In the battle between government and the hedge fund gamblers – the government has all the cards

Given my inflation report yesterday, I have shifted my usual Wednesday light blog post day and music feature to today. The economic debate has moved in recent years from ‘when is the government going broke’ to ‘hyperinflation is approaching’. It amazes me how puerile the economic commentary is as journalists and economists seeking headlines trot out headlines about how bad something (insert: insolvency, inflation, whatever is the latest craze) is going to be and what needs to be done about it. Nothing much happens in the real world and they keep their jobs and begin the next mania. Replay. And so it goes. It seems though that within this fictional world, that masquerades as informed economic commentary, subtle changes are underway. Governments worked out that during the GFC, the only weapon they had that would save the system was fiscal policy. They also worked out that large-scale bond buying by their central banks complemented the effective use of fiscal policy and didn’t deliver all the maelstrom that the mainstream New Keynesian textbooks predicted. The pandemic has accentuated that. And now there is this sort of stand-off between the ‘markets’ that were given too much latitude in the pre-GFC period and governments. The market players, who have become accustomed to manipulating government policy to ratify their speculative bets, which delivered massive profits to the hedge funds and the like, are now confronting central banks and treasuries that actually have power and cannot be bullied into delivering such policy ratification. That is progress and interesting to observe.

Monetary policy developments

With all the inflation hysteria about at present, I guess it is a relief from the ‘government is going broke’ narrative that we have morphed out of since the pandemic began.

It was only a matter of time I guess.

And when the latest anxieties provide no data to perpetuate the fear, then I guess we will switch back to the insolvency stuff for a while.

It comes in cycles, that is what I have observed over the course of my career.

There was a Financial Times article (October 26, 2021) – Lagarde set to push back on market bets of eurozone rate rise – which is relevant to what I have been writing about in recent weeks about the way the financial markets try to bully policy makers into pushing up rates and the profits of the gamblers (banks etc) in those markets by invoking inflation fears.

When you examine the voices in this debate – the interest rates must rise lobby – are dominated by the big investment banks who get platforms in the mainstream media (or whose opinions are propagated to the public by compliant journalists).

They tell the public that inflation is already ‘priced in’, which gives the impression that rising interest rates are somehow a fait accompli.

It is one of the biggest cons around and even the public broadcaster falls into the con by regularly having these ‘experts’ on TV and radio to give commentary without disclosing whether their companies (banks etc) would have portfolio positions that would benefit if policy makers followed the advice given by the ‘expert’.

The FT article notes that:

Investors, however, are betting the ECB could begin raising its deposit rate as soon as late 2022. These expectations helped lift Germany’s two-year bond yield from minus 0.78 per cent in August to minus 0.66 per cent on Monday.

Investors is code for speculative gamblers.

The article though discloses that the ECB really is in charge here.

It reports that an ECB official noted that “he did not think the market had “fully absorbed” the central bank’s new guidance on when it will raise rates.”

Which means the ECB is staring down the gambling bullies who will lose significant amounts if the ECB holds its line.

The ECB has made it clear that reates will not increase rates any time soon – before 2024 is not likely.

And the battle between the hype and the reality is, in my opinion, in favour of reality.

As I have noted many times, inflation has to have distributional propagation – the wage-price spiral – for it to become sustained rather than just reflect ephemeral supply constraints.

The FT article reported the comment of one economist – “One of the reasons we are less worried about a tightening of monetary policy in the eurozone . . . is what is happening with wages.”

Wages growth is flat.

And will not accelerate any time soon.

There was also an interesting input this week in the form of the latest Discussion Paper (No 40/2021) from the Deutsche Bundesbank (released October 26, 2021) –
Hitting the elusive inflation target.

Interesting doesn’t mean that it is correct.

It means, rather that the questions posed by the researchers are interesting and suggest paradigmic tension.

The Discussion Paper’s motivation is based on the observation that:

Since the 2001 recession, core inflation has been on average below the Federal Reserve’s implicit 2% target … This phenomenon has become even more severe in the aftermath of the 2008 recession. In other words, the “conquest of US inflation” that started with the Volcker disinflation seems to have gone too far …

In a low nominal interest rate environment, this deflationary bias is a predictable consequence of a symmetric strategy to stabilize inflation, like the one followed by the Federal Reserve until the revision of its framework announced in August 2020 …

We argue that in the current low interest rate environment, it is advantageous for a central bank to be more concerned about inflation running below target than about inflation going above target. A low inflation target should be combined with an asymmetric monetary policy strategy calling for more aggressive actions when inflation is below target than when inflation is above target.

So this is a little step away from the hardline New Keynesian view that monetary policy should be conducted in a symmetric fashion.

I say ‘little step’ because the same sort of New Keynesian nonsense is rehearsed in the paper – which I do not recommend anyone read. I have done the hard yards to filter it.

The point is that while the authors still believe that monetary policy adjustments are an effective way to discipline the economic cycle, they now recognise that the, previously dominant, ‘forward-looking’ approach, where central banks have tightened monetary policy prematurely because they ‘fear’ future inflation, is a costly approach.

Even within the New Keynesian mindset they are manipulating equations to show that it is better to allow inflation to reveal itself as being well above the target before policy should tighten.

Of course, the absence of any discussion of the role the bias in fiscal policy towards surplus generation (fiscal drag) has played in the persistently low inflation environment is telling.

MMTed update

We are close to completing a short new course which we hope to offer in early December, depending on how time plays out.

We are highly resource constrained because we are financially constrained, unlike a currency-issuing government, so things take time to develop.

We also hope to offer the MOOC, which we ran earlier this year again in the not too distant future.

We are also looking for an app developer who is interested in helping us. If you are interested and skilful, please contact me on my usual E-mail or phone addresses and I will fill you in with the details.

We cannot pay any large cheques though!

Music – a (pre)-funky morning

This is what I have been listening to while working this morning.

One of my favourite bands was (is) – Sly & The Family Stone – who defined, in my view, the late 1960s West Coast US sound combining soul, funk and pyschedelic instrumentation.

It was led by the brilliant – Sylvestor Stewart (aka Sly Stone) who many attribute being one of the pioneers of what became funk music in the 1970s.

This single – Everybody Is A Star – was released in December 1969 and I recall as a teenager that it was one of the best things I had ever heard.

It was the b-side to their song – Thank You (Falettinme Be Mice Elf Agin.

The a- and b- side reached number 1 in the Billboard charts in February 1970.

It was compiled on their 1970 – Great Hits – album, which was among my favourites of all time.

The single was classified as – Psychedelic Soul – and was the last release the band made before turning very funky.

That is enough for today!

(c) Copyright 2021 William Mitchell. All Rights Reserved.