Written by Jim Welsh
Macro Tides Monthly Report 01 November 2020
The initial wave of Baby Boomers turned 65 in 2011 and each year the number of Baby Boomers in the workforce has fallen from 50 million to less than 25 million in 2020. The surge in the 65+ population has and will continue to draw on the assets in the Medicare and Social Security programs.
Graphic: “Untergang der Titanic” by Willy Stower, 1912, Wikipedia.
Please share this article – Go to very top of page, right hand side, for social media buttons.
According to the Congressional Budget Office (CBO), funding for the Highway Trust Fund will be depleted in 2021, the Medicare Hospital Insurance Trust Fund Part A will run out of money in fiscal 2024, the Social Security Disability Trust fund in fiscal 2026, and Social Security could run dry in 2032 or sooner. While this is alarming it’s just the tip of the unfunded liability iceberg that is coming.
The Social Security Administration is led by a Board of Trustees, which produces a massive annual report on the financial condition of the Social Security system. The Statements of Social Insurance includes projections for Social Security and Medicare that estimates future income and expenditures for based on future demographic trends and then calculates a present value to produce a 75-year projection. They calculate the net present value (the present value of revenues less the present value of expenditures) for participants who have retired, current workers who are paying into Social Security and Medicare, and future participants who are too young to be working and those who will be born in the future. There are a lot of assumptions in this analysis but demographic trends change slowly so these can be viewed as an educated guess.
The projections for Social Security and Medicare indicate that there is an unfunded liability of $101 trillion over the next 75 years. The federal government will incur other unfunded liabilities of more than $30 trillion. As a side note I found estimates that are far higher and only one that was less ($122 trillion), but $10 trillion here and $10 trillion there and pretty soon we’re talking about a lot of money. The Federal government’s unfunded liabilities are never included in the Federal government’s annual budget, so much like an iceberg they remain mostly out of view.
Since the mid 1980’s Social Security has collected more in payroll taxes than it paid out. The annual surplus was invested in interest bearing non-marketable Treasury securities, with the Trust fund reserve reaching a peak of $2.9 trillion in 2020. In 2021 expenditures will exceed the amount of payroll taxes paid so the value of assets in the Trust fund will begin to fall.
Once the Social Security Trust fund is depleted in 2032 if not sooner, the amount of payroll taxes collected are expected to allow Social Security to pay out 79% of promised benefits. For those living on a tight monthly budget any reduction in social security income could make it difficult to get by. By law Social Security can’t pay out more in benefits than its income, so the number workers in the workforce will dictate whether the payout is 79% or a bit more or less.
In the 30 plus years Social Security was taking in more than it was paying in benefits, Congress used the surplus in Social Security to lower the amount of the annual deficit. By performing this accounting maneuver Congress made the annual budget deficit would look less bad. Essentially the total deficit since the mid 1980’s was in reality $2.9 trillion higher than Congress reported. This practice was followed irrespective of which party was in control of Congress or the White House.
The primary sources of funding for Social Security and Medicare are the number of workers paying into the Trust fund and the tax rate. In 1950 the ratio workers to Social Security recipients was 16 to 1, but fell to just 3 to 1 in 2015, and will drop to just 2 to 1 in 2035. The ratio could improve in coming decades if the number of births in the U.S. increased or there is an increase in immigration.
The trend in the birth rate doesn’t offer much encouragement. Since peaking in 2007 the number of births has declined in 11 of the last 12 years. At first glance the peak of 3.75 million births in 2007 is not much lower than the 4.3 million births in 1960, but that simple comparison is misleading. The population of the U.S. in 1960 was 179 million compared to 300 million in 2007.
The Baby Boom was truly a boom as it represented 2.40% of the total population in 1960 almost double the 1.25% in 2007. In 2019 the birth rate fell to its lowest level since 1985, according to the Centers for Disease Control and Prevention (CDC) and has likely dropped again in 2020 in response to the COVID-19 Pandemic.
Whether future recipients are fully aware of these statistics, the level of confidence in Social Security diminishes the younger the worker.
Baby Boomers have the highest level of confidence, which isn’t a surprise, but that only 65% believe they will receive their full benefits is. Millennials and younger Gen X’s have the least confidence at just 28%, which may be due to Gen Xers having experienced the dot.com bust and financial crisis. Millennials have been burdened by student debt and after the financial crisis a soft labor market that weighed on their earnings. Millennials are getting married later than prior generations, buying their first car and home later in life as well. For them capitalism hasn’t been great leaving them receptive to more government intervention.
When President Roosevelt signed the Social Security Act on Aug. 14, 1935, monthly benefits were paid to retired workers starting at age 65 or older. In 1935 the average lifespan for a male was 59.9 years and 63.9 years for women, and in 2018 it was 76.2 for men and 81.2 for females. In 1935 the average American didn’t live long enough to collect any Social Security benefits. That has changed dramatically with most male Baby Boomer collecting Social Security for more than a decade and women for 15 years.
Mandatory spending represents 70% of the federal budget and 85% if defense spending is included. Congress can only lower the 15% of the budget that is discretionary making it nearly impossible to shrink budget deficits.
The largest programs within the Mandatory spending category are Social Security, Medicare, Medicaid, and other benefit programs. The only way funding for these programs can be lowered is by an Act of Congress.
Republican attempts to lower the rate of increase in Medicare spending in 1996 were met by ads showing Grandmothers in wheel chairs being pushed over a cliff and wrecking balls destroying a home. Future spending would have gone up, just at a slower rate. If either party ever attempted to address Social Security, which is considered the third rail of politics, the other party would have a field day. The political will to address mandatory spending doesn’t exist in the U.S., which is one reason the Federal government has succeeded in running a budget deficit in 55 of the past 60 years.
The depth of the Great Depression inspired John Maynard Keynes to develop his macro economic theories which were published in his 1936 book, ‘The General Theory of Employment, Interest and Money’. Household consumption, business investment, and government spending were the three primary sources of demand, with net exports adding a little when there was a trade surplus. Keynes conclusion was that prior recessions and the Great Depression were the result of a pronounced decline in private aggregate demand. When a recession began households would spend less as confidence fell and unemployment rose, which would lead businesses to cut back on investment. As demand weakened further, the risk of a downward spiral would rise and the private sector could not be counted on to reverse an economic contraction.
In Keynes view the federal government should step in to arrest the contraction in private demand and increase aggregate demand through deficit spending. The lift the economy would receive would improve consumer confidence and spending and, as economic growth resumed, lead to increased business investment.
Keynes thought that lowering interest rates, expanding the money supply, and other monetary policies could only go so far to spur demand. Tax cuts could help, but Keynes noted that people were likely to save some or all the money they gained rather than spend it. On the other hand countercyclical government spending was more effective in boosting aggregate demand in the short run and thus providing the economy a positive jolt.
Although countercyclical spending would create a budget deficit, Keynes believed it was necessary to prevent extended periods of high unemployment. What is often conveniently overlooked is that Keynes believed that budget surpluses would occur during periods of growth and be used to pay down national debt, or allowed to create a rainy day fund to stimulate growth when a recession developed. Keynes also expected the government to raise taxes if aggregate demand was too strong and resulted in inflation.
The genius of Keynes’ analysis is its simplicity but its Achilles heel was his naivety in expecting politicians to possess the discipline to curb spending during the good times so a surplus could occur. The net result is that the annual increase in Federal debt has been growing faster than GDP for decades and is expected to soar as the spending in Social Security and Medicare climbs in the next 30 years.
This chart is scary enough but it doesn’t include the massive unfunded liabilities. If unfunded liabilities were included, the debt to GDP ratio would double to more than 400% of GDP.
Unfunded Programs and the Coming Crisis
The Federal government has made promises it can’t keep and the options are less than optimal, especially for any politician that wants to get reelected. Workers currently pay 6.20% of their wages into Social Security and 1.45% into Medicare, with employers matching the amounts. Congress could vote to increase the tax rates for both programs, and substantially raise the cutoff from $142,800 in 2021 or eliminate the limit. This would extend the solvency of Social Security and Medicare.
The problem with increasing the Payroll Tax rate is it disproportionately affects those with less income compared to those whose income is significantly above the limit. For the Top 1% the Payroll Tax represents an average of just 2.2% of income, but soaks up 7.2% of the bottom 20% and 8.2% of those in the fourth quintile (60% to 80%) of all taxpayers.
If Congress changes anything it will be to increase the limit, or create a gap. Those earning more than $142,800 and less $400,000 will pay no additional Social Security and Medicare taxes, but those above $400,000 would pay on their income above $400,000. This is an attractive option since it will only affect the top 1% of tax payers.
Congress could also cut benefits before Medicare runs out of money in 2024 and Social Security depletes the Trust fund in 2032, but that has zero chance of passing. The only benefit cuts that have even a remote chance of occurring will be to slash Social Security and Medicare payments to those earning more than what is deemed appropriate, or have a net worth above a specific threshold. Again the goal would be to pull in as much money from the top 1% as possible without dimming one’s reelection prospects.
As discussed in the October Macro Tides, the Federal Reserve’s monetary policy has since 2002 contributed to income and wealth inequality, as has Corporate America’s fixation in maximizing shareholder wealth and willingness to pay executives 300 times or more the median income of workers. Change happens over time but the pace varies as written in ‘The Sun Also Rises‘: ‘Gradually, then suddenly‘.
Since 1781 the U.S. has experienced significant changes every 80 years as discussed in the 1997 book by William Strauss and Neil Howe entitled ‘The Fourth Turning: What Cycles Tell Us About America’s Next Rendezvous with Destiny‘. After researching economic trends in Europe as far back as the mid 1400’s and in the U.S., Strauss and Howe found that economic and social patterns repeated themselves, after a crisis every 100 years in Europe and 80 years in the U.S. Within each large cycle there were 4 minicycles each lasting 20 – 22 years that shaped aspects of each generation.
The four mini-cycles are the High, Awakening, Unraveling, and Crisis.
The first 80 year cycle in the U.S. began in 1781 at the founding of the U.S., followed by the beginning of the Civil War in 1861, the U.S.’s entrance into World War II in 1941, with the next cycle due in 2021. However, events often signal when one mini-cycle is ending and the next is starting. Strauss and Howe forecast that, sometime in the middle or end of the 2000 – 2010 decade,
“a spark will ignite a new mood of national urgency. The spark might be as ominous as a financial crash, as ordinary as a national election, or as trivial as a Tea Party.”
The spark would set off a chain reaction of further emergencies rooted in “debt, civic decay, and global disorder“. Strauss and Howe believe the financial crisis was the event announcing the onset of the Crisis phase of the cycle that began in 1941. If it lasts 20 to 22 years as is expected, it suggests the coming years are likely to be wrought with change.
The prior crisis cycles coincided with a war. When economic growth is weak and millions of people are out of work and hungry, domestic unrest is prevalent. Unpopular leaders often initiate conflict to boost nationalism and distract the masses. It is certainly possible that the U.S. may not be directly involved in a war but the conflict would disrupt global commerce and cause another global recession. It is easy to see that a conflict between the U.S. and China in the South China Sea or over Taiwan is possible before 2027. In some ways the U.S. and China are already waging an economic war.
Another observation is the rule of alternation regarding the U.S. In 1781 people in the U.S. came together as we were fighting an outside foe, but in 1861 the country was divided which resulted in the Civil War. During World War II the people of this country were united as we fought an outside foe. With the next Fourth Turning at hand, the level of discord and divisiveness is high, so the coming changes could prove dramatic and alter the future course of the U.S., since there are few signs of people coming together.
In the last 25 years America has become increasingly divided, which is clearly evident in the widening gap between the median Democrat and median Republican since the 1994 election. Since 2017 the divide between the median Democrat and Republican has surely become significantly wider.
With millions of American workers out of work due to the Pandemic and millions of small businesses struggling to keep their doors open, the Democrats and Republicans couldn’t come to an agreement to provide additional support prior to the election. I’m an optimistic cynic, but have been dismayed political differences couldn’t be over come to do what’s best for the country.
Election Will Resolve Little
According to the BofA Global Fund Manager survey, a plurality of fund managers believe the 2020 presidential election will be contested, since a clear result may not be known for days. The huge increase in mail in votes and different methodologies and time tables used by numerous states almost assures the outcome of some Senate races could be delayed.
As of October 31 an estimated 90 million voters have already voted, which dwarfs the number of pre-election votes in 2016. Of the 141,114,502 votes cast in the 2016 election, 57,856,945 (41%) were cast before Election Day, with 33,867,748 mailing in their vote (24%) and 23,989,465 (17%) voting in person. Only 17 states begin counting votes before Election Day, while 33 states don’t including Michigan, Nevada, Pennsylvania, and Wisconsin. In this era of vitriol neither side will be open to concede anything if the margin of victory is small in any key Senate race or the presidential election. It’s possible the 2020 election could make the 2000 election look like a tea party.
After a wild election night on November 7, 2000, during which TV networks first called the key state of Florida for Gore, then for Bush, followed by a concession by Gore that was soon rescinded, the results for who would be the nation’s 43rd president were simply too close to call. In the 36 days that followed, Americans learned Gore had won the popular vote by 543,895 votes, but failed to win the Electoral College .
As accusations of fraud and voter suppression dominated the air waves, calls for recounts and the filing of lawsuits ensued. The terms “hanging chads,” “dimpled chads” and “pregnant chads” became part of the lexicon of every day conversation. The U.S. Supreme Court eventually decided by a 5 to 4 vote that the time to accurately determine the outcome had run out and decided that Bush had won Florida. This allowed George Bush to garner 271 Electoral College votes, just 1 more than needed to win, to Al Gore’s 266 electoral votes. A real ‘chad’ hanger!
If a lengthy process unfolds in 2020, it will surely play into some of those who stand ready to hit the streets. Whether it’s seen as a green light to cause mayhem and participate in looting and destruction of property, or show up armed with an AK-47 protected by the second amendment, the post election reaction will sadly not usher in a period of calm and peace.
No matter who wins the election the risk of violence has grown significantly since 2017 when only 8% of Democrats and Republicans thought it was OK to use a little violence or more to achieve political goals. In September 2020, 33% of Democrats supported violence to achieve their political goals while 36% of Republicans did according to Politico. Police departments are preparing for an increase in violence no matter who wins.
In the final week of the 1980 presidential campaign the two candidates held their only debate and Reagan posed what may have become the most important campaign questions of all time: “Are you better off today than you were four years ago?” Whenever more than 40% of registered voters have answered that question with a yes, the incumbent president has won reelection. Ronald Reagan won in the 1984, Bill Clinton won in 1996, George Bush won in 2004, and Barack Obama won a second term in 2012. The only incumbent not win was George Bush Sr. in 1992.
Gallup is a middle of the road pollster, which in the current polarized political environment is worth noting. When Gallup asked registered voters ‘Whether they were better or worse off than four years ago‘ in September 2020, 56% of the respondents said yes. That’s a higher percentage than any of the prior incumbents received. There is a good chance you haven’t heard the results of this poll as it doesn’t conform to the negative narrative that dominates the mainstream media.
It has been reported that some people are reluctant to admit to a pollster that they will vote for President Trump, but many voters do vote based on their pocket book. This explains why President Trump is receiving more Hispanic and Black votes than in 2016 and why the election may be close. If Biden wins by a small margin, the Republican chances of holding the Senate would increase. A split government may prevent the Democrats from pursuing an agenda that would easily increase the divide between Americans.
A number of prominent Democrats have indicated what the agenda would be should the Democrats win the White and Senate. At John Lewis’s memorial on July 30 former President Obama listed the goals: automatic voter registration, including former felons; more polling places; an expansion of early voting; making Election Day a national holiday; guaranteeing citizens in D.C. and Puerto Rico equal representation in the federal government; ending partisan gerrymandering; and, if necessary, eliminating the Senate filibuster, which Obama decried as a “Jim Crow relic“.
Eliminating the filibuster is interesting since it was Democrat Senator Harry Reid in November 2013 who changed the threshold from 60 votes to 51 votes for Senate approval of executive and judicial nominees, in order to confirm three liberals to the D.C. Circuit Court of Appeals. The Republicans led by Mitch McConnell had blocked the nominees. President Obama didn’t object to the change in rules when it served his and the Democrats goals, but denounces it now that Republicans have used the rules pushed through by Reid to confirm Amy Coney Barrett with 51 votes. Pushing through Amy Coney Barrett was a flexing of political power but in accordance with the Constitution.
The number of Supreme Court Justices has been fixed at 9 since 1869. Increasing the number of Justices on the Supreme Court backfired when FDR tried it in 1937 and should be viewed as a valuable lesson. Eliminating the filibuster and voting to make the District of Columbia or Puerto Rico states to increase Senate seats and an assured Democratic Senate majority for years to come is a blatant power grab. After local law enforcement in a number of cities was unable to contain riots and looting last summer, President Trump was accused of being a fascist for offering National Guard troops to quell the rioting and looting, but not peaceful marches. Providing for the safety of citizens and private and public property is one of the most basic responsibilities of government. Packing the Supreme Court and adding Senate seats so one party can exert control for many years seems far more fascist than quelling rioting and looting.
Whether Joe Biden becomes the next President and the Democrats take over the Senate, individual tax rates are likely to go up in coming years, as Congress attempts to pay for Social Security, Medicare, and other increases in spending. According to the Tax Foundation, residents of California, New Jersey, Hawaii, and New York will pay more than 60% of each dollar earned above $400,000. Those who can will move, which will shrink the tax base in these states and other states with high tax rates.
The increase in taxes is likely to marginally weigh on economic growth since the revenues collected by the Federal government and states will be spent through income transfers or outright government spending. The notion that those in the top 1% will work less hard due to higher taxes is exaggerated by Republicans. However, with potential returns reduced there will be less investment which will hurt productivity.
Modern Monetary Theory to the Rescue
No matter how high Congress increases taxes for the top 1% or even the top 5%, it won’t generate enough revenue to equal the coming increases in government spending. If Joe Biden becomes president federal spending is projected to increase by $11.1 trillion through 2029 compared to an increase in tax revenue of $5.8 trillion, according to the Committee for a Responsible Federal Budget. Total Federal Debt would thus rise by another $4.3 trillion before 2030, so spending will continue to outweigh tax revenue. The other wall Congress is running into is that the income tax code is already fairly progressive.
The National Taxpayers Union Foundation (NTUF) is a nonpartisan research and educational organization that has compiled historical data tracking the distribution of the federal income tax burden from 1980 through 2017. In 1980 the income tax share of the top 1% of filers was 19% and increased to 38.5% in 2017. The Top 25% of filers paid 86.1% of all income taxes in 2017.
The tax burden of the Bottom 50% of taxpayers has dropped from 7% in 1980 to 3.1% in 2017. In 2017 Congress passed the Tax Cuts and Jobs Act which lowered personal income taxes and took effect in 2018. The Tax Policy Center (TPC) is a nonpartisan think tank that aims to provide independent analysis of tax issues. In 2020 the Top 0.1% of tax payers will average an effective tax rate of 30.3%, while the bottom 20% of payers will pay 3.3% and taxpayers in the second quintile (20% to 40%) will pay 8.0%.
In 2019 the Top 20% earned 53% of total income and paid 68% of total personal income taxes, according to the Peter Peterson Foundation. The 60% to 80% (second quintile) received 21% of total earned income and paid 18% of total personal income taxes. In 2019 the Top 40% of earners paid 86% of income taxes. The bottom 60% of workers earned 26% of total income and paid 14% of total personal income taxes.
This discussion is not intended to take away from the problem of income inequality, which has been discussed previously. The point is that the U.S. system has become more progressive since 1980 and there isn’t enough money to pay for future federal spending, even if the top 20% of earners were taxed at a much higher rate. If Congress is to keep its promise not to increase taxes on the middle and lower class and fund the mandatory spending required in the Social Security and Medicare programs, Congress is going to have to find another source of revenue.
Whereas Keynes suggested increases in federal spending and budget deficits should be used to offset a decline in private demand, Modern Monetary Theory (MMT) suggests the Federal government should run a budget deficit until inflation appears. As long as inflation is under control the Federal government should employ deficit spending to meet every economic and social need in the U.S.
Supporters of MMT believe traditional economists have it backwards, since they believe the government must generate revenue from taxes before it can spend on anything. Those who espouse MMT believe the government should spend whatever money is necessary to create a utopian economy and not worry about deficits. The only limit on how much money the government can spend shouldn’t be dictated by a budget but instead by inflation. If the government is spending too much money and that spending creates shortages in the labor market so wages are bid up, or the elimination of spare capacity production leads to higher prices for goods, the government will simply raise taxes until inflation cools. An increase taxes would pull money out of the economy, lower consumer spending, and lead to a slowdown.
MMT is fairly seductive since it would theoretically allow the government to spend enough money to keep unemployment low, launch aggressive investments in infrastructure so every road and bridge in the U.S. can be improved, provide a free college education, build a green power network, increase military spending, establish a basic universal income program to eradicate poverty, and not only fully fund Social Security and Medicare but allow for an expansion of benefits and a lowering in the retirement age. Basically the government can spend whatever to takes to create a more perfect union.
There is an old saying: “If it sounds too good to be true it probably is.” That certainly applies to MMT since it shares the same Achilles heel that undermined Keynesian economics. Keynesian economics has led to a historic increase in the U.S.’s debt to GDP ratio, because it depended on politicians to raise taxes during the good times.
MMT requires politicians to increase taxes on every worker rich or poor, as soon as inflation becomes problematic. I have no faith that politicians can ever be counted on to provide the discipline to remove the punch bowl just as the party is jumping. The Federal Reserve has been tasked with that job since its’ founding in 1913 and the track record is not inspiring, and the Fed has been independent.
For MMT to fund the massive deficits that are likely the Federal Reserve would have to play an active role in buying a significant amount of the debt sold to fund the spending. As I discussed in the February 2019 Macro Tides:
“During the next recession, the Fed’s balance sheet could easily balloon to $10 trillion or more, as it attempts to prevent an outright deflationary debt collapse. The debt issued to support the economy and purchased by the Fed amounts to free money for the government, as the Fed remits the interest it collects back to the Treasury. With a slight alteration to the Dire Straits song Money for Nothing, the lyrics would be:
‘That’s the way you do it. Money for nothing, get your programs funded for free.'”
The Federal Reserve has expanded its balance sheet from $3.8 trillion in September 2019 to $7.2 trillion in October 2020 and it will likely reach $10 trillion by the end of 2021. The Federal Reserve’s status as an independent central bank could erode if inflation does materialize and politicians fail to act quickly and decisively to raise taxes on the majority of workers to slow economic growth. In that situation the Federal Reserve would have to buck political pressure and raise interest rates to fulfill its mandate to maintain stable prices.
If the Treasury market threw a Tantrum, the Federal Reserve would need to initiate a Yield Curve Control (YCC) program, so higher interest rates wouldn’t contribute to a more pronounced cyclical down turn or recession on top of the too little or too late higher taxes imposed by Congress. Congress could be expected to take the fund every ‘worthy’ program too far and potentially leave the Fed in the position of deciding if funding the new Pet Project fulfilled a legitimate economic need. The Federal Reserve could find itself having to voice its approval or not, which is well beyond the purpose of any central bank.
Although the Federal Reserve can likely manage the Treasury bond market through the YCC program, it would likely find it far more difficult to control the foreign currency market. If foreign investors decide to dump the Dollars they hold, the Federal Reserve would need to buy the Dollar aggressively and then sterilize its purchases to avoid a surge in the money supply within the U.S. Central banks have often been forced to increase domestic interest rates to reward foreigners for holding the domestic currency. Even if this maneuver succeeds, it damages the domestic economy which simply provides foreign investors another reason not to hold the currency.
The biggest risk in coming years is the status of the Dollar as the world’s Reserve currency. Most of global trade is conducted in dollars so the demand for the Dollar would fall as other currencies assume a greater role. This is likely to develop as China desires the Yuan to play a greater role. The issue is how quickly and how fast this evolves.
The U.S. trade deficit increased to $67.1 billion in August the highest level in 14 years. This is a sign of strength and weakness. Strength in that demand for goods was healthy, and weakness in that what Americans wanted to buy was produced overseas. (Chart of the Trade deficit is compliments Doug Short of AdvisorPerspectives.com)
A weaker Dollar buys less so the cost of imports rises. A decline in the Dollar increases import inflation, while periods of Dollar strength are followed by lower import inflation. U.S. demand for imports falls during recessions as increases in unemployment curbs demand, which was the case in 2001 and during the financial crisis.
If the Dollar experiences a meaningful decline over an extended period of time, import inflation will rise and contribute to any increase in inflation. If this coincided with a cyclical uptick of inflation, it would simply add to the challenge the Federal Reserve would face in supporting the Dollar via foreign currency market purchases and pressure to increase short term interest rates.
No one knows if and when foreigners will flee the Dollar, or when and if the Dollar’s role as the world’s reserve currency will be diminished. Observing the gradual change in the Dollar’s fundamentals is of value but provides little guidance as to when the tipping point has been reached. This is where the combination of fundamental analysis and technical analysis can prove most helpful.
Technical analysis can provide insight when the risk of these fundamental factors are increasing to a dangerous level and often well before ‘Dollar crisis’ makes headlines. The range of 87.50 and 88.50 on the Dollar index has been a critical pivot point since 2008. The Dollar rallied from a low of 70.00 in March 2008 to a high of 88.50 in November of 2008, which was tested again in March of 2009. The Dollar subsequently fell to 75.00 in December 2009, only to rally up to 88.70 in June 2010. By May 2011 the Dollar had fallen all the way back to 72.70. The Dollar index broke decisively above 88.50 in December 2014 and by March 2015 traded up to 100.39. After peaking in January 2017 at 103.82 the Dollar fell for 13 months before bottoming at 88.25 in February 2018.
This chart analysis indicates that any decline below 88.00 in coming months will open the door for a decline to at least 75.00 and potentially 70.00 – 72.00 on the Dollar index. The key takeaway is that the Dollar will fall below 88.00 well before a ‘Dollar crisis’ makes headlines. This makes the integration of technical analysis with the Dollar’s fundamentals indispensible.
I appreciate that those who are unfamiliar with technical analysis may question its value. Here is my analysis of the Dollar which was included in my October 2014 analysis of the Dollar and Euro, which was entitled ‘The Return of the Almighty Dollar and Deflation‘. It was based solely on technical analysis without a shred of fundamental analysis to identify the trend and extent of a large rally in the Dollar:
“Between July 2001 and March 2008, the Dollar index fell from 121.29 to 70.69, or 50.6 points. A .382% retracement (a common Fibonacci rebound from a large decline) of the 50.6 point decline would be 19.33 points and targeted a rally to 90.01. This target is just above the highs of 89.25 in November 2008, 89.71 in March 2009 and 88.80 in June 2010. The price range of 88.80 to 90.00 is likely to attract the Dollar 13 index like a magnet in coming months. Should the Dollar index reach this range, as I expect it will, the odds of it breaking out above the range are good. The Dollar has already tested this zone three times, so a breakout after a fourth attempt should be a near certainty. The 50% retracement of the Dollar’s 50.6 point plunge from 2002 to 2008 would target 95.99, and a 61.8% rebound (another common Fibonacci rebound from a large decline) would suggest a possible high of 101.97. I like the higher target for two reasons. After breaking through serious resistance at 89.00-90.00, a rally to just 95.99 seems too small, whereas a pop to 100-101.97 is a more appropriate follow through.”
As noted, The Dollar index broke decisively above 88.50 in December 2014 and by March 2015 traded up to 100.39.
The Market’s Faith in the Fed May Fade
‘Don’t fight the Fed‘ is one of Wall Street’s most revered axioms and for good reason. Bull markets have often begun, even as the economy was in a recession, after the Federal Reserve lowered interest rates. The S&P 500 bottomed in late 1966 after the Federal Reserve lowered the federal funds rate and rallied into late 1968. In 1970 the S&P 500 bottomed a few months after the Fed cut the funds rate, although there was one final drop of -22% as the economy was in recession. In 1974 the S&P 500 recorded its low after the Fed began lowering the funds rate, but after a -27% swoosh down. In 1980 the federal funds rate went on a roller coaster ride as the Fed increased the fund rate early in the year, causing the S&P 500 to fall. The Fed then slashed the funds rate precipitously in mid-year and the S&P 500 rallied.
The faith in the ‘Don’t fight the Fed‘ is thus understandable but shouldn’t be taken blindly. It has not always worked as believed, since meaningful declines have often followed the initial rate cut, especially if the economy was in a recession (1970, 1974). In 1981 the Federal Reserve lowered the federal funds rate from a peak of 20% to 13% in early 1982, but that didn’t prevent the S&P 500 from falling another -20% until it bottomed in August 1982. Only then did the Great Bull market of the 1980’s begin.
In December 2000 the Fed began cutting the funds rate from 6.5% and by January 2003 it was down to 1.25%, but that didn’t keep the S&P 500 from falling -40%. In August 2007 the Federal Reserve started lowering the funds rate from 5.25% as the first signs of the housing bust began to emerge. In December 14 2008 the funds rate was 0.15%, but the S&P 500 had plunged by more than 50% before bottoming in March 2009 despite all the rate cuts.
When the Federal Reserve realized that the federal funds rate had lost its potency to stem the financial crisis, the Fed launched the first Quantitative Easing program in December 2008. The S&P 500 bottomed in March 2009 and continued to rally as the Fed launched additional QE programs. The market didn’t stumble until the Fed began to increase the federal funds rate in earnest in 2018, but quickly reversed course after the S&P 500 fell 20% in the fourth quarter. In response to the COVID-19 Pandemic the Fed took monetary policy where no central bank had gone before when it started to buy corporate junk bonds, municipal bonds, and offered its balance sheet to back stop Treasury loans to small business.
The Federal Reserve is so far down the path of using Modern Monetary Theory as part of its normal monetary policy that it can’t reverse course. Congress will continue to spend and the Fed will continue to expand its balance sheet. In the short run the stock market will respond favorably, which is why a new high in the S&P 500 is likely in the first half of 2021. There is a risk that at some point in the future the expansion in the Fed’s balance sheet will become impotent, just as lowering interest rates lost its Mojo to support the economy and lift equities. This risk was addressed by Bill Dudley, the former president of the New York Federal Reserve from 2009 to 2018, in a speech at the Yahoo All Markets Summit on October 26.
“The efficacy of monetary policy is rapidly diminishing. The interestsensitive sectors of the economy are doing fine, so if the Fed did more, what would be the effect on the economic trajectory? It would be very, very modest.”
Dudley said he expected the Fed to further press fiscal policymakers on stimulus.
In a speech to the National Association for Business Economics on October 6, Chair Powell emphasized the need for additional fiscal stimulus, likely as encouragement for the negotiations between Treasury 15 Secretary Mnuchin and Speaker Pelosi to be successful:
“The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods. [A failure to provide timely and additional fiscal support could] “lead to a weak recovery, creating unnecessary hardship for households and businesses.”
Powell’s comments confirm the Fed’s commitment to expand the Fed’s balance sheet, as the federal government increases government spending and maintains high deficits in coming years. The only question is whether investors will at some point lose confidence that more QE will bring a sustainable economic expansion. If that happens the S&P 500 could experience a bear market not dissimilar to 2001-2002 and 2007-2009, irrespective of the Fed expanding its balance above $10 trillion.
.
include(“/home/aleta/public_html/files/ad_openx.htm”); ?>
