The Bezzle. Either Inflate By $7-$18 Trillion or Bonfire Away $4-$8 Trillion of Paper Wealth. Is This What Velocity is Telling Us?

I am hoping for push-back here, so please poke holes!  Question my assumptions!  Help me think this through!

Looking at the past 20 years, it is clear we have an increasingly fat jockey (wealth) riding a faltering horse (the real economy).  This might continue for some time, but it can’t continue forever.  The resolution is likely to be ugly – either via the fires of asset write-downs or the freezer rot of inflation.

If I were alone in that view, I’d doubt my own judgement or facts or both.  My reading this summer has given me courage to write this post.  A former head of the Bank of England sees those same imbalances (see Mervyn King’s “The Alchemy of Finance“).  Two respected heavy-hitters spotlight “the” major cause of those imbalances (see “Trade Wars Are Class Wars“).  So I’m not alone in seeing those imbalances or worrying about an ugly resolution.   I may well be alone and wrong in the below, but here goes…

Over the last 20 years, the US has pumped a huge volume of dollars into increasingly stagnant pools of non-circulating paper wealth.  The money has piled up much faster than the economy has grown.  Those stagnant pools might give us a rough estimate of “the Bezzle.”  Paper wealth that exists only as long as a financial confidence game lasts.

At any given time there exists an inventory of undiscovered embezzlement [not the illegal kind.  The legal, clever Wall Street kind.  Think 2008’s mortgage backed bond bubble] in — or more precisely not in — the country’s businesses and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

There is a lot more cash-per-dollar-of-GDP sitting around than there used to be.  Since 2008, the amount of money sitting around has doubled (+100%).  The real economy has only grown by half (+50%).  All as measured by declining monetary velocity (see prior post for the velocity data etc. here).

  • Since 2008, GDP has grown 48%.  Money has grown by 94%.
  • Since 2000, GDP has grown 115%.  Money has grown by 296%.
  • Most of the “excess” money has been created via the various Fed interventions  especially Quantitative Easing (QE). Fed Chair Ben Bernanke once said;  “The problem with QE is it works in practice, but it doesn’t work in theory.”  In other words, the placebo effect. 
  • All these numbers are up to 2019.  Pre-COVID.
  • “Money” here means ready cash. MZM – US bank deposits, checking accounts, money market funds, etc…   Notably, it does not include money sitting at the Fed (“excess reserves”).

The scale of that mismatch suggests a Bezzle does exist.  The above gives us a guesstimate measure of the (inherently un-measurable) Bezzle.  A lot of paper wealth sitting around that isn’t backed up by the real economy.  An increasingly fat jockey on an increasingly enfeebled horse.

If GDP and money had stayed in rough balance, either GDP today would be much higher or Money would be much smaller.  The difference might give us a rough estimate of the Bezzle.  If we make the (potentially very false) assumption those two number series re-synchronize, then the catch-up-effect requires that…

  • …either nominal GDP grows much faster to catch up with the money supply (inflating away the value of those “Bezzle” assets)
  • …or a big chunk of paper wealth evaporates to shrink “money” back down to proportion with GDP (deflating those “Bezzle” asset values by potentially violent write-downs).

In dollar terms, we either need to write off $4 to $8 trillion of “Bezzle” paper wealth, or inflate the Bezzle away by increasing nominal GDP by $7 to $18 trillion (with no real dollar increase in wealth).  This assumes a catch-up effect. Either we grow nominal GDP faster than “money” or we shrink “money” to re-proportion it to GDP.  For context, GDP in 2019 was $21.4 Trillion.  So destroying $4 to $8 trillion of paper wealth is 20%-40% of one year’s GDP.  Brutal and worryingly plausible in size.

The longer we keep this up, the bigger those stagnant pools of paper wealth get.  Making for an uglier reckoning.  This is the problem with any embezzlement or Ponzi scheme.  The numbers eventually compound until the edifice collapses under its own weight.  Which is arguably why the policy response to COVID has been so frantic.  Trying to push an ugly reckoning into the future.  Piling up more Bezzle that will, eventually, have to be destroyed via the fires of asset write-downs or the freezer rot of inflation.  Or, maybe, more wisely, trying to over-print enough to tilt a resolution in the direction of (less-destructive) inflation instead of deflation.

Either way, we are left with that fat jockey on that thin horse.  The jockey is getting fatter and fatter.  Eventually the horse must falter.  Maybe not this crisis.  But sometime somewhere.

This crisis might be big enough to force the issue.  We’ve seen a huge move into stocks recently.  At a time the real economy looks extremely shaky.  We all know the stock market can be an incredibly efficient money destruction machine.  One day you wake up and 30% of it just is gone.  Poof.  Like what happened in, say, March 2020.

Yes, values have come back since then.  Based partly on a placebo-effect belief in a “tidal wave of Fed money” that has not actually circulated into markets or the real-economy (see prior post here).  But there is no iron law saying the market has to recover from the next crash.  On 2019 numbers, US equity markets were worth about $40 trillion and global markets add another $50 trillion.  A $4 to $8 trillion hit to “wealth” (5%-10% of global value, 10%-20% of US market cap value) is a worryingly plausible chunk of that paper wealth.

It might not happen through stocks.  Real Estate and Bank Loan markets take longer to adjust (it took ages in 2008-2011).  But all asset markets will, eventually, do their job of destroying paper wealth that isn’t supported by real-world cash flows.  Usually over-correcting downwards before leveling out.  So we could “lose” $8 to $16 trillion (on a $21.5 Trillion GDP), and bounce back up from there.

There is a huge mental chasm between a “temporary market pullback” and a “permanent loss of wealth.”  People will spend through a pullback.  But if/as they figure out the Bezzle is never coming back… Same quote below with a different sentence in bold.  It could foretell a much less exuberant future…

“At any given time there exists an inventory of undiscovered embezzlement [not the illegal kind.  The legal, clever Wall Street kind.  Think 2008’s mortgage backed bond bubble] in — or more precisely not in — the country’s businesses and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

We might avoid a resolution this time around.  We did in 2008.  Extend and pretend…  Moreover, this piece could just be howlingly wrong.  Please push back.  And/or please forward this on to someone/anyone who might be able to push back at it (please forward me the replies no mater how brutal).  I’ll learn the most from the push back.  Two immediate caveats where I am obviously “wrong.”

  1. There are all sorts of valid reasons why money supply and monetary velocity might never rebound.  Big permanent demographic shifts especially.  Also the impact of low rates, foreign trade, etc… So the ENTIRE underlying premise here is also questionable.  Still interesting perhaps.  But there is no God-given reason this catch-up effect must happen.
  2. This is in no ways a “valid” economic analysis.  A real economist would justifiably tear this whole piece to shreds.  But the worship of false precision is the hobgoblin of small minds (and most Economics departments).  I still think this sort of “analytically leaky but directionally interesting” analysis has value.  It is clearly faulty, but it shines a light on something we otherwise can’t measure.  So it might remain useful.
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Book Recommendations

Good fortune is good in-laws 🙂  I’ve had a little more time to read in the last few months (courtesy of the aforementioned in-laws).  I figured I’d share.  Forgive any typos below – this small laptop keyboard and my machine gun typing style don’t go so well together.

Strongest recommendation would be “Biggest Bluff” and then the combo of “Alchemy” and “Trade Wars.”   The MMT book is less consistently strong, but worth it for its first few head-exploding chapters.

BIggest Bluff:  Psychology PHD turned New Yorker staff writer with no poker experience decides to try and play in the world series of poker in one year.  The book itself is much less about poker than about life, risk, etc.  Great meditation on a lot of elements that also touch on investing.  Found its really helped me feel OK with sitting out the last few months in particular so timely.  Very readable.

I’m going to present the next three books in the order that I read them because they ended up layering nicely on each other.

The End of Alchemy:  Books saying the world has become imbalanced and we are all headed for a big reckoning are a dime a dozen.  Usually written by some tinfoil hat crank.  They are almost never well researched, reasonable, carefully argued thoughts from the retired head of the Bank of England (Meryvn King).  THis book gave me “permission” really start worrying about stuff.   t is skimmable in places, but very readable and an excellent macro 101 piece too if your last money and banking class was back in college.

Trade Wars are Class Wars:  Ignore the title, it is not a political polemic.  It is an extremely readable look at how international trade imbalances and domestic income imbalances are driving the world economy in a can’t-go-on-forever unsustainable direction.  Most refreshing is that the US ends up almost a passive victim in this telling – “forced” to over-consume and over-borrow by the surplu-producing Chinese and Germans and wealthy elites).  THis follows on from King’s book and points you to where the imbalances are building.  THey pull their punches a bit about how it all unwinds (one author teaches in China and I guess wanted to keep his job), but it clearly doesn’t unwind well for anyone.

The Deficit Myth:  Written by the main proponent of MMT economics.  Guaranteed to change how you think about money, deficits, the economy, stimulus, the role of government, etc.   You may not necessarily agree with her and there is way too much not-as-well-supported policy commentary mixed in. But there are some real Plato’s cave moments in here too.  And explains the (valid) core argument of MMT, which is that the ONLY things that matters is the real economy’s productive capacity. “Money” per se doesn’t really matter.  Milton Friedman said “Inflation is always a monetary phenomenon.”  MMT turns that on its head to say “Inflation is always a real economy productive capacity phenomenon.”  Outside of true Weimar Germany Zimbabwe style money printing hyper inflations, that MMT formulation seems like a much more useful construct for looking at the world.  You probably won’t agree with some of her policy suggestions.  But you really will never look at the (economic) world the same way again.  Extremely readable too.

I have this book teed up for when I get home.  Meryvn King (BofE) and John Kay (FT).  Argues against the increasing tendency to equate “risk” with “volatility” in financial markets.  After that I’m not sure where it goes but Mervyn King is a smart guy so….

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Placebos Are Powerful Until They Aren’t. We’re Dangerously Close To A Policy Error Based On Misplaced Faith in the Fed.

Placebos are powerful.  Until they aren’t.  Faith in the Fed’s trillions has sustained markets so far.  But the hard-dollar prop holding up the economy is the merely-billion-dollar flow of fiscal stimulus – especially expanded unemployment benefits.  With Congress likely to start turning those taps off in July, our collective delusion about the power of the Fed might not survive much longer.  Like the Cowardly Lion, Scarecrow, and Tin Man, we’ll have to find our way without our Wonderful Wizard of Oz.  That probably gets ugly before it gets better.

The Fed’s money can’t have juiced the markets because the money never touched the markets.  The Fed did create some $2.3 Trillion in new money. And yes the markets have responded as if that wall of money has hit them. But, outside of some swap lines with foreign central banks, that money has never circulated.  Bank lending has been tight.  The Treasury hasn’t drawn down their account. The Fed has made some promises to buy corporate bonds, but what they’ve actually spent has been inconsequentially tiny.  Most of the Fed’s money never left the Fed.  At least not in reality.  In our heads, however, the placebo effect has been massive.

The Man Who Overdosed on Placebo

Several years ago, a published case study describes a 26-year-old man who was taken to the emergency room. After arguing with his ex-girlfriend, he attempted suicide by swallowing 29 capsules of an experimental drug that he obtained from a clinical trial that was testing a new antidepressant. When he arrived at the hospital, he was sluggish, shaking, and sweating and had rapid breathing. His blood pressure was extremely low at 80/40, and his pulse was 110.

Doctors were successful at raising his blood pressure. Over the course of four hours, they injected him with 6 liters of saline solution. His blood pressure increased to 100/62, which is at the lower end of the normal range, but his pulse remained high at 106.

What finally cured the patient wasn’t anything the emergency room staff did. Instead, a doctor from the clinical trial arrived at the hospital. He told the patient that those antidepressant pills weren’t antidepressants because he had been randomized into the control arm of the trial. Yes, that’s right: He overdosed on placebos.


Within 15 minutes, the patient’s blood pressure stabilized at 126/80, and his heart rate dropped to a perfectly normal 80 beats per minute.

We know the Fed’s “wall of liquidity” never hit the markets because we know it never left the building It hasn’t gone into the real economy.  It hasn’t gone into the Financial Markets.  It didn’t even make one round-trip.  It has just sat in the “Fed Savings Accounts” of the US Treasury and the banks.  They have just left it parked there.  Un-moved and un-moving.  The data in the article below are accurate up to mid-June…

So far, since March 11, the Fed has pumped in $2.3 trillion to the economy in new dollars. That is mostly QE (the blue column), with an additional $195 billion in loans (the facilities), offset by a reduction in repo of $163 billion.

Where is that $2.3 trillion? We know exactly where it is, because it is in only two places – bank reserves at the Fed, and the US Treasury’s checking account, also at the Fed. Together, these have risen $2.5 trillion, $180 billion more than the Fed’s liquidity injections.

All that has actually happened is that rates have gone down by a decent-but-not massive amount.  That interest rate cut is something.  It should/could boost markets.  But it is hardly a “wall of Fed money.”  Especially if the banks aren’t actually lending at those rates (or any other rate).  Low rates simply don’t explain enough.  Leaving us back at the Placebo effect.

You might argue “the Fed’s money is funding the Treasury’s various fiscal stimulus programs.”  But the Fed’s only role there is to create additional serial numbers for additional dollars already appropriated by Congress.  Going through the fiction of one arm of the US government printing up new serial numbers to exchange for IOU’s from another arm of the US government.  That is all just an internal accounting fiction within a single entity – the US Government.  The money thus created doesn’t “do” anything until it leaves the US Government and hits the real economy.  It hasn’t.

Moreover, that stimulus money flow isn’t some “trillion dollar wall of Fed liquidity hitting markets.”  It is a measly few-billion dollar dribble of monthly unemployment checks and business loans.  The increasingly maligned, at risk expanded unemployment benefits and PPP loan programs.  Plain vanilla fiscal stimulus.  Libtard Keyensian stuff.

In real-economy, real dollar terms, those few billion dollars of money flow are what is standing between us and disaster. If we all understood that reality, those benefits would be renewed (or raised) at the end of July.  But in our collective placebo-effect fantasy, the magical Fed is doing all the work.  The feckless Congress is just spending our hard earned money on undeserving layabouts who are “earning more on unemployment than they would by working.”  Ignoring some inconvenient facts.

  1. Those checks are flowing straight through those people’s bank accounts into rent payments, car payments, mortgage payments, and retail spending.  Cut those back and you choke off that upstream flow of payments.  That will create a wave of defaults up the chain.  That “free money to the undeserving” is flowing on to keep ALL of us afloat – rich and poor.
  2. There are no jobs for ALL those people to go back to.  Anecdotally and individually perhaps.  Collectively?  No.  They won’t be able to replace the lost benefits with wage income.  It is just a subtraction.
  3. Those checks are also supporting people trapped with kids at home.  Someone has to take care of them.  Because there’s this virus thing killing Grandmas and Grandpas…

Stimulus isn’t about efficiency and who “deserves” what.  It is about getting dollars out and circulating.  So that payments get paid.  So we all stay afloat.  The expanded unemployment program is doing a fantastic job as stimulus.  But it looks increasingly likely those benefits will be cut back.  Risking a plunge into crisis. 

  • I get a sinking feeling some folk’s are hoping that crisis happens – shaking loose some nice assets at fire-sale prices.  A lot of folks made nice returns out of the 2008 crisis.  Maybe they want another bite at that apple?  Precipitate a crisis, but not so big as to fall into the next Great Depression.  Just like 2008.  That is a very dangerous game.  And post-2008 has sucked for most people.
  • Alternatively, we are just too politically blindered to see reality.  Trapped in our information silo echo chambers.  Listening to booming noises about the Fed an imagining it will all be OK even if we cut those programs back.  Which is about as stupid and self-defeating as, say, re-opening the country too early in a mass pandemic.  Are we really that dumb?

I keep coming back to the Wizard of Oz. A study in the power of the Placebo effect.  The Wizard may be a powerless old man, but has a powerful impact on his world.  His simple existence (and their belief in him) pull the Cowardly Lion, the Tin Man, and the Scarecrow along a journey of personal growth.  The good citizens of Oz sleep better at night knowing the Wizard is there to protect them.  It all works until Toto pulls back that curtain.

The Fed today is mostly exercising similar Placebo power.  In reality, it has been pushing on a string since 2008.  Pushing on more of a soggy noodle from 2000 to 2008.  The data show that. The main thing sustaining our faith in the Fed today is no more than… our faith in the Fed.

How will we react when (not if) that collective delusion is shattered?  Eventually, we’ll rise to the occasion.  But we’ll likely flail and thrash through a lot of economic damage along the way.  Or maybe we’ll get lucky and keep that curtain closed…

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Why is McConnell Delaying On Stimulus? He Doesn’t Have The Votes…

Mitch McConnell is leaving negotiations over a new stimulus package until mid-July.  With the critical $600 unemployment benefit expiring July 31.  Those unemployment benefits are our most important economic prop.  Leaving the discussion to a last minute scramble up to the deadline seems insane.  So why delay?

I don’t think he has the votes. 

McConnell wants to pass a “Republican” bill.  He can’t do that without a rough Republican consensus on policy.  That consensus doesn’t exist.  There are too many Senators given to grandstanding about debt (Ron Paul).  Even more whose paymasters are presumably moving heaven and earth to kill that $600 benefit and keep wages down  (Tom, Cotton ARK, aka “the Senator from Wal Mart and Tyson Foods”).  And the party as a whole lives in an alternative reality where the Fed is all-powerful and benefits for “those people” are always bad.

Here’s where the fantasy centrists swing into action.  Cue Friedman and Brooks et al.  We’ll just pass a bill with a mix of Republican ad Democratic votes.  Sensible people reaching across the aisle.  Blah Blah Blah.

What incentive do Chuck Schumer, much less Nancy Pelosi have to help Mitch McConnell?  In an election year?  When he is fighting for re-election himself?  Zero.

Think about what McConnell would do if the tables were turned.  He’d choose to obstruct any stimulus, tank the economy, and win the election (his post-2008 playbook exactly).  Pelosi and Schumer aren’t quite so evil, but they aren’t stupid either.  Mitch needs a win more than they do.

If Mitch reaches a hand across the aisle, they will ask for the whole arm.  Schumer and Pelosi will offer a reasonable-sounding “compromise” that can pass with all the Democratic votes and a handful of Republican ones.  Take it or leave it.

Lets say McConnell fights to a compromise.  That will still look like a defeat.  Because any compromise is a defeat in the all-or-nothing mindset that grips the modern Republican party.

But he can’t walk away.  No deal = no stimulus.  That would (or should) tank the markets.  even these wildly optimistic ones.  Also those payouts are supporting a lot of Real Estate that a lot of other rich people own.

Given the two unpalatable choices above, he’s taking the third option.  Delay.  Wait until after the July 4 recess.  Hope the exploding COVID numbers bring enough Republican Senators to their senses.

We’ll see.  But a lot of people seem to share a cozy assumption that further stimulus is assured.  Intermixed with a folk-remedy faith in the Fed* and corresponding lack of appreciation for the stimulus doing the actual heavy lifting (that $600 a week).

The sentence above that worries me most is “But he can’t walk away.”  What if he does?  Does McConnell prioritize his personal political survival over the country?  Does he decide to keep his Senate seat even if it plunges the country into a depression?  Which do you think is more important to him?

* The Fed’s own numbers show the money hasn’t gone anywhere (see this piece here for the numbers).  Money has so far gone to foreign central banks (stabilizing exchange rates), the Treasury, and into the banks.  The banks have NOT lent that money on.  They’ve but just parked it as “Excess Reserves” back at…. the Fed.  All those trillions have led to a (placebo effect) drop in market rates and a (placebo effect) investor faith in “liquidity.”  Placebo effects are real.  But they are faith-based.  That is a pretty thin reed to hold up the economy.  Especially if that $600 a week prop gets kicked away.

PS:  Why is McConnell talking so little about the unemployment benefit and so much about “liability protections for hospitals, businesses, etc…”  Because there is a Republican consensus on liability.  Which is irrelevant to keeping the economy afloat right here and right now.   His silence [on unemployment benefits] points to where consensus is lacking.

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Actions Speak Louder Than Words.  Economic Leaders Are Terrified. We Should Be Too.

We are one or two policy errors from something pretty awful.  The massive policy response so far tells us we face a massive threat and a massive risk of a policy error. Maybe it all works out.  But never lose sight of the risk.  How long will our luck hold?

Your quiet spring day is shattered by a cacophony of sirens.  Seemingly every fire engine and police car in the city are rushing somewhere.  Helicopters appear and hover.  Other cities police and fire trucks zip by.  Eventually trucks full of National Guard troops rumble past.  What do you do?

  1. Hunker down.
  2. Go back to business figuring “they” have it all under control.

I’m taking my cues from the unprecedented scale, speed, and scope of the economic response so far.  Policy actions tell us we are facing a massive, unprecedented threat.  Meaning without precedent.  Meaning no-one has a playbook for dealing with it.

Lets take a look at those policy actions.  The commonality is that some behind-the-scenes conversation got normally cautious, cowardly, prevaricating politicians to put their own careers at risk.  They acted big.  Something must have scared them big.

  1. The Fed and the Treasury pulled out all the stops.  Every action taken since that 50bp rate cut in March has had “panic” written all over it.  The Fed has likely broken the letter of the law by wading so deep into buying up private market assets.  It definitely, knowingly broke the spirit of those laws.  The folks at the Fed aren’t stupid.
  2. Congress acted… quickly and decisively!?!  passed a massive spending bill at light speed a few months before an election.  The bill solved the partisanship problem by funding everyone’s priorities.  The Republicans got billions for big companies.  The Democrats got billions for unemployment benefits that will permanently raise US wage levels.  The sum added up to Trillions.  Congress does nothing fast.  Mitch McConnell does nothing bipartisan.  And congress learned from 2008 that “bailouts” are political death down the line.  Congresscritters are not (collectively) that smart.  Something big stiffened their backbones enough to act big, fast and decisively.
  3. States rushed to re-open with unseemly haste.  This panic signal seems to have  been mostly missed. The politically smart (ie. cowardly) path for a Governor would be to re-open somewhere in the middle of the pack.  Don’t get singled out for blame by opening “too early” or “too late.”  So why did so many Governors rush to re-open?They knew they were risking blame for out-of-control case counts a few months later (as we are now seeing).  What (or who) scared them into acting with such haste?

In all those decisions, you know the usual voices were advocating the usual caution and half-measures.  So why didn’t we get the usual half measures?  Because someone in the room presented an argument that amounted to an ultimatum;  Do this or else…  That “or else” was clearly terrifying.  Normally spineless creatures stood up straight and marched into danger.

I’ve spent the last few months trying to guess at the full shape of that “or else.”  I suspect it was (and is) a massive debt “house of cards” crisis.   But we don’t really need to know the details.  It was a big, dire, and unprecedented risk of disaster.

Looking ahead, the bet you are taking is that “the authorities” have that potential disaster corralled and under control.  That seems like a pretty complacent bet to make.  We are betting on the courage and competence of a class that is pretty reliably gutless and sloppy.

Or maybe we are just betting the Fed can do all the heavy lifting and save us all.    That also seems like a pretty complacent bet.

To repeat the intro paragraph:

We are one or two policy errors from something pretty awful.  The massive policy response so far tells us we face a massive threat and a massive risk of a policy error. Maybe it all works out.  But never lose sight of the risk.  How long will our luck hold?

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The Fed isn’t Saving Us. The $600/Week Unemployment Benefit Is. It Lapses July 31. Does Congress Screw it Up? I Fear They Will.

Next month, Congress risks making an epic policy error.  Will they let the $600 a week unemployment benefit lapse in July? It only require a failure to act.  And politicians are pretty good at failing to act…

That extra $600 a week is carrying a lot of the economy’s weight right now.  Most obviously supporting consumption.  But also carrying asset markets dependent on consumer rents and debt payments – credit cards, auto debt, mortgage debt, student loans are the biggies.

The weekly checks are doing the heavy lifting, but the Fed is getting the headlines.  I worry the Fed myth is so strong that Congress fails to act.  Pitching us into free fall.  Similar to Congress’s original failure to pass TARP – hoping the Fed could keep doing all the work – in 2008.  I worry Congress will make that error.  Why?

1).  There is so little coverage and focus on that $600.  When it is mentioned, the focus is on the partisan dynamic and/or how many people are “making more on unemployment than they would if they are working.”  The catastrophic, immediate risk of letting it lapse isn’t part of the dialogue.

2).  Faith in the Fed is so strong.  In popular myth, a wall of Fed money has saved us in every past crisis.  So why not just sit back and let the Fed do its magic once more?  Avoid the tough choices?  That is OK if Fed intervention is “working” mostly by impacting the real economy.  It is not OK if Fed intervention is working mostly by lifting animal spirits while that $600 a week benefit keeps the real economy limping along.  If the Fed is just the Wizard of Oz – an old man behind a curtain – the Wizard can’t save us.  We must save ourselves.  Dorothy and the Cowardly Lion figure that out.  But what if we don’t?  See my prior posts for more on Fed impotence.  Or just note that the Fed hasn’t actually done very much real-world buying or lending of any real money so far.  Outside of emergency dollar swaps with other central banks, it has all mostly been moral suasion and animal forces to date.

3).  That $600 benefit is hated and feared by a lot of core Republican paymaster constituencies.

  • Business owners hate it because it raises the prevailing wage.  They recognize it is a back-door route to a $15 minimum wage.  Which is a lot closer to a living wage.  Which is a lot more efficient than my paying taxes to top up the meager wages of people who don’t earn a living wage – taxes to fund food stamps, free school meals, section 8 housing vouchers, etc etc. But a lot of businesses would prefer to keep “those people” down, dependent on capricious government programs, and docile.
  • A lot of Red states like the out-of-State Federal subsidies (from blue states) that help pay for those programs. This dynamic gets overlooked in the whole “makers vs takers” debate.  But us well meaning liberal types are the ones writing those checks.  To folks who delight in biting the hands that feed them.
  • Older, affluent people are terrified of inflation.  Raising the prevailing wage would, eventually, feed through to higher prices.  The economy as a whole would benefit massively from higher inflation.  We are teetering on the precipice of deflation as it is.  But affluent older folks would suffer from inflation.  And older affluent folks vote Republican.
  • Racism.  A lot of Republicans just like anything that keeps “them” down.  More to the point, the vicerally attack anything that might help “them.”  And lets not pretend “they” aren’t poor and non-white.   Most Republican’s airbrush out all the white faces in any picture of the poor.

Democrats love that $600 a week because the longer it goes on, the further it drives us further towards a $15 minimum wage. It also validates the need for fiscal policy responses to futre crises.  And helps their core voters most.  All of which are further good reasons for the Republicans to hate it.

But won’t Trump prove the deciding vote?  Just push it through?  He just wants to get re-elected.  Any checks going out now are good checks, right?  Yes, but Trump has been utterly silent on the subject so far.  While at least some of his advisors – serving the interests above – seem inclined to kill it (see below).  Trump doesn’t necessarily listen to his advisors, but if he hasn’t yet figured out how critical it is to his future, we’re on pretty thin ice.

Kudlow said the $600-a-week bonus payments made to some Americans laid off during the coronavirus pandemic will end as planned on July 31 to prevent a “disincentive” for workers to return the jobs market.

So that leaves us in a depressingly familiar battle.  On one side, the interests of the economy, Democrats, and the general welfare of most Americans.  On the other side, crony capitalists, affluent older folks, Red State politicians protecting their subsidy streams, and a decent-sized minority of racist deplorables.

Which side wins?  Ask yourself which side has has won in the past?  Now you see why I’m worried.

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The Bezzle – “an Inventory of Undiscovered Embezzlement.” Is Declining Velocity A Rough Measure?

I’ve been musing about monetary velocity because it points to a possible diagnosis on a that nasty feeling in a lot of guts today.  How much of our current prosperity is built on false hopes?  I’m not the first and definitely not the smartest guy to think about that.  So lets introduce the concept of “the Bezzle.”  The Bezzle the queasy-making part of that gut feeling.  The term comes from JK Galbraith’s history of the Great Depression.

“In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in — or more precisely not in — the country’s businesses and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

The economic magic is that; for a while; maybe for a very long while; we all get to live like that magic million dollars existed.  Until it doesn’t… 

The Bezzle is the monetary equivalent to Schrodinger’s cat. The money exists twice in two different states of reality.  You embezzle a million dollars.  For a time, you live like a millionaire.  But your victim also keeps living like a millionaire.  You are both spending with the confidence that million dollars exists.  And, for a time, it does exists in two different realities.  Until it is observed.  One reality collapses.  A million dollars disappears in a puff of smoke (smelling vaguely of singed cat hair).

The Bezzle concept suffers from two problems.

  1. It exists only when un-observed.  It is reliably, necessarily forgotten exactly when it is most relevant.  The Bezzle only exists when people are credulous.  They have to believe that magic million dollars is real.  And that depends on people forgetting about the Bezzle.
  2. It isn’t easily quantifiable.  This is the ultimate sin in modern economics.  You can’t build clever models explaining it.  Clever models get you tenure.  And talking about the Bezzle tends to repel folks in finance.  There’s a bit of Bezzle sprinkled into most financial products – especially the more profitable products.

That leaves the Bezzle unloved and un-observed.  Tucked in the same box as Schrodinger’s cat.  Except in the rants of dangerous amateurs (like myself).

The next post will start to tie the prior 3 posts together (loosely as is my wont).  Monetary velocity is decliningFed intervention is delivering diminishing returns.  And now have this concept of the Bezzle – magical, imaginary, temporary wealth.  My guess (and it is just a guess) is we can get a rough estimate of the the Bezzle from how much (or how little) money is circulating.  It isn’t huge – a few Trillion.  But that’s enough to do some damage.

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Diminishing Velocity => Increasing Impotence

Monetary velocity has been steadily declining, with increasing deceleration after every Fed intervention (see chart going back to 1959 here).  That gnaws at me (see prior post here).  Why does it worry me so much?

“How did you go bankrupt?”
Two ways. Gradually, then suddenly.”
― Ernest Hemingway, The Sun Also Rises

The Fed’s Growing Impotence

Over the last 30-40 years, monetary policy (the Fed) became the only politically acceptable tool of economic intervention.  That reached its apogee with popular lionization of “the maestro” Greenspan. When crises hit, Congress got used to sitting back and letting the Fed do the heavy lifting.  Fed intervention worked great in the 1990’s, OK, in the early 200’s and barely at all in 2008….

Why?   Over-use of any economic input leads to diminishing returns – less bang for every incremental buck.  Even if the tool is more actual dollars at ever-lower interest rates.  By leaning harder and harder on one-dimensional Fed intervention, we’ve limited the impact of that intervention.

The evidence?  That steady decline in monetary velocity, with those downward kinks of deceleration after every successive recession (and Fed intervention). We printed more and more money.  We got less and less growth from it.  Some of that declining velocity is from “natural” factors (aging demographics and increased global trade).  But the kinks in the curve – coming after every recession/intervention – tell a clear story of diminishing returns. Velocity deceleration will kink down further/faster after the 2020 recession.  The Fed has cranked out around $6 trillion (~28% of 2019’s $21 Trillion GDP).  Unless/until GDP grows, velocity (just “GDP” over “money supply”) will plummet.

Pumping out more and more money to less and less effect.  That growing impotence was already growing increasingly obvious – see my October 2019 post “The Fed Isn’t Manipulating Mr. Market. Mr. Market is Manipulating the Fed.”  The poor Fed has ended up like the Wizard of Oz – trapped into sustaining a naive folk belief in its limitless power.  Every time we face a crisis, the Wonderful Wizard will solve all our problems!  Painlessly! No effort or loss or tough choices! See this post for more.  Or just watch the video below.  With sympathy for the poor guy behind the curtain…  🙂


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“Don’t Fight The Fed” Assumes The Fed Is Actually In The Fight…

The Fed’s recent interventions may have had more moral effect than practical effect. The Fed has huge impact on Keynes’s “Animal Spirits.” But it might be more placebo effect than anything else.  Fed Chair Ben Bernanke made a joke out of it once; “The problem with QE is it works in practice but it doesn’t work in theory.”  The uncomfortable implication is that it only worked because people believed it would work. 

The data suggest “don’t fight the Fed” may be more of a folk belief than a quantifiable economic effect. At least in real economy terms.  The evidence has pointed that way since 2008.

If that is correct, the main prop supporting the pandemic economy may not be the Fed’s mega-massive interventions.   It is probably the “temporary” $600 a week unemployment benefit.  Which is looking increasingly at risk. 

Excessive faith in monetary intervention might lead Congress to assume they can turn off the fiscal taps.  Rely on the Fed.  Like we have learned to do over the last few cycles.  Concentrating the benefit among asset holders.  Why mess with success?

Because someday monetary interventions may not work in theory OR practice.  Monetary velocity suggests that day may be now.

Money used to circulate around 2x a quarter. Now it is only circulates around 1.2x.  This is, roughly speaking, a measure of the Fed’s growing impotence.  More and more money supply is having less and less effect.

I keep finding my way back to the monetary velocity chart below.  Its message is clear.  We keep pushing more and more money into circulation, but we get less and less economy to show for it.  What isn’t clear is why.

The chart shows US “monetary velocity”  – how much economic activity do we get for each dollar of money in circulation?  GDP divided by the money supply (MZM).   If we have a GDP of $100 and $100 of money, velocity = 1.  Every dollar changes hands once in a cycle.    If we have $100 of GDP and $50 of money, velocity equals 2.  Every dollar changes hands twice.

Declining velocity means money is changing hands more slowly.  Instead of flowing in a rushing steam of commerce, it is collecting in increasingly stagnant pools and eddies of inactivity.  Money is really only worth something when it is used to buy something else…

So the chart tells us most of the Fed’s post 2008 “money printing” never really found its way into the real economy.  A problem that really started in 2001, just about when faith in the Fed became absolute.  Monetary base keeps going up but GDP increasingly didn’t follow. We print a lot of money, but it fails to circulate.

Something is clearly busted.  But what?  What exactly is broken?  That is less clear. What does it imply for the future? That is even less clear.  I’ve got some thoughts I’ll try to write out in series over the next week.  But take the time to click on the link and look at that chart.  There is something rotten in there somewhere.

MZM Monetary Velocity:

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Discretionary Retail Dynamics Will Look Like 1st Class Carriages on The Paris Metro – Less Crowded and More Expensive.

Summary:  Facing a grinding, random virus threat, people will self-regulate to keep crowd density at “comfortable” levels.  Meaning sparse retail traffic.  Meaning anemic economic activity.  Continuing until an effective vaccine has been widely administered (not just invented).

The Virus Will Remain a Random, Omnipresent Menace.

Lets set the stage with this likely scenario from the “Epsilon Theory” blog.  I’ll take this to mean that “everyone” will eventually at least know someone who’s either died or gotten horribly sick.  Or gotten sick themselves.  But with herd immunity elusive.  Like a horror movie where some unseen, stalking menace picks off members of the party one by one.

Covid-19 is now endemic in the United States. That means it is everywhere. That means it is something to live with rather than something to eliminate. That means Covid-19 is now being “handled” as a chronic disease rather than an acute infectious emergency, a chronic disease where – every day while it remains endemic – 15,000 to 20,000 Americans will get so miserably sick that they will seek treatment and be officially diagnosed, and 500 to 1,000 Americans will die.

15,000 to 20,000 Americans really sick. 500 to 1,000 Americans dead.  Every day.

Paris Metro Pricing Tells Us How People Will Respond.

A brilliant friend (Andrew Odlyzko) wrote up the human/economic phenomena of “Paris Metro Pricing” ages ago in the context of a possible Internet “quality of service” pricing scheme (PDF Here).  It hit me today Paris Metro pricing also perfectly captures the likely dynamic we’ll see in retail stores.  Quoting Odlyzko

Until [1991] the Paris Metro operated in a simple fashion, with 1st and 2nd class cars that were identical in number and quality of seats. The only difference was that 1st class tickets cost twice as much as 2nd class ones. (The Paris regional RER lines still operate on this basis.) The result was that 1st class cars were less congested, since only people who cared about being able to get a seat, etc., paid for 1st class. The system was self-regulating, in that whenever 1st class cars became too popular, some people decided they were not worth the extra cost, and traveled 2nd class, reducing congestion in 1st class and restoring the differential in quality of service between 1st and 2nd class cars.

This seems to be a perfect model for behavior in an endemic epidemic.  Self-regulating  congestion management driving sparse retail traffic.  If a store/bar/restaurant seems “too crowded,” people simply won’t enter.  If a place starts to feel “too crowded,” people will head for the exits.  Self-managing ourselves into an informal, low-level, self-policing quarantine.

That means crowds will remain sparse.  At least in any sort of discretionary retail activity.   Non-discretionary shopping (grocery stores, etc) might end up retaining their metered entry congestion management systems.  Or opening at longer and odder hours to spread out crowding.

Likely a Price Premium

Less crowded retail tends to be more expensive retail.  Shops, restaurants, bars, airplanes, etc… If nothing else, paying the same rent per square foot costs more for fewer people vs more people.  Meaning a higher ticket price per person.

Some of that price “premium” will come via stealth by lower discounting.  Once retailers offload unsold pre-virus stock, they likely take advantage of the traffic dynamic to charge full price.  Consumers will be more inclined to just buy whats on the shelf versus shopping around for the best deal.

Antibody Carriers Are Likely Spoilers

The already-infected crowd will (presumably) feel less constrained by this dynamic (glossing over whether prior infection does actually lead to immunity).  They will presumably not care if stores or bars are crowded.

In the Paris Metro model, they will just barge their way into the First Class car – indifferent to the crowding effect.  That behavior will further depress traffic from those who haven’t yet had it. Eventually, the number of antibody carriers will get large enough to return traffic to “normal.”  Although lets hope a vaccine comes along before that.

On current infection patterns, antibody carriers are more likely to be less affluent and non-white.  Unfortunately those folks are the least important drivers of the consumer spending equation. The more affluent, work-from-home crowd will be the last to return to “crowded” shopping and eating out. Those folks being the most important drivers of consumer spending.

I’ve just wrapped up a 7 day RV trip across the US (surprisingly enjoyable even with a 2 1/2 year old and a 5 month old).  Currently at the in-laws in Virginia.  I’ve got a whole bunch of thoughts percolating so stay tuned.

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