The Piketty Solution
Last Wednesday, Fed Chairman Jerome Powell held a news conference following the two-day meeting of the Federal Open Market Committee in which he basically stated that the Fed isn’t going to begin to taper now and, moreover, isn’t even going to be thinking about tapering sometime in the future right now but will begin to start thinking about when to start thinking about tapering sometime in the future. Tapering, for those of you who do not follow the Fed closely, would be a slowdown of the Fed’s $120 billion of monthly purchases of US government bonds which dumps nearly $1.5 trillion in cash into the economy every year. As a result, the Federal Reserve’s balance sheet has ballooned to $8.3 trillion. And keep in mind that tapering is not an end to these purchases, it is just a slowdown in such purchases.
This flood of cash has pushed equity markets to all-time highs despite the pandemic (which primarily benefits the wealthy that own equities and other assets) but has recently been accompanied by rising inflation (a burden mostly borne by the poor), which Fed Chairman Powell said was transitory and caused by supply disruptions in defiance of Milton Friedman’s statement that, “Inflation is always and everywhere a monetary phenomenon.” The Wall Street Journal has even speculated that the Fed might be intentionally stoking inflation in order to facilitate the repayment of the ever-growing public debt with inflated dollars, noting that the progressive intelligentsia are promoting this idea.
Well, of course that progressive intelligentsia is promoting the idea of inflating away the public debt. French Marxist economist Thomas Piketty wrote in his book, Capital in the Twenty-first Century, “How can a public debt as large as today’s European debt be significantly reduced? There are three main methods, which can be combined in various proportions: taxes on capital, inflation and austerity. An exceptional tax on private capital is the most just and efficient solution. Failing that, inflation can play a useful role: historically, that is how most large public debts have been dealt with. The worst solution in terms of both justice and efficiency is a prolonged dose of austerity.”
What do we care about what a French Marxist economist thinks about reducing public debt? You need to recall from my commentary of July 20, 2020, What’s so Great about Equality? that Piketty protegees Emmanuel Saez and Gabriel Zucman were advisors to the presidential campaigns of Bernie Sanders and Elizabeth Warren. That is probably where they got the idea of the wealth tax on millionaires that they are promoting now in the Senate. And now, apparently, Piketty’s thinking may be infecting the Fed, as well.
On Friday, July 30th, Fed Governor Lael Brainard reiterated that the Fed would continue bond purchases until it sees “substantial further progress” in getting people back to work. A laudable goal but not one that the Fed’s bond purchases are well equipped to handle (if you believe Milton Friedman – and I do). The US economy is surging and GDP has surpassed its pre-COVID levels, but the economy still has a shortfall of seven million jobs compared to February 2020. Maybe the fact that the stock market is up over 20% above its pre-pandemic levels, bitcoin is up over 450% and that someone awash in cash was willing to fork over $69 million for an NFT (non-fungible token) collage by a virtually unknown artist who goes by the name Beeple will give you an idea where all the cash the Fed is spewing out is going.
But despite all these incredible increases in asset prices, the consumer price index has been very tame. Until now. Fed cash slopping around institutional markets combined with cash payments to citizens by both Presidents Trump and Biden have carried over to price increases in consumer markets. The Bureau of Labor Statistics (BLS) estimates the year over year inflation for June 2021 was over five percent. And while you youngsters out there may have little experience with inflation, us ancianos remember that once inflation gets started it is really hard to get it back under control.
At the height of the pandemic in March/April 2020 some of these extraordinary payments to citizens and monetary accommodation may have been necessary to avoid panic and a complete collapse. But those days are over and the need for a change in monetary policy is becoming urgent. It would be one thing if Fed policy had a significant impact on employment, but it doesn’t. That was proven in the slow recovery of employment after the great recession of 2008, and it is being proven again now.
Monetary policy can only do so much. Add in massive government spending, high taxes and more public debt combined with the roll back of President Trump’s deregulation and you will witness an economic scenario we haven’t seen since the 1970s. and it wasn’t very pretty back then.
Since the end of the Second World War the United States has been a giant among nations with powerful military capabilities and an even more powerful and innovative economy. It not only defeated Nazi Germany and Imperial Japan but stared down the Soviet Union and emerged at the end of the twentieth century as the solitary superpower of the world. But there was another weapon in America’s quiver that was vital to securing that position – the dollar.
The dollar is the world’s reserve currency. This means that the central banks of other nations hold dollars as an asset on their balance sheets and residents of foreign nations use dollars for foreign trade transactions with counterparts in other countries. The fact that foreign nations and their citizens want and need dollars gives the United States a unique ability.
The United States can borrow in dollars and create dollars to service that debt (as it is doing right now) so there is no risk of default. Most other nations lack this capability, their domestic financial markets are too small to finance their needs and foreigners don’t want to hold their pesos, rupees, ringgits or dinars. So they must borrow in dollars. Sure they can borrow in Euros or Yen or pounds, but mostly it’s in dollars. For a more detailed explanation of this market you can go to my July 6, 2016 commentary Another reason Mr. Trump (as well as Mrs. Clinton) is wrong about trade.
The US’s position as the principal monetary power in the world is pretty secure. The Euro showed its weakness after the Great Recession because all the Euro countries have their own monetary interests and policies and that makes it almost impossible to coordinate monetary policy. The British Pound and Japanese Yen are also used as reserve currencies and for international transactions, but their markets are not big enough to supply all the liquidity the market needs. And anybody that thinks that they can use the Chinese yuan (especially the digital version) must be willing to let the Chinese Communist Party see every transaction they do.
But although the dollar’s position as the world’s reserve currency is strong compared to other currencies, this position is not impregnable. The British pound once held the dollar’s enviable position. Basic economics states that it is prices that intermediate supply and demand (this is the part that socialists forget). If we increase the supply of dollars without a change in demand, then the price of the dollar will fall, and the price of goods and services will rise. Imported goods will also become more expensive increasing inflationary pressures. And if inflation starts running rampant in the US, demand will likely fall not only for dollars but also for US bonds for the precise reasons pointed out by Thomas Piketty. And boy have we ever increased supply. Just take a look at this chart on the growth of the money supply since 1960 from the website of the St. Louis Fed.
China’s currency, the yuan, is unlikely to replace the dollar as the top reserve currency, especially since the digital yuan will be able to track every purchase and develop social credit scores for Chinese citizens and anyone else using the yuan. But the Chinese would dearly love to see the dollar knocked down a few pegs. The Chinese Communist Party views the United States as a declining power, riven with internal dissent, with a faltering economy and an exhausted military with decrepit equipment. A weakening of the dollar’s role as the world’s reserve currency would fit into this scenario, damaging our international reputation and weakening the commercial ties that help bind the Western Alliance together. The Piketty solution would cause more problems than it would solve just like other progressive solutions to the challenges we face. Fed Chairman Powell needs to take that into consideration in changing the direction of monetary policy, and sooner rather than later.