Transcription
If you look at the period from 1925 to 1939, the only thing that stopped the process in '39 was the German tanks rolled into Poland and we started World War II because everybody kept trying to get the better position. They were not satisfied with the deals that they made and so they tried in some other way to enhance their position vis-à-vis others. The effects were pretty swift across all categories of assets.
But I suspect that that answer is not adequate and it really depends upon how you value each of the assets. In other words, are stocks fairly valued or overvalued or undervalued or treasury bonds fair value or so it depends upon the current level of valuation? But the fact of the matter is these flows are massive and ultimately unless the central bank of the United States offsets the liquidity drain, then we're all going to be affected.
If you view the world's financial structure as this inverted pyramid, the balance sheet of the Federal Reserve is sitting at the neck of that pyramid. And currently, what is happening is the Fed is still shrinking its balance sheet. The critical measure is what I call modernized world dollar liquidity, which is the sum of the System Open Market Account of the Fed and also the foreign central bank holdings of treasuries. Like it or not, for the time being and in the current situation, the reserve currency of the world is the dollar, which means the Fed is the world central bank. And so they have to accelerate the growth in world dollar liquidity.
Historically, world dollar liquidity has grown at 10% per annum in the last six or seven decades. And currently, we're still contracting at a 5% rate for the latest 12 months. The latest week, the Fed shrunk its balance sheet about $14 billion. They're not shrinking it as fast, but they're shrinking it. And so, in my opinion, they're going to have to reverse or the liquidity drain will trigger the Kindleberger spiral. Let's first of all end quantitative tightening, bring the federal funds rate down, and see whether or not this is enough to offset the endogenous shock to liquidity. But I think that the Federal Reserve is sitting on its hands at a time when it is ill-advised to do so.
I mean, I don't question that the first-round effect of instigating tariffs is inflationary. And Powell has emphasized this first-round effect over and over again. But what he has failed to do is to acknowledge that the second, third, fourth, and fifth rounds are severely disinflationary. And so from my perspective, it's better to look at the longer-term consequence rather than the immediate term. And this dual mandate of the Federal Reserve may paralyze them at a time when they cannot afford to be paralyzed.
I'm not really conversant to understand those deals. I read what was publicly available and I thought it was very ambiguous. So to me, what is tangible are the tariffs. We can calculate their impact. In fact, some of the Europeans have said that they can't deliver on the promises that the head of the EU made. So in this particular case, we have to wait to see if they materialize. I don't have enough information to know whether it's a positive or whether it's merely a talking point. I personally think that the tariffs will probably settle in around 15 to 16%. But right now, based upon everything that we have, and keep in mind we have a lot that haven't been settled, and we also have sector tariffs which complicates the whole process of the computation process, but 15 or 16% is still a monumental impact in my opinion.
That's one of the real problems and contradictions because our current account deficit is going to diminish, which is going to then diminish net foreign saving. And so the EU and Japan and others that may promise this may not have the assets to carry forth the bargain because the great lesson that people need to understand what I'm talking about is this linkage between the current account and the capital account. This is not an opinion from me. It's algebraic substitution. And in other words, if you believe that gross domestic income equals gross domestic product and gross domestic product is C + I + G + X. If you rearrange it, what you get is that the current account is minus one multiplied times the capital account or vice versa. They are the inverse. And so how do you have the funds to honor an investment flow if your resources are coming down? Don't contradiction in terms.
I think your points are well made. I ran the numbers a little bit differently. The CBO has said that the "big beautiful bill" will add $3.4 trillion to debt over the next 10 years. They also indicated that $3 trillion was the cost of just merely rolling over the 2017 act. In other words, when you net out all the other good items that you listed and also the expenditure reductions, according to the latest numbers from the CBO, the effect is $400 billion of net stimulus over 10 years. That's $40 billion a year. The imports are already running at about a $370 billion annual rate. And the CBO numbers do not take into account any saving that may have been effectuated by the DOA. So I don't believe that there is any net stimulus coming, net net, from all of the fiscal policy operations. In fact, we're in negative territory.
You have to have the net national saving, as you said, to have the investment, and the investment is the key to raising the standard of living. And I want to just give you a couple of numbers. From 1870 to 1970, our GDP in real per capita terms grew 2.3%. And in 1970, the government share of economic activity was 25% of GDP. In the last 20 years, the real per capita growth rate is down to 1.2%. And the government share of economic activity is 35% of GDP. So the thing that concerns me the most is that we undertake government spending, debt-financed mostly, almost entirely now, to basically respond to needs. But we don't understand that borrowing the money has negative consequences. And so by coming in to try to solve the problem with debt capital, you trigger the law of diminishing returns which undermines growth. You also then have the interest expense, which is the deadweight loss. And so when the real per capita growth rate comes down, one of the consequences is that you adversely affect the distribution of income. More and more of the income is skewed to the upper side, and that's not been the key to success in the United States or any other country.
Well, it's in a far more fragile state than I think is generally recognized. One of the things that we know about the U.S. economy is that the service sector, which is our biggest share, is generally rock solid. It's hardly ever affected by what goes on in the cyclical side. Recessions occur in the cyclical. The service sector is steady as she goes. And one of the telltale signs that we're on the precipice of something more serious is that the service sector has flatlined in the last three months. That just doesn't happen by accident.
The other problem is that the economy, as was portrayed by the critical statistics in 2024, appear to have been very overstated, and not just for the employment, which are probably the most critical of all, but in turn for a whole host of other economic measures. But the economy primarily keys off of the monthly employment report. The payroll jobs, but the payroll jobs is a very limited survey, just 360,000 firms. Admittedly, they're large firms, but we have 12 million firms in total. And so the BLS has to go from this small sample to the full sample. And moreover, the BLS has no current information on what's happening to small firms that are being created and are dying. And the BLS has overshot now, or the payroll jobs have overshot the broader full labor market. Something called the Quarterly Census of Employee and Wages. Its companion, the Business Employment Dynamics, for five of the last six quarters. And every single quarter in 2024, it looks like that the overcount in the private sector alone was just under a million. Huge miss. Now, they've had misses in the past. In fact, they had a miss that was equivalent. Whether it's the same or a little higher or lower, we don't know. But in 2008 and 2007, the BLS got a lot of criticism for that, and they reworked this formulation of going from the small to the large full sample, and they said they had fixed the problem. But as the data is now coming in, it appears that we had a five to seven sigma error, which is very similar to what occurred during the great financial crisis.