Archive for May 2019


There’s something wrong with my car

Last week, I brought my new car back to the dealer. It’s not working properly. Here’s how I explained the problem to the dealer:

When I merge onto the freeway, I have trouble getting the car up to 65mph. I tapped on the brake pedal 9 times, and still no luck. The car doesn’t accelerate to 65mph. There must be something wrong with my car.

The dealer gave me a funny look, and made up some phony excuse about how tapping the brake pedal might have prevented the car from reaching the desired speed.

I continue to receive comments telling me that the Fed lacks the ability to get inflation up to 2%. The Fed has raised interest rates 9 times since 2015, each time with the goal of reducing inflation. And now, in 2019, they still haven’t got inflation up to 2%. There must be something wrong with the Fed’s inflation raising mechanism.

What does it mean to “finance government spending by purchasing bonds”?

Here’s the Financial Times:

Torsten Sløk, a Deutsche Bank economist, pointed out the US central bank is not only under pressure from the White House, but also from progressive economists and lawmakers, where there is a growing belief that central banks can help finance extra public spending by purchasing government bonds, without triggering dangerous levels of inflation.

I see this sort of thing quite often.  It’s not exactly wrong, but it’s so misleading as to be the moral equivalent of wrong.

Debt can be monetized in two ways, by using newly printed currency to purchase T-bonds and by creating zero interest reserve accounts at the Fed and exchanging them for Treasury bonds in an environment where market interest rates are positive.  In contrast, creating positive interest bearing reserve accounts does not provide revenue for the government, it merely swaps one debt for another.

As a practical matter, in a world of positive interest rates about 98% of debt monetization is cash for bonds, and 2% is the creation of non-interest bearing reserve accounts at the Fed.  So as a first approximation, when people talk about financing spending by monetizing debt they are talking about buying Treasury debt with currency.

If you are willing to tolerate hyperinflation, then you can use money printing to finance spending up to roughly 3% or 4% of GDP, at most.  If you are not willing to tolerate hyperinflation (and we are not willing to), then the amount of spending that can be financed by printing currency is trivial.

If bonds pay positive interest rates, then banks don’t want to hold large quantities of zero interest reserves.  If the yield on T-bonds is zero then banks are willing to hold large reserve balances, but in that case swapping zero interest base money for zero interest bonds doesn’t finance anything.

So yes, you can finance spending by printing boatloads of currency when interest rates are positive and create high inflation.  That’s a tax on money holders, which is every bit as unpopular as any other tax.

I wish people would stop talking about this option; it’s simply not important in the modern world.

How can the world best gang up on America?

The US has many fine qualities, but in the field of international relations the US is becoming one of the single worst nations on Earth.  Here is just one example:

  • President Donald Trump’s administration announced Monday that buyers of Iranian oil must stop purchases by May 1 or face sanctions. 

  • The move, which took many market participants by surprise, ends six months of waivers which had allowed Iran’s eight biggest buyers of crude to continue to import limited volumes.

It’s bad enough that the US refuses to buy oil from Iran; we insist that every other country in the world follow our lead. And in this case we cannot even cite support from allies such as the UK, France and Germany, all of which oppose this move.

Of course there are numerous other examples I could cite. We punish other countries for being tax havens, while the US is perhaps the world’s biggest tax haven. It’s easy to set up secret shell corporations in the US in order to hide wealth.

We also threaten sanctions against foreign multinational companies that do business with Iran. Because of the size of the US, and the fact that it is difficult to do international business without using US dollars, we are able intimidate foreign companies into avoiding Iran.

Trump frequently praises evil leaders like Orban, Kim Jong-un, MBS, Putin, Duterte, while trashing the more respectable leaders of our allies. We are now a part of the “dark side” of authoritarian nationalism. The axis of evil.

We launch trade wars against one country after another, on the flimsiest of justifications. And one could cite dozens of other examples. Some of this predates Trump, but it’s become far worse over the past two years.

So what is to be done? The purpose of this post is to look for ideas as to how the rest of the world can fight back against American bullying.

Consider that the behavior of Russia and Saudi Arabia is at least as bad as Iran’s behavior, if not worse. So why don’t we ban other countries from buying oil from Russia or Saudi Arabia? The answer is clear; they are too big for us to pick on. We know that a cutoff of oil from either of those two countries would push the global economy into recession. We pick on the weak. This suggests a path forward.

It seems to me that it would be in the interest of the major European nations to join up with China, Japan, Russia, Turkey, India and other major powers in an anti-American alliance. That way the US could not pick them off one country at a time. Yes, the Europeans are not completely happy with the behavior of China, but right now the US is the biggest threat to Europe. (Something Angela Merkel seems to understand.) By joining together in an anti-American alliance, it will make it harder for the US to achieve its goals. We can sanction one country for doing business with Iran, but do we dare sanction the entire world? I doubt it.

Perhaps there could be an international effort to replace the dollar with the euro as the dominant currency in global trade and investment. It would not be easy, but the leverage of US policymakers would be reduced if the US banking system did not occupy such a central role in the global economy. Or perhaps the EU could fine American companies doing business in Europe every time we fined a European firm for doing something that was perfectly legal under European law.

The US is a big country, but it generates only about 20% of global GDP. If the rest of the world worked together they ought to be able to put an end to American bullying. Bullies are usually cowards, and tend to back down when they meet actual resistance.

If you have any good ideas, please add them to the comment section.

PS. The recent US ultimatum given to Iran reminds me of the old days when countries like Germany would deliver a ridiculous set of demands to a weaker country in the hope they would be rejected and offer a pretext for war. (I suspect the actual US goal is regime change, not denuclearization.) My favorite example was the US insistence that Iran not intervene in Yemen. Pot, kettle.

Update: Although this Foreign Affairs piece ends up (sort of) defending Trump, it’s still the best thing I’ve read on the Mueller investigation. Highly recommended.

Bad news for Dems

In 2015, the UK Conservatives did better than predicted by the polls. In 2016, Brexit did better than expected. At the time, I did a post pointing out that the surprise Brexit vote was bad news for Dems (although I later botched the election itself.)

Yesterday, (conservative) Liberals won a surprise victory in Australia. This is also bad news for Dems. It’s becoming increasingly clear that polls consistently underreport support for the more “politically incorrect” political party in Anglo-Saxon countries.

One glimmer of good news is that Democratic voters seem to be leaning toward more “electable” candidates such as Biden. Even though Biden is not particularly popular among progressives on the two coasts, all that matters is the “Obama/Trump” voters in the Rust Belt. NOTHING ELSE MATTERS. The Dems must win Wisconsin, Michigan and Pennsylvania.

On balance, I think the Aussie election is more important and points to a likely Trump win in 2020.

PS.  The Aussie economy is doing fine, but they have the same political polarization that we do:

Even by Australian standards, the leadership coups at public broadcaster ABC last week, which led to the sacking of managing director Michelle Guthrie and the resignation of chairman Justin Milne, have been brutal.

They have also highlighted the hyper-partisan nature of the country’s politics and the wider “culture wars” between conservatives and progressives, which are polarising debate and risk undermining confidence in public institutions.

As I keep saying, it’s not about the economy.

Tariffs can be deflationary

Tariffs are generally assumed to have an inflationary effect on the economy. I imagine that’s true in most cases, say a developing country with a newly elected populist government. But is it always true?

In my (still underrated) book on the Great Depression, I explained how the Smoot-Hawley tariff had a deflationary impact on the US economy. Stock and commodity prices fell sharply in April-June 1930, as the bill moved toward passage. The biggest stock market crash of 1930 occurred right after Hoover announced that he would sign the bill.

The same appears to be true of the recent trade war with China, which triggered a narrowing of the 5-year TIPS spread, down .08% to 1.73%:

In both 1930 and today, the Fed could have prevented a contractionary impact by an aggressive easing of policy. But in both cases they were reluctant to ease too rapidly, as that would make their previous rate increases look mistaken. (I’ve discussed this problem in previous posts, which is why I prefer daily rate adjustments, to the nearest basis point.)

I suppose that one could also point to the Fed being reluctant to look like they were being bullied by Trump, although that’s highly speculative.

The Fed funds futures now show one rate cut by year end, and another by mid-2020. That does not mean that money is currently too tight, as rates should move up and down with changes in economic growth. A better argument for money being too tight is that the newest Philly Fed forecast for 2020 inflation has dropped to 1.9%, and I suspect even that’s a bit too high, as market indicators suggest even lower inflation.

That doesn’t mean that everything is gloom and doom; the economy will probably do fine if inflation runs at 1.7% over the next 5 years. But if the Fed is going to have a 2% inflation target, it is better that they actually hit their target—if only to put them further from the zero bound.

Trump is arguing that the Fed needs to cut rates because of the trade war with China. Is Trump correct? The 5-year TIPS spread suggests that a rate cut would indeed be appropriate. But given my severe case of TDS, I’m reluctant to give him any credit. I hope readers won’t be offended if I point out that his argument makes no sense. Trump insists tariffs have an expansionary impact on the US economy. If that actually were the case (it isn’t), then Trump would be wrong in arguing that the trade war provides a rationale for the Fed to cut rates.

Trump is probably of two minds. His primitive understanding of trade theory leads him to view tariffs as expansionary, whereas the strongly negative view of stock investors toward tariff news triggers fear in the reptilian part of his brain. (And really, is there any other part?) And that fear leads him to call for the Fed to assist him in the trade war.

PS. Slightly off topic, but this David Beckworth tweet gets to the heart of the problem with monetary policy:

Here is my real critique: the Fed can get all the new tools in the world–neg rates, yield curve control, auto QE, etc.–but with a low inflation target regime they probably won’t matter much. IMHO, the past decade has shown us it is the monetary regime not the tools that is key.

I worry that the profession is focused too heavily on technical gimmicks, and is missing the bigger picture.