Economic Divide Is Widening and Worsening

 | Jun 21, 2017 | 2:00 PM EDT
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One of the themes that's been consistently an integral part of my macroeconomic assessment for the past several years is that the U.S. economy has bifurcated and that process is not going to reverse. 

That bifurcation is between the people with skills that are in demand and those that aren't. 

This is very different from a typical recessionary episode in which there is a temporary decrease in demand that results in elevated levels of unemployment and reduced economic activity until the situation resolves, with or without monetary and fiscal stimulus. 

The recessionary bifurcation the economy is experiencing is not temporary; it's structural, systemic and worsening. The size of the population that is ending up on the uneconomic side of the divide is growing and the other is shrinking, and that process is accelerating. 

The two biggest problems with this scenario are 1) most private- and public-sector policymakers are still operating on the assumption that this is temporary, and 2) the currently predominant economic models being used by nations globally are incompatible with the uneconomic human labor. 

I've written many, probably hundreds, of columns about what this implies about social, political and economic conditions for countries and humanity in general, which I won't discuss again here. 

What is important for individuals, regardless of which side of the bifurcation you are on, is to acknowledge that it is permanent, and that fiscal and monetary policy can't reverse it, no matter what those leaders and other pundits say. 

That means the deflationary forces that are a part of this process are greater than, and overwhelm, the countercyclical inflationary force provided by monetary stimulus. 

The fact that the Federal Reserve is raising rates, and thus the costs of debt capital, in this environment raises the chances of stalling the anemic growth rate that's been in place ever since the Lehman-crisis era and inducing a swift and deep recession that is resilient to a reversal of monetary policy. 

As I discussed briefly near the end of last week's column, "Trump's Economic Agenda Could Get Derailed, Even by Trump," this could be a catalyst for a decline in long-end U.S. Treasury yields and mortgage rates to all-time record lows. 

I am of the opinion that this is far more likely to occur than rates moving up and that the Fed will unwittingly help to drive the 30-year fixed conventional conforming mortgage rate below 3%. 

This is contrary to the Fed and institutional narrative on economic activity and interest rates, though. 

The difference between the narrative the Fed is selling and what people are actually experiencing is very wide and causing much stress and confusion. 

Builders and their lenders are nervous about building new residences in this environment because they expect rates to rise and depress buying activity at the same time demand for housing is exceeding supply. 

I don't think this situation can last much longer. 

Either the Fed's narrative is correct and inflation is imminent, or it's not, and its actions will contribute to deflation. 

Although I've been of the opinion that long-end U.S. Treasuries have been maintained above what is appropriate for this economy for years now, and that they would eventually decline to record lows, if bond market participants believed the Fed narrative was correct, long-end yields would be rising. 

The fact that they are declining even as the Fed is telegraphing intentions to begin to shrink its balance sheet is an indication that the bond market does not buy the Fed's logic. 

If the Fed is proven wrong and contributes to a recessionary, deflationary trajectory, bonds will do well, but ironically the biggest winner will be the increase in economic activity that will come from a booming housing sector. 

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