Saxobank: MMT cometh

Via Steen Jakobsen at Saxobank:

Last night’s FOMC meeting made it official: the Fed has thrown in the towel, and central banks are committed to defying the business cycle. But where does this leave us in terms of positioning for 2019, 2020 and beyond?

If you are familiar with my research over the last 20 years, you know that I am no fan of central banks; they are glorified bureaucrats with an academic sense of infallibility who believe they have a supreme power’s insight into the economy and markets. But yesterday marked a new low for world central bankers as the US Federal Open Market Committee completely threw in the towel.

Anyone who ever thought the Fed or other central banks are truly ‘independent’ should spend $20 on the great 2018 Paul Volcker book “Keeping at It”. In it, Volcker tells the story of how both Jimmy Carter and Ronald Reagan tried (with partial success) to force easing on him and the Fed in the 1980s.

(Also have a look at Nixon and his relationship with Volcker’s predecessor as Fed chair, Arthur Burns…)

Current chair Jerome Powell saw himself as a new Volcker, but last night he cemented his panicky shift since the December FOMC meeting, and instead cut the figure of Alan “the Maestro” Greenspan, who set our whole sorry era of central bank serial bubble blowing in motion.

The Fed’s mission ever since has been a determined exercise in defying the business cycle, and replacing it with an ever-expanding credit cycle.

This latest FOMC meeting has set in motion a race to the bottom, with the European Central bank currently in the lead, but the Fed and the Bank of England are gaining fast.

I am presently in London, and on my way to China and Hong Kong with Saxo’s Gateway to China events. I am joined at these events by the impressive Dr. Charles Su of CIB Research, China. He and I agree on many things, but one in particular:

Monetary policy is dead.

My view has long been that monetary policy is misguided and unproductive, but the difference now is that we are reaching the most major inflection point since the global financial crisis as central bank policy medicine rapidly loses what little potency it had.

In the meantime, the harm to the patient has only been adding up: the economic system is suffering fatigue from QE-driven inequality, malinvestment, a lack of productivity, never-ending cheap money and a total lack of accountability.

The next policy steps will see central banks operating as mere auxiliaries to governments’ fiscal impulse. The policy framework is dressed up as “Modern Monetary Theory”, and it will be arriving soon and in force, perhaps after a summer of non-improvement or worse to the current economic landscape. What would this mean? No real improvement in data, a credit impulse too weak and small to do anything but to stabilise said data and a geopolitical agenda that continues to move away from a multilateral framework and devolves into a range of haphazard nationalistic agendas.

For the record, MMT is neither modern, monetary nor a theory. It is a the political narrative for use by central bankers and politicians alike. The orthodox version of MMT aims to maintain full employment as its prime policy objective, with tax rates modulated to cool off any inflation threat that comes from spending beyond revenue constraints (in MMT, a government doesn’t have to worry about balanced budgets, as the central bank is merely there to maintain targeted interest rates all along the curve if necessary).

Most importantly, however, MMT is the natural policy response to the imbalances of QE and to the cries of populists. Given the rise of Trumpism and democratic socialism in the US and populist revolts of all stripes across Europe, we know that when budget talks start in May (in Europe, after the Parliamentary elections) and October (in the US), governments around the world will be talking up the MMT agenda: infrastructure investment, reducing inequality, and reforming the tax code to favour more employment at the low end.

We also know that the labour market is very tight as it is and if there is another push on fiscal spending, the supply of labour and resources will come up short. Tor Svelland of Svelland Capital, who joins Charles and I at the Gateway to China event, has made exactly this point. The assumption of a continuous flow of resources stands at odds with the reality of massive underinvestment.

Central bankers and indirect politicians are hoping/wishing for inflation, and in 2020 they will get it – in spades. Unfortunately, it will be the wrong kind: headline inflation with no real growth or productivity. A repeat of the 1970s, maybe?

Get ready for bigger government and massive policy interventions on a new level and of a new nature. These will be driven by a fiscal impulse to stimulate demand rather than to pump up asset prices. It will lead to stagflation of either the light or even the heavy type, depending on how far MMT is taken. With all of these ’70s throwbacks preparing to take the stage, we can’t help but wonder if ‘Paul Breitner hair’ is ready for a comeback as well!

Last night, a client asked an excellent question: how much of this scenario is already priced in? Here is my take: Saxo’s macro theme since December has been the coming global policy panic, and this has now been fully realised. The Fed proved slower to cave than even the ECB, but last night saw them give up entirely. The US-China trade deal, another key uncertainty, is priced for perfection despite plenty of things that can go wrong.

The Brexit deal, however, is extremely mispriced. The UK’s biggest challenge may not even be the circus act known as Brexit, but rather the collapsing UK credit cycle which our economist Christopher Dembik has put at risking a 2% drop in UK GDP. If nothing changes over the next six to nine months, and nothing will change, the UK economy will be in free fall. Forget Brexit, UK assets are simply mispriced from the lack of credit juice in the pipeline.

China is also misunderstood and mispriced. If our two talks so far with clients on China and its opening up of its markets have taught me anything, it is that the western ‘reservation’ on anything Chinese is entirely built on bias. Governance is the word that keeps coming back in discussions. I am no fan of Chinese-style governance, but… less than 10% of global AUM is currently in China. This year alone will see the inclusion of China’s bonds in global indices like Barclays, Russell, and S&P and the allocation to China in the MSCI’s emerging markets index will quadruple from 5% to 20%. The overall China-bound inflow over the next three to five years will exceed $1 trillion using very conservative estimates.

China is perhaps the country in the world least likely to treat inbound capital poorly. It has transitioned from being a capital exporter to now being an importer. It has a semi-closed capital account, which means little money flows out, but a massive inflow is beginning to stream in as global investors acquire Chinese assets.

China and its growth model now need to share the burden of becoming an industrialised country, and Beijing knows that only the only way keep the capital flowing in 2019 is to treat investors well. On the domestic front, meanwhile, the CPC seems to be signaling that it wants domestic investors to move excess savings from the ‘frothy’ and less productive housing market to the equity market, where capital can flow to more productive enterprises. Foreign investors are more likely to want to participate in the more liquid and familiar equity market.

2019 for China is like 2018 for the US. The first 10 months of 2018 saw the US stock market near-entirely driven by the buy-back programmes fueled by Trump’s tax reform. US companies plowed over $1 trillion into buybacks over the year. This year, the Chinese government is telling its 90 million domestic retail investors to raise their allocation to the stock market while global capital allocators/investors will need to increase their exposure to China as its capital markets are reweighted.

But where does this leave me on asset allocation at the moment?

Equities: the Fed, ECB, BOE and BOJ have all given up because they only believe in credit cycles. The price of money going down is not enough for growth as it’s only the second derivative of the growth engine; the first derivative is quantity of money. This is stabilising but because of base effects (a very high starting point), it will not be enough. For now, however, the market is euphoric due to the usual lack of integrity from merry bureaucrats. A new high could be on the cards, but… slowly change overweight to China from the US mainly, but also MSCI.

Fixed income: 250 bps in 10-year maturities… where are all the sell side analysts calling for 400 bps? The FOMC panic took out the 260 bps floor – is 200 next? Probably. Observe how the two/10-year yield curve is now attacking 10 bps. My economic studies really only taught me three useful things (but then, I’m a terrible economist):

  • The yield curve is never wrong.
  • Say’s law (supply creates its own demand).
  • Productivity is everything.

An inversion of the 2/10 is coming, I don’t see 200 bps before the late summer, however, when concern about the lack of growth overtakes the global policy panic in place.

Commodities: it’s all structural – Tor Svelland taught me that. We like all commodities, especially all sectors that have a foot in infrastructure. This is due to the coming of MMT, partly, but its mainly due to widespread underinvestment.

Cash: love it!

Forex: Underweight the two credit monsters: GBP and AUD. Overweight the US dollar, NOK, CHF, JPY. I like carry (for the summer) in TRY, ZAR and BRL.

China…maybe…but only for the usual bubble and bust. Commodities, meh. The West does not need dirt for building. It recycles. And China will ratchet down as MMT ratchets up.

The rest is good.

David Llewellyn-Smith
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  1. Overweight NOK & CHF is curious. They look almost as bad as the other credit monsters.

  2. Stewie GriffinMEMBER

    While I agree with the Theory behind MMT my biggest fear with it is that instead of being used to dis-inflate debt relative to income, it will instead be used as a means to facilitate continued debt servicing and instead of bringing about change, only succeed in locking in place the status quo, maintaining asset prices and allowing debt peonage to continue forever.

    Without debt reform it risks acting as another transfer mechanism from society to those ultimately holding the debt… the WASP cultural aversion to debt and the liquidationist mindset would have produced a far simpler, far fairer and far more prompt solution to the debt mountain than all the kitchen sinks that we have been collectively throwing at it for over the past 10 years.

    Perhaps if the debt was first allowed to fail and be written off I could bring myself to uncritically accept MMT as a solution to any resulting nuclear winter of demand depression, but without that first act my suspicion is that this will simply become another conduit to the banker class.

    • The sensible thing to do would be to raise interest rates, create public money to take the place of liquidating private money (preventing overall deflation), then simply hand out the replaced money as one-time payments to taxpayers, based on how much tax they have paid in the past (individuals and firms). A retrospective tax-break if you will. There needs to be no net change in money supply, because new public money is simply taking the place of disappearing private money. (Note that public money does not have to be liability free, which assuages the concerns of inflationistas).

      The effect is to definancialise the economy by cycling money out of Wall St and into Main St, resulting in falling asset prices and capital income (deflation of Wall St), with rising savings and labour income in Main St (inflation of Main St).

      The twist of making payments dependent upon past taxes is that it adds a qualitative aspect to the process. All the money, that is needed to fill the black holes appearing in balance sheets of the financially reckless, will exist in the economy, ready to be earned, but it will sit in the hands of individuals and firms with a proven track record of civic duty (actually paying tax) and productivity (they had to earn something for it to be taxed). Such firms and individuals are far more likely to allocate funds in a way that benefits society than the financially reckless who now need to be bailed out. The delegation of allocation decisions to millions of such individuals is likely to be more effective than leaving allocation decisions in the hands of the government decision makers, a point that helps assuage the concerns of libertarians.

      A condition of the money replacement would also be that individuals and firms with debt MUST use the payments to liquidate that debt (high interest rates can help incentivise it). So the major winners in the scheme will be individuals and firms that pay a lot of tax (or did in the past) and have no debt. The major losers in the scheme being individuals and firms that dodge tax and have a lot of debt.

      The latter should be left to default. All the money needed, to bailout the subsequent black holes, will exist in the economy, in the hands of people and firms that know best what to do with it. If the specufestors want to keep operating, then they’ll have to find a way back into the game by earning money from the prudent beneficiaries on Main St.

      This is both a qualitative and quantitative approach to dealing with the problem. To date, central banks have preferred quantitative approaches, taking the lazy option of bailing out Wall St, ensuring liquidity is in the system and deflation is prevented, but doing nothing to actually help the real economy. In response, asset prices have inflated enormously (but these aren’t considered in “official” inflation stats). Where CBs have attempted to act qualitatively, they’ve completely screwed it up with austerity measures that hammer Main St at a time when Main St is already being unfairly punished, versus Wall St, thanks to the nature of Wall St focused bailouts.

      [Edit: where everything gets hairy, and which is where I always fall out with MMT proponents, is what happens when taking into account international financial interdependencies. If something like this is going to be done, then it must be done in a coordinated international manner. If one nation decides to go it alone, then it will be isolated and attacked by international capital, starting with capital flight and an attack on the currency, triggering very high inflation that may spiral into hyperinflation. Tread carefully].

      • drsmithyMEMBER

        The major losers in the scheme being individuals and firms that dodge tax and have a lot of debt.

        Seems like middle to low income earners with debt would be pretty rooted as well. Little back because little tax paid (because little income earned to pay it on) and substantial increase in cost of servicing their debt.

      • Fair point drsmithy. Low income earners pay little tax and may have high debt, just trying to maintain a normal standard of living. It may need a safety net to be politically acceptable. This could take the form of a minimum payment for low income earners, prior to the rest being divvied out based on taxes paid.

        A counter argument comes from the Thomas Sowell type conservatives who would argue that low income earners would need no special treatment as the deflation of Wall St and inflation of Main St would offer higher incomes for previously low income earners, allowing them to earn their way out of trouble.

        Personally, I’m somewhere in the middle. A safety net must exist because some people simply can’t be highly productive (in a $ sense) through no fault of their own (disabled, elderly, unpaid carers, etc), however I’m wary of going too far with it and creating a dependency culture. I’m also strongly opposed to Wall St encouraging productive people to get into debt situations from which they can’t possibly escape, hence I’d like to see public banks allowing such people to refinance at low (even zero) interest, provided a serious attempt is made to pay down the debt.

      • This is a really interesting idea, thanks for writing it

        As someone who has paid a lot of tax and who has a mortgage of around 3.45:1 LTI I would be incentivised to pay it straight off my mortgage. I view that as a win personally as it lowers my interest burden, gets my mortgage down quicker, and I can commence banking savings into the now higher interest bank accounts etc.

      • There are a number of other observations made by MMT economists , aside from the big one (that the government is not revenue constrained)

        that paying interest on government bonds is basically welfare for the rich
        That primary bond dealers are granted an extraordinary privilege for no good reason
        That private loan creation is an extraordinary and unnecessary privilege

        The powers that be are cheerleading the fiscal stimulus aspect but the other three issues are getting no airtime

      • drsmithyMEMBER

        A counter argument comes from the Thomas Sowell type conservatives who would argue that low income earners would need no special treatment as the deflation of Wall St and inflation of Main St would offer higher incomes for previously low income earners, allowing them to earn their way out of trouble.

        It is a struggle to see the mechanism there to drive higher wages other than faith. Wages go up when workers have power.

        At first glance it would seem to me the people who would benefit the most from your suggestion are higher-end (say, top-decile) PAYG workers who have used little to no tax minimisation mechanisms.

        Personally, I’m somewhere in the middle. A safety net must exist because some people simply can’t be highly productive (in a $ sense) through no fault of their own (disabled, elderly, unpaid carers, etc), however I’m wary of going too far with it and creating a dependency culture.

        Even quite generous welfare is not going to provide as well as a low-end job. Being poor sucks and most people won’t choose it given an option. You get welfare “dependency” mostly because people don’t get the option (ie: not enough jobs).

      • @drsmithy:

        Yep →

        Neoliberalism did this. No need to detail the mechanisms driving working conditions & remuneration into a global race to the bottom because I reckon you already know them.

        The “Golden Era of Capitalism” following WW2 was a period of heavily regulated capitalism (ordoliberalism) in which markets were protected against regulatory arbitrage. Neoliberalism took over in the late 1970’s. If it’s allowed to continue unchallenged then we’re going to end up in another world war as inequality pushes people to breaking point (again). I’d rather like to avoid that!

        The kind of money / power shuffling that reformers (such as myself) are actually calling for is a big, big deal. A fundamental challenge to neoliberalism, intended to return back into a state of regulated capitalism that worked so well before. (In case it wasn’t obvious before, I am an Ordoliberal).

        Where I feel rather black-pilled is that I appreciate just how powerful global neoliberals are. It has already been clearly demonstrated that any nation that goes against the grain will be destabilised into war (or close to it). If nothing is done, then the current vector takes us into world war anyway, but I wouldn’t put it past TPTB to kick off major conflicts deliberately even if it just LOOKS like they might be losing power. Depressing.

    • If you’re talking about private bankers, the idea in favour with MMT supporters is to reduce the standing of private banking in the money creations stakes.

  3. Hnh how do we trade it?
    If its coming where’s it heading?
    Who’s the loser if the US does this?

      • Even StevenMEMBER

        That’s my gut feel too.

        I’m still grappling with the “Cash: love it!” comment. In an MMT environment where government/central bank is printing and devaluing the currency? Why on earth hold cash…?

    • If all the helicopter money is used to pay down debt then those with cash will have even more – but what do they buy?

      Also, what happens in developing economies as the west brings a helicopter gunship to the monetary gun fight? All that emerging market debt is going to be hammered as the developing countries won’t be part of the coordinated printing

  4. he WASP cultural aversion to debt ….

    Huh? In past generations perhaps. The WASP insitutions have been the most strident proponents of debt-based societies.

    • Perhaps not at the individual level though? “Neither a borrower nor a lender be” was pretty common advice 30+ years ago. Somewhere along the line, we forgot what we were taught.

      • Stewie GriffinMEMBER

        “In his memoirs, Hoover wrote that Mellon advised him to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. Purge the rottenness out of the system. High costs of living and high living will come down. … enterprising people will pick up the wrecks from less competent people.”

        The cultural difference between the WASP approach (above) and our new elites approach is best summed up by their favorite economic spokesperson, Paul Krugman….

        (Interesting that Krugman blames the liquidation of debts as being one of the triggers of WW2 and not the preservation of unsustainable debts imposed on Germany following WW1)

        I think this chart speaks volumes more as to how effective the solution sprang from Krugman’s cultural values of saving the banks and preserving debt has been:

        Ten years later and the mega wealthy have only grown more wealthy and the poor only poorer…. and I ask the question – is the world a more stable place today with those debts preserved?

      • drsmithyMEMBER

        “Neither a borrower nor a lender be” was pretty common advice 30+ years ago.

        At the height of the “greed is good” ’80s ?

      • Stewie GriffinMEMBER

        By the 1980s thanks to the Baby Boomers, WASP culture was already well and truly in decline into the valueless, barbarous cultural flotsam and jetsam that Western culture is today.

        This decline commenced as a part of the cultural revolution in the 1960s and continues to this day… as Alan Ginsburg prophesied when he said “We’ll Get You Through Your Children”

        And THEY did, the Boomers culture and its emphasis on hedonism and self over society is not WASP culture – its Ginsburgs’.

  5. MMT will not work in AUS because foreign “students” can take every new job that is added. Even their wives have the right to work here full time from day one.

    No to mention, an unlimited number of foreign “students” are allowed to come here.

    Obama set up a fake uni to catch foreign “students”:

    US set up fake uni to catch foreigners

  6. The government modulating a diverse basket of tax streams as a means of controlling inflation? It sounds even less effective than a central bank trying to do the same with a single cash rate, never mind that both are still using the same lagged data that is of questionable efficacy.

    What will end up happening is that it will drive inflationary pressure from within the labour market. I suspect that when inflation inevitably gets out of hand, they’ll panic and abandon tax modulation in favour of good old rate hikes. This will cause debt to act as a deflationary force, dragging on economic growth at the same time as inflation is running rampant; hence stagflation.

    Aside from the immediate negative of stagflation, there will come positives:
    – Interest rates will rise, causing defaults and a cleansing of malinvestment/bad debts
    – Much needed infrastructure will be built

    Both of these will allow future productivity and real growth to thrive once more.

    • Yes, I also don’t trust taxation to be an effective counteracting force (deflationary) for money that’s created liability-free (inflationary) under MMT. People are clever and are very good at avoiding tax. (More thoughts: ).

      However, there’s no reason why public banks cannot be created that operate in essentially the same way as private banks. (Commonwealth used to be a public bank before it was privatised). The same interest rates levers would be pulled in the same way, the key difference is that the electorate actually has some say over the inflation rate as the government has far more power to regulate lending in the public interest and prevent asset bubbles from forming. If the government fails in this role, then it pays the price at the next election.

      As it stands, our banking system is almost entirely privatised, there’s no balance at all, various sector inflation/deflation is a huge issue in most peoples’ lives, and they have a government they take it out on which actually has very little power to do anything about it.

      When we cede control of the money supply to private agents, they care not who makes the laws.

  7. Way too early for all this to be happening……something big must be going to occur. Maybe they can’t keep Deutsche Bank propped up any more and will have to resolve its derivatives book……or maybe they intend to move into Taiwan and keep it in the face of Chinese objections…..something truly huge.

    I just don’t see them using some of their best ammo without a real reason.