Welcome to Finance and Fury

Last week – talked about Goodhart’s law – “When a measure becomes a target, it ceases to be a good measure.” – yet central banks have made inflation the policy target – Went through permanent QE and lowering rates and cashless economy

Today – talk about fiscal expansion from govs and the need for deficit monetisation (helicopter money) and final step of abandoning dollar as reserve currency – effects on economy

To start – Step 3: Fiscal Expansion and Deficit monetisation

  1. The QE and lowering interests will flood banks with ‘liquidity’ = lots of money to lend out – to themselves (wall street) or main street –
  2. If this doesn’t work – government may eventually assume the role of resource allocator, through public spending financed by a permanent increase in the money stock
  3. If government spending does not help either, then helicopter money might, which is to allocate resources directly into the pockets of households – either cutting taxes or UBI

Fiscal expansion – The government spending more

  1. Fiscal expansion may help, when coupled with monetary printing. Public spending in infrastructure, clean energy to cope with global warming, technologies, and education are obvious candidates.
  2. China example – GDP
    1. Consumption is lower than west – USA 71%, Aus think in the high 60% – China sits in lower 30%
    2. Net exports only about 4-8%, large portion is Government spending and investment
  3. Deficit monetisation – Monetizing debt is thus a two-step process initially
    1. The government issues debt (Government bonds) to cover its spending
    2. The central bank purchases the debt from secondary markets
      1. Then perpetually rolls it over – issue more money to continually buy it back
      2. Gov issues $1bn bond today to the market – 10y maturity – someone buys it (banks or super funds) – then central bank buys these off banks or super funds – it injecting money to be reinvested or lent
    3. So Govs know that they can raise easy quick cash from issuing a bond – as Bank, investment manager or super fund will buy it off them and exchange the cash – and the buyer knows that the central banks will buy them back off them – sometimes at inflated values as issuing more money decreases interest rates = increase the price of the bonds above face value
    4. So the middle men make profits, gov gets its cash for spending, then central bankers get to carry out monetary policy unopposed to all 3 parties benefit – as the central bank makes income from the cash rate they issue funds at
  4. It turns out that Both Quantitative Easing and negative interest rates policies (NIRP) alone have turned out to be deflationary.
    1. QE led to banks hoarding cash – resulting in a reduced impact on money supply = destructive at negative rates
    2. Negative rates lead to banknotes hoarding (it just started in Japan, Switzerland) – contracts the money supply further: a smaller propensity to invest as uncertainties about the future growth, with fears of expropriation/bail-in/wealth tax, right at a time of lower inflation expectations and prospective returns.

Central banks and Governments will need to go further – Helicopter Money

  1. The concept of helicopter money refers to Milton Friedman’s thought experiment of 1969 –
    1. If there are negative rates why cannot there be negative taxes? In economics, a negative income tax (NIT) is a welfare system within an income tax where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. 
      1. Aus Gov – low-income tax offsets, franking credits = exactly this – I think it has benefited us – but debt has finally caught up and the ever-increasing regulations hasn’t helped
    2. So far in this list of policy tools, negative rates are synonyms of wealth tax, and bail-ins in disguise. As such, intrinsically deflationary. Which means self-defeating, as the whole point is to resurrect inflation in a moribund economy overloaded with too much nominal debt. But negative rates may become pure incentive to spending, and boost the velocity of money, if and when coupled with various forms of tax cuts, both temporary and permanent ones: raising minimum salaries, temporary / depletable spending coupons.
  2. Some of the traits of this form of fiscal expansion may be inspired by Roosevelt’s New Deal, a series of government programs implemented between 1933 and 1938 to provide relief to people suffering during the Great Depression. – may lead to a temporary suspension of laissez-faire capitalism.

  1. Crisis policymaking should then target two objectives:
    1. Currency debasement: to reduce the value of debt vis-à-vis productive economy / income stream, to decrease debt ratios overhang
    2. Velocity of Money and Money Multiplier: to boost private sector spending, for both businesses and households, and its impact on output
  2. I hope this is starting to make sense – that this is a bought and sold system that is promising ever increasing spending for vote – who doesn’t like free stuff? Like $10k p.a. no questions asked – if politicians proposed this a lot of people would vote for them, regardless of any other policy.
  3. Summary – three levels of monetary redistribution – Banks, govs and households
    1. Objectives – A debasement of coinage is the practice of lowering the intrinsic value of coins, 
    2. Issuing with leaving the system with an increased supply of money – the value of it goes down
    3. Inflation is slow – but when it kicks in it can go quick – hyperinflation
    4. Eventually, there will be too much debt for future productivity increases in the economy to pay off – using debt to grow is fine – as long as the growth is enough to pay off the debt

Final step: De-Dollarization and IMF’s SDR Reserve Digital Currency

  1. If you are a fan of history – know that our current version of the dollar is been around for a while – but similar to older civilisations (asyrians, romans) – currencies collapse –
  2. Many problems today including deficit spending, trade deficits, and income inequality have their roots in 1971
  3. Current state of economy – after Brenton woods 1944 – US become the major player – global reserve currency – then form 1971 – off the BW system – Kissinger got the Petro dollar going – oil in OPEC nations had to be sold in USD – any leader who deviated (sadam, gadafi, alasad) US seemed to take a keen interest into very quickly after – That is a major thing keeping the USD up in demand
  4. IMF has been moving towards replacing the USD as the global currency reserve – tried to do it in 1969 with the issuance of the SDRs – basket of currency backed by gold – could be used as a reserve instead of the USD – way to increase the monetary supply – but then 1971 comes and USD abandons any backing to Gold – making this SDR useless – so switches to basket of newly floating currencies
  5. Which is why central banks have taken so much control – floating currencies need more management to maintain stability – remember central banks major goals is economic stability – includes currency controls
  6. Today – China and Russia (both had negative effects on their economy/currency from US monetary policy)
    1. As if it can be controlled – it can be used as a form of financial warfare – sanctions, being cut off from payment systems and exchanges
    2. China and Russia – spoken in favour of a de-dollarization of the global economy
    3. China – like Keynes’ proposal for a common accounting unit – dismissed at the Bretton Wood –
      1. Originally called the Bancor, now it is the SDR
  7. Central banks are running out of printing press – and the negative effects of their environment it evident
    1. Like everything central planned – goes horribly wrong – in Soviet Union and China it was with peoples lives – for US and Aus, UK, EU – it is just economic growth that suffers – which is a blessing – unless Gov wants to get into authoritarian rule

SDR – Basked of currencies used as a reserve currency – Rather than hold 100% USD as reserves, 44%, plus China, EU, Frank, Pound.

  1. Current suggestions for a possible way of dealing with it: National Central Banks could increase their SDR allocations at the IMF (thus expanding their balance sheets in the process, which accounts for more QE)
    1. The IMF would then play the role of resource allocator and invest in member countries
    2. Investments may include supra-national projects – Covered in SDGs – there is no shortage of push for infrastructure spending $6trn is needed annually over the next 15 years to address global warming
    3. Don’t forget the additional $7.1trn necessary to invest for the purpose of global growth
  2. Shifting reserve currency regime and investing in SDRs achieves a dual mandate of QE and Fiscal Expansion on social impact and growth-enhancing projects.
  3. Also, it takes the utility function away from mere US domestic needs, at a time in which there is a disconnect between what serves the interest of the US and what matters to the rest of the world.
    1. Europe has similar issues between Germany and the rest of the Union, which the EU could not address as yet: a supra-national body may attempt at that again, with or without the EUR. Needless to say, such policy coordination may well be utopist and far-fetched; however, the US Dollar plays his current role only given global coordination at Bretton Woods in 1944, so no much reason to believe this is an eternal fact of life either.

Summary

  1. Central Bank keeps going with monetary printing and permanent quantitative easing
    1. Debase the currency faster than the speed at which deflation increases the real burden of debts in the economy
  2. Gov – starts large-scale fiscal spending programs
    1. Monetized by the Central Banks through a permanent increase in the money stock, which further balloons its balance sheet
  3. Banks are cut out as the middle men – money wasn’t getting out to the people but pumped into housing or between the banks
    1. Banks as the transmission channel failed there – instead – plan to have income redistributed – the aim is to spur more growth
    2. The government implements tax cuts, negative taxes, temporary spending coupons, permanent minimum salaries, so to re-allocate resources directly to households and forcefully reset inflation expectations.
    3. Against this backdrop, there are negative rates on deposits, so to penalize cash hoarding and incentivize spending, and a cashless economy, so to prevent banknotes hoarding / bank runs and have more grip over inflationary spirals. Sometimes later, a new reserve currency emerges in the form of IMF’s SDRs, which may one day compete with the US Dollar in dominant reserve currency status.
    4. In another way – inflation / currency debasement is default by another name. Inflation curtails the value of fixed income claims as much as default, at a time where there is too much debt for too little growth.
      1. Seen as a more politically palatable course of actions than going through outright defaults
      2. Plus – rising tide to lifts all boats but Big losers are the banks, and creditors in general
    5. But at least the interest curve steepens back up, inflation expectations reset, rates rise without defaults, business gets unclogged and starts all over again. Banks get re-capitalized once, from zero, as opposed to multiple times in small increments out of negative profitability over a decade long period. The economy may then spring back to life, inflation and growth may resurrect.

 

Thank you for listening today. If you want to get in contact you can here: https://financeandfury.com.au/contact/

 

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