The Return Of Fiscal Policy To The Center Of Economic Policymaking
One of the growing challenges for many retail investors around the globe is the fact that fiscal expenditure by states will almost certainly be rising in the years ahead. Many of these investors (and voters!) haven't realized it yet but the state is going to have spend more and do more, often with less coming in.
This presents a tough tension but one that must be resolved. More money has to be found, the only question is where the political calculus will fall. Everyone should be nervous because when the state is hungry, it is the people who go without.
We have focused a lot on US monetary policy over the last two years.
There was a good enough reason for this: The decisions or the lack of decisions emanating from the US central bank have been, even more so than usual, crucial for financial markets.
The relevant authorities first hoping and then pretending inflation would be "transitory" (ha) meant that first the inaction and then the actions of the US central bank have been the economic story over the last 2+ years.
This has been both:
Boring.
And yet really significant.
That is a tough challenge for even the bravest of newsletter scribblers.
The sad truth is that everyone gets that the intricacies of monetary policy and especially where interest rates are going matters. But it is both incredibly dull and also a bit of a drag to constantly agonize over the same (boring topic). Whether to stop hiking interest rates or not might be critically important question for asset prices and the broader economy but it can get a bit dull. It is also very easily get bogged down in the minutiae of this or that utterance and sort of lose the big picture.
We have tried to avoid that fate as much as possible but there is also some good news on that front as well:
Monetary policy simply doesn't matter as much as it once did.
Instead, while still important, monetary policy is increasingly taking a back seat to some other important economic drivers:
Namely, fiscal policy.
Fiscal policy, as you may recall, is the use of government spending and taxation to influence the economy. Fiscal policy matters! How you decide to structure and incentivize your economy and spend your scarce monies is a critical decision by the government.
It will go a long way to determining what type of state and also, society, you have.
Thanks to inflation and also previous spending profligacy, fiscal policy has also been largely irrelevant for 2 years+ as monetary policy has taken primacy.
We have mentioned this before. Fiscal policy was on the mat and largely consistent, monetary policy was where all the action was. By action we mean: changes that will affect how quickly the economy can grow (or not).
Yes, inflation could come roaring back and yes the question of whether rates are going higher or lower is still important but most of the hard work has been done and the big questions - for now -have been resolved.
Questions such as:
Will inflation come down?
Will there be a recession?
Will the US central bank stop raising interest rates?
No longer carry the weight of uncertainty they once did.
These days, however, a new set of questions is coming to the fore. Many of them are centered in fiscal, rather than monetary policy. This is largely because, monetary policy can only do so much. To get our fiscal house in order we require serious amounts of political decision making in Washington.
Helpfully this situation was clarified by Federal Reserve Chair Jay Powell in his 60 Minutes interview last Sunday.
In responding to the question "....is the national debt a danger to the economy in your review?" Chair Powell said:
So, it, I would say this. In the long run, the U.S. is on an unsustainable fiscal path. The U.S. federal government's on an unsustainable fiscal path. And that just means that the debt is growing faster than the economy. So, it is unsustainable. I don't think that's at all controversial. And I think we know that we have to get back on a sustainable fiscal path. And I think you're starting to hear now from people in the elected branches who can make that happen. It's time that we got back to that focus.
Chair Powell sounds like us!
He also isn't alone. Jamie Dimon, CEO of JPMorgan, was also recently worrying about this as well. He made the case, and not for the first time, that the mounting US debt will eventually cause a rebellion in global markets.
We have, of course, made similar arguments in the past. These were often centered around why this is high debt and deficit are changing certain central dynamics to how the US economy - and therefore US financial and debt markets - operate.
There is another angle however. This is that if you want to actually confront these problems it will largely occur at the level of fiscal policy. If you want to cut spending, whether it be discretionary or at the level of entitlements (Social Security, Medicare, Medicaid etc) most of it will all happen at the fiscal level.
If you want to read our in depth coverage of the deficit and why it is newly important you can read it right here. The upshot was: the deficit will matter again in 2024, sooner rather than later.
The good news is that all signs point to the US fiscal deficit dropping in 2024. It was around 8% in 2023 and will, with a bit of luck, be around 7% this year.
That is an important first step but like the battle with inflation, this will be a multi-year road. 7% is still far, far above the historical norm for a stronglt growing economy. As we have argued before the first problem with the high deficit is that the economy is growing right now. Typically, this is the period when the deficit is the lowest not highest.
That isn't the only perverse and unusual situation.
Secondly, however, is the fact that the political pressure and the political debate is about how to increase spending rather than cut it.
For more on that we turn to.....
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