It is MMT? Not Yet

Increasingly aggressive fiscal and monetary measures are being applied on a weekly basis. For this I am extremely grateful as these actions allow the US to continue as a "going concern" and stop the domino effect of unemployment from morphing into a domino effect of bankruptcies.

All recessions are simply a contraction of consumer demand and are normally induced by the Fed's tightening. But this time the Fed was already in a loosening phase and has accelerated that support. The recession-fighting actions of the U.S. Treasury and the Federal Reserve have been seen by many as inflationary. But I think that's wrong - assuming that radically different structures are not employed.

Typically the U.S. Treasury functions as the "fiscal" piece of the U.S. Government (USG) by issuing debt and collecting taxes. When the USG spends more than it earns, this deficit is funded by issuing USG bonds. On the other end of the USG, in its own non-constitutionally based room is the Federal Reserve. This central bank functions as the "monetary"  piece of the USG by issuing the only legit money (look at the top of your currency "Federal Reserve Note") to control interest rates and, thus, the growth rate of the economy.

These two functions - fiscal and monetary - have been kept as separate in the USG as church and state in the US society. The financial crisis of 2008-9 brought coordination between fiscal and monetary functions and so profitably concluded its operations that it was able to quickly set up a beautiful coordination to respond to COVID-19's economic impact.

The scale of the operations at $50 billion per day in the US alone with comparable scale operations in Japan and Europe lead observers to predict inflation. Further, those who have advocated Modern Monetary Theory (MMT) have declared its arrival.  MMT is the proposition that we don't need to have any social ails with a paper money economy because we can simply "helicopter" or print more money.

Without getting too technical, the important distinction between the current USG processes and the radical money printing mechanisms of Modern Monetary Theory (MMT) is that all of our processes are currently structured by instruments created between a legit borrower and lender. The monetary mechanisms are merely providing liquidity and value stability for instruments that were created on a reasonably sound basis pre-COVID.  MMT, on the other hand, advocates a simple handout of money where needed. This is very different and gets to the important issues constraining current actions.

For example, the Fed is willing to consider "fallen angels" - instruments that were investment grade (thus reasonably sound pre-COVID) but no longer so. Instruments that were made on a less than investment grade basis or speculative basis do not qualify. Such actions would move us more closely to the world of MMT.

Of course, another related but different issue is moral hazard. Given the large scale of these actions, individuals will be able to game these actions to receive benefits where none should be given. This concern for moral hazard has been affecting the legitimate receipt of fund for organizations as varied as large restaurant chains to private universities.

For all of the above, I don't see these actions as inflationary, while MMT would clearly be. The challenge in our economy is to grow productivity adequately in such a way as to create new investment grade instruments. Without these, the brutal machinery of capitalism is more likely to continue to drive a deflationary outcome despite the record levels of debt creation.

Redefining the Social Contract?

Many pundits are evaluating the long-term effects of the current pandemic. One possibility seems to be the redefinition of the Social Contract. This book title was employed by Rousseau in a work to advocate a then revolutionary shift in power from the divine right of monarchs to the general will of the people.

As the pandemic as disrupted, this health crisis has made heavily leveraged corporate entities likely to receive ample government assistance. This raises the inevitable issue of fairness. Why is it that when an individual experiences a health crisis, that individual is expected to pay all bills or declare "one of those chapters" but corporate entities are allowed to dodge their responsibility?

I have argued that corporate taxation should be lower than individual taxation because the businesses are those which lay the golden eggs while the individuals consume said eggs. But in this situation, the businesses have been leveraging their statements in a serious misallocation of capital. Shouldn't these entities be held to consequences for their behavior? How is it appropriate for CEOs to cry, "it's not my fault!" and receive benefits that he was not likely to provide for employees who have been in a similar situation.

Rumblings about the relationship between leverage and stock repurchasing are surfacing, as well as the connection to extraordinary stock option compensation for the privileged few. Could it be that "one of those chapters" would be the easiest means of a redefined Social Contract?

Framework for Assessing COVID - 19

COVID - 19 is not the first virus to affect large populations, but its impact may be the greatest because of the global connectivity driven by debt-financed markets. In the past, lower economic activity was less frightening because populations relied on their reserves. However, today's propensity to borrow ourselves rich puts us in a precarious position. In thinking about this, I would break the analysis into cause-effect approach with a mind-body distinction:

1) determinate cause - virus
2) actual effect - economy
3) mental effect - stock market

In the first area, we still need critical data on the virus that will allow us to better asses the potential range of effects. The questions to answer are:

Transmissibility - when is the virus transmissible. The answer to this question can be then be quantified. Currently, the virus pathway is well understood in terms of human to human transmission as well as durability of virus outside human body. But the time of transmissibility is not clear. The less symptoms required to transmit, the greater the transmissibility. Transmissibility may even occur after someone is recovered. If understood, this factor can be quantified as somewhere between the flu and the measles.

Fatality rate - how the virus affects bodies. This virus has a wide range of outcomes on mortality. So far these are difficult to assess. Lower fatality rates could be ascribed to better testing or better genes or less overwhelmed healthcare systems. At the inception of this virus, people were unconcerned due to a perception of low ultimate fatality rates relative to the flu. That has changed. In the future, this fatality rate could be affected by treatments or vaccines.

The resulting TF could be assessed and grouped for % outcomes by a 2X2 square:

HighT*LowF: 50% - 75% (depends on treatment)
LowT*LowF: 25%
HighT*HighF: 25% - 0%

In the second area, we are gathering data on the impact of the only successful approach we have seen so far - social distancing. There are clearly degrees of social distancing. The impact on the spread is more positive the more radical the social distancing, but the impact on the economy is directly negative. In addition, the longer the duration of the social distancing, the more negative impact the economy receives. These could be grouped for combo impacts using some kind of normal curve:

LowSDLowEI:16%
ModerateSDModEI:66%
HighSDHighEI:16%

Taking these two areas together, an estimate of stock market impacts could be structured:

Market Collapse: High all: 4% or 1% (good treatment)
Series of Ws: Moderate all: 92% or 80% (good treatment)
V-shaped Recovery: 4% or 19% (good treatment)

There will be many kind of robust statistical models generating likely scenarios. From this crude model, it would appear that a muddle through period is likely ahead.