The program ran Saturday-to-Saturday, each day with lectures beginning at 9am and ending at 6pm (we had one afternoon off to visit FDR’s home). One attendant calculated we had 41 lectures from 32 speakers. Needless to say, it was one of the most intense, and enjoyable, academic experiences of my life. I kept describing it as a “firehose” of information to the other attendees and they seemed to agree.
The official agenda was “Minsky, Godley, and Modern Money Theory” but the topics covered a broad range, including the history of money (with a focus on US colonies), the Job Guarantee, FinTech, strategies for developing nations, and current outlook/projections for the next few years. In preview, things are not looking particularly rosy for the US economy. Needless to say, there is a LOT to cover, and I won’t be able to fit it all in one post. Plus, I want to keep this relevant for financial markets. Without further ado, let’s dive in:
The Fed
A core tenet of MMT is that the Fed sets the price for money; it doesn’t affect the actual supply. Money is created and destroyed by commercial banks and/or the federal government. The Fed sits between the two, acting as an agent of the federal government and ensuring payments clear. It also conducts monetary policy (i.e. setting interest rates) through its open market operations. But it does NOT affect the aggregate stock of money in the economy. It can impact the composition of bank balance sheets by adding or removing reserves, but doing so necessarily involves swapping those reserves with US Treasury securities. As we have argued in the past, Treasuries are not loans made to the US federal government. Rather, they function as a “reserve drain” for banks. Banks tend to play “hot potato” with reserves because they offer meager yields and occupy space on their balance sheets, so they are incentivized to hold as few as possible. They purchase US Treasury securities with excess reserves in order to maximize their profitability. As an aside - I recently asked Warren Mosler on Twitter whether the Fed’s RRP (which has attracted much attention in the press and recently surpassed $2T) whether that program was functionally the same as US Treasuries, in that they served as a reserve drain, which he agreed.
Another important point about the Fed is that it’s power is limited. It can raise or lower interest rates, but these are blunt, ineffective tools for achieving its goals, which include maximum employment and price stability. There is a perception that the Fed is in the “driver’s seat” for the US economy, but we have seen repeatedly over the decades since WWII that that is a farce.
For example, consider the Global Financial Crisis of 2007-2008. A few days after the failure of Lehman Brothers (September 15, 2008), Fed Chair Ben Bernanke realized that credit markets were freezing up, meaning banks were at risk of failing. Capitalism and the entire economy was at risk of disappearing. Recognizing the gravity of the situation, he urged US Treasury Secretary Hank Paulson to lobby Congress to pass a $700 billion spending bill so the Fed could purchase toxic mortgage assets. Think about that for a moment - the Fed needed money. It needed Congress to pass a bill because only Congress has the legal authority to create new money. After the Emergency Economic Stabilization Act of 2008 failed to pass, financial markets were in full meltdown mode, with the DJIA recording its largest ever daily point decline. The panic forced Congress’ hand and they eventually passed the bill. While financial markets continued to sell off, the country momentarily avoided a complete extinguishment of the financial system. It’s worth noting that Warren Buffett’s famous “Buy American” Op-Ed came after Congress approved this bill. Clearly, he understands that it’s Congress, NOT the Fed, who has the power of the purse in the US. In February 2009, President Obama signed the American Recovery and Reinvestment act, which authorized nearly $800 billion economic stimulus package. The stock market would eventually bottom out a few weeks later in March before an incredible 12-year bull run.
This episode is illustrative, because the Fed clearly lacked the power and/or legal authority to authorize new money creation to save the financial system from a complete meltdown. Only Congress has that power. And it also shows the impact that spending from the US federal government has on financial markets. People on Wall St love to talk about how the Fed “injects liquidity,” but the reality is that Congress is the only entity that can actually add new dollars into the economy. And financial flows into and out of the US Treasury impacts financial markets - when the Treasury spends, it adds to the net financial assets of the economy, and likewise removes them when it collects taxes. This dynamic played out again in the COVID crisis of 2020 - financial markets bottomed out following Congress’ passing of the CARES Act in March 2020, and financial markets continued to roar all through the end of 2021. Many of the programs passed in that period were not renewed in 2022, and the progressive nature of our tax policies has meant that spending by the US federal government has dropped by over $1T year-on-year so far in 2022, financial markets have been in a tailspin all year. The takeaway for investors is that fiscal flows can at times be used for opportunistic buying (and selling) of financial assets.
That’s not to say that Fed policy is completely irrelevant. Raising and lowering interest rates do have impacts on financial markets and the economy; raising rates makes it more expensive for people who need to borrow money to subsist, raises the cost of capital for companies to expand production, and stimulates demand through the income channel. It is also argued by some MMTers that it raises the general price level, as it raises the term structure of the rates curve. I am also of the belief that raising rates when margin levels in the stock market is high forces leveraged traders (i.e. HFs) to de-gross their portfolios. And it makes it more expensive to take out a mortgage or an auto loan. It is a blunt tool that is intended to slow credit growth and therefore demand, although they ignore the impact that slowing growth has on the supply-side of the economy. One thing that was pointed out last week was Keynes’ idea that money demand = money supply; money is created when it gets voted into existence by Congress or when a bank makes a new loan, so there has to be both supply and demand for the “creditworthiness” of what that money is going to be used for.
One final point on this topic is that the Fed is supposed to be counter-cyclical, i.e. raising rates when the economy heats up and lowering them to stimulate when things slow. However, history has shown that for whatever reason, be it flawed economic models or institutional/political structure, they have proven to be pro-cyclical: lowering rates when the economy heats up and raising them into a slowdown. The Fed recently announced a surprise 75bp rate hike, and Chairman Powell anticipates more in the near future. If history is any guide, that is a bad sign for the US economy (more on that later).
To be continued...
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