Sweet Fruits

SocGen’s Albert Edwards still believes in “The Great Melt.”

Not the BBC David Attenborough documentary. Rather, the thesis that says overt fiscal-monetary partnerships are inherently inflationary and will eventually “thaw” developed market economies after decades spent languishing in the frozen tundra of Albert’s secular “Ice Age” theme.

By now, everyone should be able to recite some version of the narrative. The pandemic compelled policymakers to respond in something like real-time to the burgeoning crisis. There could be no “deliberation.” Economies were shuttered. All but the most essential businesses were closed. Citizens were ordered to remain in their homes. Healthcare systems were overwhelmed. People were dying.

As in war time, governments simply conjured money. As cash materialized in bank accounts, it dawned on many a previously clueless citizen that government expenditures are not, in fact, “funded” ahead of time. The Trump administration’s decision to delay tax day only underscored the point. No developed nation that issues a respectable currency needs to “locate,” “source” or otherwise “find” that currency when it’s needed. Rather, lawmakers can simply order it into existence, then hand it out to citizens.

The charade that says outlays are offset by debt was maintained, but simultaneous asset purchases by central banks left little room for interpretation. The various veils that obscured the nature of QE from the general public were lifted. It was impossible to maintain the facade due to the sheer magnitude of the expenditures and the simultaneous expansion of central bank balance sheets. The figure (below) is dated, but it gets the point across.

Some call this progress. After all, we’ve been doing it for years. If we’re going to carry on doing something manifestly absurd in perpetuity, we may as well tell ourselves the truth about it.

QE is just debt monetization at arm’s length. When central bank balance sheets are never unwound (or only partially unwound), there can be no other interpretation. There are no “alternative facts.”

Since the financial crisis, developed markets have been buying debt from themselves. When you consider that “debt” isn’t really “debt” for a currency-issuing nation with sufficient monetary sovereignty, the entire exercise is exposed as a ridiculous, self-referential carousel. One organ of the state creates currency to buy an interest-bearing version of that same currency from another organ of the state. Then, the state spends the “proceeds” from that “transaction.”

It’s not just circuitous, it’s pointless. I’d call it sleight of hand, but it’s not clear who we were trying to fool. Prior to the pandemic, anyone who cared to understand the dynamic understood it all too well. And it’s been obvious for years that inserting a middleman (banks) into the equation was more trouble than it was worth. The falling velocity of money pretty clearly suggested the arm’s-length character of the self-funding scheme was impairing the monetary policy transmission channel (figure below).

Ostensibly “serious” people prefer we preserve at least some version of this ridiculous charade rather than admit the obvious. We’re buying debt from ourselves. Period. And we’ve been doing it for quite a while. That being the case, the obvious question is: Why? If this is what we’re going to do, why do we need to go about it this way? Why would we issue currency to buy debt from ourselves in order to “spend” that same currency? That’s not “borrowing.” You can’t “borrow” from yourself. But we do. And then we close the insanity loop by paying ourselves interest in a currency we issue.

The problem isn’t so much calling out the insanity inherent in the arrangement described above. It’s self-evidently silly. Rather, the real debate centers on what happens if we recognize how silly it is and do away with it in favor of simply issuing currency with no offset whatsoever.

It’s easy enough to claim that would cause hyperinflation, or at least higher inflation, especially when you consider the distinct possibility that politicians would never relinquish the keys to the money printer. That, in essence, is the theoretical backdrop for Edwards’s “Great Melt” thesis.

“I believe that the pandemic has allowed policymakers to cross the Rubicon of fiscal rectitude to a reach a new land – one where their existing monetary profligacy can now be coupled with fiscal debauchery,” he said Thursday, noting that “at a political level, I do not believe there is any turning back now the sweet fruits of monetary-funded fiscal largesse have been plucked and tasted.”

He’s right about that. However, Albert has always been among the first to charge central banks with thinly-disguised monetary financing. What’s the difference between now and the dozen years between the GFC and the pandemic?

Well, again, one difference is simply the scope of the experiment, but from a qualitative perspective, the difference is that the general public is now more aware than they were previously of how government financing actually works in developed economies. I still maintain that the same general public is far too — how should I put this? — disinterested and distracted, to determine that already worthless pieces of paper are now even more worthless because the supply of them is growing faster than some macro aggregate. But I’d be obtuse not to acknowledge the risk that heightened public awareness undermines faith in fiat currencies enough to entrench an inflationary mindset.

In the same Thursday note, Edwards said that “any government which attempts post-GFC style austerity will be cast into the electoral wilderness.” Indeed, in the US, lawmakers on both sides of the aisle are now increasingly predisposed to donning MMT lenses. Centrists and old-guard Republicans decry MMT as though it’s an ideology. MMT doesn’t do itself any favors in that regard by holding onto the word “theory” when there’s nothing “theoretical” about it. MMT isn’t prescriptive. It’s descriptive. The same lawmakers who decry it as heresy are more than willing to accept any and all “unfunded” handouts they can extract for their constituents and districts. And no lawmaker would dare balk at unfunded expenditures to drive the PLA out of London if China ever invaded the UK. Lawmakers only pretend they don’t understand how government finance works when they don’t like what’s being financed.

So, what’s happening right now? Why are bond yields falling? Why is the reflation narrative seemingly passé despite the crossing of so many Rubicons and the breaking of so many taboos?

For Edwards, the secular inflation/reflation theme that should invariably accompany the post-pandemic policy conjuncture won’t truly play out until “later in this cycle.” Markets “have been too early in betting on the reflation trade and are now set up for a huge disappointment,” he said Thursday.

Earlier, I mentioned that markets appear suddenly concerned about peak rate of change in earnings and growth more generally. Edwards applies the same logic to deficits.

“The OECD expect all headline deficits to shrink sharply, but the US stands alone in facing an unprecedented discretionary fiscal tightening (of around 5% of GDP) despite the headline deficit staying at a high 10% of GDP,” he wrote. “That tightening begins to unfold as we progress through the rest of 2021.”

If it’s the change in the deficit and not the absolute size of it that matters when it comes to driving growth, then the US is staring down a fiscal headwind which, for Edwards, “suggests the inflation trade has a long way to unwind yet.”

Ultimately, though, Albert believes there’s no going back. As he put it, “the sweet fruits of monetary-funded fiscal largesse have been plucked and tasted.”

Of course, the rich spent the last dozen years savoring the “sweet fruits” of monetary largesse. That arrangement was lampooned and derided mercilessly for more than a decade as an exacerbating factor in the widening wealth gap.

And yet, the notion of leveraging monetary accommodation in direct service of the poor and middle-class is everywhere and always greeted with cries of “Weimar!” and “Stop the socialists!” Sometimes by the very same people who argued, post-GFC, that central bank profligacy, if it was destined to continue, should be directed to demographics that can use it.

If I didn’t know any better, I’d be inclined to think some of the same people who spent the post-GFC years penning screeds about how central banks were perpetuating inequality, were themselves benefitting handsomely from the very same dynamics and now aren’t particularly keen to see governments put their fingers on the scale in favor of Everyday Joe and Plain Jane.

It’s easy to decry inequality. And it’s not all that difficult to correctly identify its causes. Neither is it hard to champion the plight of Main Street from behind the ornate wrought iron of a gated community.

Populists in name only. Finance is full of them.

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