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April 14, 2019

Modern Monetary Theory: Economic absurdism enters the mainstream

After the Trump election victory, tradi- tional, conventional politics and politicians have largely fallen out of favor. Middle-of- the-road ideas, proposals crossing party lines and common-ground platforms that once played a prominent role in many campaign playbooks have been replaced with a very different type of strategy. These days, amid sharp political polarization and social division, it is the loudest voices and the most extreme ideas that get the most airtime. In such an environment, where emotional arguments routinely reign over facts and logic, policy platforms have dra- matically shifted their focus to style over substance.

This trend can be spotted in many countries in the West, but it is arguably most apparent in the US, where the next election is already on the horizon. The Democratic party, eager to dethrone Donald Trump, has already pro- duced a small army of candidates that will compete for the nomination. At the time of writing, there are 17 confirmed candidates and 3 exploratory committees, while there are even more “suspected” candidates, like former Vice President Joe Biden, that are still keeping their cards close to their chest. With“choice overload” being a real risk, standing out from one’s opponents is clearly a challenge and a strategic necessity in win- ning the overcrowded primary.

To achieve this and to increase the contrast with the Trump administration, which is much-reviled within their ranks, some of the candidates and other high-profile young Democrats have embraced strategies ranging from the naively idealistic to the downright populist. Policy proposals like the Green New Deal, support for the Universal Basic Income and other crowd-pleasing, blue-sky pitches have shown a steady deficit of practical consideration and fiscal realism.

As is usually the case with political promises like these, the numbers don’t add up. However, today there is the new solution to this old problem: when the numbers don’t add up, simply cast doubt on the numbers themselves. And that’s where “Modern Monetary Theory” comes in.

A brief crash course on MMT

Even though Modern Monetary Theory (MMT) has only recently entered the public consciousness, it has been around for quite a while. Academically, it mostly lurked in the dark alleys of the Economics field, dismissed as a fringe notion and thus largely ignored. The theory would likely have lived out its days in obscurity had it not been for high-profile political figures like Alexandria Ocasio-Cortez dragging it into the limelight.

MMT, commonly derided as the “Magic Money Tree” theory, flies in the face of most basic economic and monetary principles. It is based on the idea that since a country can exert control over its own currency, it really doesn’t need to be concerned over things like debt accumulation, as it can simply print more money to pay it off. Since the “burden” of the gold stand- ard is no longer a problem, the government can print its way out of debt, while deficit spending is not just seen as accept- able, but also encouraged.

The only real constraint, according to MMT, is infla- tion. Even that, however, is not a big problem, as inflation can easily be managed through taxation.

The theory also rejects the widely accepted idea behind the common central bank practice of tweaking interest rates to nudge a country’s economy. Instead, MMT holds that the “natural” rate of interest is zero and anything higher than that is giving an unfair advantage to the rich. Supporters of the the- ory also claim that this practice is ineffectual too, because companies make their decisions based on growth and not on the cost of money. Once again, MMTers seem unfazed by facts, even in the face of our current predicament, where the historic pile-up of corporate debt, incentivized by artificially low interest rates, is posing a serious threat to the US and global economy.

'The deficit itself could be deployed as a potent weapon in the fights against inequality,

poverty and economic stagnation' - Stephanie Kelton

According to the theory, as interest rates are not an appropriate tool to centrally control the economy, government spending itself should take over this role. Since MMT grants that a government’s printing power is unlimited, deficit spending is seen as having an exclusively positive impact on the economy. Therefore, we should do more of it to solve all kinds of problems. For example, to manage employment figures, MMT proposes a government-funded job guarantee, where the state is the employer of last resort, aiming at full employment. As prominent MMT supporter and Bernie Sanders advisor, Stephanie Kelton, put it: "Unemployment is evidence that the deficit is too small”.

While the political appeal of the theory might already be becoming apparent, the real ace up the sleeve of MMT is that, unlike any other left-leaning economic approach, it does not require enormous tax hikes to pay for all the ambitious political visions of its sup- porters. For MMTers, since the primary income stream comes from printing money at will, taxation in general is just an offsetting tool to keep inflation under control, when and if it is necessary. As for taxing the rich in particular, it is not really a fiscal necessity, but a mere social and moral one in order to close the inequality gap. This rare combination of promising both high government spending and low taxes is a political silver bullet. Through the lens of MMT, grand designs, expensive government pro- jects, large-scale benefits programs and even solutions to global problems can be promoted as not only fiscally feasible, but also as a “win-win” proposition to the taxpayer.

The entire MMT framework and all its proposals might seem outlandish and nonsensical at first, yet it all becomes even more bizarre once you look at the core tenets of the theory. For MMTers, the essential question of “what is money” has a largely political answer. They do see fiat money as a mere IOU with its value entirely reliant upon the reputation of the issuer, which is to a large extent a common argument with significant mainstream acceptance.

However, they extend this logic to gold-backed currencies and even to actual gold coins too. They argue that even back in the old days, it was still the government or the stamp of the monarch that gave the coins their value, instead of the gold or silver they were actually made of. Of course, such an idea contradicts not only common sense, but historical facts as well, since if gold coins issued by one ruler were worth more than those of another, there would be exchange rates. Yet, quite predictably, the relevant records only mention exchange differentials based on the actual amount of gold in the coins.

A slippery slope

The core MMT belief of the government’s duty and capacity to centrally manage the economy through limitless money-printing quickly crosses over from the harmlessly eccentric to the downright ominous when the theory manifests in actual policies. Once again, there is a distinct political note, rather than economic reasoning, behind most MMT proposals. As advocates of the theory wrote in a recent letter to the Financial Times: “The more actively we regulate big business for public purpose, the tighter the full employment we can achieve”. An extreme degree of interventionism is vocally propagated by many MMTers, with proposals and arguments that place the theory much closer to centrally-planned, social- ist models than the free market.

Nevertheless, whatever the motivations of MMTers might be, it is the glaring factual deficit of the theory that makes its recent ascension to a mainstream sta- tus highly problematic. As a Bloomberg analysis concisely put it: “mainstream economists argue that the correct parts of MMT aren’t new and the new parts aren’t correct.” To facilitate mainstream acceptance, MMTers have used the 2008 crisis to prove that the current system doesn’t work and to position their theory as the better way forward. While the regulators’ and the central banks’ actions before and after the crash can hardly be defended as sound, enforcing what MMT prescribes as the “cure” would be far more destructive than the disease itself. Also, at this point, where national debt levels have reached unprecedented heights, positing that even more debt is the solution to all our plights is not just absurd, but extremely dangerous too.

Similar concerns over debt accumulation are among the core arguments of most conservative critics of MMT, of whom there are many as one might expect. What is slightly more surprising, however, is the opposition that the theory faces from the liberal camp. Among the detractors, for instance, is Larry Summers, former Treasury secretary and Harvard president, known for supporting stimulative deficit spending by governments and rejecting the usual conservative-led fiscal responsibility concerns. He has attacked MMT in no uncertain terms, as has Paul Krugman, another vocal proponent of government spending, and many other economists and politicians from the progressive field. A likely explanation is that there is a widespread concern that MMT will give a bad name to their own views on deficits, making it difficult for even the more conventional ideas to be taken seriously moving forward.

Economic quackery as a political weapon

As we mentioned before, MMT has already proved its value as a handy political tool by providing a convenient response to the common question, “How are you going to pay for it?”. Alexandria Ocasio Cortez, the young and ambitious new star of the Democratic Party that has ceaselessly been in the news for almost a year now, has already invoked MMT in connection with her “Green New Deal”. While the plan has been the target of much ridicule and ire for its exotic proposals and was ultimately voted down in Congress in a crushing a 57–0 defeat, the core ideas that it was based on are still alive and well. More than that, MMT-derived proposals and plans continue to be propagated and are very likely to end up among the main issues that voters will be called upon to decide in 2020.

While it was Cortez that brought the theory to the headlines, it was Bernie Sanders, widely seen as a frontrunner for the Democratic nomination, that first opened the door for MMT to mainstream politics by hiring the aforementioned Stephanie Kelton as his economic advisor. Kelton, an economist and profes- sor at Stony Brook University, ranked 182nd in the Forbes top colleges list, emerged as a leading and prolific advocate of the theory. As for Sanders him- self, he is in the process of crafting a proposal for a “jobs guarantee” plan that would offer jobs paying $15/hour nationwide with benefits and healthcare, with an estimated annual cost between $200 billion and $400 billion.

Yet it’s not only in the left fringes of the Democratic party that MMT has found a home. Even more conventionally positioned candidates, like Cory Booker of New Jersey, Massachusetts Senator Elizabeth Warren, and Kirsten Gillibrand of New York, are supporting a government-funded “jobs guarantee” or universal employment plan. Furthermore, there are many more popular and common-denominator policy ideas promoted by most Democratic candidates that are very likely to increase support for MMT.

“Medicare for All”, free college, and other crowd- pleasing and expensive ideas have so far been weakened by the old “How are you going to pay for it?” question nipping at their heels. Now, they have the MMT defense.

Implications for investors

This February, the US posted its largest-ever monthly budget deficit, as the gap widened to $234 billion, while the country’s national debt passed a new milestone, topping $22 trillion for the first time. The issues that divide the two parties in the US might be countless, but government spending does not seem to be among them. And while the fiscal reality and the figures can hardly be argued with, there is a key distinction between the political rhetoric of the old guard of both parties and this new breed of progressive challengers: the understanding that the debt problem needs to be urgently rectified, not gleefully exacerbated.

Although the term “populism” has been in recent years associated with the rise of the political right in the US and in Europe, that seems to be now chang- ing. Young politicians from the other side of the aisle are increasingly promoting policies and ideas in line with what most voters want to hear, without concerning themselves with the realistic aspects of their plans or their longterm impact.

The promise of a “free lunch” is the oldest trick in the political playbook, going back thousands of years, but it has mostly been delivered at the expense of a significant part of the working and voting population. However now, in this post-factual landscape, this promise is much more marketable and therefore much more dangerous.

With an increasing number of economists and ana- lysts expecting the next recession to hit in the next two years, this political trend is only likely to add to the severity of its impact. As the next US election draws near, there is a very real risk that we might see these economically destructive ideas manifest into actual policies.Given the extensive damage that absurd theories like MMT can inflict, especially on a steamed-out economy, a solid precious metals position is neces- sary, as an essential part of a defensive strategy for investors who seek to protect their wealth.

Deutsche Bank: Europe’s largest domino

After news of merger talks intensifying between Deutsche Bank (DB) and Commerzbank made the headlines in mid-March, hordes of analysts and experts rushed to dissect this scenario and outline their predictions for the outcome of the negotiations between the two major lenders.

However, the merger of Germany's two biggest banks itself is arguably not the most important aspect of this story. What is much more relevant is how DB got to the point it is today, the true current state of the bank, and why so much pressure has been exerted to secure this merger deal.

A meteoric rise

DB’s story goes all the way back to 1870, when a group of private bankers in Berlin decided to create a competitor to rival the UK banks that dominated the trade financing arena. In a few decades, the bank became a cornerstone of German trade, supporting the growth of many industries and becoming a core pillar of the economy. By 1914, it even briefly held the title of the world’s largest bank, according to Frankfurter Zeitung.

Following the first World War, DB contin- ued to grow, absorbed smaller operations and also played a central role in the rise of the German automotive industry. During WWII, with banks in Germany funding the regime and bankrolling its military and occupational activities, DB was no excep- tion, having facilitated large gold purchases from the Reichsbank, later to be sold on to Istanbul. After the end of the war, DB was broken up by the Allies, while it also suffered sizable losses, along with all other German banks that lost their operations in the East.

Nevertheless, DB was soon revived in 1957 and quickly returned to its former status as a pillar of German trade. By the early 1970s, it had an established international pres- ence, with branches all over the world. Through strategic mergers and deals, DB continued its aggressive expansion all the way until the early 2000s, becoming a for- midable player in the global investment and financial services sector.

When the 2008 crisis hit, DB was one of the precious few lenders of that scale that seemed to come out of it unscathed. By contrast, Commerzbank had to get bailed out twice, received over $18 billion in taxpayer money and gave up a 25% stake to the state. At the height of the carnage in the global banking industry and in the tough years that followed, DB was the exception to the rule. Not only did it not suffer as its peers did, but it also went on a buying spree only a couple of years after the crash. While Commerzbank was once again taking serious losses from the EU debt crisis in 2011 and the nosedive of Greek bonds, DB appeared to be in a much better defensive position.

Fall from grace

Despite the comparatively good shape that the lender was in during the first few years following the crisis, troubling signs didn’t take long to surface. After capitalization concerns intensified, the bank had to turn to its shareholders to raise cash, €3 billion in 2013 and €8.5 billion in 2014. Scandals also started to emerge and multiply, as did the corresponding fines.

DB was involved in the rigging scandal of the benchmark European Interbank Offered Rate (Euribor) and then in the case of the London Inter-bank Offered Rate (Libor) too, while in 2015 it was handed additional fines by the US for multiple sanctions viola- tions. However, the charges and the billions in fines truly accelerated and piled up in 2017, along with the massive reputational and stock price damage. US and UK authorities handed the German bank a $700 million fine for money laundering, while its past sins also caught up with it. An investigation from the US Department of Justice into the causes of the 2008 crisis revealed the bank was amongst those guilty of selling toxic mortgage-backed securities to investors. The settlement cost DB $7.2 billion.

To this day, the pace of new scandals and revelations has been unrelenting. From criminal cartel charges in Australia, to investigations over the Panama Papers and possible involvement in yet another money laundering scheme, this time tied to Danske Bank, DB has so far run up over $18.3 billion in fines and legal costs. It also had its Frankfurt headquarters raided by German authorities and multiple executives targeted in numerous investigations.

Apart from the inevitable death spiral of its public image, its stock price has suffered a similar fate. After consecutive years of poor performance, tens of thousands of job cuts and investors’ trust being seriously shaken, the bank’s stock fell below €8 last December, hitting an all-time low, a long way down from its $107 high in 2007.

Systemic risk

The German bank’s importance to the structural integrity of the sector at large can hardly be over- stated. Already in 2016, the IMF labeled DB the“world’s biggest potential risk among peers to the financial system because of its links to other banks.” Thus, it is easy to understand the fears of yet another“too big to fail” scenario and the concerns over the impact of a bailout.

To fully appreciate the risk that DB poses, one must consider its position in the appropriate context. Its woes might have been less worrying if the rest of the banking sector in the continent was in good shape. However, that is by far not the case. After half a dec- ade of negative interest rates, the banking crisis in Italy and the devastation of Greek banks, which have yet to recover, European banks are far too weak- ened to sustain further damage. They are also mostly cash-strapped and struggling to get back to profitable levels.

To make matters worse, as the Eurozone’s economy slows down, despite the ECB’s decade-long and aggressive efforts to artificially support it, Germany has arguably never been more vital in keeping the bloc together, both economically and politically. And for Germany, there is very little that is more important than a solid, reliable and resilient lender that can support its exports, the main driver of its own economy. Thus, DB’s troubles pose a serious threat, especially at a time when the German economy itself has come to a grinding halt and is flirting with a recession.

An unpopular rescue mission

While it’s not the first time that talk of a possible DB- Commerzbank merger is making the rounds, this time key preliminary obstacles seem to have been cleared. When the issue first arose in 2016, negotia- tions soon collapsed, but now the leadership of both parties appear to be in support of the deal. For example, DB chief executive Christian Sewing, until recently opposed to the idea, has now reversed his position. The merger also has strong state backing, with the German Finance Ministry openly willing to “orchestrate” the deal between the country’s two largest listed lenders, according to Focus magazine.

Should the merger be completed, it would result in Europe’s third-biggest bank by assets, after HSBC and BNP Paribas. It would also give Germany exactly what it needs to support its economy before the next downturn, a large lender with the international presence and wherewithal to effectively support its exporters. It is thus plain to see the incentives behind the governmental support for the deal, especially considering that it would also allow the state to have a stake in this “German champion”. And yet, for all the apparent benefits the merger would bring, there are considerable objections to it from multiple sides.

What lies ahead

Even if the merger was to go through, there are still considerable doubts that it would suffice to resolve DB’s deep and chronic problems. As its merger partner is also plagued by poor performance and profitability issues, the union of the two “problem banks” would arguably result in one even bigger problem bank. Or as Fabio De Masi of the Left party put it,“you don’t get an eagle out of two sick turkeys”.

A lot of the criticism has also been revolving around concerns that the merger between two large, ailing lenders would also serve to amplify the systemic risk the resulting mega-bank would pose. According to a recent survey of financial market experts conducted by the Leibniz Centre for European Economic Research, around 80% of respondents fear an increase in systemic risk, while according to the authors, the results indicated that “the disadvantages of the merger between Deutsche Bank and Commerzbank – which is complicated and expen- sive to implement – clearly outweigh the benefits”.

Overall, only time will tell whether this move will vindicate those who see it as a viable rescue plan. Despite the aforementioned concerns, it is still possible that the increased efficiency resulting from the merger and the combination of the strategic advantages of the two lenders could help resolve past issues, giving rise to a much more stable and competitive bank.

In any case, however, even a successful merger is unlikely to hold back the tide of the wider economic and banking sector problems in Europe. Thus, as the vulnerabilities and risk factors multiply in the entire bloc, building up a defensive physical precious metals position and keeping one’s holdings outside the banking system could make a key difference in the months and years to come.

The aftermath of the crypto-crash

Bitcoin has once again been in the news, as it made an attempt at a comeback in early April. Although the near-20K highs seen in 2017 are unlikely to return, the recent uptick that pushed the price around $5,300 has reignited interest in crypto. Investors are once again split between those who believe in another rally and those who dismiss the entire sector as a bubble long burst and fueled by nothing but hype. As is usually the case, the truth lies somewhere in the middle.

The spectacular rise and crash of the sec- tor over the past couple of years has largely served to justify the cynics’ criti- cism. The sector’s poster child, Bitcoin, suffered extensive losses, dropping from its near-$19,800 peak to below $3,500, with many other prominent cryptocurrencies and tokens suffering a similar fate. The whole market was decimated, mostly in a matter of days, with digital assets crashing by as much as 90%.

The sector’s 2017-2018 performance indeed displayed all the marks of a bubble, as did the widespread crypto-mania stoked up by the media. Intensely reminis- cent of the Dotcom bubble, the crypto crash was practically inevitable, as speculation, greed and “fear of missing out” drove prices to unjustifiable highs in the nascent and largely unregulated industry. Fraud, heists and hacks, as well as first-time investors with no understanding of even the basic elements of the technologies entering the rally at a late stage, com- pleted the recipe for disaster.

However, there are still valuable lessons to be drawn from the crash. The sector’s collapse itself might have presented a stern warning against rash invest- ing decisions and the dangers of the “bandwagon” effect, but the developments that followed also served as a reminder that nothing is black and white. As hundreds of thousands of crypto companies went bankrupt or ceased their operations worldwide and investments dried up, those that managed to survive had to offer true value instead of just adding the word “blockchain” to their name. They were also forced to operate under lean and efficient condi- tions, with investors keeping a watchful eye on their expenses, eliminating the financial mismanagement and extravagances that characterized the sector during its glory days. Thus, the parallel to the Dot- com bubble still holds, as this drastic thinning of the herd could very likely result in a few solid companies with great growth potential.

In the beginning of the rally, there were those who compared Bitcoin and other cryptocurrencies to precious metals, while some even prophesied that gold would be replaced as a safe haven. It didn’t take long for reality to contradict these predictions, as gold was being pushed to a six-month high while Bitcoin and its kin were in free fall.

As we highlighted in our previous articles on the topic, it is misguided to see precious metals and crypto-assets as competitors. Up to this point, they have offered very different value propositions and served very different purposes.

Digital assets have a wide variety of uses, some of them targeting niche segments, while overall, the technologies behind the crypto sector have the potential to transform entire industries and change the way we do business, communicate and engage in commercial activities online. Nevertheless, physical precious metals, having passed the test of time and proven their resilience in times of crisis, will continue to play a key role for investors that have a long- term view and seek to preserve and protect their wealth.

The Future of Gold Conference

Global Gold had the pleasure of sponsoring this year’s “The Future of Gold” conference that took place in Breda, the Netherlands, on March 24. The conference featured a number of distinguished speakers with a great deal of experience and valuable insights, while it also provided a rare opportunity for precious metals investors to interact with leading experts from the investment world and exchange ideas on the outlook of the gold market.

Thought-provoking and in-depth analyses on the future of the stock markets in the US and in Europe, the outlook of the global economy and the impact of central bank policies, as well as gold’s performance, offered important and actionable insights for investors. Diederik Schmull’s macro-economic outlook, reinforced by his 40-year hands-on experience at Morgan Stanley, presented a very interesting take on the US economy and the dollar. Brecht Arnaert of Macrotrends, the conference’s organizer, also presented a solid case on how to effectively structure a portfolio in a deeply trou- bled and unstable investing landscape like the one we face today.

Dimitri Speck delivered a compelling speech on the future of gold, drawing on his extensive analytical experience and market exper- tise. Mark Valek of Incrementum added a crypto-twist to the conference’s gold theme by presenting a rebalancing strategy combining gold and crypto assets, while Thibaut Lepouttre, author of the Caesar’s Report, shared some of his valuable insights from the mining industry.

Finally, our own presentation on the key competitive advantages of Global Gold and of Switzerland addressed many of the increasingly common questions among European precious metals investors who recognize the need for jurisdictional diversification outside of the EU.

You can watch our full presentation here.Interviews from the conference will also appear in our blog in the coming weeks.

The Fed under pressure

Despite all the tightening and rate hike talk by the Fed during the past year, it seems that reality has now finally caught up with it. With the markets being dangerously addicted to its accommodative policies, the Fed (as well as the ECB and the BOJ) has backed itself into a corner with no moves left. On the one hand, the need to normalize its policies is urgent, lest it has no tools left to fight the next recession, which is arguably already on the horizon. On the other hand, the slightest hint of higher interest rates or the removal of the artificial crutches that keep the markets standing is sure to trigger a tantrum that could easily escalate into a meltdown.

Although this “catch-22” predicament is not really new, currently, it’s especially pronounced in the US. With an eye on the 2020 elections, President Trump has been increas- ingly critical of the central bank, piling on pressure to cut interest rates and lift the economy. In the beginning of April, the President stepped up his attacks, claiming thatthe Fed has "really slowed us down” and that “in terms of quantitative tightening, it should actually now be quantitative easing”. Given the fact the central bank has missed its 2% inflation goal, the calls for lower interest rates might actually be heeded, even afterfour rate increases in 2018.

As for the probability of yet another round of QE, it might seem unlikely now, but it is still important to remember that the Fed has already largely reversed its previously solid stance on normalization. In March, the central bank abandoned projections for any interest rate hikes in 2019 and it also announced its plans to slow down its balance-sheet shrinkage and end it altogether in September, putting an end to its quantitative tightening mission much earlier than expected.

Overall, this monetary direction might pro- vide relief in the short-term by continuing to support the economy and the markets. However, apart from its obvious unsustainability, it is also very likely to prove gravely misguided once the next economic down- turn sets in. With its arsenal depleted, the central bank will be hard-pressed to find ways to control the damage and ensure a soft landing.

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