QE4Ever

A bit like love, eh?

This article offers some good insights into monetary manipulation. The one thing I see missing is the recapitalization of assets based on depressed long-term interest rates, which is a result of Quantitative Easing and Zero Interest Rate Policy (ZIRP). So we have massive asset bubbles across many real asset classes as a result. No one seems to have any idea how this unwinds, but unwind it must.

‘Quantitative Easing’ Isn’t Stimulus, and Never Has Been

By Ken Fisher, RealClearMarkets

(AP Photo/Jose Luis Magana)

Upside down and backwards! Nearly 13 years since the Fed launched “quantitative easing” (aka “QE”), it is still misunderstood, both upside down and backwards. One major camp believes it is inflation rocket fuel. The other deems it essential for economic growth—how could the Fed even consider tapering its asset purchases amid Delta variant surges and slowing employment growth, they shriek! But both groups’ fears hinge on a fatal fallacy: presuming QE is stimulus. It isn’t, never has been and, in reality, is anti-stimulus. Don’t fear tapering—welcome it.

Banking’s core business is sooooooo simple: taking in short-term deposits to finance long-term loans. The spread between short- and long-term interest rates approximates new loans’ gross profit margins (effectively cost versus revenue). Bigger spreads mean bigger loan profits—so banks more eagerly lend more.

Overwhelmingly, people think central banks “print money” under QE. Wrong. Very wrong. Super wrong! Under QE, central banks create non-circulating “reserves” they use to buy bonds banks own. This extra demand boosts bond prices relative to what they would be otherwise. Prices and yields move inversely, so long-term interest rates fall.

Fed Chair Jerome Powell and the two preceding him wrongheadedly label QE stimulus, thinking lower rates spur borrowing—pure demand-side thinking. Few pundits question it, amazingly. But economics hinges on demand … and supply. Central bankers almost completely forget the latter—which is much more powerful in monetary matters. These “bankers” ignore banking’s core business! When short-term rates are pinned near zero, lowering long rates shrinks spreads (“flattening” the infamous yield curve). Lending grows less profitable. So guess what banks do? They lend less! Increase demand all you want—if banks lack incentive to actually dish out new loans, it means zilch.  Stimulus? In any developed world, central bank-based system, so-called “money creation” stems from the total banking system increasing net outstanding loans. QE motivates exactly the opposite.

Doubt it? Consider recent history. The Fed deployed three huge QE rounds after 2008’s financial crisis. Lending and official money supply growth shriveled. In the five pre-2008 US expansions, loan growth averaged 8.2% y/y. But from the Fed’s first long-term Treasury purchases in March 2009 to December 2013’s initial taper, loan growth averaged just 0.8% y/y. After tapering nixed the nonsense, it accelerated, averaging 5.8% until COVID lockdowns truncated the expansion. While broad money supply measures are flawed, it is telling that US official quantity of money grew at the slowest clip of any expansion in history during QE.

Now? After a brief pop tied to COVID aid, US lending has declined in 12 of the last 14 months. In July it was 4.7% above February 2020’s pre-pandemic level—far from gangbusters growth over a 17-month span.

Inflation? As I noted in June, it comes from too much money chasing too few goods and services worldwide. By discouraging lending, QE creates less money and decreases inflation pressure. You read that right: QE is disinflationary. Always has been. Wherever it has been tried and applied inflation has been fried. Like Japan for close to …ah…ah…ah….forever. Demand-side-obsessed “experts” can’t see that. But you can! Witness US prices’ measly 1.6% y/y average growth last expansion. Weak lending equals weak real money growth and low inflation—simple! The higher rates we have seen in recent months are all about distortions from lockdowns and reopenings—temporary.

The 2008 – 2009 recession was credit-related, so it was at least conceivable some kind of central bank action might—maybe kinda sorta—actually help. Maybe! But 2020? There was zero logic behind the Fed and other central banks using QE to combat COVID. How would lowering long rates stoke demand when lockdowns halted commerce?

It didn’t. So fearing QE’s wind-down makes absolutely no sense. Tapering, other things equal, would lift long-term rates relative to short rates—juicing loans’ profitability. Banks would lend more. Growth would accelerate. Stocks would zoom! Almost always when central banks try to get clever they wield a cleaver relative to what they desire.  A lack of FED action is what would otherwis be called normalcy.

Fine, but might a QE cutback still trigger a psychological freak-out, roiling markets? Maybe—briefly. Short-term volatility is always possible, for any or no reason. But it wouldn’t last. Tapering is among the most watched financial stories—has been for months. Pundits over-worry about it for you. Their fretting largely pre-prices QE’s end, so you need not sweat it. This is why Powell’s late-August Jackson Hole commentary—as clear a statement that tapering is near as Fed heads can make—didn’t stoke market swings. The ECB’s September 9 “don’t call it a taper” taper similarly did little. Remember: Surprises move markets materially. Neither fundamentals nor sentiment suggest tapering is bear market fuel.

Not buying it? Look, again, at history. The entrenched mythological mindset paints 2013’s “Taper Tantrum” as a game-changer for markets. Untrue! After then-Fed Chairman Ben Bernanke first hinted at tapering back in May 2013, long-term Treasury bond prices did sink—10-year yields jumped from 1.94% to 3.04% by that yearend. But for US stocks, the “tantrum” amounted to a -5.6% decline from May 21 through late June—insignificant volatility. After that, stocks shined. By yearend, the S&P 500 was up 12.2% from pre-taper-talk levels. Stocks kept rising in 2014 after tapering began. 10-year yields slid back to 2.17%. My sense is even tapering’s teensy impact then is smaller this time because, whether people consciously acknowledge it or not, we all saw this movie before.

Taper terror may well worsen ahead of each coming Fed meeting until tapering actually arrives. Any disappointing economic data will spark cries of “too soon!” Tune them down. History and simple logic show QE fears lack the power to sway stocks for long.

Ken Fisher, the founder, Executive Chairman and co-CIO of Fisher Investments, authored 11 books and is a widely published global investment columnist.

Modern Monetary Fantasies 2

The Myth of Big Government Deficits – A TED Talk

This is quite the tale. I’m sure Ms. Kelton studied her economics but here with MMT she takes a few basic truths and spins an elaborate fantasy. Essentially her argument is that debt is no obstacle to economic policy and economic outcomes. You want a Ferrari? No problem, the Fed can write a check and it’s yours, no taxes, no worries. Advocates will hate this simplification but that’s essentially what Ms. Kelton is selling. (You can substitute free healthcare, free college, whatever you want, but I’d go with the Ferrari 365GT.)

MMT is utopian economics. Yes, in theory it can make sense, just don’t go too far down that rabbit hole. Govt debt is not like private debt because it never has to be paid back, only serviced and rolled over. So the debt in $ terms doesn’t matter, but the productivity of that debt matters a lot (the debt to GDP ratio is a good indicator – it looks worse every day).

She lauds the pandemic stimulus because that essentially was an MMT experiment. Look, no recession! But recessions are measured in monetary terms (not value), and if the Fed keeps pumping out money, voila! No recession. But value creation matters and in value terms, we are suffering an extreme recession and stagflation. How many small businesses have closed in the past 2 years? How much price inflation are we experiencing? 5-9%? Have you tried to buy a house lately? 20% price increases. Tried to get a plumber or electrician?

Yes, when the government spends $28 trillion, that money goes somewhere in the private sector. And yes, we’ve seen it skimmed off by the banking industry, the asset-rich who have merely leveraged 3% debt, and the securities markets that have bubbled up even as production has declined. This is what is driving inequality to new heights as the global elites suck up this cheap credit courtesy of the central banks. Check out the number of mega yachts plying the oceans.

Yes, we’ve seen the fantasy of MMT in action and that’s why we’re having a political revolution. Kelton and the handful of economists selling MMT are assuming a utopian political world where everybody always does the right thing. Ultimately, intellectual dishonesty like this is extremely damaging.

Read her book, there’s nothing there that will address these false assumptions. Credit and debt are tools that the market uses to restrain profligacy. Without those restraints, the party will eventually implode.

Modern Monetary Fantasies

I read this comment to an article on cultural conflict and politics (the article was a UK perspective and not that insightful – see link below). I was struck by this reader’s comment because it hits the nail on the head, despite its rudimentary tone and language. I could write an empirical and theoretical analysis that would bore readers to tears but it would all support this view.

It’s US$ monetary policy that is driving the distributional consequences of deficit spending along with globalization and technology into the cul-de-sac we find ourselves in. Think about it: when the government borrows and spends $28 trillion, where do we think it goes? Into private pockets controlled by those at the top. (All those real estate assets we own are merely keeping pace – it’s still the same four walls and roof.)

There’s probably not more than a handful of politicians in Washington DC that could explain this well or understand it, but they’re all setting the policies in ignorance.

Money Printing, the ability to spend more than is taken in has had a vast set of consequences – and almost all the problems can be laid at its feet. Really Nixon in 1971 taking US off the ‘Gold Standard’ to fund Johnson’s ‘Great Society’ and the Vietnam War. Both these make the rich richer. The Military-Industrial Complex goes directly to the wealthy, and the increased Social Spending $ always trickle-up while paying the poor to be poor traps them in poverty.

And so it has progressed till the National debt is 28$ Trillion! About equal to 8 years of all USA’s tax revenues. At the current ZERO percent interest rate it takes 1.5$ Trillion to service the debt! About half of all the Fed Tax revenues! Biden wants to add 4.5$ Trillion on human infrastructure (waste, pork, corruption, and free money to minorities, to trickle to the super-rich (and China, via Amazon and Walmart)). This on top of the monthly 120$ BILLION purchases of Treasuries and mortgage-backed securities the Fed buys – and the 1-3$ Trillion budget deficit! (If, when, interest rises to 5% it will take all the gov tax revenue just to service the national debt – )

Anyway, the printed $ all rise to the super wealthy, they get all of it. The poor just get addicted to the drug of the Welfare Trap, and become multi-generational poor. The working class and middle class have all their savings and pensions harvested by the stealth Tax called Inflation (now officially 5%, but really 9) because interest must be kept at Zero for the debt to be serviced. So all workers’ savings get eaten up by inflation Tax of 5% – (minus the bank and bond interest of 1% = MINUS 4% savings growth). Their pensions and savings melting like snow as the printing inflates the money supply….

But the above just scratches the surface of the harm. USA will eventually lose ‘Reserve Currency Status’ over this. The foreign trade deficit is a Trillion – how can that continue – the hard assets and Equities so inflated – and the wealthy own them. The rich have hard assets which appreciate, they carry HUGE debt at 3% interest while inflation eats the debt basis away – and Dividends, so make money while everyone goes broke.

This is what Lefty/Liberal MMT is doing – the death of America. The Left economics is always same – all the money to the elites, and the rest go broke.

Why Does America Hate Itself?

Afghanistan and the Politics of National Security

To Stop War, American Needs a Third Party

by Matt Taibbi, Substack

For the past few years I haven’t read much from Matt Taibbi to disagree with, as he has done a masterful job exposing the degeneracy of our political and cultural elites. I would agree here with the gist of his criticisms of bipartisan foreign policy and national security policy that has resulted in a long series of futile small war engagements.

However, I do fail to see the connection between war and political party systems he draws out in his title. Perhaps he is a bit unclear himself of the connection as he doesn’t really present the case as a solution, only that our two-party system is part of the problem. Basically he argues our two parties have failed and are corrupt (agreed), but then unconvincingly suggests maybe a third party is the solution. But I can’t find either internal logic or empirical history supporting the case for multiparty systems solving the national security dilemma, even while conceding Eisenhower’s warning concerning the Military Industrial Complex as a real danger. The solution to corrupt politics is to clean out the corruption through the voting process and, if necessary, through the checks of the judicial branch.

To review recent history, no multiparty democracy in the post-war world has satisfactorily solved the security dilemma without becoming dependent on the bipolar great power conflict between the USA and the former USSR. Even after the 1989 demise of the Soviet Bloc, the hegemonic dominance of US continued to provide a convenient security umbrella for European democracies, as well as many developing countries around the world. One must merely offer tacit submission to US global interests to have the US military do all the heavy lifting while the US taxpayer picks up the bill.

This convenient arrangement started to unravel as the global system became unipolar while the rest of the world began to catch up economically during Pax Americana. The cost of hegemony has continued to rise as the US$-centered global monetary system has undermined global trade flows and fundamental prices in asset markets. The liberalization of India and China has also contributed heavily to this transformation of global trade by shifting the global mix of capital and labor. What we have seen in the frequent mismanagement of global conflict by US hegemony has been, as Taibbi notes, an exercise in managing peace rather than decisively ending conflict. As Taibbi notes, one does not wage war for any other reason than to win by vanquishing one’s enemy. There is no polite, dignified way to do this and better not to start a war than to try to manage it over time.

Taibbi’s forlorn hope seems to be like that of Immanuel Kant, who believed democracies do not wage war against each other, so a world characterized by free democracies would ensure everlasting peace. History has proven otherwise as democracies are just less likely to initiate wars, but they are always drawn into them. We have not seen the End of History.

But this brings us to the suggested salve of multiparty systems, which are somewhat analogous to a multipolar international security system. Multipolar systems rely on configurations of alliances and these alliances must be trustworthy. Allies must be willing to commit to the alliance and absorb their share of the costs. This is a radically different dynamic than hegemony, where the big dog takes care of everything in return for obeisance. It is also radically different than bipolarity, which is what a two-party system is.

The USA is no longer the global hegemon because its leaders have not promoted the necessary commitments from the voting populace, and so the American public has moved away from supporting such a role. Remember, President George W. Bush maintained that we could fight the Afghan and Iraq wars without distracting ourselves from shopping at the mall. In other words, zero commitment from anyone, save those who volunteered to be on the front lines. This lack of commitment to assume the costs of global stability permeates US society today, from national politics to the financial sector to our cultural and educational institutions. It was reflected in President Trump’s desire to disengage from the Middle East. What should concern us, and Taibbi, is how global monetary hegemony of the US$ is destabilizing the global economic system, leading to more conflict at the periphery. US monetary policy, in coordination with the 4 other C5 central banks is creating massive inequalities between US$ holders and everyone else. The elite oligarchs of the world benefit from US$ portfolios, but their citizens do not and they will become increasingly restless and combative. There is no global policeman, so the world will become a more dangerous place in the absence of US hegemony.

A third-party in US politics can do nothing to reverse this trend toward irresponsible national policies in a multipolar world. And a multiparty electoral system is just as unstable as a multipolar global security system. It relies on fragile coalitions that give disproportionate power to minority parties that can tip the balance. On the other hand, a two-party system is quite effective in stabilizing a diverse, multi-ethnic, multi-racial pluralistic democratic society, albeit with certain trade-offs. Those trade-offs for stability include resistance to change and political sclerosis. But this is a crucial and deliberate element inherent to the overall design of our constitution to prevent passing populist fads from changing our form of self-government. I would be loathe to throw out national stability for the unwarranted hope of convergence on international comity. Instead, in a multiparty system we would expect the instability of comparable historical cases like post-war Italy, India, Indonesia or Brazil. A global superpower can hardly afford those kinds of risks.

I find Taibbi’s criticisms of our political leaders, our foreign policy bureaucracies, and our military-industrial complex to be on the mark. I sincerely doubt a third party solves any of these problems, but we will never find out because the logic of the two-party electoral system supersedes any argument against it for myriad reasons. Paramount is that national stability is a necessary precondition for good government, continuity, and preservation of the union. We’ve had dozens of third party movements in US history and the only ones that have been successful have been those rare moments when a new party replaces one of the two that has been rejected by the voters. The US electoral system favors reform from within the major parties by holding elected politicians to a higher standard and by removing them from office when necessary. The Republican party accomplished much of this house-cleaning in 2016, but the Democratic party is still conflicted over its future path.

It should be added that to reduce the risks of national politics we should devolve as much power away from the central government back to the states, counties, municipalities and individuals where it belongs. The central government was designed to coordinate democratic self-rule, not overrule.

But what we really need is a much broader understanding of our loss of political and financial integrity. What we need is another Greatest Generation on the horizon that recognizes good and evil and is willing to take a stand.

Bretton Woods – #2 of Series

Second of a Series of articles on the international monetary regime reprinted from the NY Sun.

Not sure I would agree with all of this. Net exports is different than manufacturing exports and manufacturing employment, especially in the global information economy. I believe the problem here is that the reserve currency allows the US central bank to issue too much US$ credit liabilities without paying the direct consequence. Our trading partners are not exactly happy about this either since they surrender control of their currencies to the dominance of the US Federal Reserve and US politics. I think we need to rein in political discretion over the value of money.

Time To Reverse the Curse Over the Dollar

nysun.com/national/beyond-bretton-woods-the-road-from-genoa/91606/

By JOHN MUELLER

Journalism thrives on simple narratives and round numbers. So I must note that what President Nixon ended 50 years ago was not the international gold standard, which persisted despite interruptions for more than two millennia to 1914, but its complicated parody: the gold-exchange standard, established 99, not 50, years ago by a 1922 agreement at Genoa.

Prime Minister David Lloyd George convened the Genoa Conference in an effort to restore the economies of Central and Eastern Europe, modify the schedule of German reparations owed to France, and begin the re-integration of Soviet Russia into the European economy. Lacking any American support, the conference was a failure on all those counts.

The gold-exchange standard, John Maynard Keynes’ idea, was Genoa’s one tangible result. Keynes had proposed in 1913 that the monetary system of British colonial India be adopted world-wide. The British pound would remain convertible into gold, but India’s and other countries’ domestic payments would be backed by ostensibly gold-convertible claims on London. Following Genoa, the pound could be exchanged for gold, and other national currencies could be exchanged for pounds.

But there was a complication: unlike most currencies, the Indian rupee actually was based on silver, not gold, and British officials, including Keynes, overvalued the silver rupee, hoping to reduce heavy demands for British gold. British monetary experts inserted this scheme (without the silver wrinkle) in the 1922 Genoa accord, incidentally forestalling impecunious Britain’s repayment of its World War I debts in gold.

While working 35 years ago for Congressman Jack Kemp, I first coined the term the “reserve currency curse.” I was tutored in the subject by Lewis E, Lehrman, who in turn was influenced by the French economist Jacques Rueff (1896-1978). Keynes had claimed that what matters is only the value, not kind, of monetary reserves. It was Rueff who countered in 1932 that foreign exchange is qualitatively different from an equal value of precious metal.

With the creation of, say, dollar reserves, purchasing power “has simply been duplicated, and thus the American market is in a position to buy in Europe, and in the United States, at the same time.” This credit duplication causes prices to rise faster in the reserve-currency country than its trading partners, precipitating the reserve-currency country’s deindustrialization. That fate soon befell Great Britain, then the United States after the dollar replaced the pound under the 1944 Bretton Woods agreement.

Other countries backing their currencies with dollar-denominated securities led to a dilemma for America. The United States is the only major country with negative net monetary reserves (foreign official assets minus liabilities). All others — even those whose currencies are used by foreign central banks — have positive net reserves (i.e., those countries’ foreign official assets exceed their foreign official liabilities).

There is a correlation of more than 90% between America’s net reserves and its manufacturing employment. American net reserves had been positive before but turned negative by 1960, and manufacturing jobs have since disappeared in direct proportion to the decline in our net reserves. Focusing on one bilateral trade balance or other — say, the US and China — is a mug’s game. What matters is the total balance, not bilateral subsets.

How could an American president reverse the reserve-currency curse? By making honesty the best policy: negotiating and starting repayment of all outstanding dollar reserves over several decades. Since international payments must be settled in real goods — not IOUs — the necessary production of American goods for export is the surest way to revive America’s manufacturing employment.

To increase our manufacturing jobs back to the peak of 17 million from today’s 12 million, it would be necessary to repay most outstanding official dollar reserves. If President Biden is as ineffectual as most of his recent predecessors in responding to the “reserve-currency curse,” he, too, will have to get used to the title “ex-President.”

________

Mr. Mueller is the Lehrman Institute Fellow in Economics at the Ethics and Public Policy Center in Washington DC and author of “Redeeming Economics.” Image: Conferees at the Genoa Conference, with Prime Minister Lloyd George of Britain front and center. Detail of a British Government photo, via Wikipedia Commons.

What is Money?

This looks to be an excellent series of articles concerning the most important policy issue of the past 50 years. The global monetary regime that uses the US$ as the reserve currency and gives the world’s central banks discretion and control over the supply of fiat currency drives current global events, for better and worse. The effects range from economic crises and financial meltdowns to inequality, political conflict, and environmental degradation. Given the importance of money, I print the following article from the NY Sun in full…

God and Money: ‘A Perfect and Just Measure Shalt Thou Have’

nysun.com/national/god-and-money-a-perfect-and-just-measure-shalt/91597/

By JUDY SHELTON

Following begins a new series of columns marking the 50th anniversary of the collapse of the Bretton Woods gold exchange standard established in the closing months of World War II. A related editorial appears nearby.

* * *

The 50th anniversary of the collapse, on August 15, 1971, of the Bretton Woods monetary system is a momentous moment in the history of money. It should provide an occasion for thoughtful discussion focused on the road to reform, our priceless constitutional foundation, and the restoration of honest money.

Let us avoid an academic food fight among economists over prior international monetary systems. We should not be arguing about the classical gold standard versus the Bretton Woods pegged exchange-rate system, as these are just variations on the more significant theme of gold convertibility and the role of government in regulating money.

We can’t even usefully revert to debating the old fixed-versus-flexible arguments that were part of Milton Friedman’s justification for freely floating rates in the 1960s; the theoretical models for both positions have been mugged by reality.

Instead, we should be talking about money itself — what is its basic purpose, its relationship with productive economic growth — and whether today’s dysfunctional international monetary regime deserves to be designated any kind of system at all.

As the former chief of the International Monetary Fund, Jacques de Larosiere, noted at a conference in February 2014 at Vienna, today’s central bank-dominated monetary arrangements foster “volatility, persistent imbalances, disorderly capital movements, currency misalignments.”

These, he warned, were all major factors in the explosion of credit and leverage that precipitated the 2008 global financial crisis. Such an unanchored approach, he said, does not amount to a “non-system” but something considerably worse: an “anti-system.”

It is time to think creatively about money. We need to remind ourselves what it means as a measure, how it facilitates voluntary commerce and opportunity — how it can lead to greater shared prosperity while remaining compatible with liberty, individualism, and free enterprise. We’re at a moment when everything is on the table. For the wisdom of central bank mechanisms for conducting monetary policy is being called into question just as private alternative monies are making ever more credible bids for legitimacy.

Looking back and looking ahead, we can see that the most relevant and stimulating views emphasize the importance of productive economic activity and an open global marketplace. Money’s crucial role is to provide clear price signals to optimize the rewards of entrepreneurial endeavor and increased human knowledge.

Adam Smith wrote his treatise “The Wealth of Nations” during an age when nations forged a global monetary system by defining their currencies in terms of precise weights of gold and silver. A level monetary playing field arising from a system inherently disciplined by forces outside the control of government — wherein the economic decisions of private individuals are not held hostage to the ambitions of politicians—served profoundly liberal goals such as rule of law, private property, and the equal protection of human rights.

Modern-day visionaries likewise focus on the integrity of market signals conveyed through money. When Elon Musk says, “I think about money as an information system,” he goes to the heart of money’s unit-of-account function and underscores the importance of price signal clarity. When he tweets that “goods and services are the real economy, any form of money is simply the accounting thereof,” he illuminates the same reasoning that caused our constitutional Framers to include the power to coin money and regulate the value of American money, and of foreign coin, in the same sentence of our Constitution that grants Congress the power to fix our standard of weights and measures.

Money is meant to be a reliable measure, a meaningful unit of account, and a dependable store of value. When those qualities are undermined — especially by government — for purposes of redirecting economic outcomes at the risk of global financial instability, the dynamism and productive potential of free-market forces is diminished.

Political arguments in favor of maintaining government control over the issuance of money tend to invoke short-term objectives couched in words such as “stimulus” and the need for central bank “support” for an economy. Such calls are met with somber warnings about long-term “unsustainability” from the monetary authorities who nevertheless indulge them.

“But thou shalt have a perfect and just weight, a perfect and just measure shalt thou have,” goes the passage from the Book of Deuteronomy (25:15), “that thy days may be lengthened in the land which the LORD thy God giveth thee.” The biblical injunction against dishonest measures can be interpreted as alluding to sustainability not only in economic terms but also in the moral realm.

As noted by Robert Bartley, editor of the editorial page of The Wall Street Journal for more than 30 years, economist Robert Mundell was correct in his assessment that the only closed economy is the world economy. It’s time to start building an ethical international monetary system.

________

Judy Shelton, an economist, is a senior fellow at the Independent Institute and author of “Money Meltdown.” Image: The conference room at the Mount Washington Hotel, Bretton Woods, New Hampshire, where, in 1944, the Bretton Woods Treaty was crafted. Via Wikipedia Commons.SupportAboutTerms

Debt Follies

The New Monetary Regime: An Expert Panel Discusses Debt and Inflation

Written remarks from our three panelists follow below:

U.S. Fiscal Profligacy and the Impending Crisis

by David P. Goldman

The Rise and Rise of Deficit Government

by Christopher DeMuth

The Costs of Our Debt

by Veronique de Rugy

These remarks from the symposium offer a revealing analysis of US financial and fiscal policy. I include in this post the essay by David Goldman, as I believe it offers a foundation for understanding the predicament we have created with poorly conceived financial policies that are now being accelerated and amplified. I have highlighted sections in RED.

May 5, 2021

Massive demand-side stimulus combined with constraints on the supply-side in the form of higher taxes is a sure recipe for inflation and eventual recession. The Fiscal Year 2021 US budget deficit will amount to 15% of US GDP after the passage of an additional $1.9 trillion in demand stimulus, according to the Committee for a Responsible Federal Budget, a proportion that the United States has not seen since World War II.

It is hard to avoid the conclusion that the Biden Administration’s fiscal irresponsibility arises from a cynical political calculation. It evidently proposes to employ the federal budget as a slush fund to distribute benefits to various political constituencies, gambling that the avalanche of new debt will not cause a financial crisis before the 2022 Congressional elections. The additional $2.3 trillion in so-called infrastructure spending that the Administration has proposed consists mainly of handouts to Democratic constituencies.

Where is Foreign Money Going?

During the 12 months ending in March, the deficit stood at 19% of GDP. Even worse, the Federal Reserve absorbed virtually all the increase in outstanding debt on its balance sheet. In the aftermath of the 2009 recession, when the deficit briefly rose to 10% of GDP, foreigners bought about half the total new issuance of Treasury debt. During the past 12 months, foreigners have been net sellers of US government debt. (See Figure 1.) The US dollar’s role as the world’s principal reserve currency is eroding fast, and fiscal irresponsibility of this order threatens to accelerate the dollar’s decline.

The Federal Reserve has kept short-term interest rates low by monetizing debt, but long-term Treasury yields have risen by more than a percentage point since July. Markets know that what can’t go on forever, won’t. At some point, private holders of Treasury debt will liquidate their holdings—as foreigners have begun to do—and rates will rise sharply. (See Figure 2.) For every percentage point increase in the cost of financing federal debt, the US Treasury will have to pay an additional quarter-trillion dollars in interest. The United States well may find itself in the position of Italy in 2018, but without the rich members of the European Union to bail it out.

The flood of federal spending has had a number of dangerous effects already:

  1. The US trade deficit in goods as of February 2021 reached an annualized rate of more than $1 trillion a year, an all-time record. China’s exports to the US over the 12 months ending in February also reached an all-time record. Federal stimulus created demand that US productive facilities could not meet, and produced a massive import boom.
  2. Input prices to US manufacturers in February rose at the fastest rate since 1973, according to the Philadelphia Federal Reserve’s survey. And the gap between input prices and finished goods prices rose at the fastest rate since 2009. (See Figure 3.)
  3. The Producer Price Index for final demand rose at an annualized 11% rate during the first quarter. The Consumer Price Index shows year-on-year growth of only 1.7%, but that reflects dodgy measurements (for example, the price shelter, which comprises a third of the index, supposedly rose just 1.5% over the year, although home prices rose by 10%).

If foreigners are net sellers of US Treasury securities, how is the United States financing an external deficit in the range of $1 trillion a year? The US has two deficits to finance, the internal budget deficit, and the balance of payments deficit, and here we refer to the second. The answer is: By selling stocks to foreigners, according to Treasury data. (See Figure 4.) Foreign investors have been dumping low-yielding US Treasuries and corporate bonds during the past year, according to the Treasury International Capital (TIC) system. Foreign investors bought $400 billion of US equities and nearly $500 billion of US agency securities (backed by home mortgages) during the 12 months through January, but sold $600 billion of Treasuries and $100 billion of corporate bonds.

This is a bubble on top of a bubble. [Double Bubble = Trouble.] The Federal Reserve buys $4 trillion of Treasury securities and pushes the after-inflation yield below zero. That pushes investors into stocks. Foreigners don’t want US Treasuries at negative real yields, but they buy into the stock market which keeps rising, because the Fed is pushing down bond yields, and so forth.

At some point, foreigners will have a bellyful of overpriced US stocks and will stop buying them. When this happens, the Treasury will have to sell more bonds to foreigners, but that means allowing interest rates to rise, because foreigners won’t buy US bonds at extremely low yields. Rising bond yields will push stock prices down further, which means that foreigners will sell more stocks, and the Treasury will have to sell more bonds to foreigners, and so forth.

The 2009 crisis came from the demand side. When the housing bubble collapsed, trillions of dollars of derivative securities backed by home loans collapsed with it, wiping out the equity of homeowners and the capital base of the banking system. The 2021 stagflation—the unhappy combination of rising prices and falling output—is a supply-side phenomenon. [Back to the Future of That 70s Show] That’s what happens when governments throw trillions of dollars of money out of a helicopter, while infrastructure and plant capacity deteriorate.

The present situation is unprecedented in another way: Not in the past century has the United States faced a competitor with an economy as big as ours, growing much faster than ours, with ambitions to displace us as the world’s leading power.

The source of the 2008 crisis was overextension of leverage to homeowners and corporations. I was one of a small minority of economists who predicted that crisis.

Federal debt in 2008 was 60% of GDP, not counting the unfunded liabilities of Medicare and the Social Security System. As of the end of 2020, Federal debt had more than doubled as a percentage of GDP, to 130%. The Federal Reserve in 2008 owned only $1 trillion of securities. US government debt remained a safe harbor asset; after the Lehman Brothers bankruptcy in September 2008, the 30-year US Treasury yield fell from 4.7% to 2.64%, as private investors bought Treasuries as a refuge.

The Treasury: Not a Refuge from, but a Cause of Crisis

Today the US Treasury market is the weak link in the financial system, supported only by the central bank’s monetization of debt. If the extreme fiscal profligacy of the Biden Administration prompts private investors to exit the Treasury market, there will be no safe assets left in dollar financial markets. The knock-on effects would be extremely hard to control

The overwhelming majority of over-the-counter (privately traded) derivatives contracts serve as interest-rate hedges. Market participants typically pledge Treasury securities as collateral for these contracts. The notional value of such contracts now exceeds $600 trillion, according to the Bank for International Settlements. Derivatives contracts entail a certain amount of market risk, and banks will enter into them with customers who want to hedge interest-rate positions only if the customers put up collateral (like the cash margin on a stock bought on credit) (See Figure 5) The market value (after netting for matching contracts that cancel each other out) is about $15 trillion. If the prices of Treasury securities fall sharply, the result will be a global margin call in the derivatives market, forcing the liquidation of vast amounts of positions.

Something like this occurred between March 6 and March 18, 2020, when the yield on inflation-protected US Treasury securities (TIPS) jumped from about negative 0.6% to positive 0.6% in two weeks. The COVID-19 crash prompted a run on cash at American banks, as US corporate borrowers drew down their credit lines. US banks in turn cut credit lines to European and Japanese banks, who were forced to withdraw funding to their customers for currency hedges on holdings of US Treasury securities. The customers in turn liquidated US Treasury securities, and the Treasury market crashed. That was the first time that a Treasury market crash coincided with a stock market crash: Instead of acting as a crisis refuge, the US Treasury market became the epicenter of the crisis.

The Federal Reserve quickly stabilized the market through massive purchases of Treasury securities, and through the extension of dollar swap lines to European central banks, which in return restored dollar liquidity to their customers. These emergency actions were justified by the extraordinary circumstances of March 2020: An external shock, namely the COVID-19 pandemic, upended financial markets, and the central bank acted responsibility in extending liquidity to the market. But the Federal Reserve and the Biden Administration now propose to extend these emergency measures into a continuing flood of demand. The consequences will be dire.

The present situation is unprecedented in another way: Not in the past century has the United States faced a competitor with an economy as big as ours, growing much faster than ours, with ambitions to displace us as the world’s leading power. China believes that America’s fiscal irresponsibility will undermine the dollar’s status as world reserve currency.

Here is what Fudan University Professor Bai Gang told the Observer, a news site close to China’s State Council:

Simply put, this year the United States has issued a massive amount of currency, which has given the US economy, which has been severely or partially shut down due to the COVID-19 epidemic, a certain kind of survival power. On the one hand, it must be recognized that this method . . . is highly effective. . . . The US stock market once again hit a record high.

But what I want to emphasize is that this approach comes at the cost of the future effectiveness of the dollar lending system. You do not get the benefit without having to bear its necessary costs.

A hegemonic country can maintain its currency hegemony for a period of time even after the national hegemony has been lost. After Britain lost its global hegemony, at least in the 1920s and 1930s, the pound sterling still maintained the function of the world’s most important currency payment method. To a certain extent, the hegemony of the US dollar is stronger than any currency before it. . . .

We see that the US dollar, as the most important national currency in the international payment system, may still persist for a long time even after US hegemony ends. Since this year, the US has continued to issue more currency to ease the internal situation. The pressure will eventually seriously damage the status of the US dollar as the core currency in the international payment system.

America has enormous power, but the Biden Administration and the Federal Reserve are abusing it. And China is waiting for the next crisis to assert its primacy in the world economy.

Everything is Broken

A couple of excellent articles that give the long-tailed, big picture of how the global economy has gotten itself between a rock and a hard place. Mostly due to political and financial mismanagement. The consequences were not inevitable, but Mauldin explains how we’re beyond the point of no return.

We have arrived. Any choice the government and central banks of the US and the rest of the world make will ultimately lead to a crisis. Just as the choices that Greenspan and Bernanke made about monetary policy created the Great Recession, Yellen and Powell’s choices will eventually lead us to the next crisis and ultimately to what I call The Great Reset.

I believe we have passed the point of no return. Changing policy now would create a recession as big as Paul Volcker’s in the early ‘80s. There is simply no appetite for that. Further, the national debt and continued yearly deficits force monetary policy to stay accommodative.

John Mauldin, Inflation is Broken.

Everything is Broken.

Inflation is Broken.

Broken Credit
Broken Retirement
Broken Stocks
Broken Data
Broken Unemployment System
Puerto Rico, Vaccines, and Some Good News

Broken lines, broken strings,
Broken threads, broken springs,
Broken idols, broken heads,
People sleeping in broken beds

—Bob Dylan, “Everything is Broken” from the album Oh Mercy, 1989

Global Depression or Persistent Stagflation?

Dr. Doom and Gloom lays out the downside global economic scenario. Worth reading and factoring into our economic posturing…[Comments bracketed in red].

Published in NY Magazine

Why Our Economy May Be Headed for a Decade of Depression

Eric Levitz May 22, 2020

The worst is yet to come?

In September 2006, Nouriel Roubini told the International Monetary Fund what it didn’t want to hear. Standing before an audience of economists at the organization’s headquarters, the New York University professor warned that the U.S. housing market would soon collapse — and, quite possibly, bring the global financial system down with it. Real-estate values had been propped up by unsustainably shady lending practices, Roubini explained. Once those prices came back to earth, millions of underwater homeowners would default on their mortgages, trillions of dollars worth of mortgage-backed securities would unravel, and hedge funds, investment banks, and lenders like Fannie Mae and Freddie Mac could sink into insolvency.

At the time, the global economy had just recorded its fastest half-decade of growth in 30 years. And Nouriel Roubini was just some obscure academic. Thus, in the IMF’s cozy confines, his remarks roused less alarm over America’s housing bubble than concern for the professor’s psychological well-being.

Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity.

A decade later, “Dr. Doom” is a bear once again. While many investors bet on a “V-shaped recovery,” Roubini is staking his reputation on an L-shaped depression. The economist (and host of a biweekly economic news broadcastdoes expect things to get better before they get worse: He foresees a slow, lackluster (i.e., “U-shaped”) economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts. Specifically, Roubini argues that the massive private debts accrued during both the 2008 crash and COVID-19 crisis will durably depress consumption and weaken the short-lived recovery. Meanwhile, the aging of populations across the West will further undermine growth while increasing the fiscal burdens of states already saddled with hazardous debt loads. Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade. As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines. Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression. And through it all, humanity will be beset by unnatural disasters, from extreme weather events wrought by man-made climate change to pandemics induced by our disruption of natural ecosystems.

Roubini allows that, after a decade of misery, we may get around to developing a “more inclusive, cooperative, and stable international order.” But, he hastens to add, “any happy ending assumes that we find a way to survive” the hard times to come.

Intelligencer recently spoke with Roubini about our impending doom.

You predict that the coronavirus recession will be followed by a lackluster recovery and global depression. The financial markets ostensibly see a much brighter future. What are they missing and why?

Well, first of all, my prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a “Greater Depression.” Markets, of course, have a shorter horizon. In the short run, I expect a U-shaped recovery while the markets seem to be pricing in a V-shape recovery.

Of course the markets are going higher because there’s a massive monetary stimulus, there’s a massive fiscal stimulus. People expect that the news about the contagion will improve, and that there’s going to be a vaccine at some point down the line. And there is an element “FOMO” [fear of missing out]; there are millions of new online accounts — unemployed people sitting at home doing day-trading — and they’re essentially playing the market based on pure sentiment. My view is that there’s going to be a meaningful correction once people realize this is going to be a U-shaped recovery. If you listen carefully to what Fed officials are saying — or even what JPMorgan and Goldman Sachs are saying — initially they were all in the V camp, but now they’re all saying, well, maybe it’s going to be more of a U. The consensus is moving in a different direction.

Your prediction of a weak recovery seems predicated on there being a persistent shortfall in consumer demand due to income lost during the pandemic. A bullish investor might counter that the Cares Act has left the bulk of laid-off workers with as much — if not more — income than they had been earning at their former jobs. Meanwhile, white-collar workers who’ve remained employed are typically earning as much as they used to, but spending far less. Together, this might augur a surge in post-pandemic spending that powers a V-shaped recovery. What does the bullish story get wrong?

Yes, there are unemployment benefits. And some unemployed people may be making more money than when they were working. But those unemployment benefits are going to run out in July. The consensus says the unemployment rate is headed to 25 percent. Maybe we get lucky. Maybe there’s an early recovery, and it only goes to 16 percent. Either way, tons of people are going to lose unemployment benefits in July. And if they’re rehired, it’s not going to be like before — formal employment, full benefits. You want to come back to work at my restaurant? Tough luck. I can hire you only on an hourly basis with no benefits and a low wage. That’s what every business is going to be offering. Meanwhile, many, many people are going to be without jobs of any kind. It took us ten years — between 2009 and 2019 — to create 22 million jobs. And we’ve lost 30 million jobs in two months. [This begins to show why employment is the wrong focus for the Information Age.]

So when unemployment benefits expire, lots of people aren’t going to have any income. Those who do get jobs are going to work under more miserable conditions than before. And people, even middle-income people, given the shock that has just occurred — which could happen again in the summer, could happen again in the winter — you are going to want more precautionary savings. You are going to cut back on discretionary spending. Your credit score is going to be worse. Are you going to go buy a home? Are you gonna buy a car? Are you going to dine out? In Germany and China, they already reopened all the stores a month ago. You look at any survey, the restaurants are totally empty. Almost nobody’s buying anything. Everybody’s worried and cautious. And this is in Germany, where unemployment is up by only one percent. Forty percent of Americans have less than $400 in liquid cash saved for an emergency. [This is a major policy failure that citizens of other countries do not share. Our tax policies have discouraged savings but encouraged borrowing.] You think they are going to spend?

Graphic: Financial Times
Graphic: Financial Times

You’re going to start having food riots soon enough. [I don’t see that happening, at least not in the US. People on state welfare support are going to need more of it and the welfare roles will rise.] Look at the luxury stores in New York. They’ve either boarded them up or emptied their shelves,  because they’re worried people are going to steal the Chanel bags. [Yes, because luxury goods are a form of currency. Luxury stores are also a focus of resentment.] The few stores that are open, like my Whole Foods, have security guards both inside and outside. We are one step away from food riots. There are lines three miles long at food banks. [This not a riot, it’s an overload on govt provided welfare.] That’s what’s happening in America. You’re telling me everything’s going to become normal in three months? That’s lunacy.

Your projection of a “Greater Depression” is premised on deglobalization sparking negative supply shocks. And that prediction of deglobalization is itself rooted in the notion that the U.S. and China are locked in a so-called Thucydides trap, in which the geopolitical tensions between a dominant and rising power will overwhelm mutual financial self-interest. But given the deep interconnections between the American and Chinese economies — and warm relations between much of the U.S. and Chinese financial elite — isn’t it possible that class solidarity will take precedence over Great Power rivalry? In other words, don’t the most powerful people in both countries understand they have a lot to lose financially and economically from decoupling? And if so, why shouldn’t we see the uptick in jingoistic rhetoric on both sides as mere posturing for a domestic audience?

First of all, my argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen. That said, everybody agrees that there is the beginning of a Cold War between the U.S. and China. I was in Beijing in November of 2015, with a delegation that met with Xi Jinping in the Great Hall of the People. And he spent the first 15 minutes of his remarks speaking, unprompted, about why the U.S. and China will not get caught in a Thucydides trap, and why there will actually be a peaceful rise of China.

Since then, Trump got elected. Now, we have a full-scale trade war, technology war, financial war, monetary war, technology, information, data, investment, pretty much anything across the board. Look at tech — there is complete decoupling. They just decided Huawei isn’t going to have any access to U.S. semiconductors and technology. We’re imposing total restrictions on the transfer of technology from the U.S. to China and China to the U.S. And if the United States argues that 5G or Huawei is a backdoor to the Chinese government, the tech war will become a trade war. Because tomorrow, every piece of consumer electronics, even your lowly coffee machine or microwave or toaster, is going to have a 5G chip. That’s what the internet of things is about. If the Chinese can listen to you through your smartphone, they can listen to you through your toaster. Once we declare that 5G is going to allow China to listen to our communication, we will also have to ban all household electronics made in China. So, the decoupling is happening. We’re going to have a “splinternet.” It’s only a matter of how much and how fast.

And there is going to be a cold war between the U.S. and China. Even the foreign policy Establishment — Democrats and Republicans — that had been in favor of better relations with China has become skeptical in the last few years. They say, “You know, we thought that China was going to become more open if we let them into the WTO. We thought they’d become less authoritarian.” Instead, under Xi Jinping, China has become more state capitalist, more authoritarian, and instead of biding its time and hiding its strength, like Deng Xiaoping wanted it to do, it’s flexing its geopolitical muscle. And the U.S., rightly or wrongly, feels threatened. I’m not making a normative statement. I’m just saying, as a matter of fact, we are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history. So we’ll be lucky if we just get a cold war.

Some Trumpian nationalists and labor-aligned progressives might see an upside in your prediction that America is going to bring manufacturing back “onshore.” But you insist that ordinary Americans will suffer from the downsides of reshoring (higher consumer prices) without enjoying the ostensible benefits (more job opportunities and higher wages). In your telling, onshoring won’t actually bring back jobs, only accelerate automation. And then, again with automation, you insist that Americans will suffer from the downside (unemployment, lower wages from competition with robots) but enjoy none of the upside from the productivity gains that robotization will ostensibly produce. So, what do you say to someone who looks at your forecast and decides that you are indeed “Dr. Doom” — not a realist, as you claim to be, but a pessimist, who ignores the bright side of every subject?

When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. That is a fact. How is the corporate sector going respond to that? It’s going to respond by replacing labor with robots, automation, and AI.

I was recently in South Korea. I met the head of Hyundai, the third-largest automaker in the world. He told me that tomorrow, they could convert their factories to run with all robots and no workers. Why don’t they do it? Because they have unions that are powerful. In Korea, you cannot fire these workers, they have lifetime employment. [There is a serious cost to raising labor rates in a world with price competition. Raising input costs means pricing power rules and most producers lack that pricing power. If Hyundai cars become more expensive, then Hyundai loses sales and Hyundai requires state subsidies paid for by Korean taxpayers. If Hyundai reduces costs, Hyundai workers face dimmer income prospects and more state welfare. The only way out of this conundrum is to share the economic costs across all stakeholders. That’s best done through equity rights than through state directives. This is especially true in the US under the corporate legal structure.]

But suppose you take production from a labor-intensive factory in China — in any industry — and move it into a brand-new factory in the United States. You don’t have any legacy workers, any entrenched union. You are going to design that factory to use as few workers as you can. Any new factory in the U.S. is going to be capital-intensive and labor-saving. It’s been happening for the last ten years and it’s going to happen more when we reshore. So reshoring means increasing production in the United States but not increasing employment. Yes, there will be productivity increases. And the profits of those firms that relocate production may be slightly higher than they were in China (though that isn’t certain since automation requires a lot of expensive capital investment).

But you’re not going to get many jobs. The factory of the future is going to be one person manning 1,000 robots and a second person cleaning the floor. And eventually the guy cleaning the floor is going to be replaced by a Roomba because a Roomba doesn’t ask for benefits or bathroom breaks or get sick and can work 24-7. [I’ve written many times in the past, what matters is who owns and controls the robots.]

The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. [Yes, but conceptually we can close this conflict of interest by turning more of Main St. into entrepreneurial risk takers through the sharing of diversified equity risks.] That wasn’t even true during the global financial crisis when we were saying, “We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.” How did Wall Street react to the crisis? They fired workers. And when they rehired them, they were all gig workers, contractors, freelancers, and so on. That’s what happened last time. This time is going to be more of the same. Thirty-five to 40 million people have already been fired. When they start slowly rehiring some of them (not all of them), those workers are going to get part-time jobs, without benefits, without high wages. That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. But of course, your labor cost is my consumption. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. [Again, this is why using wage labor as the dominant distributional mechanism for the success of capitalism is no longer viable. It only was during the industrial age.] And they’re going to save more to protect themselves from another coronavirus crisis. And so consumption is going to be weak. That’s why you get the U-shaped recovery.

There’s a conflict between workers and capital. [Only in the short-run.] For a decade, workers have been screwed. Now, they’re going to be screwed more. There’s a conflict between small business and large business.

Millions of these small businesses are going to go bankrupt. Half of the restaurants in New York are never going to reopen. How can they survive? They have such tiny margins. Who’s going to survive? The big chains. Retailers. Fast food. The small businesses are going to disappear in the post-coronavirus economy. So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win. [We all win by participating in the financing and risk sharing of capitalism. We all need to be invested in Wall St., and finance – both ownership and control – must be transparent. Someday we will have blockchain smart contracts distribute corporate profits to shareholders in a transparent manner under the shareholders’ control, reducing the agency costs and conflicts of interest.]

Clearly, you’re bearish on the potential of existing governments intervening in that conflict on Main Street’s behalf. But if we made you dictator of the United States tomorrow, what policies would you enact to strengthen labor, and avert (or at least mitigate) the Greater Depression? 

The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. [Yes, but that does not mean wage or labor supply controls – intervention on the cost side of production will only backfire.] Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free. [These policies all lead to productive investment in human capital, but it is not enough. Workers need financial capital that generates diversified streams of income.]  Otherwise, the trends of the market are going to imply more income and wealth inequality. [The Fed has been no help here.] There’s a lot we can do to rebalance it. But I don’t think it’s going to happen anytime soon. If Bernie Sanders had become president, maybe we could’ve had policies of that sort. [No, Bernie is completely focused on intervening into labor markets. Workers look like they’re gaining in the short-run and lose big time in the long-run.] Of course, Bernie Sanders is to the right of the CDU party in Germany. I mean, Angela Merkel is to the left of Bernie Sanders. Boris Johnson is to the left of Bernie Sanders, in terms of social democratic politics. Only by U.S. standards does Bernie Sanders look like a Bolshevik.

In Germany, the unemployment rate has gone up by one percent. In the U.S., the unemployment rate has gone from 4 percent to 20 percent (correctly measured) in two months. We lost 30 million jobs. Germany lost 200,000. Why is that the case? You have different economic institutions. Workers sit on the boards of German companies. So you share the costs of the shock between the workers, the firms, and the government. [Yes, this is how it should be, but in US society and business, equity is the cleanest way to achieve this representation. Stakeholders should have board representation through their equity ownership claims.]

In 2009, you argued that if deficit spending to combat high unemployment continued indefinitely, “it will fuel persistent, large budget deficits and lead to inflation.” You were right on the first count obviously. And yet, a decade of fiscal expansion not only failed to produce high inflation, but was insufficient to reach the Fed’s 2 percent inflation goal. Is it fair to say that you underestimated America’s fiscal capacity back then? And if you overestimated the harms of America’s large public debts in the past, what makes you confident you aren’t doing so in the present?

First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. I was not in favor of fiscal consolidation. There’s a huge difference between the global financial crisis and the coronavirus crisis because the former was a crisis of aggregate demand, given the housing bust. And so monetary policy alone was insufficient and you needed fiscal stimulus. And the fiscal stimulus that Obama passed was smaller than justified. So stimulus was the right response, at least for a while. And then you do consolidation.

What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus. What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it (because that’s what the Fed has been doing) — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. [We will have asset price inflation in the immediate and longer-term – this greatly aggravates inequality.] This is because we’re going to see two big negative supply shocks. For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock. And technology is not going to be the same as before. The 5G of Erickson and Nokia costs 30 percent more than the one of Huawei, and is 20 percent less productive. So to install non-Chinese 5G networks, we’re going to pay 50 percent more. So technology is going to gradually become a negative supply shock. So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ’73 and ’79, the Yom Kippur War and the Iranian Revolution. What did you get? Stagflation.

Now, I’m not talking about hyperinflation — not Zimbabwe or Argentina. I’m not even talking about 10 percent inflation. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds — which today have interest rates close to zero percent — will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent. And ask yourself, what’s going to happen to the real economy? Well, in the fourth quarter of 2018, when the Federal Reserve tried to raise rates above 2 percent, the market couldn’t take it. So we don’t need hyperinflation to have a disaster. [So we seesaw between heeling one way or the other –  inflationary or deflationary pressures with volatile financial policy. Sounds like a great policy scenario.]

In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates?

For the last decade, debt-to-GDP ratios in the U.S. and globally have been rising. And debts were rising for corporations and households as well. But we survived this, because, while debt ratios were high, debt-servicing ratios were low, since we had zero percent policy rates and long rates close to zero — or, in Europe and Japan, negative. But the second the Fed started to hike rates, there was panic.

In December 2018, Jay Powell said, “You know what. I’m at 2.5 percent. I’m going to go to 3.25. And I’m going to continue running down my balance sheet.” And the market totally crashed. And then, literally on January 2, 2019, Powell comes back and says, “Sorry, I was kidding. I’m not going to do quantitative tightening. I’m not going to raise rates.” So the economy couldn’t take a Fed funds rate of 2.5 percent. In the strongest economy in the world. There is so much debt, if long-term rates go from zero to 3 percent, the economy is going to crash.

You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?

I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. The science says these extreme events are becoming more frequent, are coming farther inland, and are doing more damage. And they are doing this now, not 30 years from now. 

So there is climate change. And its economic costs are becoming quite extreme. In Indonesia, they’ve decided to move the capital out of Jakarta to somewhere inland because they know that their capital is going to be fully flooded. In New York, there are plans to build a wall all around Manhattan at the cost of $120 billion. And then they said, “Oh no, that wall is going to be so ugly, it’s going to feel like we’re in a prison.” So they want to do something near the Verrazzano Bridge that’s going to cost another $120 billion. And it’s not even going to work.

The Paris Accord said 1.5 degrees. Then they say two. Now, every scientist says, “Look, this is a voluntary agreement, we’ll be lucky if we get three — and more likely, it will be four — degree Celsius increases by the end of the century.” How are we going to live in a world where temperatures are four degrees higher? And we’re not doing anything about it. The Paris Accord is just a joke. And it’s not just the U.S. and Trump. China’s not doing anything. The Europeans aren’t doing anything. It’s only talk.

And then there’s the pandemics. These are also man-made disasters. You’re destroying the ecosystems of animals. You are putting them into cages — the bats and pangolins and all the other wildlife — and they interact and create viruses and then spread to humans. First, we had HIV. Then we had SARS. Then MERS, then swine flu, then Zika, then Ebola, now this one. And there’s a connection between global climate change and pandemics. Suppose the permafrost in Siberia melts. There are probably viruses that have been in there since the Stone Age. We don’t know what kind of nasty stuff is going to get out. We don’t even know what’s coming. [Climate change and environmental degradation need to be managed, probably in a decentralized manner using market signals to change behavior. But a society needs resilience, slack, and insurance to manage the vagaries and risks of uncertain change. We’ve reduced our ability to adapt through misguided policies for about 50 years now, greatly increasing systemic risk. That’s what man-made disasters are made of.]

Bubblenomics

Some people will read this and say, “No inflation, no problem.” But that completely misses the point of asset price volatility and distortions of resource allocations. People complain about inequality, but then ignore these policies that aggravate inequality while making unequal outcomes rather arbitrary. In the meantime we live in a far more volatile and precarious world.

The Federal Reserve’s everything bubble

Desmond Lachman, May 19, 2020

Good economic policymaking resembles good medical practice. In much the same way as a skilled doctor’s effective prescription for a disease rests on an accurate diagnosis of the illness, so too a wise economic policymaker’s effective crisis policy response depends on a comprehensive understanding of the crisis’s underlying causes.

One has to regret Federal Reserve Chairman Jerome Powell’s seemingly partial diagnosis of our present daunting economic challenge, especially considering his key role in defusing the crisis. In Powell’s view, our economic predicament has nothing to do with the possibility that years of ultra-easy U.S. monetary policy might have contributed to the creation of worldwide asset and credit market bubbles. Rather, he seems to believe that our economic challenge is solely the result of the supply side shock delivered to the economy by the coronavirus pandemic. 

Following the bursting of the U.S. housing and credit market bubble in 2008, it took the U.S. economy some six years to regain its pre-crisis employment level. Dismissing any notion that the coronavirus pandemic might now be bursting asset and credit market bubbles of the Fed’s creation, Powell believes that this time around we could have a quicker economic recovery than we did following the 2008-2009 Great Recession. 

Indeed, Powell believes that the U.S. economy could fully recover by the end of 2021, notwithstanding the very much deeper economic recession that we are now experiencing than in 2008-2009. 

Despite Mr. Powell’s assertions to the contrary, over the past decade the Fed, along with the world’s other major central banks, created a global asset and credit market bubble. They did so by buying a staggering cumulative $10 trillion in low-risk government and private sector bonds with the aim of forcing investors to take on more risk and to stretch for yield. The net result of that policy was the creation of a global equity and housing market boom as well as the major distortion of world credit markets.

One indication of the world equity price bubble was the very high valuation to which the U.S. equity market reached before its large coronavirus-induced correction earlier this year. Measured by the cyclically adjusted price-earnings ratio, before the pandemic’s onset U.S. equity valuations reached lofty levels experienced only three times in the past hundred years. Meanwhile, numerous housing markets around the world, including those in several large U.S. cities, had price-to-income ratios that exceeded those reached at the 2006 peak of the earlier housing market bubble.

More troubling yet, the world’s major central banks have distorted global credit markets in a major way, as investors were encouraged to take on excessive risk. One indication of such credit market excess was the more than doubling in the risky U.S. leveraged-loan market to its present level of around $1.3 trillion. Other indications were the approximate doubling over the past decade of lending to the emerging market economies and the very low interest rates at which highly indebted countries like Italy were able to finance themselves. 

A key point to which Powell is choosing to turn a blind eye is the great likelihood that the very depth of the current economic recession, which is almost certain to be the worst experienced in the past 90 years, will burst asset price bubbles around the globe and make it all the more difficult for debtors to service their loans. This will be particularly the case for the travel, hospitality and entertainment sectors of the world economy that are bound to be particularly hard hit, at least until a COVID-19 vaccine is made widely available. If a wave of debt defaults and bankruptcies were to occur, we could see real stress in the world financial system. [The only option the Fed has at this point is to ramp up ZIRP and QE4ever as well as underwrite US Treasury borrowing.]

Another key point that Powell seems to overlook is the likelihood that the global economic recession could trigger both another round of the European sovereign debt crisis and yet one more major emerging market economic crisis. In this respect, it is hardly encouraging that the European economic recession shows every sign of being deeper than that in the United States and that Europe is still struggling to fashion a united fiscal response to the recession. Nor is it encouraging that capital is being withdrawn from the emerging market economies at a record pace and that a number of emerging market currencies already appear to be in free fall.     

To his credit, Powell responded both boldly and promptly to the initial phases of the current economic crisis. Hopefully, he stands ready to do more of the same at the first signs of real stress in the global financial system. If not, we can be sure that our full economic recovery will be delayed until well after the end of 2021. 

[Not sure how writing more trillion$ blank checks really is a solution.]

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.


The problem we see here is that the world’s economies, made up of the world’s citizens, have been dangerously pushed out on the risk curve. Meltdowns of inflated asset values are sure to occur and each one means we are less able to respond to excess risk and loss. The USA is in an envious position because its control of the world currency means all those dollars come back to the US economy to buy real assets, so those who own those assets (Americans) are far more fortunate than those who want to buy them. But this only means more economic and political volatility across the globe.