Free money to all!
One of the oldest sayings in economics is, ‘There’s no such thing as a free lunch.’
The point is that even if a lunch appears to be free, you’re paying for it in some hidden way, such as reciprocal obligations, higher contract prices or some moral obligation to do business.
Of course, the principle is even broader than that and applies not just to lunches but to any transaction where the price is too good to be true.
Despite that well-considered wisdom, economists and politicians are promising something today that’s even better than a free lunch.
It’s free money!
Getting rich by blowing dollars
Free money is the promise of a new school of economics called Modern Monetary Theory, or MMT.
If you haven’t heard of it yet, you will be hearing about it a lot as the 2020 presidential race kicks into high gear.
Bernie Sanders is a believer in MMT and the vocal Congresswoman Alexandria Ocasio-Cortez claims that it should be part of the ‘conversation’ among Democrats.
The idea is that the US Treasury and Fed are a merged entity.
The US Treasury creates wealth by spending money.
The notes issued by the US Treasury can simply be bought by the Fed and stashed away on the Fed’s balance sheet until maturity.
There is no limit on the amount of debt the US Treasury can create or the amount of money the Fed can print to buy the US Treasury debt.
The money created by the Fed is spent by the Treasury, which increases GDP and enriches the recipients of Treasury spending.
This money can be used for infrastructure, healthcare, free tuition, guaranteed jobs and income, or anything else.
What’s not to like?
The MMT plan will lead to national insolvency and the repudiation of the US dollar, but very few will see that coming until it’s too late.
This will be destructive for the US dollar.
Keynes and the liquidity trap
John Maynard Keynes was famous for the idea that in a liquidity trap where individuals and companies refused to spend or invest and hoarded cash, it was the responsibility of government to stimulate the economy by deficit spending.
Keynes’ ideas have some merit in a situation where the government is not heavily indebted to begin with and where the economy is in a severe recession or the early stages of a recovery.
Keynes died in 1946, but his ideas lived on.
The problem was that ‘deficit spending’ became an all-purpose excuse for more government entitlements rather than the limited recession remedy Keynes envisioned.
The US has only had three modest surplus years in the past 50 years; the other 47 years were all deficits.
The US national debt now stands at US$21 trillion (not including guarantees and entitlement liabilities) and the debt-to-GDP ratio now stands at 106% (the highest since 1945).
Worse yet, the US is past the point where debt creates any growth at all.
The US is in a zone where more debt actually hurts growth and slows the economy, while the debt remains.
Welcome to the return of US$1 trillion worth of annual deficits under Donald Trump for the first time since the early years of the Obama administration.
Both Republicans and Democrats embrace crude versions of Keynes’ original ideas without regard to the fact that there is no stimulus in current conditions, and additional debt risks a complete loss of confidence in the US government’s finances and the role of the US dollar.
If Keynes were alive today, he’d be the first one to object to such out-of-control spending and profligate debt levels.
The Fed is stuck in a burning building
An 11-year monetary experiment is coming to an end in failure.
No one knows what happens next, but the need to position portfolios to preserve wealth has never been greater.
The experiment began in the midst of the financial panic of 2008 when the Fed began printing money under a program called ‘quantitative easing’, or QE.
This first program lasted until June 2010.
After a pause, the Fed began a new program of money printing called QE2 in November 2010, which lasted until July 2011.
The Fed then took another pause, but the economy weakened so a new program called QE3 started in September 2012, which lasted until October 2014.
All told, the QE programs expanded the Fed’s balance sheet from US$800 billion to US$4.5 trillion.
At the same time, the Fed held interest rates at zero from December 2008 to December 2015.
It has raised rates to 2.5% since.
The benefits of money printing and zero rates are still under debate.
But beginning in December 2015, with the first rate hike in nine years, and in October 2017, with the first balance sheet reductions since the crisis, the Fed began to ‘normalise’ interest rates and its balance sheet to prepare for the next recession.
The goal was to get rates up to 4% and get the balance sheet down to US$2.5 billion in time to fight a recession.
Could the Fed normalise without causing the recession it was preparing to fight?
Based off recent remarks by Fed Chair Jay Powell, it appears the answer is no.
The Fed will pause in its interest rate hikes in March and may also slow the rate of balance sheet reductions in the near future.
This is in response to a slowing US economy and slowing global growth.
The Fed cannot normalise without causing a recession, which means it cannot prepare for the next recession.
The Fed is stymied and cannot escape the room.
All the best,