Lacy Hunt Blasts MMT and Speaks of Hyperinflation If Implemented

-edited

In the Hoisington First Quarter Review, Lacy Hunt blasts MMT as "self-perpetuating" inflation.

Please consider the Hoisington Investment Quarterly Outlook for the first quarter of 2019.

MMT Leads to Hyperinflation

Under existing statutes, Fed liabilities, which they can create without limits, are not permitted to be used to pay U.S. government expenditures. As such, the Fed’s liabilities are not legal tender. They can only purchase a limited class of assets, such as U.S. Treasury and federal agency securities, from the banks, who in turn hold the proceeds from this sale in a reserve account at one of the Federal Reserve banks. There is currently, however, a real live proposal to make the Fed’s liabilities legal tender so that the Fed can directly fund the expenditures of the federal government – this is MMT – and it would require a change in law, i.e. a rewrite of the Federal Reserve Act.

This is not a theoretical exercise. Harvard Professor Kenneth Rogoff, writing in ProjectSyndicate.org (March 4, 2019), states “A number of leading U.S. progressives, who may well be in power after the 2020 elections, advocate using the Fed’s balance sheet as a cash cow to fund expansive new social programs, especially in view of current low inflation and interest rates.” How would MMT be implemented and what would be the economic implications? The process would be something like this: The Treasury would issue zero maturity and zero interest rate liabilities to the Fed, who in turn, would increase the Treasury’s balances at the Federal Reserve Banks. The Treasury, in turn, could spend these deposits directly to pay for programs, personnel, etc. Thus, the Fed, which is part of the government, would be funding its parent with a worthless IOU. In historical cases of money printing, the countries were not the reserve currency of the world, as the U.S. is today. Thus, the entire global system could be destabilized in very short order if this were to occur.

There would be no real increase in services or money since very little time would lapse before people realized increasing inflation was not increasing real purchasing power. If the government responded by issuing more central bank legal tender, the inflationary process would become self-perpetuating, and as was the case in numerous historical instances this would lead to hyper-inflation. Moreover, the central bank would have no capability of reducing the money supply. All they could offer would be the zero maturity, zero interest liabilities of the government, but there would be no buyers. This would mean that hyper-inflation would be difficult to stop.

Rates Too High Already

Presently, the Treasury market, by establishing its rate inversion, is suggesting that the Fed’s present interest rate policy is nearly 50 basis points too high and getting wider by the day. A quick reversal could reverse the slide in economic growth, but the lags are long. It appears that history is being repeated – too tight for too long, slower growth, lower rates.

Velocity

In the article, Lacy also touched on the velocity of money. While I agree with Hunt that velocity has generally been falling, the equation itself is useless.

As I have pointed out, velocity can rise or far with rising or falling GDP. It is not an independent variable that can be tracked.

Velocity = Value of transactions/supply of money. This expression can be summarized as: V = P(T/M) , where V stands for velocity, P stands for average prices, T stands for volume of transactions, and M stands for the supply of money.

This expression can be further rearranged by multiplying both sides of the equation by M. This in turn will give the famous equation of exchange: M(V) = P(T).

Many economists employ GDP instead of P(T), thereby concluding that: M(V) = GDP = P x (real GDP).

Velocity Does Not Have an Independent Existence

Contrary to mainstream economics, velocity does not have a “life of its own.” It is not an independent entity–it is always value of transactions P(T) divided into money M, i.e., P(T/M). On this Rothbard wrote: “But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation.” (Man, Economy, and State, p. 735)

Since V is P(T/M), it follows that the equation of exchange is reduced to M(PxT)/M = P(T), which is reduced to P(T) = P(T), and this is not a very interesting truism. It is like stating that $10=$10, and this tautology conveys no new knowledge of economic facts.

The above paragraphs are excerpts from Fran Shostak's Is Velocity Like Magic?

For further discussion, please see Velocity of Money Picks Up: Inflation Coming? Stagflation? How About Deflation?

Case for Hyperinflation

In regard to hyperinflation, I have been asked many time what it would take for me to change my mind on that happening in the US. My response, has been unchanged for years: Give Congress Control of Money Supply.

MMT does precisely that. There is no project that could not be funded including AOCs absurd Green New Deal which might cost as mush as $200 trillion.

It would not stop there. Guaranteed "living wages" and "guaranteed jobs would finish it off. The amount needed to have a living wage could never be met. Prices would soar along with the guarantee.

What About Rate Cuts

Hunt says interest rates are 50 basis points too high. In relation to the Fed's mandate, I believe Hunt is correct.

If one wants to factor in asset bubbles the Fed isn't. Alternatively, the Fed should have started hiking in 2010 or 2011 and be cutting rates now.

The Fed is constantly chasing its own tail. I believe that is what Hunt means when he speaks of lags. If so, we are in agreement on that point as well.

Regardless, because of Fed actions and the lags, I am certain we are headed for another very deflationary asset bubble bust.

The next deflationary bust could easy last for years, perhaps even without the job losses like we saw in 2008-2009. I discussed the job setup in Zombified Economy: What Will the Next Recession Look Like?

Mike "Mish" Shedlock

Comments (47)
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Carl_R
Carl_R

An interesting problem with the government using the wealth of the Fed to fund a Socialist agenda is that the Fed is not a part of the government. It is an independent entity owned by the banking system, and it is not own by the government. The government does have some power over it, in that the President can appoint some of the board members, and in that it exists under a grant of authority created by Congress. It will be interesting indeed if the government tries to tap into the wealth of the Fed.

AWC
AWC

“The next deflationary bust could easy last for years,”

‘The next stagflationary bust could easy last for years,’

FIFY, Mish. MMT enablers don’t do Deflation. The main selling point of MMT will be a return of the old meme, brought back by Central Bankers in full panic, the world around, “In the long run, we’re all dead.” Kinda like “TINA,” maybe?

themonosynaptic
themonosynaptic

I can't completely rule out that there might be something to MMT, but experimenting with ideas that radical on the largest economy in the World isn't a good idea.

Let's see the strengths and weaknesses of MMT play out in another economy - it does not stipulate that the country has to have the World's reserve currency.

Let's see it work in e.g. Denmark or Hungary first. Then move up to something the size of the U.K. before we try it here.

caradoc-again
caradoc-again

Just put a % of net worth into gold, it's all you can do to dodge that bullet. Real estate can be taxed to oblivion. Grow your own food perhaps.

We're all screwed as soon as nut jobs in charge can change the laws to the untried and untested.

Some of the worst are ideologues, he'll bent on change and unable or unwilling to recognise the consequences. Beware ideologues in all walks of life.

FromBrussels
FromBrussels

.....the financial cesspool is now in full fermentation process....

JonSellers
JonSellers

Lacy Hunt doesn't understand the mechanism. The treasury has an account at the Fed from which all federal expenditures are drawn. The Fed works daily to issue enough treasuries to fund the current deficit and keep that account from being in an overdraft status. And it is not difficult. That is because the deficit spending itself is the creation of new money. That money ends up in the banking system. And the banks prefer interest bearing treasuries to cash, so they will always use that money to buy said treasuries. Not to mention that they are also obligated to do so by law.

So the newly printed money always gets converted into treasury bonds, which is why the federal government cannot create hyperinflation by printing money. MMT does not look to change this mechanism at all. MMTers will argue that their policies can create inflation if their spending over taxes the nations ability to produce goods and services.

The financial problem with MMT is the same on you get with any deficit spending: asset inflation. By putting more assets in bank reserves you drive down interest rates, because banks don't have to compete for money. Coupling low interest rates with a fractional reserve system will lead to ever higher housing prices.

BillSanDiego
BillSanDiego

Wait. "The Fed can only purchase a limited class of assets, such as U.S. Treasury and federal agency securities, from the banks, who in turn hold the proceeds from this sale in a reserve account at one of the Federal Reserve banks."

So, what purpose is served by this? According to the media, the Fed bought assets from the banks with "money" and the banks used that money to make loans to businesses and consumers, thereby stimulating the economy. You're telling me that all the Fed is doing is increasing the Fed's balance sheet. How does a bigger Fed balance sheet help the economy?

Advancingtime
Advancingtime

The hyperinflation that occurred during the Weimar Republic and the speed at which inflation suddenly destroyed the currency dovetails with some of my thoughts on currency trading today. It confirmed that inflation can stem from a growing lack of faith in a currency, or all currencies, rather than just a lack of available goods.

As inflation takes root the goods available for sale often contracts as sellers retreat from the market awaiting higher prices which creates a self-feeding loop. The speed at which this can happen and the fact it could occur across the globe is explored in the article below.

Zardoz
Zardoz

Progressives are the only threat? Can anyone provide an example of when conservatives were in power and the deficit went down?

Casual_Observer
Casual_Observer

Mauldin's latest with lots of great explanations about Japan and how the world is headed in the same direction.

baldski
baldski

Who the hell is Lacy Hunt? Why should I care what she says?

Snowman777
Snowman777

However, the Fed can create unlimited funds for the commercial banks via quantitative easing

ReadyKilowatt
ReadyKilowatt

MMT falls under the same banner as "deficits don't matter, because we owe it to ourselves." Well, if "we" owe "ourselves" the loans, does that mean I can take my neighbor's stuff when he doesn't pay up? Or maybe just take a baseball bat to some random person's kneecaps on April 16th?

wootendw
wootendw

"There is currently, however, a real live proposal to make the Fed’s liabilities legal tender....i.e. a rewrite of the Federal Reserve Act."

"I am certain we are headed for another very deflationary asset bubble bust."

I suspect that the latter will be the political justification for the former which means that the latter will precede the former.

awc13
awc13

"It would not stop there. Guaranteed "living wages" and "guaranteed jobs would finish it off. The amount needed to have a living wage could never be met. Prices would soar along with the guarantee."

the government would then likely put price controls into place, likely demanded by the people. then that would finish things off nicely. out of control inflation coupled with price controls.