Category Archives: Financials

MMT advocates, where are you? Hello? Hello?

Modern Monetary Theory advocates, who claimed that government could spend without concern for deficits, have gone very quiet. They argued that inflation could be easily controlled, mostly by issuing bonds to soak up the excess money.

Well folks, you got your spending. Now deal with the inflation. Right now, please. That means not only stopping QE, but moving to Quantitative Tightening (QT) by divesting the Fed of its enormous pile of Treasuries. Cat got your tongues?

More Nonsense

I keep reading articles bemoaning the fact that the massive government debt cannot possibly be repaid and will therefore be inflated away. Conveniently forgetting that inflation will drive up interest rates, causing the debt pile to grow.

Since when, in modern times anyway, is government debt ever repaid? It is rolled over and grows more quickly or slowly and may even occasionally shrink slightly, but it is not repaid. The question is not the repayment, but firstly the cost of servicing the debt and secondly the negative impact on the growth of the economy.

Federal debt is currently about 128% of GDP. Thanks to inflation, the Taylor rule currently suggests that Fed funds should be about 18%. At which point interest costs would be 23% of GDP. Federal tax revenues are currently about 14.4% of GDP. Oopsie. Even if you say, well, 7% would be a zero real rate, interest costs would be 9% of GDP, well over half of tax revenue. There’s a reason that the Fed is talking about pitifully small quarter point increases – the government can’t afford any increase at all.

Grow your way out of it so the percent of GDP declines? GLWT. History strongly suggests that debt loads over 80% of GDP strangle growth, as we are about to find out once more, I suspect. Recovery from a major hit doesn’t count, much as Biden would like.

The bottom line is, total debt in the economy must be reduced. Inflation helps, but inflation kills the economy. If the government won’t default, then the private sector must. And it will. That’s what the coming depression is all about.

The Fed Put

I’ve been reading apparently serious pieces wondering where the strike price of the Fed Put is. The Fed Put is a deeply held belief in the investment community. It is the belief that the Fed will step in and save the stock market before any kind of serious decline.

The dot-com bubble did not stop until the Nasdaq 100 had lost 83% of its value. The GFC was, in fact, arrested by the Fed, which eliminated mark-to-market accounting for banks. The Nasdaq 100 at that point had lost 52% and the S&P 59%, although most of the real carnage was in real estate. Both of these bubbles were created by the Fed.

Here we are in the everything bubble. Also created by the Fed. What makes people believe, contrary to all history, that the Fed will be able to keep this one inflated?

Back To Normal?


Thanks to Sven Henrich, Northman Trader

Bond Bubble

CPI reported this morning to hold at 5.4%. Historically, the average real yield on the 30-year Treasury is about 3%. This means that the 30-year should be yielding in the mid 8% range. Instead, it is yielding 2.05%, thanks to Powell et al. Crazy.

Edit: Strong auction today, pushing down 30yr yield. Short yields (2,5) increased though, so this is a bear flattening that will likely end up with a recession-signalling inversion.

The Top Of The Cycle

Jeremy Grantham is the expert on bubbles. This interview was a month ago, but is still extremely relevant. I recommend reading the whole transcript.

Jeremy Grantham (02:15):
I wouldn’t say necessarily, that we’re at the peak, I think it’s clear that we’re deep into bubble territory. Bubbles are characterized typically at the end of a long bull market by a period where they accelerate, and they start to rise at two or three times the average speed of the bull market, which they did last year, of course. And the Russell 2000 actually went up an amazing 50% in three months, ending in early February this year, which compares very favorably to the 50% rally in ’99 of the super tech bubble. And the NASDAQ went up 50% in six months. So, this was bigger and better.

Jeremy Grantham (03:01):
And, of course, they’re always extremely overpriced by average historical standards. And this one, there are a few people who would still argue that 2000 was higher, but most of the data suggest that this is the new American record or highest-priced stocks in history. And then, there’s the most important thing of all, which is crazy behavior, the kind of meme stock, high participation by individuals, which has kind of tripled in 18 months to an abnormally high level, enormous trading volume in penny stocks, enormous trading volume in options, and huge margin levels, peak borrowing of all kinds.

Jeremy Grantham (35:21):
No, I am not. I am leaving currency worries to other people. I have enough to worry about. With every real asset category, badly overpriced, that is quite enough for me to worry about. And history is quite complicated enough anyway without attempting to think about every aspect of the system. So, I will leave that to that. What is slightly unusual about this bubble on a global basis is that, yes, real estate has bubbled everywhere and often worse than in the US. Yes, commodities are everywhere. Yes, bonds are everywhere overpriced and interest rates are negligible everywhere.

CPI Indicates Financial Stability?

I just read an article that makes a compelling argument that the Fed has consistently used the CPI as the primary indicator of systemic financial stability.

SPACs are hot, the IPO market is hot, credit markets are hot, commodities are hot, the crypto markets are hot. Everything is hot – only the Consumer Price Index is cold. And that is all that matters for the Fed.

It is actually pretty scary, if true. And since the CPI is politically so visible, it may well be true. The reason it is scary is because the CPI is an artifact, designed and refined over the years to lowball actual inflation. And actual inflation is what blows bubbles and destroys currencies, economies, lives and livelihoods in the aftermath. And, apparently, consistently blindsides the Fed.

It is not complicated. Our economic system is based on using money – the dollar, in our case – as a means of making the exchanges of labor and goods which constitute the economy. And if the dollar becomes unreliable and no longer has a stable value, the whole thing goes pear-shaped, as the English would say. People resort to barter, other currencies and these days probably crypto (GLWT), none of which function as legal tender. It is like when you have a diesel engine runaway – the engine starts running on its lube oil, spins faster and faster and then all of a sudden explodes when the oil pressure fails.

Modern Monetary Theory

Investopedia on MMT

Modern Monetary Theory (MMT) is a heterodox macroeconomic framework that says monetarily sovereign countries like the U.S., U.K., Japan, and Canada, which spend, tax, and borrow in a fiat currency they fully control, are not operationally constrained by revenues when it comes to federal government spending.

In other words, governments can spend whatever they want and just print money without collecting taxes.

Or, in still other words, “To infinity and beyond” — Buzz Lightyear

Well, governments have been spending whatever they want for quite some time without much theory behind it. However, they issued and sold debt securities to fund spending not covered by revenues. Then, in 2001, the Bank of Japan (BoJ) initiated a program called “Quantitative Easing” (QE), since adopted by other central banks around the world, including the Federal Reserve. QE is simply the purchase of debt or other securities in exchange for newly issued money in order to lower interest rates. Now the Fed purchases $120 billion worth every month. So MMT is in effect to the extent that Federal debt that is purchased by the Fed is effectively cancelled and replaced with money.

Stephanie Kelton, Joe Biden’s economist, MMT advocate and author of “The Deficit Myth” is correct in most of what she claims because it is simple accounting. Yes, GDP increases (although it should not – government “output” should be treated like business sales, and valued at the amount paid for it, i.e. tax revenue). Yes, household savings increase. But she ignores or avoids the most fundamental aspect of money, and that is value. Money has value when it represents an exchange, of labor for pay for example.

New credit, whether government or private, creates money. A signed promissory note creates money, for example a checking account deposit in the name of the borrower. Joe Biden just signed a $1.9 trillion promissory note on everyone’s behalf. But credit money includes no value – nothing was exchanged except a promise of future value, there is no supply of value to the economy – even though goods and services will likely be demanded in the present.

What creates inflation? Credit. “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” — Milton Friedman

While credit is necessary for the functioning of the economy, disproportionate expansion of credit, such as is caused by artificially low interest rates or government deficit spending, causes inflation. That is why we have seen obscene inflation since the founding of the Federal Reserve in 1913.

Ms Kelton uses the low interest rates of WWII as an example to support her theory, claiming that these demonstrate that the Fed can always suppress interest rates, while ignoring the fact that during WWII, the Office of Price Administration (OPA) used price controls and rationing to manage the value of the dollar. Between April 1942 and June 1946, the period of the most stringent federal controls on inflation, the annual rate of inflation was just 3.5 percent; the annual rate had been 10.3 percent in the six months before April 1942 and it soared to 28.0 percent in the six months after June 1946

I’ve discussed the 1970’s inflation crisis, largely associated with the Vietnam war, in a previous post. The nation spent more than $120 billion on the conflict in Vietnam from 1965-73; this massive spending led to widespread inflation, exacerbated by a worldwide oil crisis in 1973 and skyrocketing fuel prices. Well, $120 billion was massive then, now it is pocket change, it is the amount of debt the Fed monetizes every month.

While there is no OPA, we have had a form of rationing in effect for the last year with lockdowns, restrictions on travel, cancelled events, business bankruptcies and shutdowns, etc. As these restrictions come off, as they must now that vaccination is well underway, we will see how MMT holds up. We may get a hint tomorrow as to the Fed’s willingness to cooperate. Will the Fed monetize Biden’s $1.9T note, thereby essentially committing to purchase the whole supply of Treasury and agency debt going forward, implementing full MMT? As I understand it, budget reconciliation is done and dusted until September at the earliest, so a tax increase would require Senate Republicans to agree. Unlikely. So if the Fed is not the buyer, then who and at what price? The banks’ balance sheets are full, will the Fed waive the limit?

In 1913, when the Fed began, prices were only about 20 percent higher than in 1775 and around 40 percent lower than in 1813, during the War of 1812. The Fed has enabled government deficits to ruin the value of the dollar. The government’s inflation calculator says the 1913 dollar is worth about $26 today. Comparing average annual income in 1912 to 2019’s median gives $52. But obviously there have been quality-of-life improvements so the best value is somewhere in between. Speaking of which, after the death of Julius Caesar, the annual pay of a legionary in the Roman Army was set at 225 silver denarii. Using today’s price of silver, that’s about $750. Compares to about $20K for a private in the US Army, but today’s soldier lives a lot better!

Insanity – Einstein’s Rule?

According to Bank of America’s Michael Hartnett, “global central banks bought $1.1bn of financial assets every hour since March.”

The shibboleth originated from Rita Mae Brown, the mystery novelist, not Einstein. In her 1983 book “Sudden Death,” she attributes the quote to a fictional “Jane Fulton,” writing, “Unfortunately, Susan didn’t remember what Jane Fulton once said. ‘Insanity is doing the same thing over and over again, but expecting different results.'”

The Debt Trap

Federal debt (meaning publicly held debt, excluding intragovernmental debt such as trust funds) has an average maturity of 63 months (Yardeni Research, most recent data Q3 2020) and an average rate of 1.5%. Over the last 20 years, average maturity has ranged from about 48 months to 71 months. The average rate paid has fallen more or less steadily from 6% at the end of 2001.

25% of Federal debt is held by the Federal Reserve. 16% is held by foreign central banks, another 21% is held by other foreign investors. 20% is held by domestic banks leaving 18% to be held by other domestic investors.

Federal debt amounts to $185,200 per employed person (household survey). At 1.5%, this amounts to a $2,778 annual charge. More interestingly, the public debt amounts to about 2.9 times the annualized total of wages and salaries. At 1.5%, interest amounts to 4.3% of wages and salaries. At a more normal 6%, this is 17.2% just for interest. And all this is before Biden’s mega-helicopter dumps another $2 trillion on the burden.

Of course this means that the Fed cannot normalize interest rates.