Keep Calm and Carry On

November 10, 2020
Keep Calm and Carry On

After a week of uncertainty, Joe Biden has become the president-elect. While we still don’t know which party will control the Senate, many believe the Republicans will prevail in at least one of the January 2021 runoff elections in Georgia. At this time, my outlook for the U.S. economy will assume these results will stand.

Some suggest that with Republicans controlling the Senate, changes from politicians will be limited due to “gridlock.” As Biden’s team introduces desired changes to programs, and as they express the desire to launch new programs, it’s believed Republicans will act as a “stopper” in the Senate. I’m not so sure. Remember that the Republicans’ control of the Senate would only be by a few seats. Will a majority be enough to stifle all of Biden’s spending plans? I doubt it. Eventually, liberal public support will become very vocal if long-held desired Democratic changes are all stopped. 

While I have few doubts the more extreme, big-ticket desires may indeed be held in check, there will be changes. That is what a new president is all about. Particularly one who enjoys strong press corps support, such as Biden.      

We know what Biden has been talking of during the campaign. But what changes may be politically possible to enact? I don’t know, neither does anyone else. Are we going to see tax increases? Perhaps, but more than likely at a more limited rate than those expressed during the election. Are we going to see major new programs launched? I think so. Remember that Biden has had a good record of working with Mitch McConnell. Historically, the two have been able to compromise.  

I suggest we may eventually expect to see the following desired changes announced over the first few months following the presidential inauguration:

  • Washington should announce a new, fairly large “rescue” package. Multi-trillion in size, the package would probably address, not only aid to the unemployed and troubled service-based companies, but would also offer aid to local and state municipalities. The funding of the extremely large package might occur through the bond purchase program of the Federal Reserve.
  • But perhaps the initial focus for the Biden administration will be his response to the COVID-19 virus. We have seen a recent reacceleration in infection rates, and if these rates continue, I suspect the first action items (along with the aid package mentioned above) will focus on Cabinet appointments and a national response to the virus problem. 


Longer term, we should expect a new focus on:

  • Some form of the “green initiative.” I believe renewable energy investments should receive Washington aid. This raises the question of the sustainability of U.S.-based carbon (oil and gas) production. 
  • Eventually the Biden administration may likely attempt to build on the Affordable Care Act. The long-held desire to move the health system to a single-payer structure could come forward.


Of course, there will be other issues that will be addressed by the Biden administration over the first 100 days of his term. 

We will see how all of this sorts out. I think we’ll see a more active level of government involvement in many areas of business and our lives. Many will welcome these changes, many won’t.  But I believe changes are in the air.

2020 – An Economically Radical Year

To understand the outlook for 2021, we need to study some detail as to the radical changes our economy experienced in 2020. This year will go down in the history books as an economically radical year – a year when growth rates collapsed and then soared due to the ravages of the COVID-19 virus. 

The long-anticipated third quarter GDP report is now in the books, or at least the advance report has been registered. Following the second quarter Coronavirus-inspired economic meltdown, most were anticipating a strong rebound during the third quarter, a period when the nation’s economy was reopening following the earlier shutdown.

According to the Bureau of Economic Analysis, the nation’s GDP rose by an annualized 33.1% during the third quarter, which followed the 31.4% contraction in the second quarter. To put these numbers in perspective, our national economy has grown by around 3% per year, on average, for decades. But nonetheless, the numbers are the numbers. The information in the chart provided by Yardeni Research shows historical GDP changes. Note how radical the last two quarter’s changes have been.

Below is data which breaks down the two extreme GDP reports by economic segment (all data is quarterly change, on an annualized basis, and represents sector “contribution” levels.  All data is “flash” data, provided by TrendMacro).

 2nd Quarter Change3rd Quarter Change
GDP-31.4%+33.1%
Consumer Spending-25.1%+25.2%
Goods-2.2%+9.2%
Services-22.9%+16.0%
Fixed Investment-5.4%+5.0%
Nonresidential-3.6%+2.9%
Residential-1.8%+2.1%
Net Exports+0.7%-3.1%
Government+0.8%-0.7%
Inventories-4.0%+6.6%

When one studies the above, it becomes obvious that the main driver of both the economic contraction in the second quarter and the rebound in the third quarter was consumer spending. No surprise here – consumption represents upwards of 70% of overall GDP activity, according to Bureau of Economic Analysis (BEA).

It is very instructive to understand that, while consumer spending on goods as a percent of the GDP change has recovered from the second quarter contraction, spending on services is still not fully recovered. Services include spending on restaurants, travel, out-of-home entertainment, etc. It is further instructive to understand that the services segment has historically been one of the areas that has rebounded rapidly following an economic contraction. Not this time. 

Further, it is necessary to understand that the consumer services segment of our economy tends to be very labor intensive. In other words, this area employs more people than most other segments of our economy, particularly entry-level and lower paying jobs. Knowing this leads to a less-than-positive view toward employment gains going forward…at least until a vaccine to fight the virus is widely available.  This reality may eventually lead to further irritation of the income disparity issue.

Lastly, some are calling for another broad, sweeping government spending program to rescue the economy. Please note the information above. The consumer services segment is where the real pain continues to reside, along with state/local government budget problems. It is these two areas that need help. I believe that simply sending a $600 check to every person in the country, while politically popular, doesn’t really address the current economic problems. The remedy to carry the economy over needs to be more targeted than many politicians may wish to consider. 

Year to date, on an annualized basis, economic GDP is down 3.5% this year. We have been calling for GDP to decline by 5% on a year-over-year basis for all of 2020. I am maintaining that view.

Outlook for 2021 – U.S. Economy

Cutting to the chase, I suggest we should see U.S. GDP growth of 3 – 4% during 2021. The growth should accelerate throughout the year. Tax rates may rise for some. This will negatively affect corporate profit growth rates and investment rates. The impact should be less radical than some were thinking prior to the election results. Unemployment should remain above 5% during the year, as government programs raising unemployment benefits should occur.

I believe inflation is a wild card for next year. I don’t expect to see a real upward push in inflationary pressure develop until the economy kicks into the expansion phase of the business cycle – which probably won’t happen until late 2021/2022. Let’s call inflation at 2% for next year. 

Adding together the 3 – 4% expected real GDP growth rate along with the 2% inflation rate gives us a nominal GDP growth range of 5 – 6% for 2022. This is a large number, which should usher in corporate profit growth rates above 15%.      

Longer Term Thoughts – Costs of the Pandemic and Government Remedy

Some thoughts as to the long term. First, the degree of volatility in economic activity change has been unprecedented. Think of economic activity as water running through a hose. The contraction in the second quarter acted as a kink in the hose, rapidly slowing the flow, with a build-up occurring behind the kink.  The third quarter represented a partial release of the kink, but it will remain in place until a vaccine to fight the virus is in place. The question asked in a recent article in The Economist – is there permanent damage that has been done to the “hose” from the kink in the above example? Will there be what economists call “hysteresis,” or an economic event that continues (economic weakness) even though the cause of the event (COVID-19) is removed?        

The answer to this question isn’t clear-cut. But because of the pandemic, consumer spending for services may not fully recover for some time. Many businesses will fail and close, placing those who work for these firms on the unemployment line. Why? In many cases, business lost is business lost. 

For example, if one doesn’t go to a restaurant for dinner today, that doesn’t mean that same person will go to a restaurant twice the next day. It is business lost. Other examples include spending on vacations, trips to the dentist, going to concerts, sporting events and the theater. Spending on these events/activities in many cases have not occurred and won’t be “made up” when a vaccine is available. That is pure lost economic activity.

Consequently, consumer spending shifted rather significantly from services to goods over the last six months. Goods-producing companies tend to be less labor intensive than service-based organizations. This puts further pressure on the labor market.    

Because of the economic kink has driven deep, and in many cases non-recoverable losses in the services sector, the probability of rising loan defaults in these types of businesses and the households that rely on employment from these firms, may intensify. According to the article in The Economist: Company shutdowns that sever job ties could delay a return to full employment and extend the period during which jobless workers’ skills and networks erode. A shortfall in investment has also checked the flow of GDP this year in ways that might depress long-run growth by reducing levels of capital per worker and undercutting productivity growth. Tumbling private investment accounted for roughly a quarter of the dramatic decline in America’s GDP in the second quarter.

The other area that arguably has been harmed over the last nine months is the nation’s balance sheet.  The amount of government debt outstanding has risen dramatically. On top of that, foreign investors, by and large, have been net sellers of U.S. government debt. This trend is in place and has been happening on balance over the last three years, according to Ned Davis Research. 

If foreign investors have been selling U.S. bonds, who has been buying all the new government debt?  Enter the Federal Reserve. The government has been buying its own debt. Where has the government come up with the money to buy the debt? They printed the money. M2 (money supply) growth has risen dramatically over the last year. In addition, the Fed’s government bond holdings have become extremely large (see data below).

A train of thought suggests we shouldn’t worry. The Federal Reserve will simply print money to purchase all of the bonds on the market, providing a never-ending stream of 0% money to the government to spend as they see fit. As long as the dollar is the world’s reserve currency, there will always be a demand for a never-ending rising stream of U.S. dollars. 

This is the crux of the new, Modern Monetary Theory (MMT) in which pro-government spending people have found nirvana, a never-ending stream of costless money to finance the government’s spending. 

Getting back to the Fed’s actions. How many Treasury bonds has the Fed purchased? Consider the level of Treasury notes/bonds the Fed has had on their balance sheet (data in billions) as provided from the St. Louis Federal Reserve:

 Holdings (end of period)Change
2009$474
2009-2014 (QE 1-3)$2,431$1,957 (+412%)
2014-2019 (rationalization)$2,080$(351) (-14%)
2019-2020 (Covid-19)$4,484$2,404 (+115%)

As shown above, the Fed has purchased more than $2.4 trillion in U.S. bonds since the beginning of the pandemic primarily by printing the money.

The actual cost of this largesse may not be realized until interest rates rise, and the government has to pay more to attract more capital, not only on new bonds but also on maturing existing bonds. It is a scheme that will blow up if either interest rates rise markedly or the value of our currency contracts significantly or the United States is no longer the core global reserve currency. Then the chickens come home to roost and the true cost of the government’s rescue plans come into focus.      

Summary and Final Thoughts

We are living though an uncertain age. Nothing new there. But I continue to be amazed at the resiliency of the American economy. And even with the shouting, yelling and upheaval apparent in our society, I am amazed at the steadfastness of most Americans. We in America need “Keep Calm and Carry On.”  

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