Magic Monetary Theory Comes at a Price
Once upon a time, US money supply was increased in keeping with gross domestic product ... and then something went wrong:
Terribly wrong.
Money started growing exponentially, but GDP didn't see the slightest bump in growth. Nevertheless, the central bank became unable to stop itself from making more and more of the stuff, though it profited no man on the street.
Always, they promised the money will start to trickle down and make all men rich. Yet, this graph of GDP alongside the line for money supply, shows how none of the new money ever went into the Main Street economy where GDP happens. Not a cent that can be seen.
We all know, of course, where the money was going -- into assets, particularly stocks. The change in the incline of the red line (non-existent change) shows how much of that trickled down into new jobs resulting in new purchases or domestic products. None.
However, once the stock market was dependent on the new money, and members of the Federal Reserve System were all fully invested in stocks, it became a self-feeding loop -- and addiction of money-creating empowerment. The Fed rationalized it as "creating a wealth effect" that would trickle down from the market to the masses.
Clearly it did not, but the money ring kept cycling in financial circles.
US gets credit downgrade
Spinning up this money cycle comes, however, with a cost.
With the latest surge in Federal Reserve money creation going off the charts as the Fed now funds government spending that has also gone off the charts, the government just received the first new nick in its credit rating since Standard & Poor's downgraded the US in August, 2011, for walking too close to debt default as congress parleyed over raising the debt ceiling -- a move that cost S&P's CEO his job.
The credit-rating downgrade in 2011 did not come because the US congress went past the debt ceiling, but just because it walked too close to the brink, causing the ratings agency to think members of congress were becoming reckless:
The 2011 S&P downgrade was the first time the US federal government was given a rating below AAA. S&P had announced a negative outlook on the AAA rating in April 2011. The downgrade to AA+ occurred four days after the 112th United States Congress voted to raise the debt ceiling of the federal government by means of the Budget Control Act of 2011 on August 2, 2011....
Both Fitch Ratings and Moody's, designated like S&P as nationally recognized statistical rating organizations (NRSRO) by the U.S. Securities and Exchange Commission (SEC), retained the U.S.'s triple-A rating. Moody's, however, changed its outlook to negative on June 2, 2011, and Fitch changed its outlook to negative on November 28, 2011
Now Fitch has made the same bold move.
Fitch Ratings revised its outlook on the country’s credit score to negative from stable, citing a “deterioration in the U.S. public finances and the absence of a credible fiscal consolidation plan.†The country’s ranking remains AAA.
“High fiscal deficits and debt were already on a rising medium-term path even before the onset of the huge economic shock precipitated by the coronavirus,†Fitch said. “They have started to erode the traditional credit strengths of the U.S.â€
This time, nobody cares. CEO gets to keep his job. Last time, the stock market crashed so hard the Fed had to leap in with promises of Operation Twist and ultimately QE3 to end the plunge.
So far, only one credit agency showed the courage to trim the outlook. In 2011, by the end of the year, only one agency had downgraded the credit score, but all had cut their outlook to negative.
Money printing creates its own imperative
It is hard to stop the "printing presses" once you have them spinning at full speed. As we saw with all of the Fed's earlier attempts to back off on the money printing, once the market and economy become dependent on all the new money, you cannot ever back down without crashing the recovery you have built up with it. (Which is why I've always called it a "fake recovery. It's not a sustainable path. It doesn't resolve any problems.")
The money printing has now become so fierce with no end in site that even one of the most longterm deflationary prognosticators just turned hyper-inflationary last month:
One month ago it was SocGen's Albert Edwards, who after calling for a deflationary Ice Age for over two decades, finally threw in the towel and conceded that "we are transitioning from The Ice Age to The Great Melt" as "massive monetary stimulus is combining with frenzied fiscal pump-priming in an attempt to paper over the current slump...."
At roughly the same time, "the world's most bearish hedge fund manager", Horseman Global's Russell Clark reached a similar conclusion writing that "all the reasons that made me believe in deflation for nearly 10 years, do not really exist anymore.... The conditions for both good and bad inflation are now in place."
This month, these deflationary permabears picked up some company in their switch to becoming highly inflationary in their thinking because of the Fed's new amperage.
Finally, it is the turn of another iconic deflationist, Russell Napier, who in the latest Solid Ground article on his Electronic Research Interchange (ERIC) writes that "we are living through another deflation shock but [he] believes that by 2021 inflation will be at or near 4%."
The game changer, as I noted in my last Patron Post, is the new move to helicopter money. Unlike all those surges in "money printing" that didn't trickle down to Main Street in the past, as shown in the leading graph, much of the money now is going straight to the people who buy on Main Street.
What I've noted that these reformed permabears have not, however, (which I stand by) is that this will only cause inflation if the money being created in the hands of the masses is greater than the money they are losing due to their loss of employment or of collected rents, etc., or if we have a shortage of goods and end up with too much money chasing too few goods, as could easily happen due to COVID shutdowns.
Napier points out the transformative nature of the change, which is what I've said makes this new turn finally dangerous in its potential for creating high inflation:
What has just happened is that the control of the supply of money has permanently left the hands of central bankers - the silent revolution.... The supply of money will now be set, for the foreseeable future, by democratically elected politicians seeking re-election.
As I noted earlier, this means we must watch how far politicians go now that the Fed has tacitly ceded control over money supply to them. (It was always congress's constitutional power to take that control, but they had long ago given it to the Federal Reserve to keep money supply from being politically set because politicians are inclined to throw out enough candy to get re-elected -- a short term interest causing long-term impact.
There is now a chorus of voices that have made major changes in their deflationary thinking, going along with my own. I don't go as far, though, as to say this transition in power over money supply makes inflation certain; but we are betting on politicians being able to discipline themselves to creating only as much money as is needed to replace lost income during one of the most intensely competitive, hotly contested election seasons in US history. We can already see that Democrats are having a hard time not throwing out more bags of money than mankind has ever seen with their proposed $3 trillion spending bill.
So, as I said before, be vigilant about inflation.
In the years following the financial crisis, numerous economists and market observers warned of rising inflation in the face of the unorthodox monetary policy by central banks. They were wrong time and again. Russell Napier was never one of them.
Neither was I.
The Scottish market strategist has for two decades – correctly – seen disinflation as the dominant theme for financial markets. That is why investors should listen to him when he now warns of rising inflation.
Unsurprisingly, I agree with that logic :)
"Politicians have gained control of money supply and they will not give up this instrument anymore", Napier says. In his view, we are at the beginning of a new era of financial repression, in which politicians will make sure that inflation rates remain consistently above government bond yields for years. This is the only way to reduce the crushing levels of debt, argues Napier.
I see it a little differently in terms of how it will work. It is not that politicians will create money to deliberately inflate away the nation's debt. They don't need to. The Fed can keep the nation's interest rate down as much as it wants by buying up as many bonds as the government issues (government's way of creating that money because the Fed buys those bonds entirely with newly created money).
If the banksters want to keep their government charter, they have every incentive to do that. So long as the Fed agrees to soak up all the debt, the government can create endless amounts (until the whole system breaks down) and just keep refinancing the interest MMT style.
But try to keep a horse from eating the oats once you've led him into the oat mill.
Money goes populist
The following is a picture of the critical difference between money creation during and after the Great Recession and now. As the Fed's money supply grew during the Great-Recession years, broad money supply did not grow all that much because the money, figuratively speaking, stayed in bank vaults. But look at what is happening around the world now:
Broad money supply is that money that is making it into general circulation. It had remained range-bound for decades. Not any more.
Now that the horse is in the oat mill, will it be willing to leave? Will politicians step back out of controlling money supply when the COVIDcrisis is over?
Politicians will, of course, tell themselves their money creation will end as soon as the crisis ends, and they probably already delude themselves into thinking that will come as soon as a coronavirus vaccine is created.
But it won't.
The crisis won't end with a vaccine. The economic damage, as I've been laying out throughout the crisis, has a great deal of permanence. If Democrats seize the reins of government in November, the MMT crowd of AOC, Elizabeth Warren and Bernie Sanders will gain a lot more influence over spending.
So, be vigilant.
Banks are now under the control of the government. Politicians give credit guarantees, so of course the banks will freely give credit. They are now handing out the loans they did not give in the past ten years. This is the start.
It will be tempting for politicians to think they can now do everything they've dreamed of doing and solve all our problems with easy money.
Theresa May made a famous speech a few years ago where she said there is no magic money tree. Well, they just found it. As an economic historian and investor, I absolutely know that this is a long-term disaster. But for a politician, this is the magic money tree.
This is also the Zimbabwe plan, if it happens. So, be very vigilant.
Magic Monetary Theory's time has come
MMT (actually called "Modern Monetary Theory") limits the creation of money (in theory) based on inflation. The government may do all the spending it wants through its central bank funding until inflation rises. However, who forces the government to obey the theory at election time? Will politicians discipline themselves to that limit and stop short of funding their favorite projects for their states?
It is one thing for a committee like the Fed's FOMC to limit inflation since it is not enticed by trying to get re-lected by the masses and is relatively small in size. It is another for hundreds and hundreds of elected representatives and senators and the elected president all with their pet ideas.
This, we have always known, is the problem of having elected officials regulate money supply. It is why congress stripped the power from themselves in the first place, believing they couldn't handle it.
As Gandolf warned Frodo, in Lord of the Rings, about the power of his newly gained magic ring:
Clearly the ring had an unwholesome power that set to work on its keeper at once. That was the first real warning I had that all was not well. I told Bilbo often that such rings were better left unused; but he resented it, and soon got angry. There was little else that I could do. I could not take it from him without doing greater harm.
Will government unclench the ring it has now fingered? Remember, once you start solving an economic crisis by throwing more money into it, you cannot stop without crashing whatever kind of recovery the new money has created.
The easy path of money creation as a way out of complex systemic problems runs just like the power of the ring:
A mortal, Frodo, who keeps one of the Great Rings, does not die, but he does not grow or obtain more life, he merely continues, until at last every minute is a weariness
If you use magic money (the kind created out of thin air through issuance of more debt that will never be paid), you do nothing to solve the really hard problems that are damaging the economy. You take the easy path and dim the pain. Solving the problem reopens the wounds for repairs and brings back the pain.
We can keep printing our way along this path for a long time -- as the Fed has already been doing for a long time and the government now does since it has seized the ring -- but it does not solve any of our underlying economic problems, and so the way grows more and more weary and problematic as the value of the money being created wears thin.
As for his long life, Bilbo never connected it with the ring at all. He took all the credit for that to himself…. Though he was getting restless and uneasy. Thin and stretched he said. A sign that the ring was getting control.... And if he often uses the Ring to make himself invisible, he fades: he becomes in the end invisible permanently, and walks in the twilight....
We are now moving into such twilight times. If we keep using magic money, money itself will become as thin as a film of soap around a bubble of hot air until our buying power pops and disappears.