All Eyes on Fiscal Policy Now

 | Jul 26, 2017 | 3:00 PM EDT
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Over the course of the past few years there have been some observations concerning the status and potential of the US economy that I've offered repeatedly and in support of different ways of considering the economy's growth prospects.

Among these there have been three core observations:

1) Consumer capacity has been exhausted.

2) Monetary policy capacity to influence consumption has therefore been exhausted. 

3) Demand, as a result, can now only come from fiscal intervention of some kind.

Throughout this time, I've also continuously monitored economic data and market developments for a change to this situation. That change would either be data that proved I was wrong on one or more of those points or that public financial policy makers and private financial industry leaders would acknowledge the validity of the three points and the need to focus on fiscal intervention as a necessary catalyst for an increase in real economic activity.

There has been no change to the data, and as such no change to my contention that the three points are still valid.

Bizarrely, as to the recognition of this situation by public financial policy makers, the monetary authorities have chosen simply to push the opposite narrative. That being that inflation is imminent and preemptive rate increases are necessary to counteract it.

I'm not sure what the real motivation is for pursuing that policy course but it is interesting to note that the leadership at the ECB and BOJ have also begun pushing similar narratives of "the worst has passed and good times are ahead."

I'll write more about that in the future.

The fiscal policy responses of restructured healthcare insurance, restructured income tax schemes, and increased federal spending, especially on infrastructure are being held up by politics.

What's most interesting about that is that neither the executive branch, nor the Republican leadership in Congress, has fostered the economic importance of these changes based on the three points referenced earlier.

It appears that they are all of the opinion that these changes are about ideological preferences and politics rather than about very real pragmatic and empirically supported necessity.

As strange as the actions of monetary and fiscal policy leaders are though, neither bank leaders nor most capital market participants appear aware of the implications of the three points referenced at the opening of this column combined with the occurrence of monetary tightening and fiscal stalemate.

None of this should be construed as support for the position that stocks are not being properly priced and must crash. There are some really great things happening that support increasing values.

The most important of these, which I discussed last August in the column, If Oil Prices Don't Rise, the Middle East Will Sink, is that the U.S. is now the marginal producer and thus price setter of oil globally.

There are also very positive signs on the foreign policy front, which I discussed in the column, Truth Be Told (and It Seldom Is), Trump Is Getting It Right.

These things however, in the absence of an increase in domestic consumption, cannot drive the U.S. economy.

There doesn't appear to be any concern, or most importantly, awareness of this by equity market participants.

A kind of strange circular reasoning seems to have taken root in the equity markets that is along the lines of rate hikes are supportive of the stock market because it gives the Fed room to lower rates to support the stock market.

Of all of this so far though, the most troubling factor is the lack of understanding of the macroeconomic situation by bond market participants.

They appear to be caught between the negative economic implications of exhausted consumption and tightening monetary policy on the one side, and the Pollyannaish narrative concerning the economy being promoted by the FOMC.

In aggregate, the capital markets are expressing expectations for economic expansion that can't be met unless something changes for fiscal policy soon.

If tax policy and infrastructure spending are halted due to infighting within the Republican party, as has so far been the case for healthcare, the markets will have to reset.

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