This past week a colleague of mine shared with me the 2007 UC Berkeley commencement address presented by Professor Tom Sargent Nobel Laureate of New York University. The commencement address was less than 350 words and was able to be completed within five minutes. In addition to the 12 economic points presented by Professor Sargent #8 was most interesting in regard to the behavior of governments:
#8. Governments and voters respond to incentives too. That is why governments sometimes default on loans and other promises that they have made.
For the past eight years we have witnessed firsthand, the effects of combined monetary and fiscal stimuli. Yet, as we look at the variables that are available to us today in order to stimulate growth, the US government is faced with an interesting predicament. During the Obama administration, we had a deadlocked Congress; therefore, the only institutional entity within the US government that could affect the economy was the US Federal Reserve.
Through a progressive policy of quantitative easing the Federal Reserve was able to create an environment where the immediate outcome was directly higher asset prices. In addition, by keeping yields so low, the Fed made fixed income investments so low in return, that any investor had to buy equities. Alongside the Federal Reserve you also had the BOJ, the ECB and the PBOC as other Central Bank buyers on the markets
Now each central bank, in their own declarative policy statements, have begun to signal the end of QE; thus paring back their balance sheets.
In light of the absence of QE, that what other policy tools remain in order to stimulate growth? Fiscal policy.
If we sideline our initial concerns about the individual in the office of the executive branch in the United States, and instead focus on the institution of Congress, we find ourselves in a position where Congress can implement several variables that would have the effect of continuing the market rally.
The first of which is exactly what we just saw in regard to the tax package just passed by Congress. Ironically, whilst the tax package is of no real economic benefit to those who voted Trump into office, it does however provide significant economic benefit to the corporations that withheld cash reserves overseas in order not to pay US corporate tax rates. Case in point is the recent repatriation of over $350 billion in reserves held over seas by Apple which are now being brought back to the United States for a tax bill of over $35 billion.
Yet we all seem to miss a very, very obvious fact... Apple is not the last company to make a move such as this. At the same time Apple now has to consider the use of proceeds from all of the ample cash it is now coming into the US economic system.
Apple’s Treasury team will be faced with the classic decision affecting all corporate entities: how best to deploy the capital? Regardless of which percentage is allocated to where we can safely assume that a certain percentage of the capital base will be deployed back into the US equity and fixed income markets.
That same conclusion can be drawn with each corporate entity going through the same repatriation that Apple just went through
Let’s extend the simple variable framework a little bit further. There are some more levers that the United States government also has had its disposal.
It is anticipated that given the still low yields in the fixed income market that the USA will go through substantive infrastructure fund raise in order to rebuild much of America’s declining roads and highways (look no further than the NYC rail system!) In addition to supporting the financial services industry, this bond issuance will have the consequence of creating jobs and providing support to the US manufacturing base.
Last, we have a loosening of the regulatory framework. After the US crisis, many argued that US regulations were too stringent and did not benefit the US consumer. If there is any relief of regulations, the impact to consumer debt could be staggering. But, the near term benefit, would be increased consumer spending. So, while having no real wage growth, Wall Street can extend further credit to a US consumer already in deep debt.
These several variables: lower taxes, bond issuance, and lower regulations portend a market rally fueled by debt. We have one last silver bullet to add: the US dollar.
A lower dollar means cheaper US exports.
But, as a means of explicit policy, I doubt we will hear Treasury Secretary Mnuchin publicly espouse a lower dollar. However, our Twitter User-In-Chief is an altogether different variable/manipulator.
All of this means, that the US is literally throwing the “kitchen sink” at this problem. Barring a market shock, the US equity market should continue to rally until the Fed takes the punch bowl away!
On that note, let me share Professor Sargent’s other commencement point that is quite insightful relative to what I have written:
#10. When a government spends, its citizens eventually pay, either today or tomorrow, either through explicit taxes or implicit ones like inflation.
*PS: I have not forgotten my fixed income write-up. Soon to come!