MacroPass™: Lacy Hunt On His Quarterly Outlook & Review

He's seeing a widespread deterioration in the economic landscape

This week’s installment of our popular MacroPass™ service for premium members of this Substack comes from former Dallas Federal Reserve senior economist Lacy Hunt.

It’s the quarterly market update that Lacy sends to his private clients. In it, he shares his latest economic outlook, which is souring as net national savings remain negative while reckless fiscal spending makes the situation even worse. There’s an unavoidable reckoning ahead, in his assessment.

As a reminder, MacroPass™ is a weekly rotating selection of premium analysis from many of the big thinkers interviewed on Thoughtful Money.

To-date that list of contributors includes experts like Lacy Hunt (Hoisington), Stephanie Pomboy (Macro Mavens), Danielle DiMartino Booth (QI Research), Tom McClellan, Michael Howell (Capital Wars), Darius Dale (42 Macro), Doomberg, Ted Oakley (Oxbow Advisors), Kevin Muir (The Macro Tourist), Alf Peccatiello (The Macro Compass), Lance Lambert (ResiClub), Ed Yardini (Yardini Research), David Hay (Haymaker), Melody Wright (M3_Melody), David Stockman (Contra Corner), David Brady (FIPEST Report), John Rubino, Adam Kobeissi (The Kobeissi Letter), Sven Henrich (Northman Trader), Jeff Clark (The Gold Advisor), Chris Whalen (The Institutional Risk Analyst).

The reports issued so far in this MacroPass™ series include

• Ted Oakley on his latest market outlook

• Lance Lambert on rising housing inventory

• Doomberg on the future of nuclear energy

• Jeff Clark on Outcrop Silver

• Ed Yardeni on the labor market, fed rate cuts & more

• David Stockman on stolen economic growth

• Michael Howell on global liquidity

• Melody Wright on mortgage default risk

• Edwin Dorsey on the short argument for Primerica

• Danielle DiMartino Booth on the debt-default reckoning lying ahead

• David Hay on the wild action in the Japanese yen

• Kevin Muir on the emerging opportunities in Chinese stocks

• Alf Peccatiello on the growing fragility in credit markets

• Tom McClellan’s excellent April Market Report

If you’re already a premium subscriber to this Substack, just continue below to read this week’s report from Lacy.

And if you’re not (yet), read the start of it below. If you like what you see, just upgrade to premium and access the full report, as well as all past and future MacroPass content.

---

Monetary and Fiscal Extremes

Amidst a widespread deterioration in the economic landscape, it is crucial to underscore the current detrimental roles of monetary and fiscal policy. The sharp deceleration in detrended real M2 money supply growth, a fundamental cause of aggregate economic fluctuations, is a stark reminder of the past. Prior to nine of the ten recessions since the early 1950s through the start of the Pandemic, monetary restraint has consistently reduced inflation, economic activity, and short- and long-term bond yields.

The worsening fiscal policy condition, as measured by the existing status of negative net national saving (NNS), reinforces the contractionary influence of monetary restraint. The premise of J.M. Keynes, founder of the Keynesian school of economics, was that excessive saving is the cause of major economic downturns. When individuals do the right thing (i.e. save for future needs and contingencies) consumer spending is insufficient to prevent economic slumps, which Keynes called the "paradox of thrift." Negative saving, however, means that Keynes' paradox no longer applies because no surplus exists. Thus, Keynes' solution of enormous deficit spending to drive the economy disappears. Indeed, it suggests just the opposite. Deficit spending must be reversed or net national investment, a requirement for future growth, will not exist.

These extreme monetary and fiscal conditions occur at a highly inopportune time as they follow a declining twenty-year trend in the growth of the standard of living. As measured by the average of real per capita GDP and GDI, U.S. living standards have been eroding significantly for seven and one-half decades, falling from 2.2% per annum in 1971 to 1.3% in 2023, a loss of 41%. The Fed has the tools to reverse the monetary restraint, but the process will prove painstakingly slow. The fiscal imbalance may not be reversible since the budget deficit was not reduced significantly in the current economic expansion for the first time since the end of World War II. Moreover, neither major political party is offering a plan to address the prospect of significant budget deficits for years to come.

The Clarity of Detrending

Detrending, an indispensable and often overlooked aspect of economic analysis, takes on particular significance when analyzing the economic impact of the equation of exchange. Algebraically formulated by Irving Fisher in 1911, the equation of exchange states that money (M) times velocity (V) equals GDP (MV = GDP), with each of the components reflecting both cyclical and secular trends. An advancing economy requires an increase in net usable liquidity to facilitate the absorption of changes in the four factors of production - technology, capital, labor, and natural resources. When the Federal Reserve/Treasury Accord, reached in 1951 and fully implemented in 1953, ushered in floating Treasury rates, real M2 grew at an average of 2.9% while velocity (V2) declined on average -0.2% with a steady state growth (SSGR) in real M2 of 3.1%. SSGR would need to be greater than the trend rate of increase in real M2 to compensate for the drop in V2. If subtracting SSGR from the actual real M2 rate of increase rate equals zero, the economy is on a noninflationary path of trend economic growth. An above-zero reading would signal that the rate of increase in nominal GDP would move above the trend, resulting in either faster inflation, economic development, or a combination of the two. At the same time, a below zero reading would point to subpar economic conditions with either falling inflation, real growth, or a combination of the two. The necessity of detrending economic indicators cannot be overstated, as they provide crucial insights into assessing the future direction of economic activity.

Monetary Results

During the last four years, real M2 and real other deposit liabilities (ODL) fluctuated from highly stimulative/inflationary to extremely restrictive/disinflationary. Based on the annualized growth rate, detrended real M2 swung from slightly above zero in late 2019 to a post-1950 peak of 5.6% during 2021 to a deeply negative -2.6% in the last 48 months (Chart 1).

Detrended real ODL's pattern was similar, but the 2021 peak was a higher 6.6%, and the latest 48-month decline was 80 basis points deeper (Chart 2).