This week, the June 2021 jobs report came out and the market cheered. The U.S. economy added 850,000 jobs in June, compared to May’s 583,000 job gain and Wall Street expectations of about 700,000. (source: https://www.politico.com/news/2021/07/02/us-adds-850k-jobs-497800)
I guess we are on our way back to full employment slowly but surely. One thing that’s surprising is the fact that despite 25 states phasing out unemployment insurance, the labor participation rate did not increase. This should put tremendous pressure on the wages inflation, although this is not particular a bad thing in my mind. As a society, we should really be paying workers a living wage. Obviously, I understand the danger of run-away inflation.
In order to assess how big of an issue is inflation going to be. I looked to the US government’s financial forecasts. The Congressional Budget Office (“CBO”) released a report this week where it anticipated a 3 trillion dollar deficit in 2021. This is absolutely wild, especially when you take into considerations the assumptions taken in the report. The CBO report assumes no extension of tax cuts, no additional stimulus and emergency funding. And if I know anything, it’s that politicians love to print money and run deficits. So what is the CBO report trying to tell us:
- The US real interest rate will be likely negative for the next couple of years.
- Debt to GDP ratio will be above 100%.
- The only way that this will be sustainable is if US is able to continue to borrow substantially from abroad.
This reminds me of a recent CNBC interview where David Tepper became bullish on the market when Japan a few months ago became a net buyer of US Treasuries. One thing that is interesting is that US, given its large Treasuries issuance, has every incentive to maintain its position as the world reserve currency. This makes me wonder if it will ever let bitcoin and other crypto gain prevalence. I feel like it won’t give up its monopoly on the world’s reserve currency to bitcoin without a fight. The regulators should feel emboldened to take action because the Chinese regulators have already cracked down on bitcoin hard.
Realistically, I think the Feds and Treasury department are betting on global secular stagnation, therefore forcing foreign investors to buy into the US Treasuries. Japan has been in a state of chronically slow economic growth and trivial inflation or even deflation since a giant real-estate bubble popped in the early 1990s. I think Europe faces similar problems. UK Brexit has created all sort of problems for the UK economy. Germany I think is still trying to recover from a string of high profile corporate scandals from VW emission scandal to the Wirecard fraud.
Therefore, from an allocation perspective, the only two economies that are worth investing in in my opinion are the US and Chinese economies. However, being based in North America, I’m not entirely sold on the ADR Caymen Island structure that Chinese companies use to list in the US. I would feel a lot more comfortable if one would start paying steady dividends, but I have yet to find one. Hence, I think my focus will be pro-dominantly US focused.
Another thought I had about US real interest rate being negative for the next couple of years is that I need to use leverage somehow in a safe way. I’ll have to explore that further in a future post.
If you enjoy the content, kindly subscribe and leave a comment.