Paradigm-busting Times

Paradigms are a funny thing. They are collective conventions people believe in --even rely upon for functioning. They're ideas everyone has agreed as truth, which few (or not a substantial number of people) question, until a revolutionary thinker, or a massively influential event (or a combination of both) occurs, and they are busted. The earth was flat and no one questioned it until a "brave revolutionary" called Copernicus dared to think outside convention and declared earth revolved around the sun. And boom: Ptolemaic cosmology was gone.

Money and government, both social constructions that rely on people according them legitimacy, also rely on paradigms to function. A major one is that money is finite --we can run out of it. Another one is that we can get it only if we do (work on) something of value for somebody else. Also, that we can't make our own money --unless we want to land in jail. Or be tragically killed. Therefore, the reputation of a currency, at its core, rests on its Government's ability to coerce its own population into being scared enough of them to work hard, pay taxes, and not print your own money. Only currencies with this kind of reputation can be considered for world reserve currency status.

Government has historically abode by the same paradigm: It can run out of money --if the Fed denies it the money, that is. But Government is the Fed's boss, too --it names its Chair and Governors. So a huge conflict of interest arises:

If you (the Fed) produce something (money) everyone wants --something also wanted by the person who put you in the position to produce that very thing-- but your job is literally not to produce too much of it lest we suffer from the social destruction caused by the overproduction of that very thing you produce (inflation), things can get awkward. Your boss publicly humiliates you because he wants you to produce more of that thing. But you refuse. You actually want to prove you're independent and responsible, because you know very well about the destruction that can be brought upon by the overproduction of that thing you produce. And to make matters more complicated, you're looked at as the only remaining institution with a modicum of legitimacy and credibility, provided how the reputations of every other institution is being shat upon on a daily basis --even by the persons in charge of them.

Now go do your job. No pressure.

Inflation is thus that phantom everyone is afraid of, but no one knows when, or how exactly is going to appear. It certainly didn't appear after three consecutive rounds of QE, when every textbook told us it should have. Some say it doesn't appear because the Fed is not measuring it correctly, with an index that ignores financial asset appreciation, and that anchors 40% of the index to an artificially static formula based on residential asset appreciation, so they can print money freely without it ever showing up in the index they keep. Others say it doesn't appear because of interest paid on reserves: if the Fed pays it, banks won't lend (they will keep their cash at the Fed), and the multiplier won't occur (therefore, no inflation).

Yet others say just the opposite: that the Fed doesn't print enough money because it's a victim of conservative bias. That they're so afraid of inflation they prefer to perennially condemn millions to unemployment so the NAIRU (unemployment rate below which inflation kicks in) is never reached. These are the Copernican "brave revolutionaries" of today's economic thought. 

Sure, they are right. Government can't run out of money --if the Fed keeps providing it. 

This would obviously imply that inflation is not that big a problem; that we shouldn't be worried about it because we simply haven't seen it, and that it won't arrive... just yet.

Total Assets of the Federal Reserve

The fact is, the Fed's balance sheet has grown to close to 7 trillion dollars. The strategy being to buy up Treasuries ($80Bn/month), Mortgage-backed Securities ($40Bn/Month), and high grade corporate bonds ($750Bn total), in effect sequestering the stock of safer financial instruments into the (digital) vaults of the Fed and out of the grasp of frugal-minded investors. Financial repression is fine. Screw pension funds and insurance companies. Responsible fixed income savers be damned. All hail the wealth effect and its magical trickle down economics. Anything to avoid deflation. 

Given the monstrous deficit we're about to have, all this amounts to full-blown MMT policy, whether the Fed acknowledges it or not.

And this would all be fine, if only we were sure that inflation is not in the horizon. Only problem is, we can't be sure of that. The ballooning of the Fed's balance sheet is debasing the dollar, and hard. Just this month was the worst for the greenback in 10 years. Gold is at a record highs and way past $2,000/oz. 

In its effort to stimulate economic activity, the Fed has gone full on cash-is-trash. But managing and administering a soft run on your own currency is easier said than done. Implicit is the proper management of expectations of the public, whereby the Fed wants people to get rid of their cash in exchange for goods and services to stimulate economic activity, but just at the right pace (otherwise we'd have high inflation). Only problem is, like other social cascade dynamics, inflation is a psychological phenomenon. And you can't control it (much less predict it). Social cascades apply to inflation just as they apply to things like art popularity. Just like the Mona Lisa is considered beautiful because people think other people think it's beautiful, people will believe there will be inflation if they believe other people will believe there will be inflation. And just like there's simply no way to know which piece of art will be popular and which one won't, there's no way to know when inflation is going to appear --or not. 

The revolutionaries seem to think we should play closer to the fire because, after all, it's been a long time since we got burnt, and by doing that we will be less cold (and suffer less). They forget burns leave scars that never heal, or that you could also die from them. 

Yet here we are. Living hunkered down, afraid of touching each other and unable to live our normal lives. You'd think that all of these actions by authorities are bad, and in a sense, you'd be correct --if we were living normal times. 

But we're not. We're living in paradigm-busting times. Times in which paying people money for not working is exactly what you need to do, because going to work means spreading the disease and making things worse. Times in which the Central Bank must semi-nationalize the financial markets, stepping in as buyer of last resort lest the economy collapses. Times in which the Fed's balance sheet must explode, inflation be damned. Times in which we act as if money is infinite, and our government won't run out of it. 

The revolutionaries might have had crazy ideas, but given the circumstances, they might not be that crazy after after all. 

You know how the saying goes: "never let a crisis go to waste".