Anyone reading the headlines sees how the U.S. job market is supposedly on solid ground. The report that came out last week showed a large increase in the number of jobs in October. This is exactly what the President was looking for. It is a grand time economically.
Of course, we have record highs in the equities market. Everything is golden. Even Bitcoin broke out and is running like the wind. Who is going to put a damper on this?
Perhaps this article will help to poke a bit of a hole in the sails. Things are not as rosy as everyone lets on.
As I stated on a number of occasions, one report does not make a trend. We are seeing a lot of data that is very concerning. From a macro standpoint, there is every reason to worry about what is taking place. The Fed, by aligning with what the masses want, is making a mistake again.
That said, let us look at some of the data.
On a number of occasions I pointed to the participation rate as a problem. This is the percentage of the working age population that is employed or seeking employment. We keep heading lower, a trend for the past 30 years.
At the same time, I often point to the Velocity of Money. This is an important indicator for the inflation equation. There is no way to have sustained inflation if money is not moving through the system. When money sits, inflation cannot persist. For it to remain, people need to be passing the currency on to others.
It is very interesting when we combine the two.
Let us look at these two data sets overlaid with each other. This is since 1980 so we are not looking at a short period of time.
Notice how they proceed in lock-step with each other. This is especially true since the late 1990s. Since that time, these two indicators moved together.
At present, we see a bit of a divergence over the past year. Since Q3, 2020, the VoM is heading lower. We got another negative reading this money.
However, the participation rate is moving a tad higher over the last few readings. This is causing a bit of divergence.
Over the last decade, it seemed the VoM was the more stable of the two. The participation rate experiences some more volatility. Thus, it is likely that the VoM is going to hold true while the participation rate eventually moves back towards it.
According to the line of thinking I am using here, the question is whether the VoM will rebound or will it bleed lower?
It is obvious the trend is long established. That does not mean, however, that there will not be a reversal. The track record is not great though.
To start, we see much lower VoM in the Euro, Yuan, and Yen. All these countries have a slower VoM (Japan is about half the US) while having higher debt-to-GDP ratios. There is ample evidence that increasing debt negatively impacts GDP, the numerator in the VoM equation.
Thus, if the long established trend of slowing growth in GDP holds (we printed a preliminary 2% in Q3 after 6.5% in Q2), then the VoM will only worsen without a complete reversal in both monetary and fiscal policy. The Fed talks about that but I do not believe they will go through with it. As for Congress, well they are going to spend until their noses fall off (and then they will spend to get then fixed).
One of the major issues, in my view, is the reserves on commercial bank balance sheets that is at the Fed. As shown by this chart, it is now in excess of $4.1 trillion. This is part of the money supply, yet it does not go anywhere.
As more is locked up in the Fed in the form of reserves, it can only slow down the aggregate Velocity of Money. The problem with the reserves is that they are housed at the Fed and can only appear on member bank balance sheets. Since this is not able to be utilized for wages, stock buybacks, rents, electricity, or tax payments, the velocity is near zero. The only movement is if one banks has to settle with another, hence having the Fed move the asset from one commercial bank balance sheet to another.
This, I believe the trend of a slowing of VoM will continue. We might see a move slightly higher since the Fed is implementing tapering. However, my view is this will eventually result in greater tightening of economic conditions which will cause the reversal of that policy. Either way, the Fed will not be tightening anytime soon which would result in a reversal of the original swaps that occurred on the second chart.
By the middle of next year, it is a safe bet that the participation rate will be lower than it is today.
Things do not look very rosy on the employment front.
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