Please consider the Hoisington Investment Quarterly Outlook for the first quarter of 2019.
MMT Leads to Hyperinflation
Under existing statutes, Fed liabilities, which they can create without limits, are not permitted to be used to pay U.S. government expenditures. As such, the Fed’s liabilities are not legal tender. They can only purchase a limited class of assets, such as U.S. Treasury and federal agency securities, from the banks, who in turn hold the proceeds from this sale in a reserve account at one of the Federal Reserve banks. There is currently, however, a real live proposal to make the Fed’s liabilities legal tender so that the Fed can directly fund the expenditures of the federal government – this is MMT – and it would require a change in law, i.e. a rewrite of the Federal Reserve Act.
This is not a theoretical exercise. Harvard Professor Kenneth Rogoff, writing in ProjectSyndicate.org (March 4, 2019), states “A number of leading U.S. progressives, who may well be in power after the 2020 elections, advocate using the Fed’s balance sheet as a cash cow to fund expansive new social programs, especially in view of current low inflation and interest rates.” How would MMT be implemented and what would be the economic implications? The process would be something like this: The Treasury would issue zero maturity and zero interest rate liabilities to the Fed, who in turn, would increase the Treasury’s balances at the Federal Reserve Banks. The Treasury, in turn, could spend these deposits directly to pay for programs, personnel, etc. Thus, the Fed, which is part of the government, would be funding its parent with a worthless IOU. In historical cases of money printing, the countries were not the reserve currency of the world, as the U.S. is today. Thus, the entire global system could be destabilized in very short order if this were to occur.
There would be no real increase in services or money since very little time would lapse before people realized increasing inflation was not increasing real purchasing power. If the government responded by issuing more central bank legal tender, the inflationary process would become self-perpetuating, and as was the case in numerous historical instances this would lead to hyper-inflation. Moreover, the central bank would have no capability of reducing the money supply. All they could offer would be the zero maturity, zero interest liabilities of the government, but there would be no buyers. This would mean that hyper-inflation would be difficult to stop.
Rates Too High Already
Presently, the Treasury market, by establishing its rate inversion, is suggesting that the Fed’s present interest rate policy is nearly 50 basis points too high and getting wider by the day. A quick reversal could reverse the slide in economic growth, but the lags are long. It appears that history is being repeated – too tight for too long, slower growth, lower rates.
Velocity
In the article, Lacy also touched on the velocity of money. While I agree with Hunt that velocity has generally been falling, the equation itself is useless.
As I have pointed out, velocity can rise or far with rising or falling GDP. It is not an independent variable that can be tracked.
Velocity = Value of transactions/supply of money. This expression can be summarized as: V = P(T/M) , where V stands for velocity, P stands for average prices, T stands for volume of transactions, and M stands for the supply of money.
This expression can be further rearranged by multiplying both sides of the equation by M. This in turn will give the famous equation of exchange: M(V) = P(T).
Many economists employ GDP instead of P(T), thereby concluding that: M(V) = GDP = P x (real GDP).
Velocity Does Not Have an Independent Existence
Contrary to mainstream economics, velocity does not have a “life of its own.” It is not an independent entity–it is always value of transactions P(T) divided into money M, i.e., P(T/M). On this Rothbard wrote: “But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation.” (Man, Economy, and State, p. 735)
Since V is P(T/M), it follows that the equation of exchange is reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a very interesting truism. It is like stating that $10=$10, and this tautology conveys no new knowledge of economic facts.
The above paragraphs are excerpts from Fran Shostak’s Is Velocity Like Magic?
For further discussion, please see Velocity of Money Picks Up: Inflation Coming? Stagflation? How About Deflation?
Case for Hyperinflation
In regard to hyperinflation, I have been asked many time what it would take for me to change my mind on that happening in the US. My response, has been unchanged for years: Give Congress Control of Money Supply.
MMT does precisely that. There is no project that could not be funded including AOCs absurd Green New Deal which might cost as mush as $200 trillion.
It would not stop there. Guaranteed “living wages” and “guaranteed jobs would finish it off. The amount needed to have a living wage could never be met. Prices would soar along with the guarantee.
What About Rate Cuts
Hunt says interest rates are 50 basis points too high. In relation to the Fed’s mandate, I believe Hunt is correct.
If one wants to factor in asset bubbles the Fed isn’t. Alternatively, the Fed should have started hiking in 2010 or 2011 and be cutting rates now.
The Fed is constantly chasing its own tail. I believe that is what Hunt means when he speaks of lags. If so, we are in agreement on that point as well.
Regardless, because of Fed actions and the lags, I am certain we are headed for another very deflationary asset bubble bust.
The next deflationary bust could easy last for years, perhaps even without the job losses like we saw in 2008-2009. I discussed the job setup in Zombified Economy: What Will the Next Recession Look Like?
Mike “Mish” Shedlock
“There is currently, however, a real live proposal to make the Fed’s liabilities legal tender….i.e. a rewrite of the Federal Reserve Act.”
“I am certain we are headed for another very deflationary asset bubble bust.”
I suspect that the latter will be the political justification for the former which means that the latter will precede the former.
MMT falls under the same banner as “deficits don’t matter, because we owe it to ourselves.” Well, if “we” owe “ourselves” the loans, does that mean I can take my neighbor’s stuff when he doesn’t pay up? Or maybe just take a baseball bat to some random person’s kneecaps on April 16th?
However, the Fed can create unlimited funds for the commercial banks via quantitative easing
Who the hell is Lacy Hunt? Why should I care what she says?
For the same reason you should supposedly care what Trump and Warren Buffet says: The Fed handed them big welfare checks.
Mauldin’s latest with lots of great explanations about Japan and how the world is headed in the same direction.
Mauldin is wrong about the rest of the world becoming Japan. We can’t all print money on that scale without consequences. Japan’s currency, worthless as it is fundamentally, stills holds its own because of strong investment and trade inflows. One day those inflows will weaken dramatically and that will be the end as demand for Yen will decline in the face of a dramatic increase in supply. Japan’s debts continue to rise as their population continues to plummet. Sound sustainable?
Progressives are the only threat? Can anyone provide an example of when conservatives were in power and the deficit went down?
From the revolutionary war, until the War Between The States. After that, the progressives took over.
Have you already forgotten that Republicans controlled the government just a year ago? Why yes you have! What a good boy… here’s a chinese made MAGA hat.
The Republicans are, if at all, barely any less progressive than the Dems. Has been that way, since at least Teddy Roosevelt.
Drug and alcohol prohibition, The Fed, Income Taxes, women’s suffrage, pervasive publicly funded indoctrination, government intervention into absolutely every facet of private life and business, and ensuring every outcome is a result of policy rather than individual action etc…… is what progressivism has always been about. Here, in the Soviet Union, Nazi Germany, Scandinavia, China, Cambodia, Venexuela etc, etc.. Democrats vs Republicans is just diversion. Both parties are solely focused on confiscating your output, corralling your freedoms and in every other way render you nothing more than a pawn in some harebrained, self serving on their part, idiotic scheme.
Ron Paul was a bit of a throwback to a less totalitarian mindset. And he did happen to be a Republican. But until that party becomes a party in his image, they’re no less a gaggle of useless, self righteous, dumb as doorknobs progressives, than their co-conspirators across the non existent nominal isle.
The hyperinflation that occurred during the Weimar Republic and the speed at which inflation suddenly destroyed the currency dovetails with some of my thoughts on currency trading today. It confirmed that inflation can stem from a growing lack of faith in a currency, or all currencies, rather than just a lack of available goods.
As inflation takes root the goods available for sale often contracts as sellers retreat from the market awaiting higher prices which creates a self-feeding loop. The speed at which this can happen and the fact it could occur across the globe is explored in the article below.
Wait. “The Fed can only purchase a limited class of assets, such as U.S. Treasury and federal agency securities, from the banks, who in turn hold the proceeds from this sale in a reserve account at one of the Federal Reserve banks.”
So, what purpose is served by this? According to the media, the Fed bought assets from the banks with “money” and the banks used that money to make loans to businesses and consumers, thereby stimulating the economy. You’re telling me that all the Fed is doing is increasing the Fed’s balance sheet. How does a bigger Fed balance sheet help the economy?
“How does a bigger Fed balance sheet help the economy?”
It doesn’t. Nothing The Fed can even possibly do, can “help” the economy.
By propping up asset prices and preventing bankruptcies, it saves idle, well connected incompetents from having to make some of their unearned wealth available to those more competent but less connected, though. Which is the whole purpose of its existence.
Well, yes, of course. I should have asked how does that purport to help the economy? The idea that money was injected into the economy in the form of consumer and business loans at least had a gossamer pretense of sense, but for it to appear in the Fed and then change form from Fed money to bank money on deposit is just transparently nonsensical.
So, given your response, which I appreciate, how does the money that the Fed created and that banks are leaving sitting in the Federal reserve on deposit “”prop up asset prices and prevent bankruptcies” precisely?
🙂
The Fed filling up banks’ reserve coffers, and indicating they will keep filling them up no matter what, is similar to guaranteeing someone “free” health care: They’ll be less concerned about putting aside savings in case they get sick; leaving them free to spend more. In banks’ case, lend more. Even if all the newly created money just went into excess reserves, those reserves are reserves the banks no longer have to set aside from other sources. Which they would otherwise have to do, in times of rising default risk, and declining collateral values.
Policy considerations aside, MMT is first and foremost a description of how the government creates and spends money and interacts with the central bank.
The Fed regularly buys and sells Treasuries on the open market in order to inject or remove bank reserves from the financial system. These activities are conducted by the Fed so that they can achieve their overnight interest rate target. This is apparently well documented in all undergraduate macroeconomics textbooks.
Warren Mosler, hedge fund founder and one of the founders of MMT, came to the insight that bond sales by the Treasury Department have exactly the same effect (removing bank reserves). This is why MMT understands government bond sales as something quite different from borrowing. Issuing of government bonds is an operation to offset government spending rather than a requirement to finance it.
Lacy Hunt doesn’t understand the mechanism. The treasury has an account at the Fed from which all federal expenditures are drawn. The Fed works daily to issue enough treasuries to fund the current deficit and keep that account from being in an overdraft status. And it is not difficult. That is because the deficit spending itself is the creation of new money. That money ends up in the banking system. And the banks prefer interest bearing treasuries to cash, so they will always use that money to buy said treasuries. Not to mention that they are also obligated to do so by law.
So the newly printed money always gets converted into treasury bonds, which is why the federal government cannot create hyperinflation by printing money. MMT does not look to change this mechanism at all. MMTers will argue that their policies can create inflation if their spending over taxes the nations ability to produce goods and services.
The financial problem with MMT is the same on you get with any deficit spending: asset inflation. By putting more assets in bank reserves you drive down interest rates, because banks don’t have to compete for money. Coupling low interest rates with a fractional reserve system will lead to ever higher housing prices.
There is a practical limit to house price inflation, namely the inability of individual buyers to afford the mortgage payments, due to wages not keeping up. Unless houses become purchased by investment groups, and not individuals. Hmmmm…
In totalitarian hellholes, people can always be forced to top up their rent payments, by writing notes signing over the future output of more and more generations of their descendants, in addition to their own. That way, the landlord can book the NPV of ever more generations of indentureds as an asset, and borrow fresh print against it.
The indentureds will then be born into bondage, forced to work ever harder to pay for “rent,” “their” debt, and Chicago public union pensions. That’s how indentured servitude has always worked. No real reason to believe this particular hellhole will be any different.
ALL FINANCIAL CRISES ARE THE SAME
What often not appreciated is that commercial banks create money out of thin air much the way that the government does.
Straight from the Bank of England (Money Creation in the Modern Economy, 2014).
“The principal way in which [deposits] are created is through commercial banks making loans: whenever a bank makes a loan, it creates a deposit in the borrower’s bank account, thereby creating NEW money. This description of how money is created differs from the story found in some economics textbooks.”
Note: Banks do NOT lend deposits and they do NOT lend reserves. Bank loans and mortgages create NEW money out of nothing. This is how over 95% of our money supply is created.
As many have pointed out, uncontrolled money create leads to inflation (assets and real estate) until individuals can no longer afford their mortgage payments, at which point the financial system collapses–the perfect Ponzi scheme.
However, it is caused by the private sector banks, not the government.
Agree. But UST rates and the Fed funds rate influence mortgages, and the Fed is the buyer of last resort for toxic MBS, as well.
…..the financial cesspool is now in full fermentation process….
Just put a % of net worth into gold, it’s all you can do to dodge that bullet. Real estate can be taxed to oblivion. Grow your own food perhaps.
We’re all screwed as soon as nut jobs in charge can change the laws to the untried and untested.
Some of the worst are ideologues, he’ll bent on change and unable or unwilling to recognise the consequences. Beware ideologues in all walks of life.
I can’t completely rule out that there might be something to MMT, but experimenting with ideas that radical on the largest economy in the World isn’t a good idea.
Let’s see the strengths and weaknesses of MMT play out in another economy – it does not stipulate that the country has to have the World’s reserve currency.
Let’s see it work in e.g. Denmark or Hungary first. Then move up to something the size of the U.K. before we try it here.
Economics never have been, never will be, some form of empirical “science.”
Replacing the source of the purchasing power people enjoy; away from creating something of value others are willing to trade them something for; towards simply printing the purchasing power out of the blue while creating no value in return; doesn’t not work because it hasn’t yet been tried in Denmark.
Rather, it doesn’t work simply because printing money doesn’t create any value. It never will. Hence, no matter how much you do of it, and no matter how many cheesy acronyms you make up to obfuscate what you are doing; it will never, ever work. Not here, not in Denmark, not even in any possible universe where every natural law is different from here.
” it does not stipulate that the country has to have the World’s reserve currency.”
Well not really. One of the important points of MMT is this: “the federal government can always make any and all
payments in its own currency, no matter how large
the deficit is, or how few taxes it collects.”
The key here is “in its own currency”. So while you don’t have to be the reserve currency, you still must be a sovereignty currency. Venezuela, for instance is not. Its debt is issue in $$ or EUs or whatever.
Now even though Mish seems to be against MMT, he in the past has said that even though banks may have tons of money to lend, no one is obligated to borrow it. In essence that was the argument he presented when explaining that QE (and the rest of the Fed actions during the financial crises) would not cause inflation even if liquidity was very high (I may have miss understood him). For the record, I don’t see much difference between how the US operates today and MMT. In other words, when was the last time the government stopped issuing new debt to “meet” new obligations? Just saying…
MMT is quackery. Plain and simple. There is no such thing as a free lunch but if you believe it’s possible then MMT is just the thing for you.
An interesting problem with the government using the wealth of the Fed to fund a Socialist agenda is that the Fed is not a part of the government. It is an independent entity owned by the banking system, and it is not own by the government. The government does have some power over it, in that the President can appoint some of the board members, and in that it exists under a grant of authority created by Congress. It will be interesting indeed if the government tries to tap into the wealth of the Fed.
The Fed can only do those things that are specifically legislated for it to do. Which is probably more authority than I prefer, but that is for another thread.
The Fed is ONLY independent in its ability to set the overnight interest rate. Even this limited independence is only present because it was granted this authority by Congress and it can be taken away in the same way.
In practice, the Fed regularly meets with the Treasury Department so that they can coordinate their activities. In addition, as the federal government’s bank, the Fed ensures that all payments made by the government are ALWAYS honoured. The federal government’s cheque will never bounce–must be nice to have your own private bank!
Mmt is total nonsense and for anyone in power to subscribe to the theory is an indictment on the intelligence level of those that elected them.
Talk of Magic Money Tree reeks of desperation to prevent the inevitable.
Would someone explain to me how deficit countries could apply MMT and be successful?
It sounds fine and dandy if, like Germany, you have a massive balance of payments surplus, but I’m British and can remember several times when our lack of a hard currency played havoc with our economy.
Even the US was forced, as I understand it, to come off the Gold Standard by West Germany because the German’s refused to accept the dollar at the then exchange rate. Where is your sovereignty then?
Or have I got it desperately wrong?
Not sure why you think “balance of payment” status makes much of a difference.
In real terms, all that money printing does, is transfer wealth/purchasing power. From someone who needs to work to create it, to someone who can simply sit back and print it without effort. It’s not fundamentally any different than forcefully transferring wealth by more traditional means, like taxation. Just more stealthy. At least as long as you can rely on those you transfer from, not being particularly economically literate.
“Not one man in a million….” as Keynes quipped, back when he still practiced economics. Before he, like his starry eyed imitator Krugman a few generations later, decided playing rockstar party apologist, was more lucrative and fun.
MMT is just another obfuscatory term, employed to fool the ignorant into believing there exists some forms of crass printing, which as long as they are labelled something sciency sounding, somehow differ from others. Which there, of course, does not. Since, again, all that printing does, is transfer wealth/purchasing power from those who create it, to those who can simply print it.
Balance of payments matter because counter-parties will sell you their goods as long as they get in return something which will buy goods of equivalent value from someone else.
When you debase your currency, eg Philip II of Spain, or print like there is no tomorrow, eg Weimar Republic, then people will stop selling you their goods because they will have no trust in you, your government and your currency. That way anarchy lies.
I think we are in agreement on MMT. I would like to hear from a proponent of MMT to make me stop believing that it is nothing more than smoke and mirrors.
West Germany was very happy to trade inflated dollars for gold. So were all of the other counter-parties that belonged to the Bretton Woods agreement.
Nixon had to remove the US from the agreement or lose the rest of the hoard.
Post-war the US held about 50,000 tons of gold, when Nixon pulled the plug on the agreement the reserve had been reduced to around 8,000 tons. Where it is today.
MMT is first and foremost a description of how the government creates and spends money and how the government interacts with the central bank.
An interesting implication of MMT is that a sovereign government that issues its own currency, borrows in its own currency, and allows its currency to float cannot be forced into default and can afford to purchase anything offered for sale in its own currency–whether or not it should is a different question.
Balance of payments are important because imported goods and services must be paid in FOREIGN currency.
According to MMT, if the government creates too much money, the currency will DEVALUE (since it is on a floating exchange rate). Although the relative cost of imports will increase, in some cases devaluing a currency might be desirable as exports become cheaper and more competitive.
The US is in the unique position of holding the world’s international reserve currency, so it is somewhat forced into a current account deficit as the rest of the world wants/needs to hold US dollars.
FWIW, I think we end up with a long slow slowdown and then no growth for years like Japan. Or at best growth between 0 and 1 %. Every week that goes by this feels more like Japan barring some black swan event.
MMTers went too far in trying to let congress take over the money supply. MMTers simply should have stated they will spend what is needed to take care of the citizenry via deficit spending. We are at 22T now. Let the economy tank and the Fed will move rates to 0% again. Then with no interest on any new debt, it would not matter. It would be up to debt holders who hold debt in dollars to call the United States’s bluff. They wouldn’t do it because a dollar even with no interest is worth more than nothing.