Sorry, Inflation Worries are Not Behind the Selloff in Stocks

This article was published by The McAlvany Intelligence Advisor on Wednesday, February 7, 2018:  

All manner of explanations for the recent market selloff in stocks have come out of the woodwork: the market has gotten ahead of itself; it was due for a correction anyway; it’s been 400 days since a three percent correction; and so on. The least informed is that all of a sudden there is inflation! See? The yield on the 10-year Treasury is up 80 basis points since September! That must mean there’s inflation! Couple that with the “surge” in wages just reported by the Bureau of Labor Statistics (2.9 percent year-over-year compared to 2.2 percent reported previously) and – voila! – inflation is back. Time to take profits!

Most commentators didn’t bother to check with the Fed, specifically the Cleveland Fed and the St. Louis Fed, which report the real numbers on inflation and money supply. First: Inflation, properly defined, is an increase in the money supply (prices increase in response). But since January 2014 there has been virtually no change in the money supply. No increase, no decrease. Sorry.

Second: CPI. According to the Cleveland Fed, the median CPI has remained almost constant, at 0.2 percent a month since last July. Nothing to see here, either.

Something must have happened, but most commentators were oblivious to, or completely ignorant of, an obscure advisory committee that consults with the U.S. Treasury Department every quarter. On Wednesday, this obscure agency, known as the Treasury Borrowing Advisory Committee (TBAC), announced that, because of shortfalls in revenue thanks to Trump’s tax reform program, the Treasury would have to sell a trillion dollars’ worth of bonds every year for the next three years, starting today. Specifically, the TBAC estimated that the Treasury would be forced to raise $955 billion through the sale of new bonds this year, $1.083 trillion next year, and $1.128 trillion the year after.

That’s a total of $3.2 trillion in new issues coming to market in the next three years, enough to spook stocks into a sharp and continuing selloff. For some, the concept is hard to grasp: When the supply of anything (including new U.S. debt) increases, the demand for it goes down. Prices consequently fall. Here’s the twist: When the price of a bond falls, its yield – the interest the bond pays compared to its price – increases. When it increases a little, the stock market ignores it. In September, the yield on the 10-year Treasury note was 2.05 percent. The yield jumped on Thursday to 2.722 percent, a breathtaking rise of two-thirds of a percentage point. In the bond market that’s huge. The yield on that note jumped further on Monday, to 2.85 percent, putting additional pressure on stocks.

All commentators saw was the increase in yield of the 10-year Treasury and immediately ascribed it to inflation, even though there isn’t any (certainly not enough to trigger such a selloff).

The problem is that this announcement from TBAC vastly overstated the need for the Treasury to sell bonds to make up for the coming estimated decline in tax revenues. When tax reform was being considered, the impact on federal revenues was estimated to be approximately $1.5 trillion, and that would be spread over the next ten years. When economists at the Wharton School at the University of Pennsylvania took a look at tax reform, it estimated that it would add $2 trillion to the national debt, again over ten years.

But the obscure TBAC – acting in its advisory role only – said the Treasury Department would have to inundate the global bond market with more than $3 trillion in less than three years.

Just who is on that committee, and by any chance do any of them happen to have a particular ax to grind concerning Mr. Trump and his plans for banks?

Let’s look. There are 17 members on the committee, including representatives from JPMorgan Chase, Morgan Stanley, Goldman, Sachs & Company, Citigroup, BNY Mellon, Barclays, and Bank of America. Each of them has a vested interest in advising the U.S. Treasury department simply because Treasury will look to them to sell those new issues. But those entities also have a political ax to grind as well. In July 2016, the liberal Huffington Post reported that:

The party platform approved at the Republican National Convention in Cleveland offers official support for reinstating the Glass-Steagall law, which separates riskier securities trading from traditional commercial banking. The move would require busting up the six largest banks in America.

A year later, on May 5, 2017, Investors Business Daily reported:

President Trump’s hint this month of a breakup of big Wall Street banks such as JPMorgan Chase (JPM), Bank of America (BAC), Goldman Sachs (GS) and Wells Fargo (WFC) hit their stocks hard….

The question then becomes “Why?” Why now? It’s pure speculation from here, of course, but it’s plausible that the powers-that-be – those who help sell the bonds that finance the government – decided it was time to take both the stock market and the president down a notch or two. Perhaps Mr. Trump was getting just a little too cocky in taking credit for the unleashing of the economy and the millions of enhanced paychecks following passage of his tax reform bill. Perhaps it was time to remind Mr. Trump that he serves, whether he knows it or not, at the good pleasure of those who help finance the government.

As a businessman, Trump knows the power of banks and bankers to make or break deals. After all he has been forced to declare bankruptcy four times. Perhaps Wednesday’s announcement was intended for Trump’s ears and the stock market was listening in.

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Sources:

Cleveland Fed: Median CPI

St. Louis Fed: Adjusted Monetary Base

Chicago Tribune:       Analysis: Government set to borrow nearly $1 trillion this year, an 84 percent jump from last year

The Wall Street Journal: New Fiscal Worry: Too Much Short-Term Borrowing as Deficit Climbs

The Wall Street journal: Real Time Economics: The Treasury and Debt

CNBC.com: The Treasury is set to borrow nearly $1 trillion this year, and at least that much afterward. Here’s why it matters

The Blaze: Government plans to borrow $1 trillion, some say to offset new tax law, this fiscal year

Treasury.gov: Members of the TBAC

Treasury.gov: What is the TBAC?

Investors.com: Trump Will Bust Up Bank Regulation, Not The Banks

HuffingtonPost.com: Donald Trump Wants To Break Up Big Banks

Politifact.com: Fact-checking claims about Donald Trump’s four bankruptcies