The Scourge of Fiscal Dominance

The Daily Reckoning presents... [Morning Reckoning] May 30, 2024 [WEBSITE]( | [UNSUBSCRIBE]( The Scourge of Fiscal Dominance Asti, Northern Italy May 30, 2024 [Sean Ring] SEAN RING Good morning Reader, Thomas Jefferson would’ve pooped his pants if he saw what Congress is doing right now. There should be no such thing as fiscal dominance; fiscal policy should be frugal. Spend enough to keep the lights on and let the people drive the economy. Jefferson would’ve hated our Hamiltonian central bank as well, rap musicals be damned. But over the past few years, we've learned that printing money didn’t cause consumer price inflation (in our everyday definition of inflation). What caused consumer price inflation was reckless fiscal spending, much to the chagrin of many economists of the Austrian school. I include myself in this group. Consumer price inflation following money printing and unchecked credit expansion (the Misesian definition of inflation) has been seen throughout history. But that didn’t happen this time. It didn’t happen because that credit expansion never reached the people. It stayed in the banks. However, thanks to reckless fiscal policy, the stimulus checks went straight into people’s pockets, and Biden’s social spending further blew out the deficit. Let’s take the time today to understand the difference between monetary and fiscal policy and why money printing in the 2010s didn’t set off consumer price inflation. [NEW: Urgent Warning About The U.S. Stock Market]( [Click here to learn more]( If you currently have money in the market… Or you’re thinking of buying stocks soon… Then you need to watch this immediately. [LEARN MORE]( What is Fiscal Dominance? Fiscal dominance occurs when a government's fiscal policy (taxing and spending) precedes monetary policy (control of money supply and interest rates). In essence, the central bank becomes subordinate to the government's fiscal needs. This creates substantial inflation for several reasons: When the government increases spending significantly without a corresponding increase in tax revenue, it leads to large budget deficits. To cover these deficits, the government may rely on the central bank to print more money (known as "monetizing the debt"). If not matched by an increase in goods and services, this increase in the money supply leads to inflation. Speaking of fiscal dominance… I had a rousing discussion with my colleague, Jim Rickards, on this topic at our Whisky Bar discussion last night. We also talked about where America is failing right now… and our hopes for America’s future. You can check out the replay of our Whisky Bar by [clicking here](. Mechanisms: From Congress to the People Let’s look at how fiscal policy passes money from Congress straight to the people: - Legislation: Congress passes spending bills, deciding where and how much money should be spent. This could include infrastructure projects, social programs, or direct stimulus payments. - Treasury Issuance: To fund these expenditures, the Treasury issues debt through bonds. - Central Bank Purchases: The central bank (e.g., the Federal Reserve in the US) buys these bonds, injecting money into the economy. This is done through open market operations. - Distribution of Funds: - Government Programs: Funds flow through various federal and state programs, such as Social Security, unemployment benefits, and healthcare. - Direct Transfers: Direct payments (e.g., stimulus checks) are sent to individuals and businesses. - Bank Deposits: The funds eventually land in bank accounts, increasing the money supply and liquidity in the financial system. - Spending and Investment: Individuals and businesses spend or invest this money, boosting demand for goods and services. As a result, we had an inflation rate not seen since the 1970s. The Fed then hiked rates to quell the higher prices, but the inflation story isn’t over yet. Now, let’s examine why the Fed’s printing money didn’t create higher consumer prices. Limited Consumer Price Inflation in the 2010s The Fed's QE programs involved buying large amounts of financial assets, which increased bank reserves. However, banks didn’t significantly increase lending due to stricter lending standards and a lack of creditworthy borrowers. The velocity of money (how quickly money circulates in the economy) remained low. High bank reserves didn’t translate into proportional increases in consumer spending. The increased money supply largely stayed within the financial system, boosting asset prices (stocks, real estate) rather than consumer goods and services. Globalization and technological advancements kept production costs and consumer prices low. Cheap imports from countries with lower labor costs helped keep inflation in check. The period saw relatively high unemployment and underemployment rates that limited wage growth. Without significant wage increases, consumer spending power remained constrained. Long-term inflation expectations remained anchored due to credible Fed policies and the aftermath of the financial crisis. This anchoring effect prevented a significant rise in consumer prices despite increased money supply. While fiscal dominance leads to high inflation through increased government spending and money printing, the Fed's expansionary monetary policy from 2009 to 2020 failed to generate significant consumer price inflation because of low bank lending, global economic conditions, and anchored inflation expectations. So what happened to all that money? Banks primarily held onto the excess reserves created by the Federal Reserve’s quantitative easing (QE) programs rather than lending them out. Here’s a detailed breakdown of what banks did with these excess reserves: Holding Reserves at the Federal Reserve The Fed began paying interest on excess reserves (IOER) in 2008. This incentivized banks to hold their excess reserves at the Fed rather than lending them out. The IOER provided a risk-free return, making it an attractive option for banks. This may be the dumbest Fed policy ever. IOER is now the Interest Rate on Reserve Balances (IORB), which is 5.40%. Yes, the Fed prints money and gives it to the banks. The banks then give it back to the Fed and earn interest on it. Asinine. Lending and Investment In the aftermath of the 2008 financial crisis, banks became more risk-averse, tightening their lending standards. They feared defaults and were more cautious about extending credit to individuals and businesses. During the recovery period, demand for loans was relatively weak. Businesses and consumers were deleveraging and were more focused on paying down existing debt rather than taking on new loans. Instead, banks invested in low-risk government securities (such as Treasury bonds). These assets were considered safe and provided a stable return. Some banks also invested in high-quality corporate bonds, seeking higher returns while managing risk. Impact on the Economy Banks used excess reserves to bolster their liquidity positions. This was partly in response to new regulatory requirements (e.g., Basel III) that mandated higher liquidity and capital standards to ensure financial stability. The presence of substantial excess reserves, along with low interest rates, contributed to a search for yield, also called “chasing yield.” It led to increased investment in financial markets, inflating asset prices such as stocks and real estate, rather than translating into higher consumer price inflation. Why Excess Reserves Did Not Lead to Significant Inflation The money multiplier effect (whereby initial bank reserves lead to multiple rounds of lending and deposit creation) was weaker. Since banks held onto the reserves rather than lending them out, the potential for money creation was limited. Ongoing economic uncertainties and the slow recovery after 2008 meant consumers and businesses were hesitant to borrow and spend, reducing the impact of excess reserves on the broader economy. Due to factors like technological advancements and globalization, low inflationary pressures globally kept consumer price inflation in check despite the increase in reserves. Wrap Up Banks largely kept excess reserves at the Fed, earning a risk-free return through IOER. They were cautious in their lending practices, invested in low-risk assets, and bolstered their liquidity positions to comply with regulatory requirements. These actions resulted in limited money creation and lending, contributing to the subdued inflation observed from 2009 to 2020 despite the expansionary monetary policy. But now, the USG opens the fiscal spigot, and the people drink deeply. That’s why consumer price inflation was unleashed in 2021 and will continue to be a problem in the coming years. Ensure you invest in assets that’ll rise with inflation, such as some stock market sectors, commodities, crypto, and real estate. All the best, [Sean Ring] Sean Ring Contributing Editor, The Morning Reckoning feedback@dailyreckoning.com X (formerly Twitter): [@seaniechaos]( [Bloomberg: “Elon Musk Will Become a Trillionaire With [This Company]”]( [Click here to learn more]( As soon as December, Elon Musk could take yet another company public… One that could instantly become the biggest IPO in U.S. History… AND make Elon the world’s first trillionaire in one single move. But it won’t just be good for Elon… Because technology analyst Ray Blanco discovered another company… One that could be a hidden “backdoor” way to profit thanks to the ‘trillionaire-making’ company Elon is building right now. [Click here for the full story](. [LEARN MORE]( In Case You Missed It… Laughing Down the Road to Climate Change Hell Greg Guenthner, Editor [Greg Guenthner] GREG GUENTHNER Good Morning Reader, I didn’t find out about my county’s new plastic bag ban until I was left standing dumbfounded with an arm full of groceries at a crowded (and bagless) self checkout station. An annoyed clerk finally walked by and handed me a paper bag, charged me five cents, and sent me on my way. Thanks to the bag ban, I have a new grocery store routine. Every last-minute trip to pick up bread, milk, and bananas now involves me forgetting to return my reusable bags back in my car. I won’t remember this detail until I’m halfway through my shopping, leaving me digging into the pile of brown paper bags at checkout, paying a few extra cents, and swearing I’ll remember those pesky bags on the next trip. For the record, I don’t mind paying an extra dime every time I go to the store. A bag of chips that used to cost a buck goes for $4.99 these days, so a couple of brown paper bags aren’t going to bust my grocery budget. But I did have the distinct feeling that the plastic bag ban wasn’t actually saving anything – not the planet, not sea turtles, and certainly not me. And I didn’t have to dig very deep to confirm my suspicions. A quick search led me to a report from the Freedonia Group examining the effects of a similar single-use plastic bag ban enacted in New Jersey in 2022. The report cites that the ban worked as intended, curbing the use of plastic grocery bags 60% statewide. Of course, this doesn’t tell the full story. The issue is consumers instead started using those thick, reusable polypropylene bags. And – you guessed it – these bags require a lot more plastic (and energy) to make and aren’t even recyclable. Even worse, the report finds most of these reusable bags are only used two to three times on average before they end up in a landfill or lost somewhere in your house. I can relate. My family owns a polypropylene bag that we’ve stuffed with at least two dozen other reusable bags we’ve accumulated over the years. It sits in a closet, and occasionally gets rifled through to find “the big bag” used to gather overdue library books. In the end, unused piles of those non-recyclable bags and forgetful consumers like me are negating any intended positive effects of the plastic bag ban. The final tally for post-ban New Jersey: greenhouse gas emissions increased 500%. Mission accomplished! Cruising for the Climate Even if ban-happy jurisdictions ran the numbers (which they won’t), I doubt the powers-that-be would reverse course. Sucking on soggy paper straws, cutting up six-pack rings, and toting around reusable sacks are the perfect low-effort “solutions” for the social media scrambled minds of the performative climate change generation. Carry your reusable bags at all times. Throw paint at an office building. Sit in the middle of the street. The road to climate change hell is paved with good intentions. The last decade has also brought about a profound shift in the way the media reports on climate issues, which has also managed to leak into the finance world. I won’t even bother to dive into ESG today – that’s a whole other can of worms. But we do need to discuss how the media is reframing every topic as a climate change concern. Don’t like a product or service? Just complain about how it’s a threat to the environment. You can find a perfect example of this phenomenon in the criticisms of Royal Caribbean's new mega cruise ship, Icon of the Seas. The world’s largest cruise ship cost $2 billion and just launched its maiden voyage packed with 7,600 passengers who are currently tearing across the big boat’s six waterslides, seven pools, and (I assume) more than a few seafood buffets. But the launch “sparked renewed concerns about the environmental impact of cruise tourism,” frets a CNBC piece. The boat runs on liquified natural gas, which burns more cleanly than conventional marine fuels. The issue with LNG is it contains high levels of methane, which is what has the climate alarmists up in arms. I’m not sure what anyone can do to please these people. Do they want folks cruising in older boats? No boats at all? Perhaps we could fly all 7,600 passengers to Hawaii instead? Would that produce a smaller carbon footprint? I’m not even going to attempt to crunch those numbers. Thankfully, I’ve found a hidden benefit to the hysteria… Building a “Green” Portfolio Charts don’t lie: The climate complainers are becoming extremely proficient at spotting strong investment candidates. The louder they scream about a company’s environmental issues, the stronger the trend. RCL shares have gained more than 200% off the October 2022 lows, compared to a gain of 37% in the S&P 500. That’s some serious climate change alpha. This little trick doesn’t just work on party boats. If we mosey on over the energy space, you’ll see the dirty coal stocks are beginning to firm up as they approach breakout levels. Arch Resources (ARCH) has posted a nice little run, gaining almost 30% over the last six months. I doubt the clean energy folks are too happy about that! But what about some of the alternative energy names? Will the climate complaint trick work in reverse? Let’s check in on solar. Most of these stocks remain well off their 2021 highs. In fact, the Invesco Solar ETF (TAN) has dropped almost 50% over the past 12 months. Score another point for “team dirty”. If you’re looking to find strong trends in this market, just follow the loudest climate change gripes. It’s the best way to help your portfolio go green. Best, [Greg Guenthner] Greg Guenthner Contributing Editor, Morning Reckoning feedback@dailyreckoning.com Thank you for reading The Morning Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [Sean Ring] [Sean Ring, CAIA, FRM and CMT]( is a former banker and financial educator and is the editor of the Rude Awakening. Sean has trained interns and graduates from Goldman Sachs, Morgan Stanley, Citi, Bank of America, Standard Chartered Bank, DBS (Singapore), the Abu Dhabi Investment Authority (ADIA), Bank Indonesia (the central bank), HSBC, Barclays, RBS, and BlackRock. 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