US Fiscal: Acute or Chronic - VP May 2024 Big Picture Discussion

  • We discuss our recent thematic report, The Structural Limits of Fiscal Policy, which dives into how politics led the US to its current state of "fiscal purgatory" and what history tells us is the most likely path forward to finance deficit spending.
  • The US fiscal situation appears to be a chronic rather than acute problem, making positioning for financial repression and low real yields our preferred allocation strategy in the long run.
Market DiscussionBig PictureFiscalPublic

AI Summary

Tian: [00:00:05] Hello everyone, welcome to Variant Perception’s big picture discussion for May 2024. Last month we released a thematic piece on the structural limits of fiscal policy, building on our previous reports like the Age of Scarcity. Today, we'll focus on the most crucial takeaways and nuances that didn’t make it into the report. Scott, could you summarize the key point from the report in about 30 seconds?

Scott: [00:01:06] The main takeaway is that the US is in a state of fiscal purgatory, unable to reduce fiscal deficits significantly. Historically, in democracies, fiscal spending tends to increase as politicians prefer issuing debt over raising taxes. This trend is expected to continue, affecting asset allocation for decades, although the US has not yet reached the crisis levels of debt seen in past historical examples.

Tian: [00:02:37] That’s a succinct summary. Our report illustrates how political necessity often overshadows economic principles, like with Social Security and national defense spending. We've historically justified substantial expenditures during crises like WWII and COVID-19, indicating a continuing trend of 'Age of Emergency' where fiscal spending is morally justified.

Scott: [00:03:51] Exactly, inflation might be a theoretical limit to fiscal spending, but the practical limit is politics. This isn’t unique to the US; it’s a global phenomenon. Upcoming elections and economic data like April's tax receipts might influence short-term fiscal policies, but the long-term trend towards higher spending is likely to persist.

Tian: [00:04:27] This long-term trend suggests a shift towards real assets and away from nominal bonds, influencing core asset allocation. Since 2020, we've discussed these themes extensively. Considering many now accept this outlook, the discussion shifts to how these scenarios might unfold—whether dramatically, chronically through financial repression, or an unexpected route like a technological revolution that could upend current predictions.

Scott: [00:06:35] Discussing the potential for an acute crisis, we've examined thresholds like debt monetization levels. The US hasn’t reached the extreme levels associated with historical hyperinflation or significant social upheaval, which might precipitate such a crisis.

Tian: [00:07:18] We’re closely watching these indicators. The US holds a unique position that might shield it from scenarios typical of smaller economies. Yet, we're considering all possibilities, including scenarios where unexpected technological advancements or demographic changes could alter our projections significantly.

Tian: [00:10:10] If AI leads to a major supply side boom, it could change the demand dynamics significantly, impacting inflation and economic growth differently depending on how technologies are integrated into the economy. The long-term impact could mirror historical shifts seen with major technological advancements.

Scott: [00:14:12] In a scenario where real yields rise due to positive developments, growth equities could see substantial benefits relative to credit which would still face debt service problems, reinforcing the need for an overweight in growth-driven assets within portfolios.

Tian: [00:16:09] Summing up, our long-term view is that real interest rates may need to remain negative, which will continue to drive our asset allocation strategies towards equities, real assets, and commodities. We must remain vigilant about the potential for acute political crises and other tail risks that could necessitate adjustments to our strategy.