Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Transitory Inflation Debate - 15th Jun 21
USDX: The Cleanest Shirt Among the Dirty Laundry - 15th Jun 21
Inflation and Stock Market SPX Record Highs. PPI, FOMC Meeting in Focus - 15th Jun 21
Stock Market SPX 4310 Right Around the Corner! - 15th Jun 21
AI Stocks Strength vs Weakness - Why Selling Google or Facebook is a Big Mistake! - 14th Jun 21
The Bitcoin Crime Wave Hits - 14th Jun 21
Gold Time for Consolidation and Lower Volatility - 14th Jun 21
More Banks & Investors Are NOT Believing Fed Propaganda - 14th Jun 21
Market Inflation Bets – Squaring or Not - 14th Jun 21
Is Gold Really an Inflation Hedge? - 14th Jun 21
The FED Holds the Market. How Long Will It Last? - 14th Jun 21
Coinbase vs Binance for Bitcoin, Ethereum Crypto Trading & Investing During Bear Market 2021 - 11th Jun 21
Gold Price $4000 – Insurance, A Hedge, An Investment - 11th Jun 21
What Drives Gold Prices? (Don't Say "the Fed!") - 11th Jun 21
Why You Need to Buy and Hold Gold Now - 11th Jun 21
Big Pharma Is Back! Biotech Skyrockets On Biogen’s New Alzheimer Drug Approval - 11th Jun 21
Top 5 AI Tech Stocks Trend Analysis, Buying Levels, Ratings and Valuations - 10th Jun 21
Gold’s Inflation Utility - 10th Jun 21
The Fuel Of The Future That’s 9 Times More Efficient Than Lithium - 10th Jun 21
Challenges facing the law industry in 2021 - 10th Jun 21
SELL USDT Tether Before Ponzi Scheme Implodes Triggering 90% Bitcoin CRASH in Cryptos Lehman Bros - 9th Jun 21
Stock Market Sentiment Speaks: Prepare For Volatility - 9th Jun 21
Gold Mining Stocks: Which Door Will Investors Choose? - 9th Jun 21
Fed ‘Taper’ Talk Is Back: Will a Tantrum Follow? - 9th Jun 21
Scientists Discover New Renewable Fuel 3 Times More Powerful Than Gasoline - 9th Jun 21
How do I Choose an Online Trading Broker? - 9th Jun 21
Fed’s Tools are Broken - 8th Jun 21
Stock Market Approaching an Intermediate peak! - 8th Jun 21
Could This Household Chemical Become The Superfuel Of The Future? - 8th Jun 21
The Return of Inflation. Can Gold Withstand the Dark Side? - 7th Jun 21
Why "Trouble is Brewing" for the U.S. Housing Market - 7th Jun 21
Stock Market Volatility Crash Course (VIX vs VVIX) – Learn How to Profit From Volatility - 7th Jun 21
Computer Vision Is Like Investing in the Internet in the ‘90s - 7th Jun 21
MAPLINS - Sheffield Down Memory Lane, Before the Shop Closed its Doors for the Last Time - 7th Jun 21
Wire Brush vs Block Paving Driveway Weeds - How Much Work, Nest Way to Kill Weeds? - 7th Jun 21
When Markets Get Scared and Reverse - 7th Jun 21
Is A New Superfuel About To Take Over Energy Markets? - 7th Jun 21
Why Tether USDT, Stable Scam Coins Could COLLAPSE the Crypto Markets - Black Swan 2021 - 6th Jun 21
Stock Market: 4 Tips for Investing in Gold - 6th Jun 21
Apple (AAPL) Summer Correction Stock Trend Analysis - 5th Jun 21
Stock Market Sentiment Speaks: I 'Believe' We Rally Into A June Swoon - 5th Jun 21
Stock Market Russell 2000 After Reaching A Trend Channel High Flags Out - 5th Jun 21
Money Is Cheap, Own Gold - 5th Jun 21
Bitcoin and Ravencoin Cryptos CRASH Bear Market Buying Levels Price Targets - 4th Jun 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