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The Stagflation Threat is Very Real but Congress Holds the Key

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31 comments on The Stagflation Threat is Very Real but Congress Holds the Key

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The Alice in Wonderland image is courtesy of Chris Temple and the National Investor.

“What Would it Take for Me to Change my Mind on Inflation?”

Previously I responded to the question A Reader Asks “What Would it Take for Me to Change my Mind on Inflation?“

I mentioned two things.

  1. Monetary Madness From Congress Signed Into Law
  2. The Fed Moves to Make Its Liabilities Legal Tender

My answer has not changed much but I want to further comment on both points starting with point number two.

What If Fed Liabilities Become Legal Tender?

I discussed the legal tender issue several times lately, most recently in Lacy Hunt On Debt and Friedman’s Famous Quote Regarding Inflation and Money.

“Friedman’s famous phrase that ‘inflation is always and everywhere a monetary phenomenon’ would only hold if the central bank’s liabilities were legal tender, stated Lacy Hunt.”

Some may not understand Lacy’s comment relates directly to QE. 

Confusion abounds even among well known and widely followed persons.  For example, consider this Tweet.

I addressed that inaccurate but widely believed assessment in Will the Fed Balance Sheet Get Spent into Circulation Causing Inflation?

Also consider What is the Best Measure of Monetary Inflation?

A key idea in both articles is “The Fed’s Balance Sheet is Not Spendable Money.”

QE gets reported as an increase in M1 and M2, with nearly everyone going gaga over the increase, but unlike consumer deposits, central bank liabilities are not legal tender, i.e. they cannot and will not be spent. 

Not legal tender (Hunt) and not spendable money (Mish) are two ways of expressing the same idea. 

Don’t Confuse QE with Congressional Fiscal Stimulus

The three rounds of Congressional stimulus in response to Covid (one round under Trump and two under Biden) were indeed spendable money.

That stimulus also increased M1 and M2 but it should not be confused with QE.

Should the Fed’s liabilities become legal tender, I would quickly change my mind on the possibility of sustained inflation. 

Hunt points out that it would “take an act of Congress to make the change“.

I would add the word “legally” to his statement. We have seen the Fed usurp control in many dubious areas. 

For example, many of us contend that the Fed’s excursion into buying junk bond ETFs was clearly illegal. 

Fed’s New Facility 

Please recall Fed’s New Facility Will Buy Junk Bonds With 7-1 Leverage

John Hussman further commented “It’s not a loophole, it’s an end run. They are not even pretending anymore.“

So legally or not, the concern is the Fed would act to make its liabilities legal tender or expand upon other illegal activities.

The Fed halted it’s junk bond activities but that small excursion could be a trial run for much bigger operations next time. 

Unemployment Insurance

Millions of people make more being unemployed than they made being employed.

The result is wage pressures, unfilled job openings, and a mini bout of stagflation minus the stag.

Federal benefits expire on September 6 and many states voluntarily ended benefits early.

Those who saved the excess can afford to wait rather than take the first job that comes along.

A return to work will likely be spread out as opposed to one big bang in October. 

Monetary Madness From Congress Signed Into Law

The other sustained inflation possibility is monetary madness from Congress.

Recall that Trump temporarily morphed into a mini-Andrew Yang as noted in AOC Agrees With Trump’s Request to Send $2,000 Free Money to Everyone

Trump supporters cheered free money but only because Trump supported it. 

Congress passed “one time” stimulus  handouts three times but no additional rounds are in the horizon.

Guaranteed Living Wage

AOC, Nancy Pelosi, Elizabeth Warren, Andrew Yang and numerous others would make a Guaranteed Living Wage permanent and index that to inflation as well.

Such an act would guarantee permanent inflation at a high rate. 

Biden’s $3.5 Trillion Socialist Express

Please recall the energy aspect of Democrats’ $3.5 trillion proposal: The Greens Hijack Biden’s $3.5 Trillion Budget Proposal (That Could be a Blessing)

The Greens inserted provisions for a “clean energy standard” that would mandate 80 percent clean electricity as soon as 2030. Biden’s goal was 2035. 

To achieve that goal, the bill would put a tariff on imports forcing every country to comply.

In addition, the bill would expand Medicare, offer universal “free” pre-kindergarten, two years of “free” college, and other massive giveaways.

Stagflation Guarantee Act of 2021

If that boondoggle passes, it would practically guarantee deep and lengthy stagflation by increasing prices, reducing demand, and lowering growth.

If that’s what you want, call your Congressional representatives and tell them “I want higher prices, lower growth, and higher unemployment. Please vote for the Stagflation Guarantee Act of 2021.”

How likely is passage?

Here is the key question: Are Manchin, Sinema, and Tester On Board Biden’s $3.5 Trillion Socialist Express?

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Mike Shedlock

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31 Comments
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oee
oee
4 years ago
This is from the same crowd that said BHO’s policies would lead to…inflation. It never did. You have advocated for Au to skyrocket. It has not , You have touted that driveless trucks and robots would replace us.. They did not evidenced by the fact the employers are crying …worker shortage. you are batting a 1000% in the wrong direction.
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Jacques Arnaut
Jacques Arnaut
4 years ago
I frankly don’t understand the point here, what am I missing?
The Fed’s liabilities have ALWAYS been legal tender. In the form of little green pieces of paper you have in your wallet. Or in the form of a transfer from your bank to another bank -Fed wire, ACH- to pay for what you buy. That’s the definition of a national currency.
And as a reserve currency, it extends to the world as such: if Zimbabwe buys oil from Brunei, they don’t transfer Chinese Renmimbi or Venezuela Bolivars. They transfer US Dollars.
Simple as that.
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Mish
Mish
4 years ago
Reply to  Jacques Arnaut
You are wrong and have no idea what you are talking about. 
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RedQueenRace
RedQueenRace
4 years ago
Reply to  Mish
Jacques is partially correct.  Federal Reserve Notes are legal tender and are a Fed liability.
The other liabilities on its balance sheet are not.  But as I’ve said before, making those liabilities “legal tender” makes no sense.  So please explain how making the rest of the Fed’s liabilities legal tender would work by demonstrating how the accounting for it is performed when the Fed supposedly uses them to buy something.
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RedQueenRace
RedQueenRace
4 years ago
Reply to  Mish
I’ll also add, once again as I wrote you on this before, that it is not some legal definition assigned to the Fed’s liabilities that prevents them from buying stuff.  They are simply restricted by law in what they are allowed to purchase.
For example, the Fed is not allowed to buy stocks.  But that is not because their liabilities aren’t designated as “legal tender.”  They simply aren’t allowed to buy them.  All that is necessary is to remove the purchase restriction.  It puts the balance sheet at risk of going into negative equity but that is something that can be handled.
They are also prohibited from buying directly from the Treasury.  Again, this has nothing to do with liabilities being legal tender.  If they were allowed to do so they could simply credit the TGA (Treasury General Account) directly. Deposit money (and corresponding reserves) would be created when the Treasury spent it.  But the Fed was the source of those funds.
The Fed buys by directing a bank to create a deposit and crediting that bank’s reserves for the same amount as the deposit.  It does not and would not use liabilities to make a purchase.  It would instead expand its liabilities.
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ColoradoAccountant
ColoradoAccountant
4 years ago
Where on the Periodic Chart of Elements is the US Dollar?  Who enforces the laws of physics?  Thank goodness it is not anybody mentioned in this article because when I wake up tomorrow I would know whether to fall down or fall up when I get out or bed.
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goldbear77
goldbear77
4 years ago
@Mish
Your analysis is fair as far as it goes, but it seems partial. I agree, alarmists tend to think of roaring 20s growth, wage inflation driving purchase competition + monetary debasement then hyperinflation risk.
The current stagflation –  already evident on the math even using the US’ jaundiced gov numbers – is that more typically associated with a stagnant economy and imported cost push inflation.    The fact Wall St has been braying about high mark to market gdp growth beats when economy still sits below pre Feb 2020 economic output is just illustrating that the market is all about short term messages – until it isnt.
There’s now been an ~11 year global capex drought in greenfield resource and manufacturing capacity ex the US.  The result will be rising cost recovery claims eating everyone’s lunch – into a backdrop of excess monetary supply driving trend lowering of USD while demographics ensure tepid growth.
Add  the trade war backdrop-linked reshoring and lower trade efficiencies will be a new counter to the price deflationary pressure globalisation brought since the 1970s.
Stagflation for sure – but a horrible drip drip drip of mildly negative real gdp growth, eroding fiscal position, ongoing money printing as a response.
Money velocity will remain low – so hyperinflation due to to purchasing competition on consumables is unlikely.  Hyperinflation in assets will continue to express itself sporadically.
Schiff is right about the long run outcome – but like most soapbox speakers they don’t offer much nuance on the zigs and zags between point A and point Z.   They know detail is the enemy of message effectiveness.
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Mish
Mish
4 years ago
Reply to  goldbear77
Schiff is has been a hyperinflationist nutcase for years. 
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goldbear77
goldbear77
4 years ago
Reply to  Mish
yet provably been correct on a trend look back in history basis where most short term market pundits are wrong – but you can say that for many independent ‘economics-based’ pundits vs IB market pundits.
i dont follow him closely but ive not seen him flag hyperinflation as a real ‘right now’ risk – he’s been more aggressive on forecasting weak USD in the nearer term with hyperinflation a big risk further down the track.   he’s been right about USD of recent times and cyclically its on a trend to go much lower – but that trend’s big level shifts tend to  play out over 4-5 years at a time
the point he keeps making is the symptoms are all progressively showing up
but any balanced observer recognises these things tend to take a long time to brew then relatively short time to manifest
absent a global debt jubilee, or USD de-reserving into a poly-reserve SDR basket he has to be right  in the end because there’s no other way to get out from under US debt impost but inflation gradually then at speed. 
its an engine that can only go in 2nd gear now – every economic shock pothole it hits further retards speed and money printing is the only temporary balm
I posted elsewhere though I dont see really rampant inflation risk as measured via US CPI until 2023-4 at  earliest – which is when some of the US demographics start to improve
but its stealthy cost push stagflation all the way from here – regardless of US wage growth – absent another global economic collapse
Most US economic pundits simply dont see it due to US-blinkered myopia. They think global inputs cant rise sustainably if US growth isnt doing likewise
thinking from last century in my view
nearly all economists of any stripe underestimate the commodity long cycle wave because its so  difficult to define causally and hence forecast
Not even Kondratieff’s K-Wave’s do a great job of that. Yet  its a fairly regular phenom
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Doug78
Doug78
4 years ago
The Fed’s balance sheet is just assets they bought from the private sector. Most of these assets are good but a growing portion of them are bad. What happens if the Fed buys a bad asset? The Fed doesn’t go bankrupt. It just sits on it forever if necessary or until they decide to write it down. If they write it down the Fed technically loses the money but it is an accounting loss and not a cash loss. Essentially the Fed can never lose cash because they can create cash at will so in my opinion the size of the Fed’s balance sheet is not important. 
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RedQueenRace
RedQueenRace
4 years ago
Reply to  Doug78
“Essentially the Fed can never lose cash because they can create cash at will …”
Money (reserves and paper notes) is a Fed liability, not an asset.  Creating money increases their liabilities and assets by the same amount so they cannot repair the balance sheet that way.  It would make the “hole” smaller as a percentage of the balance sheet size, but it will not close it.
They can repair the balance sheet by not remitting interest income to the Treasury, which they are currently required by law to do.  An asset going bad shrinks the asset side of the balance sheet.  By not remitting income to the government they can shrink the liability side back in line over time.
A negative equity position is not a big deal.  It would only become an issue if it were very large AND the public ran for cash as the Fed could be placed in a position where they had insufficient assets to post as collateral for notes printed by the Treasury (because reserves > assets due to the “hole”).  Cash withdrawals would very likely be shut down long before that would become an issue.
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QTPie
QTPie
4 years ago
Making the Fed’s liabilities legal tender means not just inflation but very high and prolonged inflation which might start out feeling good but will quickly evolve into a monetary disaster. It’s a Banana Republic type of action that’s eschewed by other industrialized countries’ central banks as all are aware of the risks associated with that sort of move. It also likely means the loss of the dollar as the world’s reserve currency for real this time, as foreigners will look for any and all possible alternatives to transacting business in dollars. Let’s hope Congress’ stupidity is not actually up to the degree required to make this change.
I think the best way to think of QE as currently practiced is as a massive swap of existing interest-bearing debt for zero-interest debt.
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anoop
anoop
4 years ago
i don’t believe peter schiff, but i do believe all the ceos that are either talking about inflation and/or raising the prices of their products–berkshire, pepsi, jp morgan, blackrock, …
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thimk
thimk
4 years ago
OK the new green deal/rampant government fiscal spending  is indeed the inflationary elephant in the room but me thinks maybe  2 additional ancillary variables need to be added to the inflation mix (i.e. covid shut downs  and extreme weather events) . The former is somewhat more transitory .   
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RonJ
RonJ
4 years ago
“What If Fed Liabilities Become Legal Tender?”
Question is, what is the chance of that actually occurring? The profligate guns and butter over spending during Vietnam, lead to decoupling the dollar from gold. Is it only just a matter of time till FED liabilities become legal tender?
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john_byrne
john_byrne
4 years ago
Is it not true that QE involved buying assets from institutions other than banks, i.e. companies that don’t have Fed accounts, but just ordinary deposit accounts? And if thats case, what is stopping them from spending the money?
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Mish
Mish
4 years ago
Reply to  john_byrne
The Fed lends money to the banks
The money sits as an asset swap between the Fed and the balance sheet of banks.
The banks customers have no access to that money.
Banks Don’t Lend from deposits.
Who is it that spends the money, besides no one?
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Doug78
Doug78
4 years ago
Reply to  Mish
If you want to stimulate the economy you send the money directly into people’s accounts and bypass the banks. Then it will get spent.
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john_byrne
john_byrne
4 years ago
Reply to  Mish
So you are saying that no one but banks get QE money? (My assumption that non-banks get the money is based on sources like this: https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy). I’ve read it in other places too. But I don’t know – that’s way I asked if it’s true or not.
From the article above:
While the central bank’s asset purchases involve — and affect — commercial banks’ balance sheets, the primary role of those banks is as an intermediary to facilitate the transaction between the central bank and the pension fund.
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Mish
Mish
4 years ago
Reply to  john_byrne
In the US, It would not matter who gets it – banks or non-banks, it is not spendable. It is a FORCED asset swap.
Lacy did notice a change in the BOE that does matter to the UK. There was a step in the direction by the BOE such that QE that could be considered spendable. It was small. It always is initially.
Here is the discussion
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john_byrne
john_byrne
4 years ago
Reply to  Mish
So if a pension fund sells a bond to the Fed, then they get money in their deposit account, but they are legally barred from spending it? Is that how it works?
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RedQueenRace
RedQueenRace
4 years ago
Reply to  john_byrne
The “it’s just an asset swap” has been repeated so many times it has become established fact in the minds of many.  This is wrong but Mish is not going to believe anonymous Internet posters.
He does, however, respect Pater Tenebrarum, so I recommend that he read the following article that Pater wrote back in 2015 and which I supplied to another poster that supported the same POV:
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Viking
Viking
4 years ago
Actually free education makes a lot of sense: The brightest minds can go the farthest (regardless of parents income). It is a well established fact among historians, that longterm succesfull cultures are the ones with some element of social mobility. 
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TexasTim65
TexasTim65
4 years ago
Reply to  Viking
The brightest minds can already go the furthest regardless of parents income. It’s called a Scholarship and there are plenty available for the top 1% brightest students.
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Zardoz
Zardoz
4 years ago
Reply to  TexasTim65
1% is significantly less than plenty .
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Doug78
Doug78
4 years ago
Reply to  Zardoz
Most Ph.D students at R 1 rated schools receive full scholarships  plus a stipend at so that helps the brightest of the brightest. 
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Eddie_T
Eddie_T
4 years ago
Reply to  TexasTim65
My son got a 50% ride to SAIC and still had to take on 80K in debt for two years. I don’t think full scholarships are that easy to come by, especially for privileged white kids. Not sure he’d be in the 1% of brightest, but I expect he’d be close, no matter what metric you used to determine intellectual ability. I think his highest calling probably would be to teach college, but that is no longer a decent way to make a living, unfortunately. He will have to invent his own success, but I’m not worried.
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TexasTim65
TexasTim65
4 years ago
Reply to  Eddie_T
Is SAIC the School of the Art Institute Chicago? Not sure what it stands for otherwise based on you mentioning you went their to retrieve him.
80K for 2 years? Is that college courses / books only or does that including living expenses? Living expenses have to be paid regardless of whether or not you go to college (ie you need to eat and live somewhere whether you work or go to college) so it’s not quite fair to claim that part as college costs.
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Eddie_T
Eddie_T
4 years ago
Reply to  TexasTim65
Ever try to make it through college without eating or having a place to live? Not sure about you, but in general, living expenses are a very significant part of of college costs, for almost everybody.
Some of that went for living, but I did help out a little…Not as much as for his undergrad. Most of it went for tuition, which is 51K pr year with no scholarship.
Yes, SAIC is the School at the Art Institute of Chicago. It’s rated #2 in the country.
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TexasTim65
TexasTim65
4 years ago
Reply to  Eddie_T
General living expenses are a significant part of costs for everyone, not just college students.
That’s why I’m hesitant to lump living costs in with costs of attending college because you have to pay living costs regardless of what you do (work or go to college). The difference when attending college is that normally you don’t make much money (part time job maybe) so either family helps or you go into debt to finance your living expenses.
But when comparing costs of college across different time frames it’s important to separate out the living costs from the college costs so you can at least compare how much tuition/books etc has risen.
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Doug78
Doug78
4 years ago
Reply to  Eddie_T
Many very smart kids turn down scholarship offers to go to good schools in order to accept offers from top schools who do not give scholarships if your family makes over a certain amount of money. 
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