Biden plan, RBI's annual report and Keynes insight

Stock markets across are in green whether they are the US ones (Dow, S&P which closed up) or in the far east like Hang Seng, Nikkei, Shanghai Comp, Kospi etc which are up in the morning trade today. Dollar Index is trading a shade above 90 and the US 10-year yield is trading around 1.61. The major news on the data front was the weekly initial jobless claims number which came better than expectations, the seasonally adjusted number was at 406k which was a decrease of 38k from the previous week. This was for the week ending May 22^nd. The continuous claims number for week ending May 8^th came at 15.7 million which was an improvement of 175k over the previous week. The placement in ON RRP with Fed which we mentioned yesterday saw a placement of around 480 bn USD!

In other news the Biden infrastructure plan proposal of close to 1.7 tn USD was countered by a 928 bn USD proposal by the Republican side. Biden’s proposal was part of the overall 6 tn USD budget plan which he is going to unveil today. The budget proposes to transform the US infrastructure in the coming year along with new investments in education and climate change. The funding for the plan is expected to come from an increase in corporate taxes and taxes on wealthy Americans. Though we have previously written that the Republican side is not very amused by the tax increase plan which they had lowered during their regime in 2017. Hence it can be expected that before the proposals on spend and taxes become reality they will be contested at many forums.

Let’s see the fiscal spending from an ECO 101 perspective. Any infrastructure spend by the government or for that matter any fiscal measure requires money. This money has to be arranged either by taxes or by borrowing. If taxes are not sufficient then the borrowing is the last resort, or it can garner some money by selling its assets also. Now extra borrowing increases the supply of government paper and increases the yield which the market demands. As the corporate yield curve is linked to the sovereign curve, the corporate can also experience an increase in borrowing cost. Also, there is a second phenomenon called crowding out. The savings in the economy for which either the government or the private borrower are vying for are limited, if one entity takes the lion’s share of it by borrowing indiscriminately then the other will be “crowded out” from accessing that pool. Readers can argue that now we are operating in a world where a global pool of saving is accessed not just a local one. We will nod in affirmation there.

In the past we have invoked a Keynesian model whenever we have discussed about government spending. The Keynes insight was that whenever the economy is in a recession and the private investment is not forthcoming, government should step in and spend on infrastructure to get the economy in groove again. Even if it runs deficit for those periods it is justified. But the readers should note that the Keynesian medicine was supposed to be administrated during lean times as a counter cyclical measure. An economy which is opening up and doing fine, extravagant government spend can result in it becoming overheated and there can be consequences (read inflation). Second and more nuanced argument against excessive government spending is the one which is the fundamental argument of capitalism. Any centralised decision-making regarding spending runs the risk of misallocation. Government decision making is centralised and follows the command and control model. The highways, the freeways, the walls built through deficit financing can result in misallocation and ultimately destruction of capital.

We will have the Core PCE reading in the US today which will be keenly watched by the market. On the domestic front, the RBI annual report for the year 21-22 was released yesterday and presented 333 pages of unadulterated wisdom. Over the weekend we would try to go through the same so as to collect enough cues on the monetary and Fx related policy.