In a semi-annual report(.pdf) that serves as this week’s commentary on financial markets, fund manager John Hussman does a fine job of detailing the key drivers behind the U.S. economic recovery, factors that few others really seem to want to talk about so long as the stock market is rising.
The U.S. economy appears suspended at the boundary between tepid growth and recession, requiring a trillion-dollar federal deficit and unprecedented monetary easing simply to maintain that position. The Federal Reserve continues a well-known and fully-announced policy of quantitative easing, on course to push the monetary base (currency and bank reserves) to 27 cents per dollar of nominal GDP.
The last time the monetary base reached even 17 cents per dollar of nominal GDP was in the early 1940’s. This was not unwound by subsequent monetary tightening, but instead by a near-doubling in the consumer price index by 1952. Based on the strong relationship between the monetary base and short-term interest rates, even a normalization of short-term interest rates to 2% would tolerate no more than about 9 cents of base money per dollar of nominal GDP without inflation.
As a result, an eventual normalization of Fed policy would require either a 50% contraction in the monetary base, a doubling of the consumer price index, or about 14 years of economic growth at a 5% nominal rate. It is doubtful that the Federal Reserve will be able to extricate itself smoothly from its current policy stance by any of these means.
Those comments about inflation the last time the Fed balance sheet was growing rapidly are pretty interesting, though not as interesting as what we see today that, when you think about it, is simply amazing.
This year we will likely have a combined $2 trillion in deficit spending and Fed money printing while, according to the latest CBO estimate, we’ll have economic growth of 1.4 percent, which, for a $15 trillion economy is about $200 billion, all of this coming four years after the recession ended.