"The 'Sugar Rush' Economy"
by Dan Amoss
January is still a ways off, yet many economists have already forecast the types of stimulus plans that might arrive from the federal government and how these plans might impact the economy. So, will the size of the expected 2021 stimulus package surprise on the upside or the downside? I’ll first explore this question. Then I’ll explain its impact on the dollar.
Barring a successful Trump legal challenge to the election results, Joe Biden will take office in January. A Biden administration would likely have to negotiate with a Senate led by Mitch McConnell (though that’s not certain, depending on the outcome of the two runoff elections in Georgia on January 5).
The two men have a long history of negotiating. Each has shown a willingness to let the other side claim a “win” in a compromise, while also getting something they want. Infrastructure and government-supported jobs seem to be Biden’s priorities. A federal judiciary that doesn’t “legislate from the bench” seems important to McConnell. I could imagine a compromise in which McConnell trades Biden a hefty stimulus package for tangible commitments to protect the independence of the judiciary.
Throughout their careers, neither of them has been very concerned about deficits. So we can be fairly confident that federal deficits will remain very high and that the Fed will ultimately fund a large percentage of the deficit in order to suppress yields on Treasury bonds. So the national debt will likely continue to balloon despite predictions of “gridlock” in the federal government. And rapid growth in the debt is a strong source of support for gold. High deficits with heavy spending foster the conditions for rising inflation in the years ahead.
As my colleague Jim Rickards often notes, a jump in inflation is not likely in the near term because money velocity is so low (see below for more). But one thing that could make money velocity jump higher would be broader recognition that federal deficits are out of control and will keep growing at a rate that far exceeds GDP growth.
Why should we expect government deficits and debt to grow at a faster pace than the underlying economy? We’re long past the point when central bank rate cuts can stimulate economies because consumers would simply react by saving more than they already are saving. It’s like raising a kid on a diet with frequent sugar rushes. The economy has become addicted to easy monetary policy and a massive government budget. Tighten conditions for either of these factors, and the economy quickly goes into withdrawal.
Too much stimulus, like too much sugar, has damaging long-term consequences. When an economy’s debt grows, it transfers what would have been future economic activity into the present. So it’s logical to assume that as the stock of global debt soared over the past decade, a large amount of production and consumption activity was pulled from the future to the present. The borrowed-against future eventually arrives and brings with it a collapse in demand for the already-bought items.
So when you see or hear the word “stimulus plan” in the months ahead, imagine a sugar rush. It might yield a satisfying short burst of energy. But there is always a hangover, and there are long-run consequences for the economy. The endgame of this cycle is a radical debasement of the U.S. dollar (and most other paper currencies), which will make precious store metals like gold an excellent store of value.
Below, Jim Rickards shows you why we’re actually in a depression and why neither monetary policy nor fiscal policy can lift us out of it. He also shows you when you can expect to see inflation. Read on.
"Monetary and Fiscal Policy Won’t Work"
by Jim Rickards
"As I’ve argued before, we’re in a new depression. You won’t hear that from mainstream economists. They’ll say we had a recession because of the COVID lockdowns, but they’ll never mention a depression. But, most of them don’t understand what a depression really is. The starting place for understanding a depression is to get the definition right.
Most think a depression must mean an extra-long period of decline. But that's not the definition of depression. The best definition ever offered came from John Maynard Keynes in his 1936 classic "The General Theory of Employment, Interest and Money." Keynes said a depression is "a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse."
Notice that Keynes didn’t refer to declining GDP; he talked about "subnormal" activity. In other words, it's entirely possible to have growth in a depression. The problem is that the growth is below trend. It’s weak growth that doesn’t do the job of providing enough jobs or staying ahead of the national debt. That is exactly what the U.S. has been experiencing for years and is experiencing today.
Monetary and fiscal policy won’t lift us out of the new depression. Let’s first take a look at monetary policy.
It’s the Velocity, Stupid: Fed money printing is an exhibition of monetarism, an economic theory most closely associated with Milton Friedman. Its basic idea is that changes in money supply are the most important cause of changes in GDP. A monetarist attempting to fine-tune monetary policy says that if real growth is capped at 4%, the ideal policy is one in which money supply grows at 4%, velocity is constant and the price level is constant. This produces maximum real growth and zero inflation. It’s all fairly simple, as long as the velocity of money is constant.
But, it turns out that money velocity is not constant, contrary to Friedman’s thesis. Velocity is like a joker in the deck. It’s the factor the Fed cannot control. Inflation is caused by the velocity, or the turnover, of money. Velocity is a psychological phenomenon. It depends on how an individual feels about his economic prospects. The Fed can “print” all the money in the world. But if people don’t actually spend it but save it instead, it won’t create inflation because there’s no velocity. Think of when you tip a waiter. That waiter might use that tip to pay for an Uber. And that Uber driver might pay for fuel with that money. This velocity of money stimulates the economy.
Velocity has been crashing for the past 20 years. From its peak of 2.2 in 1997 (each dollar supported $2.20 of nominal GDP), it fell to 2.0 in 2006, just before the global financial crisis, and then crashed to 1.7 in mid-2009 as the crisis hit bottom. Velocity continued to fall to 1.43 by late 2017, despite the Fed’s money printing and zero rate policy (2008–15).
Even before the new pandemic-related crash, it fell to 1.37 in early 2020. As velocity approaches zero, the economy approaches zero. There is no economy without velocity. The bottom line is, monetary policy can do very little to stimulate the economy unless the velocity of money increases. And the prospects of that happening aren’t great right now, especially as new lockdowns loom. But what about fiscal policy? Can that help get the economy out of depression?
The Broken Keynesian Multiplier: The government will add more to the national debt this year than all presidents combined from George Washington to Bill Clinton. That added debt could increase the U.S. debt-to-GDP ratio to 130%. That’s the highest in U.S. history and puts the U.S. in the same super-debtor’s league as Japan, Greece, Italy and Lebanon.
The idea that deficit spending can stimulate an otherwise stalled economy dates to John Maynard Keynes, who I mentioned earlier. Keynes’ idea was straightforward. When the government spent money (or gave it away), the recipient would spend it on goods or services. Those providers of goods and services would, in turn, pay their wholesalers and suppliers. This would increase the velocity of money. Depending on the exact economic conditions, it might be possible to generate $1.30 of nominal GDP for each $1.00 of deficit spending. This was the famous Keynesian multiplier. To some extent, the deficit would pay for itself in increased output and increased tax revenues. Here’s the problem:
There is strong evidence that the Keynesian multiplier does not exist when debt levels are already too high. In fact, America and the world are inching closer to what economists Carmen Reinhart and Kenneth Rogoff describe as an indeterminate yet real point where an ever-increasing debt burden forces a debtor nation into austerity, outright default or sky-high interest rates.
Here’s how it happens: When the Keynesian multiplier falls below 1, a dollar of debt and spending produces less than a dollar of growth. Creditors grow anxious while continuing to buy more debt in a vain hope that policymakers reverse course or growth spontaneously emerges to lower the ratio. This doesn’t happen. The economy is addicted to debt, and the addiction consumes the addict.
The endpoint is a rapid collapse of confidence in U.S. debt and the dollar. This means higher interest rates to attract investor dollars to continue financing the deficits. Of course, higher interest rates mean larger deficits, which makes the debt situation worse. The result is another 20 years of slow growth, austerity, financial repression (where interest rates are held below the rate of inflation to gradually extinguish the real value of debt) and an expanding wealth gap.
The next two decades of U.S. growth would look like the last two decades in Japan. Not a collapse, just a slow, prolonged stagnation. This is the economic reality we are facing. And neither monetary policy nor fiscal policy will change that.
So, we’re looking at disinflation and deflation for now, despite all the money creation we’ve been seeing. But that doesn’t mean inflation is dead. Not at all. The inflation will arrive, just not yet…
When You’ll See Inflation: Between 2008 and 2014, the Fed created trillions of dollars through quantitative easing. Many analysts sounded the alarm about “inflation” as the inevitable consequence of all that excessive money printing. But, despite all the fears, nothing bad happened.
Inflation actually fell; there was no serious inflation threat. Interest rates fell. There was no “bond bubble” or rout in the bond market. As a result, it seemed that debt didn’t matter after all. That’s why there’s so little resistance to all the money printing we’ve seen since the pandemic started. It’s like the boy who cried wolf. Analysts cried wolf about inflation during the last crisis, but the wolf never materialized. Why should we listen to them now?
But inflation will come when people lose confidence in the dollar and suddenly dump dollars for any hard assets they can find. Money velocity will accelerate, but it won’t be into consumer goods. It’ll be into hard assets that hold their value over time, gold in particular. In other words, the best leading indicator of inflation won’t be found in the grocery store or at the gas pump.
It’ll be found in the dollar price of gold. Of course, higher gold prices mean higher consumer prices since higher gold prices mean a weaker dollar. More dollars will be required to buy the same amount of goods. When gold pushes past $2,000 per ounce toward $3,000, that’s your signal that inflation in the price of everything else is not far behind. Don’t wait until that happens. Buy your gold now while it’s still affordable (about $1,860)."
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"The General Theory of Employment, Interest and Money",
by John Maynard Keynes, here:
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