ESSAY 4 Featuring Lacy Hunt
The Fed Has Put Itself Out of Business, Where to Now?
...The Fed’s failure to address over-indebtedness has caused irreversible damage to the economy. When debt levels rise past a certain threshold, additional debt-financed stimulus becomes ineffective. Worse yet, when an economy becomes extremely indebted, monetary policy stops working altogether.
I often get asked if I am still a deficit hawk. The answer is, “Yes, more than ever,” because current debt levels are rendering monetary and fiscal policy ineffective. And that, my friends, is a game-changer.
...As Lacy says, “By allowing the country to become extremely over-indebted, the Fed has put themselves out of business.”
....Future tax cuts and other fiscal measures may generate spurts of growth, but given the debt burden, it will fizzle out shortly thereafter.
...The composition of our debt is becoming increasingly inferior. We have the wrong type of debt. We’re taking on debt that is not going to generate an income stream, and that feeds financial speculation. That may benefit some, but not the society at large.
...Economists have been perplexed by the absence of growth and inflation over the past decade. The unproductive nature of the debt being borrowed goes a long way to explaining why.
... In 1997, $1 of new [money] increased GDP by $2.20. [Now] it is $1.43. This reflects the fact that we have too much of the wrong type of debt... if money is being used for unproductive purposes and doesn’t generate an income stream, velocity will fall.
...Velocity can also tell us about the long-term direction of bond yields. As velocity is a main determinate of nominal GDP, and yields track nominal GDP, Lacy believes that the secular low for interest rates are not in hand: “In my view, we will not see the secular low in interest rates until the velocity of money reaches its secular trough, and that is not something that’s going to happen soon.”
..While the debt burden is putting downward pressure on velocity, which is dampening growth, it is also incapacitating monetary policy.
...Again, the reason why inflation and growth have remained anemic despite record-low interest rates and multiple rounds of QE is the over-indebtedness of the US economy....you have to look to the money multiplier. The money multiplier is the amount of money that banks generate with each dollar of reserves. Due to the over-indebtedness of the economy—or more precisely, the lack of “savings”—the multiplier has plunged from 12.1 in 1985, to 3.6 today.
... the five rate hikes since December 2015 have produced a noticeable slowing in the growth of the money supply and several important areas of bank lending.
Given the strong impact the five 25-basis-point hikes have had on the money supply and bank lending, I am highly doubtful that the Fed can continue on their current tightening path.
... how will the coming wave of retirees, which will significantly increase mandatory spending, affect the measures I discussed in this letter?
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