Emergency Government Deficits For Normal Times
The most anticipated recession was papered over by government spending.
2023 was supposed to be catastrophic for the economy. I was onboard with this thesis as markets across the globe were recoiling from coordinated central bank interest rate hikes, geopolitical conflict, and persistent inflation. Financial markets were not expected to hold up and global central banks were playing hardball working on lowering inflation from multi-decade highs.
But was this the whole story? The U.S. was supposed to be tightening financial conditions aggressively to stop inflation. However, at the end of 2022 something changed. Financial conditions loosened at the end of the year and continued to loosen after multiple regional banks failed in March of 2023. This was the turning point. Suddenly, safe haven assets like government bonds became a losing trade while risk assets were the only game to play. Look at the chart of Bitcoin, the NASDAQ 100, and Gold versus U.S. government bonds since November 2022. Bond holders lost money on nominal terms (even more on real terms) while the high risk investors were flourishing.
Chart 1: The Government Lost Control in November 2022 (Source: Koyfin)
How can this be when everywhere you turn is doom and gloom?
Take a look at the Federal deficit to GDP over the last 15 years.
Chart 2: U.S. Government Deficit as a Percentage of GDP (Source: FRED)
The deficit is around 7% of GDP today. The last time the deficit made up this much of GDP outside of the pandemic (that had the entire world in lock down) was during the Great Financial Crisis in 2009. Now take a look at financial conditions today.
Chart 3: Financial Conditions Index (Source: FRED)
The more negative the index, the looser financial conditions are. The last time the U.S. had this loose of financial conditions was 2021 when interest rates were zero and quantitative easing was in full force. Bitcoin and the NASDAQ were at all-time highs back then (until recently). Venture capital was throwing money at anything they could. Companies were raising money for any idea they could get onto a pitch deck. This is the same environment we see today, but with a much more negative investor sentiment.
The economic numbers we see today in the U.S. are still healthy. However, one must stop and think are these healthy numbers because the economy is good or are these healthy numbers because the government is making up 7% of GDP with Federal deficits? And another thought: what happens to deficits when the economy actually turns sour?
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Don’t fight convexity.
This post consists of high level commentary on research conducted by Tetelestai Capital, LLC into economic conditions. Though compelling, your own research should always be done before investing into any security. The risks mentioned in this post are not all encompassing either. This post should not be viewed as investment advice. Tetelestai Capital is not associated with any of the investment companies or products mentioned in this post. If you have any questions about the research Tetelestai Capital conducts, please reach out through the website for more information.