OF THE WORLD. Generally, everyone will take a dollar!! The Bank of International Settlement (BIS) estimates that the US dollar is involved in almost 90 percent of the $7.5 trillion of foreign exchange transactions that occur every day: 85 percent of the transactions in spot, forward, and swap markets; 50 percent of cross-border loans, international trade in debt securities, and trade invoicing; and 58 percent of disclosed global official foreign reserves in 2022. Everytime another nation puts a dollar into its official foreign reserves it acts as an interest-free loan to the United States. The United States gives other nations dollars in exchange for trade goods that we need, because everyone assumes that dollars will retain their value and can be used elsewhere as a medium of exchange. But, without the US dollar dominance, the United States would lose the capacity to borrow quickly and cheaply, potentially damaging its ability to influence the foreign policy of other nations, fund domestic industrial policy, or domestic welfare programs! As of July 2023, China has the largest foreign currency reserves in the world with more than $3 trillion, compared to the United States that currently holds about $244 billion of assets in its official reserves.?

The changeover to another Reserve Currency normally takes a very long time to occur. The dominance of the British Pound began to lose that status after World War One (1914-1918), but the process wasn’t completed for nearly 50 years. If the world marketplace was smart it would start looking for the dollars’ replacement sooner, rather than later!?

Second, the United States is relying more on the FOREIGN MARGINAL INVESTOR for the value of its currency, stock market, and the overall economy. A textbook definition of the term “Marginal Investor” refers to an individual, company, nation, or entity that possesses the financial capability to influence the value of a security or investment. This influential position is attained by the marginal investor through their significant holding or trading in a particular security, enabling them to impact the market value and price dynamics. The primary characteristic that defines the marginal investor is their ability to affect the equilibrium price and market conditions of a security. Currently the United States Net International Investor Position (NIIP) is a negative $19.77 trillion (4th quarter, 2023). In other words, foreign investors own nearly $20 trillion more of the United States assets (businesses, stocks, bonds, houses, and other such assets) than United States domestic investors own of foreign assets.??

We need to understand it doesn’t take much to affect the price of any asset or good. A rather simple example of this, there are currently 100 houses in the market to be sold and there are 100 people looking to buy a house; supply and demand are equal, so there is no pressure for prices to rise or fall. Let’s say over time the number of houses in the market rises to 105 houses, but the demand stays the same at 100; this will continuously put pressure on the price of houses downward. Or, let’s say over time the number of houses in the market drops to 95 available houses, but the demand stays the same at 100; this will continuously put pressure on the price of houses upward. So it is the margin investor of houses that pushes house prices upward or downward, not the vast market of buyers and sellers, but those on the margin.

The United States has sold much of its assets to foreign investors that have given them the power to independently affect the price of those assets. It also puts the United States economy under more pressure to keep foreign investors in our marketplace. This is one factor that has caused our interest rates to be higher than the rest of the developed countries, we need to attract foreign investors to buy more of our bonds and other assets to keep us afloat, and to prevent those investors, more importantly, from selling their current purchases and leaving our market of assets. A great example of this is if we look at the market rate between the 10 year US treasury bond and the 10 year Germany treasury bond over the past 10 years (2014 -2024). Under normal conditions and ceteris paribus, less risky debts pay lower interest rates to attract needed investors (less risk, less interest charged; greater risk, more interest charged). Over the past ten years the German government has had to pay between one to two percentage points less on their 10 year bond versus the United States and their 10 year bond rate. The market has stated that the United States bonds are a greater risk than Germany’s. What is really interesting is that between 2019 to 2022 the German 10 year bond was being issued with a negative yield. In other words, investors were paying Germany for the privilege of loaning it money; Germany was making money by borrowing money (what a great deal was that).?

This means the United States will be under pressure to keep interest rates higher and for longer than our other global competitors to keep foreign investors in our asset marketplace, also to preserve the value of the dollar. This will not be good for borrowers in our domestic marketplace. If you have noticed, the other central banks around the world are beginning to cut interest rates; the European Central Bank (ECB), as well as the Swedish, Swiss, and Canadian central banks. This will help keep the value of the dollar higher than their currencies, not helping our trade imbalance (trade deficits). The Federal Reserve continues to push back the date and number of the interest rate cuts it plans for this year. We need to understand one of the reasons that inflation continues to be elevated here is that fiscal policy (run by the current administration and Congress) is working against the monetary policy of the Federal Reserve (see more about this below).?

Third, BUDGET DEFICITS still seem to be the only true driver of economic growth in the United States! Over the last 24 years we have never grown the economy faster than the national debt, as measured by the percentage of growth in the Gross Domestic Product (GDP) versus the growth in the national debt, also measured as a percentage of GDP. President Bush’s (43) administration spent on average $67 billion A MONTH in deficit spending (compared to the President Clinton’s administration that spent an average of JUST $15 billion A MONTH in deficit spending); President Obama’s administration spent on average $86 billion A MONTH in deficit spending (taking into account the fact of inflation and inheriting the “Great Recession,” the deficit spending as close to the same amount each month); then President Trump’s administration spent on average $171 billion EACH MONTH in deficit spending (a huge increase), and then President Biden’s administration spent $207 billion EACH MONTH in deficit spending (again, about the same once inflation is taken into account). Neither party seems to have any interest in dealing with the national debt or budget deficits. Let’s be honest, whichever party is in power, and tries to balance the federal budget or the marketplace, raises interest rates so high that we can’t afford to avoid dealing with it, either way we go into a deep recession. That party is going to lose political power for a very long time (just like the Republican party did after the “Great Depression” and they had held political power in the United States for the previous 64 years!).?

The United States currently (probably) is more divided as a nation than any other period, other than just before our Civil War (1861-1865). For those readers who are not familiar with the United States current political system, let me share with you a few oddities of our electoral process that helped us (Americans) get to this extremely divided nation. For the House of Representatives, it is the individual states that decide the political boundaries of each House district (total of 435 House seats). For most states, this has encouraged the controlling party of each state to gerrymander each district to create the greatest number of members of their own party. (The current Supreme Court seems to believe that you can gerrymander districts like this, just as long as you don’t overtly use race as the criteria.) This gerrymandering has created 80% of all House seats as “safe” for one party or the other. To become the nominee of either party you must first win in the primary election; because it is mostly the party loyalists that vote in these primaries and with low voter turnout overall, that means just 10% of eligible voters are going to decide who is going to represent them in Congress. So for most candidates they have to convince the extremest of their own party to win the nomination, which then pretty much guarantees their election come November!

The other problem in the House of Representative is that the number of members has not increased since 1913, when it was raised to the current level of 435. The census of the United States in 1920 had the population at 106 million, which meant that each member represented 244,000 citizens; based upon the 2020 census of 331 million, each member represents 762,000 citizens today (currently there are three states that don’t have that many citizens). This greater number of constituents puts more distance between each member of Congress and the people they represent.

There is also a distortion in the United States Senate. When the Constitution of the United States was first written to prevent the larger states in population to have an overwhelming control of the legislative branch, each state was granted just two senators apiece. At that time the ratio of population between the largest to the smallest was 12.7 to one (Virginia 747,610 to Delaware 59,094, 1790 census); today the ratio has grown to 66.7 to one (California 38,965,193 to Wyoming 576,851). That means the citizens of Wyoming have more than 66 times the voting weight (in the Senate) than citizens in California. Also, in the Senate by normal rules of order to advance any bill you have to have at least 60 votes. The total population of the 21 smallest states is 37,174,922 (giving them 42 votes and the ability to block almost any legislation) , while California has a total population of 38,965,193 and have just two votes and really can’t pass nor block much of anything (one man, one vote isn’t really true). This also distorts the Electoral College, where small rural states get an added advantage over large urban states and the Republican party controls many more small states versus large ones; it gives them an edge in Presidential Elections.???

The problem with the Electoral College (how the President is elected) is it pulling further away from the popular vote. During the 2016 Presidential election, Hillary Clinton won the popular vote by about 2.9 million votes, but lost to Donald Trump because he won four states Florida, Michigan, Pennsylvania, and Wisconsin by a total of 190,655 votes (with Trump taking 63 million votes, Electoral College votes of 304, to Clinton’s 65.9 million votes Electoral College of 227), taking all of their Electoral College votes (75) and pushing him over the top of the 270 votes needed to win the election. In 2020, Biden won the popular vote by over 7 million votes, but could have lost the election because he took four states by a total of just 125,364 votes Arizona, Georgia, Pennsylvania, and Wisconsin (Biden had 81.3 million votes with 306 Electoral College and Trump had 74.2 million votes with 232 Electoral College votes), with their total of 57 Electoral College votes pushing him over the top of 270 votes. Under the current system that means the Democratic candidate probably needs to win at least 5 million more popular votes to have the margins enough to win the Electoral College (again not one man, one vote).?

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Now the extremists on the “Left” think the Republican Party is filled with ignorant, Bible-thumping hypocrites, science-denying, racist fascists, who are trying to destroy Democracy. While the extremists on the “Right” think the Democratic Party is filled with elitist, woke, baby-killing (eating and drinking their blood), demonic communists, who are trying to destroy America. This might explain why the two sides have a hard time working together; when extremists on both sides see that compromising with the other side is just wrong (evil). These are the people you have to convince to win the primary election to make it into Congress. Which would explain how some of our current elected officials got elected!?!?

With Echo Chamber, Silo Thinking, and Confirmation Bias it would take individuals of great moral courage to overcome their peer “group think.” To blot out the social media noise that is trying to keep them from thinking anything but nice safe thoughts, to never challenge themselves, or even attempt to try and see the other person's point of view. Until then we will have a nation divided against itself.

STATE CAPITALISM VERSUS GOOD ECONOMIC PLANS

As an Economic Historian I’m always looking to see patterns, trends, ideas, and successes or failures in the past to help understand events of today and what might happen in the future. With the election coming up in November, I felt it might be important for people to think about the economic future of the United States from a different approach than what is normally heard in today’s media and political circles. In 1923, at Goethe University in Frankfurt, Germany a new project was developed, a critical theory of contemporary society that would combine philosophy, social theory, cultural criticism, and economics in a new type of interdisciplinary theory; this became known at the Frankfurt School. It combined a group of German-American scholars who worked in Frankfurt in the 1930s and after the rise of Nazism fled first to Switzerland, then settled in the United States at Columbia University.

The group’s interdisciplinary work in the 1930’s produced an analysis of the new era of state capitalism. This new form of state capitalism provided new roles for the state, which were to manage the economy, provide employment and welfare, and overcome the crisis of the 1930’s depression. The Frankfurt School believed that there were two different models of state capitalism. If we were to step back and leave some of our prejudices behind, we might see the two models today in our own two political parties.?

The first model of state capitalism is a fascist/nationalist model where the state would take over the political sphere, dominate the cultural sphere, and play a major role in the economy; much like what Nazi Germany did during the 1930’s. This would be the extreme right of the Republican party today, with its white, Christian, and American-only elements. The other model would be the democratic state capitalism, exemplified by the Franklin Roosevelt administration and the “New Deal.” Under this model, the state provides welfare and jobs, manages fiscal and monetary policy, and unlike fascism, preserves democracy. This would be the extreme left of the Democratic party today, with its push toward a Scandinavian Social Democratic economic model! The important part of this is that both models aim for a period of state economic control of capitalism! The problem with this is that state capitalism was intended as a solution for the Great Depression not for the problems we face today.?

It would seem that both political parties have the same basic economic plans, just different flavors. This is putting more pressure on the three macroeconomic factors? supporting the United States economy, which in the long-run increases the possibility of American decline from world power status. Now I’m not a “Doomsday Prepper” who believes in the collapse of the United States. What I do see is a very fragmented nation that no longer has the will to solve its problems collectively. As I have previously written we are becoming more of a 50 States of America, rather than the United States of America. We see individual states come up with their own immigration policy, climate change policy, healthcare programs, educational systems, and economic development programs, rather than a national system for the entire nation. We repeatedly see factions within Congress block any attempt to deal with our nation’s problems at the national level.?

As a Economic Historian, I know by looking at the collapse of an empire it just doesn’t disappear, it morphs into something new. The best two examples of the twentieth century are first the British Empire (the largest global empire in the history of the world) which became England. The second, is the? Soviet Union and its Eastern European Empire which became Russia! The world’s first truly global empire was the Spanish Empire and it became today’s Spain. Other examples are the Byzantine Empire, which eventually became the Ottoman Empire, which became today’s Turkey. At least three different Persian Empires became today’s Iran; and finally China, which has a long history of dynasties (some 4,000 years) the Xia dynasty, then the Yin dynasty, the Zhou dynasty, followed by the Han dynasty, later the Sui dynasty, succeeded by the Tang dynasty, the Yuan dynasty, then the Ming dynasty, followed by the Qing dynasty and finally the Communist dynasty (am sure I missed a few in there). I believe the United States will decline from its premier status and it won’t have the same level of influence on the world’s marketplace and political stage.? But, it will still have a role to play!????

It would be prudent if the world marketplace began to make plans for the transition to the next world power. I feel we have three prime candidates for that role, China, the European Union, or India. Each of these have their own strengths and weaknesses, that I will briefly talk about here. I don’t have the space to deal with this issue in any great depth, but will leave you with some facts to ponder.?

First, there is China, some of their strengths are: It is already the largest economy in the world (2014, using PPP basis of GDP), became the largest manufacturer in the world (2011), became the largest exporter in the world (2010), is currently the largest Creditor Nation, and it has the largest holding of Foreign Reserves. It is the second most populated nation, so it has potentially a large domestic market for goods and services. It has the second or third largest armed forces in the world (depending on how and what you count, they recently surpassed the United States navy in the number of warships).

Some of China’s weaknesses: The Chinese currency Yuan is not widely accepted in the international marketplace, its is rather xenophobic, it doesn’t have many immigrants going to China (which historically is a sign of greatness, people want to move to great nations), China is currently thought of as a totalitarian nation and many nations in the west will not follow their lead because of it.?

Second, the European Union, some of its strengths are: collectively it is the third largest economy and manufacturer in the world (behind China and the USA), collectively it is the largest trading partner in the world, the Euro is the second most used currency in the world and spends collectively the second or third most on its armed forces in the world (again it depends on how and what you measure). It has the third largest population in the world (behind India and China), and a fully modern domestic market. The European Union Model on the principles of the “Four Freedoms,” makes it an attractive place to move to and has a huge immigration population, and in some ways it is more capitalistic than the United States!

Some of the European Union weaknesses: It still hasn’t completely integrated itself in a single unit politically, diplomatically, or militarily (it has to come to realize Ukraine will need EU troops on the ground to successfully fight against Russian aggression). Doesn’t completely realize it needs to step up and be and act like a world power!?

Third, there is India, some of it strengths are: It is the world’s fastest-growing large country, growing at an annual rate of 6-7%, it is the world largest nation by population and is growing internally without the need for immigration, it is the third largest economy using the PPP method, it has the second largest army in the world (by number of service men and women) and has become a regional power in the Indian Ocean.

Some Indian weaknesses: India is still about 20 years behind China in development, the divide between Hindu and Muslim has been used for political power and weakens the whole nation (India has it own style of religious nationalism), regretfully global warming will be hitting India before the other major powers and will put at risk economic growth, its military is large, but needs to modernize to have influence greater than just a regional power.??

This is not by any means a comprehensive list of the strengths and weaknesses of the next potential world power, but does give the reader something to ponder. The problems that the United States has before it can be solved, but they all require a political answer; and there is not the will of the fragmented populace to come together to actually face and then agree upon a solution. The problem for the world marketplace is that either the United States comes up with its solution or the marketplace will force a solution upon the United States; the ripple effect for the world will be severe and the nations of the world will need to find a new leader of the world or suffer its own decline!!!

Respectively Submitted 756 Worden Ave Kalamazoo, MI 49048

Christian M. [email protected] ?07/01/2024 4039