Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Investing in the METAVERSE Stocks Universe - 8th Dec 21
Stock Market Sentiment Speaks: I Expect 15-20% Returns For 2022 - 8th Dec 21
US Dollar Still Has the Green Light - 8th Dec 21
Stock Market Topping Process Roadmap - 8th Dec 21
The Lithium Breakthrough That Could Transform The Mining Industry - 8th Dec 21
VR and Gaming Becomes the Metaverse - 7th Dec 21
How to Read Your Smart Meter - Economy 7, Day and Night Rate Readings SMETS2 EDF - 7th Dec 21
For Profit or for Loss: 4 Tips for Selling ASX Shares - 7th Dec 21
INTEL Bargain Teck Stocks Trading at 15.5% Discount Sale - 7th Dec 21
US Bonds Yield Curve is not currently an inflationist’s friend - 7th Dec 21
Omicron COVID Variant-Possible Strong Stock Market INDU & TRAN Rally - 7th Dec 21
The New Tech That Could Take Tesla To $2 Trillion - 7th Dec 21
S&P 500 – Is a 5% Correction Enough? - 6th Dec 21
Global Stock Markets It’s Do-Or-Die Time - 6th Dec 21
Hawks Triumph, Doves Lose, Gold Bulls Cry! - 6th Dec 21
How Stock Investors Can Cash in on President Biden’s new Climate Plan - 6th Dec 21
The Lithium Tech That Could Send The EV Boom Into Overdrive - 6th Dec 21
How Stagflation Effects Stocks - 5th Dec 21
Bitcoin FLASH CRASH! Cryptos Blood Bath as Exchanges Run Stops, An Early Christmas Present for Some? - 5th Dec 21
TESCO Pre Omicron Panic Christmas Decorations Festive Shop 2021 - 5th Dec 21
Dow Stock Market Trend Forecast Into Mid 2022 - 4th Dec 21
INVESTING LESSON - Give your Portfolio Some Breathing Space - 4th Dec 21
Don’t Get Yourself Into a Bull Trap With Gold - 4th Dec 21
GOLD HAS LOTS OF POTENTIAL DOWNSIDE - 4th Dec 21
4 Tips To Help You Take Better Care Of Your Personal Finances- 4th Dec 21
What Is A Golden Cross Pattern In Trading? - 4th Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - Part 2 - 3rd Dec 21
Stock Market Major Turning Point Taking Place - 3rd Dec 21
The Masters of the Universe and Gold - 3rd Dec 21
This simple Stock Market mindset shift could help you make millions - 3rd Dec 21
Will the Glasgow Summit (COP26) Affect Energy Prices? - 3rd Dec 21
Peloton 35% CRASH a Lesson of What Happens When One Over Pays for a Loss Making Growth Stock - 1st Dec 21
Stock Market Sentiment Speaks: I Fear For Retirees For The Next 20 Years - 1st Dec 21 t
Will the Anointed Finanical Experts Get It Wrong Again? - 1st Dec 21
Main Differences Between the UK and Canadian Gaming Markets - 1st Dec 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

This Is Why US Monetary Policy Is So Ineffective

Interest-Rates / Economic Theory May 30, 2019 - 05:54 PM GMT

By: John_Mauldin

Interest-Rates

Back in the 1980s and 1990s, many people thought excessive government spending and the resulting debt would bring inflation or even hyperinflation.

We wanted a hawkish Federal Reserve or, better yet, a gold standard to prevent it. Reality turned out differently.

Federal debt rose steadily, inflation didn’t. Here’s a chart of the on-budget public debt since 1970:




Source: St. Louis Fed

Here is the same data in terms of debt to GDP:



You can see the debt growth started to level out in the late 1990s but then took off again. Yet the only serious inflation in this whole period occurred in the first decade.

I am not saying we had no inflation at all. Obviously we did—and in many parts of the economy more than the CPI reflects.

Some of it showed up in asset prices (stocks, real estate) instead of consumer goods. We like that and typically don’t consider it inflation, but it is.

But there was nothing remotely like the kind of major inflation that this level of government debt should have caused.

My good friend Lacy Hunt of Hoisington Investment Management presented two important theorems that explain this phenomenon.

Debt Leads to Lower Interest Rates

I’ll start with a quote from Lacy:

Federal debt accelerations ultimately lead to lower, not higher, interest rates. Debt-funded traditional fiscal stimulus is extremely fleeting when debt levels are already inordinately high. Thus, additional and large deficits provide only transitory gains in economic activity, which are quickly followed by weaker business conditions. With slower economic growth and inflation, long-term rates inevitably fall.

The first sentence will shock many people who think rising federal debt raises interest rates through a “crowding out” effect.

That means the government—because it is the most creditworthy borrower—sucks up capital and leaves less available to private borrowers. They must then pay more for it via higher interest rates or a weakened currency.

That is the case for most countries in the world.

Yet clearly it has not been the case for larger developed economies. That’s not to say it never will be. But today’s situation supports Lacy’s point, and not just in the US.

In the US, Japan, the eurozone, and the UK, sovereign rates fell as government debt rose. That is not how most macroeconomic theories say debt-funded fiscal stimulus should work.

Additional cash flowing through the economy is supposed to spur growth and in turn raise inflation and interest rates. This has not happened.

The reason it hasn’t happened is that we have crossed a kind of debt Rubicon in recent history.

In much of the developed world, the existing debt load is so heavy that additional dollars have a smaller effect.The new debt’s negative effects outweigh any benefit.

The higher taxes that politicians often think will reduce the deficit serve mainly to depress business activity. The result is slower economic growth, plus lower interest rates and inflation.

Past performance is really not an indicator of future results.

Falling Money Velocity Makes Debt Unproductive

Lacy’s second theorem supports the first.

Monetary decelerations eventually lead to lower, not higher, interest rates as originally theorized by economist Milton Friedman. As debt productivity falls, the velocity of money declines, making monetary policy increasingly asymmetric (one sided) and ineffectual as a policy instrument.

The Federal Reserve controls money supply, but has no effect on its velocity. That is a serious problem.

Looser financial conditions don’t help when the economy has no productive uses for the new liquidity. With most industries already having enough capacity, the money had nowhere to go but back into the banks.

That’s why velocity fell 33% in the two decades that ended in 2018:



Now, if velocity is falling, then any kind of Fed stimulus faces a tough headwind. It can inject liquidity but can’t make people spend it, nor can it force banks to lend.

And in a fractional reserve system, money creation doesn’t go far unless the banks cooperate.

Conventional Stimulus Doesn’t Work Anymore

The banks respond to each crisis the same way.

And every time they find that it takes more aggressive action to produce the same effect. Obviously, that can’t go on forever.

In a world of falling monetary velocity, the amount of GDP growth produced by each additional dollar of debt fell 24% in the last 20 years.

The result is that public and private debt keeps rising but also becomes less productive. That’s why we have so much more debt now and yet slower growth.

This also explains why growth has been so sluggish since 2014. That was when money supply peaked. So for five years now, we’ve had both a shrinking money supply and slowing velocity.

That’s not a recipe for inflation. And the more recent jump in federal deficit spending is making matters worse, not better.

The Great Reset: The Collapse of the Biggest Bubble in History

New York Times best seller and renowned financial expert John Mauldin predicts an unprecedented financial crisis that could be triggered in the next five years. Most investors seem completely unaware of the relentless pressure that’s building right now. Learn more here.

John Mauldin Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in