[This blog post is an excerpt from a recent commentary published at TSI]

It is claimed that government indebtedness can be reduced via something called “financial repression”, which is the combination of “price inflation” and interest rate suppression. The idea is that the government debt burden can be made smaller in real terms in a relatively painless way by depreciating the currency in which the debt is denominated while the central bank prevents a large rise in the cost of servicing the debt. At a superficial level it seems plausible and may well be attempted over the years ahead by some governments, including the US government. However, aside from it having never worked as advertised in the past, the problem with financial repression is that when viewed through the lens of good economic theory it is not plausible. On the contrary, good economic theory indicates that the financial repression path leads to the destruction of the currency and economic collapse.

To support their argument, advocates of the idea that financial repression can achieve its intended goal (a reduction in the real government debt burden without dramatically adverse economic consequences) point to the US experience during the decade following the end of the Second World War. During this period there was significant “inflation”, a large reduction in federal government indebtedness and a successful effort by the Fed to prevent the yield on US government bonds from rising to reflect the inflation. However, this is an example of the logical error of observing that ‘B’ followed ‘A’ and concluding that ‘A’ must therefore have caused ‘B’.

In economics there are always many potential influences on an outcome. As a result, to avoid coming up with nonsensical cause-effect relationships you must be armed with prior knowledge in the form of good theory. For example, an observation that over the past twenty years the US unemployment rate has tended to move inversely, with a lag, to the price of beer in Iceland, should not lead to the conclusion that the rate of US unemployment could be reduced by increasing the price of beer in Iceland.

With regard to the US post-War experience, the key to success was not “financial repression”. The keys were the dismantling of New Deal programs, the general freeing-up of the economy, a reduction in government spending (government spending collapsed in the two years immediately after the War and then essentially flat-lined for a few years), and a currency linked to the world’s largest gold reserve. It was the combination of economic strength and restrained government spending, not the combination of inflation and interest-rate suppression, that enabled the US government to greatly reduce its debt burden.

In today’s world, we can safely assume that a general freeing-up of the economy leading to strong real growth is not on the cards.

To envisage what would happen in response to financial repression over the years ahead, bear in mind that if the central bank stops one pressure valve from working then the pressure will blow out somewhere else. For example, by monetising enough government debt the Fed could create a situation involving high price inflation and a low interest expense for the US government, but even in the unlikely event that the US government tried to its rein-in its spending the non-interest-related cost of running the government would surge due to price inflation. As a result, the total amount of government debt would rise rapidly and the Fed would be forced to ramp-up its bond monetisation to keep a lid on government bond yields, causing more “inflation” and giving another substantial boost to the cost of running the government, and so on.

Summing up, in a high-inflation low-growth environment, financial repression would lead to a downward spiral in currency purchasing power and an upward spiral in government indebtedness.

[This blog post is an excerpt from a recent TSI commentary]

A basic and very important fact of which hardly anyone is aware is that a general rise in asset prices has nothing to do with economic progress. It is, instead, driven totally by an increase in the supply of money. To put it another way, the general appreciation of asset prices is driven totally by the depreciation of money.

For example, there is no reason other than an increase in the money supply for broad stock market indices to rise over the long-term. The prices of some stocks would rise due to certain companies gaining an advantage and becoming more valuable relative to other companies, but the overall market would not rise in the absence of monetary inflation. An implication is that if the money supply were stable then dividends would constitute 100% of the long-term returns on investment achieved by the owners of broad index funds.

For another example, there is no reason other than an increase in the money supply that residential property prices should rise over the long-term. The prices of some houses would rise due to renovations or zoning changes or some locations increasing in relative popularity, but the median house price would not increase over the long-term in the absence of monetary inflation. In other words, the increase in the median house price is solely due to monetary inflation. This means that if the market value of your house gained 25% over a period and the median house price gained 20% over the same period, then 80% of the increase in the market value of your house was due to the depreciation of money.

A source of confusion is that over the past 50 years asset prices have tended to rise much faster than the prices of goods and services, creating the impression that the price increases are mostly real (that is, not driven by the depreciation of money). This has happened due to the nature of monetary inflation and policies designed to boost the prices of assets.

An important characteristic of monetary inflation is that the new money does not get injected uniformly throughout the economy and therefore does not affect prices in a uniform manner. As explained in a TSI commentary in 2019, this is one of the three reasons that the Quantity Theory of Money (QTM), which holds that the change in the “general price level” is proportional to the change in the money supply, doesn’t work.

Instead of a uniform rise in prices in response to monetary inflation, different prices get affected in different ways at different times depending on who the first receivers of the new money happen to be. In the case where the new money is created by the central bank as part of a QE program, which has happened a lot since 2008, the first receivers of the new money are bond speculators. This makes the owners of financial assets the initial and main beneficiaries of the money creation. In the case where the new money is loaned into existence by commercial banks, the main beneficiaries are the owners of assets that are purchased with the borrowed money. Over the past few decades a sizable portion of the borrowing from commercial banks has been related to the purchase of real estate (most buyers of houses are able to borrow a high percentage of the purchase price), causing the owners of houses to be among the main beneficiaries.

As an aside, monetary inflation is responsible for the widening of the “wealth gap” that has occurred over the past 40 years, because it benefits the asset rich at the expense of the asset poor. The expanding wealth gap is now being touted as the justification for greater government intervention and/or taxation, almost always by people with no understanding of the underlying cause.

As another aside, the big inflation-related change that happened during 2020-2021 is that a large increase in the money supply was accompanied by government actions that simultaneously destroyed supply chains and super-charged consumer spending.

Monetary inflation’s pivotal role in boosting/distorting asset prices is why we pay so much attention to it and so little attention to the more popular ‘fundamentals’. In some cases the more popular fundamentals, market-wide corporate earnings being a good example, are themselves just functions of the monetary inflation rate.

[This blog post is an excerpt from a recent commentary published at TSI]

This is a follow-up to our 25th April piece titled “Inconvenient Facts” in which we summarised some of the issues that are ignored or brushed over by many proponents of a fast transition to a world dominated by renewable energy sources. The follow-up was prompted by a recent RealVision.com interview of Wil VanLoh, the CEO of Quantum Energy Partners, by Kyle Bass. The charts displayed below were taken from this interview.

To summarise the summary included in our earlier piece, it takes a lot of energy and minerals to build renewable energy systems and it takes years for a renewable energy system to ‘pay back’ the energy that was used to build it. Consequently, achieving the energy transition goals set by many governments will require increasing production of fossil fuels for at least the next ten years, which, in turn, will require substantially increased investment in fossil fuel production and distribution (pipelines, terminals, storage facilities and ships). In addition, achieving today’s energy transition goals will necessitate substantially increased production of certain minerals, meaning that it will require more mining.

With regard to the need for more mining to bring about the Sustainable Energy Transition (SET), the top section of the following chart compares the quantities of minerals required to build a conventional car with the quantities required to build an electric car. The bottom section of the same chart does a similar comparison of fossil-fuel (natural gas and coal) power generation and renewable (solar, on-shore wind and off-shore wind) power generation.

The next chart illustrates the increase in the production of several minerals that will have to happen by 2030 to achieve the current energy transition goals. Of particular interest to us, it shows that over the next eight years copper and zinc production will have to double, manganese production will have to increase by 5-times, nickel production will have to increase by 11-times and lithium production will have to increase by 18-times.

On a related matter, mining is an energy-intensive process. Moreover, the bulk of the increased mining required to meet the current SET goals will occur in places where the only economically-viable sources of energy will be fossil-fuelled power stations or local diesel-fuelled generation. This means that the increase in mining required for the energy transition will, itself, require increased production of coal, natural gas and diesel.

Soaring prices of oil, natural gas, coal and oil-based products (gasoline and diesel) have focused the attention of senior Western politicians on the urgent need for more oil and natural gas production. However, today’s supply shortages are due to a decade of under-investment in hydrocarbon production, which, in turn, is a) the result of political and social pressure NOT to invest in such production, b) a problem that even in a best-case scenario will take many years to resolve, and c) a problem that will be exacerbated by chastising oil companies and threatening government intervention to cap prices.

If it were possible to do so, ‘greedy’ oil and oil-refining companies would be very happy to flip a switch and increase production to take advantage of current high prices. The reality is that it isn’t possible and that increasing production to a meaningful extent will require large, long-term investments. But why should these companies take the risks associated with major investments to boost long-term supply when they continue to be pressured by both governments and their own shareholders to prioritise reduced carbon emissions above all other considerations and when there is enormous uncertainty regarding future government energy policy?

[This blog post is a excerpt from a recent TSI commentary]

In terms of effect on the money supply, reverse repurchase agreements (reverse repos) are the opposite of quantitative easing (QE). Whereas every dollar of QE adds one dollar to the money supply plus one dollar to bank reserves at the Fed (bank reserves are not counted in the money supply), every dollar of reverse repos subtracts one dollar from the money supply plus one dollar from bank reserves at the Fed. Consequently, although reverse repos are not done with the primary aim of tightening monetary conditions, they effectively are a form of quantitative tightening (QT).

Unlike QE, reverse repos are temporary. To be more specific, the money removed from the banking system via a reverse repo will be returned within 24 hours unless a new reverse repo is created to replace the expiring one. However, the following chart shows that since April of last year the Fed has not only been rolling over or replacing expired reverse repos, but also has been adding to the outstanding pile by creating new reverse repos. As a result, the outstanding pile of reverse repos now amounts to $2.16 trillion. This means that the Fed’s reverse repo program has removed $2.16 trillion from the US economy since the beginning of April-2021.

From April-2021 until March-2022 the Fed was adding money to the economy via QE and simultaneously removing money from the economy via reverse repos. The amount of money being added via QE was greater than or equal to the amount being subtracted via reverse repos until early-December of last year, at which time the Fed became a net subtractor from the US money supply and US bank reserves.

One implication is that even though the Fed officially won’t start QT until this month, for all intents and purposes QT has been happening for about six months. Another implication is that the Fed now has more than two trillion dollars that it could inject into the economy simply by allowing existing reverse repos to expire. This could enable the Fed to boost the money supply over the months ahead while pretending to do QT.