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The Fed, Financial Witchcraft, andConcoctions of Economic Disaster

The Great American Obituary:

David Stockman

The Stockman Letter

By David Stockman

We’ve reached a critical juncture in the long-term experiment that is the United States of America.

This feels like an inflection point because we’re stressing and stretching both financial markets and political institutions just about as far as they can be stressed and stretched.

As I see it, “Peak Trump” is either the signpost we blast through on our inevitably disastrous – in almost every conceivable respect – rendezvous with the Empire Hedge.

Or, the Donald realizes his destiny as the Great Disruptor and becomes the destroyer of this postwar world. An entrenched, self-interested, and Acela Corridor-dominated global elite has turned the entire apparatus for its own devices.

Here it is, in one graph:

Today, the Federal Reserve engulfs everything it touches. That’s Alan Greenspan’s gift to posterity. Right now, the Donald seems to be exploiting it to decent effect on his reelection bid. He can’t not be the center of attention.

All we lack now are the specifics of the scenario. But it’s increasingly apparent that the president of the United States will, eventually, tip the entire global system into a critical condition.

The Donald will, one way or another, fulfill his destiny and become the Great Disruptor.

Despite its apparent failure to properly succor Wall Street, we know, beyond any doubt, that the Fed is committed to nothing else like it is to “wealth effects.” It believes that rising share prices lift all boats, from the canyons of Lower Manhattan all the way to Main Street, just like that.

Maybe we see yet another bounce toward a new incremental “Peak Trump.” Recent experience says speculators and traders will once again fall back on the Powell Put/Empire Hedge and back up their trucks.

Part I: “Only Americans Can Do That…”

Is the survival of American-style free-market capitalism in question? Of course, folks on the Left are screaming – literally –

UnsustainableShare of American wealth owned by the top 1%

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The Great American Obituary: The Fed, Financial Witchcraft, and Concoctions of Economic Disaster

The Stockman Letter

about “Inequality!” and the “inherent evils of capitalism.”

Well, there are folks on the Right concerned about multiple destructive tendencies first fiscal and, now, perhaps catastrophically, monetary authorities have let fester.

It’s more than a crony here, a crony there. There’s a crony everywhere. It’s systemic, it’s established, it’s bipartisan. And this duopoly just might kill us all.

Let’s put it this way: Why do you think Russia and China “seek to rebalance military might in Asia-Pacific” and are conducting joint air patrol tests around neighboring Japan and South Korea?

Those “Great Powers” – Russia and China – would like to end this era of the single “Super Power.” Sometimes it seems they’d like nothing more than to bury the whole idea of the “American Century.”

And, with our mismanagement at home on top of misadventure after misadventure abroad, we’ve exposed ourselves to challenge, by serious players, who control considerable resources.

Russia and China are plagued with their own sets of problems that render their individual cases for global domination basically moot.

But history tells us that hegemonic challengers need not necessarily “win.”

We will certainly lose our status – all by ourselves, with no malign exertions from overseas – if we maintain our present heading.

“Status quo” is certainly in the entire Acela Corridor’s interest. Ask yourself why, for example, Nancy Pelosi really is so shy about impeachment.

There’s a lot of explanatory value in the simple statement, “Well, the Dow’s 27,000 and the S&P’s at 3,000.”

Daredevils keep nibbling at the dips, and the indexes keep scrambling up.

But it’s a fool’s errand, as incoming data reminds us more and more each day.

The broad financial and economic landscape is nothing near this “greatest economy ever” of presidential imagination.

Neither the ballyhooed U-3 unemployment rate at 3.7% nor the Dow at 27,300 measure sustainable success.

They’re fluky artifacts of thoroughgoing rot.

When it comes to the core fundamentals, in fact, we’ve never before seen end-of-cycle conditions this bad.

Global debt markets are busted; asset allocators are mired in a mindless-desperate-and-growth-retarding search for yield.

Equities are egregiously overvalued; they hang from a fragile skyhook, as Corporate America’s profits are flatlining, not soaring as claimed.

And Main Street – the good, old, borrowed-up American Consumer – will run out of gas.

It’s been 121 months, and “recovery” is still but a rumor when it comes to work and wages.

The Stockman Letter

Indeed, this is not the “Greatest Economy Ever.”

The Producers?Bubblevision was excited by a slight uptick in manufacturing output revealed in the Fed’s recent update on industrial production. The truth is you can’t see it at all on a chart with any meaningful timeframe to it.

When you look at the June number in its cyclical context, it’s downright punk.

In the near term, the 106.3 index reading for June was still below the sugar high of 107.5 reached in December 2018 in response to the Trumpified GOP’s credit-card-based tax cuts for business.

It’s been six months of retreat since. And the hook lower in the far right-hand panel

of the chart below looks suspiciously like the those evident before the 2008 and 2001 recessions, respectively.

More importantly, the June print was 1.6% below the level posted at the pre-crisis peak in December 2007. In fact, the 12-year growth rate across this “recovery” is -0.2% per year. That’s about as sharp a break from prior economic experience as you’ll find.

During the 1981-to-1990 Reagan Recovery, manufacturing output grew by 2.8% per year on a peak-to-peak basis. From June 1990 through February 2001, it grew by 4.5% per year. The cycle that ended in 2007 say annual gains of 2.3%.

Off the MakeIn short, a healthy economy can’t survive on Pilates studios, nursing homes, and day-

Trump Slump: ManufacturingIndustrial producon index (2012 = 100) for manufacturing, seasonally adjusted, January 1981 through September 2019

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care centers alone. It needs to make stuff, even if it specializes in product lines of comparative advantage.

But, when it rolls into recession from a base lower than the prior peak, we’re talking about serious fundamental deterioration in competitiveness.

And the way we’ve gong about things – debt-driven “growth” – we’re killing our capacity for future sustainable expansion.

Let’s take apart the components that make up the Fed’s manufacturing survey… because the story becomes even more striking.

In a world teeming with low-cost labor, the one thing the U.S. economy needs is higher investment in business equipment; that provides more tools per worker.

But production of business equipment has flatlined over the past 11 years. That too marks a sharp departure from prior expansions.

The annualized gain during the 1980s cycle was 3.6%. It surged to 6.9% on a peak-to-peak basis between June 1990 and February 2001. It “settled” to 2.6% during the 2001-to-2007 cycle.

The production index for June posted at 102.1. That’s exactly what it was in December 2007. And it’s lower than what it was in November 2014.

There has indeed been a substantial increase in business equipment imports since the pre-crisis peak. But is the U.S. economy incapable of competing in the capital-intensive production of business equipment in the global economy?

When it comes to consumer goods, of course, it’s been outright retrogression since the December 2007 pre-crisis peak. After rising nearly continuously at a 2.1% annual rate across three business cycles from 1981 through 2007, output of consumer goods production dropped by

Trump Slump: Business EquipmentIndustrial producon index (2012 = 100) for business equipment, seasonally adjusted, January 1981 through September 2019

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14% during the Great Recession. And it’s never recovered.

Output in June 2019 was still 7.2% below the pre-crisis peak, at a level first reached way back in November 1999.

We sure have seen two areas of real “expansion” on Main Street since late 2007. It’s come through increased government support in areas such as health care and education.

And there’s been a bump in energy production owing to a massive shale boom. But the cheap-debt-funded capex spree that made it possible has generated negative economic returns.

This is not organic, sustainable growth.

Nor is this the “Greatest Economy Ever.”

Part II: Xxx

Is it fair to blame the Donald alone for thinking the U.S. economy is in a real “good place,” as Jerome Powell framed it in early July 2019? Turns out he’s in all the right company.

The Acela Corridor – bereft of ideas, guided by bile, bombast, braggadocio, and bullshit – is thick with data-dependents, cherry-pickers, and know-nothing grifters. That’s not to mention a generally compliant and at useful times fawning press.

They all want to spin the data – and the data to be spun – in ways that keep them and theirs in good places.

It’s not about Main Street. It’s about Wall Street and “buy the f***ing dip.”

The Wall Street Journal, for example, reiterated the line that things really perked up this summer:

Trump Slump: Consumer GoodsIndustrial producon index (2012 = 100) for consumer goods, seasonally adjusted, January 1981 through September 2019

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Strong retail sales in June coupled with an increase in manufacturing output, set the stage for a stronger-than-expected reading for economic growth in the second quarter.

Well, if you consider 2.1% real GDP growth “strong,” perhaps…

We’ve already dissected punk data about the recovery in manufacturing output since the Global Financial Crisis/Great Recession. The June retail sales data were of similar quality. That is, “not strong.”

As David Rosenberg noted, actual June retail sales dropped by a sharp 5.1% from May. But the Commerce Department’s magical seasonal adjustment factor turned this into a 0.4% gain.

Rosie, the chief economist and strategist for Gluskin Sheff, tracked the data all the way back to 1992. He couldn’t find “anything close to a 5% decline in non-seasonally adjusted terms coincide

with a 0.4% increase in the seasonally smoothed data.”

You could call this just another case of Wall Street seeing another sow’s ear as a silk purse; no need for questions, just buy, buy, buy…

Well, here’s more on the “Greatest Economy Ever”…

Gathering Darkness

Let’s step back from the month-to-month noise.

On a year-over-year basis, the growth rate for retail sales has slowed sharply. And that – the purple line in the chart below – is only the half of it.

That dark line represents the year-over-year rate of consumer inflation as measured by the very stable 16% trimmed mean consumer price index (CPI). Alas, retail sales growth dropped below the

Trump Slump: Mining and Crude OilIndustrial produc�on index (2012 = 100) for mining and crude oil, seasonally adjusted, January 1981 through September 2019

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inflation trend in the third quarter of 2018. It’s remained there ever since.

Another way of saying it is that retail sales have been shrinking since September 2018. When that kind of thing happens this late in a recovery cycle – and, at 120 months, this particular June is the “latest” we’ve ever been – there’s usually serious trouble just ahead.

Let’s consult some history.

At the end of the 119-month expansion of the 1990s, real retail sales hit the skids quite dramatically during the 12-month run-up to the official commencement of recession in March 2001.

After peaking at 5.8% on a year-over-year basis in March 2000, the growth rate of real retail sales fell under 3.0% by July. It essentially turned negative during the final five months before the recession started.

Leading into the far more severe Great Recession, real retail sales hugged the flat-line… until they turned negative in December 2007 and then plunged deep into the red from there.

Casino BoogieWall Street is nothing more than a casino right now. It knows neither history nor fundamentals of economics and finance.

But every day is a new day thanks to the Powell Put and the Empire Hedge.

Our monetary central planners exercise awesome power over the entire global financial system, given to them by their very clients inside the Acela Corridor.

Sustaining that power depends on avoiding recession. They must also maintain a level of calm on Main Street.

So, of course, the one thing America’s debt-encumbered $21 trillion economy simply can’t stand is another stock market crash.

Ominous SalesYear-over-year change in advance real retail and food services sales, measured monthly and seasonally adjusted, March 2000 through March 2001

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That’s why what started in Ben Bernanke’s name remains firmly in place. The Powell Put, of course, is now essentially an Empire Hedge: We’re going as far as our capacity to borrow and spend will take us.

As long as the Fed and its global convoy maintain those measures, the odds of windfall gains remain high. So, it’s fundamentals be damned.

The data are not discounted honestly. They’re cherry-picked, massaged, and messaged into excuses to back up the trucks.

Virulent AgeismNow, the crucial matter of time…

This “recovery” is now in its 121st month. It’s the longest uninterrupted period of growth on record.

The unassailable reality is that this month No. 21 of a recovery is absolutely not the same thing as month No. 121. That’s

particularly true under this regime of monetary central planning. And there are inherently dangerous excesses and instabilities built up by the tail end of any cycle.

It’s always dangerous to ignore the real macroeconomic trends. But it’s sheer folly to cherry-pick the monthly noise at the end of the cycle when financial and economic fragility is at its peak.

All of that’s compounded when you embrace monthly blips amid data series that reflect fundamentally failing trends.

We saw it again with the release of June housing starts and permits data.

Not only were starts down 1% from May and 6% from a year ago. But they’ve remained impaled on a flatline for most of the past four years, at levels far, far below the pre-crisis peak.

Indeed, housing starts in June posted at 1.253 million on an annualized basis.

More Ominous SalesYear-over-year change in advance real retail and food services sales, measured monthly and seasonally adjusted, September 2006 through April 2008

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That’s the same as 30 years ago, in June 1989. At the same time, of course, the number of households in the U.S. has soared, rising from about 93 million in 1989 to 127.6 million.

That’s astounding.

None of it marks the “Greatest Economy Ever.”

Part III: Built for Bust

Many thoughts come to mind when I look at this chart showing housing starts and permits data for June. “Greatest economy ever” is not among them…

As we’ve discussed, housing starts were down 1% from May and 6% compared to June 2018.

June housing starts were 1.253 million on an annualized basis – equal to the number for June 1989. And, since 1989, the number of U.S. households has grown from 93 million to 127.6 million…

UnworkableEqually astounding is the rate of growth in the total number of labor hours employed on nonfarm payrolls by the U.S. economy.

From 1964 through December 2000, total labor hours grew consistently at about 2% per year. That’s including temporary dips amid five recessions during that 37-year span. From January 2001 forward, total labor hours have grown by 0.63% per year. That’s a third of the historic rate.

Look, this slowdown is not about lack of available hours. There’s still about 169 billion out there. That’s based on a 2,000-hour potential work year for members of the population aged 20 to 69.

Another way of looking at the problem is this: The comprehensive, hours-based unemployment rate in the U.S. is 40%.

The abrupt slowdown in labor utilization is not due to some Keynesian faltering of

Seasonally adjusted annual run rate for privately owned housing units started compared to total households, January 1990 through September 2019

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aggregate demand. Real final sales, for example, have grown by 2% per year during the 21st century.

The (many) problems are on the supply side of the domestic economy.

There’s too much debt. There’s costs, wages, and prices that are too high to compete in globalized markets. There’s excessive diversion of resources to non-productive speculation and rent-seeking. There’s the Welfare State. There’s the Warfare State.

All those things are “growing.”

But, at the end of the day, prosperity depends on productivity. And growth in productivity is a function of one of two things.

It’s about more bodies working more hours. Or it’s about more capex, better technology, and entrepreneurial innovation.

Totally UnproductiveAlas, labor productivity growth has skidded into the ditch along with most other Main Street fundamentals.

Between 1998 and 2010, labor productivity growth averaged 2.84% per year. That’s slightly above the long-term average of 2% per year from 1954 through 1997.

Like industrial production, in the aftermath of the Global Financial Crisis/Great Recession, productivity has been punk.

Productivity growth averaged just 0.74% per year from 2011 through 2018, marking an extended drought with no parallel in the last half century.

The Fed never says much about these kinds of things – not with the Tweeter-in-Chief on the case. But not ever, really, because it doesn’t fit their narrative.

The HoursSeasaonlly adjusted annual run rate of total hours of wage and salary workers on nonfarm U.S. payrolls, measured quarterly, January 1964 through April 2019

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Of course, Wall Street only reacts to Bubblevision’s inevitably upbeat interpretations of the inevitable positive month-to-month noise that comes from data series such as these. In other words, their interest is only so far as it means “buy the f***ing dip.”

This Boom’s Bust

All this macro-stagnation makes you wonder…

How have corporate profits been able to “boom,” to borrow Bubblevision’s favorite word?

In fact, they haven’t. That’s the dirtiest open secret out there.

During the first quarter of 2012, “national income” posted at $2.20 trillion on an annualized basis. During the first quarter of 2019, it was $2.18 trillion.

That’s right… seven years of nowhere. But this flatlining was felt only on Main Street, certainly not on Wall Street.

“National income” is the aggregate profits of all corporations, whether publicly traded or private. It accounts for profits whether CEOs and CFOs have been increasing or decreasing their share counts through financial engineering.

It also represents pre-tax economic profits generated without regard to accounting adjustments for accelerated depreciation, tax accruals, inventory valuation adjustments, or the Donald’s big Christmas Eve tax rate reduction of December 2017.

Now, aggregate profits for companies in the S&P 500 Index for the 12 months ended March 31, 2012, were $98.12 per share. The figure for the 12 months ended January 31, 2019, was $152.24 per share.

Long-Term SlideYear-over-year percent change in real output per hour worked in the nonfarm business sector, 1998 through 2018

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That’s based on Wall Street’s ex-items accounting flimflammery.

When it comes to plus or minus $2 trillion of corporate profits, it does make a difference whether the seven-year gain was 0.0%, per the national income accounts, or 55%, per Wall Street accounting.

Suffice to note that there was total mergers-and-acquisitions deal-value of $11.5 trillion in the U.S. between from 2012 through 2018. And, overwhelmingly, these did not involve the minnows swallowing the whales.

That massive merger was stimulated by Fed-enabled cheap debt and overvalued stocks. And it’s caused the girth of the S&P 500 to “grow” far faster than Corporate America as a whole. It’s an illusion.

That they’ve been buying back a lot of their own terrible stocks does not make this the “Greatest Economy Ever.”

Part IV: Roots of a BustEvidence of easy-money-driven stock-buying abounds.

Take the massive spree of corporate buybacks over the past seven-odd years. S&P 500 companies repurchased $3.8 trillion of their own shares from 2012 through 2018, shrinking their share count by 10% and flattering their per-share earnings accordingly.

You also have the big corporate tax cut to 21%. That move reduced the average

Profit SlideSeasaonlly adjusted annual run rate of total hours of wage and salary workers on nonfarm U.S. payrolls, measured quarterly, January 1964 through April 2019


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effective rate for the S&P 500 from about 27% to 19.8%. And it boosted reported net income by about 10%, or $15 per share.

That GOP-sponsored, Trump-signed piece of fiscal debauchery was funded on Uncle Sam’s credit card, of course. And it produced a one-time step-change in profits. There’s no recurring growth there that can be recapitalized at today’s bloated price-to-earnings ratios.

Wall Street’s ex-items flimflammery is making for wider and wider gaps from the profits reported based on Generally Accepted Accounting Principles and filed with the Securities and Exchange Commission upon penalty of jail time.

It’s about $18 per share on a trailing-12-month basis. It was $10 per share back in the first quarter of 2012. It hovered between $5 and $6 in the mid-1990s. And it was virtually $0 prior to 1990.

Those “extraordinary” “one-time” “non-recurring” items may well cause some lumpy reporting at the company level.

But they do indeed represent destruction of corporate cash, whether its severance payments for workers or writeoffs for plant closures and/or “intangibles.”

At the aggregate level, they are certainly growing at an extraordinary rate.

Corporate profits are about as “great” as most other measures of U.S. economic fundamentals.

How to Eat the Seed CornNone of it is sustainable.Tax revenues from corporate profits declined by 31% in 2018, plunging from $297 billion in 2017 to just $204 billion. That’s fine in a vacuum. I do not object to cutting the corporate tax or even abolishing it entirely.

It’s just that any revenue loss must be paid for with either spending cuts or new, more benign revenue sources.

But that didn’t happen this time around. In fact, it never happens anymore. The

The Stockman Letter

entire $93 billion plunge in collections was charged to Uncle Sam’s credit card.

It’ll generate carry costs forever and no permanent economic gains at all. Based on the surge in 2018 buybacks, it’s obvious that most of it went to share repurchases, not enhanced capex or other productive investment.

That’s the prerogative of CEOs and CFOs and corporate boards, of course.

And that’s true even if this windfall benefits the top 10%, who own 85% of the stock… even if it’s a gift from monetary central planners and fiscal elites… even if there’s no sign of rising real wealth…

Aggregate operating cash flow before research and development (R&D) expenses and capital expenditures for the S&P 500 rose from $1.86 trillion at the 2007 pre-crisis peak to $3 trillion during 2018.

That’s a 61.2% gain over the 11-year period.

But nominal U.S. gross domestic product (GDP) growth increased by just 41.8% during the same period. U.S. GDP grew from $14.45 trillion in 2007 to $20.43 trillion in 2018. Meanwhile, operating cash flow for the S&P 500 rose from 12.9% of GDP to 14.6%.

That was partly a function of the $11.5 trillion wave of consolidation via mergers and acquisitions (M&A) during the period. Corporate margins were also getting fatter due to rapidly falling carry costs.

Nevertheless, these gains did not go primarily into productive investment in the form of R&D and capex. In fact, the reflow to Wall Street in the form of buybacks, dividends, and cash-based M&A soared by 60%. It went from $1.15 trillion during the deal-making frenzy of 2007 to $1.85 trillion in 2018.


MalinvestmentAnnual real net fixed nonresidental investment, 2000 through 2018

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That $700 billion gain in the Wall Street take rate between 2007 and 2018 amounted to 11.6% of the entire $6.04 trillion gain in GDP during the period.

That’s right…

Nearly one dollar of each eight-dollar gain in U.S. GDP since 2007 has been cycled into the maws of Wall Street, where it’s fueled the greatest financial asset inflation in recorded history.

Net business investment after inflation and consumption of capital in current production has stagnated since the turn of the century. Real net capex of $493 billion in 2017 was still below its turn-of-the-century level. It’s been dead in the water for nearly two decades.

Low labor hours growth… low productivity growth… low investment growth in productive assets…

We haven’t even touched on the dual burdens on the American economy represented by the Welfare State and the Warfare State.

And then there’s Achilles Heel. That’s the $73 trillion of public and private debt held by Americans.

Nothing the Donald has done will accelerate sustainable U.S. economic growth. Most of it – Trade War, Border War, Fiscal Debauch, Ultra-Easy Money – will only decelerate it even further.

The trend real GDP growth rate has already fallen to 1.5%, and here we are, in month No. 121 of an old and weak expansion, on the brink of recession….

Do you still believe this is the “Greatest Economy Ever”?


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The Fed, Financial Witchcraft, and Concoctions of Economic ... · Rosie, the chief economist and...

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