'..Lacy once told me that he had to "unlearn" nearly everything he was taught in school about economic(s).''Dr. Lacy Hunt: I think that the main element suppressing growth is the heavily leveraged U.S. economy. We have too much public and private debt, and this debt does not generate an income stream for the aggregate economy. As a result of the prolonged indebtedness, which is on the verge of going much higher because of problems in the governmental sector, the economy is now experiencing very poor demographics. We have a baby bust, a household formation bust, and the lowest birth rate since 1937. These demographics are exacerbating the problems because we have too much of the wrong type of debt and thus the velocity of money has been falling since 1997. Velocity this year is only 1.43 percent, which is the lowest since 1949. Furthermore, the debt creates a situation where monetary policy capabilities are asymmetric. In other words, a lot of action is needed to provoke even a muted impact on the economy, whereas the slightest monetary tightening goes a long way in depressing economic activity. So the root cause of this underperformance is extreme indebtedness.
FRA: And what about the Federal Reserve? How has it undermined the economy’s ability to grow?
Dr. Lacy Hunt: The Fed’s most serious mistake was made in the 1990s up until 2006 during which they allowed the private sector to become extremely over-indebted with the wrong type of debt. And, in essence, I think that quantitative easing, through the push for higher stock prices, created more problems than it has solved for the economy. QT caused the corporate executives to switch funds from real capital investments into financial investments through the paying of higher dividends, buying shares of their own companies, and buying back their shares from others. While this type of action does produce a higher stock market; it doesn’t generate a higher standard of living. And so, Federal Reserve policy has not improved the economy, although it certainly has well served components of the economy.
..
Another element not in the public understanding, since the Federal Reserve no longer produces this sort of monetary analysis, is a very sharp slowdown in the money supply’s rate of growth, bank loans, and within important credit aggregates. Last year, the M2 money supply was up 7 percent. In the latest 12 months, it decelerated to less than 4.5 percent. The rate of growth in bank loans and commercial paper, which topped out on a 12- month basis about 9 percent, is now under 4 percent. So the Fed is raising the short-term rates, reducing the monetary base, and causing a tightening in the financial side of the economy. Some investors understand what is happening and yet it’s not in the general psyche because such monetary analysis is increasingly rare.
However, another more public indicator is the very dramatic flattening of the yield curve. And when the yield curve flattens in such a way, first of all, it’s a symptom that monetary restraint is beginning to bite. Now, the slowdown in money supply growth and the bank credit flattening of the yield curve will occur well before there is any noticeable impact on a broad array of economic indicators or long lags in monetary policy. But when the yield curve starts flattening, that intensifies the effect of the monetary tightening because it takes away or, at the very least, greatly reduces the profitability of the banks and all those that act like banks. Banks make a profit by borrowing short and lending long. When those spreads recede, bank profitability is hurt, particularly for the higher, riskier types of bank loans since not enough spread exists to cover the risk premium. So the banks begin to pull back, further intensifying the restraint pressing on economic growth. To the vast majority of investors, we have an economy that is apparently doing well, but in fact there are elements right beneath the surface that strongly suggest to me that the outlook for 2018 is considerably more guarded than conventional wisdom implies.
..
For example, when President Reagan cut taxes, government debt was 31 percent of GDP and now that’s 106 percent on its way to 120-125 percent. And so if you go back and if you read Ricardo’s great article in 1821, he was asked whether it made a difference as to whether the Napoleonic wars were financed by taxes or by borrowing. Ricardo said that, theoretically, either way private sector activity was going to be suppressed. Now we have a lot of evidence, including some that I produced, that the government multiplier is negative, not positive, over a three-year period. Thus, the tax cuts may work for a very short while, but not on balance. And if the tax cuts were revenue-neutral and financed by reductions in government expenditures that would be a positive since the evidence shows tax multipliers are more favorable than expenditure multipliers. Such a theoretical proposal would provide greater efficiency for private sector spending and government spending. There’s also evidence that you would lower the cost of capital, but that’s not what we’re talking about is it? We’re talking about a debt-financed tax cut and we’re not talking about a revenue-neutral infrastructure plan, just as we were not talking about a revenue-neutral stimulus package in 2009. We’re talking about the debt-financed variety of tax cuts and at this stage of the game, this will make us more vulnerable, except for a few fleeting instances.
..
..Lacy once told me that he had to "unlearn" nearly everything he was taught in school about economic(s).'
-
Lacy Hunt on the Unintended Consequences of Federal Reserve Policies, December 25, 2017
Context'..Every serious deflation I've looked at is preceded by an asset bubble and then it bursts..'