by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning on this GDP day.  We cover the data in detail below, but the short take is that the data came in a bit below forecast.  Although consumption was robust, falling inventories reduced the overall number.  U.S. equity futures are higher this morning as stocks continue to trend higher.  Our coverage leads off with President Biden’s address to Congress and the spending plans.  The FOMC meeting recap follows.  Our roundup of China news is next, followed by international news.  An update on economics and policy follows.  Our usual update of pandemic news is next, and we close with technology.

The Biden address to Congress:  There is a ton of media coverage of the speech, so our focus is more on two things—what the speech (and policy) signals and the chances of passage.  In 1996, President Clinton’s State of the Union address is remembered for the famous line “The era of big government is over.”  To a great extent, this was obvious by 1996.  It wasn’t so much that the government has shrunk, but the confidence that it could solve problems was mostly lost.  Clinton’s line was less a birthing and more of a funeral.  The GOP had moved on from big government with Reagan; Clinton was indicating that the Democrats were too.

The Biden address has all sorts of details and spending plans, but the clear message is “big government is back.”  The Great Financial Crisis showed that the private sector alone couldn’t fix the problems of excessive debt, slow growth, and inequality, at least in a way that was politically acceptable.  So now, fiscal support and higher taxes are the order of the day.

What makes this change interesting from a political perspective is usually, these sorts of changes are accompanied by legislative dominance.  Roosevelt enjoyed a strong Congressional majority.  Reagan gained seats in Congress, reversing years of Democratic dominance.  Biden has a very aggressive program, about $6.0 trillion in total spending, with very narrow majorities in Congress.  The proposals include fiscal support for families, infrastructure spending, and funding to support the transition away from fossil fuels.  Included is a redistributive tax proposal to pay for it.  Getting everything through will likely require Congressional leaders to use reconciliation, which could reduce the scope of the proposals.

Here is what we are watching:

• It’s important to remember that this legislative action is occurring in a period where party affiliations are in flux. The rising stars in the GOP are the “populist Turks” of Hawley, Rubio, Cotton, and Cruz.  They might not be very opposed to the Biden tax plans and antitrust policies.  There will be party differences.  We expect the GOP to be less inclined to go “green.”  However, the idea that the GOP is the party of capital is probably out of date.  If anything, Biden’s strongest opposition could come from the tech/finance wing within the Democrats (e.g., the SALT controversy).
• President Biden, unlike most administrations, clearly realizes he is on the clock. We suspect he has another year, at most, to get everything done.  The GOP will likely regain control of Congress at the midterms; history is on the Republican’s side.  The problem is that because the administration is working with slim majorities, the chances are high that some of what he gets passed is undone in the next administration (either in 2024 or 2028).  In fact, this may be the greatest risk to investors.  Policy swings will likely become increasingly violent, thus making long-term projections more difficult and lead to truncated market trends.
• If there is one trend we would not diminish, it’s fiscal deficits. In MMT, there are limited reasons to tax.  The first is to cool inflation by withdrawing liquidity (paradoxically, from a political standpoint, this requires taxing the less affluent).  The second is to tax things you want less of…so “sin” taxes or levies on unwanted behavior.[1]  Therefore, a government taxes the rich not to raise revenue but to reduce its influence.  Thus, a tax rate that brings less revenue isn’t the point.  Expect both sides of the aisle to mostly give up on fiscal austerity.  Of course, this will change at some point.  Inflation control is usually when that trend changes.  But, for the foreseeable future, high deficits will be the norm, and eventually, we expect that eventually yield curve control will be required.

The FOMC:  The Fed made almost no changes to policy or the statement.  Rates are steady, as are bond purchases.  It did admit that the economy is doing better and inflation, though rising, is transitory.  Forward guidance indicates that policy is going to be steady for at least a couple of years.  Not a whole lot of news emerged from the press conference either.  The Fed is paying attention to the issues with money markets at what occurred with Archegos, but Powell made it clear he didn’t view high asset prices, in isolation, as a sign of trouble.  Initially, we did see a modest rally in Treasuries, gold recovered, and the dollar declined.  The market reaction was consistent with a dovish policy statement.

China:  German policy to China may change, the population is falling, and regulators that initially approved the Ant Financial IPO are probably in trouble.

• China has been able to use its trade with Germany as leverage against the EU. If German elections in the fall lead to a Green-led government, if party rhetoric can be believed, Germany, and likely the EU, would be less compliant toward China.  This development has caught the attention of Beijing.
• Last year, when the Ant Financial IPO was scuttled, one of the remarkable issues was that the sale was pulled just before the IPO was to be held. Now, Chinese regulators are investigating why the IPO was initially approved in the first place.  Of course, the issue is likely that the Xi government is looking to see if regulators were swayed by some factors to approve the stock sale.  But, if we see bureaucrats punished for approving the sale, it could prove to be a dampener for future IPOs.
• As we noted earlier this week, China’s population likely fell last year, the first annual decline since the famine triggered by the Great Leap Forward in the 1950s. We think it will take several weeks before Beijing officially confirms this news. The reports are, to some extent, a pre-release of this adverse news.  However, we do note that Beijing’s initial reaction to the news was to deny its accuracy.  Although the pandemic played a role, China, through its one-child policy, has created a social situation that has discouraged family formation and childbearing.  Such situations are very difficult to reverse.
  • Part of the way the CPC plans to address the population decline is to delay retirements. Currently, the retirement age for men is 60, 55 for white-collar women, and 50 for blue-collar women.  Reports suggest that the idea of lifting the retirement age is deeply unpopular.
  • The decline in population will, over time, reduce China’s economic growth and power. Although immigration could mitigate this, it is unlikely China would adopt this solution.  The U.S. is also seeing slower population growth, but historically, America has been more open to immigration.
• China is considering a pricing mechanism for pollution. Usually, this would be something like a carbon tax; in economics, pollution is usually a “negative externality,” meaning the costs of pollution are rarely fully reflected in the market price.  It is not clear how China plans to do this, but the fact it is being discussed bears watching.
• Here is an interesting insight into China and the CPC. China’s largest on-demand delivery company is called Meituan (MPNGY, USD, 80.29).  It has come under scrutiny for its treatment of its drivers.  General Secretary Xi referred to the drivers recently.  A party official, adopting a version of “Undercover Boss,” took a job as a delivery driver for the company and reported how difficult the job was.  The party official has been widely complimented in the official press.  Meanwhile, a driver who has become a labor activist has been detained for his criticism.  The moral is that it’s acceptable for the CPC to point out the failings and crimes of a company or official, but it is not acceptable for a common citizen to do so.
• We continue to monitor the situation with Huarong Asset Management (2799, HKD, 1.02); we note that China’s Industrial and Commercial Bank (IDCBF, USD, 0.69) has given a loan to the company to ensure the company can pay its April 27 interest due on bonds. Chinese regulators have encouraged Chinese banks to offer credit for the next six months to facilitate the refinancing of debt.  It is still unclear how China will deal with this issue and avoid creating moral hazards due to a bailout.
  • Two high-speed rail projects have been delayed due to debt concerns.
• There are increasing reports that China, though far from the Arctic, views the region as a key area to expand its influence.
• Remember the fad of bike rentals in major urban areas? In China, a number of firms have tried to grab market share by flooding cities with bike rentals.  Pictures in this article show how China is now dealing with massive ‘graveyards’ of these bicycles that have been damaged and abandoned.

International roundup:  Brexit is approved (finally!), and we continue to watch the German Greens.

• The European Parliament, calling Brexit a historic mistake, voted to approve the deal anyway. So, at long last, Brexit is now official.  However, that doesn’t mean everything is completely wrapped up.
• The Greens, as we noted above, are taking a harder line on China. They also appear supportive of fiscal spending and want to end the official policy of zero budget deficits.
• In recent reports, we noted that central European nations were expelling Russian diplomats over the actions of Russian operatives accused of destroying arms destined to be sent to Ukraine. We note that Bulgaria has joined the trend.

Economics and policy:  Labor markets, semiconductors, and prices lead the news today.

• There is growing concern about the inability of firms to hire workers. It is a complicated issue, one that we will be commenting on in the coming weeks in the AAW.  The expanded unemployment benefits and cash support may be leading potential workers away from accepting jobs they would have accepted before.  Another factor has been the pattern of older workers opting for retirement during the pandemic.  It’s possible they won’t return to the labor markets.  An additional issue could be the use of a bachelor’s degree as a screening device.  Studies indicate that employers have been moving to use the degree as a minimum job requirement for positions that arguably don’t need one.  Firms like the fact that a worker would make the effort to get a degree and perhaps hope that the worker taking a job he is overqualified for would eventually move up in the company.  But, inflating the requirement for a job may be keeping some potentially qualified workers from some jobs, exacerbating the inability to fill positions.  We will be watching in the next few months for signs that employers are relaxing standards for positions.
• The semiconductor crisis continues. One by one, automakers have been cutting production due to the lack of chips.  Tech firms are not immune, either.  Taiwan is warning that that drought is a threat to chip production.  Taiwan is critical to semiconductor production, and the process uses lots of water.
• Grain prices have been on a tear. Corn, for example, is up 16% in April.  Usually, high prices trigger a supply response from farmers.  However, the response so far has been modest.  Weather concerns are playing a role.  The spring, cold weather (it was snowing last week in the Midwest) is putting planting behind schedule in the key corn states of Iowa and Illinois.  For the country, 17% of the acreage has been planted compared to the 20% five-year average.
• We have been watching trends in residential real estate; namely, younger households are moving to the suburbs, and older households are downsizing into retirement. This report confirms these trends.  Meanwhile, landlords are complaining about promised relief from the government.
• Canada’s finance minister has called Biden’s global tax plan a “breakthrough moment” for international trade talks.
• Amazon (AMZN, USD, 3458.50) announced pay increases.

COVID-19:  The number of reported cases is 149,718,851 with 3,530,418 fatalities.  In the U.S., there are 32,230,809 confirmed cases with 574,330 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high-frequency data on various factors.  The CDC reports that 301,857,885 doses of the vaccine have been distributed with 234,639,414 doses injected.  The number receiving at least one dose is 142,692,987, while the number of second doses, which would grant the highest level of immunity, is 98,044,421.  The FT has a page on global vaccine distribution.  The weekly Axios map shows the majority of states are reporting either steady cases or declines.  Oregon, which had been reopening, has reinstituted restrictions due to a rise in cases.

Virology

• There is a growing concern about vaccine hesitancy; recently, the pace of vaccines has slowed, and reports of unused vaccinations have emerged. One way to address this issue is to follow the plan in West Virginia, which is to give recipients a $100 savings bond for their trouble.
  • New York City will fully reopen on July 1.
  • There is growing evidence that vaccinations are slowing the spread of the virus in the U.S.
• Russia and China have engaged in a disinformation campaign to undermine confidence in Western vaccines. The EU is monitoring these activities.
  • Brazil, which has been suffering from an uncontrolled outbreak, has rejected the Russian Sputnik vaccine due to the lack of documentation for “safety, quality, and effectiveness.”
  • Meanwhile, Russia and China are resisting efforts by the WHO to expand studies over the two countries’ pandemic responses.
  • The Brazil variant is now spreading into South Africa.
  • BioNTech (BNTX, USD, 175.77) reports that it believes its vaccine will be effective against the Indian mutation.
• In India, where the virus is also raging, the new variants appear to be spreading into the countryside. The Philippines is also facing a resurgence in infections.
• Germany’s domestic intelligence agencies are now monitoring coronavirus deniers.
• Vaccine manufacturers are planning to increase vaccine production.
• Japan, which is dealing with an uptick in cases, outlined rules for the Summer Olympics.

Technology: 

• Foreign governments are getting increasingly hostile to the large tech firms. Although the U.S. has been slower to react, we note two new books from Hawley (R-MO) and Sen. Klobuchar (D-MN) on antitrust and technology.  Although these senators probably don’t agree on much, it does appear there is a level of bipartisan support.

 View PDF

[1] One of our criticisms of MMT is that it ignores the financial markets.  Hyman Minsky is claimed by MMT as being part of its intellectual “family tree,” but Minsky argued that there can be situations where the government must reduce the deficit to improve financial confidence and reduce interest rates.  MMT obliquely relies on the central bank to address this issue.