We do not believe that investors fully appreciate how fragile the U.S. economy is. Our view is that the U.S. economy is in a recession and that this period will be followed by long-term muted growth given: 1.) the enormous U.S. Government debt load ($30.4 trillion), 2.) persistent price inflation, 3.) a consumption-driven economy rather than a production-driven economy and, 4.) weak labor participation (which speaks to a structural skills shortage).
The U.S. economy is in a recession. We believe Q4 2021 Real GDP “growth” was overstated as the GDP deflator used to adjust Nominal GDP was understated. Similarly, we believe the Real GDP decline in Q1 2022 was understated. Our view is that the touted economic growth of the past year was primarily driven by price increases rather than unit growth or productivity increases.
Further, 2021’s economic “growth” was less about a COVID re-opening and more about the fact that Treasury and the Fed sent helicopter money to millions of Americans. That stimulus is gone and the related personal savings are dwindling.
1.) U.S. Government Debt Load: The Public Debt stood at $30.4 trillion as of April 30th (125% of Nominal GDP). It is difficult for any government to encourage economic growth when it consistently runs annual deficits that range from hundreds of billions of dollars to trillions of dollars. These deficits are subsidized by the printing of new dollars which reduces the purchasing power of the dollar. Entitlement programs and various government subsidies directed to non-productive activities are primarily to blame for budget overages to say nothing of government overreach including punitive regulation. Think about it. Can any business or household comfortably grow disposable income if it saddles itself with an ever-growing debt load each year? Government behavior will not change which means larger debt loads over time and larger amounts of new money printing each year. Money printing to subsidize government debt is especially nefarious as it reduces the purchasing power of every American and is the sole source of price inflation. If there ever was an example of taxation without representation it is price inflation.
2.) Price Inflation: Reported CPI figures are significantly understated given the Federal Government’s insistence on not using real-world (think owner’s equivalent rent for example) price data. “Food” is one broad CPI category that will remain elevated given COVID regulations on the food processing side combined with a labor shortage (processing, distribution and retail) and higher transportation costs (road, rail and shipping). Our local grocery store is a regional chain of 79 stores. I personally observed price increases ranging from 30-50% last week for non-seasonal, non-specialty food items. Our household grocery bill is up approximately 40% year-to-date, far higher than the underestimated USDA figure of 5-6% for calendar 2022.
Food price increases will be a catalyst for knocking the U.S. economy further into recession as these and other price increases combine with higher interest rates and higher interest payments (mortgages, credit card debt) to squeeze consumer disposable income. Much of the quarterly data around mortgage debt service ratios and consumer credit service ratios are not yet available for Q1 2022. However, given the trend in the 10-year Treasury (many credit agreements are based off of the 10-year Treasury) it is not difficult to assume that consumer disposable income and purchasing power in Q1 2022 came in below Q4 2021. Further, given that the Federal Reserve expects to lift rates at the next two policy meetings (June and July) combined with the fact that the Fed plans to trim its balance sheet in June means rates are going higher for the foreseeble future which will further squeeze consumers.
3.) Consumption-Driven Economy: The U.S. economy is a personal consumption-driven economy as personal consumption has accounted for 66-69% of Nominal GDP over the past 22 years. While personal consumption expenditures have grown in absolute terms coming out of COVID, we believe this increase in consumption is due to price increases rather than unit increases. We believe that disposable income is about to shrink as a percentage of household income as price inflation and interest rates march higher. You can view the inverse relationship between consumer sentiment and CPI in the chart below. Our view is that consumer sentiment began to sour around the December 2021 timeframe as food prices had been elevated for a period of a few month and Q4 2021 was also the time frame when Government officials and market “experts” began to aknowledge in the media that inflation was not “transitory”.
Unlike China, the U.S. economy does not have a robust “production of goods/ export of goods” side to offset periods of weak personal consumption. The U.S. primarily exports services (financial services) and this does little to raise the standard of living at home across income classes. Therefore, while prices are increasing for every American, real income is increasing for only a few.
4.) Weak Labor Force Participation Rate: This speaks to a skills shortage and why the civilian labor force participation rate has been increasingly weak over the past 20-plus years. In fact, the labor force participation rate declined in April to 62.2%, down from 62.4% in March. Those who regularly read TEK2day know that we believe that as the Federal Government increases the amount of entitlement programs and the amount of money spent on those programs an increasing number of people living in the U.S. choose to live off of Government programs rather than be productive. Thus, when the Federal government touts a “strong” unemployment rate, it is always important to analyze the labor force participation rate in conjunction with the unemployment rate. The unemployment rate calculation does not include those people who would prefer to work but have stopped looking for employment for one reason or another, whereas the labor force participation rate does capture this cohort of people. We are far off of pre-COVID levels when labor force participation was north of 63%. It is difficult to make the case for a “strong” U.S. economy when almost 40% of people eligible to work are not gainfully employed.