Demand Destruction is Looming Large
The climax of an immense monetary binge
The US economy is in the final stages of a demand climax caused by a decades-long increase of the money supply, and systematic suppression of interest rates. We’ve seen fifteen (15) years of the Fed buying trillions in US Treasury Bonds and Mortgage-Backed Securities (MBA) using money literally created from nothing. Add the trillions distributed in direct fiscal subsidies to the US consumer’s pocket from Treasury since the Great Financial Crisis (GFC) in 2008. It’s easy to see how the Fed has added over $8T (USD) to the US Federal Balance Sheet in just 13 years. This has been a massive monetary expansion, given the size of the Federal Reserve Balance Sheet was under $1T (USD) in late 2008. That’s an 800% increase in assets held by the Fed since 2008.
The value of assets held by all Federal Reserve Banks as at April 2022 is $8.965T:
Figure 1
Combine the fantastic increase in the size of the Fed balance sheet with the Fed suppressing the Federal Funds Rate to near zero since 2008:
Figure 2
As the largest buyer of Treasury debt, and having held interest rates near zero, the Fed has driven public debt from 60% of GDP in 2008 to almost 140% of US GDP in 2022. Sales of Treasury debt to the Fed represent interest free loans for Treasury. The Fed returns all interest paid by Treasury, every year, after paying its operating expenses and stockholder dividends:
Figure 3
The Fed’s balance sheet expansion was based on money created from nothing. Therefore, Fed asset purchases have resulted in increasing the money supply (M2) by 260% since the end of 2008:
Figure 4
While price rises have been meteoric, traditional asset classes simply haven’t been large enough to soak up all the demand arising from a 260% spike in M2. The Median Sales Price of homes in the US increased by over 100% from December 2008:
Figure 5
As a result, owner’s equity in US real estate increased by 250% from December 2008:
Figure 6
Investors poured trillions into the growth miracle of NASDAQ tech stocks with the index climbing 970% since 2008, minting tens of thousands of new millionaires. This was almost the same rate of growth as the Federal Balance Sheet itself, over the same period:
Figure 7
The S&P 500 index has grown 363% since 2012:
Figure 8
Companies have used the windfall in free cash flow from equity investors, together with cheap debt, to automate work process, and invest in new property plant and equipment (PP&E). Quarterly investment in PP&E has risen by 150% since 2008:
Figure 9
Buying excess capacity has been cheap. In line with the growth of the federal balance sheet, and the collapse of the fed funds rate from 1980, the utilization of production capacity across all industry has fallen from 86% in 1978 to 78% in 2022:
Figure 10
In addition to pumping up prices of these traditional investment assets, demand arising from the massive increase in the money supply (M2) has increased prices in entirely new asset classes, especially for those investors who could harness the power of cheap debt.
New markets for hundreds of Crypto currencies and their trading platforms (e.g., Coinbase) as well as Non-fungible Tokens (NFT) and Carbon Credit Trading are now attracting trillions of dollars in investment.
In 2021, the market capitalization of Crypto currencies was variously estimated to be around $3T (USD). The capitalization of the Carbon Trading System (led by the European trading system) was variously estimated at close to $1T (USD), while even the arcane Non-Fungible Token (NFT) market was variously estimated to be capitalized at around $100B.
An abundance of cheap debt has also propelled investment in companies which claim to satisfy popular, new, political and social preferences. The Environmental, Social and Governance (ESG) category of stock investment has provided a new dimension in a traditional asset class. In 2020 there were 905 ESG investment funds. The top 10 ESG exchange traded funds had $60B under management in 2020 and according to Bloomberg intelligence, ESG assets may hit $53 trillion in 2025, a third of global assets under management.
On top of lifting investment and prices in existing stocks and investment funds, the FinTech industry has risen rapidly with the digitalization of traditional financial products like the new ‘Recurring Revenue’ debt products offered by businesses like Pipe. Online real estate cash buyers and flippers like Opendoor and Redfin as well as blockchain digital payment and security operations like Verify, Venmo, and Circle dot the investment landscape.
Truly, monetary policy over the last 20 years has resulted in a bonanza of government and consumer investment, spending and profit. What happens to demand for these investments and products when liquidity is drained from the economy, and interest rates rise, subject to a radical tightening of monetary policy? How far will prices fall? For how long? US Inflation (CPI) has just hit a 40 year high at 8.5%. Will it rise further?
It’s obvious that tightening of monetary policy will result in demand being destroyed across asset classes in the near future. The only question is whether that destruction will be marginal or life threatening. Is your company ready to leverage these changes? We design and implement operating strategies which offset the impact of monetary policy tightening.