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Three Things I Think I Think – Deep Weekend Thoughts

1) How About That Jobs Report? Wowzers. That was something else. Yesterday’s Jobs Report was huge figure after huge figure. The unemployment rate collapsed to 5.4% and the US economy added almost a million jobs. Truly great numbers across the board. I said it in my recent interview – people are pouring back into the workforce. This momentum is really picking up now and that’s only going to continue as the stimulus winds down and the demand for labor picks up into year-end.

Now, the really interesting thing about this report is the unemployment rate because that’s the figure that the Fed is really honed in on at this point. Powell has been clear that he doesn’t care about the current inflation readings. He wants to make sure that the economy is back to full potential before raising rates at all. He wants to be absolutely certain that the COVID recession is over before moving too early. I know that’s controversial, but it is what it is. In my view, the 4% range is key. As we barrel towards that level the Fed will start signaling balance sheet changes and rate hikes. That means we could be in this weird environment later this year or early next year where inflation is actually turning down, the unemployment rate is grinding lower and the Fed will start getting more concerned about future potential inflation.

2) Is The Stock Market All About Flows? Here’s an interesting paper that considers the way that flows impact stock market prices. The basic theory, which they call the Inelastic Markets Hypothesis is that most institutions operate with fixed allocations to equities, which could mean that flows into institutions can result in exacerbating the procyclical price trends in the equity market. This would potentially explain a lot of the multiple expansion in markets over the last 20-30 years during the growth of passive investing and policy expansions.

Personally, I don’t have an issue with the idea that flows matter. But I think you need to get a lot more granular than this mainly because you can get caught in the “cash on the sidelines” myth if you’re note careful. For instance, with a fixed money supply there is no “flow” because the quantity of existing assets are just being shuffled around. As buyers flow money into stocks some seller is flowing money out of stocks. So the price changes would be all about the eagerness of the buyers and sellers as opposed to being impacted by “flows”. What matters for the context of “flows” is the endogeneity of the flows. Regular readers have learned that endogenous money is an expansion of the money supply from thin air. An endogenous credit expansion can dramatically impact the demand for assets such as the expansion we saw during the 2006 housing boom. Likewise, a deflationary credit contraction can greatly reduce demand for assets. So, same basic concept here. Flows can occur in stocks when there is an endogenous expansion of money that causes a flow of new money to impact new potential demand for stocks.

To me, this is useful to understand because, from a policy perspective, it means that something like government deficits can have a huge impact on financial markets. Which makes sense since we know that the Kalecki Equation shows us that government deficits add to corporate profits. So, not only is this a consistent macroeconomic understanding of endogenous money, but it is confirmed by the accounting of corporate profits.

On the other hand, I think some people will tend to think that these “flows” mean passive investing is bad. This is not necessarily true in my opinion since the flow into passive funds is really a function of other factors and it’s the endogeneity of assets that matters most over time.

It’s an interesting paper. Worth a read.

3) The Not So Independent Fed. We saw it time and time again when Trump was in office – politicians trying to influence what is supposed to be an independent Federal Reserve. And now we’re seeing the Democrats do it. This time it’s Joe Manchin of West Virginia telling the Fed that they should wind down their balance sheet. Grrrr.

Honestly, I am not sure why politicians do this. Well, actually I know exactly why – it’s pandering to their voters and hating on the Fed is pretty much a universally popular pastime. But they really should know better than this. The Fed is specifically designed to operate as an independent entity. They’re designed to be able to swiftly operate regardless of how dysfunctional Congress is. This independence is crucial to them being able to make unbiased and objective decisions. So, here’s a reminder to Joe Manchin and other politicians – cut it out. You’re only making the Fed’s job harder by pandering to voters.

But this is even worse coming from someone like Manchin. Manchin voted in favor of all those trillion dollar stimulus packages. So it’s pretty rich to come back after printing trillions of dollars and then blaming inflation on the Fed. If Manchin read Pragcap he’d know that deficits add to net financial assets and policies like QE merely shuffle the composition of those assets around. So, Manchin is the one to blame for inflation and he doesn’t even know it….

Bonus Thing I am thinking about – Here’s my daughter going down a slide for the first time ever. I hope you are doing something this weekend that makes you this happy.