Political Calculations
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30 March 2023
The High Cost of Living Upheaves the Nation - New York Tribune Magazine and Review, 10 August 1919

In late 2020, the policy makers of the Biden administration and its partisan supporters started crafting a new COVID stimulus package. What they wrought set off a chain of events that ultimately led to the cost of living and banking system crisis we face today.

It didn't have to be that way. When they started their discussions, the participants had modest goals for what an additional stimulus would look like. Considering the federal government had just enacted its fourth Covid relief package on 27 December 2020, totaling $900 billion, no one at the time was advising the Biden administration to pursue for another stimulus of similar size, much less one that was $1 trillion larger.

That changed quickly after 5 January 2021, when President Biden's political party gained control of the U.S. Senate after runoff elections in Georgia came out in their favor.

With control of the U.S. Congress in hand, the most rabidly partisan among President Biden's supporters quickly switched gears to exercise their new political power. Instead of linking the magnitude of any new stimulus package to the actual scale of the problem the U.S. economy was facing at the time, they decided they would "go big", putting their fringe political agenda ahead of sound fiscal policy.

But in ditching sound fiscal policy, they opened a rift among those who had been crafting the new stimulus measure. That rift took the form of an academic controversy that erupted while they were developing what would ultimately become the American Rescue Plan Act, which the Biden administration rammed through Congress and signed into law on 11 March 2021.

The controversy involved an economic concept known as potential output, or potential GDP. Here's a quick primer:

Potential output is an estimate of what an economy could feasibly produce when it fully employs its available economic resources. The Congressional Budget Office (CBO) estimates potential output by estimating potential GDP, which it describes as "the economy's maximum sustainable output." The word "sustainable" is important — it doesn't mean that the entire working-­age population is working 18 hours per day or that factories are operating 24/7. Rather, it means that economic resources are fully employed — at normal levels. Potential output (estimated as real potential GDP) serves as an important benchmark level against which actual output (measured as real GDP) can be compared with at any given time.

The difference between the economy's potential output and its actual output is called the output gap, which economic policy makers must consider when shaping major fiscal policies. If they adopt policies that undershoot the gap, they will fail to obtain the full positive results they seek at the cost of greatly adding to the nation's debt. If they overshoot the gap, they risk creating adverse economic conditions, like inflation, that can fully undermine whatever positive results they hoped to achieve.

These scenarios were known risks at the time the Biden administration was pushing the American Rescue Plan Act forward. In fact, because the stimulus package they were considering had swelled to $1.9 trillion, the risk of creating inflation became a primary concern among the more fiscally responsible members of Biden's policy making team. But they lost the internal argument when President Biden sided with the most extreme elements among his supporters.

That victory didn't make the likelihood the enormous new stimulus package would almost certainly overshoot the output gap and create persistent inflation go away. By Inauguration Day, the progressive activists who hijacked the stimulus development still needed to dispell that risk to ensure they could get the massive stimulus through a still closely-divided Congress. Their chosen path to achieve their political agenda would hinge on an assumption cooked up by the Biden administration's most rabidly partisan supporters: that the nation's potential GDP and output gap were much larger than the CBO estimated and thus, would not create inflation. That assumption would become the focal point of the controversy for how the stimulus bill could negatively impact the economy.

On 3 February 2021, the Committee for a Responsible Federal Budget discussed how the assumptions of the size of potential GDP and the output gap being put forward affected the forecasts of how much the stimulus could overshoot the output gap:

The output gap could differ from CBO's projections. Many forecasts and experts suggest the economy will grow faster this year than CBO estimates. A one percentage point increase in Gross Domestic Product (GDP) growth would reduce the output gap to less than $200 billion, in which case the American Rescue Plan would be large enough to close eight to ten times the output gap based on the Edelberg and Sheiner numbers. On the other hand, many have argued that CBO is underestimating full employment and potential GDP. If potential GDP were 1 percent larger than CBO's estimate, the output gap would total $1.3 trillion through 2023 and the America Rescue Plan would close 115 to 145 percent of the output gap.

The "Edelberg and Sheiner numbers" refer to a 28 January 2021 analysis of the Biden administration's proposed stimulus produced by the nonpartisan Brookings Institute's Wendy Edelberg and Louise Sheiner. Just a few weeks later, Sheiner would join with Brookings' Tyler Powell and David Wessel to report on the controversy related to potential GDP that had erupted among those who were giving input to the Biden Administration's first major economic policy initiative:

As President Biden and Congress negotiate the next fiscal stimulus package to aid the COVID-19 economic recovery, they will implicitly be making assumptions about the output gap. Analysis by one of us (Louise Sheiner) and our Brookings colleague Wendy Edelberg suggests that Biden’s $1.9 trillion package would result in GDP reaching its pre-pandemic path by the end of 2021 and exceeding it in 2022. In other words, some of the economic activity lost during the pandemic would be made up after the virus subsides.

Based on the CBO’s recent estimate of potential GDP, though, this would leave a large positive output gap—peaking at 2.6 percent in the first quarter of 2022. Some critics — including former Treasury Secretary Lawrence Summers — argue that pushing output this far above potential could drive up inflation.

Others, including Nobel Laureate Paul Krugman, warn against putting too much emphasis on a projected output gap in determining the riskiness of a large fiscal stimulus. They note the significant uncertainty that surrounds any estimate of potential GDP. Indeed, by CBO’s estimates, the U.S. economy was operating above potential in 2019, yet inflation remained subdued and below the Fed’s 2 percent target. Moreover, there is little historical precedent to predict how the pandemic will affect potential output or consumer and business demand once the virus recedes.

With hindsight being 20/20, we know that Larry Summers' view was correct. President Biden's COVID stimulus overshot the output gap and created significant inflation, which quickly became evident after its enactment. Mainstream economists using different methodologies indicate the American Recovery Plan Act played a "sizable role" in causing inflation, adding anywhere from 2.6% to 3.5% on top of the inflation rate that would have been recorded without President Biden's $1.9 trillion stimulus.

Bianchi and Melosi (2022) Figure 3: Inflation, Federal Funds Rate, and Output Gap Actuals and Counterfactuals

That inflation was allowed to fester for a full year because of a commitment the Federal Reserve made to hold rates near zero percent for as long as possible. It took Americans seeing prices inflate faster than their incomes to finally force the Fed to address the inflation they allowed to gain traction with a series of interest rate hikes beginning in March 2022. Flashing forward one year later, the actions to fix the inflation unleashed by the stimulus measure has had negative impacts on large sectors of the U.S. economy, such as the housing market, and directly contributed to the bank failures that became front page news during the last few weeks.

The Biden administration cannot say they were not warned. Here's the prescient commentary from Larry Summers' 4 February 2021 op-ed in the Washington Post:

... while there are enormous uncertainties, there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability. This will be manageable if monetary and fiscal policy can be rapidly adjusted to address the problem. But given the commitments the Fed has made, administration officials’ dismissal of even the possibility of inflation, and the difficulties in mobilizing congressional support for tax increases or spending cuts, there is the risk of inflation expectations rising sharply. Stimulus measures of the magnitude contemplated are steps into the unknown.

In another op-ed some three months later, Summers provided the epitaph for the inflationary failure of the Biden administration's first major economic initiative with just a simple, understated clause:

Excessive stimulus driven by political considerations was a consequential policy error...

The Biden administration and its extremist political supporters chose to purposefully overshoot the output gap and pretend it would not create the adverse economic conditions that are undermining whatever positive results they hoped to achieve with their $1.9 trillion stimulus. Today, they're expending much effort trying to avoid accountability for their roles in causing the catastrophic consequences of what is becoming the biggest policy error in generations.

Then again, if they weren't honest about it from the beginning, why would they start being honest and take responsibility for their failings now?


Martin Wolf. Interview with Larry Summers: ‘I’m concerned that what is being done is substantially excessive’. Financial Times. [Online Article]. 11 April 2021. Here's a video of the full interview:

François de Soyres, Ana Maria Santacreu, and Henry Young. Demand-Supply Imbalance during the COVID-19 Pandemic: The Role of Fiscal Policy. Federal Reserve Bank of St. Louis Review. First Quarter 2023, 105(1), pp. 21-50. [PDF Document]. DOI: 10.20955/r.105.21-50. 20 January 2023.

Francesco Bianchi and Leonardo Melosi. Inflation as a Fiscal Limit. Federal Reserve Bank of Chicago Working Paper No. 2022-37. [Online Article]. DOI: 10.2139/ssrn.4205158. 21 September 2022.

Doreen Fagan. Understanding Potential GDP and the Output Gap. Federal Reserve Bank of St. Louis Open Vault Blog. [Online Article]. 4 August 2021.

Committee for a Responsible Federal Budget. How Much Would the American Rescue Plan Act Overshoot the Output Gap. [Online Article]. 3 February 2021.

Wendy Edelberg and Louise Sheiner. The macroeconomic implications of Biden’s $1.9 trillion fiscal package. Brookings Institute Up Front. [Online Article]. 28 January 2021.

Tyler Powell, Louise Sheiner, and David Wessel. What is potential GDP, and why is it so controversial right now? Brookings Institute Up Front. [Online Article]. 22 February 2021.

Image Credit: Chronicling America. The High Cost of Living Upheaves the Nation. New York Tribune Magazine and Review. p. 1. [Online Database]. 10 August 1919.

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29 March 2023
Gold Price by Anne Nygård via Unsplash - https://unsplash.com/photos/g9EoUnFuqyM

Just over a year ago, we took a snapshot of the relationship between gold prices and real interest rates as indicated by the yield on inflation-adjusted 10-year constant maturity U.S. treasuries.

That original snapshot was taken on 17 March 2022, one day after the U.S. Federal Reserve started what became series of rate hikes that lifted the effective Federal Funds Rate from 0.08% to 4.83% to combat inflationary forces unleashed by the Biden administration a year earlier.

Because gold is used by investors as a hedge against inflation, rising in value when inflation-adjusted interest rates fall or turn negative, the rising rate environment the Fed has created over the past year should have reduced the price of gold by a substantial amount. When we took our snapshot on 17 March 2022, the gold spot price was $1,944.05 per ounce and the real yield of the 10-year Treasury was -0.72%.

One year later, on 17 March 2023, the spot price of gold had risen to $1,988.11 per ounce, while the inflation-adjusted 10-year yield had swung to +1.29%. That increase occurred despite the Fed's rate hikes pushed real interest rates to swing from negative to positive.

In between these dates, the price of gold fell for a time, but only while real interest rates were increasing and not by anywhere near as much as the 15-year long relationship between the two would have predicted. But that expected trend stopped after 3 November 2022, when the real 10-year Treasury yield peaked at +1.74% and the price of gold hovered around the $1,629 level, near its lows during the Fed's rate hike cycle.

After that date, the real yield of the 10-year Treasury fell back while the price of gold escalated. Our new snapshot of the relationship between spot gold prices and inflation-adjusted 10-year Treasuries illustrates these changes.

Gold Spot Price vs Inflation-Indexed Market Yield of 10-Year Constant Maturity U.S. Treasury, 2 January 2007 - 17 March 2023

If the 15-year long relationship from 2 January 2007 through 16 March 2022 between the price of gold and real 10-year Treasury yields still held (shown by the dashed black curve in the chart), the price of gold would have fallen $850 per ounce more than it has. If the price of gold dropped to where it was trending between 17 March 2022 and 3 November 2022, which would be considered recent history, it would be about $350-$400 lower per ounce than it is for a similar real 10-year yield.

But it has risen higher, which raises new questions about what's driving the price of gold. The staff at Goldmoney, who have a more sophisticated model than we do, think there has been a paradigm shift. In the following excerpt from Part I of their analysis, we've added the links to the referenced exhibits, but not the boldface font, which appears in Goldmoney's original article:

Over the past few months, the gold price has once again detached from the model’s predicted price. And it has done so in a remarkable way. First, the delta between the observed gold price and the model-predicted price has reached an all-time high. Current gold prices are more than $400/ozt over model predicted prices (See Exhibit 2). The previous all-time high was $200/ozt and it only lasted for a short period of time.

Second, this is happening in the most unlikely of all environments. The Fed has been aggressively hiking rates for the past 12 months to fight the highest inflation in over 40 years. The Fed raised the Fed Funds rate from 0% to 4.5% in just 12 months. It is very rare that we see such large rate hikes from cycle bottoms. In fact, this has only happened five times since 1975 that the Fed raised rates more than 4% from the bottom (see Exhibit 3)....

Yet despite all this, gold prices have not just held their ground; they have actually risen! Arguably, it could be that the gold market once again has simply got ahead of itself. Or we really do see a paradigm shift this time.

Before we continue exploring this thought, we must add one caveat here. In our models, we use publicly available data for net central bank sales/purchases. The official data from the IMF is notoriously lagging and incomplete, and we are certain that the reported net purchase numbers are much too low. The World Gold Council (WGC), for example, reports net additions of 1136 tonnes in 2022, more than double the 450 tonnes bought by central banks in 2021. It’s no secret that central banks have been on a buying spree in the second half of last year. But exactly how much gold they added remains a bit of a mystery. That said, even assuming that true central bank gold purchases exceeded the WGC estimates by a massive 50% would bring the model-predicted price only about $70/ozt closer to the observed price. We believe this is partially a shortcoming of our model, as it is based on historical data, and we have not seen a lot of volatility in CB gold purchases in the past. However, we have had years with large central bank purchases before, and we had years with higher overall gold demand from all sectors, and yet this didn’t lead to large distortions in our model. Hence, we don’t think central bank purchases can explain the current huge discrepancy between predicted and observed prices.

Therefore, in our view, the only reason for gold prices to detach from the underlying variables in our model by such a large amount and for such a long time is that the gold market finally starts pricing in that there is a risk central banks, particularly the Fed, are losing control over inflation, which is remarkable given the prevailing narrative that the Fed is willing and able to do whatever it takes to bring inflation under control.

Here's the bottom line from Part II of their analysis:

We believe that the most likely explanation for the recent rally in gold prices against the underlying drivers of our model is that the market is increasingly pricing in that the Fed, once it is forced to stop hiking, will lose control over inflation. Faced with the choices of years of high unemployment and a crumbling economy or persistent high inflation, the gold market thinks the Fed will opt for the latter. This would mark a true paradigm shift, and from that point on, gold prices may start to price in prolonged high inflation (and our model may not be able to capture this properly).

If true, a lot of models will be as broken as our simple model already is! Then again, in the immortal words of George Box, all models are wrong, some are useful. The trick is to know when they work, because relying on a failed model after its expiration date can lead to catastrophic consequences.

Previously on Political Calculations

Image credit: Photo by Anne Nygård on Unsplash.

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28 March 2023
New Single-Family Homes Sold Not as Large as They Used to Be - Source: U.S. Census Bureau - https://www.census.gov/content/dam/Census/library/stories/2020/12/new-single-family-homes-sold-not-as-large-as-they-used-to-be.jpg

February 2023 saw the market capitalization of new homes sold in the U.S. rise for the first time in eleven months. A combination of a higher number of new homes sold and a small increase in the average sale price of new homes sold contributed to the first increase in this measure since March 2022.

While these changes are based on preliminary estimates, they do confirm the change in momentum observed a month earlier. In January 2023, the decline in the market cap of new homes sold slowed for the first time in months. The new data indicates positive momentum building in the market, which in turn helps explain why U.S. homebuilders were becoming more optimistic last month.

Much of that optimism is tied to the direction of mortgage rates, which fell in February 2023, helping make new homes more affordable. We'll take a closer look at the trends for the affordability of new homes sometime in the next week, but for now, here's the latest update to the big picture for new home builders and the U.S. economy.

Trailing Twelve Month Average New Home Sales Market Capitalization in the United States, January 1976 - February 2023

This chart shows the time-shifted rolling twelve month average of the U.S. new home market capitalization for February 2023 is $25.41 billion. That figure represents a small increase from January 2023's revised $25.34 billion. The following two charts show the latest changes in the trends for new home sales and prices:

Sales of new homes increased:

Trailing Twelve Month Average of the Annualized Number of New Homes Sold in the U.S., January 1976 - February 2023

New home prices rose a small amount:

Trailing Twelve Month Average of the Mean Sale Price of New Homes Sold in the U.S., January 1976 - February 2023

The question for new home builders is whether this positive momentum can overcome the negative conditions that are developing in the U.S. economy. We anticipate it will continue in March 2023, but what happens after the first quarter of 2023 ends will hinge on other economic factors.


U.S. Census Bureau. New Residential Sales Historical Data. Houses Sold. [Excel Spreadsheet]. Accessed 23 March 2023. 

U.S. Census Bureau. New Residential Sales Historical Data. Median and Average Sale Price of Houses Sold. [Excel Spreadsheet]. Accessed 23 March 2023. 

Image credit: U.S. Census Bureau: New Single-Family Homes Sold Not as Large as They Used to Be.


27 March 2023
Wall Street Stock prices up - Source: WikiMedia Commons

The S&P 500 (Index: SPX) climbed 1.4% from the previous week's close to wrap up the trading week ending Friday, 24 March 2023 at 3970.99.

During the week, dividend futures rebounded from the previous week's low for the quarter. However, the bigger story is that expectations took hold the Federal Reserve is done with rate hikes after hiking them by a quarter point on Wednesday, 22 March 2023 and will be swinging to cut rates instead in the weeks ahead.

The latest update to the alternative futures chart shows the S&P 500's trajectory continued persistently tracking below the redzone forecast range we established almost three months ago, which has now reached its end.

Alternative Futures - S&P 500 - 2023Q1 - Standard Model (m=+0.0 from 6 January 2023) - Snapshot on 24 Mar 2023

With the increased focus on how the Fed will adapt its monetary policies during 2023-Q2, the Fed's rate hike provides a valuable calibration point we can use to quantify the shift in the value of dividend futures-based model's multiplier. The model requires the multiplier's value be set according to empirical observations, where a first pass suggests it has shifted from 0.0 to +1.5 as a result of the interest rate hike-induced distress in the U.S. banking system. That new shift follows the multiplier having recently shifted from +2.0 to +0.0 in early January 2022.

The next chart sets up the new hypothesis test utilizing a multiplier of about +1.5 starting from 9 March 2023, coinciding with the development of the then-impending failure of Silicon Valley Bank.

Alternative Futures - S&P 500 - 2023Q1 - Standard Model (m=+1.5 from 9 March 2023) - Snapshot on 24 Mar 2023

With this shift in multiplier, we see the redzone forecast range adjust accordingly, as if we has made the assumption the multiplier, m, would shift from +0.0 to +1.5 on 9 March 2023 from the very beginning. This visual adjustment is an artifact of how we set up redzone forecast ranges, where we anchor one point in the past and the other in the future to allow them to dynamically adapt along with changes in future expectations.

Going forward, we're starting with the assumption that m = +1.5 and that investors are focusing on 2023-Q2 in setting their forward-looking focus. Ideally, we should see the trajectory of the S&P 500 track along within a few percent of the alternative future projection associated with 2023-Q2. In reality, we anticipate a higher level of volatility driven by the onset of new information.

Speaking of which, here are the past trading week's market moving headlines:

Monday, 20 March 2023
Tuesday, 21 March 2023
Wednesday, 22 March 2023
Thursday, 23 March 2023
Friday, 24 March 2023

After the Federal Reserve's quarter point rate hike on 22 March 2023, the CME Group's FedWatch Tool now anticipates the Fed has finished the series of rate hikes it began a year earlier. From the current Federal Funds Rate target range of 4.75-5.00%, the FedWatch tool predicts the Fed will be forced initiate a series of quarter point rate cuts at six weeks intervals starting after the FOMC meets on 26 July (2023-Q3) and continuing through December (2023-Q4). In 2024, the FedWatch tool projects at least one quarter point rate cut per quarter through September (2024-Q3), when the Federal Funds Rate target range will have fallen to 2.75-3.00%.

The Atlanta Fed's GDPNow tool's projection for real GDP growth in the first quarter of 2023 held steady at +3.2%. With the first calendar quarter of 2023 nearly over, the GDPNow indicator continues transitioning to look backward instead of forward. The Bureau of Economic Analysis' initial estimate of GDP in 2023-Q1 is scheduled to be released on 27 April 2023.

Image credit: WikiMedia Commons. Creative Commons: CC0 1.0 Universal (CC0 1.0) Public Domain Dedication.

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24 March 2023

The Edge Hotel School at the University of Essex has unleashed the power of geometry to give its students an edge within the very competitive hospitality industry. They've identified the optimal angle for slicing potatoes to craft the ultimate roasted potato dish.

Their two-minute long video summarizes their research findings:

By slicing a potato in half along its long axis, then cutting the halves at a 30-degree angle, they maximize their surface area of the potatoes, which leads to better tasting results when they're roasted.

Economically prepare better tasting food is a very big deal in the hospitality industry. Developing a method of economically preparing a better tasting roasted potato can indeed make a difference at the margin. A difference that can determine success or failure in an industry known for having relatively low net margins.

HT: The UI Junkie.

Previously on Political Calculations

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