Mea Culpa: We Got the Long Treasuries Call Wrong (Or Were Just Too Early)

Back in January, we wrote a post outlining our thesis for buying long-dated US Treasuries (and I did just that in my personal account). The main points of the thesis was that there was evidence that collateral was becoming scarce, a recession was likely on the horizon, and QT has historically resulted in yields on the long end coming down. That trade has, up to now, been a disaster. However, it is my view that the underlying thesis was correct; we were just early.

As MMT proves, US Treasury securities are not "loans" made to the US government. Rather, they are best thought of as savings accounts for large financial institutions and foreign countries. They are a place to park excess cash for a rainy day. They are a gift in the sense that they offer no credit risk and pay interest, typically at higher rates than those offered on reserves held at the Fed.

Treasuries are safe, liquid assets that have historically served as a safe haven during times of market stress and recessions, as investors view holding other "risk" assets as undesirable and would rather preserve their purchasing power.

What's been unique about the last few months, however, is the extreme scale of financial tightening caused by 1) the Biden administration's relentless push to lower the public deficit and 2) elevated commodity prices thanks to supply/demand imbalances, exacerbated by Russia's war in Ukraine. We've already written about how running surpluses drains reserves from the banking system, and is causing stress in financial markets. However, the energy/commodity market tightness has caused a dollar squeeze on foreign nations who import commodities, such as oil.

Case in point: let's take a look at Japan. The US dollar has been rapidly rising in value relative to the Japanese Yen:

Japan has the third largest economy in the world, yet is only about size of California. Its lack of consumable natural resources means that it must rely on importing energy and raw materials from other countries in order for its economy to function. The vast majority of global contracts for energy and raw materials are settled in dollars, which means Japan needs to acquire dollars in order to purchase the commodities that power its economy. They acquire dollars by selling goods such as automobiles and TVs to the United States. Because the US cares about taking care of its trading partners, we generously offer Japan the option to exchange surplus dollars into US Treasury securities, which are basically dollar savings accounts. For these reasons, Japan is the largest foreign holder of US Treasuries in the world.

According to the latest Treasury International Capital (TIC) data, since reaching its high-water mark of US Treasury holdings in November 2021, Japan has since sold $96 billion worth of Treasuries - a fairly substantial figure. Looking year-on-year, and its holdings have decreased by $8 billion:

This is because rising energy costs have made it more expensive to import raw materials (dollar USE goes up). At the same time, supply chain problems and chip shortages limit the sale of items like TVs and automobiles, two staples of Japan's export economy (dollar SOURCE goes down). This forced Japan to draw down on its dollar savings, i.e. its US Treasuries. It needs to sell Treasuries to raise dollars in order to meet near-term payment obligations for increasingly expensive commodities. This came at a time when the supply of dollars became more scarce, hence the dramatic move in USD/JPY (USD strengthens vs. JPY). Fortunately, the weakened Yen makes exports to the US more attractive, so there is a self-correcting mechanism at work.

In a sense, the weakness in US Treasuries is related to inflation, because prices have indeed gone up, causing an immediate need for dollars. But it's not because of investors intentionally dumping Treasuries out of fear for a loss of purchasing power they way that's described in Econ 101 textbooks; it is more mechanical/technical than that. Literally, Japan needs dollars and the easiest way for it to get more dollars is to sell Treasuries. Hence, Treasuries have sold off precipitously.

To reiterate, the spike in yields reflects a shortage of dollars needed to fund near-term obligations. This runs contra to the narrative that there are too many dollars which causes inflation, and that's why bonds have sold off. MMT shows us that adding dollars to the banking system/economy drives yields lower. The dollar shortage makes the cost/price (i.e. rates) of dollars go up. It signals market stress as liquidity is removed. This didn't happen because of Fed rate hikes; it happened because real dollars were removed from the banking system by the Biden admin, and rising energy costs further sucked out dollars from the global economy. A barrel of oil is still the same barrel of oil, it just costs more today than a year ago.

The initial reaction to the global dollar scarcity has been to sell financial assets of all stripes - both stocks and bonds. This causes stress and liquidity problems in the economy, which will likely lead to recession. That is when the bid for bonds will come.

So to conclude, we certainly got the timing on this call wrong, and didn't anticipate the impact on short-term commodity squeezes would have on the price of Treasuries. That being said, I have not sold a single bond, and am doubling down on this call. The bonds are cheaper, and there are more signs a recession is coming. There is talk among the institutional investor community about how government bonds seem somewhat attractive at these levels. Investors would be prudent to accumulate long-dated Treasuries at these levels. I also think shorting the front end makes sense as Jerome Powell seems determined to channel his inner-Volcker. So if the Fed surprises with rate hikes, that will likely further flatten and potentially invert the yield curve. For a pair trade, consider shorting SHY (iShares 1-3 year Treasury Bond ETF) and using the proceeds to purchase TLT (iShares 20+ year Treasury Bond ETF).

Disclosure: Long US Treasuries, short SHY

Random Thoughts

US Treasury Notes are counted as part of the national debt. US Federal Reserve Notes (i.e. the cash held in your pocket) are not. Both are obligations of the federal government and are guaranteed by Uncle Sam. We shouldn't obsess over swapping one for the other. Waste of time.

Paying federal taxes doesn't "fund" the government's spending programs. It preserves the value of our currency and, in doing so, protects our monetary sovereignty. Monetary sovereignty and national sovereignty are tied at the hip. We cannot be truly "free" as a nation if we do not have control of our own currency.

Finance is a Social Science. It concerns the interaction between money and businesses, both of which are ostensibly social concerns, with shared roots in property laws.

The study of economics without consideration for laws and institutions is fraudulent.

Lowering the Deficit is Ludicrous Public Policy

The Bureau of Economic Analysis (BEA) released preliminary GDP figures for 1Q22 that indicated a contraction of -1.4%. This came as a surprise for just about everyone, but we had been warning that Biden’s emphasis on running fiscal surpluses to reduce the deficit would cause a recession (although we didn’t think it would happen this quick!).

The Congressional Budget Office (CBO) just released preliminary figures for the first 7mos of the fiscal year 2022, which shows a deficit that is only one-fifth of what the government paid out over the same period in 2021. Said differently, the US federal government’s net spending into the economy y/y is down 80% from a year ago. That is a dramatic drop. Given that economies generally require an increase in the total money supply in order to grow, an 80% drop in money injections from the world’s monopoly supplier of the reserve currency is bound to cause significant financial stress and pain. No wonder we have experienced an absolute bloodbath in financial markets year-to-date. As I write this, the major US stock market returns for the year so far have been as follows:

DJIA -10.14%

S&P 500 -14.21%

NASDAQ -23.40%

And bonds haven’t offered any cushion. The US 10-year Treasury Note began the year with a yield in the mid-1.6% range; in just four months, it now sits at 3%.

President Biden has been doing a “victory lap” (if you could call it that) on his administration’s supposed fiscal responsibility. His remarks per CBS News:

"The bottom line is that the deficit went up every year under my predecessor before the pandemic and during the pandemic. And it's gone down both years since I've been here. Period," he said.

There are two problems with this. First, voters don’t seem to actually care, as Biden’s approval rating continues to make new lows. Let me repeat: people do not actually care about the national debt and/or deficits. This is despite all the rhetoric, usually from Republicans and conservatives, about the evils of government deficit spending and the national debt. Here is a quote from the previously referenced CBS News article from Norman Orstein, an emeritus scholar at the conservative-leaning American Enterprise Institute:

Norman Ornstein, an emeritus scholar at the conservative American Enterprise Institute, noted that deficits are often "abstract" for voters. The recent low interest rates have also muted any potential economic drags from higher deficits, which have risen following the COVID-19 pandemic and, separately, the 2008 financial crisis, to help the economy recover.

"They're more likely to respond to things that are in their wheelhouse or that they believe will have a more direct effect on their lives," Ornstein said. Deficits are "a step removed for most voters, and we've been through periods where we've had the big deficits and debt and it's not like it devastated directly people's lives."

Republicans use the debt limit as a political weapon to make life difficult for Democrats not because they care about deficits and debt, but for raw political power i.e. “because they can.” That’s right: children go hungry because Republicans want political power.

What's fascinating about this take too is that it runs directly counter mainstream conservative, Republican narratives. We wrote previously about John Cochrane, economist and senior fellow at the conservative Hoover Institution, and his incoherent view that government deficits make the public anxious about its ability to repay, which causes inflation. So which is it? Do deficits cause people to fear the government won't be able to pay back its debt, or are they too far removed from the public for people to care? These two positions are mutually exclusive.

But singling out Republicans isn’t fair. The reality is that it’s Biden’s Democrats who are actively working to reduce the deficit and make children starve by denying families the Child Tax Credit. And Democrat Bill Clinton was the last president to run a budget surplus, while Democrat Barack Obama spoke of the United States' moral obligation to "tighten its belt." So, both political parities are clueless and unnecessarily cruel.

But ignoring the accounting realities of “debt reduction” - it removes from, rather than adds to, national savings - let’s think about the actual mechanics of debt/deficit reduction. Earlier in this article, we referenced the US 10-year Treasury Note. It’s generally understood that Notes issued by the US Treasury are backed by the full faith and credit of the United States federal government, and is included in the calculation for the “national debt.” However, “paying down” the debt would require tendering such Notes for dollars. As we’ve pointed out before, the dollar bill in your pocket is also a Note, only it’s issued by the US Federal Reserve rather than the Treasury. It literally says “Federal Reserve Note” at the top. These notes are likewise backed by the full faith and credit of the United States federal government. So “paying down the debt” really just means swapping one type of debt, US Treasury debt, with another type of debt, US Federal Reserve debt. Both are essentially the same “credit” - they are guaranteed by the same parent entity, the US federal government. It just so happens that one type of debt, that issued by the Federal Reserve, has special “legal tender” properties: it is legal tender for cancelling all debts, public and private. That’s why we think of it as “cash.” But at the end of the day, it is still a (credit risk-free) debt instrument that is an obligation of the US federal government. Which is why lowering the deficit is such ludicrous public policy - it doesn’t actually accomplish anything, except for removing financial savings from the real economy. How any “conservative” would support confiscation of private savings as sensible policy is simply baffling.

Warren Buffett Endorses MMT, and Explains Why Bitcoin Isn't Money and Not Worth Anything

Image source: CNBC

I was in Omaha this past weekend for the annual “Woodstock for Capitalism” i.e. the Berkshire Hathaway annual shareholder’s meeting, the first in-person meeting since the onset of the COVID-19 pandemic.

The weekend was filled with a mix of emotions and takeaways. While there was certainly a lot of “pent-up demand” for a return by the Berkshire faithful, one couldn’t help but also feel a little nostalgic. Buffett and his right-hand man Charlie Munger are approaching a combined 190 years of age. The fact that they still have the energy and mental acuity to operate at the level they do is astounding. Nevertheless, it was clear their communications skills have deteriorated somewhat. Buffett used a lot more “ah’s” when he spoke, and at times tended to ramble. It’s possible that is also a function of the last two years - it’s been a while since the old man spoke in front of a 25,000+ live audience! I think it’s safe to say we all have been more insulated over the past couple years than normal. At times, all I’ve wanted is to just talk about all the crazy stuff that’s been happening. Naturally, of course, I started a blog instead!

One point of emphasis that Buffett clearly had on his agenda for the meeting was to explain to everyone what money is. This shouldn’t come as a surprise after being called a “sociopathic grandpa” and Bitcoin’s “enemy no. 1” by Peter Thiel at a conference in Miami a few weeks ago. Thiel referred to Bitcoin as a “movement” and called not buying Bitcoin a “deeply political” choice. There’s a lot to unpack there but I’ll just say this: if your investment thesis relies on a successful political revolution that undermines the legitimacy of the most dominant nation in the world that has created immense wealth for its citizens and has the most powerful military in history by orders of magnitude, you may want to reconsider.

Returning to the subject at hand, Buffett led the meeting off with a clarification on money. While projecting a $20 bill on the screen, he remarked the following [emphasis added throughout]:

"This note is legal tender for all debts public and private, and that's what makes it money. Money is the only thing that the IRS is going to take from you. You can offer them all kinds of things, but this is what settles debts in the United States. You'll hear a lot about various kinds of money, but this is the only kind of money you're going to see throughout your lifetime." 

This is precisely what MMT has been preaching for nearly three decades: taxes drive money! Money (cash) and debt are one in the same; every financial asset has an offsetting and equal liability. Sort of like Newton's Third Law of Physics, i.e. every action has an equal and opposite reaction. And if they are equal, that means they can cancel each other out. Money is used to cancel debt, and taxes are a form of debt. Therefore, if the State levies a tax charge payable exclusively in its own currency, then that creates demand for the currency.

Buffett was keen to emphasize the $20 bill's "legal tender" status. A fantastic historical account of the origins of "legal tender" laws in the US can be found in Roger Lowenstein's fantastic new release Ways and Means: Lincoln and His Cabinet and the Financing of the Civil War. Consider the following passage from that book, which refers to what became known as "greenbacks," an early form of government fiat money which was issued by the US Treasury in order to fund the Civil War:

"the legal tender notes would constitute a 'debt.' True, they bore no interest, and carried no maturity; nonetheless, it was widely assumed that, after the war, they would be redeemed for gold. Today, people think of 'money' as having inherent value. In 1862, even proponents of legal tender thought of the paper as provisional, casting a debt up on the future."

Today, we use the term dollar bills but they are technically Federal Reserve notes. Note the nomenclature, as we use the same terms in reference to debt issued by the US Treasury (T-bills, Treasury Notes, Treasury Bonds). Indeed, the dollar bills in your pocket are essentially zero-interest, perpetual, non-callable debt issued by the Fed. They are essentially a tax credit created by the government in order to fund productive work. 

Of course, this is not the first time Buffett has been linked to MMT. He is quoted in Stephanie Kelton's The Deficit Myth with the following:

"[the US] cannot have a debt crisis of any kind as long as we keep issuing our notes in our own currency...Greece lost the power to print their money. If they could print drachmas, they would have other problems, but they would not have a debt problem."

Buffett does not subscribe to, nor does he endorse, MMT by name. But he absolutely does so in principle.

Buffett also brought up the notion of a "value." He has mocked so-called "goldbugs" for their obsession with the "barbarous relic." He took it easy on that crowd this year and instead turned his attention to Bitcoin, using similar arguments. He claimed that Bitcoin isn't worth anything because it doesn't produce anything, as opposed to other assets such as farmland or apartment buildings. However, he also made the following comment on art, too:

"Certain things have value that don't produce something tangible. I mean you can say a great painting will probably have some value 500 years from now."

He then goes on to say that if people find it interesting, they will pay someone else money to see it. This is an important point. If a piece of art leaves a strong enough impression on people, they will pay to have that experience. Taking this a step further, the world will need to spend incomprehensible amounts of money in order for Bitcoin to be around 500 years from now. This is because it relies on a network made up of physical computers that degrade over time. That's not a prediction, that is just physics. Depreciation is a real cost. There are actual physical cables running on the oceans' floors that physically link together countries in order for them to be on the same internet network. Undoubtedly those will wear out.

Not only that, but do you really think your thumb drive that holds the keys to your Bitcoin won't degrade at all, and will function properly, in 500 years? That is before considering the fact that technology tends to evolve, and computers will still be around in 500 years with thumb drive inputs. A single piece of art is easy enough to store for 500 years; the Mona Lisa was painted in 1503! And gold itself has natural properties where, for all intents and purposes, it doesn't degrade. That characteristic made it a useful money technology in the past, but the world's population grew so large that the supply of gold couldn't support a global monetary system. The fact that gold doesn't degrade means it is basically the exact opposite of Bitcoin, despite the comparisons between the two. Eventually, all of today's Bitcoin holders will die. I'm sure many will take their passwords with them, meaning there will be fewer and fewer Bitcoins available, and the network will cease to exist. By contrast, for someone who owns gold, it doesn't necessarily all disappear when they die.

Some Bitcoin and crypto fanatics seem to think that rising price for a currency is an overwhelmingly positive development. It's not. Consider a farmer who borrows Bitcoin to pay for property, equipment, and supplies he or she needs to cultivate crops to help feed the country. If they borrow in Bitcoin, and in the time between planting and harvesting/selling their crops the price of Bitcoin increases by 4x, well now the sales they generate will be one quarter of what they had originally planned with they took out the loan. They won't be able to pay back their debt if they can't generate sufficient revenues to do so, so they are forced to default on their loan and file for bankruptcy protection. If all the farmers went bust all at once, it would cause mass starvation and famine. But hey, at least the Bitcoin HODLers saw their price go up!

Like Buffett says, investors should stick to assets that produce something useful. This is likewise very MMT-like, which emphasizes that people should focus on real resources rather than made up financial ones. It's easy to forget that the companies that Buffett has so successfully invested in have produced incredible amounts of goods and services for the citizens of America for decades. And while the near-term benefit of things like gold and art don't necessarily produce something in the immediate, the cost of keeping those assets in-tact is tiny compared to Bitcoin.

Finally, when asked about the best way to fight against inflation, Buffett gave an amazing response: become exceptionally good at something!

Financials Mock Portfolio Outperforms S&P 500 Index In the First Quarter (And Other Updates)

Financials Mock Portfolio Quarterly Performance Update

In January, we published a mock financial stocks portfolio. For the quarter, the portfolio returned +1.9%, which compared favorably to the S&P 500, which returned -4.6%, as well as the Financial Select Sector SPDR Fund (XLF), which returned -1.5%.

As a reminder, these results assume dividends are reinvested.

One of the positions, MoneyGram International (MGI), accepted a buyout offer from a private equity firm. We will assume a sale of that as of March 31, with the proceeds evenly reinvested in the portfolio.

2s/10s Yield Curve Inverted

We have written multiple times about the flattening yield curve, that is actually starting to invert. Historically, inverted yield curves have proven an indication of elevated risk of recession, and we argued that a contributing factor to this was Uncle Sam's large budget surplus in January. This is an unfortunate development from the Biden administration, which recently released a statement estimating a $1.3 trillion reduction in the deficit for 2022. That is an alarming amount, as it represents nearly 5% of US annual GDP. 

As a reminder, when the US Treasury runs a surplus, the net effect is a removal of reserves from the banking system, and our contention is that this is causing stress in the markets. Last week, the 2s/10s curve officially inverted for the first time since the summer of 2019, and remains so as we write this:

It's worth pointing out that in the Fed's latest weekly statistical release, it reported a $3.830 trillion reserve balance held at Federal Reserve Banks:

This represents a $286 billion reduction in reserve balances since the beginning of the year's balance of $4.116 trillion: 

One doesn't need a PhD in economics to understand that fewer reserves in the banking system leaves fewer dollars available to purchase securities. Is it any wonder then that US government bonds had their worst first quarter in nearly half a century? This has real economic consequences, average 30-year fixed mortgage rates exploded higher in the quarter, reaching their highest level since December 2018:

Liquidity Is Drying Up

Lack of liquidity in US Treasury market is also a major concern. Per Reuters:

"Some measures of liquidity have shown stress.

Bid-ask spreads -- a commonly used indicator of liquidity -- widened significantly in March on short-term Treasury notes, Refinitiv data showed.

Data from CME Group showed order book liquidity for Treasuries has declined since Feb. 24, when Russia began its invasion of Ukraine, and volatility has increased.

Cash contracts volume in terms of the daily average top of the book bid/ask quantity for five-year Treasuries declined to $10 million in March from about $25 million in February.

For the benchmark 10-year notes, order book liquidity went down to an average of $14 million in March from about $20 million in Feb."

And daily US Treasury FTD's (industry parlance for "Fail To Deliver") reached their highest in a year on March 31:

Source: DTCC

This further supports the assertion that markets are becoming stressed. It shows that financial intermediaries are having a difficult time sourcing and delivering Treasury securities that they are legally obligated to deliver in order for trades to settle and clear. It shows that collateral chains are being stretched and are at risk of breaking, which could be a precursor for a risk-off, flight-to-safety event. Certainly, the extreme activity in commodity markets due to the COVID-19 pandemic and the recent Russian invasion of Ukraine has sent tremors through financial markets. Talen Energy, a PA-based power producer owned by PE company Riverstone, is seeking DIP ("Debtor In Possesion") financing for a potential bankruptcy, thanks to commodity hedges that went against them and drained their liquidity. Altera Infrastructure (f/k/a Teekay Offshore) is another PE-backed company that is having liquidity issues; they have hired advisors for a potential restructuring.

Consumer Price Inflation Is Crushing Consumer Demand

Indeed, the current high prices for goods is weighing on demand. Consider last week's statements from RH CEO Gary Friedman:

Yes. All of a sudden, that hits. And then all of a sudden, boom, we've got a war. Russia invades Ukraine, boom. Yellen says interest -- inflation is going from 4% to 2%, and then it goes to 7.5%. And Powell says, we're behind. I think there's a lot of -- everybody thinks supply chains are getting better. I don't think they've gotten better at all. I mean, it is what it is. I mean, product is on the water for a long time. Getting ships into port is taking a long time. We've got generally about 5 extra weeks in our supply chain right now. That's a lot of time. It's a lot of money, and that's the average. So that means some steps coming on time and some steps 10 to 12 weeks behind.

And this:

Yes. Well, look, I mean, it's probably one of the most difficult guides since 2008 and '09 because we're right in the middle of this disruption from Ukraine and Russia, which I think -- I don't think it's all Ukraine and Russia. I think it's triggered a greater awareness. Like it's like someone -- I think this was ring the bell, everybody pay attention. And then all of a sudden, everybody started talking. Yes, all of a sudden, the Fed's off to the races, and that creates concern. You've got housing prices at all-time highs. I mean, is it sustainable? I don't know for how long the math. Yes, doesn't make sense on kind of what's happening in the housing sector and other places that -- you've got inflation like I've never seen.

Now I was telling people when Yellen said, "We're going back to 2%," we were just signing our new freight contracts, ocean freight contracts. I just wonder if anybody -- the Fed has picked up the phone and called a businessperson and said, "Hey, what do you think is happening with inflation? How's ocean rates? How is this? How is that?" I mean, I think -- I don't think anybody really understands what's coming from an inflation point of view because either businesses are going to make a lot less money or they're going to raise their prices. And I don't think anybody really understands how high prices are going to go everywhere, in restaurants, in cars and everything. It's -- and I think it's going to outrun the consumer. And I think we're going to be in some tricky space.

And how about this - Big Short/Bear Stearns reference:

But it's not just us. It's everybody I know in every industry. And I just don't think it's like -- again, I don't want to scare everybody. But I talked about the theme, like there's this scene in The Big Short where everybody is in that ballroom and the guy -- I think it's the guy from Bear Stearns or someone is up there, one of those things, and he's saying how they're going to buy back $1 billion of their stock, this, this and that. And then one guy who's on his BlackBerry, he goes, "Can I ask a question, sir? In the 20 minutes that you've been talking, your stock is down like 55%." And everybody ran out of the room.

I just think we tend to just try to be transparent and honest. And look, maybe our stock is going to take a big hit because of this, and people are going to think Gary Friedman wasn't excited. I've never -- I told my team, I've never been -- in my 22 years here, I've never been more excited. I've also never been more uncertain, right? So -- and I think you have to take a real balanced view right now.

Full disclosure - I own RH stock and have been following the company for years. I can confirm Friedman is very smart, capable, and tells it like it is.

I think there is a strong likelihood that consumers start pivoting away from spending on goods and instead increase spending on services such as travel and hospitality. This does not bode well for the goods economy, as inventories are high:

Source: Logistics Managers' Index

...and there are signs the trucking market is starting to roll over. The CEO of logistics data provider FreightWaves (highly recommend you check out their services) just wrote a piece predicting an imminent recession, which followed a piece written a week earlier calling for a repeat of the 2019 "bloodbath" in the trucking market:

We think another sharp, painful downturn in the U.S. truckload market is imminent, and it could be as bad as 2019.

March has been unusually soft in the truckload freight market, according to the SONAR Outbound Tender Volume Index (OTVI). Because this index measures actual truckload tenders in the contract market, it provides a very reliable indicator of market direction. 

March is typically a strong month for trucking, as shippers start to stock their shelves in preparation for summer. And late March normally gets a reliable end-of-quarter boost in volumes as shippers pump sales and reduce inventories. This year, we are not seeing that surge. In fact, March volumes are softer than at any point in 2021 (other than holidays). 

Outbound tender volumes are down:

Additional commentary from the same article:

More than likely, the lower volumes are due to a major consumer slowdown. Inflation that began in 2020, combined with the surge in fuel prices related to increased inflation and the Russian invasion of Ukraine, have made consumers move to the sidelines. In addition to monitoring SONAR data, FreightWaves analysts also conduct channel checks through our network. Market participants are confirming what FreightWaves analysts are seeing in the data. Spot rates are falling fast and volumes are dropping.

There are many reasons to believe that the freight market slowdown will continue, and that an oversupply of trucking capacity – particularly in the spot market – will pull rates even lower.

Freight is all about the movement of physical goods. Travel and entertainment do not drive (much) freight, so any dollars spent on “experiences” means money isn’t spent on cargo. 

After two years of massive consumption of physical goods, consumers are pausing their spending. The COVID surge is largely behind us and people are starting to shift their spending away from physical goods to travel and entertainment, which will take a much larger percentage of disposable spending than we have seen over the past two years.

If traffic is any indication, consumers are on the move right now and this requires fuel. Except for the 3% of the U.S. population that have electric cars, any money spent on filling up the gas tank will mean less money going toward discretionary spending. 

Everything is more expensive than it used to be and consumers are starting to be more cautious about the future. High fuel prices and runaway inflation sap consumer confidence and will be a drag on discretionary purchases. 

The trend toward intensive goods spending has taken longer than many initially expected to reverse itself, but consumer spending data confirms that a material shift is taking place. February retail sales were nearly flat at 0.3%, missing expectations.

Over the past two years, shippers were short of inventory. In an attempt to prevent stock outages, they ordered more than they needed and now are faced with a hangover from ordering too much. Key transshipment infrastructure like ports, warehouses, transloading facilities, and intermodal ramps were clogged, slowing freight velocity, reducing sales, and increasing inventory levels. FreightWaves’ view is that shippers will compensate by slowing their purchasing and working off inventory when opportunities with acceptable margins arise.

Trucking spot rates are under massive pressure, caused by too many trucks and not enough freight. Truckstop.com’s truckload spot rates peaked at $3.83 per mile in January and are now down to $3.42 per mile. Spot rates will fall further and could hit $2.50 per mile by mid-year.

Trucking has enjoyed the largest number of new entrants in its history over the past two years. New fleet registrations were up to 20,166 last month alone. This is unprecedented. The last peak was in August 2019; there were 9,511 new trucking fleets and that was in the middle of one of the weakest freight markets in history. New trucking registrations tend to lag market conditions, so we can expect new fleets to continue to enter the market, even after things soften. This will make the downturn that much worse.

Many of the operators are unseasoned and inexperienced. They are unlikely to have ever seen a market downturn, much less run a business in the middle of one. They also bought their trucks and hired their drivers at the top of the market. 

These same drivers that were chasing high spot volumes will find fewer and fewer opportunities in the market. They will either leave the trucking market or move to trucking companies that have more consistent freight, leaving those trucks unseated. 

With falling spot rates, declining volumes, surging fuel prices and inflation across the board, it will get ugly, very quickly for many of these operators. Back in 2019, FreightWaves reporters wrote about trucking bankruptcies almost every day. I expect this will become reality for us once again.

We Should Stop Talking About Wealth "Redistribution"

One of the most common disagreements I hear in political discussions is over the notion of wealth "redistribution." See the NY Times article from over the weekend: Thomas Piketty Thinks America Is Primed for Wealth Redistribution. I think it would be best to avoid this phrasing, for several reasons. First, it gives the impression that wealth is zero-sum. MMT shows us that when the government runs a deficit, it creates non-government surpluses that are commonly thought of as wealth. When the government spends money in a non-inflationary manner, it creates financial wealth for the recipient. The wealth didn't have to "come from" anywhere. We can all be collectively wealthier without taking anything from anyone. Additionally, "redistribution" is generally used in a context where someone "earned" that wealth fair and square, only to have it confiscated by the evil, power-hungry government. We need to remind people that the government is the original source of their wealth, both financially (government is the original source of our modern money) and by virtue of granting property rights and enforcing contracts, which forms the basis of our modern capitalist system. Finally, talking about "redistribution" makes it seem like we need billionaires for essential funding. We don't. It's actually the other way around: they need us to buy their products and tolerate laws that allow them to accumulate their fortunes.  

ECASH Act: A Step In the Right Direction

I'd like to end this post on a positive note. A bill called the ECASH Act was recently proposed in the US House of Representatives. The bill "directs the Secretary of the Treasury to develop and pilot digital dollar technologies that replicate the privacy-respecting features of physical cash, in order to promote greater financial inclusion, maximize consumer protection and data privacy, and advance U.S. efforts to develop and regulate digital assets." (For more information, see here https://ecashact.us/)

This is a great development for civil liberties, right to privacy, and financial inclusion. It makes sense to have the Treasury pilot the program given its history of rolling out products designed for individuals. Physical cash is a different "form" of money than ledger cash, which requires maintaining a historical record of transactions. This bill essentially gives the Treasury a green light to create digital dollar that is more compatible with today's digital world.

General Equilibrium Theory is Nonsense

General Equilibrium Theory is nonsense. We live in an uncertain world and can't predict the future. Households and firms hoard assets (cash, securities, inventories) in order to provision themselves should they be needed in the future. If equilibrium theory was correct, and markets were perfectly efficient where supply magically balances with demand, there would be no inventories. All this "buffer stock" savings requires financing. Purchasing inventories, securities, or holding cash are uses of funds, and require an original source. While banks typically finance inventories and securities, and hold cash deposits, the ultimate source of funds is the government. This shouldn't be controversial, considering that private banks hold their own deposits at the relevant central bank. And these deposits are liabilities of the central bank, which are typically guaranteed by the full faith and credit of the government.

Pizzanomics

What equilibrium theory also gets wrong is the idea of markets "clearing" for goods and services. This concept is relevant in financial markets, assuming equal access to information and rational actors. However, it doesn't apply in the same way for the exchange of goods and services in the real economy, because of the impact of power structures on the means of production. Consider the following: an Italian immigrant comes to America and sets up a pizza shop in a town where no one had ever previously heard of pizza. Setting up a pizza shop requires a permit from the local government, and money to use up front to pay for rent, purchase equipment and supplies, and perhaps hire a worker. It's not likely the Italian would have access to financing from a bank, because this is a novel concept and banks aren't usually in the business of making risky loans. So, already there is a bias in that the Italian already had money, and the local government gave its stamp of approval on his new business venture. It wouldn't be possible otherwise - the Italian would end up in jail if he broke the town's laws by setting up his business without a permit. So already, the Italian has been granted the privilege of having money and being allowed to run his business. This gives him power over the means of production. And because no one in the town has had pizza before, there is no demand that his supply of pizza can balance with - the power granted to him by the local authorities allows him to create his own demand!

The Freedom to Buy Only What Corporations Want to Sell You

Another example is wholesale food suppliers. Oxfam put together this graphic several years ago to show how just ten companies control most of what we buy for groceries:

Source: https://www.businessinsider.com/10-companies-control-food-industry-2017-3

How can we look at something like this and say we live in a country with competitive, "free" markets? The level of concentration on such a critical portion of the means of production in our economy, where production is controlled by a handful of powerful bureaucrats, more closely resembles failed states like Venezuela and the USSR, where control over the means of production was monopolized by the government. And yet, we still call this "capitalism." No wonder we've been dealing with toilet paper shortages (among other items).

The high industry concentration leaves few alternatives, enabling these companies to have incredible pricing power over consumers. This power dynamic obliterates the equilibrium theory narrative, as sellers in these transactions are price makers, and buyers are price takers. Sellers can raise prices without a change in demand. Which is exactly what they're doing, by the way, contributing to the recent surge in consumer prices. So no, the market is not "clearing" at its "natural equilibrium" price. The distribution of power in a society has profound effects on economic outcomes.

Everyone Has to Pay Taxes

Speaking of grocery stores, why can't we use any currency other than dollars to transact at them? In a free country, shouldn't I be allowed to show up to the grocery with my bananas and exchange them for oranges? Or pay for oranges with unmarked gold coins? Or Bitcoin?

Obviously, the answers to the above questions are all the same: no. The reason is simple: the grocery store owner has to pay taxes on income generated from its operations. The landlord who owns the property and collects rent from the grocery operator has to pay income and property taxes. The utilities and insurance companies that service the grocery operator have to pay income taxes. The wholesale food suppliers have to pay income taxes. The workers who collect wages to run the store have to pay income taxes. Everyone has to pay taxes!

And what currency are those taxes paid in? In the US, by law taxes must be paid in dollars. So, the government coerces the citizenry to all pay taxes in a currency for which it is a monopoly supplier. As laid out brilliantly by Warren Mosler and Stephanie Kelton, the ability to levy a tax in dollars is the key to creating demand for them. Once again, it's not a market dictated by buyers and sellers. It's an example of a powerful entity - the US government - creating demand for its product that did not previously exist. No one was born with a desire to accumulate dollars; there is no "natural" demand for them, just like there is no natural demand for pizza. The demand comes from people's desires to stay out of jail.

Every year, the government is guaranteed to require us to pay taxes. Even Americans who don't technically pay federal income taxes do generally transact in the domestic economy, and taxes are embedded in the cost of every product or good they purchase. Sales taxes are prevalent in 45 out of 50 states in the US. And while renters may not pay property taxes, the rental outlay paid to the landlord sure does, which manifests in the rental rate.

Cue: The Job Guarantee!

Many Americans, particularly those on the political right, despise paying taxes. I'm sympathetic to this line of thinking, but MMT shows us the anger is misplaced. The real injustice is that the government guarantees the People have to pay taxes in its currency, without guaranteeing the People opportunities to obtain said currency. In fact, it's even worse: the government proactively restricts opportunities for people to obtain its currency, through its administration of monetary policy and the Fed's "dual mandate" for maximizing employment and stable prices as set by the Congress. This is not just cruel; it's an abomination. People suffer and go hungry as a result of these policies. Congress' refusal to extend the Child Tax Credit has inhumanely forced children into poverty. And what do we get out of this? Elevated levels of poor health, chronic disease, anxiety, depression, and lower academic achievement, among other things. Enacting a federal Job Guarantee would go a long way towards eliminating child poverty. It is my genuine belief that a Job Guarantee (or "Employer of Last Resort" if you prefer) is not only one of the most important legislative proposals of our generation, it can also serve as a bridge between the political left and right in our country. Neither side wants to be perceived as being "anti-work." And, a federal Job Guarantee would perhaps make paying taxes less miserable in the eyes of conservatives, as they can always get a job to cover their tax debts. 

Mo' Problems Mo' Money

First, my heart goes out to all the citizens of Ukraine who are experiencing this horrible tragedy. There simply is no place in the modern world for the tragic death and destruction that Putin has unleashed. I hope and pray for a peaceful resolution and an end to this senseless violence and suffering.

This whole experience had me thinking over the weekend about how inflation has been historically been high during war times. The typical narrative offered by people is that governments "inflate away" the financial debts incurred during the war.

Indeed, most people generally believe that inflation (i.e. rising prices of goods and services) is the effect of governments "printing money."

But what if this is completely backwards? What if higher costs of goods and services (in real resource terms) is actually the cause of money printing?

Money comes from two sources: the government and commercial banks. New commercial bank loans are "funded" with newly created money deposits. Banks have a special government license to create new money on its behalf. Banks are money printers.

When problems arise, that compels entrepreneurs and/or governments to solve them. Doing so requires new money creation.

Let's say a community's hospital is destroyed thanks to an unprovoked invasion by a psychopath (i.e. what is happening in Ukraine right now). That hospital was funded by either the government or a bank creating money to pay for it. The loss of the hospital represents a real economic cost, because hospital buildings generally have multi decades of useful lives, and sick and injured people can no longer be treated there. This represents a real resource deficit. In order to get back to square, in terms of real resources, either a bank or a government must create new money. This will obviously increase the "money supply," as the new money is added to the money that funded the original hospital. So, in order to deal with a real resource problem, we have to first create new money.

That's not to say that printing money in and of itself solves problems. But addressing real resource deficits requires printing new dollars. Real resource deficits represents real costs to people: the hospital that got destroyed by definition creates a deficit for healthcare facilities. This limits people's access to such services and is an increase in real resource "costs." The real resource costs requires money printing to be dealt with.

Likewise with the pandemic, which created a strain on real resources. It made life more difficult for people. The inflation we've been experiencing reflects the problem of real resource deficits. Money printing is the effect, not the cause. Recall that corporations drew down billions of dollars' worth of credit lines in March 2020 in order to preserve cash and liquidity given the uncertainty posed by the pandemic. That represents rapid money printing in a very short period in response to a real economic problem. That new money creation by itself did not cause consumer prices to go up.

And this isn't anything new. An economy can accurately be described as people using real resources to solve problems for other people and create real-world prosperity. If a town lacks a pizza restaurant, an entrepreneur may view that as a problem to be solved. While they may have some money saved to open the restaurant, they usually require a loan from a bank as well, to fund purchases of equipment and working capital to hire people and pay suppliers for ingredients. That bank loan represents new money creation.

More problems leads to more money creation.