My series against Cassandras has inspired many interesting discussions with readers and I have already addressed two responses in posts before my summer hiatus.
Sep 12, 2023·edited Sep 12, 2023Liked by Joachim Klement
Your in-depth discussion of the nature and causes of inflation is always stimulating. In particular you are refreshingly frank in admitting that few know what is really going on, and those that do are keeping that knowledge to themselves. In such circumstances I usually fall back on the KISS principle as exemplified by the Latin phrase "Cui bono?" The fact stands that indebted governments have everything to gain from devaluing their currencies, and thereby their debt. The problem arises when inflation damages the economy. This is the mustang they are riding
Agreed. Which is why I think the monetary policy suggested here will be necessary. It will induce much more volatile economic development and more volatile financial markets, but it is one of the only ways to devalue government debt.
Very interesting and makes sense that this may work on the monetary policy side. But one element that would not be "held constant" is the impact of this monetary policy on tax receipts and government debt. Reduced economic activity will collapse tax receipts in the US at the same time that interest expense is outstripping tax receipts. This may be the achilles heel that causes the debt bomb spiral.
Could be and indeed a point, I haven't thought about in detail..
But my spontaneous response would be that tax receipts are correlated with inflation and if inflation outruns interest rates (i.e. negative real rates) then I think a government can avoid that spiral. Of course, in a recession, tax receipts drop, but they catch up again in boom times,. And the long-term average trend growth (which determines long-term average tax receipts). But real trend growth depends mostly on demographics and productivity growth, not the level of debt the government has.
Luke Gromen has made this point (tax receipts) since a year or so. He adds to the issue an ever growing (unproductive) US defense budget, growing (unproductive) gov liabilities, declining demograpics and productivity. The only things that are growing it seems are debt and inequality. Politically a very interesting mix...
I can see JK’s argument: that a nation state which issues its own currency - USA, UK, Japan - can issue more of its own currency as a basis for more Debt.
Without disagreeing my concerns include (1) the interest payable is a drain on the future resources of that state, more so if it has to issue Debt at a higher interest rate in the future refinancing on maturity; (2) can we say that perpetual Debt is sound? Will it be capable of refinance indefinitely? (3) Will the currency be debased by more Debt involving issue of more currency? (4) States usually rely on ‘fiscal repression’ - reduce the real value of the Debt by holding interest rates down below inflation - and will the citizens object to this? (5) Yield curve control: The state could seek to reduce the harm of inflation by increasing short term interest rates as JK suggests, at risk of engineering a recession. Will the citizens stand for this if it is severe? (6) The state may have to increase taxes to pay its obligations, including interest on Debt. Will the citizens object to this?
It is interesting to read David Hume’s argument. Taking account of the comparative unsophistication of the 18th century, his arguments can still resonate today. We cannot simply dismiss them. There can come a point where the Debt and associated obligations give rise to a ‘Minsky moment’ where it collapses.
I am not an economist and there may be rational answers to this.
This is too much for JK to answer in a single post, but I shall be interested in his views.
Let’s look at the heatmap of the main bonds: https://www.tradingview.com/markets/bonds/yields-major/ The inversion of USA Germany France EU Canada and UK is clear and I can’t help but think that it is a consequence of what you wrote, even though it should be argued better. India cannot be considered a mature market. Japan and Italy are separate cases for opposite reasons. Japan did not raise rates as you explained well and left its policy almost unchanged. Italy suffers from political and economic uncertainty whose effect would require a specific intervention.
Your in-depth discussion of the nature and causes of inflation is always stimulating. In particular you are refreshingly frank in admitting that few know what is really going on, and those that do are keeping that knowledge to themselves. In such circumstances I usually fall back on the KISS principle as exemplified by the Latin phrase "Cui bono?" The fact stands that indebted governments have everything to gain from devaluing their currencies, and thereby their debt. The problem arises when inflation damages the economy. This is the mustang they are riding
Agreed. Which is why I think the monetary policy suggested here will be necessary. It will induce much more volatile economic development and more volatile financial markets, but it is one of the only ways to devalue government debt.
Very interesting and makes sense that this may work on the monetary policy side. But one element that would not be "held constant" is the impact of this monetary policy on tax receipts and government debt. Reduced economic activity will collapse tax receipts in the US at the same time that interest expense is outstripping tax receipts. This may be the achilles heel that causes the debt bomb spiral.
Could be and indeed a point, I haven't thought about in detail..
But my spontaneous response would be that tax receipts are correlated with inflation and if inflation outruns interest rates (i.e. negative real rates) then I think a government can avoid that spiral. Of course, in a recession, tax receipts drop, but they catch up again in boom times,. And the long-term average trend growth (which determines long-term average tax receipts). But real trend growth depends mostly on demographics and productivity growth, not the level of debt the government has.
Luke Gromen has made this point (tax receipts) since a year or so. He adds to the issue an ever growing (unproductive) US defense budget, growing (unproductive) gov liabilities, declining demograpics and productivity. The only things that are growing it seems are debt and inequality. Politically a very interesting mix...
I can see JK’s argument: that a nation state which issues its own currency - USA, UK, Japan - can issue more of its own currency as a basis for more Debt.
Without disagreeing my concerns include (1) the interest payable is a drain on the future resources of that state, more so if it has to issue Debt at a higher interest rate in the future refinancing on maturity; (2) can we say that perpetual Debt is sound? Will it be capable of refinance indefinitely? (3) Will the currency be debased by more Debt involving issue of more currency? (4) States usually rely on ‘fiscal repression’ - reduce the real value of the Debt by holding interest rates down below inflation - and will the citizens object to this? (5) Yield curve control: The state could seek to reduce the harm of inflation by increasing short term interest rates as JK suggests, at risk of engineering a recession. Will the citizens stand for this if it is severe? (6) The state may have to increase taxes to pay its obligations, including interest on Debt. Will the citizens object to this?
It is interesting to read David Hume’s argument. Taking account of the comparative unsophistication of the 18th century, his arguments can still resonate today. We cannot simply dismiss them. There can come a point where the Debt and associated obligations give rise to a ‘Minsky moment’ where it collapses.
I am not an economist and there may be rational answers to this.
This is too much for JK to answer in a single post, but I shall be interested in his views.
Let’s look at the heatmap of the main bonds: https://www.tradingview.com/markets/bonds/yields-major/ The inversion of USA Germany France EU Canada and UK is clear and I can’t help but think that it is a consequence of what you wrote, even though it should be argued better. India cannot be considered a mature market. Japan and Italy are separate cases for opposite reasons. Japan did not raise rates as you explained well and left its policy almost unchanged. Italy suffers from political and economic uncertainty whose effect would require a specific intervention.