Wednesday, November 24, 2021

The Fed is too easy, but profits are spectacular

Despite numerous signs that inflation is running well above the Fed's target, the FOMC today showed no signs of panic. Instead, they hinted that the current tapering of Treasury purchases is now likely to be accelerated modestly, and that might bring forward by a few months the first hike in rates (late summer '22?). In my view, a true tightening of monetary policy (i.e., a draining of reserves, a hike in real short-term interest rates, and an inversion of the yield curve) is still far in the future. Meanwhile, corporate profits have set new all-time highs, both nominally and relative to GDP (third quarter profits were released today in the first revision to third quarter GDP numbers). With a profits boom and a gentle Fed as a backdrop, the downside risk to equities of a Fed tightening is minimal and far enough in the future to ignore for now.

Chart #1

Chart #1 tells us that the bond market is not unaware of the fact that inflation is rising. 5-yr inflation expectations (green line) have jumped from 0.2% in March of last year (when deflation and depression fears were rampant) to now 3.07%. The Fed has been telling us they want to see the CPI over 2% for at least a few years, and now the bond market sees the CPI averaging over 3% for the next 5 years. The Fed's inflation-boosting efforts have thus been more than accomplished. If I were running the Fed I'd be pushing for—at the very least—an immediate end to bond purchases. I think they are way too easy at this point.

Chart #2

Chart #2 is a reminder of what true Fed tightening looks like. Every recession in the past 50+ years (with the exception of last year's recession) has been preceded by a sustained tightening of monetary policy which takes the form of high real interest rates (blue line) and a flat or inverted yield curve (red line). Today we have just the opposite. Furthermore, to judge by the level of real short-term interest rates, monetary policy has never been so easy.

Chart #3

Chart #3 shows how Treasury yields tend to track inflation fundamentals. But today, yields are far below the current level of inflation. Yes, yields have jumped from the lows of last year, but they are still far below where they should be given the current level of inflation. I predict the red line will be rising for at least the next few years.

Chart #4

Chart #4 is one of the MOST IMPORTANT charts that the world is apparently still blissfully unaware of today. This is the elephant in the living room; the 800-lb gorilla that nobody sees. Inflation is up beyond all prior expectations because the money supply has exploded in the wake of the Covid lockdowns. By my estimates, there is an extra $4 trillion sitting in bank accounts held by the public, relative to what we would have expected to see in a normal environment. Moreover, M2 has been growing at about a 12% annual rate so far this year, and that is about twice what its growth rate has been over the past several decades.  

Don't just take my word for it: check out John Cochrane's discussion of this issue here. Briefly, he says that the Fed has done a massive "helicopter drop" of money, and that is the source of the inflation that is staring us in the face. It's not transitory, it's going to be with us for awhile, and it is going to be significant. (John Cochrane is one of my favorite economists.) You can read more about this in many of my prior posts.

At some point the Fed is going to have to take major steps to bring money growth back to some semblance of normality, but it's not going to happen soon. Meanwhile, the market seems willing to give the Fed the benefit of the doubt.

Chart #5

Chart #6

Fortunately, there is plenty of good news these days to offset the bad. Chart #5 shows corporate profits compared to nominal GDP. (This measure of profits is the best measure of true economic profits that exists, and it has been consistently calculated in the GDP accounts since the late 1940s.) Both are at all time highs. Chart #6 shows that profits relative to GDP are also at an all-time high.

The economy is growing and corporate profits are on the moon. What's not to like?

Chart #7 

Chart #7 compares corporate profits as calculated in the GDP accounts (red line) and trailing 12-month earnings per share (profits from continuing operations) as calculated by Bloomberg (blue line). Not surprisingly, both tend to track each other over time. But since the red line is a quarterly number, it tends to lead the blue line. This suggests that reported corporate profits are going to be very impressive for the foreseeable future.

Chart #8

Chart #8 is my calculation of a PE ratio for the S&P 500 that uses NIPA profits (the red line in Chart #7) as the E in a standard PE calculation. I've normalized the result so that the long term average of PE ratios for both series are the same. Yes, PE ratios are elevated today, but they are much lower than they were in the "bubble" that formed in the late 1990s. They are also elevated because the market is expecting trailing 12-month earnings to rise over the next year. Relative to forward expectations, today's S&P 500 PE ratio is a relatively modest 21.

That's all for now. My attention now turns to making some of the ingredients for our family Thanksgiving gathering tomorrow; my sister is hosting 36 of us! 


ebg investor said...

Thank you Scott for the optimistic update! Happy Thanksgiving to all friends from Canada.

Benjamin Cole said...

Another excellent Scott Grannis review of the US economy.

And yes, note those present-day corporate profits, best ever---the Reagan days look positively wan compared to now.

My take: the US government needs a huge overhaul (including the military), but America's corporate sector is very well run. That is what competition does for you.

Well, we will see if the 40-year global disinflationary trend is over.

John Cochrane is a great economist and thinker, IMHO.

However, everything Cochrane says about the US is true in spades about Japan, and they have no inflation.

Wishing prosperity to all!

Scott Grannis said...

Benjamin, re Japan: Japan does not have explosive money supply growth and never has had. Check your facts.

Benjamin Cole said...,Billion%20in%20February%20of%201960.

True, Japan's big bulge was in M1 in the last two years was in M1. Eyeballing it, M1 is up nearly 25% since 2020 start of year. M2 not so much. But M1 should be even "hotter" than M2, more spendable.

But my understanding is that John Cochrane is more concerned with fiscal deficits. He talks a lot about the "Fiscal theory of the price level."

Japan is the king of fiscal deficits.

BTW, I am inclined to think the Fed has overdone it also, and I am a fan of a much, much smaller federal government. Much smaller than even the most rock-ribbed Republican would tolerate.

But I like to look around...see what people say.

Scott Grannis said...

Re Japan's M2 money supply. Here are some facts to add to the discussion. Over the past 18 years, Japan's M2 money supply has increased at an annualized rate of about 3%, while US M2 has increased at an annualized rate of a little over 7%. Japan did see a Covid-related acceleration in M2 during the year 2020, but their M2 increased by 9% that year, whereas US M2 increased by 25%. Over the past 12 months, Japan's M2 has increased by about 4%, whereas US M2 has increased by 13%.

Scott Grannis said...

Inflation in Japan vs US: Since the end of 2019, Japan's CPI has registered a net decline of -0.6%, US CPI has registered a net increase of 7.2%. Over the past 18 years, Japan's CPI has registered a net increase of 4.4%, US CPI has registered a net increase of 50%.

In conclusion, I think it's fair to say that Japan's monetary policy has been far more conservative than US monetary policy, by at least an order of magnitude.

Cabodog said...

Another great analysis. Thank you Scott and happy holidays to you and your family.

Benjamin Cole said...


I wave the white flag on M2 and Japan.

But that is not what the every smart John Cochrane talks about.

He is a fan of the "fiscal theory of the price level."

"The fiscal theory of the price level is the idea that government fiscal policy, including debt and taxes present and future, is the primary determinant of the price level or inflation as opposed to monetary theory. FTPL requires confidence the government will not default on its debts, but rather 'inflate away' debts."


Japan has run up fiscal deficits, aka the national debt, to roughly 250% of GDP, while the US is up to 130% or so.

I have asked in the comments section of Cochrane's excellent blog if the Bank of Japan practice of buying back the national debt (about half so far) reduces the public's concern that Japan will default on the debt...but never really gotten a reply.

There is yet another take on monetary policy and supply at an outfit named Divisia.

In a nutshell, Divisia says the definitions of money supply are somewhat arbitrary, and needs refining, due to evolving financial markets.

"In recent decades transaction and liquidity services have been augmented dramatically by the growth of privately supplied unregulated monetary services from bank-supplied credit cards and from the services provided by unregulated shadow banking."


They have an interesting chart showing a big bump in money supply in 2020, but coming back down now.

I have been wondering about Bitcoin, and if it walks likes a duck and quacks like a duck, if it is not a duck. More money supply.

Anyway, happy holidays, and yes we will see some inflation for a couple of years. At least I think so.

Carl said...

^The shadow banking stuff is interesting but i think there is a problem with the interpretation of the bump in money supply.
Shadow banking has become quite large but its funding is in large part dependent on wholesale funding and regulated commercial banks (especially large ones).
In March 2020, the bump in money supply was mostly due to large corporations massively drawing credit lines (creating a loan in a fractional reserve environment). The following explains that well:
Small banks took over some of the money supply support with the PPP program (financed with US public debt...). At that time of stress, most shadow bank participants were under funding stress (limited financing, often facing short-term maturities) and were able to put capital to work (and to reach main street people) only when the Fed reestablished liquidity in wholesale financing (this was an issue also in 2007-8).
The credit card financing may be part of it because main street people may use credit cards as a loan instrument (revolving debt). When a credit card is used, there is a delay between when money is created (merchant) and when the consumer pays back (money retired) and this delay can be lengthened through an aggregate increase in revolving credit card debt. The problem with the credit card story is that, in March 2020, main street people started to delever their credit card revolving balance and evidence shows that they eventually used part of their "stimmies" to do so.
So, numbers show that the evolution of revolving credit card debt after March 2020 and for a few months contributed to a lower (not higher) amount of broad money supply.

i think you should not wave the white flag on M2 in Japan and you may be onto something...

Benjamin Cole said...

Carl--I think I am wrong on Japan, at least as measured by M2.

In any event, if you are married, then you know to wave the white flag is sometimes necessary to remain a member of your household with whom conversations take place.

There may be a case to be made that M2 is no longer the right metric to follow.

Obviously, central banks have become concerned in the last 10 years they no longer "control the money supply," due to non-bank banks, Bitcoin, and who knows what else. International capital flows are yet another question.

For that matter, in Japan there is paper cash in circulation, outside of banks, equal to $8,824 in resident.

"According to a survey done by the Bank of Japan, bank notes and coins circulating among homes and businesses had a value of about 123 trillion yen at the end of 2020--by simple arithmetic, a little less than a million yen per person."


Even in the US, there is $6,700 in paper cash in circulation for every resident.

No one really knows where is all this paper cash, and many say the US dollars are offshore, though without any real evidence, except some anecdotes.

Obviously, in Japan or the US, if people started to spend the huge piles of paper cash out there, there would be a huge surge in demand.

What does this mean?

I don't know. One take-away is that whether M2 is growing too fast or not depends on the propensity to spend, or velocity.

Which is perhaps to say when inflation gets above a target, then M2 is too high.

Carl said...

^If the underlying assumption is that money supply growth has never been high in Japan then there is a red flag because it's not true. :)
Especially starting in the early 70s with the Japanese Archipelago Remodeling Plan, money supply growth remained VERY high for a long time (see graph/link below). Using the MV=PY template, fortunately for Japan, for a while, the very high money supply growth was accompanied by stable money velocity and both rising inflation AND very significant real and productive growth as a result of inside money creation (broad money from productive private loans). Of course, that went too far and when combined with a (real estate-stocks) bu**le, private deleveraging then became the order of the day and is still playing out 30 years later. One of the most consistent macroeconomic set of monetary variables has been defined in Japan since the bubble burst (at least up until recently): public support with mostly base money growth more than compensating money destruction in the private sector with declining velocity, zero inflation and no real growth (MV=PY). Japan's ratio of base money to broad money has become much lower than the US for this reason (now entered the QE to infinity era, Hotel California style). Still, as a result of what happened before their bu**le, money (base and broad) per unit of GDP has become three times larger than the same measure in the US. Since early 2020, M2 growth picked up quite a bit with inflation stuck at zero, suggesting that any artificial money growth below 8-10% would have resulted in outright deflation in Japan. To answer your question about how far they can go, it's anybody's guess but the most likely outcome is a non-linear change suddenly going from deflation to an hyper-inflationary environment.
So the US is different (different phase, different trade balance and net investment position etc) but it's reached this stage of the game with an asset price environment that may eventually be described in hindsight as one of the largest bu**les of all times.
Please note that all developed countries have entered another very consistent and long-term secular trend (declining money velocity) with Japan leading Europe leading the US.
If you think inflation will stay elevated for a while, the Economist had a featured article recently and Japan may find it harder and harder to avoid deflation, a feature that lagging countries may have to face after the unprecedented money supply injections (both base and broad) mostly compensated by a more acute negative trend in money velocity.
Oh, the 30-yr Treasury is at 1.83 now(?).
BTW Happy thanksgiving.

Carl said...

Japan's ratio of base money to broad money has become much higher

Benjamin Cole said...

Something else happened in the last 20 years in Japan, and that was the offshoring of industry. This played alongside population stagnation, and also more-open property zoning.

At the risk of being a heretic, I have never liked the idea that offshoring industry is a good idea, and obviously tight property zoning (the US norm) is a chokehold on economic growth and adaptation (and living standards).

A complicated topic.

Unknown said...

Scott said: "and that might bring forward by a few months the first hike in rates (late summer '22?)."

Goldman Sachs (Yes I don't trust a thing they say) indicated in a memorandum last week that the 1st rate hike could be announced in March 2022 and 2022 could have (3) Rate hikes. Goldman had thought mid 2023, then mid 2022 and now March 2022.

Ed Yardeni says he gives Powell a 25% chance of channeling Volcker. That means an inverted yield curve and with Treasury doing all their borrowing in the short end of the curve - that sure could blow things up sky high real fast. I am 74 yrs old and remember that era very, very well. I was at Harvard Business School at the time.

I think FED knows they blew their inflation forecasts be being way low so they may overreact and raise in March rather than Summer or Fall. Would not surprise me at all. Then the fun begins. When equities begin their crash 2023 or 2024 all hell will break loose.

Carl said...

^Who knows and maybe rate hikes are coming but we may closer to crossing the zero bound than many discount at the present time. Even such a minor event like a 10% market drop or something would put the rate-hike narrative out the window. How come we've reached that stage?

"The economy is growing and corporate profits are on the moon. What's not to like?"
Well if you remove government subsidies (government transfers) from the profit equation and look at present trends in unit costs, the present PE is around 35. Of course, this could be justified by future earnings but how is it that corporate profits will continue to match wildly optimistic expectations when the recent artificial spurt was produced by artificial excess demand supported by higher government deficits and broad money supply growth from artificial base money growth and by commercial banks directly buying government debt putting those on their asset side to balance new 'deposits'?
What Mr. Kasriel calls credit of out thin air:
The key question is what happens if/when artificial support is removed?
Anybody here ever tried to wean someone from a respirator? There are criteria and guidelines and many schools of thought so alternative thinking is welcome but, from a humble perspective, the underlying patient appears to be at risk but what do i know?

Carl said...

"Something else happened in the last 20 years in Japan, and that was the offshoring of industry. This played alongside population stagnation, and also more-open property zoning."

So the topic is offshoring and the potential relevant risk to inflation and what happens in the US now.

It seems offshoring is a good idea overall as it is mostly driven by the invisible hand of the corporate world. Issues arise from second-order effects. When the value created from offshoring is unevenly shared, democracies may tend to use redistributive policies and that's tricky. These issues will tend to be dealt with more acutely if the general economy refuses to cooperate, ie dust bowls, deaths of despair etc.
One of the major differences between Japan and the US (vs the inflation picture) is the difference in the net global investment position. Japan has had historically positive trade balances (this may be at risk now) and have built a very large net positive position which, at this point, has helped the BOJ to build such an amazing balance sheet level per GDP. i guess we'll have to see. Japan is one of the countries with the lowest inward FDI level (North-Korea-style level) and this is bound to be a negative as some point.
You mentioned before (in a slightly misleading way) that the US was losing ground in its net global investment position, mentioning that something like 40% of US equities were now owned by foreigners, forgetting to mention that this level of 'investment' has been essentially matched by US equity 'investment' in foreign countries (many of which have a relatively stable and sustainable political structure). To be fair, absolute cost investment numbers show this but, in the last few years, the US has been running a very slight equity-investments deficit because US-based investments have been performing better than the rest of the world (market-price wise).
Of course, the US is running incredibly large trade deficits but following the numbers, on a net basis for many many years now, on a cumulative basis, the trade deficits have been matched by foreigners buying US government debt (and agency securities). And these securities yield very little. The counterintuitive result is that the US, despite a very significant negative net global investment position still makes more income, on a net, basis, that the income leaving the country from the liability side! A bonus (small) is that the US currency printed by the Fed ends up in the global world outside the US and this USD liability (zero percent yield) is matched on the Fed asset side by government debt (and agency) securities which produce seignoriage-type income remitted to the Treasury. That's what Général de Gaulle (and Jacques Rueff, economic advisor, anti-Keynes, pro-Gold-Standard, saw incoming inflation) criticized in the 1960s and what they called the exorbitant privilege.
The major difference is that public and private leverage was very low then and there was room for inflation in the real world. Not anymore i'm afraid at least for the US and until deleveraged.
The USD is still, by far, the cleanest dirty shirt. It will also be a blessing in disguise.

Benjamin Cole said...

Carl- You make many excellent observations.

Re "free trade" there is a book out entitled "Trade Wars are Class Wars" by Michael Pettis. Despite its title the book is not a left-wing polemic, but written by a professor in Peking.

International trade flows do not result from the actions of free markets and multinationals, but rather the rules, regulations and subsidies of governments.

Thought to ponder: Europe runs a trade surplus with China.

Beyond that, I am concerned about the nature of the CCP.

Carl said...

^Thanks for the book suggestion.
Mr. Pettis often produces interesting pieces on China and happens to think that the USD, as a reserve currency, is more of a burden than a privilege..
Free trade will tend to help developing countries (at least some of them) to catch up so there are expected frictions. One would hope that government domestic 'intervention' could help mitigating some of the transition effects but it's possible that their actions can potentiate the negative side effects and growing inequality imbalance will have to correct, one way or another. One way is for everybody to get poorer and i hope 'we' don't get to that.
One strategy (that's one of the interpretations of what President Reagan did with Russia in the 80s) is to get going and let the other party implode on its own.
Above, you commented on high levels of cash (physical cash) in circulation. This seems to be a cultural issue in Japan and who could blame them with rates where they are? In the US, apart form the underground economy (5-10% of GDP?), perhaps about 50%+ of physical USD currency circulates outside US territory. The following provides some evidence:
When looking at long trends for currency in circulation, there are clear changes in trend lines (steeper slope of growth) after the GFC and after covid which is related to global swap lines that the Fed opened during global stress and the growing importance of the USD as a reserve (and physical) currency.
And yeah the US consumer has become the consumer of first resort and the Fed has become the lender of first resort. It's not sustainable but it's the least worse option, at this point, and i'm sure 'we' will learn how to save again.

Benjamin Cole said...


For whatever my two cents is worth (after inflation, even less than two cents), yes the US should decouple from China, but not initiate hostilities.

Anything that tightens up US labor markets is a positive and will bring 1000 times the benefits of more social welfare. In fact, social welfare programs are corrosive and tight labor markets a boon to the 160 million Americans in the labor pool.

The CCP is spooky and getting worse. The US media is totally compromised. One toe on the body of inhumanity that is the CCP: They threw publisher Jimmy Lai into prison. For being a publisher.

Fortunately, Japan, Taiwan, S Korea, Australia, New Zealand, India have the resources to provide a bulwark against China, if they want to tax themselves and get organized. It really is their fight.

I do not see an upside for Americans in another Asian war, or in enriching the CCP.

Carl said...

^FWIW, i think China now looks a lot like Japan in 1989 and wonder how they will deal with the transition and how destructive creation will work out there?

"Anything that tightens up US labor markets is a positive"
Yes, somehow, a more inclusive type of growth would mean more sustainable growth so it would be helpful if that would also mean productive growth:

This is an interesting question because the graph that Mr. Grannis has included above about the PE of the S&P over NIPA profits reveals peak profits (unadjusted) compounded by peak multiples. There may be more to it than amazing corporate wisdom.

Benjamin Cole said...

Carl-- I think the profits are high because American multinationals are well run.

Maybe the multiples are a bit rich.

The profit picture has been improving for 40 years. Corporate governance has radically improved in that time, as has the ability of M&A artists to take over any company not well run.

Carl said...

Hi Benjamin,
Of course you could be right.
For the corporate world now, it is both the best and the worst of times and time will tell if expectations have outpaced fundamentals and how, if applicable, the disconnect will be levelled.

To make sense out of all this, i've been looking in all sorts of direction. Here's a quote (i won't tell you the year):
""Prosperity has really come to mean a rate of advance rather than a state of affairs.” At the bottom of every mechanical movement is a source of powermotor or prime mover. The engine at the bottom of the rate of advance in American productivity is the new science of management. It is management which has brought the motor car to blossom like the lilies of the field. It is management which is behind the whole mass production movement. It is management which is steadily stepping up output per worker, decreasing prime costs, flooding the country with new goods, displacing labor with the machine...If prosperity be a rate of advance rather than a state of affairs, it has been more than achieved with
management furnishing the boiler pressure. But if prosperity be peace, security, and happiness, we remember that only twenty managers, out of every one hundred interviewed, gave a thought to the human side of production."
The PE graph that is included in the presentation uses the S&P 500 which may be misleading as the 2000 bu**le was characterized by very unusual multiples mostly for the largest of the largest capitalizations. Using NIPA profits (all corporate profits, large and small) and comparing to an index that is biased towards large caps will tend to make the previous bu**le smaller compared to the present one. A similar statistical artefact is occurring now with the presentation of general absolute numbers of breakthrough cases without using age-adjusted population rates (ie exploiting the relative lack of appreciation for the Simpson's paradox). Anyways, looking at a larger index helps to put things in perspective:

Carl said...

An interesting consideration is that today's high levels of corporate profits includes corporate profits which have been inflated by a recent and unprecedented level of covid-related government subsidies. Also, recent NIPA profits will need to be retrospectively adjusted downwards because of the new phenomenon (not appreciated by the crowd) of delayed NIPA recognition of shared-based compensation to top management.
Today's adjusted corporate profit levels and the widespread multiples applied on them have reached unprecedented territory. Of course, this could be justified by future earning potential but i highly doubt it. If today's levels are 'justified' by ultra-low interest rates, then, at a minimum, retail investors should heavily temper expectations going forward.
Thinking of the human side of production (a concern of yours also i guess if you think that corporations have been driven globally as a result of government encouragements), recently, in a relatively obscure and seemingly irrelevant disclosure i read that Tyson Foods management may have known about covid spread in factories and made various bets as to whom would get infected on the factory floor..
There is a very large segment of the population who is looking for new answers and hope that today's level of corporate profits doesn't provide the sufficient and necessary questions.

wkevinw said...

I tend to look at price/sales as a cleaner valuation metric.

At the bottom in 2009, the P/S was below the level from ~1955-1965, which is a screaming buy based on this metric, for example. P/S is very high at the moment.

Another item is that the profit margin of the firms making up the major indices, e.g. SP500 is much higher than it was many decades ago. There were many utilities, basic manufacturers, etc., decades ago, and now there are tech and financial firms, which have much higher margins.

Scott Grannis said...

And don't forget that profits as a % of GDP are at all-time highs. That is equivalent to saying that profit margins are also at all-time highs. Those facts alone go a long way to justifying current PE ratios.

Benjamin Cole said...


I share concerns that people who work for a living---not welfare types---deserve a better cut on the deal.

America needs lower housing costs, and to rein in health care bills, and to eliminate taxes on wages and dividends.

Free markets can go a long way to these goals. End property zoning, for example. Move taxes onto imports, land and fuels.

It won't surprise me if there is a correction in the S&P 500, for many of the reasons you allude to. But in my gut, I have felt the S&P 500 has been overvalued for the last 40 years. Maybe I will finally be right.

I wonder where you got the quote from, about management. I don't know, but it sounds like the 1920s. Alfred Sloan and so forth, and there were huge advances in management at the time.

I do think American corporations are better run than ever. I wish we could farm out national defense to a private bidder.

How much would it cost per year to present a reasonable deterrent to a military invasion of the US? What if we brought back the draft, and let the private sector come up with low-cost deterrents? I think we would get down a dime on the dollar.

The US government has become so ossified that such topics are never even on the table, let alone considered.

The same can be said for the Dept. of Labor, USDA, HUD, Education, you name it. Sunset time, no?

Carl said...

Hi Benjamin,
'We' would probably be better off with a lower share of government expenditures per GDP but it's hard (at least for now) to 'see' how this will be achieved. Most people aim to improve their standards of living but the value of productive work is certainly questioned at this point.
The corporate world is central to the net production of wealth overall but there is a problem, if, for a given level of wealth creation (growing pie), one part benefits at the expense of others. It's not the same households. It's especially problematic if corporate profits, as a share of GDP, increase while GDP growth slows down. People have been noticing.
To link with comments above and yours, it's great if margins are up because absolute profits are up and because management is business savvy.
But is this the case?
Looking at this from a Malecki equation point of view (careful: this concept is often poorly interpreted and applied as all variables are dependent variables), it's possible to get some insights as far as the present picture of corporate profits and as far as future corporate profits are concerned.
Corporate profits = net investments - private saving + current account deficit + government deficit + dividends ---) CP=NI-PS+CAD+GD+D
Lately, the large increase in corporate profits has been driven by GD (more than compensating increased PS). NI continue to be low (secular trend). How is that sustainable?

It looks like people underestimated the impact of GD on corporate profitability the same way people may underestimate the negative impact of lower GD going forward.

This may be just theoretical and all so here's an example (bottom line: i'm a private investor and in a way i don't care about the aggregate numbers; i just want my private businesses and public investments to benefit from their growing private and public profits):
From a recent conference call (Home Depot):
Home Depot reported sales and earnings growth of 10% and 23%, respectively. Their impressive results benefited from inflation, not necessarily demand (transactions). Management reports: “Our comp average ticket increased 12.7% and comp transactions decreased 5.8%. Growth in our comp average ticket was driven in part by inflation across several product categories.”
What's wrong with that?
The corporation is able to pass along price increases in order to bolster nominal sales (and profits) and customers accept to pay because the government is funding the purchases with borrowed money at close to zero percent.
How sustainable is that and what does it mean for eventual demand and inflation?
BTW, the quote (previous post) is from mid-1929 when corporate profits were (still) booming after an investment-led growth (early 20s) had transitioned to a consumer-led growth (late 20s). This is not meant to "predict" anything, simply to underline that, for the corporate profit picture, the rear-view mirror is only that.

Benjamin Cole said...


It does seem that investment in plant and equipment and bona-fide R&D in the US has been weak and for a long time.

I wonder how much of this has to do with offshoring of industry. There may be measurement issues, also.

If the ground rules are that subsidized product can enter the US without tariffs, why would anybody finance industry inside the US?

On the positive side of the coin, I take a general interest in the venture capital industry, also called private equity, and I can tell you that no good idea, and many mediocre ideas, have access to financing. There must be some truth to the idea that there are persistent capital gluts in the world.

People involved in commercial real estate say the same thing, and there are buildings selling for more than asking price.

Carl said...

^Oh the measurement issue again. People keep saying that we've entered a high productivity era and the problem is that it's not properly where are the customers' yachts?
And Mr. Charlie Munger just mentioned some comments about the present market environment and about cryptocurrencies...Let the good times roll (choose the BB King or The Cars version).

Benjamin Cole said...


Well, I have a yacht, though some people refer to it as a "dugout canoe."

It floats!

Not sure on productivity. Seems to be stalling. May be a sign that until recently, labor was cheap.

Carl said...

^When Henry Ford doubled the salary for factory workers in 1914, he made headlines and there was a lot of confusion. Obviously, the move was strategic and the essence of the 'adjustment' was to continue to make money. In fact, after, the price per car continued to decrease and production numbers took off for several years. Even if corporate profits were a primary driver, Mr. Ford possibly wanted to share the spoil to some extent but also contributed in maintaining aggregate demand, which it did, not relying on government transfers to do so.
What not many realized though (at the time and now) is that the productivity miracle had already been realized to a large extent.
What is funny about today is that the present optimism is tied to the future realization of a productivity miracle and the aggregate 'we' is relying on government support in the interim.
The US has always bet on its futurity and won but i wonder about the interim phase (what is coming).
Today's job report is sort of disappointing even if we're still early in the game (jobs numbers are typically lagging) but the stock market seems to interpret this data as a positive sign? In this recovery, people focus on the basic unemployment rate but not much attention is allocated to the participation rate. The bond market though is getting flatter. The bond market seems to suggest that the Fed may have to continue pivoting its strategy and they may need to reach another level of unconventionality. The inflation story is losing steam and this is shaping up to be one of the most interesting transition periods, ever.

Benjamin Cole said...

Carl- Boy, that was a doozy of an employment report on Friday. Net new job growth rather wan, and plenty of people quitting the job market. Unemployment sinking.

Phoenix house prices are up 30% in the last 12 months.

Warehouse workers in Southern California now make $18 an hour. The problem is due to property zoning, and fixed supply, property owners extract higher pay through higher rents. Well, a great time to own property.

Meanwhile, the mainstream media seems intent on scaring the population with increasingly horrifying stories about Omicron or the next Covid-19 variant. Wear masks! Show proof of vaccination! Vaccinate children! Booster shots!

I wish I was making this stuff up.

Where this merry-go-'round stops....

Carl said...

Hi Benjamin,
"Meanwhile, the mainstream media seems intent on scaring the population with increasingly horrifying stories about Omicron or the next Covid-19 variant. Wear masks! Show proof of vaccination! Vaccinate children! Booster shots!"
The US has done relatively poorly compared to other developed countries in terms of covid excess mortality, particularly for the 15-64 age group. Is that because the 'media' over-reacted? Are you familiar with the thought process behind the 1905 Supreme Court decision delineating that one's liberty ends where another one's starts? The 'other one' in this case living in the same community as yours and possibly animated by another political theme. The libertarian doctrine is amazing in many respects but it breaks down spectacularly when vaccine design and allocation processes are coming into play.
"Phoenix house prices are up 30% in the last 12 months."
In 2006, Mr. Shiller asked three questions: : Is the current boom in home prices temporary? Is a crash possible? And, if prices do fall, will they come back up fairly soon, or will they stay down for many years?"
In 2006, Mr. Shiller's assertions were felt to be absurd and then he became a genius. Recently, with 'reflation', many people now feel he may have over-reacted? Mr. Shiller is not a big fan of zoning and other related supply restrictions apart from some temporary and partial stickiness, giving the example of Walt Disney moving to Orlando when Anaheim became too 'crowded'.
Since the early 1980s (40 years ago!), (real) yields have been going in one direction, down, with zero as an apparent lower bound for the real economy. One of my daughters will soon look to buy a house (first) and i hope she postpones her decision some and endures some 'exploitation' by her current property owner. i do wonder about selling our house but you can guess that my individual freedom is being trampled by my close 'business' associate; she doesn't focus on money as much as i do. Life is based on a foundation of compromises.

Benjamin Cole said...

Yes, the business of marriage and the business of making and keeping money are not one and the same.

On C-19, I am agnostic and apolitical (my approach to everything. I lack the intellectual rigor to be an ideologue).

I got vaxxed twice. Now they say that is not good enough.

The US is a nation of fatties, which may explain mortality rates.

Carl said...


In the "An Interview with Milton Friedman" (1974), Milton Friedman pronounced that businessmen and intellectuals are both enemies of capitalism: most intellectuals believed in socialism while businessmen expected economic privileges."
The idea behind these constructive exchanges is to 'grow' between extremes. :)
Yes 'we' can become 'great again'.

Yes, the Covid response was too extreme (war-like deficits and war-like negative real yields) but the lack of productive rigor during Covid perhaps exemplified a prelude to what you (the US at large) have to discuss (and resolve) in the coming quarters (debt, entitlements, sustainability etc etc).

Yes, Covid vaccines are 'free' and profits are spectacular but there is no free lunch (Friedman again).
"Rise up and take the power back
It's time the fat cats had a heart attack"

Note: thank you for the inputs.

Benjamin Cole said...


Pre-bell Monday and stock market is acting iffy. China property woes, omicron.

On Tuesday you might want to look for the productivity and costs report. Let us hope higher productivity of offsetting wage gains.

House prices in Austin TX up 45% in last 12 months.

This is spooky.

randy said...

Rumor has it that Elon Musk bought a residential property in my neighborhood here in Austin. Will be interesting to see what that does to property values, and helicopter airspace. The 45% increase is potentially misleading. My anecdotal observation is that existing homes values have increased, but the real issue is new homes being built at higher price points. Young and naive tech workers, making more money than they are worth, often via stock options, think a $700k starter home sounds about right.

A back of the envelope check - bought my first home in Austin, 25 years ago, at a 8.25% mortgage and $250k purchase price. Today worth $1.4 million. At todays 3.5% mortgage - that roughly seems like a 75% increase in debt service costs (in real terms)

I'd like to think my daughter in Pittsburgh could move back to Austin one day, but it will be a cost shock.

Carl said...

Productivity numbers are expected to be disappointing for a while as more people are going back to work!
Domino effect and looking for root cause:
People are going back to leisure and hospitality work and are asking for higher wages in order to maintain nominal retail sales artificially and excessively stimulated by government.
Take your pick: Either employment truly accelerates or inflation truly fades.
Canada is dependent on the US but has already reported productivity numbers for Q3:
Austin is becoming one of Texas urban centers most expensive housing market outside of California and there is an underlying and related demographic move pointing to an accentuation of some sticky zoning restrictions. Since 2011, the Austin median income to median housing price has more or less doubled and the only way this makes sense are the factors listed by randy: gilded age demand, lower fixed mortgage rates and inflation adjusted numbers. Despite adjustments, the future return on houses bought now requires unusually optimistic assumptions about future asset inflation and general level of inflation.
Domino effect and looking for root cause:
The present housing supply-demand mismatch is addressed through social housing bonds issued with an Aa1 spread while state and city public budgets are funded through unprecedented pandemic-related federal transfers and grants, transfers which, along the pandemic driven pension returns, hides the unusual potential stresses on the partially funded public pension system.
As a sign of the times, homelessness seems to be a creeping problem and Austin authorities simply aim to 'clear' the issue. Out of sight, out of mind.

randy said...

Interesting side note - while looking at Zillow to check the home values, I checked out Michael Dell's home, which is also nearby. It is on 20 acres, and must be 15k square feet (zillow doesn't know). The property tax valuation is $4.8 million, with a tax due of $284,000 annually. The valuation should easily be 4X+ that. The more pertinent point is Michaels contribution to state revenues is just $284,000. Good to be in TX if you are super wealthy. Not such a good way to raise revenue for schools and city services though. (Mr. Dell is a reasonably good guy by the way - no shade on him.)

Benjamin Cole said...

My understanding is that in Texas property taxes are levied annually, are raised annually, and are levied at "highest and best use" for the land in question.

This may be a better policy than the California policy.

wkevinw said...

"The US is a nation of fatties, which may explain mortality rates. "


I have posted here before about the deeper statistical investigation using such tests as age and years of life lost adjustment. I believe the age adjustment explains a lot of the mortality differences in different nations. India, most of Africa, etc., have an average population age 20 years less than Europe, US, Japan, etc. Obesity and the other co-morbidities are correlated with age.

It looks like vaccinating this virus away (with current vaccines) will not happen.

UCDavis did a study (there are others) saying the viral loading and contagiousness is roughly the same for vaxxed and non-vaxxed. So, the vaxx is only reducing severity and unloading the medical system.

If you look at some of the recent death graphs, places like S. Korea are having a terrible time. It looks like Covid will eventually get to almost everybody no matter what we do.

The Pfizer and Merck meds need to be fast tracked.

Benjamin Cole said...


Unfortunately, I think you are correct.

If there is good news, it is that the omicron variant may naturally immunize a lot of people.

In some bad news, unit labor costs increased at a 9.6% rate in the third quarter.

As measured, productivity is declining. Perhaps there is a measurement issue.

Carl said...

There were some studies showing similar viral loads but more studies showing lower viral loads in the vaccinated group and, especially relatively elevated viral loads for a much shorter period in the vaccinated group. Specific references are available if required and there was a Singapore study (very well done) showing decreasing viral loads much more significantly in the vaccinated group during a period when Delta was the dominant variant.
That, combined with a well established efficacy to prevent catching the disease in the first place (including two recent NEJM studies published in early November) support the notion of significant decreased transmission spread in the community from the vaccinated group.
States report breakthrough cases in various ways and the poor efficacy and transparency of publications make it a field day for those looking for potential mis- and dis-information opportunities. Here's one report from Washington State which is helpful:
From a disease burden point of view, the comparison between the US and South Korea is interesting. Look at the following, comparing cases and deaths.
If the idea is to go through this with minimal costs (the US has produced the largest deficit to GDP for the covid 'effort') while minimizing disease burden, then no wonder reported productivity numbers have become more and more abysmal.
Why not use all productive tools available (including great again vaccines) in order to productively move on to more challenging issues?
Because corporate profits are spectacular?

Benjamin Cole said...


Just an idea: Let us posit the omicron variant is the least dangerous variant yet.

Why not let omicron do its work, and inoculate the population?

We already know children have no ill effects from C19 to speak of.

I assume all the elderly who wanted to be vaxxed are.

(Football analogy) At this point, the US game plan seems to be to play for as long as possible without scoring the winning touchdown.

A tie is preferred?

Carl said...

Hi Benjamin,
This site is macro oriented and i try to channel covid inputs into covid discussion forums but since you're asking. And there is a macro/investment connection.

Yes covid is becoming flu-like and cost-benefit questions will continue to be part of the increasingly bipolarized discussions. Yes 'we' should have taken the covid thing more on the chin (evolutionary perspective) but refusing to acknowledge that such an approach would have resulted in more disease burden is bizarre (and borderline irrational IMO). Maybe that's why necessary austerity measures that will be required will also require (IMO) a different approach. i think people are not stupid (apart from deviations from the mean (individual, collective and timeline perspective).

It's been shown (and is common sense) that people who don't 'believe' in vaccines will tend to downplay the significance of a pandemic (especially if it doesn't affect them directly) and will tend NOT to display basic behavioral adaptive changes fundamental in the community transmission dynamics.

Fruit bats are very social animals but are not recognized for their high level of 'intelligence'. When sick, fruit bats will effectively display adaptive behaviors (relative isolation etc etc) in order to help their community.

i have a dream. Let's hope humans (including the US kind) become as intelligent as fruit bats in terms of basic adaptive behavioral changes, if decreased disease burden is an objectively desirable pursuit. Obviously, this will need to take into account that resources are really scarce, something that has been collectively forgotten in this ultra-low-high-debt world.

Anyways, i you believe (like me) that an evolutionary path should have been taken and if you happen to be (like me) some kind of 'Republican', the let-it-rip 'strategy' should have been tailored to affect more the other tribe. The football game is interesting but i think one tribe has been shooting (repeatedly and in waves) into their own goals.

Personal (technical) note about children. Mine have been vaccinated.
On a collective level, covid vaccination makes sense but i understand the other perspective.
On an individual level, it's even trickier. Covid vaccines (if you look objectively) have very low significant adverse event risks. 'Natural' covid rarely makes children sick but there are some cases of post-virus systemic inflammatory disorders (including myocarditis). The evidence shows that vaccines are likely a net positive for children but the margin is very thin.
Anyways, vaccinating children in the US becomes a relatively obsolete question with such a low vaccination coverage in all age groups. In my province MD group, 99% have become vaccinated so no time is wasted on mandate discussions.
It's basically a question of productivity.

Benjamin Cole said...


But maybe humans are as smart as fruit bats.

Most people with C19 have no symptoms. You can't ask people to self isolate who have no idea they have an extremely mild respiratory illness (in their case).

Omicron to the rescue!

Carl said...

^Yes Occam's razor likely applies here.
It seems many low-hanging fruits were simply left behind and maybe we should just leave it at that.
The nice thing about vaccines is that once you've thought about it, you don't really need to think about it anymore. The same applies for dollar-cost-averaging, index investing and long-term buy and hold.
But the crowd isn't always right and, at times, bigly.
The party may go on for still quite a while but i've been following the (recent and growing) difference between input and output prices for goods and services and it seems that corporations are starting to have difficulty in passing along price increases (watch out margins) as we're going from an unprecedented level of money easing to another relatively lower level of unprecedented easing. Something is spooky.

Frozen in the North said...

Part of the problem is that the hawks have been calling for hyperinflation to arrive imminently for the past decade (at least since Obama became president), at one point those who cry wolf become the object of derision.

Inflation has been low not because of temperance but because of off-shoring by manufacturers, you just have to look at the cost of service to see where inflation would be (since the bulk of this cannot be off-shored) otherwise -- the entry of China into the WTO was a game-changer for US enterprise that shifted a substantial percentage of its manufacturing offshore.

Finally, and as a side note, with the increased tensions between the US and Russia and China's aggressive positioning vis-a-vis Taiwan, do people realize the percentage of worldwide chip production that comes from that island? (for those curious it's 60% of all sales of chips are from Taiwan...)

Salmo Trutta said...

If you back out O/N RRPs from the money stock, then R-gDp is taking such a hit that the FED must ease monetary policy:
01/1/2021 ,,,,, 0.645
02/1/2021 ,,,,, 0.659
03/1/2021 ,,,,, 0.697
04/1/2021 ,,,,, 0.671
05/1/2021 ,,,,, 0.646
06/1/2021 ,,,,, 0.518
07/1/2021 ,,,,, 0.475
08/1/2021 ,,,,, 0.252
09/1/2021 ,,,,, -0.014
10/1/2021 ,,,,, -0.042
11/1/2021 ,,,,, -0.040