This week both post and podcast are about Biden’s stimulus. The podcast, click here, is a conversation with Vanessa Morest, whose community college will be one of the beneficiaries of the plan, if it passes Congress. As Vanessa said, “when I see [the] infrastructure improvements Biden is putting forward, I think it is greatly needed … we can make colleges [where] people feel really proud walking into them.” (Note to readers and listeners: if you like these posts, please forward, encourage others to sign up via the button below and also rate the podcasts on Apple).
Regarding the plan, when Biden said Xi and Putin believe democracy can’t “compete in the 21st century” that rang true to me. My mind flashed back to a conversation I had had years before in an elegant Beijing restaurant. My interlocutor was a financially savvy Chinese acquaintance who had earned an advanced degree in the US, worked in New York for a period and then returned home. He was bald, wore a stylish black blazer and had a thoughtful manner. This was years before Trump and George Floyd.
“The US is going to collapse,” he predicted, soberly. He cited crumbling infrastructure, school children murdered by mentally ill assailants with automatic weapons, racial strife, wealth disparities and a lumbering, unresponsive Congress. All the flaws he cited are real and dangerous. I heard similar things in Moscow, echoing the reports on state-run TV.
Much has changed since that Beijing conversation but, as an investor, two points standout––the siege on the capital and the bond market. Yes, the bond market. I know non-financial people glaze over when you mention the words but they matter, particularly now. The siege created an urgency around spending and the bond market pricing invites an aggressive policy response. This response will then impact asset pricing and geopolitics.
The capital siege rattled both Democrats and centrist Republicans. Suddenly, it was more obvious than ever that if the US didn’t start to address its chronic problems more quickly the country would indeed collapse. The US has teetered before. The Civil War, Great Depression and Vietnam Era protests all come to mind. Each time, the crisis was enough to catalyze action and the system just barely flexible enough to find a new equilibrium, but only after the country had veered way off course.
Regarding the bond market, right now, the government is paid to borrow money. How can that be? A bond is a loan. While interest rates on US government debt are positive, inflation rates are even higher, meaning investors are, in effect, paying the US government for the government to borrow money, in real terms. In that sense, the borrowing spree is rational. If the market is willing to give the US government money at that price and a political crisis is at hand, why not use it?
The total bill of already approved and future programs will be roughly $10 trillion. For context, the US spent around $6 trillion on Iraq and Afghanistan. Based on Biden’s speech, many of the things on the agenda include the very issues my dinner companion cited. While logical, it isn’t normal.
Since Keynes (1883-1946), governments have typically used fiscal spending when the economy is weak. Biden is adding fiscal when the economy will be, as the vaccines kick in, strong. Meanwhile, the major regions of the world are pursuing very different financial policy. China is limiting debt growth, Russia is tightening monetary policy. Europe is using fiscal stimulus at a much more modest scale.
Biden’s bet has significant geopolitical and investment implications.
In terms of geopolitics, US-China tension is unfolding against the backdrop and is linked to a rapid technology shift centered around bio-tech, chips, AI and green energy. The disruption from technology is part of what fueled Trumpism.
Biden’s policy supposes an infrastructure boom that absorbs less educated workers combined with social spending will improve social and political stability. Making community colleges more accessible is one step in that direction, as Vanessa notes. Together, if successful, this will likely translate into improved productivity and US economic and military strength. Military spending has always been a function of economic strength. If, on the other hand, Biden’s bet fails, the US global role will fade, much as Britain’s has. It is this failure that Moscow and Beijing believe is almost inevitable.
In terms of investment implications, despite this possible spending surge, the US bond market is estimating (based on bond yield pricing) that US real borrowing costs will remain negative for years. This is what has driven savers into anything that isn’t cash. Many stocks and commodities are up over 50% in the last year. Because these assets are disproportionately owned by the wealthy, income inequality has actually worsened.
Private sector forecasters estimate the US will grow at 6% this year and 4% next year. These growth rates are well above average. Over time, bond yields tend to track, if loosely, growth rates, such that the rate of borrowing is roughly in line with the aggregate rate of economic activity. This suggests bond yields are way too low. See below from my friends at Rose. The dot suggests where we are going.
If US interest rates rise enough, many asset prices will stop going up. Prices are determined by supply and demand and if interest rates on cash rise it makes sense that more speculative investments will become less attractive. That’s what’s already happened in China. Tighter Chinese policy this year has stopped the stock market in its tracks. If Biden’s policies are successful, it’s possible many investment portfolios will get hurt. While I largely welcome what Biden is doing, the only way I can own risky assets like stocks and commodities is by simultaneously putting on positions that will benefit from a substantial rise in US bond yields. This is what’s known in the business as a hedge.
From here, I suspect either interest rates stay low and risky assets rise further, or bonds reprice and risky assets fall or some combination of the two. Not being able to predict an outcome precisely and construct a portfolio that can survive various scenarios is what makes investing, compared to politics, more contained. From a political standpoint, Biden’s bet is as significant as those placed at other critical junctures in US history. If Lincoln went long civil rights and short slavery, Biden is long Main Street, short Wall Street.