‘flation: The Aftermath

[Update: This article focuses on some potential practical implications of the ‘flation analysis I did earlier this week.  You may prefer to read it first, before taking a look at the potential cash conclusions from its implementation here.]

I really enjoyed discussing the tradeoff between monetary and fiscal policy this week.  It is a difficult issue to deal with for both theoretical and practical reasons.

From a theoretical standpoint, many debate as to whether the Federal Reserve’s current policy stance is helpful in stimulating employment.  Moreover, many also debate whether Congress should be more austere on the fiscal side of the equation.

FRED Graph (Click on Chart: http://research.stlouisfed.org/)

From a practical standpoint, even if one were to determine that fiscal, rather than monetary, stimulus would be optimal right now, it is surely debatable as to whether Congress would enact that stimulus.

It has been interesting, in facilitating feedback, to hear that many folks might not realize that tax reform also can serve as a fiscal stimulus.  Lowering taxes increases cash to the private sector, thereby also serving as a fiscal stimulus similar to government spending on specific items.  Please also note that I have advocated for improving infrastructure as well as tax reform.

But the key question I have received (big surprise!) is “How will this change affect me, Jon?”

Before I answer this, please note that it would obviously depend on your specific financial variables, but here are some of the general immediate effects.  Please also note that I think the secondary effects are mostly positive, but “dynamic” quantification is harder than some folks may realize.  However, just because something can’t be accurately quantified does not mean it is non-existent.

First, the negatives.  Normalizing monetary policy should allow interest rates to rise by at least a few points.  This increase in borrowing costs means mortgage rates would likely go up.  Also, asset (e.g. stock and housing) prices should theoretically go down.

(Click on Chart: wsj.com)

I have recommended ways to deal with the stock problem through the corporate tax reform posited.  Lowering the corporate tax rate should help dampen the blow to equity valuations because more of a company’s earnings will stay with the corporation.

Now, the positives.  For folks with any savings, your cash at the bank will finally earn more than 0%.  You won’t have to risk your capital in the stock market just to try and get the dividend yield which is likely not that much larger than the interest rate you would now get from your savings account.

Historical Dividend Yield of S&P 500 Chart (Click on Chart: http://www.vectorgrader.com/)

Most importantly, the huge tax cut for most folks (especially those earning under $1M) should make the overall transition a net cash positive despite losses in certain asset values and/or increased borrowing costs.

This substitution from lessening loose monetary policy (not eliminating, just stopping the madness) to a more balanced approach between monetary and fiscal policy would ordinarily be quite painful.

Fortunately, as I explained in my ‘flation analysis, the US reserve currency status gives us some leeway to run deficits in the short run as long as we begin to make structural adjustments like this one that will begin to make our system optimal for the long run.

Wouldn’t it be nice to focus less on macroeconomics and get back to the business of focusing on our specific daily obligations and enjoying life?  I am optimistic we will make the most of this golden opportunity.