Literal Printing Would Change the Game
Lacy Hunt at Hoisington Management has been a bond bull for three decades and accurately so.
If you are wondering what might change his mind, he explained in a Bloomberg Interview.
The first half hour of our discussion went about as expected. Even though the coronavirus pandemic has led to unprecedented Federal Reserve interventions and fiscal relief efforts, Hunt insisted it was mostly a continuation of what he’s seen for years.
Then, I asked about Modern Monetary Theory and other novel policy ideas, like direct monetary financing. That’s when his tone shifted to what he sees as a “great risk” in the years ahead.
Interview Snips
LH: When the Fed initiated QE1, QE2 and QE3, folks said those policies were very inflationary. There is a liquidity effect of what the Fed is doing, and the liquidity effect can be very powerful over the short term. But ultimately the increase in the money supply did not follow through after the rounds of Fed purchases of government securities because the banks couldn’t utilize the reserves, they didn’t have the capital base to make the loans, they had to charge a risk premium in an environment in which the risk premium was rising very dramatically and the borrowers couldn’t pay the risk premium. There was no secondary follow-through in terms of money supply growth, and the velocity of money fell and the growth rate fell back after a transitory rise. And I don’t really see this as any different.
LH: The first-round effects of the Fed look effective, and they’re widely hailed, but they make the economy even more overleveraged than it was before and credit is allocated to those who are not really in a position to generate economic growth from it. We’ve seen numerous similar programs in Japan and Europe and it looks like the central bank has the capability to do whatever it takes. They certainly have the ability to calm and reliquify markets, but those actions then compound the underlying problem, which is the extreme over-indebtedness. You get a transitory boost, you get a liquidity effect, but that liquidity effect runs out very quickly.
Bloomberg: This is usually the point at which I ask, how do we get out of this?
LH: The problem is people want a financial transaction to cover the problem. They want greater levels of debt — in other words, we’re going to try to solve an indebtedness problem by taking on more debt. Japan has tried many, many heroic measures to try to pull themselves out.
Bloomberg: Lastly, I want to ask you about the rise of Modern Monetary Theory within economics, and some proposals to have the Fed give money directly to individuals.
LH: The great risk is that we become dissatisfied with the way things are, and either de jure or de facto, the Federal Reserve’s liabilities are made legal tender. The Federal Reserve as it’s constituted today can lend but it cannot spend. Now, they’ve done some things that are different from what the Federal Reserve Act said under the exigent circumstances clauses, but so far they’re lending.
LH: There are folks who want to make the Fed’s liabilities legal tender. Now, if that happens, then the inflation rate would take off. However, in very short order, everyone would be totally miserable because no one would want to hold money. You would trigger Gresham’s Law — people would only want to hold commodities they can consume and commodities that can be traded for others.
LH: But there is that risk that you could use the Fed’s liabilities to pay directly. The Bank of England has made a small move in that direction — they say it’s temporary. There are others that want to try that because they’re frustrated with the fact that issuing the debt is not getting the job done. So we could significantly alter the whole structure of the U.S. economy. But if you use the Fed’s liabilities for directly funding goods and services, the consequences could be very extreme and very quick.
My Comments
I had a phone conversation with Lacy shortly after the Bank of England made that change, allegedly temporary, and another conversation in response to Hello. There is No Magic Money Multiplier.
Lacy agreed there is no magic multiplier and also directed me to the above interview.
I will add this caution: I have yet seen central bank changes that are temporary.
This concern is definitely something to keep an eye on.
Mish
Can’t the corporations issue new bonds, which the FED buys from the corp, then the corp buys back its own shares? I realize this is different then UBI, but it will keep the market propped up as long as they want, right?
Am I missing something?
“the Federal Reserve’s liabilities are made legal tender. “
…
They already are.
Federal Reserve Balance Sheet
Assets – Federal Reserve purchases – treasuries, gold, mbs, etc.
Liabilities – Federal Reserve Notes (cash) or their digital equivalent.
Equity / net worth – a sliver of capital.
Another LH confusion. By liabilities, does he mean not all the notes, but only the excess reserves of banks kept on account at the Fed? And by making them legal tender, he must mean that the Fed should be allowed spend those excess reserves directly, sort of like forced fractional reserve banking, except by the central bank rather than regular banks and spend rather than lend. Legal tender is just the law the makes the dollar the official currency, so he must take it mean increasing the money supply. Not very explanatory.
I just think he misspoke. He’s brilliant.
“The great risk is that we become dissatisfied with the way things are, and either de jure or de facto, the Federal Reserve’s liabilities are made legal tender. The Federal Reserve as it’s constituted today can lend but it cannot spend.”
…
Anything is possible. BUT this would mean an act of Congress (and signed by POTUS). At the end of the day, 2 Major problems. 1) risk to $US hegemony and 2) loss of Power of the Purse by Congress. Much of the power ($$s flowing to their PACs or votes by those who benefit) of Congress is deciding who gets ( and how much) what.
Pelosi entrenched her position with liberals by winning House passage of $3 trillion stimulus package (which will be cut down). Anyways, take all this away … Congress will vote for Federal Reserve to dole out $US instead of themselves? Might as well close up shop on Appropriation Committees.
LH has confounded himself. That the Fed can’t spend it is not very relevant since government as a whole is printing and spending the stimulus. What’s the difference?
I agree. Hunt noted it would take an act of Congress to allow. Just don’t see it happening … of course, if AOC becomes POTUS … anything possible, i suppose …
“Precarious shape” = Newspeak for “a smoldering crater in the ground.”
How’s this economic system worked out for the vast majority of people?
Jim says: With the S&P at new highs, the ‘actual economy’s in precarious shape,’ Jim Cramer
Sadly, he repeats the tired mantra that inflation hasn’t happened. What else is the runaway housing market, and trillion dollar market cap companies. Cut cheap Chinese imports off, and you would get a wonderful inflation, too.
Listen to the Grant Williams podcast with Lacy Hunt a couple of weeks back Very educational.
Agreed. a big part of the puzzle of why there was little inflation (in terms of CPI) is because China effectively exported deflation to the US
Asset inflation courtesy of central banks.
The rest?
Courtesy of fedgov by allowing cronyism / cartels to thrive … and backstopping (questionable) loans (education / housing).
Dr. Lacy Hunt is an absolute monument when it comes to fixed income and treasury investing. The man’s track record is amazing, his knowledge in financial history is enormous and his expertise in econometrics is without match. My respect for him is endless and eternal.
Do not get out of context what he said. He warns of the risk that FED liabilities might become legal tender aka money but he also said this is likely not for 2020 or even 2021. He doubts it will happen under Powel because Powel is on the side that the FED can finance but it can not spend. And for the new FED president entering in Feb 2022 there will first need to be held hearings about the subject, and that he says will open a whole can of worms with equally extreme proposals that will severely slow things down. After some kind of agreement, a bill needs to be drafted, this bill then needs to go trough revisions and then it needs to pass both house and senate and then Trump or Biden will need to sign it. That process is going to take time, lots of time.
That also means that the house of cards still needs to be standing until this happens. Where is your bet?
I fear that mother nature is going to topple the house of cards a lot sooner and faster than the FED and congress can change laws. You know where my bet is.
How is the Fed printing trillions to buy Treasury debt funding multi-trillion-dollar deficits not outright MMT?
Because when the FED buys treasuries it credits the reserve account of the bank from which it bought. It pays for the treasuries with printed currency that become reserves in the reserve account of the primary dealer it bought from.
Reserves are inert. They cannot be used by the bank or FED to spend and do not leave the reserve account at the FED. Technically the bank can lend them out in which case they become money to spend but for that the bank needs a healthy capital structure and a customer who is credit worthy and willing to borrow. Not an easy task when you decide to lock down an economy.
In the meantime the Fed is paying interest on those reserves.
WMVarones is right. MMT applies to government as a whole, right? The government” is printing money and spending it, so how’s there a difference?
The rest of you guys seem to be looking at it from the perspective of only one part of the government, the Fed.
Look, the government’s spending packages are funded by issuing treasuries which the Fed then purchases. The treasury then is paying the interest to the Fed which then returns the surplus back over to the Treasury. So, this convoluted process of the government borrowing money from itself and paying interest to itself is just for appearance. They are spending printed money, just slyly. The fact that the transactions run through banks is not really relevant. It ends up in reserves either way.
Because it’s borrowed, silly. It will just never be repaid.
As Bernanke has previously stated, QE is essentially an “asset swap”.
The sellers exchange their garbage assets for excess reserves.
They can choose to lend against those reserves, or not.
In the absence of credit-worthy borrowers (the current situation), they will not.
This is not in any way, shape or form “MMT”.
Creditworthy is just another way to say rich people and because of wealth inequality more than half the nation now has no net assets at all. 85% of equities and nearly all debt holdings as well as cash (highly liquid assets) are in the hands of just 10% of the people, that is why they cannot find people with the credit scores to borrow. And those wealthy potential borrowers do not NEED to borrow.
I do not care how it gets done at this point but that concentration of hoarded wealth is strangling the economy and is the source of all political problems that likewise is killing this nation. You cannot tax that wealth because the republicans will not allow it, so you MMT it out of their hands via diluting printing and UBI.
MMT is not very modern really, debasement goes back to roman times at least, here fiscal policy is used instead of lower quality money. The only difference I can tell is that the creation of money is in the hands of private banks that work in tandem with government issuance of debt, therefore not direct monopoly.
Given that government implemented legal tender law and draws its credibility from taxation it effectively owns the medium the federal reserve uses, and so it is able to claim dominance. Without the financial system functioning within prameters it can itself set via central bank though, the value of the government medium would be jeopardised , and so also governments ability to fund its own existence.
So this is maybe the danger LH is talking of, where the government takes total control by legislating its issuance is effective without central bank complicity, or with openly forced complicity.
On the one hand it could be pointed out that in effect this has been the system for the last half century in all but name and has brought great wealth, so now one side of the equation has become unbalanced it is time for government intervention to equate society into a fairer deal. Equally the central bank finds itself cornered in the global system and agrees to shut shop and hand the keys to government.
On the other hand you are basically inviting outright dictatorship because government allocation and price setting based on whatever political initiative is what will rule economic and financial activity. That would not go unnoticed. I don’t think they would dare, but who knows what would be accepted by society in event of financial meltdown or major economic disruption, especially one that could be pinned on the fed.
Though national banks are not new, the very act of transition to open direct government mandate of creation of money is what would “lift a few eyebrows” and introduce a level of uncertainty including political unheard of in the US.
The direction that would be taken though is far more likely to be of monetary reform, where cash is as good as abolished and the management of sum national accounts passes to some kind of new hybrid system that includes a redistributive effect mmt proponents look for while allowing the banking and investment world new avenues of economic and financial control.
but but the stock market is at record highs!!