Wednesday, October 13, 2021

Monetary policy is a slow-motion train wreck

There is no shortage of things to worry about. 

That's a phrase I have used several times over the past decade. I used it as a foil to argue that since the market was quite cautious (and nervous), then a surprise downturn or selloff wasn't a serious risk. Recessions usually happen when nearly everyone is feeling optimistic. Today there again is no shortage of things to worry about, and the market is within inches of its all-time high. Most disturbing, however, is that neither the Fed nor the administration nor Congress nor the bond market are very worried about inflation. Inflation and all its nasty consequences are, arguably, big things to worry about today.

Fed policy, as laid out in today's FOMC minutes, is amazingly blasé about the risks of higher inflation. The Fed currently plans to begin "tapering" its purchases of Treasuries and mortgages sometime next month, and to finish tapering by mid-2022. That's not a tightening of monetary policy; it's only making policy less accommodative over a prolonged period. Actual tightening—which would consist of draining reserves (i.e., selling bonds) and/or raising the interest rate it pays on reserves (i.e., higher short-term interest rates)—won't begin until sometime late next year. 

The market has apparently agreed that this is a sensible course of action. Inflation expectations embedded in bond prices are somewhat high, but still a relatively tame 2.75% per year (average) over the next 5 years. The bond market is currently pricing in one or two 25 bps "tightenings" by the end of next year (i.e., short-term interest rates of roughly 0.4% to 0.5%), and a 1.5% fed funds rate 3 years from now. By any standard, that would be a supremely gradual pace of monetary tightening. But at a time when inflation is at levels not seen in over 30 years? 

This is almost certainly an unsustainable situation. The Fed and the bond market are almost certainly underestimating the risks of higher-than-expected inflation. 

How do I know this? It's all about incentives. Today, the incentives to borrow are huge. Short-term interest rates are below the current level of inflation and will likely remain so for at least the next year. (Even 30-yr fixed rate mortgages are lower than the rate of inflation.) Smart investors and consumers won't find it hard to arbitrage these variables. In fact, the process is already underway. You simply borrow money and buy anything that is a productive asset and which also has roots in the nominal economy (e.g., commodities, equities, farms, factories, cars). Leverage is your friend and ally in a high-inflation, low-interest-rate world.

How does one place a bet on an asset (in this case the dollar) that is expected to decline in value (because of inflation eroding its purchasing power)? You sell it if you own it, or you sell it short (you borrow it and then sell it). You buy it back when inflation settles back down and/or interest rates rise to a level that is greater than inflation. One way to "short" the dollar is to simply borrow dollars. And a common way to do that is to get a loan from a bank. And when the bank lends you money, the bank can actually create the money it lends you, which in turn expands the money supply. Banks are uniquely able to create money, provided they have sufficient reserves on hand to collateralize their deposits. Since the banking system currently has upwards of $3 trillion in "excess" reserves, thanks to the Fed's gargantuan purchases of notes and bonds, banks have an almost unlimited ability to increase their lending.

So it's not surprising that the M2 money supply has expanded at an unprecedented rate over the past 18 months, a time in which the Fed has bought almost $3 trillion of notes and bonds and bank deposits have swelled by some $5 trillion. And it's also not surprising that in the past six months consumer price inflation has posted a 6-7% annualized rate of growth—a rate last seen in late 1990. 

As for Biden, his approval rating is now down to an abysmal 38%. His administration has committed a series of blunders, most notably with the Afghanistan withdrawal. His top priority now is to pass two bills chock full of new social spending and new taxes which he preposterously claims will cost the economy "zero." Meanwhile, inflation has risen to multi-decade highs, yet both the administration and the Fed keep insisting it's just transitory. Things will almost certainly get worse if trillions of new taxes and spending, additional layers of bureaucracy, and hundreds of billions of dollars of new handouts and subsidies get lavished on the middle class. My good friend and talented artist Nuni Cademartori sums it up in this cartoon:

As the battle in Congress over Biden's "Build Back Better" agenda rages, I would urge everyone who thinks this agenda will actually help the economy grow and prosper to read the recently released study by the Texas Public Policy Foundation in collaboration with my good friend, Steve Moore of the Committee to Unleash Prosperity.

The key findings:

• The cost of the Biden Build Back Better plan spread across two bills will reach $6.2 trillion over the next decade.

• The higher tax rates on corporate income, small business income, capital gains, and so on will raise the cost of capital and reduce national investment and the capital stock.

• Compared to baseline growth, the negative impact of these taxes over the next decade will result in 5.3 million fewer jobs, $3.7 trillion less in GDP, $1.2 trillion less in income, and $4.5 trillion in new debt.

While I'm on the subject of Steve Moore, whom I've known since the mid-1980s, I will once again recommend you read and subscribe to the Committee to Unleash Prosperity's free daily newsletter. I read it every day, as do more than 100,000 citizens and Washington policymakers. (One of his recent issues featured Nuni's cartoon, and another featured some of my recent charts.)

In the study mentioned above you will find details on a plethora of Biden's tax proposals (e.g., a 12.5% payroll tax on all income over $400K, a reduction in the estate tax exemption of $8 million, and an increase in the top marginal tax rate to 65%) and their likely negative impact on the economy and employment. It's frightening to think that the people who came up with these proposals apparently believe that the overall impact of BBB will be stimulative. Have they no common sense? Here's a fundamental supply-side truth: when you tax productive activity and success more, you will get less of it. And when the government borrows trillions only to redistribute the money to favored groups and industries, you get a weaker, less efficient economy. And you also risk boosting already-high inflation.

I'll wrap things up with some updated charts and commentary:

Chart #1

Nothing illustrates better the supply-chain bottlenecks that currently plague the global economy than Chart #1. Used car prices have literally skyrocketed; in inflation-adjusted terms, used car prices are higher than they have ever been. In nominal terms they are up over 50% since March '20. 

Chart #2

Chart #2 shows how almost half of small businesses in the US report paying higher prices. The last time this occurred was in the 1970s. It's hard to escape a higher inflation deja vu conclusion.

Chart #3

As Chart #3 shows, bank reserves are very near their all-time high. The vast majority of these reserves are "excess" reserves, meaning they are not required to collateralize bank deposits. Banks thus have enough reserves on hand to collateralize an ungodly increase in deposits via new lending (i.e, money creation). If the Fed doesn't increase the interest rate it pays on these reserves by enough to make them more attractive, on a risk-adjusted basis, than the interest rate banks can expect to earn on new lending, bank lending will surely continue to expand, and that will fuel a prolonged expansion of the money supply and ever-higher inflation. 

Chart #4

Chart #4 shows the 6-mo. annualized rate of growth of the CPI (including the ex-energy version). I think this is a fair way to measure what's happening now, since we are well past all the distortions of last year and the turmoil earlier this year. Inflation by this measure hasn't been this high since late 1990. 

Chart #5

Chart #5 compares the year over year growth in the CPI (I'm being conservative with this) to the level of 5-yr Treasury yields. Yields haven't been this low relative to inflation since the 1970s. Recall what happened back then: millions of households made a fortune borrowing money at fixed rates and buying houses. Negative real interest rates cannot be sustained for long, mainly because of the incentives they create to borrow and buy. 

Chart #6

Chart #6 is an updated version of the one featured in Steve Moore's newsletter. It's important to note that the multi-decade trend rate of M2 growth is 6-7% per year. This has been blown away in the past 18 months. If the public tires of holding $3.8 trillion more in bank deposits than they normally would at this time, that's a tsunami of money that could float higher prices for nearly everything in the next year or so. It's also worth noting that M2 has been growing at a 10-11% annualized rate so far this year. 

What worries me the most right now is how this all sorts out. The Fed seems determined to avoid even the semblance of tightening for the next 12 months. Yet if inflation turns out to not be transitory as they currently expect, how long will it be before policy becomes tight enough to threaten the economy's health?

Chart #7

Chart #7 provides some historical context which may help answer that question. Note that every recession on this chart (shaded bars), with the exception of the last, was preceded by 1) a flat or negatively-sloped Treasury yield curve, and 2) a very high real Fed funds rate. Both of those conditions confirm the existence of very tight monetary policy that was intended to keep inflation pressures at bay. Neither condition is in place today, however, which strongly suggests that monetary policy poses no threat to the economy at this time.

Past Fed tightenings, however, were different from what a tightening would look like today. To really tighten policy, the Fed would have to 1) start raising the interest rate it pays on reserves, and 2) start draining reserves by selling bonds. It might take years to get rid of all the excess reserves, however, and no one knows for sure how the economy will respond to higher short-term rates in the presence of abundant reserves—that's never happened before. In the past, the Fed simply drained reserves until they were in such short supply that the banks were willing to pay ever-higher interest rates in order to acquire enough of them to collateralize their deposits. A scarcity of reserves led to a liquidity shortage, and high real borrowing costs led to bankruptcies and weak investment. Eventually, economic growth ceased, and the inflation cycle was broken. 

The dilemma for investors: we might be years away from a return to these conditions, so selling risky assets right now might be premature. And, by the way, holding cash is a guaranteed way to lose money. But how long can you wait, knowing that another economic collapse looms on the horizon? 

In the meantime, the prospects for Biden's Build Back Better lollapaloosa are declining by the day, thankfully, and the spreading disarray in Washington only makes that more likely. I'm willing to bet that if any of his bills survive, it will be in greatly reduced form, and thus much less damaging to the economy. Just letting the economy sort things out on its own would be a great relief to everyone, in my view.

Nobody said investing was easy. There are a lot of things to worry about these days. But I wouldn't panic just yet. The next year or so might be likened to watching a train wreck in slow motion.


Carl said...

Interesting and thought-provoking, as usual.
The underlying fundamental premise is that, in the end, the US will eventually do the 'right' thing, even if, at this point, it has mortgaged its future with a yield on this futurity that will need to be more closely correlated (at some point) to future taxation.
The question is how to get there and what will the interim inflation/deflation picture be.

A problem with the theory of expected and sustainable inflation surge is that meaningful loan growth has not occurred (in the context of slowing velocity). Why would this change at this point?
The 2020 unprecedented surge in loans was a liquidity-driven event based on a Fed backstop and most of the 'created' money is going to share buybacks (not fixed capital/durable/productive items).

Another problem with the 1970s déjà vu is that (looking at the Fred graph linked above) productive loan growth was made possible by the relatively low leverage context contrary to more recent times (since GFC) and today. The sitting President is not the first MMT President, he is the second or third one. The US has been sliding on the MMT slippery slope and (IMO) has not reached yet the banana republic stage.
In the relevant 1970s inflationary period, the loans to deposit ratio at commercial banks went from 1.6 to 1.8. Since the GFC, this ratio has been going down from 1.8 to 1.3 (accelerating trend down recently).
The elephant in the room is the debt. In the relevant 1970s inflationary period the gross federal debt to GDP was around 35% (and going down). Since the GFC, this ratio has been going up from 65% to 137% (accelerating trend up recently).
Of course the divergence between longer term inflation rates and longer term interest rates has to meet its day of reckoning, somehow. Your bet is that interest rates will rise to meet rising inflation rates. My bet is that the opposite will occur. With gross debt sitting at 137% of GDP, do you realize that raising interest rates ever so slightly would reveal how the whole thing is potentially a Ponzi scheme?
Unfortunately, ‘we’ need a debt-deflation scenario. It won’t be fun but it needs to be done.

Benjamin Cole said...

As always, great post.

Whatever my two cents is worth I agree with most of this post, but I am puzzled at this one:

"His (Biden's) administration has committed a series of blunders, most notably with the Afghanistan withdrawal.--SG

Egads, only 19 years too late is my take.

Did the Afghani people fire a single shot in defense of their nation against the Taliban? I must have missed that one shot.

Other than Afghanistan, Biden is terrible is my take.

Anyways, we will see on inflation. Bill Gross, the erstwhile bond king and a neighbor of sorts of SG, says 4% inflation on the boards. That sounds about right to me.

Some funny things happening globally. Truck drivers needed everywhere. Coal is short in China and India. Indian stock market striking all-time highs.

Housing shortages across America and getting worse.

Maybe housing stocks are the way to go....

Frozen in the North said...

What's the old saying the market goes up on an escalator but comes down on an elevator.

500,000 shipping containers are stuck off the coast of California
Producer inflation is not rising, it's skyrocketing
China's Evergrand is the canary in the coal mine...
Chinese WMPs are about to hit a wall since 50% of the money is invested in Chinese real estate
Biden & Co are losing the plot, America does need a slow infrastructure program, not this massive injection

I was in Asia in 1997 when the financial crisis hit, and it was a tsunami -- contagion was a major issue, I remember flying into Seoul twice in 1996 and 1997 and the country had changed drastically. Maybe Chinese contagion will not be so bad, since China's financial system is isolated...then again maybe not. In 2008, my boss called me about a Lehman product we had in our books, he asked if I was worried, and I asked him why -- because Lehman will declare bankruptcy letter this morning he said. It took us 24 months to unravel that mess, and we were a peripheral player in that whole crisis

For once I think you are underestimating the scale of the problem; China's investors are about to face a wall of pain -- WMP issued by Chinese banks that were invested in junk and used new issuance to repay those wanting out. This will end in tears; the 1970s are back stagflation will hit!

No growth high inflation. Valuations will take a hit

Benjamin Cole said...


It was 10 years ago, maybe more, Beijing created four "asset management companies" (AMCs) that bought bad debts from their commercial banks. The 2008-9 thing.

Believe me, I am no fan of Beijing, and I wish the CCP would shrivel up and die.

But, within context, the four AMCs seemed to work. China's banking system kept functioning, kept giving out loans, and the Sino economy sailed through 2008-10.

Now, the People's Bank of China (PBOC) has a Westernized central banker in charge, named Yi Gang.

China's CPI in September was up 0.7% YOY, and the PBOC target is "about 3%," but still Gang is sermonizing about being tight, and holding down debt growth.

This could be a major problem. China is a bigger player in global markets than the US.

Beijing, and maybe Westerners, need to figure out a way to stimulate growth without larger debt loads.

My guess is Yi Gang will eventually be shoved aside by the CCP, and replaced by a pro-growth central banker. That will be good news, at least in the medium-term.

Long run, as we all know, China needs to reform somehow. Although BlackRock, Disney, the NBA, WalMart and Tesla et al think the CCP is great.

Scott Grannis said...

I want to clarify that I am not seeing the world through rose-colored glasses. I do reject a disaster scenario, but at the same time I see lots of pain ahead for many people, bond investors in particular, as well as middle-class savers, those on fixed wages and salaries, and those living on a fixed or semi-fixed retirement income. Inflation is a cruel tax that targets the less-sophisticated among us. Inflation will rob people of many hundreds of billions over the next few years. The great beneficiary of inflation will be the government as that is how a good portion of the current federal debt will be effectively erased.

Yes, social security will be adjusted upwards by 6% or so next year, but in the interim prices have already been rising by more than that. By the time bigger SS checks come out, retirees will have already suffered a serious erosion of purchasing power. That's one of the evils of inflation: prices rise quickly, but wages are slow to catch up.

I also fear the geopolitical threats that are sure to crop up given Biden's weak leadership. Really, does any sane person think he is fully capable of exercising the office of the most powerful person on earth? He is creating a huge political vacuum, and as we know, nature abhors a vacuum.

And as I've mentioned many times, hiding out in cash is not a solution to these problems. Holding cash is a guaranteed way to lose money.

I believe the fed will eventually address the inflation problem they are creating, but it won't be soon. When they do, there will likely be another recession, but this is not something that one can plan for now.

Ian said...

Scott has things exactly backwards as usual. Inflation is the result of too little government spending, not too much. If the government invests in public housing, that will increase the supply of housing and reduce prices. If the government invests in clean energy R&D, that reduces the cost of clean energy tech: because of German investment in solar and wind, these are now the cheapest sources of energy. Government subsidies can even out the economic boom bust cycle that causes supply to go off line during recessions. A lot of lumber mills had to close down during the Great Recession, with the result that, when the housing market heated up again last year, there was a shortage of lumber. The government should be paying to keep lumber mills in business during bad times.

This nation suffers from a tragic lack of government investment, with the result that our infrastructure is crumbling. It is this lack of investment that makes us vulnerable to inflation. Sadly, because of the perversely wrong mentality that Scott represents, that underinvestment will likely continue.

Unknown said...


"because of German investment in solar and wind, these are now the cheapest sources of energy."

What? I lived in Germany. Germany has the highest electricity prices in Europe. Die Energiewende has been a total disaster. This took 5 seconds to find below:

" A lot of lumber mills had to close down during the Great Recession, with the result that, when the housing market heated up again last year, there was a shortage of lumber. The government should be paying to keep lumber mills in business during bad times.

The government is the cause of the lumber mills closing. I live in a town of two big lumber mills and have for 30 years. If you don't have your own supply of stumpage (Trees) you will go under. Why? Because it is almost impossible to harvest trees on national forests. Remember the spotted owl? That was a total lie. California is burning up precisely due to GOVERMENT. Global Warming has NOTHING to do with it. Government has destroyed the US forest products industry.

Do you work for Joe Biden or Nancy Pelosi because you have no idea what you are talking about.

Ian said...

Solar and wind are widely recognized as the lowest cost sources of energy. See here:

German electricity costs are currently high because they still don't have enough renewables in their energy mix and because they shut down their nuclear power plants, which was a bad idea. Consequently, Germany is still dependent on natural gas, which is surging in price.

People complain about the energy transition and the problems that it causes as though there were some alternative, but the only alternative is a planet of unbearable heat waves, droughts, and ecological disaster.

wkevinw said...

"And as I've mentioned many times, hiding out in cash is not a solution to these problems. Holding cash is a guaranteed way to lose money. "

I follow investment signals that are related to 4-6 asset classes, depending on how you want to define them. I got the last buy signal last week, meaning that "no cash" should be held at the moment. This happens about 25% of the time over the past several decades.

This is predicting that we are in the part of the cycle where inflation gets transmitted through the economy. At some point, "something breaks", and this stops: leading to sticky higher prices and slowing economic growth: staglfation (recession?).

Pensées Par Contre said...

I'm not an economist, but it seems pretty obvious to me that the world's financial system is in deep doo-doo. For almost 13 years the Fed has maintained the pedal to the metal, and yet economic growth has ben sub-optimal. The Fed did manage to unwind some of its QE and get its fed funds rate up to almost 2.5%, but then the financial system had a minor blow-up (repo crisis of Sept 2019) and the Fed was forced to slam its pedal back to the metal. And that was before the Wuhan virus struck, with political reactions that devastated many segments of the economy. And of course all the central banks are following the some course, more or less.

When a central bank tries to manipulate the economy by injecting credit into the financial system (which it can only do to any significant degree in a fiat currency system), it creates the illusion that there is additional capital available for investment. But that is only an illusion that results in a divergence between the financial economy (denominated in money) and the real economy (real goods & services). The forces of economic nature always push toward convergence and equilibrium, and the more that a central bank pushes to maintain the divergence, the greater the forces pushing toward convergence become.

There is a massive amount of debt outstanding that simply cannot be repaid. It was invested in assets (I use the term loosely) that are not capable of generating sufficient profits to service the debt. This is the inevitable result of excessive credit creation. At some point, and I have no idea when, the investing world will realize that fact and there will be a massive exodus toward the exit, which will of course be immediately slammed shut due to gridlock, i.e. liquidity will disappear.

We can get a rough idea of the size of this divergence by looking at the ratio of total credit to GDP ( In the 1950s it was about 130% and now it's almost 400%. If we assume that equilibrium for this ratio is somewhere around 150%, this implies a credit contraction of some 60%, and that assumes GDP is constant, whereas we can be pretty sure that such a credit contraction would decimate GDP. In short, the world's financial system is a ticking time bomb. Or perhaps a better analogy would be a volcano that, after a long period of underground pressures building up, finally erupts with an insanely destructive force.

I read Lacy Hunt's recent piece, and he makes a lot of good points. But I strongly disagree with his outlook for interest rates. The fact that the economy cannot support higher interest rates is irrelevant; the equilibrium interest rate is where savings equals investment demand, which is a function of the marginal productivity of capital. Central banks today are facing an excruciatingly difficult choice: they can allow interest rates to move back toward equilibrium, which will lead to a massive wave of bankruptcies including most governments; or they can continue to hold interest rates well below equilibrium until their money goes the way of all other fiat currencies throughout history.

Carl said...

^very interesting take and i agree with many parts.
Where should interest rates be (equilibrium)?
The question i have is:
Is it possible that 'we' switch from a regime where the Fed controls events to one where events control them?
In that case a debt-deflation scenario (à la Irving Fisher) has to be considered (total money stock goes down with true deleveraging).
Another aspect to consider is that (real-world) interest rates can still go up significantly with risk-free rates going down if credit spreads also return to long-term equilibrium levels.
For all those seeing sustainable stagflation coming:
From 1970-1980, CPI increased by 90%, nominal consumer and industrial loans increased by 260% and nominal loans at large increased by 300%.
Most commercial banks have reported (and discussed) 2021 Q3 results. The bottom line looks good but the earning power is from deal-making-related activity and various 'fees'. Loan growth is close to zero or even negative, especially if one fleshes out the credit card debt used to consume..
Recurring question on conference calls: What will you do with the extraordinary cash balances building up on your balance sheet?
Recurring answer (read between the lines): We are stuck between a rock and a hard place with little or no loan growth and securities (all asset classes) being priced for perfection.
Of course, they will keep dancing until the music stops and people figure out that the emperor has no clothes.

Scott Grannis said...

Carl, re "loan growth is close to zero or even negative" Not exactly. According to the Federal Reserve, since the end of February '20, total Bank Credit has increased by $2 trillion (+14.6%).

wkevinw said...

"German electricity costs are currently high because they still don't have enough renewables in their energy mix and because they shut down their nuclear power plants, which was a bad idea. Consequently, Germany is still dependent on natural gas, which is surging in price."

"Inflation is the result of too little government spending, not too much. If the government invests in public housing, that will increase the supply of housing and reduce prices. If the government invests in clean energy R&D, that reduces the cost of clean energy tech: because of German investment in solar and wind, these are now the cheapest sources of energy. "

The studies where renewable energy sources are shown to be the low cost are misleading at best. They are low cost to the investors- but not to the consumers (that's what the articles actually say). Isn't that special? Just one of many bogus assumptions in these computations is that a greenfield renewable plant is cheaper than a traditional one. It's kind of like saying the utility lines that are on poles overhead would be much cheaper if they had been buried during construction. Yep, but that's not reality. It's too expensive to bury the utilities now, just like it's too expensive to build all new power plants.

Another item they don't address (i.e. not in the cost analysis) is the intermittent nature of the renewable supplies (no wind, sun)). There is a cost to that, which is ignored.

The government needing to spend more to reduce inflation reminds of what the POTUS said in a recent speech. He will address the labor shortage by creating new jobs (really, that's what he said!).

I am entertained, anyway, if not persuaded.

Ian said...

wkevinw--If there are a lot of articles that say that, why don't you post one?

Most of the intermittency problem of renewables will be solved by HVDC cables, which can shunt energy to points thousands of miles away from where they are generated. Plans are in the works for Singapore to get solar power from Australia and the UK from Morocco. The sun is always shining and the wind is always blowing somewhere on a continent, and that will be all we need soon.

The rest of the intermittency can be handled through gas peakers, with green hydrogen becoming a larger part of the mix as time goes on, or through storage batteries.

Carl said...

"Carl, re "loan growth is close to zero or even negative" Not exactly. According to the Federal Reserve, since the end of February '20, total Bank Credit has increased by $2 trillion (+14.6%)."
i see this topic seems to be an area of recurrent misunderstanding. My numbers usually are built from bottom (banks balance sheets) to top (Fed H.8 releases) and things seem to add up but i'll assume that i'm wrong and share some numbers here (comparing H.8 releases, numbers as of Feb262020 compared to now).
In Fed speak "Bank Credit" = securities held + all loans and leases (all # in T)
Feb262020 vs now (last release)
BC =13.96 BC=15.93 Δ=2.0 (this seems like the # you are using in your post)
sec.held =3.88 =5.46 Δ=1.6
total L+L=10.08 =10.48 Δ=0.4

Of note, C+I loans (within total loans and leases) went from 2.36 to 2.43(!) and real estate loans went from 4.64 to 4.71(!). Of note also is that "cash" assets (which include reserves or 'financial plumbing' money but which are not included in the 'credit' section of bank assets) went from 1.74 to 4.18. If still reading this, Treasury and Agency securities held within the securities section (which is basically direct government financing) went from 3.11 to 4.38.

To use the level of language that a previous President used during active duty, i wonder if you're not 'misunderestimating' the role of the Fed put in supporting markets. :)

wkevinw said...

"Plans are in the works", "green hydrogen", "solar power"

This is the perpetual state of this stuff.

Note- I am a technical person in a company that used to be in the solar business (making the collector equipment). It is not cost effective, yet.

Green hydrogen (= electrolytic from renewable original energy source)~=5x more expensive than current market H2 price.

Good luck.

Carl said...

To Ian,
Your topic (energy transition) involves three levels of questioning:
1-Should it occur?
2-How rapidly should the transition occur?
3-How should the transition be 'managed' (public vs private, regulation vs direct investment)?

It's a huge topic and it's easy to mix issues which tends to make the exchanges less efficient and constructive.
i have difficulty with (ultimately reaching MMT): "Inflation is the result of too little government spending, not too much."

Ian said...


The third question is a good one, and I don't have an answer for it. But in any case, I brought up the subject of renewables because I was making the point that the effect of government spending is often deflationary. Renewables are an example. This link makes the point that the dramatic declines in the cost of renewables are largely due to government R&D and government policies like tax breaks that incentivize private R&D.

The US government funds all sorts of R&D in the military, pharmaceuticals, energy, and other domains. The government funds research for every single drug that US pharmaceutical companies produce. Surely this funding must reduces the cost of drugs. I imagine we feel the deflationary effects of government spending throughout the whole economy.

Of course, R&D is only one type of government spending. I can't find any data that building public housing reduces housing inflation, but surely it must right?

In any case, research has found that changes in government spending has no significant effect on inflation. If anything, the effect is negative, as I'm suggesting. I guess that's because while some government spending--like pandemic subsidies to the public--is clearly inflationary, much is also deflationary, and it balances out.

randy said...

Ian and wkeview,

Something that is frustrating with green technology advocates - is the breezy "we will figure the remaining tech challenges out". For things like - what to do with the massive recycling problems; the environmental, human rights, and national security issues around massive mining needed; energy storage that's not there; transmission and distribution problems, etc. FWIW, I'm an optimist in the ingenuity of man too!

But when alternatives like nuclear and carbon capture are mentioned - the optimists see nothing but insurmountable problems! Even though the technical progress for nuclear and carbon capture are arguably far closer to industrial and economic scale ready than pure wind and solar. And with far, far less government subsidies. (Reminds me to look at some of the stocks around new nuclear....)

My take is closer to "all of the above, the right tool for the right place"

The Cliff Claven of Finance said...

To Ian, current President of
The Scott Grannis Fan Club,
whose passionate tribute
to Mr. Grannis will never
be forgotten:

"Scott has things exactly backwards as usual"

Here are my two cents:

Build Back Better = Build Back Baloney !

And Junpin' Joe Biden has 'caused' more COVID deaths
so far in 2021 than all the 2020 COVID deaths
he blamed on Trump before the election.

And I predict only a 1% to 1.5% annual growth rate
for 3Q Real GDP, which Biden will announce as
good news, or whatever it says on his teleprompter.

Carl said...

i covered/read your references. Interesting.
The healthcare aspect (drug innovation) resonates with me as most of my productive life was spent delivering direct and concrete care to ordinary folks and I also got involved in standards of care, organization of healthcare services and interactions with various government agencies. This is a controversial topic but it’s hard to offer the opinion that US government support has resulted in cheap (in the sense of costs getting higher less rapidly than inflation) medications for the typical American.
The energy aspect also resonates with me as i live in an area of the world where hydro is very important and where hydro power has been nationalized (production, transmission and distribution). This is again a controversial topic (role of government) but our electricity rates are, by far, the cheapest in North America (and ‘we’ are selling some excess electricity power to the US through the spot markets and longer term contracts). In our case, it seems that government involvement has had, overall, a neutral effect with profits that would have been made by private entities ending up mostly lost diffusely in society through various inefficiencies…

Carl said...

Random thoughts (inflation debate):
-Not enough government is bad and too much government is bad
-That level of ideal government presence varies according to circumstances and sectors
-Efficient government 'investments' can result in 'good' (productive) deflation.

What appears to be supported by common sense and multiple well done studies is that governments in the developed world have become too large (it's now a bipartisan thing in the US) and this is having detrimental effects on growth. This can be acceptable to a certain degree when safety is traded (in the sense of trade-off) for wealth but unsustainable paths clearly can lead to worsening standards of living.
The most convincing study linking real growth and this Laffer-curve type of government size effect is the following:

i think this is definitely food for thought with obvious declining levels of social trust in institutions and decreasing institutional efficiency, especially notable in the US.

The link between government spending and inflation is highly dependent on many critical variables. You can find scenarios that would support a positive, a negative or a neutral effect. The level of a macroeconomic variable, by itself, is neither good nor bad. In the late 19th century US, the trade balance was negative but the US was borrowing abroad in order to invest and to become the world leader in productive manufacturing. Now, the trade balance is negative (and growing) and net national savings is close to zero because of the focus on consumption and the new era of acceptance to live beyond ‘our’ means.
Anyways, ‘mainstream’ economists who predicted bond vigilantes have been holding their breath for quite a while now as the % of gross federal debt to GDP went from about 55-60% (2000) to 137% now and as long term Treasury rates went from about 6.5% to about 2%, a situation (along with Japan testing how one must get too far in order to figure out what is too far) which the MMT crowd uses to deride traditional economics. Geek note: the average interest rates on U.S. Treasury marketable securities in early 2000 was 6.4% and recently was to 1.47% (down from 1.64% a year ago)! For reasons that remain unclear, the Treasury is keeping the duration very short and maybe, like me, they are expecting rates to go further down, at least for a while. But they also have to deal with the debt ceiling (again).
Empires have failed before because unsustainable debt was built and when leaders tried get out of the debt morass through currency debasement, MMT-like policies etc. Of course the best course of action is to avoid slippery slopes. Opinion: I think increasing government spending at this stage of the debt super-cycle is amazingly tricky. The principle behind the formation of the Federal Reserve was to maintain independence (to maintain soundness of the currency) and be a lender of last resort for short periods in times of liquidity crises, not to be the spender of last resort to support a reckless Treasury (opinion, somewhat substantiated).

steve said...

Scott, complete agreement on your analysis except I think it will create a 70's like bear market-at some point. The only possible good news is that next year mid term elections will in all likelihood coincide with extreme pain for the consumer and the dems will get crushed and they deserve it.

griot1234 said...

Benjamin Cole said...

They say Wall Street is forward looking, and the S&P 500 is near all-time highs after a strong week. Earnings season starts off on the right foot.

I see ugly times ahead in US housing costs, as de facto US policy for forty years has been to suffocate supply through property zoning.

Energy? OPEC tightened supply thinking there would be a global recession. OPEC+ essentially declares economic war every few years, but usually the higher prices bring on supply and crimp demand, so this problem will fix itself.

If higher wages in the US are a problem, let us hope for a few generations of such problems. Higher wages will do more for the US social fabric than any amount of social engineering, welfare or propaganda.

The Biden Administration is worrisome to me, if not Wall Street. Time will tell.

Carl said...

^Hi Benjamin (i like your inputs because i know this too shall pass but the thought process is how to get there (the promised land).

"I see ugly times ahead in US housing costs, as de facto US policy for forty years has been to suffocate supply through property zoning."
You describe an unusual focus on a specific aspect of the supply equation and some places (Canada, Australia and elsewhere) show that the bu**ble-level housing prices can remain irrational for much longer than what common sense would suggest possible or reasonable. Here's a recent post by Calculated Risk. i like his emotionally detached and objective thoughts which focus on demand and supply considerations and which help reconcile with today's prices and help guess what tomorrow's prices will be. i remain thankful to Mr. McBride as he was one of the multiple inputs that helped going through (investing wise) the period that led to the tricky 2007-8 transition in US housing. The only thing that i'd add to his last input is that disaggregating the price-income graph by income quintiles indicates that housing has become increasingly unaffordable for the lower 60 to 80% of the US population, because of growing inequality (this is one of the reasons for the relatively puzzling trend in high credit scores for those who continue to play the high-real-estate-price game at this point). Another amazing piece of data is the incredibly low level of home equity extraction despite record mortgage origination and refinancing rates. The way i try to explain this is that households who could equity extract have chosen to save now because of the (un?)conscious realization that some equity has to be saved in order to pay more taxes later (Ricardo equivalence type of thing).
"If higher wages in the US are a problem, let us hope for a few generations of such problems. Higher wages will do more for the US social fabric than any amount of social engineering, welfare or propaganda."
These days, the US labor market is nothing short of fascinating (unemployment rate going down as a result of lower participation rate in a ‘reflating’ environment). From the 70s to the GFC, one of the characteristic features of the wage-inflation/productivity conundrum has been the growing disconnect between productivity growth and wage growth. Sustainability issues would suggest that these two curves should be more closely correlated (otherwise you may eventually get loss in institutional trust, in capitalism adherence etc…oups this is already occurring) and the optimal way to solve the disconnect is to have the wage growth up to more closely match the rising productivity curve. Unfortunately, since the GFC, it’s mostly the productivity curve that’s been going down to meet the low growth in wages and the recent ‘transitory’ wage inflation suggest that the productivity curve is likely to go down some more. To ‘solve’ unsustainable inequality, the most optimal way is to have conditions that help wages rise in the bottom income quintiles in a more inclusive way. If ‘we’, the elites can’t figure this out, history shows that it can be a great leveller, usually bringing everybody down. Again apologies for the doom and gloom but I think the US (despite the expected mess) will do much much better, eventually, in this respect, than, for example, what China is trying to ‘manage’, at this point.

Carl said...

To Scott (can i call you Scott or should i stick to Mr. Grannis?):
i see no response to the 2.0T question which can mean many things.
Last Thursday, the WSJ had an interesting piece on "bank earnings". The subtitle: "On Wall Street, M&A is on fire, but on Main Street, loan growth is muted"
"JPMorgan, Morgan Stanley, Bank of America and Citigroup all reported record quarters for mergers-and-acquisitions fees. Goldman Sachs’s GS 1.27% league-leading team is due to report Friday. Executives said pipelines for potential future deals remain full. That is a sign company executives are confident enough in the economy to attempt transformative deals."
-my humble take:
Real transformative changes are necessary unless the goal is to get another kind of New Deal 2.0.

Scott Grannis said...

Carl, re the misunderstanding behind the $2T growth in "Bank Credit." You are using figures from the Fed's balance sheet. The measure I'm looking at comes from the Fed also, but it refers to total loans and leases of all banks in the US. Over time, this series has a close relationship (as it should) with M2, since it is the growth of bank lending which plays an important role in the M2 money supply (i.e., only banks can create money).

Kirk said...

Genuine question here: When the US Treasury spends money in excess of what it collects in tax revenue, doesn't that also create money? (at least from the point of view of the amount of money 'in the system')

Benjamin Cole said...


Yes, I like Calculated Risk also. It is interesting that this go 'round, people are not eating equity out of their homes. Maybe they are nervous. I am nervous. Both the Donks and the 'Phants seem to detest Americans who work for a living.

The big point remains: The US should--through market forces---build millions and millions of new housing units, but is prevented by local zoning, and the effective conversion of private property into a state-managed asset (although often lucrative for the legal owner of the land).

That, and we have a welfare-warfare state in Washington that is unbeatable.

Good luck.

Carl said...

Mr, Grannis,
Maybe i'm wrong and maybe a surgeon should only be allowed to participate using a reading-only mode here but i submit that the above statement is factually incorrect. i politely insist since the idea of banks recently lending hand over fist seems to be a key input in the upcoming surging and sustainable inflation wave thesis.
When you go to the Fred website (assuming this is the data (or equivalent) you're using):
---) at the bottom right, there is a link to H.8 releases that you can pick and choose from when comparing different release dates and the data is simply presented like a balance sheet with categories (all bank "credit") and various sub-categories (loans and leases, securities etc etc). i'm quite confident the numbers i've mentioned above are exact.
There is simply too much money sloshing around and banks don't really know what to do with the excess money especially since last March when the SLR relaxation period ended. It's now become more expensive to hold cash and Treasury bills on bank balance sheets. So what have banks been doing in this excess money context, money that can't just disappear. They've been effectively refusing retail deposits (no they can't really do that but they're essentially paying 0% interest) and they have been refusing corporate and institutional deposits (no they can't do that but they've been offering negative rates!) So corporates and institutions who are flush with excess cash turned to money market funds. Now that was a problem since MMFs turned to the reverse repo window and drove the overnight rate in negative territory (to exchange excess cash for Treasury bills which the Fed had just bought in the open market using 'created' cash!). But there are two problems with that. One, The Fed have pledged to avoid negative rates (especially embarrassing in the rate window they're directly 'managing') and negative rates threatens to break the buck for MMFs, a no-no for various reasons. The Fed reacted to this excess money conundrum using a technical adjustment: fixing the reverse repo rate at 0.10%. And Friday, there was 1.46T sitting at this window. the Fed is finding out that the monetary easing has not translated into more loans, it has translated into more money lying around earning close to nothing.

Carl said...

"Genuine question here: When the US Treasury spends money in excess of what it collects in tax revenue, doesn't that also create money? (at least from the point of view of the amount of money 'in the system')"

When the Treasury credits your account with USD, it creates a deposit in a way, the same way you increase your bank account balance (and temporarily create money) when you deposit a personal check from somebody else. However there's a clearing mechanism. The Treasury has accounts in banks for these purposes (including when tax is received from citizens, cash is transferred from a private account to the Treasury account at the bank) but most relevant overall clearing happens through the TGA (Treasury General Account) at the Fed. The Treasury, like individuals, has a central account which is digitally based at the Fed (which then functions like a bank for the Treasury) and this account does not allow overdrafts (there could be temporary and technical exceptions) and the Treasury account needs to be kept above zero using taxation receipts and proceeds from debt issue.
So, once the Treasury makes a deposit in a private account and when it does 'clear' (rapidly) the account balance at the Fed TGA is adjusted. If there is a deficit, public debt needs to be issued to the private market and the USD appearing in a private account from the Treasury deposit needs to balanced by an equivalent amount of money leaving another private account. No new money created (unless commercial banks complete positive buy-sell activities of government debt for its own balance sheet but that's another story).

Scott Grannis said...

Carl ("There is simply too much money sloshing around"): Indeed, there is a lot of money sloshing around in the US banking system. Savings, checkable deposits, and demand deposits (retail level) have risen from $12.2 T at the end of February 2020 to $17.3 T as of the end of August (latest data available). That's an increase of more than $5 T. Where did all this money come from? Bank lending. Why is there so much money held in individual accounts? Because people have decided to sock away a lot of cash—they want those accounts. Banks just didn't create them. Banks supplied money to the system through their ability to create money via lending, and people wanted to hold all that extra money. Until they didn't, and I think the "trying-to-spend-money" phenomenon took off in earnest earlier this year. People wanted to save this money despite near-zero interest rates; that was how strong the demand for money was. People also have wanted to borrow money, which is what led to their being more money available that others could save.

It's interesting also to note that retail money market funds have only increased from $0.9 T to $1.01 T over this same period. Putting money in the bank yields the same (zero) return that putting money into a MMF does. Maybe it's just simpler to let it accumulate in your neighborhood bank rather than opening an account to hold a fund.

Carl said...

^The money demand and supply concept is interesting but needs to take into account that, in essence, money does not disappear unless debt is repaid and that we now live in an ample reserves world ie where there is a lot of artificially created money.

For the relevant period, the deposits numbers reveal that, of the total increase in deposits, only 9% resulted from classic money creation ie net origination of loans to private parties and the relatively low level of absolute net positive private loan generation is simply a continuation of previous trends established since the GFC. Why would this change going forward?

For the inflation debate, let's do a thought experiment. Let's say people in the US get put to sleep for a year and, when they wake up, their private deposit accounts have increased as a result of the US Treasury having borrowed 20% of GDP and credited the private accounts for the same amount. Then, would you expect a 'surge' in spending? Would it be temporary? Would this surge be associated with inflation as a result of supply chain disruptions? What would this increase in debt (we're not full MMT regime yet) mean for the future growth and inflation if there remains residual future taxation capacity, at least as perceived by the market?

i’m asking those questions because i’ve followed your writings for a long time and a recurrent theme is the expectation for the risk-on animal spirits to take over the growing lethargy, a concept with which I fully agree, eventually. However, I wonder how this new era will be reached and I wonder if ‘we’ are now going in the right direction. Using an analogy in another field, when someone has a serious lower extremity infection, there is a school of thought that pushes for more and more medical and ‘heroic’ efforts to save the leg but at some point, in order to save the person, it’s best to cut the leg and move on. Of course, it’s a tough decision, especially if a collective one.

Frozen in the North said...


All this talk about money made me wonder about cryptos which I had not thought about for a few weeks, otherwise busy with work, when I saw the price of bitcoin yesterday I was a little surprised.

Do you have a take on cryptos, has it changed over time? Just curious because although cryptos are not money, they are not really a store of value but what are they? Are crypto-like gold.

I value your insights on this, and the comments -- granted if you talk about crypto the crazy may come out, still I would love your input

The Cliff Claven of Finance said...

It's time to start considering the possibility of a recession.

Large drops in consumer confidence indices from the Conference Board and University of Michigan precede recessions. The Conference Board has had a 25.3-point drop in 2021, while UM has had an 18.4-point slump. Both are similar to a 19-point and a 21-point dip, respectively, ahead of the 2008 recession.

Down two months in a row.

Ports of Los Angeles and Long Beach are getting worse. Biden's plan to unload ships faster does not change the shortage of truck drivers and trucks (late 2020 EPA rule changes banned roughly half of US tractor-trailers from operating in California).

The Marine Exchange of Southern California reported 100 vessels berthed October 18, topping the previous record of 97 set on September 19.

Product shortages are more than just sold out Jif smooth peanut butter in our local supermarket. They include parts to fix cars ad appliances. Propane. And important metals such as magnesium -- about 85 percent of all magnesium is produced in China. Where production curbs of energy-intensive smelters have reduced the industrial metal’s output, resulting in very low stockpiles in Europe and North America.

The auto industry depends on aluminum made with magnesium.

Add up all these existing problems, and then consider the possibility of Biden making them all worse. The vaccine mandates are causing people to be fired. Does he ever make any problems better?

>>>>> For all the COVID analysts out there <<<<<<<

US Covid deaths in 2021 through September
exceeded all US COVID deaths in full year 2020.

The vaccine used in 2021
has not been a success.
Not even close.

Biden blamed Trump
for all the cOVID deaths in 2020.
Said he would stop COVID in 2021.

But of course Biden takes no blame
for even more COVID deaths in 2021.

None of his faults are his fault.

Benjamin Cole said...

Bank of Canada M2 growth annual about 11%.

"The (Canadian) annual inflation rate hit 4.4%, up from 4.1% in August, its highest level since February 2003.

The costs of transport, housing and food all jumped, the country's official statistics agency said."


Canada is facing the same housing and transport bills as the US---but this is due to property zoning and OPEC more than anything else.

Many nations that run chronic current account trade deficits seem to have exploding housing costs. Foreign capital inflows looking for home?

Benjamin Cole said...

Did I read Dow Jones Industrials hit an all-time record high?

If these are the bad ol' days....

steve said...

Cliff, a recession wouldn't be the worst thing for us given WAY too much government $ out there causing WAY too much demand and supply restricted by covid protocols. Of course, when we do have another recession you know damn well the good ole US government will want to bail us out again...

Frozen in the North said...

Ben Cole

Yep, Canada is going to have to do something. For too long the government has been playing "there's no inflation here" while costs have been going through the roof. over the past 12 months in Montreal, house prices have risen by 21%, unsustainable, considering that wages have been mostly flat.

Interest rates in Canada should be around 5%, and they are around 1%.

Benjamin Cole said...


Building housing in Montreal must be profitable. Why not more housing production?

Attila Gajdics said...
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