Here are three things I think I am thinking about this week:

1) Is QE Debt “Monetization”?

It’s been 15 years since I first said that the Fed wasn’t “monetizing the debt”. My original work on this caused a huge uproar as hyperinflation fears were rampant during the financial crisis. I’d spent years studying Japan’s stimulus programs following their 1990s bubbles and knew that QE involves the Fed printing a deposit into your account and removing a money-like instrument from your account. You sell a T-Note and get a bank deposit. Back when rates were 0% this meant that you were selling a AAA rated higher yielding instrument and then getting a AAA rated 0% yielding deposit. You have the exact same quantity of assets and less income and the Fed takes the T-Note out of the economy. You technically have more “money”, but you already had a money-like instrument in the first place so your consumption was unlikely to change after you were given the deposit because you’re actually worse off in financial terms since your income went down. My conclusion 15 years ago was that all of this was unlikely to cause high inflation because it’s the budget deficit that requires new “asset printing” and the Fed just came in after the fact with QE and changed the composition of those assets.1

Now, the textbook theory would tell us that more money means more inflation. But it turns out that that was not exactly right. Adding more money to the financial system during QE didn’t create high inflation because the Fed was just swapping money-like instruments for other money-like instruments. It’s a bit more complex than that because QE can involve buying other assets or buying depressed assets like in 2009 when the Fed bought large amounts of MBS from banks thereby creating capital gains that were essentially money printing. I used to joke often that if the Fed had agreed to buy bags of dirt that would have been hugely inflationary. But that’s not what they were doing. And so as a baseline understanding, if the government is running a balanced budget and the Fed buys T-Notes and gives you deposits then this isn’t changing much in the macroeconomy.

I bring this up because it was all the rage on Twitter over the weekend where every nerd with no life (I’m referring to myself here) was debating the relevance of this. And then Thomas Massie, the Representative from Kentucky went on Twitter saying we needed to “end the Fed” because they “monetized” debt during Covid and caused inflation. Oh boy. First, Massie was against all of the Covid stimulus so he’s at least on the right track about what can cause inflation (government deficit spending). But the Fed “monetizing debt” is not the causal factor here. Congress passes legislation and if there’s a deficit due to that legislation then the Treasury and Fed have to finance that shortfall by selling bonds. Whether they finance that deficit with a T-Bill or a deposit is far less important than the fact that Congress forced them to finance that spending by printing some type of new asset. So Massie seems to have the causation backwards. The Fed and Treasury figure out how to finance the deficit after the Congress votes to create a budget deficit. It’s the deficit that can create inflation, not the way it’s “monetized”.

This was the big lesson from Covid. Covid taught us that big budget deficits can create big inflation. And that’s the difference between Covid and the GFC. During the GFC we got big QE, but small deficits and the result was small inflation. During Covid we got big QE and big deficits and big inflation. So the conclusion should be that big deficits can cause big inflation whereas QE and “monetization” has more tangential impacts on the economy.

And so yeah, these might seem like insignificant wonky monetary semantics, but the details matter because the details can drive policy understanding and future inflation.

2) The Four Types of Wealth

I like this concept from James Clear, the author of Atomic Habits:

There are 4 types of wealth:

  1. Financial Wealth (month)
  2. Social Wealth (status)
  3. Time Wealth (freedom)
  4. Physical Wealth (health)

I quibble a bit with his definition of Social Wealth as Status because I think status is massively overrated. I’d reframe Social Wealth as relationships. And to me that’s one of the more important forms of wealth. If you have great relationships in your life the other forms of wealth likely improve or don’t matter as much. Buf if you have bad relationships it’s likely that all those other forms of wealth will suffer. Of course, physical wealth has to be the most important because if you don’t have physical wealth then it’s hard to have any other type of wealth. But in terms of a hierarchy I’d argue that the ranking for most people should probably look something like this:

  1. Physical Wealth (health)
  2. Social Wealth (relationships)
  3. Time Wealth (freedom)
  4. Financial Wealth (money)

Obviously, you need a certain amount of financial wealth to enjoy basic necessities. But once you have a reasonable amount of financial wealth the other forms of wealth become much more important.

3) Why Does Sentiment Still Stink?

Consumer sentiment took a big dive again last week as inflation continues to drag down sentiment. A lot of this appears to be a huge political divide depending on which guy is your guy. If Biden is your guy then you might be more inclined to say everything is great. And if Trump is your guy then you might be more inclined to say everything stinks. Of course, I am just a data driven and objective nerd who doesn’t care about politics so I am immune to political bias (haha) so let me explain why this is happening.

My basic view is that inflation has ravaged consumer sentiment. We went 20+ years without having meaningful inflation and then we got a 20%+ bump in the price level in just 3 years. And it was most exaggerated in some of the most consumer sensitive items like housing and food. Meanwhile real wages are stagnating and real household net worth has been flat for 3+ years. And that’s important because housing is the majority of household net worth. And there are two sides to that coin. You’re either in the 40% of the population who rents and is hoping to buy at some point and you now feel screwed by rising prices and higher mortgage rates. Or you’re part of the 60% homeowners who have unrealized wealth gains that are nice on paper, but don’t change your day-to-day life at all. So even if you’re a homeowner who benefited from the Covid house price boom you might not feel much better about your lot in life because you’re probably locked into a low rate mortgage with unrealized gains that you can’t do anything with. Meanwhile, 100% of us jump in the car headed to the grocery store every week, see high gas prices and then sees how expensive food is and you come home angry because you know the government spent $25 trillion in three years and it feels like nothing’s better than it was before.

And I don’t think it’s a lot more complex than that. Inflation caused a huge shock to the system at a time when sentiment was already poor due to Covid. And now people either feel worse off than they did before Covid or they have unrealized gains in their biggest asset that don’t even feel real at a time when lots of other things feel worse. And so on the whole sentiment stinks because the last few years just haven’t been that much fun for most people and while all that government money printing probably helped stave off a big recession we’re still paying the price for it in other ways.

1 – It’s dangerous to generalize about a policy like QE because it’s environment specific and implementation specific. For instance, I’ve argued that QE1 in 2009 had a huge impact on banks and balance sheets more broadly because it involved buying depressed assets. But once the economy normalized by 2012 the impact of subsequent iterations were much smaller. And as I’ve already noted, QE could involve buying lesser quality assets or even real assets and that would have a very different impact than swapping govt bills for bank deposits.