Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: $1.9 trillion, you say, the coming attack on Big Tech, inflation, when the selling starts, and accounting for Bitcoin. To sign up for the Capital Note, follow this link.
Where are the Bond Vigilantes?
The New York Times last night:
Congress gave final approval on Wednesday to President Biden’s sweeping, nearly $1.9 trillion stimulus package, as Democrats acted over unified Republican opposition to push through an emergency pandemic aid plan that included a vast expansion of the country’s social safety net.
By a vote of 220 to 211, the House passed the measure and cleared it for Mr. Biden’s signature, cementing one of the largest injections of federal aid since the Great Depression. Mr. Biden is expected to sign the bill Friday. All but one Democrat, Representative Jared Golden of Maine, voted in favor.
It would provide another round of direct payments for many Americans, an extension of federal jobless benefits and billions of dollars to distribute coronavirus vaccines and provide relief for schools, states, tribal governments and small businesses struggling during the pandemic.
That is one way of putting it. Another is that COVID relief is one thing, but a great deal of this $1.9 trillion is something else, much of it familiar from previous spending binges, but expanded to a gigantic scale, with many of those billions being devoted to paying off favored constituencies and, of course, pushing forward a longer-term political agenda under cover of the pandemic.
You never want a serious crisis to go to waste. I mean, it’s an opportunity to do things that you think you could not do before.
What’s more, this extravaganza is popular.
There is overwhelming bipartisan support for the $1.9 trillion “American Rescue Plan.” No doubt about it. Every poll says so. The latest Morning Consult poll, for instance, informs us that Americans support the bill by a wide 75–18 percent margin. Among Democrats, it’s 90–5. Among the GOP, it’s 59–35. Among independents, it’s 71–20.
As the Washington Post’s lead “fact-checker” Glenn Kessler put it recently on Twitter, presidents dream “of getting numbers like this for a major piece of legislation — especially if no one from the opposition party votes for it.”
Indeed, they do. But the dream can be made reality only if the media abdicate their responsibility of critically reporting and properly highlighting the partisan boondoggles in trillion-dollar legislation. How popular would the “American Rescue Plan” be if pollsters asked voters grown-up questions rather than push-polling for Democrats?
David has a few suggestions for what those questions might be.
This, for example:
Do you support an emergency-rescue bill that spends a third of proposed funding, around $700 billion, in 2022 or later, rather than right now?
But check out the whole thing. Yes, it is behind a paywall, but c’mon.
If the abuse of the pandemic for political ends was not particularly surprising, the relative calmness with which the markets have accepted the piling on of yet more debt on top of an already daunting pile of IOUs has been telling. And, in many ways that’s alarming, something highlighted in this perceptive article by Damon Linker in The Week.
The package, explains Linker, “was made possible by the worst pandemic in a century shutting down large swaths of the economy for a year.”
there’s also something else, and far more sweeping, going on behind the scenes, and that is a change in perceptions about fiscal constraints. Many Democrats have come to believe that the longstanding conventional wisdom about the limits of responsible deficit spending was wrong. That is having enormous — and unnerving — effects on how they think about policy.
Until recently, policymaking took place in a bounded world, with fiscal limits set by the assumption that the federal debt shouldn’t be permitted to get too large as a percentage of the economy. Yes, the government can and should play a vital role in building and financing the nation’s productive capacity through borrowing — and it should use deficits to tame the business cycle. But this spending needs to be strictly restrained.
Today, mainstream Democrats don’t so much believe that there are no limits at all — though some popularizers of Modern Monetary Theory might come close to such a fanciful view — as they think the limits need to be radically rethought. Exactly how high can our deficits and debt rise before we see a surge in inflation and interest rates? If we reached full employment and continued deficit spending, we’d get a spike in inflation — and possibly far more than a spike. On the other hand, if the Fed started selling bonds instead of buying them, we’d see a dramatic surge in interest rates. But other than in those situations, there’s no reason not to continue spending vastly more than we take in from tax revenue. That’s the thought that has Democrats feeling so giddy.
Linker has three specific concerns about this. The first is fairly obvious:
We’re blowing through limits based on current economic conditions, but those conditions could change rapidly at any time. In an illuminating and troubling tweet thread and Substack post, Bloomberg economic columnist Noah Smith admitted that the U.S. is running a risk of inflation — and potentially even ruinous hyperinflation — from its spending habits. But he also noted that economists can’t say how great the risk of the worst-case scenario really is, because they don’t yet understand what triggers it. What economic research does appear to show is that a transition from the very low inflation of the past several decades to a hyperinflationary reality would likely be preceded by sharp but not (yet) calamitous rise in the inflation rate. Averting disaster in such a situation would require a drastic and painful change of course.
And even then, how much of an appetite would there be to change that course? For now, I am not too concerned about the risk of hyperinflation, but I suspect that the willingness of government to live with what would now be considered a worryingly high rate of inflation is greater than we might currently think. It is quite conceivable that those in charge in Washington may decide that the political cost of higher inflation, at least within an election cycle, is less than the cost of trying to fix it. That is no small matter. Inflation feeds upon itself, not least through accelerating inflationary expectations. The longer the moment of reckoning is put off, the heavier the price to be paid (Paul Volcker could have explained), and the price paid in the meantime, whether by individuals trying to save for their futures or by society, corroded by inflation, will have been immense.
What complicates matters still further is that, given the immense debts that the country has now run up, even a relatively restrained response by the markets to increased inflation could do a lot of damage to an American fiscal order that would have shamed some of the most profligate regimes in history. And if that relatively restrained response only consists of a modest increase in interest rates, we will have been extremely fortunate. Will we be that lucky? Probably not.
Even if we do manage to muddle through without significant inflation or a savage market reaction to it, the territory into which Biden’s $1.9 trillion is taking the country comes with another danger, the third of Linker’s concerns:
Politics is about making choices, prioritizing among competing goods, weighing costs against benefits, making tradeoffs — all of it under conditions of constraint that provide elected officials with a multitude of fully justified, reasonable excuses for failing to eliminate every kind of hardship. But what if there are no constraints forcing us to choose, prioritize, think about costs and benefits, and make tradeoffs? Under those circumstances, politics could turn ugly fast, as expectations rocket into the stratosphere and every failure to alleviate suffering or rectify injustice begins to look like an act of malice or outright indifference.
In a world where everything is possible, every failure, shortcoming, or delay becomes an occasion for indignation — which means that politics in such a world would be cutthroat and volatile, quite likely even more so than the significant turbulence we’ve endured over past several years.
That is a subtle and profoundly disturbing point, but I have a feeling that the bond vigilantes will have emerged from their slumber before it is reached.
And the consequences will not be pretty.
Around the Web
More signs of the coming attack on Big Tech
President Joe Biden has decided to nominate Lina Khan, a Columbia University legal scholar championed by anti-Big Tech activists, to the Federal Trade Commission.
Along with the recent hiring of Tim Wu as an economic adviser inside the White House — also first reported in Playbook — the addition of Khan signals that Biden is poised to pursue an aggressive regulatory agenda when it comes to Amazon, Google, Facebook and other tech giants . . .
The ascendance of Khan and Wu, two of the most important intellectuals in the recent progressive antitrust revival, signals a break with that past and hints that Biden is sympathetic to the left’s view that Obama’s laissez-faire policies helped engender the populist backlash that ended with Donald Trump’s election.
Adding Khan to the FTC, a move that will likely be greeted with alarm by the tech industry, also suggests that the White House is already laying the groundwork for a second act that will include a big regulatory push once its early legislative agenda runs its course.
This news (if confirmed) will be greeted with joy by the EU, already busily engaged in doing its best to attack the position established by some of America’s greatest business successes of the past two or three decades. I don’t think that the Beijing regime will be too sad either.
Combining both strategic and economic illiteracy has become something of a trademark of the Biden administration. Doubtless this will not be the end of it.
The New York Fed’s latest survey of consumers shows that average Americans are joining investors in boosting their expectations for inflation, with consumers’ one-year inflation expectations rising to the highest level since July 2014.
Why it matters: Inflation is largely controlled by inflation expectations. If individuals expect costs to rise they will generally demand higher pay, landlords will raise rents and businesses will increase the cost of goods and services, pushing inflation higher.
In my view, all attempts to predict inflation using mechanical rules fail. They fail because inflation depends on the habits, norms, and expectations of the public at large. If people are habituated to low inflation, then attempts by the Fed to nudge up the inflation rate will not work. In fact, over the last decade, inflation has almost always come in under the Fed’s announced targets. Conversely, if people believe that inflation will be high and variable, then they try their best to protect against this: they shorten the term of agreements; they incorporate cost-of-living escalators into labor bargains; they minimize their holdings of currency or other non-interest-bearing assets. In the United States, we last saw these behaviors in the high-inflation era of the 1970s. They served to reinforce the high-inflation regime, and it took the entire decade of the 1980s to return to an era of low and stable inflation.
as an autocatalytic process. Inflation is naturally low and stable. But it can be jarred loose from that regime and become high and variable. Then it takes a lot of force to bring it back to the low and stable regime.
Autocatalytic is a very good word, its implications in this context, not so much.
When the selling starts . . .
How do these bull bashes end? When the last skeptical buyer finally sees the light and buys into the dream that every car will be electric, that crypto replaces gold and banks, that we overindulge on vertically farmed “plant-based steaks” while streaming “Bridgerton” Season 5 before we hop on an air taxi for our flight to Mars. Those last skeptics (maybe already) convince themselves there’s no longer any downside. And then boom, it’s over.
Bull markets need fuel. When the marginal buyer is done, there are no more greater fools to buy in, no matter how well companies actually perform. The dream is priced in, and firms can only meet, not beat, expectations.
For those lulled by today’s bull market, remember that you own a piece of paper. Low-yielding U.S. Treasury bills and bonds are safe because they are backed by the U.S. government, by cash flow of tax dollars and by the country’s assets (think land, not Fort Knox). Stocks are backed by expectations of future earnings, but if you overpay during periods of high expectations (like today), then your downside is huge. Crypto is backed simply by the faith of those who proclaim it is a store of value. Even art and exotic cars and silly NFT tokens are backed only by faith the wealthy will overpay for uniqueness. Faith becomes scarce when the selling starts.
There is no accounting for Bitcoin:
When Elon Musk’s Tesla became the biggest name to reveal it had added bitcoin to its coffers last month, many pundits were swift to call a corporate rush towards the booming cryptocurrency.
Yet there’s unlikely to be a concerted crypto charge any time soon, say many finance executives and accountants loath to risk balance sheets and reputations on a highly volatile and unpredictable asset that confounds convention.
“When I did my treasury exams, the thing we were told as number one objective is to guarantee security and liquidity of the balance sheet,” said Graham Robinson, a partner in international tax and treasury at PwC and adviser to the UK’s Association for Corporate Treasurers.
“That is the fundamental problem with bitcoin, if those are the objectives for treasurers, then breaking them could get them in trouble.”
Lurking beneath all this is, therefore, the question of incentives, something on which Levine focuses his attention:
If a company buys Bitcoin, it books it as an intangible asset; if the price of Bitcoin goes down, the company writes down the asset and books a loss in earnings; if it goes up, the company does not book any gain. For a volatile asset like Bitcoin, this sort of asymmetric accounting treatment is very unattractive: It probably will go up a lot and also down a lot, which means that you will win some and lose some, but as far as your earnings go you will only lose some.
Moreover (via Reuters):
Furthermore, once a company writes down its holdings, it cannot record subsequent gains until it sells.
By contrast, companies periodically reflect the impact of fluctuations in traditional currencies in their financial statements.
The FASB has no immediate plans to review its treatment of bitcoin as the issue affects few of its constituents, according to a source familiar with the matter.
And Levine quotes this passage from the Reuters article:
“The general consensus among treasurers is that very few of them are going to follow this trend initially,” said Naresh Aggarwal at the UK’s Association for Corporate Treasurers.
“As a treasurer, if I am right and the price doubles, the company may sell its holding and make a profit. Whilst the company may be worth more, it won’t be reflected in my compensation,” he added.
“But if the price falls, I am pretty confident I will be fired. Why bother putting my neck on the line?”
As Levine explains, the job of a corporate treasurer is to avoid losing money and to avoid taking risks that could involve losing money:
If you succeed in not losing money, you receive your modest, stable rewards. If you fail and lose money, you are fired. If you succeed beyond your wildest dreams and make a lot of money, (1) you do not get any extra rewards (because that was not your job) and (2) if your bosses are smart, they fire you anyway, because the fact that you made a lot of money means that you took a lot of risk, which was very much not your job.
We can talk about one exception to this — the Japanese Zaitech era — on another occasion, but Levine’s general point is correct, as is this:
The conclusion here is probably that corporate treasurers are never going to decide to buy Bitcoin, at least not until it becomes broadly normalized. How can it become normalized if treasurers never decide to buy it? Well, corporate treasurers are not necessarily the final decision-makers about the corporate treasury. Corporate chief executive officers are chosen and trained and incentivized to take risks; their pay does go up if the company is worth more. Some of them are really into Bitcoin. If Elon Musk tells his corporate treasurer to buy Bitcoin, Tesla Inc. is going to buy Bitcoin. “Ehh I just work here,” the treasurer will shrug; “they don’t pay me to take risks, and telling Elon not to do this is a risk I’m not willing to take.”
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