The U.S. Economy Is a War Economy; Sell Treasuries

 | Aug 22, 2017 | 10:00 AM EDT
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President Trump wants to ratchet up the war in Afghanistan. That was the gist of his televised speech to the nation last night. He will be ordering up an additional 5,000 troops to be deployed in the region and increasing war operations. That's going to cost. It'll mean higher levels of government spending.

The U.S. economy is a war economy. The second-largest spending item on the Treasury's Daily Treasury Statement -- a document that lists every expenditure of the Federal Government -- is "Other Withdrawals." Other withdrawals contain expenditures related to war operations; things like special ops, the so-called "black budget" and many other expenditures related to war.

It is currently at $672 billion, just behind Social Security's $755 billion figure. Other Withdrawals are up $40 billion over last year. There is no single spending item that shows such an enormous year-over-year increase. Even with millions of seniors becoming eligible for Social Security each year, that spending is only up $18 billion versus last year. No doubt, America's economy is a war economy.

What does this mean?

It means greater military involvement in Afghanistan will be bullish for the economy. That's money that ends up getting paid to firms, soldiers, workers, contractors, defense vendors, etc. Personally, I'd much rather see this money spent on infrastructure, health care, education, basic research & development, etc. But that's not my call. Who knows? Maybe I'll run for president.

The spending will not only boost economic activity; it will also raise the level of inflation. War spending is mostly the creation of capital that ends up being destroyed (think bombs, missiles, bullets) as opposed to other types of capital, like a road where trucks can drive to bring us stuff or growing more corn, or a computer that makes us more productive. These things bring us abundance, which usually means the price goes down, not up.

That brings me to Janet Yellen. She will be speaking at the annual Jackson Hole Symposium this week. That's the annual shindig where all the central bankers and economic policy wonks get together in a picturesque Wyoming mountain town. If you've never been to Jackson Hole you should go. It's lovely.

Yellen will no doubt reiterate some of her comments from recent speeches. Perhaps the one she gave before Congress back in July, when she said that the Fed was "near the end of its rate hike program." I don't think so. In my opinion, she'll end up eating those words.

The Fed is not near the end of its rate hike program. It has only begun. Higher levels of war spending will bring with it higher levels of inflation, and the Fed will find itself, once again, behind the curve -- at least in its own mind. We are still in the early stages of their rate hikes, whether they realize that or not.

It's why I think you still have to be short Treasuries. You're lucky, too, because the market is affording you a wonderful opportunity right now. We've had a nice dip in bond yields, but it's not going to last. Just look at gold. Look at copper. Look at base metals. Look at the weak dollar (which I predicted). They are all telling you that the inflation trend is headed higher. Oil will soon follow. We have the lowest level of oil inventories since January 2016, and when that happened in January last year, the price of oil doubled.

Yellen and her central banker friends will no doubt have a good time and talk a lot of dovish talk. The markets will react to this, perhaps kiting higher. But we're going to look back a year from now and realize that it was the beginning of a new phase of an insidious inflation trend that already, quietly, crept in. It's only that the folks from the world's most privileged club, at their yearly gathering in the mountains, didn't see it.

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