The Marginal Buyer

No more markets, just interventions?

“The Fed is the greatest hedge fund in history” – Warren Buffett

'Modern Monetary Theory' has nice ring to it and even its own three letter acronym of 'MMT', which seems to be de rigeur for every financial sleight of hand. A better term for MMT however would be 'Magic Money Theory', as it is merely another asymmetric risk carry trade, based on the pretence that it will ever get paid back in either incremental growth or directly from future consumption. Unfortunately, for these proponents of this Keynesian multiplier effect, the evidence from these applications of 'helicopter money' suggest the reverse, with GDP growth actually less than the stimulus applied, notwithstanding that the strategy has indeed delivered on the first part of the plan, in raising asset prices.  What is has failed to do however, is "trickle down" to the plebs and incremental consumption and GDP growth, as originally advertised. 

It is here where ivory tower economic theory has parted company with the human experience; perhaps underestimating markets ability to appreciate when it is being manipulated over a cliff. Over the past decade, investors have been conditioned not to "fight the Fed" and its unlimited capacity to swamp markets with liquidity, but the policy's failure to deliver on its stated aim while actually exacerbating problems of income inequality is hastening the demise of MMT. Like a junkie, central banks are addicted to the asset stimulus and have shown themselves unable to kick the habit voluntarily. At some point however, this lunch will have to be paid for. What remains unresolved, is whether reality and monetary discipline is restored by currency markets, or from political push-back first.  

“The Federal Reserve isn’t just inflating markets but is shifting a massive amount of wealth from the middle class to the rich" - Stanley Druckenmiller - billionaire hedge fund manager

Central Bank Interventions

And then inflation emerged and like the proverbial receding tide has exposed MMT as nothing more than a ponzi scheme to defer payment of reckless fiscal policies. 

For the US, the reserve currency status of the US dollar has just been too tempting an opportunity to use to monetise debt and buy votes, but just as with any addiction, can be difficult to kick the habit. For as long as the rest of the World is content to buy US dollars as a medium of exchange and store of value, the game was afoot, while supported by virtually every other central bank. 

The end of this road however, is inflation and then if unresolved further monetary debasement and risk of currency crisis and all that this would entail. The lessons from past similar mistakes from Wiemar Germany to those of Arthur Burns in the late 1970's ought to be well understood and even today the recent currency declines in not just peripheral currencies such as the Turkish Lira, but also the Japanese Yen suggest than markets fully sensitive to what is at stake. 

Unfortunately, this does not seem to have been fully appreciated by the US Federal Reserve which up the end of June 2022 has already missed its own balance reduction plans made a month earlier.  War risk, initially relating to Russia/Ukraine and then with China/Taiwan has perhaps sustained a safe haven premium for the USD in the short term, but should this unwind, the Fed could discover the cost of being driven by currency markets will b a lot more painful than staying out ahead of them.  

We would therefore seem to be at a fork in the road. While both ultimately lead to higher interest rates and tighter monetary conditions, the question is whether the US Fed will finally take the initiative and pre-empt a tighter fiscal environment after the forthcoming mid-term elections.

CB assets as % GDP by region

As the World's reserve currency, QE in the US under Obama provided cover for other central banks/economies with unresolved structural deficits to follow suit. What is perhaps missed by markets however, is the considerably higher proportional exposure by these other major economies, relative to GDP, than for the US. 

In the chart opposite, I have included the positions for Japan (BoJ) and the ECB (Euro) along with that for the US Fed. 

While the Paul Krugman inspired position at the BoJ ought to speak for itself, there are two points of note with regards the ECB's asset exposure.

  1. Firstly, it is over double that of the US Fed relative to the EURO 19 GDP and 

    2. Secondly, the ECB position is not directly covered by recourse to tax payers, because as of yet, it is not actually a country. 

One more reason to hasten the EU state and transfer union! 

Multiplier effect?   LoL

The chart opposite shows the quarter-on-quarter change (in USD millions) in GDP and central bank balance sheet assets for the US, ECB and Japan. 

Even if one were to exclude the exceptional intervention in 2009, what is clear from this data is that 

    1. The Subsequent QoQ growth in aggregated GDP has failed to even match the growth in Central Bank assets.

    2.  Each QoQ contraction in GDP triggers a QE (or equivalent) policy response and intervention from central banks. 

Multiplier effect - cumulative impact

'Exceptional' monetary stimulus? 

Hardly, when the incremental expansion in GDP has been less than the additional 'funny money' pumped into the economy!   

Please let the implications of this settle in, while central banks embark on a second throw of the dice. 

Perhaps the replacement of a command economy to replace the market pricing of assets is not conducive to efficient pricing of capital and therefore investments. Should we therefore be surprised if companies allocate capital to share buybacks and acquisitions rather than organic investment and expansion?

Replace the incentives to save and invest with a spend and borrow model and hey pesto, you get a zombie economy!