The Senate’s passing of a $1 trillion infrastructure package with the support of 19 Republican senators, including Senate Minority Leader Mitch McConnell, shows the Biden Administration still has momentum behind its government spending objectives.
infrastructure package 1.0
The Senate’s Infrastructure Investment and Jobs Act includes $550bn of spending on surface infrastructure over the coming 5 years. Of this, $110 billion will go to traditional infrastructure, i.e., roads, bridges and “major projects”. Experts estimate that about 45,000 bridges and 20% of highways need rehabilitation. These figures show that for decades the United States has lived off its inheritance and omitted to undertake necessary maintenance spending. Elsewhere $66 billion is earmarked to expand rail infrastructure, with $65 billion for high-speed internet and $73 billion for green energy projects.
The (much bigger) package 2.0 is in planning
Democrat strategists are now focused on the much bigger ($3.5 trillion) Budget package, which includes many of the priorities of the Biden Administration – such as clean energy tax credits, universal schooling for 3- and 4-year-olds and a significant expansion of Medicare – to be paid for in part by higher taxes on the wealthy and on corporations. The “reconciliation” process allows Budget bills to pass the Senate on a simple majority. So, if moderate Democrats can be brought on board, the Budget bill could pass the Senate without Republican support.
Official statistics already indicate an overheating of the US economy
If one believes official statistics (e.g., labor market data such as job vacancies or the unemployment rate) the US economy is already on the verge of overheating. Since infrastructure spending is not expected to increase significantly until next year, commentators would have us believe that the Senate’s $1trillion bill is not inflationary in the near-term. We think this view is too sanguine.
Benefits accrue over decades
But even if eventually passes into law, the Senate’s package will have little positive effect on growth in the short term. The USD 550 billion scheduled for surface infrastructure over the next 5 years must be considered alongside the approximately $6 trillion of stimulus approved in the last 18 months to combat the pandemic and its economic consequences. Moreover, the realization of infrastructure projects takes time. One cannot simply build overnight a new train line or a road. Project approval procedures are often cumbersome and lengthy. The mass of projects will only be started next year, and completion may well take years or even decades.
Official statistics already indicate overheating of the US economy
If official statistics are to be believed, e.g. labor market statistics (number of job vacancies, unemployment rate, etc.), the US economy is already on the verge of overheating. Since infrastructure spending is not likely to be increased significantly until next year, the economic overheating is unlikely to be further fueled by the packages that have now been passed. We do not believe that this view, which is often expressed by market commentators, holds much water.
It is problematic that financial markets have adjusted to permanent monetary and fiscal policy stimuli. Should these fail to materialize or be substantially smaller than currently expected, market dislocations threaten. Fiscal policymakers and central bankers are aware of this. There are no party “spoilers” in
sight at the moment – neither on the political stage nor in the corridors of power within central banks.
A step too far
The poet T.S. Eliot wrote: “Only those who risk going too far can find out how far one can go.” (Source: John Hussman, John Mauldin). Monetary and fiscal policymakers will in all likelihood find out how far they can go.
How far can they go?
This question is almost impossible to answer with the help of theoretical models and can probably only be answered empirically. In other words, we will find out within the next few years and unfortunately will only “know” in retrospect.
Why do policymakers tend to take that “step too far”?
Imagine you are a central banker or a politician at the center of the news. If you were to stop the party now, (stop the financial equivalent of alcohol that is monetary and fiscal stimulus) and there followed a crash and then a recession, your name would be linked to these unfortunate events. Political enemies and others might say that, had you not so acted, everything would have turned out “much better”. You might even find yourself occupying a place of shame in the history books. Many in positions of power prefer to move on before trouble hits and leave problems to their successors. (The economic “hangover”, should not be associated with my name. The financial and economic crisis should not be associated with my name.) A well-known leader of the Communist Party of the Soviet Union tried to increase Russia’s labor productivity and the life expectancy of her male population between 1985-1991 with an anti-vodka campaign. Although this was the right thing to do, Russians at the time and since have not thanked him for those policies, and what followed is well known. Even now, Michael Gorbachev only enjoys a good name in the West …
Can there be a “good solution” after all?
Although the development of credit spreads may indicate the opposite, the world’s indebtedness problem has worsened compared to the beginning of the global financial crisis in 2007. Many credit metrics have deteriorated. But spreads on risky bonds have collapsed because market participants have been “front running” central banks, buying up risky bonds in anticipation of central bank purchases.
Central banks threaten conservative investors with underperformance
If you translate the central banks’ communication into basic German, you get the following “pamphleteering” statement for investors: “All those who do not invest in risky bonds or risky shares are our enemies. We will do everything we can to make you underperform.” It might not even need a rate hike or “tapering”, (the scaling back of bond-buying programs) to risk a credit crunch. Small modifications in communication, hinting at a slightly less accommodative monetary policy could already be enough.
No relief on the debt front due to moral hazard
Low nominal interest rates and clearly negative real interest rates due to high inflation would ease over-indebtedness in the medium term if moral hazard associated with such policies were not a problem. Even the most tin-eared politicians, corporate treasurers, and private investors (i.e., those who are not finely attuned to the language of central banks) have understood that negative nominal interest rates and high inflation make it worthwhile to take on (even more) debt and to speculate on further increases in stock or real estate prices, even though these assets are already very highly valued on traditional norms. After all, central banks have promised to “inflate away” debt and to further boost asset prices.
What could be the step too far?
Just as Fed Chair Powell does not want to go down in the history books as the architect of Great Depression 2.0, he also does not want to be associated with hyperinflation that may result from the policies he has pursued in recent years. His current term of office ends in early 2022 (although he and the Administration could agree on a further term thereafter). Why not take the first anti-inflationary steps in the next few months and leave the short-term negative consequences to a successor? We think this is possible but at the moment not very likely. We will keep you informed.
Contact: Thomas Härter, CIO, Investment Office
Telephone: +41 58 680 60 44
Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
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