Economic growth or decline is the result of factors that are larger than any one administration or any one set of policies. Of course, specific policies such as tax changes or regulatory initiatives can help or hurt the economy depending on how they are designed, but they will generally not change the macro-momentum.
A tax increase may be a headwind for growth, but it will not stop a strong economy in its tracks. Likewise, a tax cut or extended unemployment benefits may be a boost for a weak economy, but they will not end a recession single-handedly.
Growth and recession are driven by larger events such as demographics, globalization, war, inflation, deflation and, yes, pandemic. Large changes in fiscal or monetary policy are the only policies that may or may not move the needle.
The recession that began in February 2020 most likely ended in July. There has been no official declaration to that effect from the National Bureau of Economic Research (NBER), the private but widely recognized arbiter of business cycles.
Still, given third quarter GDP estimates of 33.1% growth, it is almost certain that the recession is over. While the recession may be over, the new depression is not.
Annualized growth in the first quarter of 2020 was negative 5.0%. The second quarter produced negative 31.4%. The third quarter produced growth of positive 33.1%.
We won’t have the official numbers for fourth quarter growth until late January, but the best estimates as of now are growth of about 7%. Both the second quarter decline and the third quarter recovery were the highest annualized figures for decline and growth ever recorded in U.S. history.
Here’s the problem. While third quarter growth was impressive, it was working off a much lower base as a result of the second quarter decline. That 31.1% gain has to be applied to a base that was only about 65% of the level of 2019 output because of the declines in the first and second quarters.
That third quarter gain would put output back up to about 87% of that level and a further fourth quarter gain of 5% would take annual GDP up to 93% of the 2019 level.
That still leaves an estimated 7% decline in GDP for the full year 2020, the worst full year decline in GDP since 1946 when growth declined 11.6% due to the demobilization after World War II.
During the worst full year of the Great Depression (1932), growth fell 12.9%. The year 2020 marks an historic and traumatic decline in growth of a kind only seen in the context of depression or war.
It is a New Great Depression.
So, what’s the outlook for 2021? A new recession will occur in the first quarter of 2021. In fact, the economy is likely headed into another technical recession right now, which would present the first double-dip recession since 1980-1981 when a second recession began (July 1981) almost exactly one year after the prior recession ended (July 1980).
The reason is the imposition of new lockdown requirements by governors in most major states.
Investors may be encouraged by new all-time highs in the stock market, but the stock market indices are cap-weighted or formatted in favor of a small number of tech or digital economy companies (Amazon, Apple, Netflix, Microsoft, Facebook, Alphabet (Google) and a few others).
These companies are least affected by the pandemic and are not representative of the overall U.S. economy. Over 45% of GDP and 50% of all jobs are produced by small-and-medium sized businesses. These businesses include restaurants, bars, salons, gyms, dry cleaners, bodegas, boutique stores, small manufacturers and many others.
This is the part of the economy affected by the lockdowns. They are being destroyed. Many closings are no longer temporary but have become permanent as businesses fail, equipment is dumped at fire sale prices, job losses are not recovered, leases are broken and empty storefronts become a sign of the times.
You see this everywhere from Fifth Avenue in New York City to any small town near you.
The vaccines are being administered, but they won’t come fast enough to stop a new recession (and there are concerns about the effectiveness of the vaccines given viral mutation and doubts about how long the antibody response remains robust).
Lower unemployment rates reported in recent months are not quite the cause for cheer that Wall Street analysts make them out to be. Those rates do not include individuals who have lost jobs but have dropped out of the labor force and are not technically counted as unemployed.
This phenomenon shows up in the labor force participation rate, which is dropping sharply and is near the lowest rate since the 1970s when women started to enter the workforce in large numbers.
An able-bodied person without a job has zero productivity whether you’re technically counted as unemployed or not. This is another drag on growth and one more reason not to believe the Wall Street cheerleaders. Biden’s policies will not change this result, but they will make it slightly worse.
Biden supports the lockdowns despite scientific evidence that they don’t work to stop the spread of the virus. (Hand washing, social distancing and masks do work; lockdowns do not). Biden’s plans for immediate border reopenings will put downward pressure on wages. His plans for green regulation will raise costs for consumers and cost jobs in the energy sector. His tax increase plans will be another drag on growth.
The Biden plan will not cause the recession; it’s already here. His plans will make thing worse and possibly extend the new recession into the second quarter as well.
Monetary policy is not stimulus because the new money is going to the banks and the banks simply deposit it with the Fed as excess reserves on which they receive interest. If the money is not being loaned by banks and spent by consumers, there is no turnover or “velocity” of money.
That means deflation will be a bigger problem than inflation, at least for the next year. Deflation increases the real value of debt, which is another drag on growth. Fed policy is impotent; Jay Powell and his colleagues are out of the game and can safely be ignored.
Fiscal policy is not stimulus because the U.S. debt-to-GDP ratio is now over 130% and rising quickly. Extensive research shows that at debt-to-GDP ratios above 90%, the multiplier on new debt is less than one. This means we’re in a debt trap (in addition to a liquidity trap caused by the Fed).
We cannot print our way out of a liquidity trap. We cannot spend our way out of a debt trap. Neither fiscal nor monetary policy will produce stimulus given current conditions of low velocity, high savings rates, high debt, high unemployment and new lockdowns.
The Fed and the Congress may try to stimulate the economy, but they will fail.
The path for investors is clear. Equity exposure should be reduced because the gap between market perception and economic reality will close quickly once the new recession becomes apparent. Cash allocations should be increased to reduce overall portfolio volatility and to give investors flexibility and optionality once some of the political and economic uncertainty begins to clear.
Allocations to gold, silver and mining shares should be at least 10% of investor portfolios both as an inflation hedge and a hedge against declining confidence in central bank currencies.
for The Daily Reckoning