Economic

Chatter About Stock BuyBacks

Posted on by j.giglio

Before the 1980s, corporations rarely repurchased shares of their own stock.  But this year alone S&P 500 firms are buying back stock at double the pace of last year.  It is forecast that there will be at least $1 trillion in completed corporate stock buybacks by the end of the year.

All this despite a 1 percent tax included in the Inflation Reduction Act that went into effect on January 1 that is designed to slow stock buybacks.  Corporations that are awarded a piece of the $39 billion in grant money under the CHIPS and Science Act may also be barred from doing corporate stock buybacks.

Now the White House wants to further increase taxes on stock buybacks.  In his recent State of the Union address, President Biden said the tax should be much higher.  “Corporations ought to do the right thing.  That’s why I propose we quadruple the tax on corporate stock buybacks and encourage long-term investments.  They will still make considerable profit.”

That comment may have led the Oracle of Omaha, Warren Buffet, to weigh in on the hot button issue in the Berkshire Hathaway CEO’s annual letter to investors touting the benefits of repurchases: “When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).”

Still, Buffet included a caveat: he says buybacks make sense only if they are made at “value accretive prices,” i.e. when corporation don’t overpay.

Taking a step back, corporations have a number of ways to allocate capital:

  1. Make capital investments designed to grow their businesses. For example, buying new machinery or pouring more resources into research and product development;
  2. Acquire or merge with another company or business unit that the corporation believes could help grow its core business;
  3. Pay regular cash dividends to shareholders that tend to be more reliable than stock buybacks, an actual real return of cash to investors; and
  4. Use the money to repurchase their shares—a stock buyback automatically increases earning per share and has a stronger short-term impact with little, if any, tax consequences for shareholders.

As with many things in finance, the answer to whether stock buybacks are good for investors is “it depends.”

If a corporation sees its shares as undervalued and is flush with cash, a buyback could be a way to generate shareholder value.  A share buyback reduces the number of the corporation’s outstanding shares in the stock market and, theoretically, its share price should rise. Shareholders will own a bigger portion of the corporation and therefore a bigger portion of its earnings.

In theory, a corporation will pursue stock buybacks because they offer the best potential return for shareholders with relatively lower risk than other options for allocating capital.  When a corporation announces a stock buyback, it makes sense to ask if the firm believes its stock is cheap, or if there are other factors at play, such as senior management lining their own pockets in the case of a compensation incentive for executives based on stock price.

Also, investors are concerned if the stock buybacks are financed with debt, unlike dividends that are typically paid for out of cash flow, which makes the corporation’s balance sheet less resilient. Of course, it is a good sign if senior management is also buying company stock for themselves.

The tricky part in considering corporate stock buybacks is making sure senior executives are focused on sustainable long-term growth opportunities rather than increasing stock prices and engaging in share price manipulation while prioritizing the short-term.

Inflating Away the National Debt

Posted on by j.giglio

Once again, the federal debt is big news, as lawmakers grapple with bumping up against the U.S. debt ceiling. The government has reached its borrowing limit, and House Republicans claim they will not vote to raise the debt ceiling and allow further borrowing without real spending cuts, not reductions in planned increases.

High government debt is a significant problem.  The higher the debt to GDP ratio, the harder it may be for a government to borrow by issuing bonds, and investors will demand a higher interest rate for what they view as a risky investment.

It’s also a political hot potato, but quick fixes come with big downsides.  Slow and steady may be the best solution.

The federal debt held by the public as a share of gross domestic product increased to 98 percent in fiscal 2022. For governments this metric is comparable to the debt-to-income ratio a lender usually wants to know before approving a loan. Think of GDP as the nation’s income.

It is also a key metric investor use to measure just how creditworthy a country is.  When the debt-to-GDP ratio is high, investors begin to question government’s ability to pay back the debt and start demanding higher interest rates.

The Congressional Budget Office forecasts that the federal debt will increase to 185 percent of GDP by 2052.  Spendthrifts have been ramping up deficit spending for a crazy long time – U.S. debt has increased more rapidly than national income for more than half a century.  To be sure, monetary policy has contributed to the debt; providing cheap credit by keeping interest rates artificially low for more than a decade.

Federal government debt increased by $2.5 trillion in the fiscal year that ended on September 30, 2022, from $28,429 trillion to $30,929 trillion.  Since the new millennium, the debt has increased from almost $6 trillion to nearly $31 trillion.

Governments have four tools to retire debt.  One is to generate higher economic growth by focusing on GDP.  Growth increases nominal GDP, driving down the debt to GDP ratio over time and reducing the risk of a debt crisis.

Another option is to reduce deficits by cutting government spending.  This is politically unpopular in the best of times and therefore unpalatable to politicians.  Taking away something the body politic regards as a “right” or an “entitlement” can be a career ender.

Raising taxes is somewhat less unappealing, especially on those the electorate views as “rich.”  The risk here is that raising taxes may reduce the incentive to work, causing tax revenue to fall, which would force government to borrow more and thereby exacerbate the debt problem.

One other option remains: inflating your way out of debt and debasing the currency through inflation.  High inflation reduces the real value of the debt, allowing government to pay it off with money that is worth less than when they originally borrowed it. As prices go up, so does GDP.  It’s a bit like a snake eating its own tail.

Inflation makes old debt easier to pay off, but it also makes new debt more expensive. That means higher inflation can lead to spiraling hyperinflation. Trying to inflate debt away is dicey; it is by no means a silver bullet.

But compared to the other options, such as getting spending under control, slow, chronic inflation as embodied by the Federal Reserve’s 2 percent annual goal may be the most politically palatable way to reduce the debt.

If all goes well, such an approach might produce the much ballyhooed “soft landing,” or getting inflation under control without triggering a recession.

FTX Collapse Another Regulatory Failure

Posted on by j.giglio

Disgraced crypto tycoon Sam Bankman-Fried (SBF), a young man with Promethean ambitions, has been arrested for his role in the collapse of FTX, the virtual trading app he founded.  Prosecutors allege that he orchestrated “one of the biggest financial frauds in U.S. history,” using customers’ money to pay the expenses and debts of his hedge fund, Alameda Research.

The episode again raises troubling questions about the effectiveness of government regulators and the lack of regulatory oversight, despite many promises to bring crypto under their regulatory purview and avoid financial fraud.

Americans have gotten used to financial chicanery. They witnessed Bernie Madoff, who ran a multi-billion-dollar Ponzi scheme that wiped out the life savings of thousands of investors. Then there was the 2008 financial meltdown that cost millions of Americans their jobs, homes, life savings, and hopes for decent retirements. Many Americans never recovered from this cataclysm.

A grand jury in the Southern District of New York indicted Bankman-Fried on eight counts, including securities fraud, money laundering, and making illegal political contributions.  In total, the 30-year-old faces a combined maximum sentence of 115 years.

Following extradition from the Bahamas and his release on a record breaking $250 million bail bond, he has holed up at his parents’ $4 million Palo Alto home with an electronic monitoring bracelet while he awaits trial.

Bankman-Fried is also facing a civil case brought by the SEC, and possible civil actions by the Commodity Futures Trading Commission (CFTC) and state banking and securities regulators.

The house of cards collapsed when FTX filed for bankruptcy protection on November 11 with a reported $32 billion in debt. At the heart of the scandal lies a system for defrauding investors. Billions of dollars in customer assets have vanished, used to plug losses at Alameda Research, finance SBF’s lavish lifestyle, massive political contributions and bankroll his speculative’ investments.

FTX was a platform that let users buy and trade crypto currencies, such as bitcoin. The firm also minted its own digital currency called FTT and was big on environmental, social, and governance investments. SBF was a leading proponent of so-called “effective altruism,” a theory that advocates using “evidence and reason” to do societal good. He told the media he planned to give most of his wealth away to make the world a better place.

SBF donated almost $40 million to political candidates and political action committees in the 2022 congressional midterm elections. He was the second-largest individual donor to Democrats, trailing only billionaire businessman George Soros in the 2022 election cycle.

Prosecutors said one reason he made those contributions was to influence policies and laws affecting the cryptocurrency industry. There may not be a criminal trial until late 2023, legal experts say, because the government will need to build an extraordinary case.

Legions of criminal and civil defense attorneys will make bank by the time the dust settles.  Case in point, angry investors have already filed class action suits against prominent endorsers such as Tom Brady, Larry David, Steph Curry and Naomi Osaka, who all received equity in the company for failing to do due diligence before marketing FTX to the public.

The firm’s blue-chip investors included Sequoia Capital, Black Rock Third Point LLC, Tiger Global Management, the Ontario Teachers’ Pension Plan, SoftBank Group Corp. and Singapore’s investment company, Temasek Holdings.

Can there be any wonder why public trust is on the wane? The plain truth is that regulators exist to protect the interests of the regulated. Surely another special counsel is needed.

Closely related, American should be asking questions of politicians in Washington who sit on key financial oversight committees that were beneficiaries of SBF’s generosity. But that may be wishful thinking. Insulated from oversight and accountability, they will not be performing surgery on themselves anytime soon.

All of which brings to mind Honore de Balzac’s insight that “Behind every great fortune, there is a crime.”

Is the Fed Changing Course on Interest Rates?

Posted on by j.giglio

There is a sliver of good news on the economy: inflation may be moderating.  For October, the consumer price index (CPI), a key inflation barometer, came in below expectations.  Though up 7.7 percent from a year ago, it’s the smallest increase since January.

But members of the Federal Reserve (the Fed) would be wise not to repeat their earlier mistakes by reading to much into a single month of cooling numbers.

You don’t have to be a professional economist to know that inflation is insidious for working Americans, as it erodes purchasing power.  For example, in 1970, the average cup of coffee cost 25 cents, by 2019 it had climbed to $1.59.  That’s inflation and it refers to price increases across the entire economy.

For decades, central bankers led by the Fed have flatlined interest rates and created money out of thin air, first in response to financial emergencies and then to the coronavirus pandemic. What were once emergency measures became totally normal, certainly since 2008. In simple terms, over the first two decades of the 21st century, the Fed engaged in a long love affair with ultra-low interest rates and printing money.

Easy money after the global financial crisis in 2008 produced several ill effects, including the creation of multiple asset price bubbles.  As one market analyst put it, “Never in the field of monetary policy was so much gained by so few at the expense of so many”.

But now Fed officials are walking back Fed Chair Jerome Powell’s hawkish comments in his briefing that followed the November Federal Open Market Committee (FOMC) meeting.  The Fed chair emphasized that it’s “premature” to discuss a pause in rate increases. He said the goal was to get inflation back to 2 percent, as the Fed announced an unprecedented fourth consecutive three-quarter interest rate increase, taking the central bank’s benchmark funds rate to a range of 3.75 to 4 percent.

This is the highest funds rate level since early 2008 and represents the fastest pace of policy tightening since the early 1980s, as the central bank tries to slow consumer and business demand and give supply a chance to catch up.

But multiple members of the Fed are now saying it looks like time to slow the pace of interest rate increases.  For example, the president of the Philadelphia Fed recently said the central bank should “pause when it makes sense”. Then the president of the Boston Fed said: “the risk of overtightening has increased”.

And the vice chair of the Fed says “soon” it would be appropriate to move to a slower pace on rate hikes.  The FOMC gets to see one more CPI report before its next meeting on December 13-14 to decide if it is time to pull back on the level of interest rate hikes.

These dovish comments are coming from the same grand poohbahs who 18 months ago claimed inflation was transitory as they sat on the sidelines and waited for it to abate.  They ignored the alarm bells and missed a crisis in formation.

Then, when inflation got out of control, the Fed finally tightened monetary policy. It was just a year and a half too late doing so.  As history has shown, printing too much money causes inflation.

Still, Fed officials convinced themselves that inflation was a thing of the past. The threat of inflation has faded from public memory. All this was before Russia invaded Ukraine.

The takeaway from all this is that the Fed will likely dial down the pace of interest rate hikes to a 0.5 percentage point increase in December after the recent encouraging signs that October inflation cooled more than expected. If this is the case, then it raises the question of whether the Fed has the minerals to stay the course and crush inflation.

OPEC+ decision to cut oil production will impact gas prices

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Earlier this month, the 23-member oil-cartel known as OPEC+ (Organization of the Petroleum Exporting Countries), of which Russia is a member and led by Saudi Arabia, announced it would slash production by 2 million barrels per day.  The production cut is equal to 2% of the world’s daily oil production.  The cut was seen as a slap in the face to President Biden.  The move by OPEC+ drew angry criticism from Washington and the White House accused the Kingdom of taking sides with Russia.

In response the Biden Administration said it plans to re-evaluate the U.S.’s eight-decade old alliance with Saudi Arabia. It is hard to forget that during the Presidential campaign in 2020, the president’s money quote was he promised to make Saudi Arabia a “pariah” state.  He said there is “very little social redeeming value in the present government in Saudi Arabia.” He has criticized the Crown Prince for his role in the killing of Washington Post journalist and political opponent Jamal Khashoggi.  All this while courting Iran, an arch enemy of Saudi Arabia, in the hopes of striking a nuclear deal that would give Tehran billions of dollars to threaten the security of Gulf States.

Still for months the leader of the free world lobbied Saudi Arabia to help ease energy prices by pumping more oil into the market.  These pleas fell on deaf ears. The Administration urged the Saudis to wait for the next meeting of OPEC+ on Dec. 4 before making a decision on production cuts.  The Administration wants to hold down gas prices to advance the Democrats’ chances in the midterm congressional elections. Now the administration has announced it will sell 15 million more barrels of petroleum from the nation’s strategic reserve, aiming to ease gas prices.  The White House said it was prepared for more sales of the $400 million barrels in the strategic petroleum reserve if there are further disruptions in the world markets.

Not only that but the White House is starting to relax some of the sanctions on the authoritarian government in Venezuela which sits atop some of the world’s largest oil reserves to allow Chevron to resume pumping oil and exporting oil to the U.S.  There is an ominous sound of barrel scraping here.

Congressmen from both parties called for retribution against the cartel as well.  Some called for taking direct action against Saudi Arabia such as denying it access to military hardware and passing legislation allowing OPEC+ members to be sued under antitrust laws.

The Saudi’s rejected the accusation that it was getting in bed with Russia. They stated that the decision to cut output was driven purely by economic considerations and in response to future uncertainty about demand for oil.   OPEC+ was doing what it usually does.  They want to regulate the flow of crude oil to world markets in an effort to control prices. That is what the cartel is all about, full stop.. They are seeking to protect their national economic interests as has always been the case. The Saudi’s need money to provide for a decarbonized future and to fund its on-off war in Yemen.

The irony here is that according to the U.S. Energy Information Administration in September 2019, the U.S.  became a net exporter of crude oil and petroleum products for the first time since 1973.  In 2022, the U.S. will again be a net oil importer.  The Administration’s policy has been to ween the American economy off fossil fuels in favor of clean energy.  Quite apart from bans on fracking, bans on drilling, the President’s first act in 2021 was to scrap the cross-border permit for Canada’s XL pipeline which was projected to carry 900,000 barrels of crude oil a day into the U.S.

Events like the coronavirus and the tragic war in Ukraine should have revealed the dangers of being dependent on unreliable regimes and geopolitical adversaries.  These choices have left the U.S. in  an untenable, vulnerable place.

Insider Trading in Congress

Posted on by j.giglio

A New York Times analysis found that between 2019 and 2021, 97 senators and representatives or their family members bought or sold stocks or other financial assets in industries that could be affected by their legislative committee work, violating a law designed to prevent insider trading and stop conflicts of interest.

Over the three -year period, more than 3,700 trades posed potential conflicts between lawmakers’ public responsibilities and private finances.

For example, 15 lawmakers tasked with shaping US defense policy actively invested in military contractors.  Still further, Senators, House members, and top Capitol Hill staffers who will help decide whether the government regulates cryptocurrency are themselves invested in bitcoins and altcoins.

All this while ordinary Americans are losing their shirts, if not their entire wardrobes, dealing with the pandemic and the rising cost of living while lawmakers ae making hay.  Sure, consumers may be getting some relief at the gas pump, but they are having to dig even deeper to pay for groceries.

The price of eggs is up about 40 percent since this time last year.  They are paying 20 percent more for milk, bread, and a staple in many Americans’ diet—chicken. Many of these working-class individuals risked their lives on the frontline of the COVID-19 crisis to stock grocery shelves, work in hospitals, or deliver food to homes, among other things.

To prevent members of Congress from taking advantage of their positions for personal gain, the U.S. passed the Stop Trading on Congressional Knowledge Act, known as the STOCK Act, signed into law in April 2012, an election year.  At a highly visible signing ceremony, it was said that the legislation would address the “deficit of trust” that divides Washington and the rest of America.

The STOCK Act prohibits members of Congress and senior executive and legislative branch officials from trading based on knowledge obtained as a result of their jobs. It increased transparency by beefing up financial disclosure requirements on stock trades and posting the annual financial disclosure forms federal officials file on a publicly available online database.  A key provision of the law mandates that lawmakers publicly and quickly disclose any stock trades made by themselves, a spouse, or a dependent child.

But transparency only works if people abide by the rules.  Congress and top senior Capitol Hill staff have violated the STOCK Act hundreds of times, but they face minimal penalties that are inconsistently applied and not recorded publicly.  If they file their disclosure more than 30 days after it’s due, they have to pay a fee this being the U.S. Congress of no more than $200.  And Congress has the discretion to waive the fines stipulated in the law.

Is it any wonder that the average American does not understand why elected officials do not play by the same rules as everyone else?  The hard truth is that the American people simply do not trust the federal government.  Only two-in-ten Americans trust leaders in Washington to do what is right, according to the Pew Research Center.

There are a variety of rare bipartisan proposals floating around the House and the Senate to tighten the rules on stock trading, and key details still need to be ironed out.  The only way lawmakers can earn back trust is to hold themselves to a higher standard, starting with an outright ban on the trading of stocks and other financial assets such as cryptocurrencies by members of Congress, their immediate family members and senior congressional staff.

Members of Congress should spend their time working for the American people. But persuading them to start putting the public ahead of their personal financial interests is like asking them to perform surgery on themselves.  And you can take that to the bank.

Russian ruble rebounds as Russia and China work hard at de-dollarization

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“Russia’s ruble is reduced to rubble. Their economy will be cut to half. The ruble is crumbling now,” President Biden said during a speech on March 26 while visiting Poland, a country that has been taking in refugees from neighboring Ukraine.

The value of the Russian ruble tumbled 30 percent after the U.S. and its allies, including most of the European Union, Canada, Japan, Australia and almost all other major Western economies imposed sanctions in response to the Russian invasion of Ukraine. But the ruble has bounced back, almost doubling in value from its low point on March 7.

The recent gains mean the currency is now back to its level before broad based, hellish sanctions on the Russian government and its oligarchs were imposed, continuing its streak as the best performing currency in the world this year.  This strong performance once again demonstrates the body politic in the U.S. has become like the other woman, wanting to believe the promises all too many politicians make about the future.  They never change.

Russian energy exports drive ruble rebound

Why has the Russian ruble made large gains in spite of the sanctions?  Reasons for that rebound include, surging energy prices, support from the Russian government putting huge capital controls in place to stabilize the ruble and the Russian Central Bank raised interest rates by as much as 20 percent.

Additionally, Russia required the European Union and other nations guzzling Russian oil and gas, to pay for the energy commodities in rubles since the U.S. and Europe weaponized the dollar denominated financial system.  In effect, Russia has weaponized its energy in response to Western sanctions.  Given super high energy prices, Bloomberg Economics estimates that Russia’s energy exports will increase this year by one-third to $321 billion.

Still further it is hard to ignore the lifeline other nations such as China, India, Brazil, South Africa, NATO member Turkey and others have tossed Russia by purchasing its oil and gas in rubles. Also, Riyadh is in discussions with Beijing to sell its oil to China for yuan in lieu of dollars.   These purchases have given Russia a current account surplus—exporting more than it imports, stabilizing the ruble.

The decision to link oil and gas and other raw materials to the ruble threatens the hegemonic order of the U.S. dollar.  In effect, Russia, the eleventh largest economy in the world by nominal Gross Domestic Product, has accelerated its de-dollarization.  For the last several years, China and Russia have sought to reduce their use of the dollar in an effort to shield their economy from existing and potential future U.S. and other Western nations sanctions and assert global economic leadership.

Dollar dominates global economy, for now

The U.S. government has acknowledged that it can’t stop these purchases because there are no secondary sanctions on countries doing business with Russia.

The U.S. can use sanctions as a weapon and compel allies to go along with it or else because the U.S. dollar is the world’s reserve currency.  For nearly 80 years the dollar has dominated the global economy because it is needed to conduct global trade.  The U.S. dollar controls about four-fifths of all currency operations in the world. It is hard to imagine things being done in a different way.

The U.S. accumulated about two-thirds of the world’s gold reserves at the end of World War II. This was the basis for the Bretton Woods system of monetary management that ensured the U.S. dollar hegemony in the western world for many years.

China and Russia have tried for some time to de-dollarize in trade and investment with limited success but if their de-dollarization efforts gain traction there could be major implications for the U.S. economy, U.S. sanctions, and U.S. global economic leadership.

Revisiting the 2008 Financial Meltdown

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This month marks 14 years since the 2008 global financial crisis. The demise of the investment bank Lehman Brothers on September 15th sparked an economic downturn that was felt throughout the world.

The crash led to the worst recession since the Great Depression. It illuminated the dangerous corporate culture that had existed in banking for many years, explaining something as tangled and multi-dimensional as the 2008 financial crisis is fraught with difficulty.

The meltdown was one of the most critical events in American history, and its aftermath saw plenty of hardship. It wiped out some $11 trillion of the nation’s wealth and destroyed more than eight million American jobs by September 2009. It froze up the nation’s vast financial credit system, leaving thousands of firms too short of cash to operate.

It also forced the federal government to spend $2.8 trillion and commit another $8.2 trillion in taxpayer funds to bailing out crippled corporations such as General Motors, Chrysler, Citigroup, Bank of America, AIG, and a host of other “too-big-to-fail” companies run by corporate panjandrums.

It cost millions of Americans their jobs, homes, life savings, and hopes for decent retirements. This was a cataclysm far worse than any natural disaster in the nation’s experience.

The lack of accountability for the banks and other bad actors helped spur social movements from the left (Occupy Wall Street) and the right (the Tea Party), the heirs of which have made themselves heard during elections dating back to 2016. It appeared to many that there were two sets of rules: one for ordinary Americans and another for the rich and well connected.

After the financial crisis, there was no shortage of wannabe Cassandras who supposedly had been warning about this for years. They wrote about “casino capitalism” and “corporate greed” without saying a word about the quite specific causes of this very specific crisis. They have been vindicated only in the way a horoscope might occasionally come true.

In November 2008, just two months after the Lehman Brothers bankruptcy and the Western economy’s descent into the abyss, the Queen of England asked a roomful of academics at the London School of Economics a disarming question: Why had they not seen it coming? They were all caught off guard.

In the years following, many economists and academics have attempted to answer her question, but few have come up with more than citing immediate causes, such as high leverage and a strong appetite for risk and failed to identify the deeper causes.

The Queen’s question resonated with ordinary people, who were baffled at why politicians, bankers, and academics all failed to spot the financial storm on the horizon.

The Financial Crisis Inquiry Commission created by Congress in May 2009 is often cited as the definitive source for information about the causes of the 2008 crisis. The commission was tasked with restoring trust in the banking sector by bringing to light the misdeeds and malfeasance that caused the Great Recession.

But the bipartisan 10-member commission could not agree on the underlying causes of the financial crisis. Instead, it completed its forensic work and produced three conflicting reports in January 2011.

All the members basically agreed on the facts, but disagreements arose over interpretation. For sure, no single narrative or satisfying theory to explain the cause of the financial meltdown emerges from the mother lode of factual information surrounding the crisis, but the variety of conclusions is informative.

It may be decades before anything approaching real perspective about the crisis can be achieved. The situation is similar to the story in the Japanese film “Rashomon,” where different witnesses give conflicting accounts of a crime.

One lesson to be learned is that what can’t be easily understood can’t be easily controlled. So, the question may be when, not whether it will occur again.

The Consequences of Interest Costs on U.S. Debt

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Over the next 30 years, the fastest growing category of government spending is projected to be interest on the national debt.  That means the government will be shelling out hundreds of billions of additional dollars each year for interest payments.

The growth in interest costs presents a huge threat to the economy and to Americans’ economic future.  The long-term societal effects will be massive; it will be a painful reckoning when the bill comes due.

According to the Congressional Budget Office’s (CBO’s) 2022 Long-Term Budget Outlook, the cost of interest on the national debt will surpass defense spending in 2029; Medicaid, Medicare and Child Health Insurance in 2046; and Social Security in 2048.

The CBO projected that annual interest costs paid to holders of Treasury securities would total $399 billion in 2022 and nearly triple over the coming decade to $1.2 trillion, growing from 1.6 percent of gross domestic product (GDP) to 3.3 percent in 2032, which would be the highest level ever.

If the Federal Reserve raises interest rates by larger amounts than the CBO has projected, costs may rise even faster than anticipated.  Still further, interest costs are on track to become the federal government’s single largest expenditure in 2054.  By then, interest costs will account for almost 40 percent of tax revenue and become the largest federal expenditure.

Rising interest payments are the result of escalating interest rates and debt levels that have risen like the blade of a hockey stick.  Treasury yields have surged with inflation running hot and the Federal Reserve in an aggressive tightening mode, while the national debt has grown by some $6 trillion since the pandemic began.  Pandemic-driven fiscal and monetary policies changed the debt situation considerably and for the worse.

The latest data show inflation at an 8.5 percent annual rate.  It is reasonable to expect the Fed to keep tightening over a sustained period, trying to reduce aggregate demand, relieve pressure on consumer prices and produce a hoped-for soft landing.  In 2017, the national debt was $20 trillion; now it is approaching $30 trillion.  Ten-year Treasury yields have climbed close to 3 percent, double what they were last December.

Increasing debt and high interest rates can crowd out important federal budget priorities and lead to a vicious cycle of even more debt, deficits, and interest payments.  This means the government will be paying hundreds of billions dollars more each year on interest payments on top of other fixed costs that are also growing, such as health and retirement provisions for an aging population.  This enhances the risk of a fiscal crisis.

As for those who hold on to the hope that folks in Washington will develop a long-term strategy to deal with the debt pile and deficits, it is likely time to label that as wishful thinking.

Congresses and presidents of both parties have long avoided making hard choices about the federal budget and failed to put it on a sustainable path.

In line with time-honored tradition, they prefer to just pop into the national arboretum of magical money trees and grab what they want.  The phrase “often wrong, but never in doubt” is only a slight exaggeration when it comes to their behavior.  The present commands their attention.  The few lawmakers raising issues about the debt, deficits, and rising interest costs are an endangered species.

Of course, crises can provide the necessary cover to make tough, hard decisions. As Stanford Professor Paul Romer said in 2004, a crisis is a terrible thing to waste – a sentiment later echoed by former White House Chief of Staff Rahm Emanuel.  Let’s hope the U.S. doesn’t waste this one.

The Shrinking Labor Force

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The country is in a fragile state – burnt out from three years of pandemic; social upheaval; the war in Europe; and an economy that is cooling under the weight of high inflation, rising interest rates and the scarcity of labor.  The U.S. may have reached the point where its past is more appealing than its present.

So when good news comes along, you might as well seize it. This could apply to a recent announcement by the Bureau of Labor Statistics that the economy added a seasonally adjusted 372,000 jobs in June, well above the 250,000 economists expected.

But this sliver of good news must be set against the continuing cost of living crisis, or “Bidenflation,” as some call it, which is impoverishing working Americans.  The consumer price index rose 9.1 percent in June on a year over year basis, the worst inflation since December 1981.  It is unclear how the Federal Reserve will put the inflation genie back in the bottle without a creating a whole lot of pain.

Education and health services led job creation, followed by professional and business services, and leisure and hospitality. Meanwhile, the unemployment rate remained at 3.6 percent, a touch above the 50-year low reached before the pandemic hit in early 2020. Job growth continues, although fewer people are looking for work.

The Covid-19 pandemic turned the labor market upside down, and it is currently drum tight.  There were more than 11 million job openings at the end of June – up substantially from 9.3 million open jobs in April 2021 and seven million prior to the pandemic.

The pandemic led many people to reevaluate what they want from a job and from life, and it prompted a wave of early retirements.  Others left to start their own businesses.  Still others left to care for children, elders or themselves.  Some people simply threw in the towel and decided to stay at home, courtesy of the taxpayers.

The demand for workers far exceeds the number of unemployed people looking for work.  The labor participation rate – the share of adults working or looking for a job – was 62.2 percent in June, down from 63.4 percent before Covid.

Workers are taking advantage of the tight labor market by switching jobs for better pay, which represents a new source of inflation for many American companies.

Average hourly earning rose 5.1 percent over the last year.  Rising wages could make it harder for the Federal Reserve to tame inflation.  Nearly 79 percent of American workers are in the service sector, where higher labor costs are a large burden.

In addition to a shrinking labor force driving up wages, a steady decline in birth rates is expected in the U.S. and many advanced economies, which will sharply reduce the growth of the labor force.

For example, life expectancy in the U.S. has increased from 1980-2019 and improvements in morbidity and mortality rates will lead to a rapid increase in the number of people who are over 65 and retired.  As a result, dependency ratios – the ratio of the number of dependents to the total working age population – are set to rise sharply.

Put simply, deteriorating U.S. dependency ratios in the U.S. and globally means dependents who consume but do not produce will outweigh those who are working.  In effect, too few people carrying the load.

This translates to lower productivity per capita, an ever-intensifying war for talent and skills, and upward pressure on inflation.

As the supply of labor contracts, their bargaining power will increase and wages will continue to rise.  The growing leverage of labor may have beneficial effects on inequality, but it may manifest an increasing risk of structural inflation.