Thankfully we've made it through what was likely the biggest event in the history of mankind with yesterday's earnings from NVIDIA and thankfully for mankind, their earnings beat and they guided higher.
Yields rose a few bps heading into FOMC minutes and held those yield increases. Those minutes generally highlighted the risk of cutting too quickly and that the Fed will be data dependent (as if there is ever a time decisions are made without any data).
Biden forgiving more student loan debt had me thinking about one of my favorite theories, the fiscal theory of the price level.
Eric Leeper, a fiscal theory proponent, and UVA professor, was a recent guest on the MacroMusings podcast. If you're looking for a theory of inflation and perhaps a different perspective on whether inflation be stickier than thought, here were some of Leeper's thoughts (with my emphasis added).
- [On dismissing other factors for inflation]. We focus on the single cause, a large increase in federal COVID-related spending financed by new government borrowing, with little to no discussion of how, ultimately, to pay for the spending.”
- [On relative price changes vs. inflation] Inflation, by definition, is a steady increase in overall prices. We often look at things that are happening at high frequency, various shocks that hit the economy, that can move relative prices around. Then, it's convenient to say, "Oh, they must have caused inflation." And it's certainly true that if the price of goods suddenly goes up relative to services, ..... But that can't be sustained. Eventually, they will adjust their habits to accommodate what's happened to the relative prices. And so, those kinds of shocks to the economy are inherently going to have transitory effects on inflation. Then, the other side of this, which you already alluded to, is that people still have to have the income to buy the stuff when the relative prices have gone up. Where is that coming from? To me, that's really getting at what the fundamental cause of the overall inflation is. As you suggested, I think it was because we handed out a lot of transfer payments to businesses and individuals in the economy.
- [On general FTPL] one of the themes of the fiscal theory of the price level is that inflation is always and everywhere a monetary and fiscal phenomenon....Critically, the atmosphere around fiscal policy was different than it often is....And, if you lay on top of that the idea that President Trump had his name on some of the checks, it was pretty clear that these transfer payments were meant to be gifts. They weren't meant to be loans that would have to be paid back with interest in higher taxes in the future. You don't typically put your name on a check when it has attached an IOU for future taxes. That communicated to people that their permanent income had gone up. Well, they're going to want to translate that permanent income into consumption. That's what standard economic theory tells you.
- [On fiscal dominance] What happens is that the government issued $5 trillion in new debt. There was no expectation that primary surpluses were going to rise in the future to pay off that debt. So that debt has to be revalued, has to be devalued, which happens through a combination of lower bond prices and a higher price level. That's because, basically, the current value of the goods that will support those new debt issuances hasn't changed, and so the real value of debt can't change.
- [On the Fed's current role in fighting inflation] what has happened is that Congress did what we call an unbacked fiscal expansion, and then turned to the Fed and said, "Okay, now you mop it up." But what the theory tells us is that, in the absence of some kind of fiscal consolidation that ultimately raises primary surpluses to soak up that debt, there's nothing the Fed can do to permanently offset the inflation. They can change the timing of it. And so what the theory tells us is that the Fed's increase in interest rates serves to reduce inflation, at the time, by pushing it into the future.
- [On the role Interest on Govt Debt can lead to inflation] the Fed has raised the interest rate. And so, what we're now seeing— another way of thinking about what's going on right now— is that interest payments on the debt are exploding. Then, the question becomes, how are those interest payments going to get financed? So far, they've been financed by just issuing new debt. If that continues, you can expect more inflation. If, on the other hand, what happens is that Congress starts to see that they've got to pay the bills from borrowing, and therefore they can't spend money in other ways that they would like to spend it, then they do something to either raise revenue or cut spending. How those interest payments get financed is, I think, the critical question for thinking about inflation going forward
- [On the fundamentals of FTPL] nobody disputes that Treasury bonds are a liability of the government. Nobody disputes that the bank reserves that the Fed created to buy government bonds are also a liability of the government. Both of these liabilities these days pay interest. Then, you've got to think, what are the offsetting assets? If the government's going further into debt, there have to be assets that offset that. That's where the primary surpluses come into play. And those assets don't have to be present today. There has to be some assurance that, as these bonds mature, those assets will be present. And so, that's the other way to think about it. We think about those assets as being denominated in units of goods. The liabilities, though, are denominated in dollars. So, the price level can adjust to equate the real value of those liabilities to the real value of the assets that back them
- [On fiscal sustainability] I think there are just some very troubling signs coming from the bond market....he $1 trillion-plus that we'll have in the deficit that has to be financed and the fact that the Fed is undertaking QT and putting more bonds into the system. Easily, we have to finance about $10 trillion, which is roughly a third of the stock, in one year.....And to be honest with you, I did paint a grim picture, but deep down inside, I actually believe that, when interest payments get high enough, even a highly dysfunctional Congress will do the right thing.....And I think that they all recognize that you can't just make marginal changes, that something fundamental has to change. And I'm sure that entitlements would be part of that, and maybe there'd be some other taxes, maybe a consumption tax. But the resistance to taxes in the United States is so fundamental to our nature.
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