by Chris Hamilton
Private investment makes up just under 17% of US GDP, government consumption about the same, and the remainder of GDP is private consumption (mostly services…detailed HERE). But it is the year over year change in private investment (yellow line in the chart below) that seems to offer the greatest insight into the economic health of the nation. It turns out that private investment mirrors federal debt creation with about a twelve to eighteen month lag time (red arrows showing peak YoY federal debt creation…yellow arrows showing subsequent peak YoY private investment growth).
Simply put, during each economic slowdown, the Fed lowers rates and the Treasury pumps out the deficit spending. This flow of new money creates demand but also new capacity. As the flow of deficit spending decelerates after the “crisis”, demand likewise slows but the existing and the new capacity remains. This means decelerating demand for private institutions, while the cost of new debt is rising, the cost of rolling over record quantities of existing debt is rising, and the quantity of new deficit spending projects and activities is decelerating (not exactly a recipe for growth). So, this time is really no different. Record quantities of federal debt creation spurred private investment post ’09 (still with about a years lag)…and vice versa now with decelerating debt creation. Based on this, in the coming quarters, a deceleration and outright decline in private investment is an odds on event.
If we focus solely on year over year change in private investment, same for federal debt creation, plus the federal funds rate…every period of rate hikes since ’81 has coincided with decelerating federal debt creation…and resulted in a decline in private investment which concluded with a recession. The chart below highlights the same circumstances that led to the ’91, ’01, and ’08 recessions is again presently underway in ’18. Absent a reversal in deficit spending or a u-turn on the FFR…is there any reason to believe the result be different this time?
Finally, the chart below offers some perspective where we are in this cycle. Household net worth as a % of disposable income has clearly exceeded any previous period (asset prices rising far in advance of income to support them). Federal debt creation (YoY on a quarterly basis) has decelerated by almost 75% from the ’09 peak. However, during each downturn, yoy debt creation has doubled or tripled from the previous cycle (something to ponder as the next downturn is on the horizon). The federal funds rate is rising but at a snails pace and not likely rising for much longer.
This particular set of circumstances has been a losing play every time since ’81 and each rise and fall in household net worth as a percentage of disposable income has been greater than the last. A 30% to 50% fall in net worth appears the most likely outcome (particularly with the Fed’s inability to lower rates significantly from current levels in response to this likely slowdown).
Just two big questions remain. Will the Federal Reserve allow this outcome? Can the Federal Reserve stop this outcome?
My two cents on much of what has brought us to this point…domesticallyHERE…and globally HERE or HERE.
by Chris Hamilton