A Bit of Backtracking
This post represents a bit of a reversal from what I stated at the start of the year. I had pledged to not discuss stewardship much, except in the context of the feeding of the war machine. I have reconsidered. It seems important enough that we as followers of Jesus think about and act on our beliefs in the area of financial stewardship. These financial decisions are a part of our witness, and they absolutely have a moral dimension. Also I have experience in the financial services world and know where the traps are set, that it seems irresponsible to not share that perspective.
Therefore, I intend to post perhaps once a month on financial issues and how we can responsibly live out our Gospel call with regard to money issues. There are no guarantees in this world, except that God loves us, but together we can grapple with the challenges of earthly life and help each other live a more comfortable life. This I truly believe is what God wants for His children. Now, sadly, on to previewing what I think may be a financially dreary 2023.
Spending Drives All
The Congress passed and the President signed just before the Christmas holiday a $1.7 trillion spending bill. This included a significant increase in military spending as well as large increases in a variety of other agency budgets.
Lost in the reporting is the fact that this was just the “discretionary” portion of the federal budget. Total federal outlays in FY2023 will be in the neighborhood of $5.5 Trillion. Non-discretionary spending, which is primarily Medicare, Social Security, Medicaid, and interest on the debt, makes up about 70% of total federal outlays. 70% of the federal budget is so agreed upon by both parties that it is put on autopilot. And people say bipartisanship is dead.
Spending has come down form pandemic highs, which explains the drop in the deficit. Spending levels, however, will be notably above their long-term averages as well. Outlays are estimated to be over 25% of GDP this fiscal year, compared to a historical average of 21%. The deficit will be above average as well; 5.5% of GDP compared to the long-term average of 3.6% of GDP. In fact, current plans will increase the structural deficit by trillions according to the Congressional Budget office. This in spite of the President and the media claiming the deficit is coming down. In fact the deficit widened to a record $249 billion last month.
The important thing to realize is that spending drives all the choices that confront politicians and policy makers. If spending rises, then taxes or deficits must rise as well. There has clearly been little inclination to increase direct taxation (hence the rising deficits), so it is the two indirect methods of taxation to which we now turn.
How this Gets Paid
There are only two ways that a deficit can be financed; by issuing debt in the form of government bonds or by inflating the money supply. It is that simple, regardless of how much gobbledygook gets put forth on “financial” shows. The goal today is not to go deep into the mechanics of either of these deficit financing methods or to explore who benefits from them (It should be apparent to all that all of this is patently immoral). It is enough to understand that it is one of these two choices that confronts policymakers.
If Spending Continues to Rise And:
The Federal Reserve continues a tighter monetary policy
If the Federal Reserve continues to tighten monetary policy, or to simply keep rates where they are for the next several months, then interest rates will rise, perhaps significantly. The reason is simple; with less money being created via inflation (monetary growth is currently negative) then the federal government must cover the deficit by means of issuing bonds. That is, they must borrow.
Like any other good or service, if you have more of it, then each one is valued less and less. More goods equals a lower price. For goods and services in the economy this is a good thing, as people get more value for their money. In the world of bonds, more supply also equals a lower price per unit. This by definition means that the rates on those bonds must go up to reflect the discounted price created by an increased supply. In plain language, if you have a lot of people trying to sell bonds, you entice customers to buy by offering them a higher interest rate as an inducement.
The result of all this is rising interest rates. It is the classic crowding out effect. The government will have to increasingly compete with corporate debt issuers and raise rates to meet that competition. The government cannot lose this competition because they have unlimited resources. Nonetheless, rates will rise in this scenario.
The Federal Reserve Pivots and Resumes Money Creation
If the Federal reserve panics in the face of an almost certain recession and increases monetary growth again, then rates will ultimately rise as well. The markets, including the bond market, may like this at first. You may very well see a pop in the stock market as well as see rates decline. This will likely be only a temporary reprieve.
Inflationary expectations will rise exponentially in this scenario. The market, and that includes consumers, will understand that the Federal Reserve will never stop inflating the money supply. This will deeply embed those inflationary expectations into the economy. We might possibly see hyperinflation.
These embedded inflationary expectations will then raise rates, especially long-term rates. This is because no sane market participant will hold onto debt that is all but guaranteed to be paid back with less valuable currency. In plain language, every point up in inflation is a point downward in the interest rate on the bond you hold. The market will respond by raising rates.
The difference in this scenario is that you will see continued inflation alongside rising interest rates. This is the stagflation that the United States has not seen since the late 1970s.
2023 Likely Outcomes
A recession is almost a lock. This will either be a normal(ish) looking downturn with all the pain associated with such events; that is if the Federal Reserve holds the line and continues to prioritize squeezing inflationary expectations out of the market.
A stagflation recession will arise if the Federal Reserve pivots back toward monetary growth to ease the downturn. This will only get us rising rates and rising prices.
Either way 2023 looks to be rocky. I will not venture to guess what the Federal Reserve will do. The book is out on whether Jerome Powell is another Paul Volcker or another Arthur Burns. The answer to this question will determine how bad things get and for how long.
Meanwhile, if you are a long-term buy and hold investor then you stay the course. If you try to avoid the stomach churning ups and downs of the investment cycle, as I suggest may be possible on the Believe and Obey Stewardship page, then you may be on the sidelines for much of the year. Either way, hunkering down, eliminating debt, and doing what you can to save as well as enhance your earning power is the best course of action. Living as best you can in response to God’s gifts of grace upon grace is always the best course of action.
Praise Be to God