Modern Money Ventures
Friday, January 6, 2023
On Inflation
Sunday, November 13, 2022
Rate Hike Disinformation is Getting Out of Hand
Monday, October 17, 2022
A Thought Experiment
Friday, October 14, 2022
Rate Hikes Are Loose, Not Tight, Monetary Policy
Public (and private) discourse about inflation and rates is truly bizarre. Consider the following scenarios:
Scenario A:
Savings account beginning balance = $10,000
Savings account ending balance = $10,000
No contributions or withdrawals over the period
Time lapse = 1 year
Scenario B:
Savings account beginning balance = $10,000
Savings account ending balance = $10,300
No contributions or withdrawals over the period
Time lapse = 1 year
The only difference between Scenarios A and B is the ending balance, for which B is $300 more than A. It is self evident that Scenario B is more expansionary than scenario A - there are literally more dollars at the end of a year in Scenario B, whereas Scenario A's balance is flat. And yet, according to the economists at the Fed, the media, Wall Street, elected officials, most of academia, and basically everyone with an "informed" opinion on the subject, Scenario B is considered a form of monetary tightening. The finance and economics professions are some of the highest paid industries in the country, and generally employ our nation's "best and brightest" or "Masters of the Universe." And yet despite this incredible brain trust, people continue to accept the axiom that rate hikes = monetary tightening, generally without thinking twice about it. The Fed has never released any research supporting the assertion that rate hikes "tighten" credit, limiting the availability of credit and subsequently tightening the money supply. Over the past year, the Federal Funds Rate (i.e. the rate that banks lend reserves to each other overnight) has gone from nearly 0% to around 2.5%:
This has resulted in the 10-year US Treasury, the risk-free rate for which all securities are priced off of, to rise from around 1.5% a year ago to nearly 4% today:
And yet, despite this "tightening," credit growth has remained strong:
And the employment to population ratio has ticked higher:
With US debt to GDP at around 120%, the impact of rate hikes on US federal spending is amplified. Total interest paid on Treasury debt is up nearly 30% year-on-year:
This increase in federal spending is a form of fiscal stimulus for people with savings. Similar to the checks sent out to Americans in 2020 and 2021, this increase in government spending stimulates aggregate demand (albeit to a wealthier cohort than the COVID stimulus programs).
And yet, the vast majority of the population calls this "tightening."
While we have been fairly negative in our outlook for the economy, it appears these rate hikes are having the unintended effect of stimulating aggregate demand, keeping us out of recession. In addition, federal programs such as the CHIPS Act, the Inflation Reduction Act, and President Biden's executive order to cancel a portion of student loans are further sources of stimulus that are coming down the pike. The student loan cancellation is especially important: Penn Wharton has modeled the program will "cost" over $500 billion in 2022 (in reality, it's not a cost but rather savings for households who qualify). Functionally, this is a tax cut: it reduces households' payment obligations to the federal government. And it is progressive, as it targets lower-income households. This is a very positive development for the US economy, as it creates capacity for these households to borrow and spend money on things like a house, a car, or other productive goods.
I'm not ready to go all-in on US avoiding a recession, but these developments are noteworthy and the Atlanta Fed GDPNow predictor indicates 2.9% growth for the third quarter:
Remember: savings don't drive investment, it's the other way around - investment creates savings. When consumers and businesses borrow and spend, that spending creates income. Rate hikes ostensibly are a form of increased government spending, which increases income for those with savings. Recall the scenario comparison above: in Scenario A, rates were at 0% and there was no change in the savings balance over the course of a year. In Scenario B, the interest rate was 3% which resulted in a higher savings balance at the end of the year. People make economic decisions based on real supply/demand factors. If a family decides it needs to buy a house to accommodate the birth of a child, they will pay the rate that's offered - assuming they can afford it. Whether they can or can't is a matter of a host of other economic factors. Rate hikes impact the distribution of income - people with savings get paid more at the expense of people who are net borrowers. That can have very negative economic effects. But to call that "tightening" is a stretch.
Saturday, August 6, 2022
Inflation, Markets, and Macro
Two straight quarters of neg GDP (we predicted coming recession)…
At the beginning of this year, we predicted a recession and risk-off period in markets based on the extreme fiscal tightening by the US federal government. While in the US the NBER is the ultimate authority on when recessions start and end, the “rule of thumb” is that two consecutive quarters of negative GDP indicate recession. Some even refer to this as a “technical recession.” While the NBER may very well not categorize the last two quarters as a recession, the fact that we are even having this debate shows the incredible predictive power of the MMT macroeconomic framework: literally no one in the mainstream press or Wall St was predicting recession at the beginning of this year.
Hot jobs report…
That being said, yesterday’s jobs report was undeniably, unmistakably strong, as total non-farm payrolls rose by 528k and unemployment fell to 3.5%, officially matching the pre-COVID era low (although the labor force participation rate ticked lower to 62.1% in July from 62.2% in June).
We are not in a recession yet, but will likely be in the coming months/quarters.
Inflation rolling over…
We’ve experienced relief on the inflation front recently, following the red-hot 9.1% CPI increase in June. Commodities have largely rolled over, and crude oil finished below $90/barrel for the first time since February:
Source: https://www.marketwatch.com/investing/future/crude%20oil%20-%20electronic
5yr/5yr breakevens have come down substantially:
This is not a surprise, because this period was not a “real” inflation. There are essentially two types of inflation: a “real” inflation is when our economy is at true full employment, and additional spending/money creation does not yield enhancements in productivity. We are far from that state of affairs (more on that topic below). The second type of inflation is one related to bottlenecks: we may not be at full employment, but supply side constraints, hoarding, and other bottlenecks are causing prices of goods and services to go up. Once those bottlenecks clear, prices will come down. There is no “secular” change in inflation expectations as many are arguing, and the market largely agrees based on breakevens and an inverted yield curve (which we predicted would happen).
I don’t have data to support, but I suspect there is some merit to the argument that financial markets stress (both in traditional stocks and bonds as well as a frauds like cryptos and NFTs) is forcing people who thought they could make a living off day-trading back into the job market. If true, then this is more of a one-off jobs boost.
Why is consumer sentiment so bad? Taxes remove dollars out of circulation causes fiscal tightening, rate increases force companies to raise prices without expanding output…
Consumer sentiment surveys are at or near historic lows:
Why is it so bad, despite the favorable jobs backdrop? Because consumers are being squeezed: on the one hand, fiscal tightening has caused money to be tight, forcing consumers to go into debt to meet their obligations. Revolving consumer credit balances (e.g. credit card debt) have exploded as of late, after falling substantially during COVID recovery period. This is entirely consistent with the framework of MMT, as federal surpluses are creating household deficits.
Meanwhile, there is no evidence of a “wage price spiral,” as real wages are negative year-on-year. The explanation for this is simple: the Fed’s rate hikes are causing companies to raise prices without expanding output. Think about it: if a large corporation issues commercial paper to meet its short-term funding obligations, and the cost of that debt has gone up thanks to the Fed’s rate hikes, then those companies must raise prices to maintain their margins. Fed rate hikes cause prices to go higher.
Big relief rally in July…
Stocks returned +9%, while HY spreads came in:
YC inversion trade worked…
Our yield curve inversion trade idea has worked:
TLT has outperformed SHY since we posted our idea on May 18, although the spread compressed a fair amount yesterday following the strong jobs report (note, the below shows price comparisons, and doesn’t include dividends reinvested, which would put TLT even further ahead of SHY).
Thursday, June 30, 2022
Levy Economics Institute MMT Seminar Post-Mortem (Part II)
Last week, I wrote part I of a post-mortem from a fantastic MMT seminar at the Levy Institute earlier this month. There is a TON of material to cover, so I am sharing what I consider to be the most important takeaways. Last week I wrote about the Fed; below are notes on inflation. Without further ado:
Inflation
Inflation has been all over the news for the past 6-9 months, and the public's discourse around it has intensified. Inflation is an incredibly emotional/moral/political topic, which I suspect is because it effectively serves as a tax on rich and powerful people. As we have written about in the past, modest inflation and low rates helps low-income people who are net debtors: they generally experience higher incomes while their debt obligations remain fixed. Rising rates and unemployment are devastating for this cohort, which is why it is so shameful that people in positions of power and privilege are demanding the Fed to hasten its rate hikes in order to put people out of work. It's astonishingly cruel and out of touch with the American people to be spewing this rhetoric. I will never understand how intentionally putting people out of work can possibly give us a collective better quality of life in real terms. But that is a discussion for another day.
Anyway, the most important fundamental takeaway from our roundtable on inflation came from Randy Wray, who put it concisely, "money is a stock; spending is a flow." This is critically important. Most of us think of inflation as a general rise in prices due to an increase in the supply of money (i.e. all things being equal, increasing the supply of money makes it less valuable and depreciates its purchasing power). However, Wray's point is an important distinction. Prices going up (or down) reflect transactions. Transactions reflect spending, where money flows from one party to another. We use transacted prices (and some imputed ones, based on surveys) in order to come up with a reasonable guess of the rate of inflation (e.g. CPI, PCE). So using concepts like the "money supply" (as most mainstream economists and analysts do) is nonsensical for the purposes of predicting and analyzing inflation. The water in a bathtub does not magically become "faster" when one has increased its supply; however once the drain pipe is pulled, the increased mass would cause the flow rate of the water moving through the drain pipe faster. Gravity forces the water through the drain pipe, and the additional force from the added water mass causes it to move through the pipe faster. Arguing that increasing the stock of money causes inflation is like arguing that increasing the quantity of water in a tub makes it faster. It's a ridiculous assertion, because if the drain hasn't been pulled, then the velocity of that water is still zero, just as it was before!
Two additional points on the money supply myth. First, the panel confirmed my proposal that, to the extent there may be periods when both inflation and increases in the money supply are high (which is questionable at best), analysts and economists have the cause and effect backwards: increasing the supply of money doesn't by itself make prices go up, but an increase in the real costs of goods and services may be the cause, rather than the effect, of new money creation. The example I used is if a retailer normally buys a product from a wholesaler with a four-week lead time, and supply chain disruptions suddenly causes that same product to have a four-month lead time, then the retailer can't realize a sale of the product until it is actually delivered, and will need additional credit to make up for the shortfall in cash flows it would normally generate. The real shortage of that product, combined with the additional money/credit required to finance it may be reflected in a higher price.
This example provides a bridge to the second point, which is that the demand for money is equal to the supply. Because modern money is simultaneously one party's asset and another's liability, the demand for money must equal supply. There must be a party willing to have a money deficit in order for another to have a money surplus. This is why the "increased money supply causes inflation" trope is so ridiculous. Increasing the money supply requires a party to simultaneously be in deficit, so the aggregate change in financial assets and liabilities is zero! What matters is how that money is spent. Looking at things like M2 as a measure of the money supply is misleading, because it assumes money exists on its own. The Fed defines M2 as:
"A measure of the U.S. money stock that includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers' checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds."
It ignores the fact that currency and coins held by the non-bank public, checkable deposits, travelers' checks, savings deposits, small time deposits, and shares in retail MMMFs are assets for their owners but liabilities for their issuers! It's this dual-entry accounting, "two sides of the same coin" reality that most people fail to understand. Increasing one person's supply of money requires an increase in someone else's deficit. So unless the government, as the monopoly supplier of money, is willing to run a deficit, then the only way for a person to have a surplus of money is for someone else to be willing to take on debt. Therefore, treating money as if it were a fixed, scarce commodity that follows simple supply/demand curves is incorrect. Money supply is equal to demand.
Some may argue that the American Rescue Plan may not have caused inflation but it increased the "potential" for inflation. Going back to our bathtub water analogy, the money printing is akin to doubling the supply of water, causing an increase in potential energy that, once the drain was pulled, created conditions for higher kinetic energy output. The problem with this argument is that the US federal government already has an unlimited amount of money it can create. Thus, there is already infinite "potential" monetary energy in our modern money system. Actually converting that potential energy into kinetic energy requires a political process. If the votes are there, the checks will clear. If the new money is used productively, we all experience a raise in living standard. If not, we don't.
Turning to MMT's view of inflation: MMT makes a distinction between true inflation (i.e. fiscal spending beyond real capacity) and bottleneck or supply-side inflation. The current bout of inflation is very clearly the latter. There is ample evidence that we are nowhere near our full productive capacity, the current inflation is supply/bottleneck-driven, and that it's real resources that matter. As Keynes wrote in How to Pay for the War, by thinking about real resources, the government can increase its spending by a large degree without causing excessive inflation. See selected slides below:
Source: M. Nikiforos, Levy Economics Institute
Energy prices are high for a variety of reasons, including declining production in the US, which is still below pre-COVID levels:And two substantial oil refineries have been closed since December 2020:
Which has led to crack spreads (i.e. what oil refineries charge for refined product vs. the price of crude) at all-time highs:
Meanwhile, the Saudis (who are a quasi-monopolist as they are the swing producer for oil) continue to raise their prices.
The other big items are shelter and things related to transportation: new and used vehicles as well as transportation services, which have been supply-constrained thanks to a chip shortage.
Importantly, the inflation is NOT driven by higher wages, as real wages have on average declined year-on-year, so the idea of a wage-price spiral is taking place is total nonsense:
Source: M. Nikiforos, Levy Economics Institute
Meanwhile, the 10-year breakeven rate for inflation is around 2.3%, and trending lower:Finally, Randy Wray recommended an inflation measure I had not heard of before: the Trimmed Mean PCE Inflation Rate, published by the Dallas Fed. The definition of this measure is as follows:
The Trimmed Mean PCE inflation rate produced by the Federal Reserve Bank of Dallas is an alternative measure of core inflation in the price index for personal consumption expenditures (PCE). The data series is calculated by the Dallas Fed, using data from the Bureau of Economic Analysis (BEA). Calculating the trimmed mean PCE inflation rate for a given month involves looking at the price changes for each of the individual components of personal consumption expenditures. The individual price changes are sorted in ascending order from “fell the most” to “rose the most,” and a certain fraction of the most extreme observations at both ends of the spectrum are thrown out or trimmed. The inflation rate is then calculated as a weighted average of the remaining components. The trimmed mean inflation rate is a proxy for true core PCE inflation rate. The resulting inflation measure has been shown to outperform the more conventional “excluding food and energy” measure as a gauge of core inflation.
The result is a smoothed measure of inflation that is arguably a better measure of the change in the "general price level." The latest reading for this measure is roughly 3.5% - high for recent history, but by no means extraordinary relative to the 1970s and 1980s:
As we can see, too, this is arguably a more useful measure than PCE and CPI, which are much more volatile:
Bottom line: this is a supply/bottleneck driven inflation that will prove to be a temporary setback. Unfortunately, the Federal Reserve is buckling under the political pressure to "do something" about inflation, and is hiking rates as the economy slows down. This is likely to exacerbate the slowdown and cause a recession, and unless Congress passes a new spending package, we are risk of a financial crisis. More on that in Part III.
Thursday, June 23, 2022
Levy Economics Institute MMT Seminar Post-Mortem (Part I)
On Inflation
[Note: I originally started writing this piece on December 23, 2022, then got held up with holiday festivities. More posts for the new year ...
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Before diving in to today’s post, let me first acknowledge that, when I began this blog in early 2022, I was very much still at the beginnin...
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Finance 101 introduces the concept of the "time value of money." The idea is that there is an opportunity cost in having money tod...
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Public (and private) discourse about inflation and rates is truly bizarre. Consider the following scenarios: Scenario A: Savings account beg...