If you regularly read this post, you know that as recently as last week I wrote about the strong correlation between the Federal Reserve’s expanding balance sheet and the continued rise of stocks.
For newer readers who may not be familiar with what expanding the Fed’s balance sheet might actually mean, it simply means the Fed is printing money.
Historically speaking, the pursuit of this policy never ends well. And, once the practice starts it’s a very slippery slope and extremely difficult to stop. But, the practice can’t go on forever. As the late economist, Herbert Stein said, “if something cannot go on forever, it will stop.”
Simple, but profound.
This past week, Societe Generales strategist, Albert Edwards commented on this practice and also forecast what’s next in his view. For those unfamiliar, Societe Generales is a French-based, multi-national investment bank.
Mr. Edwards stated that he believes the Fed’s fondness for “pouring more and more liquidity” into the markets will ultimately lead to a deflationary bust. When the bust occurs. Mr. Edwards predicts the Fed will turn to negative interest rates to try to recover.
For the uninitiated reader, “pouring more and more liquidity” simply means to print money. (Note: There are a lot of ways to say that without actually saying it>)
In a letter to the bank’s clients, Edwards called the Fed’s actions a “new level of fiscal debauchery for the US” that won’t stop. Obviously, if you’ve been reading this weekly update for any length of time, you know that I agree.
This from the article (Source: https://moneyandmarkets.com/albert-edwards-nirp-mmt/) (emphasis added):
And when the crash comes, Edwards predicts the only thing the Fed will be able to do is to engage in negative interest rate policy (NIRP).
“(I’m) now more convinced than ever before that the coming deflationary bust will take the US 30-year yield below zero,” he said. “I am also convinced that helicopter money will be the chosen way out of this deflationary quagmire, especially as it becomes increasingly clear that there is now no way left to reverse every government’s exploding fiscal liabilities. The Ice Age is nearing the end.”
Looking around the world, negative interest rates are now the norm in Japan and parts of Europe. Around $11 billion of global sovereign debt is yielding in the negative currently, and U.S. President Donald Trump has blasted the Fed in the past for not being more open to trying NIRP.
Edwards also thinks Modern Monetary Theory (MMT), aka “helicopter money” is inevitable as well, which backers of the policy believe is OK to use as long as inflation doesn’t balloon out of control.
On the surface, it’s difficult to reconcile money printing with a deflationary bust that sees many asset prices, particularly financial asset prices plummet. When one thinks about money printing, inflation is the anticipated outcome in the minds of most people.
Technically defined, deflation is a contraction of the money supply. So if the Fed is continuing to print, how can we have a deflationary bust?
The answer is that most money today is debt. Many analysts would tell you that more than 95% of money today is debt. In other words, it’s only money as long as the borrower pays the debt. As soon as the borrower defaults, it’s no longer money.
Here’s an example that could have taken place about a decade ago to make the point clear.
A banker loans a home buyer $200,000 to buy a $250,000 house. The home buyer signs a promissory note agreeing to pay the banker $200,000 over time, per the terms of the promissory note.
Now, let’s say that due to the hefty decline in home prices, the home buyer decides to move out of the house and default on the note.
The bank has taken the home as collateral for the note but finds the house is now worth only $175,000 on the open market.
The bank had $200,0000 in cash and loaned it to the home buyer. Now, after selling the home for $175,000, the bank finds its assets have diminished by $25,000. That money has simply disappeared, or as we like to say, it went to money heaven.
That’s deflation.
A little more than a decade ago, we had a deflationary bust that saw the stock market crash. It was the second crash within a ten-year time frame. The first crash saw the Federal Reserve reduce interest rates to around 1%. It had the desired effect.
Since money is loaned into existence, significantly lower interest rates resulted in more borrowing and more money creation. Gradually the Fed increased interest rates until they reached 5% in 2007. Then the next crash hit.
The Fed’s response was predictable. They reduced interest rates, this time to zero. The desired outcome of more money creation didn’t happen. So what did the Fed do?
They began printing money and using the newly created money to buy assets from banks. On and off for the past 10 years, the Fed has been chasing this policy. Most recently, since mid-September, the Fed has been expanding it’s balance sheet to keep the repo market (the overnight lending market between banks) operating.
Mr. Edward’s point is that the next crash will require an even more radical response than printing money to give to banks. He says that money will be printed and given to consumers. This is also known as ‘helicopter money’ a phrase coined by the late economist Milton Friedman. It simply means that large amounts of money are distributed to the public to stimulate the economy and get growth.
Edwards makes the case for negative interest rates and helicopter money:
“You can call it Modern Monetary Theory (MMT), you can call it ‘Fiscal and Monetary Co-operation’ or you can call it whatever you like, but there is only one realistic way out of this mess – and that is for governments to inflate away their debts.
Does anyone seriously believe that any democratically-elected government would be willing to raise taxes or cut government spending and future pension/health benefits in a bid to delay the fiscal timebomb? Of course, they wouldn’t! Any government that attempts to do so will be hounded from office by an indignant public armed with pitchforks and much else besides.”
Edwards is of the opinion that governments won’t be able to resist the power a tool like MMT could provide,
“Helicopter money will work for Joe Sixpack much more effectively than it will for Mike Moneybags and so it will be much more widely popular. Once politicians have their hands on this policy tool, make no mistake, they will never hand it back to the central bank.”
A study of history confirms Edward’s forecast.
It also reveals that it won’t end well.
100% of the time historically speaking, disrespecting currency destroys it.
My forecast?
Look for negative interest rates here sooner than you might imagine.
Once negative rates get here, or perhaps simultaneously, look for helicopter money.
When you see these policies appear, think about getting tangible and maybe even tax-free with some of your investments.
History teaches us that’s how you not only survive but can also potentially prosper.
During the hyperinflation in the Weimar Republic after World War I, when the German government printed money to make reparations payments to the point of destroying the currency, those holding physical assets survived, those with only paper assets perished.
There is a lesson there.