In a normal economy, mass layoffs are bad for everyone — workers lose income, consumers stop spending, revenues collapse, profits fall. Once the government commits to backstopping nominal income and spending, that chain breaks. Layoffs no longer threaten profits — they enhance them, because the deficit absorbs the lost wages on the demand side while wage suppression accrues the gain to shareholders on the supply side. The market becomes upside-down: bad news for workers is good news for capital.
Simple Picture
Imagine a town with one factory. The factory hires 100 workers, sells goods to those same workers, and earns a small profit. Layoffs would be catastrophic — fewer workers means fewer customers means lower revenue.
Now imagine the government promises to keep total town spending constant no matter what. If the factory lays off 50 workers, the government writes the laid-off workers a check large enough that they keep buying goods at the same rate. The factory’s revenue is unchanged. Its wage bill has been cut in half. Its profit has doubled.
This is the entire mechanism. The deficit replaces wages on the demand side without restoring the wage cost on the supply side. The factory’s pain becomes the factory’s gain. The fiscal channel converts a labor expense into a shareholder return.
The Profits Equation
The accounting identity underneath this is the Kalecki-Levy equation. Corporate profits in any economy equal:
Corporate Investment + Dividends + Current Account Surplus + Government Deficit + Household Deficit
It is not a theory. It is bookkeeping — every dollar of profit must have come from somewhere, and these are the only somewheres available. The income of each entity in the system arises from the spending of every other entity. Profits, at the aggregate level, are not earned by being clever or efficient. They are injected by one of these five sources.
Three of the five are usually small or negative. Investment fluctuates. Dividends are paid back to shareholders themselves, so they wash out at the household level. The current account is mildly negative for the U.S. and has been for decades. Households save more than they spend. Which means in a low-investment, household-saving regime, the government deficit is what’s keeping corporate profits positive at all.
In WWII, federal deficits hit ~22% of GNP and pre-tax corporate profits reached ~12% of GNP — among the highest in U.S. history. The relationship was not coincidence. The deficit was the profit. The only thing limiting after-tax gains was a 90%+ excess profits tax. The state injected the income and the state clawed back the surplus, because the circuit was visible enough that nobody could pretend the gains were “earned.”
After 2020, the same mechanism ran without the tax. Deficits exploded, household withholding hit 33% in April (against a normal 7-10%), and corporate profits — which by every traditional model should have collapsed — held up almost completely. The Kalecki-Levy equation predicted it. Almost no one was using the Kalecki-Levy equation.
The Supervirus Thought Experiment
To see how strange the regime gets at the limit, imagine a permanent supervirus that requires everyone to live indoors forever. Restaurants empty. Airlines die. Tourism vaporizes. Real economic activity collapses by half.
Under a laissez-faire regime, equity portfolios get destroyed — revenue falls, profits fall, prices fall.
Under a fiscal spending-targeting regime, the nominal value of those portfolios goes up. The government continuously injects whatever stimulus is needed to maintain nominal spending growth. The money has to land somewhere — restaurants are closed, but grocery stores are open, so the spending shifts. Diversified investors who own both segments suffer no net revenue loss. Meanwhile labor is desperate, wages collapse, and interest rates are crushed to zero — so margins expand and discount rates compress.
The portfolio rises while the real economy is in ruins. This is not a paradox. It is the exact behavior the regime is engineered to produce. The two-economy split taken to its terminal form: the financial economy fully decoupled from the real one, sustained by fiscal injections that flow through whichever surviving channel can absorb them.
The Asymmetric News Channel
Once the regime is in place, the information environment inverts:
Bad news triggers unlimited stimulus. Layoffs, recession, contraction — every signal of distress unlocks more deficit, more rate cuts, more support. The downside is capped because the policy reaction function is asymmetric.
Good news triggers patience. Strong employment, rising wages, hot data — instead of tightening into the recovery, the Fed waits. The upside is uncapped because the inflation that should trigger restraint is treated as transitory.
This is the central bank put generalized into a fiscal-monetary put. Worse outcomes get bigger interventions; better outcomes get permission. Both directions are bullish for equity. The market is no longer pricing the economy. It is pricing the policy reaction to the economy — and the reaction function is rigged on both sides to favor capital.
The serpent gorges in this regime. Stability gets manufactured by the policy backstop, leverage piles in to harvest it, and the entire structure looks like a permanent free lunch — until it isn’t.
The Withholding Problem
The mechanism has one structural weakness: fiscal stimulus only works if recipients spend it. Households can withhold — receive the check, refuse to circulate it. The savings rate spike to 33% in April 2020 was exactly this. The deficit was injected; a third of it just sat there.
Withholding breaks the chain. If households save the stimulus instead of spending it, corporate revenue does not get supported, and the Kalecki-Levy injection dries up at the source. The government can spend more to compensate, but each round of injection produces diminishing real flow as more of it gets parked.
This is the part the model gets wrong if you only count the deficit. Velocity matters. A trillion-dollar deficit that sits in savings accounts is monetary noise. A trillion-dollar deficit that gets spent is the upside-down market in motion. The serpent eats only what the river actually delivers, and the river runs only at the speed the public chooses to flow.
What Eventually Breaks It
The regime works because inflation hasn’t asserted itself. The deficit injects nominal demand without producing matching real supply, but as long as the gap stays inside the noise band, no one notices.
When inflation does assert — when the goods-and-services prices catch up to the asset prices, when the real economy forces itself onto the policy radar — the reaction function reverses. The central bank that was patient becomes hawkish. The fiscal authority that was generous becomes constrained. The asymmetric put gets withdrawn from underneath the leveraged stack that was built on its assumption.
This is the Minsky failure mode of the upside-down regime: the longer the policy backstop holds, the more capital piles in to harvest it, and the more violent the unwind when it gets pulled. Every quarter of stability accumulates the leverage that will turn the eventual repricing into a cascade.
The current valuations are pricing the regime as durable. The historical record on durable suppression of inflation by fiat is short and unflattering. The bet implicit in record equity multiples is that the policymakers can run a permanent fiscal-monetary backstop without ever provoking the inflation that would force them to stop. That bet has never been won at scale. It is being placed at scale right now.
Dimwit / Midwit / Better Take
The dimwit take is “stocks went up because the Fed printed money.”
The midwit take is “stimulus inflated asset prices through low discount rates and the wealth effect.”
The better take is that fiscal regimes that target nominal income and spending sever the link between economic distress and corporate revenue, turning labor weakness into shareholder strength through the accounting identity that ties profits to deficits. The Fed is a small player in this. The real machine is the Treasury check that lands in the bank account, gets spent on something the consumer would have bought anyway, and shows up as undiminished corporate revenue while the wage bill shrinks. The investor who interprets a strong jobs report as bullish or a weak one as bearish is reading the old book. In the upside-down regime, the news doesn’t matter; the policy reaction to the news matters, and the reaction is asymmetric in the direction of capital. The only thing that flips the regime is inflation finally arriving — at which point the same asymmetry that lifted everything reverses, and the unwound leverage discovers the floor was a load-bearing fiction all along.
Main Payoff
The deeper reframe is about whose economy the market is pricing. In a laissez-faire regime, equity prices reflect the productive economy — revenue from goods and services produced and sold, wages paid and consumed, the loop of stored time circulating between producers and consumers. In a fiscal-targeting regime, equity prices reflect the deficit — the rate at which the government is willing to inject income that bypasses the wage channel and lands directly on the corporate side of the ledger.
These are not the same thing. The first is a measure of real value creation. The second is a measure of policy commitment. Confusing them produces the strangest investor behavior of the era — buying records highs into a recession, treating layoffs as catalysts, reading deflationary collapse as a bullish setup. None of it is irrational. It is the rational response to a regime that has decided, for political reasons, to keep the financial economy whole even at the cost of letting the real economy distort underneath. The portfolio is a hostage to the deficit. As long as the deficit holds, the portfolio holds. When the deficit stops, the portfolio stops with it.
References:
- Jesse Livermore, Upside-Down Markets: Profits, Inflation and Equity Valuation in Fiscal Policy Regimes, OSAM (2020)