Snorting M&M’s

If you listen closely, you can hear the questions asking themselves.

After a dozen years, we know what happens when monetary policy is compelled to shoulder the burden of sustaining economic growth and inflationary momentum in developed markets scarred by a deep recession and plagued by structural disinflationary forces. The result, in short, is asset price inflation, an ever wider wealth gap, and limited benefits for the real economy.

Something had to give, and the pandemic brought forward the day of reckoning. It’s now clear that the future is fiscal-monetary partnerships, perhaps of the overt kind. Covert debt monetization (i.e., QE) hasn’t worked, at least not if “worked” is supposed to mean good things happened for everyday people.

While monetary policymakers are prepared to brave a new world in which the connection between, on their end, low rates and asset purchases, and on the fiscal end, government borrowing, is readily ascertainable to the public, there’s still an embedded arrogance.

Before, the arrogance manifested in central banks’ contention that they could engineer economic outcomes, with an emphasis on micromanaging inflation around an arbitrarily defined target. Generally speaking, they failed at that and blamed, in part anyway, a lack of sufficient fiscal support.

Now, with the pandemic having lit a fire under lawmakers who are suddenly compelled to “make fiscal policy stimulative again” (sorry), central banks are expressing arrogance of the opposite sort. Before, they arrogantly assumed they could bring inflation up to target. Now, they arrogantly assume they can keep inflation from accelerating well beyond target, even to the point of adopting a policy stance that explicitly aims to run inflation hot to “make up” for past shortfalls.

As a quick aside, there was never really a question about whether developed market central banks were “capable” of engineering inflation. Lawmakers could, at any point, give central banks the authority to, for example, make grants to businesses, pay off student debt burdens, or just send everyone $20,000 for the fun of it. You’d get some inflation then, by God.

The question was never about that. Rather, the question was whether, under the existing legal framework and accepting that hyperinflation is undesirable, central banks could engineer a “benign” amount of inflation and keep it running at (or around) that rate in perpetuity simply by tinkering with policy rates or creating money to buy government bonds (and other assets) through intermediaries.

Again, that didn’t work. They failed. The Fed, the ECB, and the BoJ have all undershot their inflation targets despite massive asset purchases persisting for years.

Developed economies are about to embark on a new adventure involving more direct forms of stimulus, ultimately financed by central banks. As alluded to at the outset, the questions are myriad.

For quite a while, critics have insisted that central banks should end the policies that have inflated asset price bubbles and exacerbated inequality. One way to get to a point where those policies can be rolled back is for fiscal policy to take the reins. But the same critics argue that could be unduly inflationary.

So, do you want monetary policy normalization or don’t you? Because how else are you going to get there? A dozen years of the most extreme monetary accommodation imaginable hasn’t produced robust growth outcomes. You need fiscal policy and it needs to be demand-oriented. You say that’s inflationary, especially if it’s enabled by central banks. But that’s the whole point, is it not? To engineer an economy that’s running hot enough to allow central banks to normalize monetary policy and restore a semblance of sanity, where that means savings accounts and money market funds yield something, and where there actually is an alternative to risk assets.

Critics will say of course that’s the point, but they’ll fret about stagflation. They’ll say the way things are shaping up, inflation will accelerate before the labor market (for example) has a chance to heal. Or they’ll trot out some version of Ricardian equivalence. Or they’ll say too much government is the problem, not the solution, despite decades of evidence against the idea that supply-side economics works for anyone but corporations and capital.

There are risks to what we’re apparently on the brink of doing. And, yes, one of those risks is inflation. But you can’t have it both ways. You can’t continue to argue both sides of the coin in perpetuity, where that means demanding an end to central bank accommodation and steadfastly refusing to countenance fiscal spending “because inflation.”

The visuals (below, from BofA) are familiar. The chart on the left just shows secular growth favorites and profit machines tracking central bank liquidity provision in the aftermath of the financial crisis. The figure on the right is a summary of the shift BofA sees for 2021.

“Redistribution policies against [a] hubristic tech industry [are] coming very soon,” the bank’s Michael Hartnett said, in a note dated Thursday. He also reiterated familiar talking points around policy overshoots. “Global central banks bought $1.1 billion of financial assets every hour since March,” he wrote, adding that the Fed’s balance sheet and US government spending as a share of GDP are now at wartime levels (or beyond). He sees the “D.C. policy overshoot inciting a Wall Street price overshoot” which will eventually spill over into Main Street inflation and higher bond yields.

Coming full circle, the answers to all of the questions posed implicitly and explicitly above can be framed as additional questions. Without the overt adoption of what the majority still views as “radical” policies, how are we actually going to break the cycle? The fiscal hawks are already circling anew, and even if they weren’t, no one (or virtually no one) is ready to implement a federal jobs guarantee or UBI or anything with the potential to bring about actual, real change.

“One does not have to be an advocate of MMT to see its promise to directly employ people to do something society wants is more logical than pouring trillions into markets — like candy scattered above ADHD kids, or chum into a school of sharks– and then expecting anything that creates long-lasting, high-paying employment to result (outside Wall Street),” Rabobank’s Michael Every said Friday, adding that,

The Fed –whom Yellen knows well!– have just pledged to keep rates on hold for many years. So assuming we got full employment via 500K payrolls every month this year and next, the Fed apparently still wouldn’t raise rates for some years afterwards anyway(?) Presumably they are thinking that this is how one gets wages up within a “free market system”. And presumably this is why markets are thinking about wage inflation.

Yet this is central planning with no plan.

The only part of the plan that seems clear is wild asset-price speculation, which is already ludicrous. Are we really going to have ‘many years’ of this ahead, with what we see today as just the starting base?

To repeat: For markets, the key issue is whether this snorting M&Ms strategy is going to be inflationary or not. Near-term we can all see it is. Longer-term, it still seems far more asset- than wages-based – yet again.

Nothing further.