As the Fed winds down its Treasury purchases, will banks step in and buy that debt instead?
Modern Monetary Theory is the latest fashion in economics. What started out as loose talk at the University of Missouri, Kansas City about making government the employer of last resort morphed into a full-scale campaign for unlimited monetization of budget deficits without the concerns for inflation. Without ever explaining how, proponents of Modern Monetary Theory decouple inflation from the supply of money and, more importantly, from government deficits funded by that same money supply. They casually ignore adverse empirical evidence, a.k.a., Weimar Germany in the 1920s, Latin America in the 1970s and 1980s, Zimbabwe in the 1990s and Venezuela in the 2000s.
The unwillingness of MMT economists to put their theory in view of just the Venezuelan disaster is a red flag in itself. At the height of their hyperinflation experience, the Venezuelan people had to put up with 300,000 percent inflation.
The path from applying MMT to such extreme rates of price increases is unimaginable to practically every American, apparently MMT proponents included. That, however, does not absolve its proponents from their responsibility to actually explain how unhinged amounts of monetary expansion in the United States would not cause destructive levels of inflation.
It is easy to dismiss MMT proponents based solely on the grounds that they do not care about inflation. However, as mentioned, history has shown again and again that politicians are more than willing to use central banks to implement ideological agendas. The common denominator of strato- or hyper-inflation cases is that government wants to spend money on entitlement programs of various kinds (with Weimar Germany being the exception as the money there went to war reparations under the Treaty of Versailles). The exact configuration of the entitlement program varies, but the purpose is always the same: provide cash and in-kind benefits to a select group of entitled citizens.
As I explained in my piece on MMT for the Cayman Financial Review (2018, #53, pp. 68-69), the link from government as a universal job-guarantee provider to unlimited monetary expansion is alive and well, only now at a global scale. The United Nations has included MMT in its project on global sustainable development.
American politicians would use MMT for the very same purpose. It is already happening on a small scale, with the deficit monetization that started as “Quantitative Easing” under Federal Reserve Chairman Ben Bernanke. When the central bank buys government securities on an ongoing basis, it provides cash to the sovereign-debt market that goes into the Treasury and thus finances current government spending. This funding is either direct, with the central bank buying Treasury securities as they are issued, or indirect in the form of central-bank purchases on the secondary market; regardless of how the central bank participates regularly on the sovereign-debt market, its purchases do constitute deficit monetization.
A full-scale implementation of MMT would cause a larger expansion of Federal Reserve Treasury purchases than we have seen so far. The central bank would make an open-ended commitment to putting money into entitlement programs. However, this is not the only channel through which Modern Monetary Theory makes its way into the pockets of businesses and families in America. There is also a direct central-bank method, one has been brought to daylight by President Biden’s nomination of Saule Omarova for Comptroller of the Currency at the U.S. Treasury.
Omarova is the architect of a radical reform that would literally socialize the entire banking system in America. Reports the Epoch Times (Nov. 10-18, pp. A6-A7):
Every American would have a bank account set up at the Fed and authorities would be free to inflate the currency by issuing interest on the deposits or even crediting the accounts directly. To counter inflation, the Fed could also slash the interest rates or even, if all else fails, take away people’s money as needed
This is the same mechanics that MMT proponents want to see used by the U.S. Treasury, only there it would run through existing and new entitlement programs under the federal government. In this case, Congress would authorize the Treasury to spend more on entitlements that hand out cash or in-kind services and pay for that spending with newly minted cash from the Federal Reserve. To counter inflation, Congress would raise taxes to pull money back in again from the economy.
In its practice, MMT is nothing more, nothing less prosaic than a polished form of central economic planning. Conventional wisdom suggests that central planning must include the socialization of private property, including the government seizure of businesses. However, as I explain in Democracy or Socialism: The Fateful Question for America in 2024, there are two pathways to government control over the economy. Confiscation of property is only the special case we often refer to as communism; the general case is economic redistribution by means of a welfare state.
Barry Goldwater aimed for the same argument in his Conscience of A Conservative in 1960, where he explained why a communist revolution became a decreasingly attractive option for socialists in the Western world – or “collectivists”, as he called them (pp. 55-56):
The collectivists have found, both in this country and in other industrialized nations of the West, that free enterprise has removed the economic and social conditions that might have made a class struggle possible. Mammoth productivity, wide distribution of wealth, high standards of living, the trade union movement – these and other factors have eliminated whatever incentive there might have been for the “proletariat” to rise up, peaceably or otherwise, and assume direct ownership of productive property. … The currently favored instrument of collectivization is the Welfare State. The collectivists have not abandoned their ultimate goal – to subordinate the individual to the State – but their strategy has changed.
Goldwater does not refer to the welfare state as explicitly socialist – he calls it “welfarism” – but his conclusion is the same as mine: the socialization of needs is a workable alternative to the socialization of property in terms of placing government in control of the economy. What is missing in Goldwater’s analysis, namely the ideological end goal behind the welfare state, is provided in my book The welfare state rests on the same Marxist foundation as does the communist state, with the goal to eliminate economic differences between individuals.
Proponents of MMT give away the same ideological preference, in part in their desire to make government an employer of last resort. Saule Omarova does the same, explaining as she does how the Federal Reserve, by socializing banking in America, can become an effective central planner of the economy. As such it necessarily becomes a force for implementing a specific ideology. The Epoch Times article quotes Alex Pollock, senior fellow with the Mises Institute. explaining how Omarova’s vision of the Fed as a central planner would govern practically all decisions on the supply of credit – lending, for short:
“If you have all of the deposits in the government bank, then all of the loans, or at least a very high percentage of the loans, are going to be there as well,” said Alex Pollock, former head of the Federal Home Loan Bank of Chicago and financial research executive at the Treasury who is currently a senior fellow at the classical liberal Mises Institute. Controlling credit means the Fed – and de facto the federal government – would have a say in most of the major individual economic decisions, such as what factor or office tower gets built, who gets to build or buy a home, and even who gets to go to college or buy a car.
Such decisions, of course, will be motivated by ideological preferences, something the paper reports Omarova being in favor of:
Omarova seemed to affirm the influence of political priorities. the Fed would be “explicitly preferencing certain categories of assets” such as “loans to small and medium-size non-financial enterprises and minority-owned businesses, student loans, credit supporting development in underserved communities” and others, she wrote.
We are already seeing clear elements of such explicit ideological influences, the paper explains, in the federal government’s interference with the financial industry:
While [Omarova’s] focus is mainly on suppressing what she sees as maladies of the financial market, the Biden administration has made clear it wants financial regulators to target a much broader set of priorities, including steering capital toward companies it sees as furthering the climate-change agenda and away from those that don’t.
However, Omarova wants to ramp up MMT-based central planning even further:
In Omarova’s proposal, the Fed wouldn’t have to bother financing political priorities through private parties. It would create a National Investment Authority (NIA) to funnel money from the Fed into “publicly beneficial infrastructure projects.”
This NIA would effectively socialize the supply of business credit throughout the economy. Only private entities in good standing with the Federal Reserve would be allowed a share of the money the NIA would be doling out.
It goes without saying that such a level of central planning would practically render useless the very private ownership of businesses. With the socialization of all private bank accounts – including individual ones – and with the government’s ability to give or take balances on those accounts at its own discretion, there is no longer any room for private economic decisions, or even individual freedom itself. Everything an individual decides to do, or not do, is related to how the actions and decisions will affect the individual’s status vs. government. If you don’t appreciate the ideology by which the country is being governed, you are at grave risk of having your personal finances gutted by the very government you just criticized.
If you don’t take a certain vaccine, government might punish you buy garnishing your bank account.
On top of the severe consequences for individual freedom, there is also the de facto implosion of the economy itself. Countries that use central economic planning always get stuck in a state of stagnation. Once there, they slowly sink into gradually expanding poverty. Product shortages become permanent, and expand over time until they are universal. As people start competing for increasingly scarce resources, corruption and crime replace private enterprise as people’s means of providing for themselves and their families. Law and order breaks gradually down, society is fragmented, and it is only a matter of time before anarchy erupts.
This process is sped up by hyperinflation. Central planning exacerbates the consequences of hyperinflation. Political arrogance fuses the two into a force capable of competing with wars in terms of economic and social destruction.
Let us pray to God America never goes down that path. We are already on its doorstep. May the Lord lead us away from it. If America plunges into the dungeon of full-fledged socialism, that’s it. There is nowhere else to go on this planet. We account for more than one quarter of the world’s economy: if we destroy our prosperity, we will pull the rest of the planet with us.
If we destroy American liberty, there will be no other beacon holding its light. Anywhere.
Among the arguments being made for higher taxes under President Biden’s agenda to drastically increase spending, one that stands out is about corporate income taxes. Back in February the Tax Foundation evaluated his proposal to raise the tax rate back to its pre-Trump reform of 28 percent:
An increase in the federal corporate tax rate to 28 percent would raise the U.S. federal-state combined tax rate to 32.34 percent, highest in the OECD and among Group of Seven (G7) countries, harming U.S. economic competitiveness and increasing the cost of investment in America. We estimate that this would reduce long-run economic output by 0.8 percent, eliminate 159,000 jobs, and reduce wages by 0.7 percent. Workers across the income scale would bear much of the tax increase. For example, the bottom 20 percent of earners would on average see a 1.45 percent drop in after-tax income in the long run.
Later, a rate hike to 25 percent was floated, but it now looks like the Democrats have given up on that idea as well, at least for now. However, the calls for higher taxes on corporations are not likely to go away, especially if the ideological battle currently raging within the Democrat party continues into next year’s mid-term election season. Therefore, I decided to set the record straight on corporate taxes in America.
The best way to do so is to not look at the tax rate per se – it is subject to all kinds of deductions and corporate-welfare programs – but to instead look at actual tax payments. I already wrote an article with this approach back in September:
I calculated tax payments as a share of total revenue, gross profit and earnings before taxes. Using the last one as the actual tax base, here is what I found:
Amazon paid $2.37 billion in income taxes in 2019, more than three times what it paid in 2017; as a share of earnings before taxes, these tax payments fell from 20 percent to 17 percent, a marginal reduction compared to the significant expansion in their tax payments;
Apple reduced its tax payments from $15.7 billion in 2017 to $10.5 billion in 2019, cutting its effective tax rate from 24.6 percent to 15.9 percent; at the same time, Apple repatriated well over $200 billion in foreign assets and made significant investments in several places around the country, including a $1 billion new campus outside Austin, Texas; these investments would not have happened without the Trump tax reform;
Citigroup paid a substantial amount of taxes in 2017, with its $29.4 billion check to the IRS amounting to a 129.1 percent effective tax rate (again over earnings before taxes); in 2019 they paid $4.4 billion, an effective tax rate of 18.5 percent;
Coca Cola also made an enormous tax payment in 2017, with its $5.6 billion equaling 81.4 percent of their earnings before taxes; by 2019 their tax payments had fallen to $1.8 billion but that still amounted to an effective tax rate of 16.7 percent;
Exxon went in the exact opposite direction, from a negative tax rate of 6.3 percent in 2017 (and tax deductions exceeding payments by almost $1.2 billion) to paying 26.3 percent of earnings before taxes – or $5.3 billion – in 2019;
Ford, a struggling car manufacturer, only paid $402 million in 2017 and ended up with a negative tax payment of $724 million two years later; by contrast, in 2018 they shipped $650 million into the federal, state and local government coffers, which amounted to 15 percent of their earnings before taxes;
Microsoft paid $19.9 billion in income taxes in 2017, equal to 54.6 percent of earnings before taxes; two years later they only paid 16.5 percent, but it still came out to almost $8.8 billion;
Tesla is a tax dwarf compared to the rest of this sample: in 2017 they paid $32 million, which is still impressive given that their earnings before taxes were negative at $2.2 billion; by 2019 their taxes had increased to $110 million, even though earnings before taxes were still in the red at -$665 million;
Walmart is the most consistent taxpayer in this sample: in 2017 they paid $4.6 billion; in 2018 $4.3 billion; in 2019 $4.9 billion; and in 2020 almost $6.9 billion; on average, they paid 31.4 percent of their earnings before taxes.
In total, these corporations paid $74.7 billion in income taxes in 2017. By 2019 that number had fallen to almost exactly half, just below $37.5 billion. During the same period of time, however, the federal government only lost 11.6 percent of its revenue from the corporate income tax. This indicates that other corporations delivered more tax revenue in ’19 than they did two years earlier. Or, put differently,
In 2017 the ten corporations in my sample paid 25 percent of all corporate-tax revenue, federal, state and local;
In 2019 they accounted for only 13 percent.
In other words, U.S. corporations pay a lot of taxes. But is there any truth to the allegations that corporate taxes have become more lenient, in other words that they aren’t contributing according to some “fair share”?
There is merit to this question, especially since the Biden administration is floating changes to our tax code that would raise taxes on middle-class families while reducing them for the highest-earning taxpayers. Even with a hike in the corporate tax rate off the agenda, this kind of tax-burden shift only reinforces the need for more clarity as to what our tax system actually looks like from the “output” side. In other words: what tax revenue does it actually produce, and who pays those taxes?
To begin with, it is true that corporate taxes have become a bit more lenient over time, but not in the traditional sense: it is not the case that Congress now lets corporations get away with an across-the-board lower tax burden, by historic comparison. However, if we look at the corporate income tax from the other side, namely how important the revenue is that it yields, things look a bit different.
To start with its role in the federal budget, its share of total tax revenue has certainly declined. In 1949 the corporate income tax accounted for 29.4 percent of all federal tax revenue. It remained at that level until the late 1960s, when its share fell below 25 percent. In 1989, when the Reagan tax reforms were fully implemented, the corporate share of total federal tax revenue was down to 16 percent. Another 20 years and one more big tax reform later, the rate had declined to 12 percent.
By 2019, the last year of the actual Trump economy (with 2020 being the year of the artificial economic shutdown), the corporate income tax only contributed 10.2 percent of all federal tax revenue.
Is this long-term trend the result of an increasingly lenient taxation of corporations? With all the changes that have been over time to such intricate variables as the rules for how fast you can deduct investment costs, or how foreign revenue is to be counted, it is de facto impossible to answer this question at a detailed level without an exhaustive review down to individual corporate finances. However, if we look at actual taxes paid, and look at them in the aggregate, businesses appear to have been given a more lenient tax burden. That, however, has not come without compensating changes to other items in our vast tax code. Figure 1 reports total income taxes paid to both the federal government and to states and local governments, as share of U.S. GDP. As the green function suggests, revenue from corporate income taxes have become less important: counted as a percentage of GDP, their share has declined from about four percent in the 1950s to three percent in the 1960s, to somewhere in the vicinity of 1.5-2 percent today.
At the same time, though, taxation has shifted to individual income. Back when John F Kennedy was president, revenue from individual income taxes equaled approximately 8.5 percent of GDP; in 2019, after the Trump tax reform, that share was 10.3 percent. (During the Obama presidency it averaged 9.5 percent.) In other words, from a revenue perspective it is clear that our lawmakers, regardless of party affiliation, have shifted the aggregate tax burden from corporations onto individuals:
That’s not all, though. While individuals now pay 80 percent of all federal taxes, that burden is not evenly spread. The tax burden on individual income earners is heavily concentrated to those who make big paychecks. Figure 2 reports the Fair Share Value by income group: the Fair Share Value compares taxpayers’ share of taxable income to their share of total federal income taxes. If a given group of taxpayers make five percent of all taxable income and pay five percent of all personal income taxes, their Fair Share Value is 1; the tax burden on their income is fair. If the Fair Share Value is less than one, their tax burden is unfairly low and they are not contributing their fair share to funding government; if the value is higher than one, their tax burden is unfairly high and they are paying for a larger share of government than they should.
Based on IRS income and tax data for 2018 – after the Trump tax reform – it is clear that the federal personal income tax is designed very unfairly:
Moreover, this unfair profile of the tax code is not new, but has been around for a long time. Figure 3 reports the Fair Share Value for the top-20 percent income earners from 2001 through 2018. They consistently carry a tax burden that is about 50 percent higher than it would be if the tax code was fair:
Isolating the top-one percent gives an even more pronounced picture of the unfairness in our tax code:
Plain and simple, over the past several decades, Congress has gradually shifted its taxation from corporations to individuals, but it has also made sure to place an unfairly high portion of the individual income taxes on the shoulders of a small group of taxpayers. This unfair profile was exacerbated by the Trump tax reform, after which the top-20 percent income earners pay two thirds of all federal taxes.
Does that mean we would be better off taxing corporations instead? No. Corporate taxes are more complex than individual taxes, with deductions and amortizations that can make the tax burden differ significantly between taxpayers. Furthermore, the tax burden that already applies to corporations differs vastly between industries, with manufacturing corporations contributing the largest share of corporate tax revenue (28.7 percent); a close second is finance and insurance (20.7 percent) and the information industry following in third place (11.6). It is unlikely that these three industries, and especially manufacturing, can carry a higher burden without significantly negative repercussions.
If we want a more fair tax code, a much better option is to reduce government spending. That gives Congress room for long-term, permanent reductions in the unfairly high taxes on high-earning individuals, and would eventually open for a completely flat income tax rate.
EXPECT HIGHER INTEREST RATES
Higher inflation will cause interest rates to rise, with substantial impact on your life:
After falling for three days straight, Treasury yields increased again yesterday. This coincides with two consecutive days of bad inflation news from the Bureau of Labor Statistics: both producer and consumer prices are again rising rapidly, with the former at 22.6 percent year to year, and the latter at 6.2 percent.
The yield increases were sharp, given that they happened from one day to the next:
- The 30-year bond rising from 1.83 percent on Tuesday to 1.92 on Wednesday,
- the 20-year bond rising from 1.86 to 1.96 percent,
- the 10-year note rising from 1.46 to 1.56 percent,
- the 7-year note rising from 1.32 to 1.45 percent, and
- the 5-year note rising from 1.08 to 1.23 percent.
These increases are all expectable given rising inflation.
There is also a moment of sell-off on the market: when the yields dropped, prices of the securities increases, which allowed speculators to sell at a profit. However, speculation only has temporary effects on the market; once the sell-offs have been completed the yields on Treasury securities will follow the trend of longer-term investor confidence.
This confidence is clearly unsatisfied with the inflation numbers that came out this week. The market has also, rightly, interpreted the Fed’s early-launch tapering of its accommodative monetary policy as a sign that the central bank harbors a genuine worry about inflation. When investors start demanding higher yield to protect them against inflation, interest rates can climb to levels unknown to most Americans alive today. During the stagflation era, inflation and interest rates rose in tandem:
- In 1977 inflation (measured as CPI) was 6.5 percent; the weighted average Treasury yield in September that year was a hair below at 6.47 percent;
- In 1978 inflation was 7.6 percent, with the weighted yield average at 7.4 percent;
- In 1979 inflation had reached 11.2 percent and yields had climbed to 8.6 percent;
- In 1980 inflation reached 13.6 percent while yields averaged 9.64 percent;
- In 1981 inflation was beginning to subside, falling to 10.35 percent, but yields still rose, reaching 12.5 percent.
We have three lessons to learn from the stagflation era, the first being that stagflation actually can happen. It is, in fact, happening as we speak. With the October inflation numbers out, there is no denying anymore that our economy, with GDP growth reverting back to its long-term, almost-stagnant normal and a labor market stubbornly stuck at subpar capacity, is following the same stagflation path as it did in the late 1970s.
The second reason to learn from the stagflation era is that inflation takes on a momentum of its own. Officials from the Federal Reserve have mentioned this mechanism several times in recent months, with focus on expectations: when people expect inflation to rise, they will act as if inflation is going to rise – and in fact make the rise in inflation either happen, or happen more forcefully than it otherwise would.
What the Fed officials have not explained is how those expectations translate into actual inflation numbers. The key here is product pricing. Under normal circumstances businesses review and adjust their consumer prices twice per year. This is an average number, cutting across the economy; actual price-review intervals vary from market to market, from industry to industry. That said, with a six-month benchmark interval, we have a periodicity for inflation that is relatively restrictive, in other words does not allow prices to take any leaps over the course of a year. With long intervals between price adjustments, you would scare buyers off if you suddenly marked up your prices by any significant amount.
If, on the other hand, you shorten your price-review periods, you can still mark up prices by the same small amount, but get a higher annual outcome. Figure 1 illustrates how the speeding-up of the price-review frequency rapidly increases inflation. Suppose the price of a product is $10 in December, and during the following year the price setter changes the price by one percent every six months. The outcome is a 2.01 percent inflation rate measured December to December. Suppose instead that he changes his prices every three months, again by one percent each time. The outcome is now a 4.06 percent annual inflation rate:
If prices are raised every month, still by one percent each time, the annual inflation rate ends up being 12.7 percent.
We don’t need large price hikes per se to cause inflation, but they obviously have a similar effect. Businesses are sometimes bound by contractual agreements as to how much, and how often, they can adjust their prices, but contracts often come with clauses that allow flexibility under adverse circumstances. This in turn means that businesses who are not used to making significant price changes can resort to somewhat disruptive pricing practices when inflation first hits: price changes may be more drastic than what may actually be needed, leading to subsequent adjustments.
At this point, with pricing behavior that seems to be looking for its footing in a high-inflation environment, many consumers will experience a substantially higher rate of uncertainty as to what their near-term finances will look like. Households may know their paychecks, but if their expenses vary by a lot more than they are used to, they mimic the over-reactive behavior of businesses. As I found in the empirical section of my doctoral thesis a long time ago – published in 2002 by a reputable international academic publisher – price uncertainty has a significantly negative effect on consumer spending.
In fact, it is better if inflation is high and stable than if it changes considerably from one month to the next. I made this point in my thesis, causing quite a bit of debate at the defense, but I stand by my results. They have also been verified later and are not too hard to see in regularly published macroeconomic data.
This means, plainly, that as we now see inflation not only at high levels, but rising from month to month – the October CPI number was 0.83 percentage points higher than it was in September – we can expect consumers to exhibit bearish spending behavior. Bluntly: they will spend less and save more.
Initially, more of their expenses will go onto their credit cards. This has become a consumer practice that is both a blessing and a curse: when you compensate for short-term cash flow strains by accumulating debt, you get through the rough patch on the hopes that you can successfully deal with the debt later. However, if the rough patch lasts longer than expected, the blessing turns into a curse.
We likely will not see an uncertainty-driven drop in consumer spending this holiday season. Households have fairly strong savings and household credit costs remain relatively low. The problems come when interest rates start rising generally and therefore drive up the cost of household credit. Squeezed by inflation on one hand and rising interest rates on the other, households will have to run down their savings balances to weather the storm.
The problem with a saved dollar is that you can only spend it once. At some point, inflation and rising interest rates will take their toll on economic activity. Expect the first quarter of next year to be bad, both in terms of GDP growth and for the labor market.
But will interest rates rise? Yes, they will. As mentioned earlier, demand for higher yields on Treasury debt will inevitably follow in the footsteps of inflation. When Treasury yields rise, other interest rates will follow, from mortgages to credit cards.
THANK YOU FEDERAL RESERVE! – It looks like the Fed might be America’s saving grace after all: