Monetary Hockey Stick
Washington DC, Dallas, and Puerto Rico
The US, Europe, and most of the developed world on are the road to Japanification. Like I wrote last week, we will see financial repression, ever increasing deficits, slower growth, etc. Essentially, the rest of us will begin to look like Japan with its astronomical deficits and ultra-dovish monetary policy.
I tried to emphasize this is not the end of the world. It’s not the best world, either, but we’ve gone too far to come back now. There is no significant constituency for any of the things it would take for the US government to balance its budget. Neither party wants to reduce the deficit, and the MMT fans want to make it even bigger.
That means the rules of investing we have come to know over the last 50 years are likely—as in very, very likely—to change. But we should generally do fine as long as we change our own investment strategies accordingly.
Ben Hunt over at Epsilon Theory recently riffed on Stanley Kubrick’s 1964 masterpiece, Dr. Strangelove or: How I Learned to Stop Worrying and Love the Bomb. He did a great parody with it called, Modern Monetary Theory: How I Learned to Stop Worrying and Love the National Debt.
Could we actually see Modern Monetary Theory in the US? Lacy Hunt in his latest quarterly explains how it is theoretically possible for the Treasury Department to issue zero maturity, zero interest bonds to the Fed, which would then deposit dollars into the Treasury bank account. This would, at a minimum, create inflation and possibly hyperinflation. To say it would be destructive is like comparing an ocean breeze to a category five hurricane. It would in fact be a financial disaster of biblical proportions.
I don’t believe it will happen that way, though. We will instead run up debt the old-fashioned way: Japanification and massive amounts of quantitative easing. Let’s look at how that might play out.
The Financial Times has a very helpful graph using Congressional Budget Office data showing the deficit as a percentage of GDP, both in the past and forecast for the next 10 years. (You can see the underlying CBO report here.)
When you realize that the GDP is well over $20 trillion now, and the CBO projects the GDP to grow, this chart visually understates the reality of growing deficits. Let’s look at another helpful chart, which actually shows the dollar amount of the projected deficits.