Harley Bassman Presents: ‘The Wages of Fear’

Harley Bassman Presents: ‘The Wages of Fear’

In the same way that one “borrows beer” at a party, having the Treasury wash their issuance through Wall Street dealers to the FED’s QE balance sheet is still “money printing”. The key difference is how those funds are used.

[Editor’s note: The following is the latest commentary by Harley Bassman. As regular readers will quickly surmise, I don’t agree with some of what Bassman says in this piece regarding MMT. For example, MMT isn’t something that is “implemented” and it’s not a road one “chooses” to go down — rather, MMT is descriptive in nature. It describes the system as it already exists. However, Harley is a smart guy. He created the MOVE, for example (more here). I’d be a fool to dismiss smart folks or argue semantics with them just because I don’t agree with a few sentences out of a 2,000-word essay. Not to mention, Bassman is generous with his distribution, which is greatly appreciated. So, without further ado, I present his latest below, which I imagine will resonate with some readers]

“The Wages of Fear”

A Commentary by Harley Bassman

The lack of (Consumer Price Index – CPI) inflation should not distract anyone from recognizing that our financial economy is presently overwhelmed by too much debt, both public and private; and it is beneath the cloak of systemic risk management that the Federal Reserve (FED) flipped on their printing press to support an alphabet soup of asset purchase programs.

And while I do not begrudge most of the FEDs actions to offer relief from both the Great Financial Crisis (GFC) and the COVID pandemic, what we all must recognize is that the financial remediation of these two crises have pulled forward the day of reckoning for how to fund the promise of Social Security and Medicare for the retiring Baby Boomer demographic.

The political game of “kick the can” for managing the two largest strands of our social safety net has reached an end; about a decade sooner than hoped. We are at a crossroads where one path is well trodden by financial history, and the other newly paved by an economic Pied Piper. But her siren song has been too sweet, and we are turning to the perfidy of Modern Monetary Theory (MMT).

Only Congress can legally “spend” money (Fiscal Policy), and since they would not offer sufficient support in response to the GFC, the FED stepped in with (Monetary Policy) Large Scale Asset Purchases (LSAP), also known as Quantitative Easing (QE), as their most potent tool. These assets landed on the FED’s –genetian line– balance sheet.

While indeed much has changed over the past decade, sometimes to the point where facts do not exist, what has remained constant are the rules for double entry bookkeeping, where every asset must be paired with a liability.

Thus, the assets on the FED’s ledger are paid for by the -brunnera line- creation of Money; an incongruity since by law the FED cannot “spend” money.

A Zero Interest Rate Policy (ZIRP) and QE were supposed to be interim measures that would be reversed upon an economic recovery; a progression always followed in the past. However, FED attempts at normalization were thwarted by the 2013 bond “taper tantrum” and the late 2018 equity tizzy.

The FED recognized that there are only two ways out of a debt crisis – either default or inflate with the caveat that inflation is simply a slow-motion default.

Since the market would not allow the FED to reduce its balance sheet via asset sales (or even the slow bleed of letting bonds mature), the alternate solution was to create inflation as a way to reduce the value of debt.

The FEDs dog-eared play book posited that if they increased the supply of Money (M2), and the economy held constant (Quantity), then Prices must rise (inflation) to keep the equation in balance.

GDP = Money * Velocity = Price * Quantity

Such a pity that –platycodon line– Velocity collapsed, almost fully offsetting the increase (printing) of Money.

But do not toss out your economic textbooks just yet, as the seeming lack of inflation from the FEDs money-printing is a David Copperfield style illusion.

While CPI inflation barely registers a pulse, asset inflation is rampant. The Case-Shiller Index of residential housing is up 63% from its December 2011 low, and is 23% above its previous peak in June 2006. Gold kissed 2000 in August, an all-time high. And, of course, the S&P 500 is a five-bagger from early 2009.

Notice the -crane’s bill line- of how much of our national wealth is held by the Top 1%. While a 3%-point increase over the previous peaks may seem small, let me assure you that 3% of a huge number is an extremely large number.

Strangely, the -anamone line- of income distribution held steady. If FED policies (inadvertently) favored the wealthy, and their share of wealth increased, why did their share of income not rise in a similar fashion?

Wealth concentration increased despite a static distribution of income because the affluent do not spend additional income. The Velocity of money declined because the dollars the FED created went into asset purchases instead of hourly wages where those funds would be recycled back into the economy.

A recent FED study reported that nearly 40% of US households do not have cash on hand to cover a $400 emergency expense (car repair or broken appliance). Surely funds directed to these households would soon be spent (recycled). Velocity is a measure of recycled spending; financial asset purchases are static.

I am loath to offer the topic of politics on these pages, if only because half my readers would soon use a hardcopy version for lining their bird cage.

But as a public policy comment, middle-class citizens should be mad as hell that Government resources were directed at policies that widened the wealth gap. I will stipulate this was NOT the intention of the FED; and that Fiscal policies by both parties have been grossly insufficient.

Thus, the trumpets have blared for the salve of Modern Monetary Theory.

As a reminder, Modern Monetary Theory (MMT) advocates suggest that Governments that create their own fiat currency can borrow so long as there is spare capacity in the economy. In a nutshell, deficits do not matter until debt capacity is reached, which will be signaled by rising inflation.

Never mind that nary an agency has created a predictive model for inflation; at best one can back test a few variables, but these models collapse in real time.

Neither the FED, the CBO, nor the major Wall Street banks have successfully modeled inflation – as such, our policy makers will only dial back a debt binge after inflation occurs. This sort of risk management is akin to racing a car down a foggy lane and not hitting the brakes until after one slams into a tree.

Neither the FED, the CBO, nor the major Wall Street banks have successfully modeled inflation – as such, our policy makers will only dial back a debt binge after inflation occurs. This sort of risk management is akin to racing a car down a foggy lane and not hitting the brakes until after one slams into a tree.

Let’s be clear, MMT was coming with or without COVID, no matter who was elected President, but recent events have accelerated the process.

The high-end for a COVID relief package is tagged at $3Tn, and the notion of forgiving all college debt would cost $1.68Tn. But this is my bar bill at the club compared to the funding gap to support Social Security.

The chart above borrows from a scholarly report by James Moore, PhD. The -lobelias bars- are the total US Treasury debt outstanding while the lines are the projected Social Security deficit. From the Social Security Trustees (SST), the -calceolaria line- is their base-case while the -santolina line- represents the SST’s high-risk scenario. Both were calculated using historical assumptions for interest rates, inflation, and economic growth.

The -alstroemeria line- is the result of using current market-based inputs for interest rates and inflation. Notice how this estimate was between the SSTs base-case and high-risk scenarios until 2010, but impact of the Great Financial Crisis (GFC) exploded the future liability.

In case I was too coy, let’s link these thoughts. The US Government has run a cumulative deficit over the past 100 years of $22.7Tn; in contrast, to fully fund Social Security using current metrics would cost an additional $45.6Tn. Unless eligibility or benefits are significantly altered, some form of debt issuance that rhymes with MMT will be required.

The -clematis chart- from the CBO offers a similar outlook as a percent of GDP. Notice the steep increase from 2030 to 2050 starts near 100% of GDP instead of closer to 40% of GDP before the GFC and COVID. These two events accelerated an already challenging decision process.

Here is the main point: This past decade’s money printing was used to purchase assets; this next decade’s money printing will be used to fund an expansive Fiscal policy which will funnel money into the hands of people who will spend it. Thus, the Velocity of money will increase and produce inflation.

By 2026 all of the -germander bar- Baby Boomers will qualify for Social Security, and the -lantana bar- Millennials will be the largest voting cohort. Both will demand Fiscal support which can only be funded via MMT budgeted borrowing.

The most prescient bond bulls (Lacy Hunt, David Rosenberg, Albert Edwards) have noted that the FED’s money creation has been a self-defeating process that may reduce rates further, with the caveat that direct monetization of fiscal spending could lead to inflation. In other words, direct funding the US Treasury.

This is a quibble that deserves a push. In the same way that one “borrows beer” at a party, having the Treasury wash their issuance through Wall Street dealers to the FED’s QE balance sheet is still “money printing”. The key difference is how those funds are used. Presently the FED’s asset purchases have coincided with reduced Velocity which dampened inflation; this will change when Fiscal money is directed toward those who will spend it upon receipt.

Modern Monetary Theory is nonsense; the excessive creation of a fiat currency (eventually) leads to inflation. If it did not, I can assure you there would be a shelf of books detailing such miracles over the past five thousand years of recorded history. “Stop eating when you are fat” is not a healthy diet.

Not to go native on you, but don’t you wonder why the Old Testament called for a trumpet to be sounded on the tenth day of the seventh month every 50 years for a Jubilee where all debts were cancelled?

While it may take longer than I expect for the final denouement, mark this as the moment our political class shirked their duty to make the hard decisions.

Investment advice:

Don’t panic (yet) as MMT will be terrific for the first number of years. There will be a “sugar high” as expansive Fiscal policy transfuses money to those who will spend it. Similar to how corporate earnings expanded with the 2017 tax cut, so too should earnings enjoy the tailwind from Fiscal support to those who tend to spend.

College debt relief will initially increase retail sales, but will ultimately migrate towards home sales as this is the household formation demographic.

Developed Market (DM) Equities should do well, especially when the dividend yield for most DM Indices exceeds their Central Bank controlled rate.

I love Mortgage REITs despite a nice rally; their dividend yield is still ~9%. This payout should be stable if the FED keeps its promise of ZIRP until 2023.

Other ways of riding the FEDs rate suppression coattails can be sourced via well-managed BDCs and Muni CEFs that employ financial leverage. For CEFs, pay particular attention to the Undistributed Net Investment Income (UNII) as a deficit here usually presages a distribution cut.

I think it’s “safe in the pool” until 2023-25, then it will be adult swim only. This is why I own long-dated options to protect against rising interest rates – a product outlined in “Pigs Can Fly” – January 28, 2020, and I will detail again soon.

You know my rejoinder: “It’s never different this time.”

Harley S. Bassman December 2, 2020


18 thoughts on “Harley Bassman Presents: ‘The Wages of Fear’

  1. According to the Center on Budget and Policy Priorities, in a report dated May, 2020, the social security fund has current reserves of $2.9T and based on continuing the same level of current payroll taxes that are currently being collected for social security, that reserve will cover shortfalls through 2035. ( Presumably, this assumes we return to pre-covid payroll levels.)
    After 2035, again assuming that payroll tax payments continue on the same trajectory as now, those tax receipts would cover 75% of the expected payouts.

    I do not know how the $45.6T ( the “amount needed to fully fund Social Security using current metrics”) was calculated. Is that amount the present value of future payouts, with or without regard to future payroll tax receipts?

    I admit that reading this is gives me pause, as I was not thinking I would be worrying too much about inflation in the next 24 months. I am anticipating that “means testing” will be part of the solution and I would really like to see the mathematical calculation of that $45.6T amount.

    1. Of course, the whole conversation is, in a sense, meaningless. Congress could just say: “Look, it’s funded forever because we say so and that’s the end of it.”

      The whole debate is a nonsense discussion. There’s no crisis. There is no obligation denominated in USDs that the US government cannot make good on. Period. That isn’t debatable.

      The US government doesn’t need to “find” USDs or cut benefits or do anything else to fund this. Congress can just give itself the legal authority to fund it with new money.

      I hate to break it to everyone (for the hundredth time), but this is a totally manufactured “crisis.” It doesn’t exist. If Congress chooses not to pay, that would be political suicide and it would be a choice. Again: There is no obligation on planet Earth denominated in USDs that the US government can’t pay. It doesn’t matter how large it is. If the “hole” were 87 quadrilion, bajallion, cajillion, to-infinity-and-beyond dollars, it still wouldn’t matter. Because the US government can create that amount with one keystroke.

      That is the reality. Everything else is fantasy land.

      The implications of exercising that authority to create USDs is what’s debatable.

      But the government’s financial ability to fund a USD obligation is not debatable. Not at all. That isn’t a conversation anyone should have because, as noted, it quite literally makes no sense.

      A corollary to that is that the US government also doesn’t need to borrow to spend. That too is a myth. What kind of sense does that make? The US government needs to borrow your USDs? Really? Or, Canada needs to borrow someone else’s CAD? Or, Britain needs to borrow someone else’s GBP? No they don’t. They print those currencies. They don’t need yours. They issue the ones you use.

      1. Also, imagine being in a country with negative nominal rates, which perhaps we may even see in the US. Imagine the market telling you (a government) that you can literally “print assets”. Then, imagine the ruling class of that country saying, “no thanks”, and continuing to gaslight the public suffering through crumbling infrastructure, institutions, and a shredded social fabric by saying that “my good people, there simply are no available public investments that will earn a positive rate of return”. This drama has being playing out in degrees around the world, and it is as ludicrous and incredible as it sounds.

      2. Right, right, H, we get it.

        But what I think Emptynester is getting at is… so if we ‘fund’ (print the USD needed to pay those obligations) SS and it’s 45.6T, who gets the shaft?

        B/C someone is likely to.

        As MMT/yourself, we all agree, the limiting factors are physical (employable population x fixed assets x TFP) and political (how do we divide the pie?)

        I can totally see a case where we got the pie produced and the retirees say “right, we’ll have half of it”, the workers say “fck you, we’re the ones who did the work to produce that pie, we’ll get that half of it” and the bosses say “scw the both of you, this is my capital at work, I am the entrepreneur, the risk taker, I get all the pie, you guys make do with the crumbles as usual”.

        At that point, the fact that the US government can print all the money it wants is both true and yet still irrelevant.

          1. Fair enough, though I meant, “we” your readers.

            TBF, you had to correct me once b/c I phrased myself wrong. Talking about debt etc. instead of using the correct MMT language.

            But what I also meant is, I’d be more interested in your views on redistributive policies, the odds of them making it in the real world etc.

            Coz I can totally see infrastructure & even social spending being financed by money printing. Certainly more likely than via taxation of the rich. But I still feel like resulting inflation (should it happen) would panic everyone at the Fed and Treasury and trigger a strong reversal in rates – a la Volcker. With further unpleasantness ensuing.

          2. All of that because we cannot convince the rich that a prosperous lower middle class is in their long term benefit and because either they (Fox etc) convinced poor people that only mooches will benefit or poor people convinced themselves only mooches will benefit.

            With the rich AND the poor/lower middle class allied against safety nets, infrastructure, private sector unions and general welfare support – how are we going to avoid fascism?

          3. H, my (ongoing) education began with regards to “what are the sources of funding a USD that our government wants to spend?”, when you regularly posted on Seeking Alpha.
            As a side note, at first I thought you were crazy, then I realized that you were right, as in correct, at least on economics (haha)!

            So if the USA federal government wants to spend a USD, they can-
            1. Repurpose an existing USD, by taxing and spending.
            2. Borrow a USD ( truly borrow, i.e. not from the Federal Reserve)
            3. Print a USD ( i.e. lend to the Federal Reserve)

            Interest rates, tax rates and the amount raised from these 3 “buckets” have to be smartly managed to achieve goals with respect to inflation, national wealth distribution, economic growth ( domestic and international), retaining the position as the primary global reserve currency and achieving an agreed upon social provision for our people ( health care, education, retirement funding, etc.). Not intended to be an inclusive list.

            From my posts, over the years, you can probably tell I am primarily libertarian. However, I have definitely leaned lefter, as a result of your educational posts. We are in uncharted times, and my hope is that we can navigate the above mentioned issues and leave something intact for future generations who are willing to work very hard.
            One of the greatest things about our country is that it provides the opportunity to start from nothing and, through hard work, create enough wealth to take care of yourself and others. Not everyone wants to have everything provided to them by the government.
            I hope you consider this last paragraph as part of a healthy, and ongoing, discussion on the future of our country and not as an outright disagreement with your political posts.
            Have a great day, H!

          4. “Not everyone wants to have everything provided to them by the government”.

            I’d go as far as to say NO ONE wants things provided to them by the government, especially if they cannot feel like they’ve earned it. Whether that feeling is always justified is another matter (say, people telling you they’ve paid for their SS…)

            But, yes, everyone wants to feel useful and self-reliant.

            OTOH, some services are just better organised at the widest possible (say, insurance. Even education, b/c it has large externalities, benefit from a wider level of coordination than the strict necessary)

      3. “The implications of exercising that authority to create USDs is what’s debatable.”
        So assuming this could/will happen at some point. Could you explore these implications in a follow up post?
        FX rates
        sub exploration (in EU countries due to fiscal/monetary disconnect)
        Gold / Silver
        Other Commodities (Oil, food)

  2. Always appreciate these great Harley posts, though there is good reason to quibble with his quibble here.

    He references Lacy Hunt, who, correctly, states in as many words that the “borrowing beer” step of the FED buying treasuries is not “money printing”. The FED liabilities from this activity are simply bank reserves, which are held at the FED and effectively locked in the banking system. Increasing reserves is “in theory” supposed to incentivize lending to the real economy. The problem is, “in practice” it doesn’t, incentivize credit to any of the places that actually need it. We have had a problem of excess reserves for many years now. Currently there are $3.1T, out of a total balance sheet of $7T. So, about 44% of the balance sheet is a big nothing burger in terms of ‘effectiveness’ or ‘easing’. But Congress still doesn’t understand. Heck, it seems that most investors still don’t understand. This is one of the very reasons why Hunt, Edwards, and Rosenberg continue to get it right, as many others continue to short bonds, lose money, and then scratch their heads about it endlessly. The money printing occurs before this step, when Congress deficit spends.

    For sanity sake, as the fiscal hawks re-emerge and start bringing out the scare charts of the national debt explosion, everyone should, first, correct the charts by deducting the amount of the national “debt” that is sitting on the FED balance sheet. Who, any longer, is still under the illusion that the FED will ever be able to sell these securities? The government cannot owe money to itself in perpetuity, unless we choose to forever remain trapped in self-referential, circular logic. It’s sort of like a company that pumps up its assets and liabilities but remains in the same position of negative equity.

    Nevertheless, Harley is of course correct that there seem two ways out of the mess, both of which are forms of default. But we should at least get the numbers right as we discuss it. Before long, the calls for “entitlement reform” will begin again in earnest and the scaremongering will reach fever pitch. People will, intentionally and not, be throwing around ‘wrong’ figures to make their points.

    1. Once again, Japan provides a leading example. Foreigners and LDP politicians love to trot out horrific (400% plus) debt to GDP numbers when speaking of the nation’s indebtedness. Sometimes they’ll qualify it by noting that over 90% is held domestically so maybe it’s not quite so bad, but still ….

      On the rare occasion that someone presents a number which does not include debt owed by one branch of government to another, those scary numbers simply vanish.

      That partly explains why so many hedge fund and prop traders have lost fortunes and their jobs by shorting JBGs over the past 30 years.

  3. Always a pleasure to read. Thought provoking, sage advice, and it expands my palette too!

    Muni CEFs have been good to me, thank you HB. Off to find some quality BDCs.

  4. Really appreciated this focus on what Harley articulated on this matter and equally appreciated H……. and his open minded approach.. Personally I have pleaded for this particular discussion on this blog because the matter is complex and the opinions are varied.. The issue of MMT (which is a reality not a theory ) in particular is located exactly at the junction of ALL the soft sciences Philosophy , Sociology , Political Science , Economics as well as Finance and the Art of Survival (Governing)) of a society .. History plays a part as well in that similar circumstances have occurred in the past…Some good comments too I might add.. Thanks all…………. this one is a re read..

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