Bond Bull Lacy Hunt Warns of a Huge Monetary Risk

Mish

Lacy Hunt has not yet changed his mind on where bond yields are headed but he has his eyes on one thing that could change his mind.

Literal Printing Would Change the Game

Lacy Hunt at Hoisington Management has been a bond bull for three decades and accurately so.

If you are wondering what might change his mind, he explained in a Bloomberg Interview.

The first half hour of our discussion went about as expected. Even though the coronavirus pandemic has led to unprecedented Federal Reserve interventions and fiscal relief efforts, Hunt insisted it was mostly a continuation of what he’s seen for years. 

Then, I asked about Modern Monetary Theory and other novel policy ideas, like direct monetary financing. That’s when his tone shifted to what he sees as a “great risk” in the years ahead.

Interview Snips

LH: When the Fed initiated QE1, QE2 and QE3, folks said those policies were very inflationary. There is a liquidity effect of what the Fed is doing, and the liquidity effect can be very powerful over the short term. But ultimately the increase in the money supply did not follow through after the rounds of Fed purchases of government securities because the banks couldn’t utilize the reserves, they didn’t have the capital base to make the loans, they had to charge a risk premium in an environment in which the risk premium was rising very dramatically and the borrowers couldn’t pay the risk premium. There was no secondary follow-through in terms of money supply growth, and the velocity of money fell and the growth rate fell back after a transitory rise. And I don’t really see this as any different.

LH: The first-round effects of the Fed look effective, and they’re widely hailed, but they make the economy even more overleveraged than it was before and credit is allocated to those who are not really in a position to generate economic growth from it. We’ve seen numerous similar programs in Japan and Europe and it looks like the central bank has the capability to do whatever it takes. They certainly have the ability to calm and reliquify markets, but those actions then compound the underlying problem, which is the extreme over-indebtedness. You get a transitory boost, you get a liquidity effect, but that liquidity effect runs out very quickly.

Bloomberg:  This is usually the point at which I ask, how do we get out of this? 

LH: The problem is people want a financial transaction to cover the problem. They want greater levels of debt — in other words, we’re going to try to solve an indebtedness problem by taking on more debt. Japan has tried many, many heroic measures to try to pull themselves out. 

Bloomberg: Lastly, I want to ask you about the rise of Modern Monetary Theory within economics, and some proposals to have the Fed give money directly to individuals. 

LH: The great risk is that we become dissatisfied with the way things are, and either de jure or de facto, the Federal Reserve’s liabilities are made legal tender. The Federal Reserve as it’s constituted today can lend but it cannot spend. Now, they’ve done some things that are different from what the Federal Reserve Act said under the exigent circumstances clauses, but so far they’re lending. 

LH: There are folks who want to make the Fed’s liabilities legal tender. Now, if that happens, then the inflation rate would take off. However, in very short order, everyone would be totally miserable because no one would want to hold money. You would trigger Gresham’s Law — people would only want to hold commodities they can consume and commodities that can be traded for others. 

LH: But there is that risk that you could use the Fed’s liabilities to pay directly. The Bank of England has made a small move in that direction — they say it’s temporary. There are others that want to try that because they’re frustrated with the fact that issuing the debt is not getting the job done. So we could significantly alter the whole structure of the U.S. economy. But if you use the Fed’s liabilities for directly funding goods and services, the consequences could be very extreme and very quick.

My Comments

I had a phone conversation with Lacy shortly after the Bank of England made that change, allegedly temporary, and another conversation in response to Hello. There is No Magic Money Multiplier.

Lacy agreed there is no magic multiplier and also directed me to the above interview.

I will add this caution: I have yet seen central bank changes that are temporary.

This concern is definitely something to keep an eye on.

Mish

Comments (35)
No. 1-11
numike
numike

but but the stock market is at record highs!!

WCVarones
WCVarones

How is the Fed printing trillions to buy Treasury debt funding multi-trillion-dollar deficits not outright MMT?

foxdbff
foxdbff

Dr. Lacy Hunt is an absolute monument when it comes to fixed income and treasury investing. The man's track record is amazing, his knowledge in financial history is enormous and his expertise in econometrics is without match. My respect for him is endless and eternal.

Do not get out of context what he said. He warns of the risk that FED liabilities might become legal tender aka money but he also said this is likely not for 2020 or even 2021. He doubts it will happen under Powel because Powel is on the side that the FED can finance but it can not spend. And for the new FED president entering in Feb 2022 there will first need to be held hearings about the subject, and that he says will open a whole can of worms with equally extreme proposals that will severely slow things down. After some kind of agreement, a bill needs to be drafted, this bill then needs to go trough revisions and then it needs to pass both house and senate and then Trump or Biden will need to sign it. That process is going to take time, lots of time.

That also means that the house of cards still needs to be standing until this happens. Where is your bet?

I fear that mother nature is going to topple the house of cards a lot sooner and faster than the FED and congress can change laws. You know where my bet is.

Maximus_Minimus
Maximus_Minimus

Sadly, he repeats the tired mantra that inflation hasn't happened. What else is the runaway housing market, and trillion dollar market cap companies. Cut cheap Chinese imports off, and you would get a wonderful inflation, too.

truthseeker
truthseeker

IMO if Biden wins the election one of the first things you’re going to see is the UBI or universal basic income concept, if we can get by the reparations idea that is part of the BLM movement, because I don’t think we can have both. Somewhere somebody said we would pay for this with a wealth tax and even a VAT, value added tax. Anyway all kinds of taxes are coming because of the fairness issue caused by a number of things, from rejecting the gold standard and the many outrageous mistakes by the federal reserve.

Casual_Observer
Casual_Observer

How's this economic system worked out for the vast majority of people?

Bam_Man
Bam_Man

"Precarious shape" = Newspeak for "a smoldering crater in the ground."

Tony Bennett
Tony Bennett

"The great risk is that we become dissatisfied with the way things are, and either de jure or de facto, the Federal Reserve’s liabilities are made legal tender. The Federal Reserve as it’s constituted today can lend but it cannot spend."

...

Anything is possible. BUT this would mean an act of Congress (and signed by POTUS). At the end of the day, 2 Major problems. 1) risk to $US hegemony and 2) loss of Power of the Purse by Congress. Much of the power ($$s flowing to their PACs or votes by those who benefit) of Congress is deciding who gets ( and how much) what.

Pelosi entrenched her position with liberals by winning House passage of $3 trillion stimulus package (which will be cut down). Anyways, take all this away ... Congress will vote for Federal Reserve to dole out $US instead of themselves? Might as well close up shop on Appropriation Committees.

Tony Bennett
Tony Bennett

"the Federal Reserve’s liabilities are made legal tender. "

...

They already are.

Federal Reserve Balance Sheet

Assets - Federal Reserve purchases - treasuries, gold, mbs, etc.

Liabilities - Federal Reserve Notes (cash) or their digital equivalent.

Equity / net worth - a sliver of capital.

ElbowWilham
ElbowWilham

Can't the corporations issue new bonds, which the FED buys from the corp, then the corp buys back its own shares? I realize this is different then UBI, but it will keep the market propped up as long as they want, right?

Am I missing something?


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