High stakes poker

Have you had your free money yet? As a resident of Jersey, I've just been told I will receive £100 by September to spend in Jersey. Of course, it's not only me, every man, woman and child will receive a £100 by voucher or pre-paid card with an expected time limit of November before the money needs to be spent. With roughly 100,000 residents in Jersey this comes at a cost of around £10 million. This will likely represent more than 20% of the tax revenues raised by the Jersey Government in 2020. Whilst this is an historic amount to spend, what's a government to do?

Governments across the globe have been desperately trying to stimulate growth above 2% since the Great Financial Crash of 2008. During that time, inflation has been a thorn in their side refusing to budge higher despite endless monetary easing. Zero interest rates and trillions of dollars of QE have lifted the money supply but done nothing to raise consumer inflation; only asset prices.

Take a look at the decline in the Fed Funds rate in the chart below. When faced with wavering demand in the economy, since the conquering of inflation in the 80s, the central bank response has been to cut rates, every time.

 

With each card the economy has dealt the Fed, their response has been to raise the stakes; betting on their reading of how the consumer and business will react. In 2020, with all cards on the table, the Fed is face to face with those people it is employed to help. It needs to throw everything it has on the table. There is no time left to let this pandemic and the 'return to work' play out. There is no way the economy is recovering to pre-pandemic levels.

What can you do at the poker table when your reputation is at stake. The world's eyes are on the Fed and indeed all the major central banks and governments. They claim to know what they're doing and hence they need to follow through with policy action. You cannot cut rates to zero, add trillions to your balance sheet and then just wait, because by now, the numbers should be turning in your favour.

Since their only other option is to fold, I think they will go all in. They will stand by the side of government in support of free money, 'helicopter money' and what has become know as MMT or Modern Monetary Theory.

They have the perfect excuse. And since they are all politicians on a public stage, they will use it. The corona virus has clearly accelerated indebtedness and slain many businesses. Governments will issue money and central banks will finance the debt. It will be marketed as a necessary but temporary solution. Just as QE was, each and every time it was rolled out.

Initially it will not work since people will believe it is temporary. When I take my £100 to spend, I will not form a habit of increased spending. I will view it as a one-off gift. Sure, businesses will welcome the temporary increase in spending. It will get them to Christmas, some of them. But what then? Will confidence be restored?

Even if there is a vaccine, the level of additional debt added by consumers who lost work, by businesses who lost custom and by state and local government who paid for the health emergency, will be a chain around the neck. Inflation will continue to be subdued and interest rates floored.

The only way to create confidence in spending is to convince people the free money is not temporary, but permanent. Imagine, believing, perhaps even knowing, you are to receive an additional amount each and every month which means you have no concerns over paying your rent, your bills and even splashing out once or twice a week. You would spend it. You would not need to repay your debt since there is more where that came from. You would not need a nest egg, since the free money would always be there. That is how you create inflation. And with central banks printing money and acting out on their promises, who is to argue against them?

Then and only then will inflation rise. And it will not stop rising, until central banks realise they cannot control inflation through micro-managing rates and the balance sheet. By the time they admit this however, inflation will already be in the psyche; just as it was in the 70s. Significant negative real interest rates will crush asset prices. likely much faster than they've risen.

The Fed having gone 'all in' to save its reputation will be found wanting and its credibility shot to pieces.

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