The U.S. Economy.

Are we heading into a recession? Did we ever really come out of the last one? Do market fundamentals matter anymore? How did Democrats miss so badly on the economy, leading to the re-election of Donald Trump? Is capitalism collapsing?

It’s difficult to get a proper read of the U.S. economy. It’s a giant, complex juggernaut that both relies on global markets and holds them all together. There is no unifying economic or political theory to provide clarity as the biggest economy in world history continues to navigate uncharted territory.

I’ve wanted to have this discussion for a while now because there are concerning signs on the eve of another Trump administration. Here’s how we’ll break it down. We’ll start by level setting with some assumptions, or assertions really; points that we need to agree upon before delving into an economic analysis. Then we’ll move through an analysis of objective macroeconomic trends analysts typically rely upon to forecast economic activity.

I’ve asked a good friend in the industry whom I trust to weigh in on key points further in the essay to keep me honest. I think you’ll appreciate the exchange.

Here are the fundamentals we must agree upon to move forward:

1. The stock market is not the economy.
2. The United States economy is the global economy.
3. Market based economies are cyclical by definition.
4. The rate of change in the labor market is faster than any time in history.
5. Inequality is a condition of capitalism and rampant inequality leads to social unrest.
6. Sentiment is just as powerful as any data point.
7. The single biggest economic force is greed.

One by one now…

Fundamentals

The stock market is not the economy.

Our corporate media culture conflates the stock market with economic health. When the market crashes it is presumed by many that the economy is out of balance. Likewise, when the markets are ripping there’s a sense that everything is okay in the world even when it might be quite the opposite.

While they are related, they are not directly correlated. Equities have been on an unstoppable run since the 1980s when changes to the tax code were first introduced and stock buybacks were legalized. This was followed by changes to executive compensation in the ‘90s that tied tax rates to performance metrics, thereby incentivizing the corporate class to reduce executive wages and artificially boost profits.

In the aughts investors had more asset class options, such as real estate. The Federal Reserve brought the Federal Funds Rate to a low of 1% in the middle of the first decade and encouraged speculative behavior, which led to massive inflows of capital into several parts of the economy. It then reversed course over the next five years, quadrupling rates and hastening the subprime mortgage collapse. At the start of the Obama administration, rates came down to effectively zero followed by several years of quantitative easing to salvage the banking industry.

The net result of this was a massive influx of free money into the financial system and equities haven’t looked back since that time. In fact, the stock market gains over the past 15 years are bigger than at any time in history and it’s not even close. And yet, these gains haven’t been felt in the wider economy as economic inequality continues to grow.

The United States economy is the global economy.

We’ve addressed this one before. There are two economies that matter in the world: The U.S. and China. If you read the headlines or watch the news you might be fooled into thinking that China is about to overtake the United States, the dollar is going to be replaced as the world’s reserve currency and that we should all be studying Mandarin. So again, for posterity: The U.S. economy is 40% larger than the Chinese economy. We’re growing, they’re slowing. Our population is around 350 million. Theirs is 1.4 billion. They have a billion more people than us. It’s not even fucking close. Also, we are China’s number one trading partner. Without our purchasing power it all falls apart for them. We are it. We’re the biggest. Happy now?

Market based economies are cyclical by definition.

I could go on for days about how we do not exist under a pure capitalist system, but rather a perverted form of oligarchic state-sponsored capitalism.

I won’t. But I could.

Over the past 250 years we have operated under a market-based economic system. The opposite of this is the pre-industrial closed feudal system. The various “isms” we talk about are related to social doctrines—i.e., how capital is organized and distributed—and not the underlying theory of markets. Socialism, communism, capitalism, libertarianism and everything in between are all organized around the principles of markets. Buyers and sellers, producers and consumers.

As such, cycles are inherent to market systems. Early, growth, peak, decline and late stage, and there are fundamental characteristics to each phase. What politicians and economists try to accomplish is to mitigate any negative effects of each stage through a complex system of carrots and sticks, incentives and disincentives. These show up in the form of interest rates, tariffs, money supply and government investment. But the cycles are a reality of the market based system so the question at any given time is, “where are we in the current cycle?” based upon certain indicators.

Now, there are a couple of factors. Not everyone shares the same view of where we are in a cycle and weeks, months and years make a huge difference. Which levers should be pulled is also a matter of opinion based on past indicators and estimates. Moreover, these past indicators aren’t foolproof as the underlying conditions change over time due to factors such as population growth or decline, access to natural resources, geopolitical forces like war and social unrest, policy changes that impact supply chains, interest rates, commodity prices and the like. And, of course, the biggest modern X-factor: Climate change. So as much as markets are fundamental to the global economy, they are difficult to predict and impossible to govern. But one thing is certain: what goes up…

The rate of change in the labor market is faster today than any time in history.

I will have to make the case for this one as it is a departure from historical norms. We’ve written at length about Schumpeter’s theory of Creative Destruction. Essentially, technological changes create upheaval in the labor market over time. The most classic example is the rapid evolution from the horse and buggy to the automobile. While it was a seismic change that continues to yield enormous consequences to this day, the transition occurred over a few decades. The saddle makers became brake manufactures, the stable owners opened warehouses, buggy and whip makers became auto parts manufacturers and so on.

Importantly, the actual people didn’t change their profession; the idea of re-skilling and retraining is largely fallacious. What really happened was that the labor force turned over across one or two generations depending upon the impact of a particular innovation.

My contention here is that the impact of AI is only beginning to emerge and holds the potential to upend the labor force in an unprecedented way. It’s only been two years since the launch of ChatGPT and it has already changed the way many of us work. At a minimum it has changed the way we view work. Because we have moved to a service and knowledge economy, the rapid adoption of artificial intelligence will have enormous consequences across multiple industries. Entire swaths of mid-level functions at first, and then higher level functions as the technology improves, will disappear.

Now, in the past we’ve seen supporting industries appear to facilitate the technological disruptions and replace the outmoded industries. I started out in the radio broadcasting field and went into the newspaper business. I know a thing or two about these kinds of transitions and the disruptions that occur. This time is different.

Radio was replaced by satellite radio, then Pandora and Spotify, but the creator economy grew and diversified as a result and over time the labor force shifted. News and information went online and web development jobs took the place of print shops and distribution channels. I’m sure mechanics who can fix a combustion engine will be around for a while longer and when there are no more gas powered vehicles on the road, there will still be EV mechanics and manufacturing plants, makers of charging stations and so on.

But in the knowledge and service economy, we’re going to see something different. Productivity rates will skyrocket in the next several years as AI is infused into every process at every stage of a traditional buyer’s journey. And then what? We will learn to do more with less. More work with less employees that is. There will be no AI bot service centers. Coding jobs won’t be replaced by ChatGPT prompting jobs, that’s a childish observation.

Point being, this is going faster than we realize, and the generational labor market turnover is going to look more like a turn under; like turned under the till and churned into the ground.

Inequality is a condition of capitalism and rampant inequality leads to social unrest.

Now we get into the socio part of socioeconomics. Conservatives think inequality is just sour grapes. They think the system works as it should and that financial rewards are just the way it is. Work hard, get paid. America is the land of opportunity. We’ve dispensed with this logic from day one of our podcast and there’s more than enough data, research and information out there to debunk this. But inequality in America has led to something more than haves and have nots.

The corporate colonial system we live under today has ripped apart the social and political fabric of our democracy. Decades upon decades of deregulation has allowed the plutocrats in charge to change the rules of the market system. They get free money from the treasury and pack it into investment vehicles with guaranteed returns. They have upended labor protections and social welfare programs that protect the poor and working classes and taken control of the levers of political power. They’ve turned the masses into wage slaves and are determined to strip away the last vestiges of the social programs designed to undergird the working class.

Inequality is an inherent characteristic of market based systems. It’s social theories that differ in terms of how to handle it. The concepts related to social economic conditions revolve around ownership of the means of production, the rights of workers, whether healthcare is a right or a privilege, does the justice system exist to protect property rights or people, and the like. When a society reaches the limits of inequality such that we’re experiencing, whether it’s under the thumb of a corrupt despot or the corporate colonial state, the social contract unravels and can lead to unrest.

And as we said before, social unrest is one of those conditions that can upend all pure economic metrics.

Sentiment is just as powerful as any data point.

Donald Trump is the president again because the Democratic establishment ignored the sentiments of the masses. Americans are stretched thin and stressed out and the Democrats acted as though nothing is wrong with the system. Likewise, when consumer sentiment collapses—which can happen for any number of reasons—it creates a contagion of fear that becomes a self-fulfilling economic prophesy.

The single biggest economic force is greed.

Adam Smith. David Ricardo. Karl Marx. John Maynard Keynes. The reason these figures continue to loom over the field of economics is they understood human nature and the impulse of greed. Adam Smith may be a curious entry on this list because his legacy has been reduced by conservatives to the father of capitalism and the invisible hand. As John Kenneth Galbraith wrote of him, “Adam Smith is far too wise and amusing to be relegated to conservatives, few of whom have ever read him.” For if they had read Smith closely, they would immediately recognize his antipathy toward corporations and their predilection to rapacious behavior.

The great economists who endure are, as individuals, greater than the sum of all contributions before or since. So many theories we rely on today, whether it’s Milton Friedman’s belief that corporations exist solely to maximize shareholder value, Ronald Coase’s eponymous theorem that markets resolve friction better than governments, or the neoliberal extrapolation of the Laffer Curve that states tax rates will stifle innovation and returns, are just that: theories. Ideas that support the unmitigated abundance of the corporate class.

All of them fall apart due to the overriding force of greed.

A Word About “Social Balance”

Let’s revisit Galbraith to help set the table. This is from a chapter in his book The Affluent Society titled “The Case for Social Balance.”

“The conventional wisdom holds that the community, large or small, makes a decision as to how much it will devote to its public services. This decision is arrived at by democratic process. Subject to the imperfections and uncertainties of democracy, people decide how much of their private income and goods they will surrender in order to have public services of which they are in greater need. Thus there is a balance, however rough, in the enjoyments to be had from private goods and services and those rendered by public authority.”

Galbraith is widely considered one of the most influential economic thinkers of the mid-20th Century. The Canadian born economist spent most of his career teaching at Harvard, but was of service to several U.S. administrations and had the biggest influence on John F. Kennedy. (Fun fact, he coined the term conventional wisdom.)

It’s stunning really. This is how economists in the Keynesian tradition used to think and speak. They thought about social contracts, public services and institutions. It wasn’t until the Friedman and Hayek neoliberal era that we began thinking in such cold hearted corporate terms about the overall economy. Galbraith lived long enough to witness the turn of the century and the evolution of neoliberal thinking, but I think even he would be shocked to see just how far we’ve moved away from classical thinking about systems and social balance.

If we think back to that time of transition from the post-Keynesian Galbraith era and the Neoliberal Chicago School era, there have been seven technical recessions: 1973, 1980, 1981, 1990, 2001, 2008, 2020. This is defined as two consecutive quarters of negative growth and is thereby called in retrospect. And with the benefit of hindsight we can pinpoint reasons for each of these, ranging from cycle norms and oil shocks to the housing collapse and global pandemic. It’s always difficult to see things clearly in the moment but what’s instructive is how our response to them has changed over time.

When I look out at the economic landscape on the eve of Trump’s second term I’m as baffled as I am concerned. It’s not entirely clear to me, for example, that we ever made it out of the financial crisis recession. I’ll give my reasoning below, but if that’s the case then Trump’s platform would be nothing short of catastrophic because it will tear safety nets to pieces.

Macro Trends

There is nuance to every economic cycle and there’s only so much historical trends can tell us about modern circumstances, particularly given the pace of change in the workforce due to technological innovation. But there are six objective trends or macro data points that typically tell the story of where we are in an economic cycle. I’m going to go through each one of them and give you two takes on them. My take and a friend of mine who is a macroeconomic financial analyst and shall remain nameless. But I really trust his perspective and he’s a good gut check for my pessimism.

Labor

The first is labor. The labor headline is typically about the unemployment rate. Here’s the issue with that. The unemployment calculation is the number of unemployed divided by the labor force and multiplied by 100. Great.

The contentious part of this number is the definition of the labor force, which is defined as the civilian population above the age of 16. Curiously, there’s no age limit so anyone over what we would consider retirement age is still part of the labor force if they are actively seeking employment or currently employed. Incarcerated citizens, members of the military, enrolled students and anyone who isn’t actively seeking employment for more than four weeks is considered outside of the labor force. Importantly, this figure includes part-time and gig workers, which make up about 17% of the workforce currently.

There are reporting and classification problems with this but it does make for a useful headline talking point to generally put a finger on the pulse of the nation. But economists look more closely at something called labor participation rate. This is a measurement of those who are 16 and over, non-institutionalized, and employed or actively seeking employment as a percentage of the total population. So who’s working and who wants to work.

Here’s where my friend and I differ. My glass half empty take stems from a historically low labor participation rate.

Source: St. Louis Fed

Right now, the rate is around 62%. It recovered from the shock of the pandemic but it’s since leveled off and that’s concerning. The last time we hit this low of a rate was the early 1970s. That said, the highest this number has even been was 67% at the turn of the millennium. Even still, we’re talking about millions of people.

Now, on the flip side, here’s the macroeconomic financial analyst’s response to this.

Macroeconomic Financial Analyst: “Yes, the labor market has aged significantly, and the retirement of baby boomers is a primary driver of the sustained low LFPR. While the overall LFPR is historically low, the prime-age workforce participation rate is a better measure of the labor market’s vitality. It reflects the active segment of the workforce without being skewed by demographic trends like aging. As such, focusing on prime-age participation gives a clearer and more actionable understanding of labor market conditions.”

Source: St. Louis Fed

So if we take his preferred vision of the prime rate of workers between the ages of 25 and 54, we’re near an all-time high of around 83.5%. Double edged sword. This number rose rapidly under Reaganomics as more households were forced to move from one-income to two-income families. I’ll let the sociologists hash out the upside and downside of this, specifically on female empowerment in the workforce, but it’s worth mentioning. Here’s my bigger takeaway.

Boomers are expensive. And they’re retiring. So here’s the math problem we have. The average household savings among boomers is $289,000. But inflation has chipped away at living expenses, healthcare costs are rising and end of life care is beyond reach. Many of the boomers rely on social security and Medicare or Medicaid. Even with health coverage as it is today, the cost of living is growing rapidly and exceeding income from investments and social security. As boomers age, the responsibility is going to fall on GenXers to fill in the gaps and here’s the problem. The average GenX household has only $82,000 in savings.

Manufacturing

ISM Manufacturing data measures sentiment among manufacturers. ISM Manufacturing data has yet to recover. This is perhaps the most authentic recession trend figure that exists. If you zoom out to look at the trendline over time, the data have been steadily depreciating over the past decade.

Source: Trading Economics

This essentially measures the health of the manufacturing sector and it’s pretty black and white. What it tells us is that the overall manufacturing economy remains soft compared to nearly all prior cycles over a 50 year period. In fact, the only time ISM data were at this level in prior periods was during the recessions listed above.

Macroeconomic Financial Analyst: “ISM is a survey based measure. Not only have the participants not been as willing to talk as they were in the past, the financialization of economic data is skewing the results of the survey to a more negative tone and are clearly not indicative of what is really happening in the economy. The world has changed and ISM has not.”

Point-counterpoint. Fine. However, a willingness to talk or not doesn’t skew the data, it just reduces the sample size. I’ll concede that a survey based measure isn’t as precise as hard and fast figures, but you can’t diminish the importance of sentiment. The fact remains that ISM is a consistent indicator of recessionary trends over a long period of time and the numbers are stubbornly depressed below cycle norms for a couple of years now. In other words, manufacturing would appear to be stuck in a late stage cycle.

Debt

Here’s what I wrote to my friend: Household debt is at unprecedented levels. Hard stop. Student debt is also unprecedented. To which he responded…

Macroeconomic Financial Analyst: “Don’t get me started on household credit. Yeah the levels are higher but that is meaningless. Household credit needs to be evaluated relative to incomes and total net worth. What If I told you Household Debt Service Payments as a percent of Disposable Personal Income is lower now that it was 11 years ago?”

I would say two things. One, fair point. But, more importantly, 11 years ago was 2013. We weren’t in great shape then either. Debt service relative to disposable income being less than that period is a positive indicator, to be sure. But what happens when the cycle flips, we head into a downturn, interest rates remain high so refinancing isn’t an option, more people are out of work and debt is still at a peak?

Give up? I believe the answer is a consumer debt collapse similar to the housing collapse but more distributed because it will include the 35% of Americans who rent as well. Now it won’t be as deep as the housing crisis because you’re talking about the primary wealth building asset of most families in this country. But it will be more widespread. And if it happens on Trump’s watch, do you think they’ll come to the rescue for working class Americans like they did for businesses in the pandemic? Do you think they’ll send checks to individuals so they can buy food like Trump and Biden did during the pandemic?

Something makes me think they won’t be as sympathetic to a crisis that they will blame on people having too much debt. The narrative will be the same as it was during the housing crisis: it was the working class that got too greedy and lived beyond their means.

Inflation

My thesis: Inflation has cooled but the cumulative effects means that prices remain elevated in the face of stagnating wages, thereby continuing to pressure household budgets. His response:

Macroeconomic Financial Analyst: “Yes, inflation was not transitory and price levels reset 22% higher today than versus 2019. And while inflation is now much cooler we still had this huge price level increase. It is never going back down absent a depression. This is why Donald won.”

So the upside here is that we agree. The downside is that we agree.

P/E Ratios

Against this backdrop, the incoming Trump administration is signaling a few troubling policy changes. The first is his tax policy. The Congressional Budget Office (CBO) estimates on his plan indicate that taxes will be slashed for the top 1% but will actually increase for the bulk of the middle class. Mind boggling. This will have the intended consequence of boosting the equity markets in the short-term, but even that won’t last. Companies are already dealing with inflated shares due to stock buy-backs, as evidenced by elevated P/E ratios on the S&P that are inching back toward recessionary highs. Yet another reminder that a hot stock market is oftentimes the ultimate false positive.

Source: GuruFocus

Macroeconomic Financial Analyst: “On your last question, yes I think the equity market is expensive but Profit Margins for U.S. companies are 20% higher than they were seven years ago. Companies in the USA are the best the world has ever seen. Innovation, investment, professionalism, energy independence, plus having low cost production in our neighbor Mexico is a huge plus. Europe kneecapped themselves with overly generous benefits and a social agenda including green energy which has destroyed their industrial base and eroded entrepreneurship. American dominance over the last ten years is completely astonishing.”

Here is where our opinions diverge the most. His is very much the economic lens of a financial market analyst, whereas I view the world through a socioeconomic lens. He’s looking at the health of corporations and, to be fair, not just the big ones. We took the conversation offline and talked through this on the phone for a bit and he made the point that most corporations are small businesses and therefore increasing profits is good for more than just Wall Street. My contention is that even these profits are not distributed enough through the whole economy as evidenced by stagnating wages, widening inequality, increasing debt thresholds and general precarity that did indeed deliver us Trump 2.0. If corporate profit is your primary measuring stick for the health of the economy and society by extension, then your measurements are built on sand.

Energy

This brings us to the last indicator. Energy. Because crude oil remains the most ubiquitous energy source and is priced on global exchanges, it’s the best indicator of global demand. For the past couple of years, even through the supply shocks that trailed the pandemic recovery, oil prices have been depressed. Moreover, they remain lower than early cycle recovery and mid-cycle periods despite ongoing Organization of the Petroleum Exporting Countries (OPEC) supply constraints.

This is partly as a result of sluggish Chinese and European economies. While gas prices may feel manageable at the moment, this is actually a negative sign, specifically because the oil cartels are trying to hold back supply. This demonstrates that the demand for energy is even more depressed than the prices suggest.

This is actually what prompted us to take the conversation offline. This is the one indicator that gave my buddy pause and required more discussion. On the one hand, it’s a negative indicator of global demand. So a bad thing, right? On the other hand, it’s coming at a convenient time because energy is one of the main components of inflation so it’s having a positive effect on the consumer.

But again, my contention here is that consumers are close to the edge as it is. So let’s assume the economy heats up under Trump, which we’ll talk about in a second. If prime age labor participation is near all-time highs and inflation is 22% higher than pre-pandemic levels, then any uptick in energy consumption will spur an increase in oil and gas prices. So the inflationary cycle would then theoretically resume.

Here comes the toddler to destroy the play room after you cleaned everything up.

Now, enter Trump. Let’s take three of his core policies at face value. Taxes, immigration and tariffs.

Taxes.

Even my friend concedes that further tax cuts for the wealthy won’t stimulate the economy. There’s a difference between cutting corporate taxes from 35% to 21%. This stimulated wealth growth among business owners and shareholders, but it didn’t “trickle down” to help wage earners. Cutting another 3% off corporate taxes will do even less. But the real kick in the teeth is that Trump’s proposed tax plan will decrease personal income taxes on the top 1% of income earners in the nation while increasing taxes on the vast majority of American households.

Immigration.

Forget the moral and ethical horror show that Trump’s mass deportation plan portends, and think about this in a cold and clinical manner. If we’re at record highs for prime labor force participation but there are nearly 11 million undocumented immigrants with gainful on and off the books employment, then what happens when you suddenly remove tens if not hundreds of thousands of low wage workers from the labor force?

The same thing that happened after the pandemic when the economy ran so hot in the recovery that it was impossible to find people to fill low wage positions in hospitality, healthcare, retail, agriculture and certain service industries. Back to work, Granny?

In fact, one of the dirty little secrets the Democrats didn’t want to admit to was that the influx of migrant workers was partially responsible for suppressing wages, which in turn held down inflation. That’s why even though inflation was high in the United States, it was still lower than most other developed nations over the same period.

Tariffs.

Trump’s tariff plan will absolutely incentivize manufacturing in the United States over the long haul. Thankfully, however, people are just waking up to the reality that this will wreak havoc on the economy in the short-term because the increased cost of goods will be born by the American consumer until such time that a domestic supply of goods can fully replace them. Perhaps his brain trust can point to that time Nixon did the same thing in an attempt to strengthen the dollar. The result was catastrophic and it didn’t take much time for it to drive up inflation. Of course, this was combined with an oil crisis because of unrest in the Middle East. Oh, wait…

I can go on. For example, if this administration goes through with its promise to eradicate all federal student loan programs and throw all student debt to the private sector, default rates will skyrocket. If Elon Musk and Vivek Ramaswamy actually convince Trump to eliminate tens of thousands of federal workers, where exactly are these people to go? Ramaswamy is actually on record saying it will give these workers the nudge they need to transition to the private sector, which he views as a positive thing.

So here’s the upshot. As much as I appreciated the back-and-forth with my friend and value his opinion on financial markets, I feel he projects unwarranted optimism founded in my very first principle: the stock market is not the economy.

Our state sponsored capitalist system has been working overtime to prop up the corporate class at the expense of the working class for decades now. Multiple bailouts, rampant deregulation, cheap money and tax cuts has hollowed out the core of the economy. Market gains are phantom gains and we didn’t even touch on the housing crisis. So much of our wealth remains tied up in housing, which excludes vast segments of the population, and prices are so inflated that accessing this equity is nearly impossible because there are fewer and fewer places to go after selling one’s nest egg.

At a time when things are (by all objective economic and historical measures) already incredibly precarious, one false move could bring the economy tumbling down. So what happens when several false moves are made? I truly feel that we’re living in a massive bubble of inequality, precarity and personal debt and that we just elected the one person who is both holding the pin and is willing to pop it.

Here endeth the lesson.