The American Rescue Plan: Limits of the Highly Visible
“We believe that hindsight will show the champion of head-smacking craziness in the American stock market to be the period playing out right now.”
~ Paul Singer, letter to Elliott Management shareholders, January 28, 2021
Who says finance has to be boring? Investing is often like watching paint dry, sometimes terrifying and occasionally exhilarating. Today the stock market is more than fun; it’s a sure thing.
Meanwhile, record stock prices have led to record household net worth ($130.2 trillion at year-end). Not one to let a boom go to waste, the federal government, by way of the $1.9 trillion American Rescue Plan, recently mailed $1,400 checks to each member of the household. Wall Street strategists expect a third of this lucre to find its way into the stock market and the rest spent, which is good for business. “We have never seen the consumer emerge this strong from a recession,” claims Chris Harvey, equity strategist at Wells Fargo Securities.
Today’s faith in stimulus would make John Maynard Keynes blush. Says Evercore ISI’s Ed Hyman:
Massive, unprecedented stimulus is already in place and increasing! It’s firing on all cylinders, i.e., QE, rates, and fiscal. So even though inflation and bond yields are moving up, equities are supported. We believe we’re at the start of a new expansion that will last five years or more.
Have we truly discovered the Holy Grail? Why didn’t we think of this sooner? Borrow, print, spend, speculate, rinse and repeat. The popular business press has long been pimping for this financial alchemy:
Barron’s said a year ago that policy makers would “have to get creative” to avert an economic catastrophe. They did and, as a result, better times await.
Is economics really this simple?
Seen and Unseen (the Lesson)
“The first lesson of economics is scarcity. There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”
~ Thomas Sowell
What is the difference between a good economist and a charlatan? The phony economist focuses solely on the visible effects of government policies whereas the sound economist considers the unseen.
Government policies follow the path of least resistance, driven by groups pining for benefits in the short run (seen), and those harmed in the long run, but oblivious to the costs (unseen), are largely silent. On occasion, some may be visibly harmed in the short term, yet support policies out of economic ignorance. (The beneficiaries tend to be concentrated and well-organized politically while the victims are disparate and unorganized.)
Let’s take minimum wage laws as an example. Wages, like any price, are set by supply and demand. If passing a law magically raised wages, why stop at $7.25/hour, or $15.00/hour for that matter? All the minimum wage does is set a floor on legal wage contracts. Any that would take place below that floor are now considered criminal. In other words, raising the wage floor, all else being equal, results in unemployment.
The harm to those at the bottom rungs of the economic ladder should be obvious, but who benefits? For starters, those marginally more productive than the targeted group get to eliminate some of their competitors. Imagine a restaurant owner pays an unskilled teenager $10/hour, generating $12/hour in incremental revenue ($2/hour profit). If the minimum wage is raised to $15/hour, the owner is now losing $3/hour to hire this person. He would be better off hiring a more productive worker worth $14/hour who generates $15/hour in incremental revenue ($1/hour profit before the minimum wage law was imposed). The new $15/hour wage will eliminate his profit, but this is far more palatable than losing $3/hour.
Still, our restauranteur is not happy having a gun put to his head and his business disrupted. Can his unskilled worker be replaced by automation? At the margin, companies providing labor-saving technology also benefit from minimum wage laws. (This may be an investment opportunity at some point. “Supplying restaurant equipment isn’t a particularly big business—sales total about $40 billion annually—but it has been a steady one, driven by the need to constantly improve labor efficiency,” according to Barron’s.)
Despite considering all of his options, what happens if our owner still can’t make a profit? He folds the tent, welcome news to his larger competitors who have access to cheaper capital and are better able to deploy technology over a chain of restaurants.
The state benefits from centralization, having fewer businesses to lean on to act as tax collectors. The state also expands by becoming a broker in more and more win-lose schemes like the minimum wage. Market entrepreneurs, who in a truly free market must profit from mutually beneficial exchange (win-win), are constantly at risk of being seduced into this game, becoming political entrepreneurs in the process.
Notice how proponents of coercive win-lose schemes cunningly label voluntary win-win exchanges “exploitation.” This is a classic, albeit subtle, case of projection.
Economic Stimulus (the Lesson Applied)
Now let’s take a closer look at the scheme du jour: economic stimulus. Notice how government has no way of conjuring up resources out of thin air. The pesky problem of scarcity remains. As economic historian Robert Higgs commented in early 2008, “Economic stimulus is like draining the deep end of the pool, pouring it back into the shallow end, and expecting the water level to rise.”
Who benefits in the short run? To the extent stimulus money props up asset prices, the investor class is an obvious beneficiary, but even this classification is too broad. Those who have already accumulated assets and expect to be net sellers benefit while younger people in their asset gathering years are harmed. Long-term investors welcome lower prices as an opportunity to accumulate more shares and build greater wealth in the future. Rising asset prices also help larger companies with access to the capital markets over their smaller privately-held competitors.
If the path of stimulus leads to price inflation, those whose income will be rising as they move into their peak earning years are in a much better position to protect themselves than retirees on fixed incomes. Similarly, those employed in emerging industries are in far better shape to deal with price inflation than those in declining industries.
Whenever new money is doled out (whether printed, borrowed or taxed), those at the front of the line benefit at the expense of those at the back, otherwise known as the Cantillon Effect. Wikipedia explains how early 18th century economist Richard Cantillon “posited that the original recipients of the new money enjoy higher living standards at the expense of later recipients.” To illustrate, consider how green energy gets preferred status while fossil fuels wait in line until everyone is seated and the carry-on compartments are full.
In the long run, there is no shortage of losers. The whole notion of saving and investing—deferring consumption in the short term in order to increase production in the long term—is turned on its head. After all, consumption is the very thing being stimulated; savings must suffer. So too, must future production, i.e., economic growth. On top of this, investors are turned into gamblers, leading to misallocation of resources, or what Austrian economists refer to as “malinvestment.”
Meanwhile, the parasitic class (the state and its clients) expands at the expense of the productive host. The free market—that system in which the consumer is sovereign and prices discovered by profit-seeking entrepreneurs—is crowded out by central planning in which priorities are determined and prices administered by vote- and power-seeking politicians.
One of the more pernicious effects of stimulus is its contribution to what economists call “high time preference” in society. People become addicted to short-term stimuli, whether social media, click-bait, get-rich-quick schemes, the next election or the evening news. They crave what is right in front of their noses, but fail to see long-term consequences. Writes Rolf Dobelli, author of Stop Reading the News:
News media outlets, by and large, focus on the highly visible. They display whatever information they can convey with gripping stories and lurid pictures, and they systematically ignore the subtle and insidious, even if that material is more important. News grabs our attention; that’s how its business model works. Even if the advertising model didn’t exist, we would still soak up news pieces because they are easy to digest and superficially quite tasty.
The highly visible misleads us.
Reading the Tea Leaves
Where should the good economist train his eyes?
Included in GDP is government spending. But the services offered by the government are not the kind that you are usually looking for. Few people wake up in the morning and say, “Today, I’m going shopping for an F-35 Joint Strike Fighter.” Instead, they want the things the government doesn’t make. Government spending is almost completely focused on the consumption of wealth, not the creation of it. In other words, it doesn’t add to the supply side of the supply/demand teeter totter. It subtracts from it.
Crises always ratchet up government spending, a pattern in the U.S. documented by Robert Higgs in Crisis and Leviathan. Covid is just the latest example.
Crisis and Leviathan
War of 1812
World War I
World War II
Consumer—The consumer is a lagging indicator: most confident at the peak of a boom and most pessimistic at the trough. Don’t forget that the consumer’s balance sheet is tied to that of the government. Says legendary contrarian investor Bob Rodriguez, now retired:
The consumer has saved a lot of money because they've gotten all this stimulus cash. They've paid down debt. They haven't spent much more than maybe half of what they've received. This is viewed as a positive. But I say, "That's only one side of the equation." The offset is the government borrowed this money, so it results in a negative savings rate and the net effect is a system-wide savings rate that hasn't been improved. It's a very pernicious environment.
Stock market—Some CEOs (and former presidents) measure success by their stock price, a classic red flag. Instead of fixating on the stock chart, focus on factors such as leverage, credit quality and valuations. Today, billionaire investor Paul Singer believes,
“Trouble ahead” is signaled by a rare combination of low-quality securities, staggering valuation metrics, overleveraged capital structures, a scarcity of honest profits, a desperate dearth of understanding evinced by the most active traders, and economic macro prospects that are not as thrilling as the mobs braying “Buy! Buy!” seem to think.
Sentiment—“The only permanent truth in finance is that people will get bullish at the top and bearish at the bottom,” Jim Grant counsels. Learn to survey the speculative landscape which Grant did recently:
Monetary laxity, fiscal profusion and zero-cost trading commissions have combined to raise up a SPAC boom, crush credit spreads, levitate meme stocks, infuse the cryptos, smile on the invention of non-fungible tokens, facilitate the issuance of trillions of dollars of low-cost public debt and train a youthful new cohort to speculate under the banner of “you only live once.”
The Market as Discounting Mechanism
Spring is upon us. The vaccines are here, stimulus is kicking in and the economy in full bloom. Nonfarm payrolls surged by 916,000 in March, the biggest gain since last August. (Employment is still 8.4 million jobs below its February 2020 peak.) Job growth was led by the leisure and hospitality sector which hired 280,000 workers, two-thirds by restaurants and bars.
How much of the good news is already baked in? The Invesco Dynamic Leisure and Entertainment ETF (PEJ) sits 3% higher than its closing price at the end of 2019, five weeks before 691 passengers aboard the Diamond Princess tested positive for the coronavirus.
To no one’s surprise, the cruise industry has been among the hardest hit. Carnival Corp. (CCL) mothballed its entire fleet last March and plans to start sailing again in May. For its fiscal year ended November, the company reported negative free cash flow of $10 billion, a gaping hole filled by issuing stock ($3.2 billion) and bonds, but without taxpayer assistance. (Cruise operators sail under foreign flags to avoid paying U.S. corporate taxes and failed to qualify for bailout funds.) On December 31, 2019, CCL closed at $50.83, valuing the company (including debt) at $52.6 billion. Today, despite guaranteed losses for several more months and a cloud of uncertainty over their customers’ willingness to stomach the high seas again, the business is worth $49.3 billion. Investors who stayed the course have a –46.5% total return to show for their fortitude; i.e., filling holes is costly.
Dave & Buster’s
Following the blowout employment report on April 2, President Joe Biden was quick to claim credit:
The first two months of our administration has seen more new jobs created than the first two months of any administration in history. It's a reflection of two things going on here, a new economic strategy focused on building from the bottom to the middle up, and one that puts government on the side of working people.
Say goodbye to trickle-down economics and hello to “trickle-up economics.” Forty years ago, President Ronald Reagan promoted stimulus through tax cuts, supply-side economics and a core belief in limited government, claim the marketing gurus on the left. “Passage of the Biden plan reflects the triumph of precisely the opposite view: that only active and competent government can get us out of the mess we’re in now,” opined E.J. Dionne Jr. in The Washington Post.
These snake oil salesmen overlook the fact that federal spending as a share of the economy actually increased slightly during the Reagan years (from 32.6% to 33.4% of GDP). More importantly, Reaganomics reversed the 35-year post-World War II decline in public debt-to-GDP, running up the federal credit card from 31.2% to 49.7% of GDP in 8 years.
When it comes to government intervention, there is not much new under the sun. The state’s objective is always to extract as many eggs from the golden goose as possible. While Reagan’s economic team acknowledged the importance of keeping the goose alive, Biden & Co. operate under no such constraints. Count on the current administration to enact new taxes on capital gains, dividends and corporations. (An increase in the corporate income tax rate from 21% to 28% would cut after-tax earnings 9%.) The rich will be made a target, assuming they stick around for the abuse. In an increasingly virtual economy with an expanding remote workplace, the wealthy have options.
At a time when the industrialized world is gripped by a host of free lunch fallacies, there can be little doubt that the $1.9 trillion rescue plan ushers in “a new era of much bigger government.”
This article originally appeared in the Coffee Can Portfolio.