Monday, November 14, 2016

A bond bear market is bullish for stocks

In the past week, bond yields are up sharply (and prices are down "bigly"), and that's great news for the economy and the stock market. Why? Because the market is beginning to realize that Trump means business. With the notable exception of his bizarre desire to reduce the U.S. trade deficit by increasing tariffs on imports (which would punish U.S. consumers), Trump's economic policies are a welcome breath of fresh air for an economy that has for too long been suffering from crushing tax and regulatory burdens. (As an aside, I'm hopeful that Trump's economic policy advisors, two of which I've known and respected for many years, will prevent him from making the mistake of starting a trade war.)

The bond bear market actually started just over four months ago, after 10-yr Treasury yields closed at an all-time low of 1.36% on July 8th, a crisis of sorts that was prompted by fears that "Brexit" represented a serious threat to global growth. Today the 10-yr is trading at 2.22%, almost a full percentage point higher. Over that same period, the real yield on 5-yr TIPS has jumped from a low of -0.5% to -0.06%. Nominal yields have risen more than real yields, which tells us that the market has all but abandoned its fears of deflation. Long-term inflation expectations are now a very reasonable 1.8%, up from a low of 1.4% last June. Higher real yields tell us that the market now believes growth will be stronger going forward.

Meanwhile, the dollar has risen to the top of its 2-yr trading range, and that tells us that the U.S. economy is likely to be the most attractive of the developed economies in the years ahead.

This is all very encouraging, but we're still in the early stages of what is likely to be a huge bond bear market. Why? Because confidence is on the rise and the demand for money and safe assets is beginning to decline, and that means the Fed is going to have to raise rates by more than the market currently expects if it wants to keep inflation expectations in check.

Perma-bears worry that Fed tightening and higher interest rates will surely abort any nascent economic boom, tipping us instead into another recession. They see the bond market flashing a warning: Trump wants to spend too much, and the bond market vigilantes are saying that's a bad idea. Put another way: if you thought the stock market rally of the past seven years was all a function of easy money, then today you're terrified that tighter money will be the death knell for the stock market.

In contrast, I've been arguing for years that higher interest rates won't be a problem, since they would be symptomatic of stronger growth. Higher rates won't lead to an exploding deficit, because the stronger growth that pushes interest rates higher will also work to reduce the deficit by boosting tax revenues. Interest rates have been low because the market has had a very pessimistic view of the future growth potential of the U.S. economy. The Fed has been easy not to stimulate the economy, but to offset a risk averse market's huge demand for money. Monetary tightening won't be as painful this time around, because the Fed won't be draining reserves as it has in past cycles, it will simply declare that it will pay a higher rate on bank reserves, which will be necessary to offset the market's declining demand for money.

By the same logic, Trump's tax cuts won't explode the federal deficit (which is currently a non-threatening 3% of GDP) since they will help boost growth and generate higher revenues. Consider: today's 35% corporate tax rate has failed miserably to generate revenues because corporations have refused to repatriate as much as $3 trillion in offshore profits. As a result, the government has collected 35% of nothing. Trump's plan to charge corporations only 10% on their offshore profits could generate revenues of as much as $300 billion (i.e., 10% of $3 trillion) if corporations decide that 10% is a reasonable tax to pay on overseas profits. As Art Laffer always says, if you tax something less, you can expect to get more of it.

Bond yields are rising because the market is becoming less concerned about slow growth and more confident that growth will pick up. Happily, the same thing is happening in Japan and in the Eurozone. Moreover, industrial commodity prices are up over 20% in the past year because global growth fundamentals are improving. Hooray!

Here are some charts that illustrate these points:


The chart above shows the explosive rise in 10-yr Treasury yields in the past week and since their all-time closing low last July.



10-yr yields are up over 40 bps since last Monday, but 2-yr Treasury yields are up only about 20 bps. This represents a modest steepening of the yield curve which is fully consistent with an economy that is expanding. As the second chart reminds us, yields are still extremely low from an historical perspective.


10-yr nominal yields have risen by more than their real yield counterparts, which means that inflation expectations have increased. The bond market now expects consumer price inflation to average about 1.9% over the next 10 years, which is almost exactly what it's been over the previous 10 years. Nothing wrong with that! Deflation worries have all but evaporated. This opens the door wide to a Fed decision to normalize interest rates at higher levels. Not surprisingly, the market fully expects the Fed to hike rates at its December meeting.


The chart above shows us where real short-term rates have been (the red line) and what they are expected to average over the next five years (blue line). The market only expects the Fed to raise real short-term rates from -1% to zero. That's a very modest tightening and as such poses no threat to growth. The time to worry is when current real rates exceed expected real rates (i.e., when the real yield curve is inverted, as it was prior to the last two recessions). If Trump manages to hit a growth home run with policies next year, I would expect to see real rates substantially higher than they are today, thanks to much stronger economic growth expectations.


The chart above illustrates how real yields on 5-yr TIPS tend to track the real growth trend of the economy. If economic growth picks up to 3% or better thanks to better policies, expect real yields to move substantially higher as well.


As the chart above shows, gold and TIPS prices have turned down noticeably of late, and this is a very good sign that investors are becoming less risk-averse. Less risk aversion means less demand for gold, money and safe assets, and a greater propensity to work and invest. All of which is very welcome. And likely to continue.


Bond yields in Germany are tracking those of the U.S., although they are still substantially lower. This tells us that while growth expectations are improving on both sides of the Atlantic, the Eurozone economy is still fundamentally weaker than the U.S. economy. Not surprisingly, the dollar has been outperforming the Euro.


The chart above illustrates the very strong performance of industrial commodity prices in the past year.


It's notable that commodity prices are up in all currencies, even the dollar. As the chart above shows, commodities typically tend to move inversely to the dollar. I think this tells us that rising commodity prices are a reflection of stronger global growth fundamentals, not because of a monetary reflation.


As the chart above suggests, short-term bond yields have been unusually low relative to core inflation. I think this tells us that the market has been very risk averse, willing to pay a lot for the safety of Treasuries. Risk aversion is beginning to decline on the margin, and if this continues we could see yields rise substantially over the next year. If inflation continues to run at 2% or so, 5-yr Treasury yields ought to be at least 3%. That's almost double their current yield.


The chart above shows that stocks are up on the margin because uncertainty about the future (the Vix index) has fallen while confidence in future growth (the 10-yr Treasury yield) has risen.

We're still in the early stages of what could be another big bear market for bonds, but we're also still in the early stages of Trump's policymaking process. Expect to see disappointments and positive surprises along the way—it could be a bumpy ride for a while.

40 comments:

PerformanceSpeaksForItself said...

You didn't mention the hundreds of billions Trump plans to spend on infrastructure, etc. What is your take?

Scott Grannis said...

Re Trump's infrastructure plans: My understanding is that Trump is calling for $100 billion per year in infrastructure spending, to be financed privately with the help of some tax credits. That's very different (and much better) than what Obama attempted. It means that whatever is undertaken will have a positive contribution to growth that can be monetized by the investor (e.g. toll roads). That further means that most of the spending will be efficient spending, not make-work spending.

Unknown said...

Considering the abject failure of the toll roads in your neck of the woods (73 and 241) and that the tax payers have had to pick up the pieces of those two debacles I am surprised to see you so supportive. Both have been hindrances to growth and certainly not monetized by investors nor models of efficient spending.

Scott Grannis said...

I'm not necessarily endorsing too roads. But I do think that if the private sector is funding the project and has skin in the game then that is better than having a government entity spend the money. The private sector is a better judge of what makes sense.

Tyler Nation said...

Scott, has your view on AAPL changed with the results of the election? The last time I asked you were still long

Scott Grannis said...

I'm still long apple. On a cash adjusted basis apple's PE looks very attractive. I'm confident corporate tax rates are coming down, especially for overseas profits. This would be a huge benefit to apple. I don't think we are going to get in a trade war with China.

Benjamin Cole said...

What a wonderful wrap-up and outlook from Scott Grannis, even if one disagrees with this or that aspect.

I wonder about a bear market in bonds. Maybe I am cynical, as I have been waiting for that bond bear market since disco was big. There seems to be huge secular, global forces pushing down inflation and interest rates.

My take is there might be a bump down in bond values, but the trend line is still to lower inflation and interest rates. Word: At the Bank of International Settlements (BIS--the central banks' central bank) the staffers are putting out studies rhapsodizing about deflation. They talk about "good deflation."

I understand good deflation, but if we have deflation good or bad, then what happens to bond values. They go up!

Central bank staffs globally may be deflationists at heart. I certainly never met a central banker who was a real estate developer, or who said something like, "I would like to see huge economic growth and if we endure some moderate inflation, so be it." They are not built that way.

PS. Worry not about protectionism. Reagan was a huge protectionist, in fact, levying tariffs of 100% on Japanese electronics, 50% on Japanese motorcycles and putting limits of Japanese automobiles, and then cheapening the dollar at the Plaza Accords. Reagan makes Trump looks like a little boy in short pants, when it comes to protectionism.

Yet the 1980s were great!

Benjamin Cole said...

If you want a reasonable concern about economic propects, here is one:

"Trump Is Leaning Toward Extreme Militant John Bolton As Secretary Of State
Donald Trump ran on a platform of non-intervention, but is leaning toward picking an extraordinarily hawkish secretary of state."

The federal government consumes money by the trillions of dollars in any conflict.

Get out your pocketbooks. This could be very expensive.

Hans said...

"Put another way: if you thought the stock market rally of the past seven years was all a function of easy money"

It is no thought but rather a fact - just ask some of the Fedheads. There is typically
a correction every 20 months, but since this bull market (Mar 2009) only a two (DJIA, 15,16)
correction in the past (almost) eight years!! 93 months and counting, Mr Grannis,
with an economy in the sick ward(s). If you did not own stocks and bonds - you were
being robbed by your own FRB on behalf of other commercial interests. There been
four corrections if using the S&P 500. http://www.yardeni.com/pub/sp500corrbear.pdf

This is the second longest bull market in history all with GNP of less than 3%.

"then today you're terrified that tighter money will be the death knell for the stock market."

Whether it does or not, our collective concerns are for the FRB to stop manipulating
market interest rates and allow the free market price discovery.

STOP Fedzero NOW!

"In contrast, I've been arguing for years that higher interest rates won't be a problem"

You are right on that score, Mr Grannis. The Crank Bank has enriched the corporate sector at
the expense of the middle class. Trillions of dollars have gone from savers to spenders
thanks to the FRB and the fools in WDC. Their decade old interest rate policy has lead
to an America in economic decline and the poverty of millions of our citizens. Just like
all other governmental unit agencies, their mandates have been approved and expanded by
CONgress, to the detriment of the American people and the enrichment of the few.



Hans said...

CONTINUATION


"In contrast, I've been arguing for years that higher interest rates won't be a problem, since they would be symptomatic of stronger growth. Higher rates won't lead to an exploding deficit, because the stronger growth that pushes interest rates higher will also work to reduce the deficit by boosting tax revenues."

"By the same logic, Trump's tax cuts won't explode the federal deficit (which is currently a non-threatening 3% of GDP) since they will help boost growth and generate higher revenues."

You have been wong, wong, and more wong on this issue. A year ago, you suggest that
the deficit would continue to decline from it's historical high. The end of this fiscal
year, the deficit has exploded once again. The CBO, has suggested it will continue
to increase going forward. And no amount economic growth will correct this because
Federal governmental unit spending will always outpace growth.

Just examine the per capita spending and it will forecast the future. Remember, GNP
percentages are not people and do not offer a real clear view of governmental unit
spending and it's adverse effects.

As I have argued, unless GU's budgets are brought under control, deficits
and spending will continue to expand. See what happens in the next recession to come,
it will not be very pretty.

"Interest rates have been low because the market has had a very pessimistic view of the future growth potential of the U.S. economy."

So the market is responsible for historically low interest rates?? Perhaps now the FRB
can retire from their interest rate actions. Yes, markets do move interest rates but
it is not in the vanguard under today's current political scheme.

"The Fed has been easy not to stimulate the economy, but to offset a risk averse market's huge demand for money."

The Reserve has done an excellent job in not stimulating the economy. There certainly
is no risk averse in the corporate world, as it has record debt on it's books. World
governments are also accumulating record debt. The FRB along with their pals, IMF, World
Bank and ECB have effectively taken control of economies worldwide. The effects of their
collective actions is now apparent for all to see. Unfortunately, there will be a price
to pay for all of their central planning. I hope and pray that it is not too severe.

Raygun, did nothing about Beltway spending and debt; and neither will The Donald.

America, will never be able to grow it's way out of this problem unless
spending is addressed!

For the young "folks" you will experience a series of shock financial crisis within
a decade or two because you have refused to act now. Of course, it is the condition
of human nature to postpone actions on unpleasant things.

The American character has become seriously flawed. I weep for you!

Frank Condon said...

Very good assessment. Thanks.

NormanB said...

Oh, will not even the brilliant ones learn? Trump isn't proposing "tax cuts" he is proposing "tax rate cuts".

Scott Grannis said...

NormanB: Thanks very much for that correction, you are absolutely right. Tax rate cuts do not necessarily mean tax revenue reductions. That's the essence of the point I was trying to make.

One famous example: Despite Reagan's massive income tax rate cuts (he cut the top tax rate from 70% to 28%), the rolling 12-month sum of federal revenues rose from $630 billion when he took office in 1981 to $930 billion by the time he left in 1989. Tax rates fell by more than half, but tax revenues rose by almost 50%. Furthermore, over that same period tax revenues as a % of GDP were unchanged at just under 18% and the economy experienced seven years of very strong growth.

riichkay55 said...

Remarkable. You casually suggest that Trump abandon the tariffs/trade war. What in hell do you think brought him these Rust Belt voters, who decided this thing? He ran as a populist/protectionist. On these trade issues he ran to the left of Bernie Sanders. He told these folks they were getting a 35% tariff on Fords made in Mexico, and 45% on China products. And 12 Mil. Mexicans (they're stealing our jobs, you know) rounded up and deported. In 2 years, midterms, the factories will not have re-opened. What will he tell these people? I conned you on tariffs and deportations? I always knew he was peddling BS, telling people what they wanted to hear. But there's a price to be paid winning this way. You suggest he just go along with the standard GOP playbook, corporate tax cuts (yeah, that's what excited the Rust Belt folks, the promise of corporate tax cuts). And de-regulation of the same Wall Streeters who collapsed the economy in '08 (Rust Belters, like most Americans, wanted jail for the bankers). And ex-Goldman hacks (Mnuchin) running the whole thing, that'll really drain the swamp...you have fundamentally misread what happened here.

Scott Grannis said...

I'm not sure how Trump will extricate himself from some of his more stupid promises. In his defense I would say that virtually all politicians renege on their promises at some point, which is why we know that politics is a dirty business. One possibility: he will use the threat of tariffs to extract other concessions such as greater respect for and enforcement of property rights by, for example, China. The fact remains, however, that restricting trade is just a dumb idea.

I won't argue that some people aren't suffering from globalization. I'm sure there are millions. But if our economy had been otherwise healthy, and not burdened by excessive taxation and regulation, then many of the workers displaced by cheap and competitive imports would probably have found employment in other areas. Unfortunately, we have a weak economy and weak investment, and that has made it far more difficult for displaced workers to find other opportunities.

As for the banks, the roots of the 2008 financial disaster go way back to government meddling in both the mortgage and banking sectors. The best explanation for the crisis that I've read can be found in two books I recommend on this blog: John Allison's "The Financial Crisis and the Free Market Cure," and Redleaf and Vigilantes' "Crisis."

Let me say again that I dislike Trump as a person. But his virtues—understanding how businesses work, plenty of executive experience, respect for free markets, disdain of government regulations—I hope will outweigh his obvious populist faults (e.g. anti-free trade).

riichkay55 said...

Agreed, Trump's protectionist policies are nuts. Regarding deregulation, yeah, let's go back to Goldman and Morgan going into the casino, and making bets (London Whale), with an implicit govt backing if the bets go wrong. We just got through with this madness...Re the housing bubble meltdown, I'm well aware of the Wallinson et al position. One question for these pundits: the housing bubble went hand-in-hand with an insane commercial real estate bubble. I know, I'm in that business. When housing crashed in '08, so did CRE. Massive number of non-performing CRE loans, both CMBS and in bank portfolios, that had been originated at the bubble peak. The write-downs would have taken down every major bank in this country. But they were bailed out, by both parties. I was one of those who was livid at this. These lenders made horrible bets, and lost...I wanted the market to clear these bad loans, just as in the S&L meltdown years. Instead, in my view, Bernanke et al decided to re-inflate the bubble, in both SFR's and CRE. Back to my question: what govt policies were responsible for the commercial real estate bubble?

Benjamin Cole said...

R-55:

There is a lot to suggest that property zoning plays a role in property values, and banks' willingness to lend on property. Today about 80% of bank lending is on property.

Through zoning, property values become artificially inflated, yet banks still perceive property as collateral.

The trouble starts when a central bank tightens in response to perceived inflation.

Property values than crack, scaring the way bank lending, leading to a further reduction in property values.

That's a recession snowball going downhill.

The solution is one the GOP and the Donks consider vile: free markets in housing and no property zoning.

The other partial solution is to somehow convince the Fed to not suffocate the economy at the slightest whiff of inflation.

Even my right-wing, pro-business friends are nutty when it comes to property. How many times have you heard someone say they are "against rent control" but then do not say they are against property zoning?

Gadzooks!

Benjamin Cole said...

R-55:

There is a lot to suggest that property zoning plays a role in property values, and banks' willingness to lend on property. Today about 80% of bank lending is on property.

Through zoning, property values become artificially inflated, yet banks still perceive property as collateral.

The trouble starts when a central bank tightens in response to perceived inflation.

Property values than crack, scaring the way bank lending, leading to a further reduction in property values.

That's a recession snowball going downhill.

The solution is one the GOP and the Donks consider vile: free markets in housing and no property zoning.

The other partial solution is to somehow convince the Fed to not suffocate the economy at the slightest whiff of inflation.

Even my right-wing, pro-business friends are nutty when it comes to property. How many times have you heard someone say they are "against rent control" but then do not say they are against property zoning?

Gadzooks!

Johnny Bee Dawg said...

Trump is very bullish for prosperity for EVERYONE...not just the Socialists. Nice rally expanded to all kinds of sectors today.

Pinch me. Can self sufficiency and rollback of unConstitutional government really be happening in America??

Feels like the lid is coming off of the economy. Time to get busy and make America great again.

Scott Grannis said...

Benjamin: no quibble from me on the evils of zoning. But please note that the Fed is at the very least one year away from being "tight." Inflation is running just under 2% and short-term rates are not projected to exceed 2% for at least a year. Negative real short-term interest rates are the very definition of "easy money," by the Fed's own admission, and I would agree. I would also note that expected inflation as implied by TIPS prices is also just under 2%. You are still tilting at the deflation windmills.

Scott Grannis said...

Re CRE: I'm not an expert in Commercial Real Estate, but it seems to me it was collateral damage given the implosion in the housing/mortgage/banking sectors. Panic selling spread to many markets, and eventually the lack of liquidity and loss of confidence gave us a deep recession. Nearly everything was affected. And it all goes back to decades of government meddling in the housing and mortgage markets.

Show me a "market failure" and I'll show you a market that has been distorted by misguided government policies and regulations.

Benjamin Cole said...

Scott: Let us hope you are right on the Fed.

You see the US dollar at record highs?

Dollar rising all year long.

Benjamin Cole said...

Scott: Let us hope you are right on the Fed.

You see the US dollar at record highs?

Dollar rising all year long.

riichkay55 said...

Trump, at the 2nd debate:

"We’re in a bubble right now. And the only thing that looks good is the stock market, but if you raise interest rates even a little bit, that’s going to come crashing down. We are in a big, fat, ugly bubble. And we better be awfully careful. And we have a Fed that’s doing political things. This Janet Yellen of the Fed. The Fed is doing political — by keeping the interest rates at this level. And believe me: The day Obama goes off, and he leaves, and goes out to the golf course for the rest of his life to play golf, when they raise interest rates, you’re going to see some very bad things happen, because the Fed is not doing their job. The Fed is being more political than Secretary Clinton."

So here's a guy who sees a crash coming. At the time, he figured Hillary would be in office. Now, the crash will be on his watch....

NormanB said...

To look at history, the 1942 to 1966 bull stock market did not roll over until the long Treasury bond hit 5% with momentum; it is now 3%.

With inflation still in check as the public and TIPs are predicting <2% inflation for the next ten years it is hard to envision long rates surging higher. Also, I do not understand the market's thinking that Trump all by himself is going to cause inflation.

steve said...

I'm with Norman. I'm skeptical of a bond rout. Everybody'd been calling that for years and they've been wrong. I'll believe it when I see it.

The Cliff Claven of Finance said...

If a bond bear market is bullish for stocks,'
then a bond bull market must be bearish for stocks?

But it seems the long bond bull market since the 1980s was actually bullish for stocks.

So if it was really true that a bond bear market is bullish for stocks,
and a bond bull market has been bullish for stocks, then you appear to be
saying one should ALWAYS be bullish on stocks?

While most people on Wall Street are perpetually bullish to keep the customers buying,
it makes no sense to always be bullish.

The median stock Price-to-Sales Ratio is currently at an all-time record.

It would be a high risk investment to buy stocks at record valuations.

In the past, investing at valuation peaks has always been bad news.

Chris Harris said...

Dear Mr. Grannis,

- Bonds up, equities up.

- Bonds down, equities up.

If so, John Stuart Mill's - System of Logic - would suggest, pretty strongly, that bonds have very little to do with equity prices. Of course, this might well be perfectly reasonable.

Chris Harris

Scott Grannis said...

Re stocks and bonds. There is no fixed relationship between stocks and bonds. Sometimes they move in opposite directions (e.g. bonds rise because stocks and the economy are weakening), and sometimes they move together (e.g. bonds fall because the Fed is tightening—raising rates—and the tightening is beginning to weaken the economy and weaken profits, so stocks fall). There are many variables which intertwine to affect the relationship between stocks and bonds.

There is a long tradition in the investment community which holds that the bonds and stocks usually move in opposite directions, so buying bonds can be a hedge against falling stocks. There is a long tradition as well that says that when the Fed tightens that is bad for bonds and bad for stocks. Thus, in the current climate, with yields being exceptionally low and stocks near all-time highs, many investors are conditioned to expect that Fed tightening, which started a year ago and will likely continue, the outlook for bonds is bad and the outlook for stocks is bad.

The point I'm making in this post is that a Fed tightening in the current climate need not be bad for stocks. I think the Fed is tightening in response to an improving economic outlook, whereas most times in the past they have tightened because they were worried about rising inflation. "Tightening," in today's climate, means only that short-term interest rates will rise modestly. This need not be threatening to the economy; it's more like a validation of the fact that the economic outlook has improved. There is no reason to think that rising short-term interest rates will be bad for the economy or bad for stocks. From the mid- to late-1990s, for example, the Fed increased short-term rates for several years running, and all the while stocks continued to rise.

Regardless, it is important to note that lots of things are different in the current environment. The Fed has never before had to reverse Quantitative Easing, interest rates have never before started out from such a low point, and at such an advanced stage of the business cycle__ one in which growth has been much weaker than ever before. Prior rules of thumb may well not prove applicable. In all prior tightening cycles the Fed has pushed short-term rates up by draining reserves from the banking system, thus creating a shortage of liquidity. That is not the case today. Rates will rise without their being any liquidity shortage; liquidity shortages can aggravate underlying problems, but that won't be the case going forward.

John A said...

No matter who was elected, has a good chance of facing a recession in the next 4 years. I don't believe Trump's policies will end up being much different than Clinton's would have. Expect the democrats to come back big in the mid-term elections.

Benjamin Cole said...

OT but maybe not:

Scott Grannis, where do you stand on the great "exogenous vs. endogenous: creation of money" debate?

In most simple terms, do banks create money when they extend a loan, or does only the central bank actually create money (by controlling how much the banks can create)?

My sense is now, with unlimited reserves at commercial banks, the endogenous crowd has won this argument.

But then maybe central banks are also creating money directly through QE.

Tracking this one through makes me feel like a blind dog in a meat house.



Scott Grannis said...

As I see it, only banks can create money, when they extend a loan. The Fed can indirectly control how much money banks create by limiting the amount of bank reserves available to banks, since banks must hold reserves in proportion to the amount of deposits they hold. Under the current regime (IOER and QE), banks in theory have an almost unlimited capacity to create money, since there are approximately $2 trillion of "excess" reserves in the banking system. In practice, the amount of excess reserves available to support increased lending and money creation may be far less than $2 trillion, due to regulatory requirements (e.g. Dodd Frank, Basel Accords) that strongly encourage banks to hold reserves in lieu of other high-quality assets.

So it is not clear whether banks are constrained or not in their ability to increase lending. Regardless, I would note that bank credit has been expanding at a 7-8% annualized pace for the past two years, which is in line with the growth of the M2 money supply. I would further note that the money supply has been expanding at a far faster pace than nominal GDP for the past 7-8 years. One could be forgiven for thinking that there have been few if any constraints on money creation in the current business cycle expansion.

riichkay55 said...

A dose of reality from Bill Gross on the "highest corporate taxes" and "repatriated" dollars nonsense:

For example, Republican pleas for tax reform are centered around the argument that America has one of the highest corporate tax rates in the world at 35%. Not so. Of the S&P 500's largest 50 corporations, the average tax rate (including state, local and foreign regulations) is 24%. U.S. corporations rank among the world's most lightly, as opposed to heavily, taxed. Trump policies also appear to favor the repatriation of trillions of dollars of foreign profits at extremely low cost under the logic that the money will be spent for investment here in the U.S. Doubtful. The last time such a "pardon" was put into law in 2004, no noticeable pickup in investment took place. Of the $362 billion that earned a "tax holiday", most went to dividends, corporate bonuses, and stock buybacks. Apple or any other large U.S. corporation can borrow the money they need here in the U.S. at historically low interest rates to fund investment. A few have, but over $500 billion annually in recent years has gone to the repurchase of corporate stock and the increase of earnings per share, instead of earnings and GDP growth. Why would they need to repatriate anything for investment in the real economy?

Scott Grannis said...

Re corporate taxes. The average corporate tax rate paid may be 24%, as you claim, but that is irrelevant. What matters most is the marginal rate, and that is the highest (35%) of any developed country. Marginal rates (the rate that is paid on each additional dollar of income) is what influences decisions. Deductions are also important, of course, and their existence explains the difference between the stated (marginal) rate and the average rate that is actually paid.

The fact that trillions of dollars of overseas profits have not been repatriated is abundant evidence to back the claim that the corporate tax rate is too high and that the U.S. tax code, which is the only one in the developed world that charges domestic corporations twice on the profits they earn overseas, is a huge problem.

Art Laffer long ago taught me that taxes that influence behavior are too high, because they end up distorting the economy; people and corporations alter their behavior because of the way the tax code is structured. In a perfect world, there would be a single flat tax rate (with an allowance for low income people of course) and no deductions. Thus no distortions.

It's true that a corporation can borrow here instead of repatriating overseas profits (and thus legally avoid paying taxes on overseas profits but still enjoy their benefits), but that does not mean that there is nothing wrong with our tax code. On the contrary, it is simply more evidence that behavior is being distorted.

The fact that corporations have not invested their profits, but instead have paid out lots of money in the form of dividends and share repurchases, does not absolve our tax code of its behavior distortions. The decision to invest in new plant, equipment, and projects is based on the existing tax code, and if rates are too high, then not many new investments can clear their hurdle rate. Heavy regulatory burdens also come into play, since they increase the costs associated with new investments. I think that investment has been weak not because of profits held overseas, but rather because the cumulative burden of taxation and regulation makes it very difficult for new investments to deliver attractive after-tax returns. Giving a one-time pardon to un-repatriated profits, in other words, is not necessarily going to make new investment more attractive or more likely to occur.

As you might guess, I don't usually agree with Bill Gross.

Benjamin Cole said...

In a perfect world there would be no taxes.

In the next best world there would be no taxes on productive behavior----working and investing!










steve said...

http://blog.yardeni.com/2016/11/is-trumponomics-inflationary.html

fits with the topic

Hans said...

Once the economy resumes normal growth rates
we shall see accelerating inflation (3% to 4%).

According to Mr Epstein, of the Red Barron's
this expansion is the fourth longest of 11 since
World War II.

Sadly, this expansion of 29 quarters has produced
a 2.1 growth rate.

xr-3609 said...

Great article and follow up comments by Scott

John said...

Trump said "I've always made more money in bad markets than good markets."

http://www.nbcnews.com/politics/2016-election/trump-2007-i-m-excited-housing-market-crash-n578761

Does the election now effectively makes him the ultimate inside trader?

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