Stagflation and neo-chartalism
"Naive application of Austrian economics does not promote the public good."
If there is any rule of literary economics I have learned, it is that Friedrich List, the 19th-century German neo-mercantilist, got it right when he said that Adam Smith (his classical-liberal foil) was right about everything—given Adam Smith’s assumptions.
Both List and Smith were right about everything. Both the Austrian School and the neo-chartalist school (“Modern Monetary Theory,” the most godawful branding since “DuckDuckGo”) are right about everything—given their assumptions.
(It may be too much to say that legitimate “macroeconomists,” with their weird, mid-20th-century algebraic models of a mid-20th-century industrial economy, are right. We must concede the possibility that they used to be right—for the mid-20th-century.)
Adam Smith is right given the assumption that the world is one giant country. If different parts of the world have divergent interests, Adam Smith is no longer right: parts can gain at the expense of other parts, winning in a negative-sum game.
“MMT” is right given the assumption that citizens are forced to save in the state currency. Once savings escape to a harder currency, “MMT” is no longer right: the “inflation tax” it depends on is straightforwardly evaded.
This is why, in all historical societies in which the government has had to finance itself by inflation—including the United States, with gold confiscation—it has had to prosecute any harder moneys out of existence by intrusive-governance techniques.
Who can forget the warning of Bulgakov’s cat, in “The Master and Margarita,” that foreign currency can get moldy under the floorboards? Every regime that finds it really has to reap the wealth of its serfs finds this “Master and Margarita Theory.”
Let’s postulate that there is always some club that can be used on the economy to enforce neo-chartalist economics, in which the only possible standard store of value is current or deferred government equity. Governments are good at enforcing standards. With standards like “MMT,” they may have to get a little heavy-handed, but…
Neo-chartalism remains a special case of Austrian economics. On the other hand—we all live inside this special case. For now, we all live inside what John Stuart Mill, in a better and simpler time, called the “Currency Juggle.”
Since it is a juggle, but it works, let us explain neo-chartalism in simpler terms. Then we will explain stagflation in terms of neo-chartalism.
The Microsoft financial system
Here is a much simpler model of the economy. This model has exactly one financial actor: the state. The state is a sovereign corporation which uses shares of its own stock as its subjects’ only store of value. As a stand-in brand for this “sovcorp,” let’s use one of my favorite companies—Microsoft.
Microsoft is the government. Microsoft shares are money. Microsoft pays its employees in Microsoft stock. It buys its office supplies in Microsoft stock. The virtual bucks in its metaverse are… Microsoft stock. Obviously, Microsoft can create or destroy its own stock as it likes—just as a neo-chartalist sovereign corporation can issue shares (“borrow”) or cancel shares (“tax”).
Once we add restricted stock—shares that become valid on a specified date—we have the definition of a complete financial system. Restricted Microsoft shares are simply risk-free bonds, issued by Microsoft, denominated in Microsoft stock. They have the same relationship to MSFT shares that US Treasury bonds bear to FRNs (“dollars”). They are risk-free because they convert automatically on their maturity date.
We could add another dimension and create varied levels of risk, giving us a model of “equity” (which might track the P/L of some new Microsoft product) within our bizarre Microsoft Financial System (tm). But this is not necessary—money and debt are enough for a convincing model.
What’s important in this situation is that Microsoft has a fixed number of shares—and a central list of who owns how many. In fact, the “cap table” of Microsoft is also the “bank” of the Republic of Microsoft. It is a database with one row for each citizen, which records how many shares that citizen has—the balance in their bank account.
Citizens can also carry debt—they can owe shares, as well as owning them. Let’s say that all debt is owed to Microsoft itself—it is a promise to deliver, on such a date, so many shares, up to the company. If delivery is not made, Bill Gates will come to your house and install Windows 95 on your wife. You were warned, citizen!
In “literary economics,” one often thinks by translating economic systems into other systems with roughly identical preference schedules. If we can simplify the logic by which a system can be represented, while preserving an incentive structure that keeps the same people doing the same things, we can understand the system better.
Let us model the USG (United States Government) as a sovereign corporation—like Microsoft, but with guns. Federal Reserve Notes (“dollars”) are shares in the USG—they are not debt, since they do not promise anything; so they must be equity.
Our first step is to fix the USG’s cap table by fixing the number of outstanding shares. This might be amended in a board resolution, but only in a case where the capital of the company was radically expanded—for example, in a major acquisition.
If the US were to acquire Canada, for example—perhaps the reunification of British North America is the new reunification of Germany—it would issue new dollars to exchange for the, the, the whatever it is they have up there. But if Microsoft were minting new shares to fund ongoing operations, Microsoft fans like me would worry!
On fixing the money supply, we notice something odd: the whole economy collapses.
This is because the dollar financial system has 100 times as many promises of dollars, as actual dollars. A game of musical chairs—with a hundred people, and one chair. We see that naive application of Austrian economics does not promote the public good. Rather, it looks more like some sort of demented “Hunger Games” sadism.
For example, the banking system collapses because M1 (promises of money by banks) is greater than M0 (actual money owned by banks). Since everyone has the right to turn their M1 into M0, everyone does so as fast as possible: musical chairs.
(There exists this odd “semiprivate company” called “FDIC,” which, in a bold act of statistical fallacy, purports to “insure” all these promises. Of course FDIC does not have anything like M1-M0 dollars, so who cares. It would work nicely, though, if its “risks” were uncorrelated.)
But bank “deposits” are only the simplest form of financial security. All securities, debt or equity, are promises or prospects of future payment in money. Imagine a planet on which the standard money is gold, on which there are 100,000 tons of gold, but 10 million tons of promises of gold. Does this, like, make sense? Musical chairs.
Monetize all the securities
Why does this not happen already? Because of informal financial instruments. These promises are never written or stated, but are known for political reasons to be good.
An example would be the Fed’s promise to bail out FDIC—by issuing new shares. Of course, just as Microsoft can issue new shares, the Federal Reserve can create new dollars (Federal Reserve Notes). It doesn’t even need to print pieces of paper—they have computers now.
Because this promise is known to be good, it need not be tested, and the banks live. But they live by the grace of “virtual” Microsoft shares—which never need to be created, because they always can be created.
This is an extremely sneaky way to expand a balance sheet, because it means making promises which turn things that aren’t Microsoft shares (be they shares in some other company, or baseball cards, or fad NFTs) into Microsoft shares. It is bad accounting—and when governments get into bad accounting, usually other things are bad.
But how can these virtual shares be eliminated without disruption? If we turn off the power of Microsoft to create new shares, the whole Microsoft economy goes into epic hyperdeflation and craters. If we leave it on, the bad accounting persists.
The only way out is to acknowledge that the monetization of all financial instruments happened. Since demonetization of the financial system will radically lower the price of financial instruments (and financed property), everyone gets an option to sell their capital back to the government, at the last price of the old regime, for new dollars. And everyone would be an idiot not to take that option.
The new dollars are not really new, in a sense—they were smuggled virtually out of the Fed. Better to recognize that this happened, than deny that this happened. And the best thing is that since this change does not disrupt anyone’s preference schedule,
Monetization of all securities is portfolio-neutral: after the transformation, everyone has the same personal net worth. It is just all in cash—not a bunch of bets on this or that. (In a sane financial system, not everyone needs to be betting all the time.) Your broker just automatically sold everything for you and everyone else—but, magically, you all got the “market price.”
It does leave the government owning all the companies. This is fine. In general, the current management can be left in charge. Eventually all these capital assets can be sold back to the public, establishing new (and totally different) capital markets. These markets will even have free-market interest rates, a long-lost feature of capitalism.
The inflation economy
In a static analysis, this transformation works. Since a normal person’s propensity to consume is a function of their personal net worth, not the distribution of their investments, they do not change their spending patterns. There is no disruption.
In a dynamic analysis, however, it does not work. This is because the whole system loses money. The whole economy is unprofitable. The whole country is unprofitable—and it is unprofitable because it sucks. This is the fundamental cause of stagflation.
How is new money created? In two ways: one, by private and government borrowing; two, by capital appreciation (“asset-price inflation”).
Borrowing creates money because, when we map it into our monetization frame, both borrower and lender end up with dollars (since the lender’s bond is monetized). True, the borrower also has a debt that becomes a debt to Microsoft—but there are plenty of ways to refinance debt until the end of the universe, and never destroy those dollars. And when the government itself borrows, this is straight-up money creation.
Since the monetization turns all capital into dollars at the market price, anything that raises the price of capital increases the number of dollars—and is as good as paying people in dollars. Since the formula for valuing assets has the interest rate in the denominator, manipulating interest rates can create arbitrary capital appreciation. This translates into people spending more money because they are using their house or their index fund as an ATM—“passive investment,” clearly a free-market concept.
With a fixed supply of money, the capital schedule of the economy becomes constant, meaning that debt becomes constant—or at least, systemically stable. Interest rates are not manipulated at all, so there is no systemic or correlated change in asset prices. In this stable economy, the Microsoft board never has to create new Microsoft shares, and (absent natural disasters and other physical correlations) “the market” never goes up or down.
Unfortunately, when we take an economy into which a large number of dollars are continually being injected, and we stop injecting those dollars, everything craters. Any system that is losing money needs a continuous injection of new money. If this feed stops, the system gets very upset and starts throwing chairs around the room.
This is the inflation economy—a fundamentally sick system.
The inflation economy inflates the economy by two paths—the same two paths described above, welfare economics (borrow-and-spend—whether the borrowing institution is the government or not scarcely matters), and trickle-down economics (giving rich people more money so they will spend it on the poor).
In the Microsoft transformation, capital appreciation just turns into a program that semi-randomly adds more dollars to your bank balance. It is observed that those with the most dollars not only get the most appreciation, but the highest rates of “return.” This is fine. In some ways, it is more than fine.
The Cantillon effect tells us that new money does not affect prices equally. When we analyze Microsoft stock as a security, we see that minting new shares equally dilutes all shareholders.
But suppose the Fed prints a trillion new dollars and gives them all to Bill Gates, who stores them on paper in a vault at his estate and does not change his behavior at all. This is dilution, but not inflation—nobody’s spending pattern changes. Now suppose the vault leaks and all the bills are ruined. Again—concentration, but no deflation.
This is a reductio ad absurdum. But capital appreciation that favors the rich, as compared to borrowing that sends dollars to schoolteachers or construction workers, is more dilutive while being less inflationary—since the propensity of the new money to be spent is generally smaller.
The more new dollars reach the broadest sector of the economy, the more spending on broadly demanded goods is created, and the easier it becomes for this spending to create supply-and-demand imbalances which can only clear at a higher price level.
If these dollars can be sucked back out of the broad spending class, ending up either overseas or back in the pockets of the rich, consumer price inflation can be avoided. The classic cause of inflation is a wage-price spiral in which the working class needs (and can get) constant salary increases to pay for the constant price increases.
Stagflation is the future
Stagflation is a condition of high consumer-price inflation and low labor demand. Stagflation is the future. We must bow to our new overlord, stagflation.
Stagflation happens when the resource whose supply and demand are imbalanced is not labor, or is a field of labor with inflexible supply—without Marx’s “reserve army of the unemployed.” In olden times, generic unskilled labor was much more of a thing.
For example, as borrowing and trickle-downs fill up the monetary pool of the broad spending class, the trade deficit—sending dollars overseas—empties it. Those dollars do not disappear, though; some of them, via exports, are even competing for American labor demand; but they are also competing for commodities, like oil.
In stagflation, the patient has an IV and is also bleeding out. The more blood goes in, the more blood comes out. The real problem, though, is when the blood starts to go straight from the input to the output—without getting to the organs that need it. Which is what it means for an economy to suck.
Giving free money to the rich to spend on expensive toys from China does not create any particular labor demand in Gary, Indiana or Redding, California. At most, the serfs at some factory in Shenzhen might be eating American pork. The expensive toys might be “designed in California.” But stagnation is visible everywhere.
Nor does welfare economics affect stagnation much. People who live on literal welfare are literally stagnant, even if they are not starving. Most government jobs are stagnant paper-pushing. Borrowing to fund construction seems better—but most construction workers are no longer American citizens.
And inflation is everywhere. Those dollars that went to China are still competing for global resources—they are still driving up the prices Americans pay. Chinese currency manipulation intentionally reduces the international purchasing power of its citizens, but China still needs to buy oil.
Stagflation is the near and medium future because the covid boom is unsustainable, for two reasons. One, covid is no longer a palpable emergency and will find it harder and harder to justify subsidies. Two, the Fed has pushed the dilution handle so hard that serious price inflation is actually happening.
As the Fed pulls back on its bond purchases and lets interest rates rise, portfolios will begin to contract and spending will begin to suffer. Welfare economics will become more austere because temporary covid programs end. Capital appreciation will become more austere because capital (and crypto!) prices actually drop.
The system, dependent on constant appreciation, is highly sensitive to a depreciative shock. Eventually this shock, a recession or depression, will elicit a political response and the whole cycle will repeat. A smart person might even be able to time it.
But the recession may not affect the causes of inflation as much as one might hope—since these causes are not the wages paid to a fully-employed domestic labor army, but global imbalances in the supply of commodities and other goods with inelastic supply (for the moment, even chips). An inflationary recession is stagflation.
So America can have huge armies of working-age people who have no idea what to do with their lives, while prices for both capital (especially houses in Malibu) and goods (whether made in China, or sucked out of the sand in Kuwait) go up and up and up. Also, New York is joining San Francisco in the ‘70s nostalgia trip. Good times!
The Yarvin Rule: invest in the reverse of whatever Curtis says. Previous profitable examples: Going long BTC in 2013 when Curtis said to short it. Going short Silver in Feb 2021 when Curtis said to long it.
So time to buy OTM puts on oil and semiconductors?
Very nice illustrations describing MMT, that system that sacrifices the store of value function at the altar of velocity! The distortions created by the financial repression and resultant absence of a risk deflator may perhaps be discussed for centuries when the collapse happens.