April 16, 2020… the much-lauded Paycheck Protection Program (PPP) that was supposed to sweep in to save “small businesses” across the USA has officially run out of money, 13 days after the program began. Despite overwhelming bi-partisan support, Congress cannot reach an agreement on the refilling the coffers. Congress baked 12 cupcakes for a classroom of 45 starving small businesses, dropped the cupcakes in the middle of the room and said “first come first serve”, and now the cupcakes are gone.
The impasse to adding more funds to the PPP is that the Democrats want to also send more funding to hospitals & local governments. The Republicans disagree, not in principle but in process. To quote one senator, “we should just continue to fund the PPP program, which has huge bi-partisan support, before we add more spending without proper review. The American taxpayer will be on the hook for this.” The American taxpayer will be on the hook for this?! That statement makes me shake my head. The “American taxpayer” has not paid for the majority of US government spending since 1971.
The US Government raises money by issuing US Treasuries (i.e. government bonds). The largest buyer of these Treasuries is our own central bank, the Federal Reserve. The Federal Reserve (i.e. the Fed) is a non-profit entity created by the US Government to control the supply of money via controlling interest rates and the creation of money. Our central government (i.e. Congress, President, Courts) require this power in order to control social unrest. Money properly deployed by the Central Government can decrease pain and social discord (some would say it can make the country more fair and prosperous). Right now, if the Fed did not exist and no new money could be created, there would be tremendous social unrest similar to the Great Depression because the of loss of jobs & income leads to the restructuring of debt which leads to the lowering of asset prices which perpetuates the painful deflationary cycle. You can read my previous article to understand deleveraging & deflation here: https://diversifiedhumansolutions.com/blog/deleverage/
The Federal Reserve, a non-profit corporation created by our own central government, “owns” about 8 trillion in US Treasuries / debt (more like 12-18 trillion after this). When a Senator says that “the American taxpayer will be on the hook for this”, he is saying that we the “American taxpayers” will agree to be taxed in order to re-pay the Fed. I beg to differ.
We will agree to NOT repay debt to the Fed because it is a non-profit entity of our own creation. However, let’s say I’m wrong and we as a society want to repay the Fed.
Every time our central government taxes you to repay the Fed… it is destroying money. Money (of this scale) exists on a balance sheet, not as cash we carry. Taxation to repay debt is essentially the destruction of money as seen on a computer screen. You open up your computer and check your account balance, then see that your bank account balance is lower because you’ve been taxed. Likewise the Fed goes and opens up their computer, then sees that the debt owed to them is lower, because your taxes went to repay that debt. That money is essentially destroyed… it does not exist anymore. That money was not involved in any transaction and therefore disappeared (i.e. was destroyed).
Let’s revisit the statement that the American taxpayer will be on the hook for this current creation of money. Consider that Congress & Presidents get re-elected based on people feeling wealthier and more prosperous. As famously uttered by Ronald Reagan, “are you better off than you were 4 years ago?” IF the answer to that question is “yes”, politicians have a greater chance to be re-elected. The American taxpayer will not be “on the hook” to repay the Federal Reserve because Congress and by proxy, we the people…will agree to not repay this “debt” to the Federal Reserve. Therefore, we can feel like we are “better off than 4 years ago”. Taxation for the purpose of repaying debt to the Federal Reserve should be viewed as the destruction of money. We only want to do this when inflation is occurring because there is too much money trying to buy not enough goods & services (i.e. supply & demand imbalance).
Now there is US debt in the form of Treasuries held by entities other than the Fed. Other nations own about 33% of that debt (I combine nations with their respective central banks as jointly owning the debt). The other 33% is owned by state & local governments, pension funds, and mutual funds (banks, insurance companies, and individuals own a small fraction as well).
So of the total USA debt burden, only 66% or 16 trillion dollars is actual “debt” that needs to be repaid. The debt owed to the Fed (by our central government) won’t be repaid. Imagine that you are the 100% owner of a corporation, and also the one and only only employee of that corporation. The corporation can “lend” you, the human individual, money. Now imagine that the corporation also has the power to create money just like the Fed! Any money the corporation lends to you, the human employee, can be forgiven by a decision between the corporation and the employee. It just happens they are essentially “you” but in 2 differing legal forms. That is essentially the relationship between the central bank & the central government.
In our government’s case, the USA can always just create more money (via the Fed) to fund spending/consumption. This is essentially what the USA has been doing since 1971. The USA repays actual debt owed to other nations and real US entities (i.e. pensions, banks, mutual funds, etc) via taxation, and pays for social programs with created money. Of course there’s more nuance but that’s the general idea. Japan has been living this way for 20 years and no one has batted an eye…not that we want anything like what Japan has experienced over the past 20 years!
You may read articles such as “the USA collects 2.4 trillion in tax revenue yet spent 3.4 trillion.” That is incorrect thinking. The USA collected 2.4 trillion in tax revenue, paid the debts and obligations they needed to, with a healthy dose on national defense & security (as the USA probably should), then CREATED 1.2 trillion (via the Fed) to pay (i.e. give) for social programs. So you may ask, “won’t this lead to inflation”? Maybe, what is supply and demand like? Japan has been creating money for years and hasn’t had a sniff of inflation.
Getting to the end of this economic cycle of deleveraging…in a fair, just, and prosperous way… will require the crafty engineering the system I describe above, in a knowledgeable and bi-partisan way, that results in increased productivity and fairness. This process being left up to Congressman who utter words like “the American taxpayer will be on the hook for this”…. Has me worried. It reminds me of the Chinese proverb… “if you want to understand water, do not ask the fish.”
The previous section is mechanics, this portion is my thinking & positioning around the those mechanics. If we agree on the mechanics, then we can move forward. If we disagree about the mechanics, we probably shouldn’t move forward and please tell me where my thinking is inaccurate or potentially flawed. That’s the healthy way to do this. But moving forward…
The risk is NOT to the American taxpayer. The risk is to our way of life. The “American Dream” of working hard & attaining achievement to live a free life, represented by dollars…and the American sense of individualism that represents.
Sure there is risk if foreign nations believe this creation of money to be dastardly, then demand this action be stopped. However, as Andrew Jackson was attributed in saying in regards to a Supreme court ruling that he disagreed with, “go ahead and try to enforce it (with your army Chief Justice Marshall)”. The rule of law is done with a stick, not a pen. If other nations want to make the USA stop creating money, it must do so with war (or diplomacy which is nicer way of saying war).
Before outright physical war, we have trade war, technology war, currency/capital war, and geopolitical war. This creation of money will probably lead to an intensification of the currency/capital war with China. Unless our current leadership understands this and can work to create a better situation rather than an escalation of war, there is an increasing external threat. The next step of this is the question, which currency will the world prefer, the Renminbi or the US dollar? Currently 70% of the world’s “debt” is held in US dollars, so I think we’re safe for now. But there’s some of the real risk if loss of confidence in the US dollar is the result of money creation. But all nations do it in one way or another, so setting the rules of the game and doing so without an escalation towards more war like behavior is the risk. Of course some may disagree with me, because the USA is pretty awesome at waging war.
I believe the bigger risk is internal. This creation of money to prop up asset prices (as I discussed in my previous article), will cause more internal pressure than external risk in the near term. We must prop up asset prices right now to prevent extreme social unrest, because not doing so would cause more pain. But let’s take a look at what this propping up of asset prices is also defending, “Cowboy Capitalism” (which I think is really just a tame version of a Ponzi scheme). This is the actual deleveraging that has to take place because each downturn… we’ll have to create more and more money, which will escalate geopolitical & internal tensions.
Let’s say Tech Company XYZ is doing something neat. So they are courted by Private Equity Fund A, who gives them 5 million dollars for 20% of the company! Private Equity Fund A also says, hmmm… “Tech Company XYZ, you should grow faster.” So Tech Company XYZ gives 2 million of that 5 million dollars to Facebook & Google to advertise in order to attain growth. One year later Tech Company XYZ is losing money, but it has a larger market share and is growing fast! So Private Equity Fund A says, “hey Tech Company XYZ, let’s raise another round of funding because we can get a better valuation now”. So Equity Fund B comes in and sees that Company XYZ is growing fast so they invest 20 million dollars for 20% of the company! This values the Tech Company XYZ 400% higher then when Fund A invested a year ago! Then Fund B says, “Company XYZ, good job, but I think you should grow faster!”. So Tech Company XYZ gives 5 million to Facebook & Google to advertise to grow faster. Then this happens again and again… and by the time Fund C invests, the folks at Private Equity Fund A say, “hey, I’m a genius! I’ve gotten a 800% return on investment in 2 years. I’m going to start another Private Equity company / Investment Fund!”. This, “We must grow” mindset, without consideration for long term value and profitability… in order for Tech Company XYZ to look sexy enough to attract another round of funding at a higher valuation…is what I consider Cowboy Capitalism. Look at the 100 year chart of the S&P 500 stock index… very sexy! P.S. your realtor does the same thing with home prices, so look at the Shiller Case index if your realtor does not understand macroeconomic principles.
The investors in this game deserve to reap the pitfalls of what they bet on, in good times and during deleveraging. But indirectly, when the Fed props up asset prices…they enable this cowboy capitalism to continue. Fed Chairman Powell is fully aware of this, but he must do what he must. Amazon is the largest company to find success via “cowboy capitalism”. Despite huge revenue growth, their profits are meager. However, the stock price of Amazon continues to surge. Uber, WeWork, and many other “start ups” follow this same model. I can never invest in Amazon because of my thinking. Maybe I’m the idiot though…because doing so 10 years ago would have looked brilliant! I’d be feeling the same way Private Equity Fund A did 5 years after they originally funded Tech Company XYZ, rich and smart. These companies are real and Amazon definitely provides services people want…but how sustainable is this formula? I think eventually that leverage has to end (i.e. deleveraging) which is a painful deflationary process. Creating money TO PROP UP ASSET PRICES…only kicks that can down the road, and doesn’t reduce the internal risk. The crash of asset prices can cause economic depressions…. and the bigger the bubble, the harder the crash. What a pickle for the Fed!
The end of this version of “Capitalism” & the “American Dream” will happen as a result of allowing the Ponzi scheme to continue un-relentingly. It’ll lead to an ever increasing wealth gap that will either end with pitchforks… “overthrow the rulers and redistribute the land / assets”, or with austerity because the wealthy and their military might will impose tribute via labor and money from the people who default on their debts, and we end up with an oligarchy. However, this time around there’s money getting out into the “real economy” via the PPP loans, expanded unemployment, and direct stimulus. That is different and Congress needs to do that to counterbalance what the Fed must do in propping up asset prices.
The USA can continue to create money to prevent this deleveraging / deflationary process. I think that is what will happen for another generation or 2. But the end result will come one day. There will have to be someone who actually does the work because we can’t all become our own Private Equity Fund E, F, G, etc.
Those who have assets will continue to use assets to create more assets… just like Private Equity Fund A did with Tech Company XYZ. Money that exists only to create more money leads to a society where we all wish to become our own Private Equity Fund, and no one is left to actually do any work of producing things we want. Our corporations behave more and more like banks each year… borrow at 3%, lend/create at 6%, golf at 3pm.
Our Central Bank has to prop up asset prices to prevent painful deflation. It’s up to policy makers to figure out an eventual solution. Creating money to support the “real economy” (i.e. not cowboy capitalism) is probably a good step in the right direction. But how long this lasts remains to be seen.
All USA citizens can still become their own Private Equity Funds because the USA & China are both spending a ton of money in Africa, the final source of cheap labor on this planet. China is becoming too wealthy to pay Chinese people to manufacture, and their prices will eventually become too high to compete, so they are quickly building infrastructure in Africa. So are Facebook & Google and many other USA companies. That can occur over the next 2 generations, so I think the eventual deleveraging I’m talking about doesn’t really have to end any time soon. However, the geopolitical tensions will escalate in various ways as we move forward. That requires competing nations to play by an agreed upon set of rules, which requires national leaders to understand what I’ve been writing about here and considering the consequences of each path forward.
Let’s hope a few things continue after this current creation of money. Instead of creating money (aka tax breaks) to prop up asset prices, how about creating money then giving it to hospitals to purchase medical supplies made in the USA? Congress could call it a tax credit (or whatever “name” you give it) instead of calling it “printed money”. Created money & tax credits are essentially the same thing if you’ve been following along. This functions the same way as tariffs in a trade war. Yes, we will be “cheating” like China does, and that’s OK. It’s an escalation of the trade war but with an inward gaze, which is preferential to the saber rattling of external tariffs.
I would love to start a company to make medical face shields here in the USA! But those would cost $7 each vs the $2 price point of a face shield made in China. Hospitals can use tax credits to justify paying $7 for a face shield made in the USA because they’ll receive a $5 tax credit. I have 6 jobs at $18 an hour ready to go if we ever get policies like that. However, take this with a grain of salt because I’m just a fish…”If you want to know water, do not ask the fish”.