Fiscal Stimulus and the Risk of Runaway Inflation (w/ Kevin Muir)

Is fiscal stimulus on the horizon? Kevin Muir, market strategist at East West Investment Management and author of “The Macro Tourist,” argues that the declining efficacy of monetary policy will force governments to run-up even larger budget deficits. In the face of central bank impotence, he predicts that politicians across the political spectrum will turn to Modern Monetary Theory, or MMT, to avert a disaster. Muir suggests that this flood of spending poses serious inflation risks and that a monetary “day-of-reckoning” is forthcoming, but not imminent. He argues that this trend makes negative yielding sovereign debt highly imprudent — particularly in Europe, where he sees a “sovereign debt bubble.” Filmed on October 4th, 2019 in Toronto.

future inflation.
I think that those that were expecting higher bond, sorry, higher yields because of higher
rates in the US, I think they’re mistaken, that will not be the trigger.
In fact, the trigger will be a Fed that is too easy and doesn’t actually chase the market
higher.
That is what the true bond bear market will be created was when we finally get the inflation
and the Fed should be raising rates and they deem that they can’t afford to because there’s
too much debt out there.

That will create a self-fulfilling inflationary loop in my opinion.

Stop attacking the Fed, Mr. President

President Trump, do yourself a favor. Stop attacking the Federal Reserve and its chairman, Jerome H. Powell (yes, the same Powell you nominated). The result would be better for you, better for Powell and — most important — better for the country.

Unfortunately, Trump can’t seem to restrain himself.

“I will tell you, at this moment in time I am not at all happy with the Fed. . . . They’re making a mistake because . . . my gut tells me more sometimes than anyone else’s brain can ever tell me. . . . I’m not even a little bit happy with my selection of Jay. Not even a little bit.”

.. Until recently, there seemed to be a crude consensus among economists that the Fed should continue its gradual increases in interest rates to preempt higher inflation. The economy seems strong enough to tolerate tighter credit.

The unemployment rate of 3.7 percent is the lowest since the 1960s; inflation is around 2 percentconsumer confidence is high.

But the consensus may be fraying. There are signs of weakness.

  • The stock market has fallen;
  • housing sales and prices have softened;
  • the trade war between the United States and China remains unresolved

.. On Nov. 26, the paper ran an op-ed by

  • Harvard economist Martin Feldstein, a chairman of the Council of Economic Advisers under President Ronald Reagan, urging the Fed to raise rates. The next day, the Journal ran an op-ed by
  • Harvard economist Jason Furman, chairman of the CEA under President Barack Obama, counseling delay.

.. One danger for Trump is that the Fed, seeking to prove its “independence,” will deliberately oppose what the president prefers.

.. One danger for Trump is that the Fed, seeking to prove its “independence,” will deliberately oppose what the president prefers.

.. “President Trump has gone completely off the rails with his criticism of Fed Chair Powell,” says economist Mark Zandi of Moody’s Analytics. He “is using the Fed as a scapegoat for anything that goes wrong in the stock market and the economy.”

In Trump’s defense, he is not the first president to try to control the Fed and corrupt its independence.

  1. Lyndon B. Johnson lambasted then-Fed Chairman William McChesney Martin in the mid-1960s for raising interest rates against his wishes.
  2. Richard M. Nixon pressured Arthur F. Burns, Martin’s successor, to keep rates low. Likewise, President
  3. Harry S. Truman pushed the Fed to maintain easy money and credit.

.. But these and other cases occurred mainly behind closed doors. Trump’s brash innovation has been to take his complaints public; the apparent aim is to intimidate the Fed into doing his bidding. If the Fed resists, Trump might propose legislation curbing its powers. That would signal a real state of war between Trump and the Fed, with what consequences for financial markets and the economy, it’s hard to know.

.. It’s also true that attacking the Fed has long been standard operating procedure for members of Congress of both parties.

Congress depends on the Fed both to steer the economy and absorb public blame when the economy falters,” write Binder and Spindel. A lot of this criticism is political theater, designed to impress voters but not to do much else. What’s not familiar is for the president to be leading the charge.

The Global Impact of a Chinese Recession

Most economic forecasts suggest that a recession in China will hurt everyone, but that the pain would be more regionally confined than would be the case for a deep recession in the United States. Unfortunately, that may be wishful thinking.

CAMBRIDGE – When China finally has its inevitable growth recession – which will almost surely be amplified by a financial crisis, given the economy’s massive leverage – how will the rest of world be affected? With US President Donald Trump’s trade war hitting China just as growth was already slowing, this is no idle question.

.. First, the effect on international capital markets could be vastly greater than Chinese capital market linkages would suggest. However jittery global investors may be about prospects for profit growth, a hit to Chinese growth would make things a lot worse. Although it is true that the US is still by far the biggest importer of final consumption goods (a large share of Chinese manufacturing imports are intermediate goods that end up being embodied in exports to the US and Europe), foreign firms nonetheless still enjoy huge profits on sales in China.

Investors today are also concerned about rising interest rates, which not only put a damper on consumption and investment, but also reduce the market value of companies (particularly tech firms) whose valuations depend heavily on profit growth far in the future. A Chinese recession could again make the situation worse.

.. High Asian saving rates over the past two decades have been a significant factor in the low overall level of real (inflation-adjusted) interest rates in both the United States and Europe, thanks to the fact that underdeveloped Asian capital markets simply cannot constructively absorb the surplus savings.

.. instead of leading to lower global real interest rates, a Chinese slowdown that spreads across Asia could paradoxically lead to higher interest rates elsewhere – especially if a second Asian financial crisis leads to a sharp draw-down of central bank reserves. Thus, for global capital markets, a Chinese recession could easily prove to be a double whammy.

.. a significant rise in global interest rates would be much worse. Eurozone leaders, particularly German Chancellor Angela Merkel, get less credit than they deserve for holding together the politically and economically fragile single currency against steep economic and political odds. But their task would have been well-nigh impossible but for the ultra-low global interest rates

.. Today, however, debt levels have risen significantly, and a sharp rise in global real interest rates would almost certainly extend today’s brewing crises beyond the handful of countries (including Argentina and Turkey) that have already been hit.

.. Nor is the US immune. For the moment, the US can finance its trillion-dollar deficits at relatively low cost. But the relatively short-term duration of its borrowing – under four years if one integrates the Treasury and Federal Reserve balance sheets – means that a rise in interest rates would soon cause debt service to crowd out needed expenditures in other areas. At the same time, Trump’s trade war also threatens to undermine the US economy’s dynamism.

.. Its somewhat arbitrary and politically driven nature makes it at least as harmful to US growth as the regulations Trump has so proudly eliminated. Those who assumed that Trump’s stance on trade was mostly campaign bluster should be worried.

.. A recession in China, amplified by a financial crisis, would constitute the third leg of the debt supercycle that began in the US in 2008 and moved to Europe in 2010. Up to this point, the Chinese authorities have done a remarkable job in postponing the inevitable slowdown. Unfortunately, when the downturn arrives, the world is likely to discover that China’s economy matters even more than most people thought.

The US Will Lose Its Trade War with China

In handicapping the US-China conflict, Keynesian demand management is a better guide than comparative advantage. In principle, China can avoid any damage at all from US tariffs simply by responding with a full-scale Keynesian stimulus.

The United States cannot win its tariff war with China, regardless of what President Donald Trump says or does in the coming months. Trump believes that he has the upper hand in this conflict because the US economy is so strong, and also because politicians of both parties support the strategic objective of thwarting China’s rise and preserving US global dominance.

But, ironically, this apparent strength is Trump’s fatal weakness. By applying the martial arts principle of turning an opponent’s strength against him, China should easily win the tariff contest, or at least fight Trump to a draw.

.. Comparative advantage certainly influences long-term economic welfare, but demand conditions will determine whether China or America feels more pressure to sue for trade peace in the next few months. And a focus on demand management clearly reveals that the US will suffer from Trump’s tariffs, while China can avoid any adverse effects.

From a Keynesian perspective, the outcome of a trade war depends mainly on whether the combatants are experiencing recession or excess demand. In a recession, tariffs can boost economic activity and employment, albeit at the cost of long-term efficiency. But when an economy is operating at or near its maximum capacity, tariffs will merely raise prices and add to the upward pressure on US interest rates. This clearly applies to the US economy today.

.. US businesses could not, in aggregate, find extra low-wage workers to replace Chinese imports, and even the few US businesses motivated by tariffs to undercut Chinese imports would need to raise wages and build new factories, adding to the upward pressure on inflation and interest rates.

.. With little spare capacity available, the new investment and hiring required to replace Chinese goods would be at the cost of other business decisions that were more profitable before the tariff war with China. So, unless US businesses are sure the tariffs will continue for many years, they will neither invest nor hire new workers to compete with China.

.. Assuming that well-informed Chinese businesses know this, they will not cut their export prices to absorb the cost of US tariffs. That will leave US importers to pay the tariffs and pass on the cost to US consumers (further fueling inflation)
.. Thus, the tariffs will not be “punitive” for China, as Trump seems to believe. Instead, the main effect will be to hurt US consumers and businesses, just like an increase in sales tax.

.. Where will the competitively priced imports that undercut China come from?

In most cases, the answer will be other emerging economies. Some low-end goods such as shoes and toys will be sourced from Vietnam or India. Final assembly of some electronic and industrial machinery may relocate to South Korea or Mexico.

.. But this should have no effect on Chinese growth, employment, or corporate profits if demand management is used to offset the loss of exports. The Chinese government has already started to boost domestic consumption and investment by easing monetary policy and cutting taxes.

.. In principle, China can avoid any damage at all from US tariffs simply by responding with a full-scale Keynesian stimulus. But would the Chinese government be willing do this?

This is where bipartisan US support for a “containment policy” toward China paradoxically works against Trump. China’s rulers have so far been reluctant to use overt demand stimulus as a weapon in the trade war because of strong commitments made by President Xi Jinping to limit the growth of China’s debt and to reform the banking sector.

.. But such financial policy arguments against Keynesian policy are surely irrelevant now that the US has presented the battle over Trump’s tariffs as the opening skirmish in a geopolitical Cold War. It is simply inconceivable that Xi would attach higher priority to credit management than to winning the tariff war and thereby demonstrating the futility of a US containment strategy against China.

.. This raises the question of how Trump will react when his tariffs start to hurt US businesses and voters, while China and the rest of the world shrug them off. The probable answer is that Trump will follow the precedent of his conflicts with North Korea, the European Union, and Mexico. He will “make a deal” that fails to achieve his stated objectives but allows him to boast of a “win” and justify the verbal belligerence that inspires his supporters.

Trump’s surprisingly successful rhetorical technique of “shout loudly and carry a white flag”  the consistent inconsistency of his foreign policy. The US-China trade war is likely to provide the next example.

Putin’s Unlikely Ally in His Standoff With the West: His Central Banker

Elvira Nabiullina has earned an unusual degree of freedom to buttress an economy buffeted by sanctions

After Russia’s central-bank chief, Elvira Nabiullina, moved to shut down a large lender last year for allegedly falsifying accounts, the nation’s top prosecutor’s office issued an order to leave the bank alone.

She closed it anyway.

In her five years in office, Ms. Nabiullina has closed hundreds of weak banks, stymied the exodus of Russian wealth abroad and transformed monetary policy to bring inflation to record lows. That has earned her an unusual amount of freedom to make tough decisions, even if that means treading on powerful interests.

.. As President Vladimir Putin bids to return Russia to great-power status, challenging the U.S. and Europe from Syria to Ukraine, it’s her job to shore up the economy against volatile oil markets and sanctions. Russia’s ability to continue its quest rests in large part on whether Ms. Nabiullina can keep the financial system stable.

Ms. Nabiullina has earned public praise from

  • Mr. Putin, who rarely commends subordinates, as well as from abroad. Last year at the Kremlin, Mr. Putin told her that “under your leadership, the central bank has done a great deal to stabilize the economic situation.” Managers at big investment funds, from
  • Pacific Investment Management Co. to Pictet Asset Management, call Ms. Nabiullina one of the world’s most skilled central bankers.
  • Christine Lagarde, managing director of the International Monetary Fund, lauded her in May for setting “standards of quality for macroeconomic policy.”

.. In 2006, the central-bank official responsible for revamping the system, Andrey Kozlov, was shot dead in his car. Russian financier Alexey Frankel, whose banking license Mr. Kozlov had revoked earlier that year, was later convicted of organizing the killing.

.. She has earned a reputation for bookishness, personal honesty and fixation on detail

.. Industry veterans said that before Ms. Nabiullina took over, banking licenses were mostly used as mechanisms to funnel money abroad and process insider deals.

.. “We used to open a newspaper in the morning and look at the banking deals and said—that’s capital flight, and that’s asset stripping,” said Sergey Khotimskiy, co-founder of one of Russia’s largest private banks, Sovcombank. “The dodgy enrichment schemes were obvious to everyone.”
.. When she took over the institution, banks and companies were moving $5 billion out of the country every month, and inflation topped 7%.She shut down 70 banks in her first year.

.. Ms. Nabiullina stopped a longstanding policy of spending billions of dollars from the country’s reserves to try to prop up the ruble. In December 2014, with the ruble continuing to fall, the central bank nearly doubled its key lending rate to 17% at an emergency late-night meeting.

.. The rate increase restored calm to markets but strangled the country’s consumer-fueled growth. The country’s emerging middle class, which had become used to foreign vacations and European cars, is still feeling the effects of the ruble’s collapse.
..  Since she took office, she has halved the number of Russian banks, shutting down about 440 lenders. She has reduced capital outflows by about 50% to $2.5 billion a month.
.. Many of the banks she closed had been considered untouchable, analysts said. Some, such as Promsviazbank, counted lawmakers and state-company executives among its shareholders and held money for national oil companies and the Orthodox Church.
.. Others, like Bank Sovetskiy, had served political objectives, providing banking services in Crimea, the Ukrainian region the Kremlin annexed in 2014.

.. When the central bank took over Yugra last June following repeated warnings, it said it found a $600 million deficit in its balance sheet masked with bad loans. Just hours before the bankrupt bank’s license was due to expire, the prosecutor’s office ordered a halt to the closure, calling the bank “a financially stable credit organization.” Ms. Nabiullina rejected the order.

.. “It was a test of will, and she won,” said banking analyst Mr. Lukashuk.
.. In January, inflation hit a record low for the post-Soviet period of 2.2%, a result of Ms. Nabiullina’s decision to keep interest rates high after the Crimea sanctions. Some tycoons have urged a faster reduction.
.. Still, she has struggled to regulate Russia’s lesser, underperforming state-owned banks, whose executives often treat them as fiefs, analysts said. These banks are kept afloat by constant injections of state funds, which the executives have funneled into unrelated assets ranging from supermarkets to railroad cars.
.. Almost a trillion rubles of public capital, about $16 billion at today’s rate, went to just three state-owned banks—
  1. VTB,
  2. Gazprombank and
  3. Rosselkhozbank—

in the first four years of Ms. Nabiullina’s central-bank term, according to Fitch Ratings. All are still saddled with bad debts or illiquid assets.

.. Her modest economic forecasts have consistently lagged behind Mr. Putin’s goals, which she said can only be achieved through deep, unpopular changes to the system.

Even if the price of oil rose to $100, from around $65 today, she said, “it’s very unlikely that our economy can grow above 1.5% to 2%” a year.