Now the Federal Reserve has tacitly let it be known interest rates are on hold and that QT balance sheet reduction will come to an end shortly, we have to start thinking about what this means.
There is no hurry as the supertanker of economics takes months and even years to turn around.
The totally obvious ramifications of QT and its recession and crash creating potential, took a year to sink in and that is a good example of how slow things move in economics these days. That’s probably a good thing and likely a positive reflection on the skills of central bankers. Any idiot can cause acute problems, solving or creating chronic ones takes the next level of skill.
So the Fed balance sheet is not going back to 1 or 2 trillion, its likely to stay 3-4 trillion. That doesn’t seem too terrible unless you work out how much money that is in the real world of ‘per capita.’
So the Federal Reserve has indicated they are going to lower their mortgage loan book and swap it into treasuries.
Whoop, whoop, up goes my danger flares.
So Trump has let the dogs of debt loose as far as the fiscal deficit goes. The Obama administration had got the yearly fiscal deficit back under control, but that ‘austerity’ has been jettisoned and the US will run a $1tr+ deficit. Call it 4-5% of GDP.
So the US will need to sell a $1tr in extra debt a year, going forwards, perhaps more.
A world in recession might not have such a strong appetite for US treasuries at the current low rates and heaven forfend if that lack of appetite in itself pushed up interest rates. Someone has to buy. Who is going to buy if the world decides it is not as keen as it was on US debt?
What to do?
Why get the fellows who bought up the new unwanted US debt from the government in the pit of the global financial crisis to buy it. Who were they? Why the US government.
So the Fed is going to sell down its trillions of mortgage debt and take up any slack of too much new US treasuries.
That will work, but it will whack real estate as in the process money for mortgages must get more expensive or less available or both. You could look at it, that from a national balance sheet point of view, home owners will be paying for the deficit with the deflation in the value of their real estate. From a ‘Dr Evil’ point of view, that’s pretty clever.
However putting that aside, the direct monitisation of debt is how you get inflation.
So called ‘modern monetary policy,’ up to recently called ‘unorthadox monetary policy’ doesn’t create inflation because it liquidises illiquid assets by swapping them out for more liquid ones of approximately the same ‘value.’ Illiquid assets plummet more in price if no one wants to buy them than liquid assets because illiquidity makes their ‘real’ value harder to substantiate. A central bank merely being prepared to buy illiquid assets makes them worth a lot more than if they weren’t there to bid. MMT doesnt print money, it swaps assets for money so the net effect is of little nett increase in assets to create more money to create more demand without more supply. MMT shifts the balance of asset liquidity towards the cash end so there are enough ready funds to keep the lights.
However, the moment you issue a treasury to yourself and use it as collateral to print cash, you are squarely into Weimar/Mugabe/Venezuela land of printing cash to pay your state workers and cover the costs of your grand plans for shiny bridges to nowhere. If you don’t export your inflation to China, a rather more difficult trick for the US to pull right now with its war on trade, the consequent inflation is going to stay at home.
Now the new money could, as we are looking at a kind of QE, go straight to the rich, which would mean inflation would hit extreme luxuries like upmarket real estate, Picassos, yachts and Ferraris, but the chances are as it will go through the public sector rather than financial carry trades, it will go to the less well off. This can only mean inflation on everyday things in the old school manner.
Forgive me, I am a child of the 60-70s so inflation is always the pre-programmed prediction of doom.
The runaway fiscal debt is not an easily manageable thing unlike the tightrope of financialised QE. Those treasuries are coming, come what may, so keep balance in the economy is going to be even more tricky than pulling the economy out of the flat spin of 2007-9. Monitising naked debt is how inflation happens and that looks like the path ahead now QT is dead and the deficit is booming.
So what to do?
Firstly as an investor you need to track this inflation hypothesis. The Fed has plenty of QT firepower to yank the chain of the economy if it needs to do another U turn. The place to look for impending inflation is in Oil and Gold. If inflation is coming down the pipe, they will move. Inflation even once it is underway will not show up in the stores right away, but Oil and Gold rallying will tell you it is in the economic pipeline and will soon enough arrive. Oil in particular and perhaps other base commodities like copper will be the first indicators.
I don’t like Gold, or rather I love Gold, but I don’t want to invest in it. It’s a crowded traded, crowded by ancient, grumpy folk who believe the world is going to fall to pieces and leave them in a post apocalypse HBO series with a sack of PGM. This makes it a hard market to navigate for all the insane noise it feeds off. However if the US monitises debt to fund its fiscal deficit gold will move. As gold has been as dead as a doornail for years, it will be the ‘canary in the coal’ mine for this idea.
Inflation won’t be the end of the world, inflation brings plenty of benefits along with the pain of savers money going down the drain.
For a start Bitcoin will go ballistic and to be clear, I’d like that.
And as if by magic, Bitcoin looks suddenly very bullish.