Rate Cuts Can have a Dark Side
Money drives both the economy and the stock market, but most people simply do not understand what money is or where it comes from.
It can be anything that we agree is capable of releasing real-resources, like labor and materials. Money is not a physical entity, and today’s money is not fixed to anything physical; Nixon took the US dollar off the gold-standard in 1971. The US dollar is created by Congressional spending-laws, and is destroyed by taxation (by-the-way, taxation is what forces everyone in the US to use the US dollar as currency). Taxpayers need to earn US dollars before they can pay their taxes. Taxpayers cannot create US dollars — that would be counterfeiting. All US dollars are created by Government spending. The Federal Government is “self-funding.”
Net spending is the difference between nominal-spending and taxation. If the Government spends (creates) more US dollars than it taxes back, then we say it has a deficit; it has deposited more money in private bank accounts than it has taxed back.
Government deficit = private surplus
Government deficits correlate positively with the SPX (chart below). This makes sense, since bigger economies (and higher stock markets) require more money in the system.
ANG Traders, stockcharts.com
Fiscal-2024 (ends September 30, 2024) has produced a deficit of only $1,380B compared to last year’s $1,720B deficit; that is $340B less money left in private bank accounts! Yet, the SPX has continued to rise.
The reason for this divergence is that bank credit is expanding and more than making up for the reduced deficit: bank credit grew by $540B in fiscal-2024.
ANG Traders, stockcharts.com
We have entered a new credit cycle that will drive the economy and the stock market higher for the next 6–12 months…as long as it can compensate for the lower deficit (chart below).
ANG Traders, stockcharts.com
However, there is a danger that could develop because of the Fed’s rate cuts.
The Treasury has created more than $1T in interest payments due to the Fed’s higher interest rate (chart below).
FRED
Now that the Fed is cutting rates, the interest-income channel will be reduced. If the rate cuts go too far, too fast without at the same time increasing Treasury-spending in other areas to replace the lost interest-income, then the deficit could be reduced enough to plunge the economy into a recession and the stock market into a bear market. But that is only if rate cuts are too big and too rapid.
Join us at www.angtraders.com with discount code: “20off” and take advantage of our 45-years of market experience.
