You don’t have to be an economic expert to recognize that very, very big things are happening in the US economy. While our economic outlook does not typically play a big role in our investment process, as we’ve written about in the past, (see here and here) we think it is critically important for investors to understand the economic context in which they are investing.
For much of the last decade, the key question investors needed to ask themselves to understand growth prospects was “by how much might demand increase over time?” But with the economy growing at historically unprecedented speed, the critical question has now been turned on its head so that investors need to understand “by how much might this company be able to increase supply?”
This key question, and its new mirror image, are a microeconomic expression of the macroeconomic question on everyone’s mind, “Can America expand our economic output capacity fast enough to meet the rapidly rising demand? Or, will demand overshoot supply leading to inflation?”
Without making any forecast about the future, investors can still seek to understand the critical aspects of the current economic context.
For instance, Americans have never made so much money! While the recession that struck in March 2020 was the fastest economic decline in history and very deep, American households brought in more income in 2020 than any year on record. That this was achieved due to massive transfer payments from the government is important for understanding context. But regardless, income received via wages or transfer payments represents American consumers’ purchasing power. And in the first quarter of 2021, income shot even higher.
This 30-year chart shows just how dramatic and historically unprecedented the surge in income has been.
Consumers have been both restricted in their ability to spend money and have likely desired to hold higher levels of savings due to the high levels of economic uncertainty. But this delay in spending means that American households currently have approximately $3 trillion more in their checking and savings accounts than they did pre-pandemic. And now, as those savings are starting to be spent even while wages begin to accelerate, consumer spending has rocketed to new all time highs. Indeed consumer spending today is almost certainly higher than it would have been if COVID had never happened.
With pre-pandemic consumer spending running at about $15 trillion a year, the $3 trillion in excess savings would fuel a 20% jump in spending. Or, if released slowly over the next 3-5 years, would be sufficient to provide a 4%-7% annual boost to consumer spending, which makes up 70% of the US economy.
While the stimulus bills passed during COVID were focused on helping households and businesses survive the COVID shock so that they could continue operating once the pandemic passed, the $4 trillion in infrastructure bills currently being debated are not meant to support the economy during COVID, but to invest the equivalent of nearly 20% of annual GDP into the physical and human capital of the United States.
Since this money is expected to be spent over eight years, it is better understood as a 2.5% of GDP ongoing investment for most of the next decade. While the full $4 trillion is unlikely to be passed, even just the Republican counteroffer of nearly $1 trillion still qualifies as a large, ongoing driver of additional demand. And don’t lose site of the fact that the Senate just voted on a bipartisan basis to approve $250 billion of new spending over the next five years to invest in scientific research and development. In any other year, a $250 billion research and development bill passing on a bipartisan basis would have been big news, but in today’s economic context, it is given only passing attention by many observers.
So, you don’t need to make any sort of forecast to simply observe that a tidal wave of money is going to be coursing through the US economy, not just in 2021 but for an as yet unknown period of time. A truly macro agnostic investor would simply ignore all of this and thus, implicitly assume that the most likely state of the economy in the years ahead would be the historically “normal” economic trends we’ve seen in the past. But to us, ignoring multi-trillion dollar tidal waves of money is not the mark of an investor who understands the difficulty of economic forecasting, but rather is a myopic point of view that ignores the unprecedented reality of the current US and global economy.
At the macroeconomic level, the amount of excess output capacity in the US economy to absorb increased demand is simply unknown. Up until the Financial Crisis, the Congressional Budget Office and other nonpartisan economic observers believed that the capacity of the US economy to deliver output increased by about 3% a year. This was made up of roughly 1% from population growth and 2% from enhanced productivity.
However, in the decade after the Financial Crisis, economic observers watched real economic output increase by just 2%, rather than 3%, per year and over time came to the conclusion that something structural had changed, which meant that the US economy was now permanently unable to increase our economic output in the ways that generations of Americans had done successfully ever since we emerged as a developed economy and global world leader in the wake of World War II.
In this chart, the red line shows the actual GDP of the united states. The other lines are the nonpartisan Congressional Budget Office’s (CBO) estimates of what potential GDP – our countries capacity to produce goods and services – would be over time. Each of the other lines are marked with a year, which is the year in[…]