Matt Howlett

Matt Howlett

every blog should have a tagline

Gerard Minack on Modern Monetary Theory, Australia, Japan and China

2020-06-12

The Real Vision interview with Gerard Minack from mid 2019 actually managed to shift my view of MMT from hard negative to somewhat positive. That's quite a feat, so I decided to do a summary in order to start thinking this through in more depth. For completeness, I included his commentary on Australia, Japan and China as well which was also enlightening.

Enjoy!

Australia

The bear case:

  • World's most expensive housing stock (almost).
  • Hugely indebted consumer.
  • Reserve bank with very little room to respond.

Things that may keep the boom alive:

  • Population growth.
  • Demand for infrastructure.
  • Mining capex bust has probably almost run its course.

Things to watch:

  • Supply of finance to housing (extent of tightening of lending standards). When you have house prices as high as they are, the demand for housing is just a function of supply of credit.
  • House prices themselves.
  • Building approvals (a drop will lead to a drop in jobs, GDP).
  • The "wealth effect" - the theory that people spend more as the value of their assets rise. This is very likely a big factor, but also a big unknown. Currently, the saving rate in Australia is effectively negative.
  • Things get really bad when you start to see job losses.

How to play a downturn scenario?

  • Cash Rate -> zero, 10 year treasury below 1%.
  • AUDUSD -> $0.60. In a recession it's not just the interest rate differential that drives the currency, it's also concerns about credit.
  • Banks drop heavily (but won't go bust). Short a basket of them, no preference. High carry though because they are high yield. Timing needs to be right.

Japan

Bullish on Japan:

  • Previously they invested way too much compared to their earnings (low RoA).
  • Compensated for this by being massively levered (ok RoE).
  • RoA is now in line with the rest of the world.
  • They've been de-leveraging whilst the rest of the world has been leveraging.
  • They've had relatively high EPS growth. But have not (yet) been out-performing.
  • Will do particularly well if there's a global growth acceleration because it's a cyclical market (but also his favorite "all weather" market).

Does the Bank of Japan own too much of the equity market?

  • BoJ own 80% of the ETF market, but their equity holding is still low relative to GPIF (Government Pension Investment Fund - the world's largest pension fund).
  • GPIF was (is still?) the largest holder of JGBs. But BoJ have been buying the bonds, effectively facilitating a massive allocation switch of GPIF out of JGBs into equities. In this context, the equity holdings of BoJ are small.
  • This article indicates the BoJ is set to become the largest holder of equities, contradicting Gerard's comment that the BoJ equity holdings are relatively small.

Concerns about public sector debt are hugely overrated:

  • Government debt to GDP on a gross basis is 220% (the number used to scare the children).
  • On a net basis it's closer to 100%.
  • Once you take out BoJ holdings, it's closer to 40%.
  • They don't have a debt problem anymore.

Demographics?

  • Demographics are one reason they've had low growth.
  • But the equity market is not the economy - the bullish case is on improving RoA and RoE - almost unconnected from the economy.
  • Generally, over the medium term, there is no correlation between GDP and equity growth (see also China - fastest growing economy over 30 years, but fairly ordinary equity returns).

Currency

  • When JPY weakens, the Nikkei goes up. Currency is nothing to worry about.

Modern Monetary Theory

Modern Monetary Theory (MMT) is a macroeconomic framework that says monetarily sovereign countries like the U.S., U.K., Japan and Canada are not operationally constrained by revenues when it comes to federal government spending. In other words, such governments do not need taxes or borrowing for spending since they can print as much as they need.

There are two big shifts that point to MMT or some variant of it becoming the main policy response in the next downturn:

  1. We exhausted conventional monetary policy (lowering interest rates) in the last cycle and also tried two unconventional tools:

    • Quantitative easing:

      Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment.

      He says it didn't work as an economic stimulant and even central bankers are saying QE as a tool for stimulating the economy has diminishing returns.

    • Negative interest rates: This too has been seen as a failure because it 1. complicates life for financial intermediaries. 2. has political limits - people will object strongly to it.

  2. It's "the theory that suits the times". From the early eighties we had a huge political swing to neoliberalism (the "Washington consensus", the "Davos consensus"). It's pretty obvious that this is swinging back. MMT will suit the people who are riding this wave - it's not just a demand management tool, it's a tool for achieving other objectives.

The active ingredient in MMT is fiscal expansion (how it differs from QE).

Here are two obvious facts:

  • If you issue debt in a currency you have a printing press for, you don't need to default.
  • Economies have capacity constraints.

If you agree with these, you can tip the conventional notion of why you tax on its head, which is you can't spend without taxing. Instead, you spend by printing, and the reason you tax is to prevent the private sector from competing for the resources you're after.

What about currency devaluation? No problem. This can be thought about in a similar way to conventional monetary policy - you can just estimate the effect of fiscal stimulus on currency devaluation and adjust it down to account for this.

A system that might be effective (that we might see) is an agreement between the government and the central bank in which the central bank will commit to purchasing say 80% of all government issuance. This is your MMT component. The government can ramp up fiscal policy to achieve whatever objective it wants. But at the same time, the central bank could be allowed to set interest rates to ensure it hits it's inflation target. This will be a constraint on how much the government will spend. I.e. you can preserve monetary policy independence of central banks even if you make them subservient to fiscal policy.

In theory, this all works. But there are a lot of potential practical wrinkles. He thinks Japan will lead the way here in implementation and when (if?) it works, everyone else will start following.

If MMT is deployed, secular stagnation (his base case otherwise) is all over. But we would not be on the road to Venezuela! There will be widespread concern about this though, and he suggests going long straw because of the inevitable flood of strawman arguments. He says the base case is that we would have acceptable inflation, but the balance of risks shifts to the right. It will start to affect asset prices.

Thinks MMT will require another crisis to take hold. If you asked policy makers before the financial crisis what they think they would have been willing to do, they probably wouldn't have said QE / negative interest rates. But when the crisis hit, they did it.

None of this removes the causes of secular stagnation - the high debt levels, the inequality, the globalization, the tech development. But it's an antidote to them. It gives you symptomatic releif which means you can push the economy hot enough that at some point you'll get inflation.

If MMT is done at the same time globally, all currencies will go down together against gold.

If you start having capital controls, you know the boundaries have been pushed too far.

China

Thinks leverage is a macro concern, but doesn't think it necessarily means they'll have a hard landing. May not be pretty, but most of the debt is RMB denominated, which means they'll be able to avoid the Minsky / Lehman moment left tail risk.

The way they've tried to apply stimulus recently has been consistent with their strategic objective to shift growth from capex to services. In 2015/16 they stimulated with lots of capex. But this added capacity in a world that had too much capacity which exacerbated their disinflation problems when they have a lot of debt (not a good macro mix!).

It's harder to calibrate the effect of service sector stimulus. If you build $1B of infrastructure, GDP goes up by $1B. If you try to boost growth by giving money to the household sector (e.g. cut tax rates), it's not straightforward how the consumer responds. The response over the last couple of quarters has fallen short of what they're expecting. But they can dial it up. Growth will inflect. But it's going to be more modest. And the spillover beneficiaries will be different (i.e. not into commodities).

Chinese trend growth is slowing - it's following the template set by Korea and Japan remarkably closely. Suspects China will continue following this, but might be worse because demographics are worse. Suspects 2-3% GDP growth will be the new normal in 3-4 years time (but whether that's what they say growth is is another matter).

We're seeing the start of a structural shift towards geo-political tensions. Bigger than just trade, bigger than just Trump, bigger than just America.

  • Xi Jinping appointed himself as emperor for life.
  • Moving away from neo-liberal system. The deal from the west was always been that we'll turn a blind eye to cheating on trade and human rights abuses on the basis that as you get richer, you get more like us.
  • They've stopped looking like us. And the gloves are off.

Australia is not an extension of China, as some people say (Australia is pushing back).

Will they weaponise the currency? Can you even become accepted as the world's reserve currency if you don't have an open captital account or enforceable law? (no) You can always bully your way into markets, but that's quite different to having a global system with an RMB base.

Related, the US has been foolish on the degree they've weaponizing their own currency. They're picking on the big boys (Russia, Europe). This will help a shift the status-quo, but not to RMB - at least any time soon.