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Notes -
Over the course of this Qeek, I've been learning about the concept of fiscal dominance.
Do you think that we are starting to see that phenomenon in the United States? It seems like the symptoms of said event line up with what we're seeing: stubborn inflation, ripping equities, increasingly schizophrenic Treasury behavior. On the other hand, I'm always suspicious of something that fits a little too well.
If it is happening, what should private American citizens expect, other than high inflation? How would an Argentinian prepare for their fiscal dominance scenario if a time traveler warned them ahead of time?
Same as it ever was, really. People in the last 50 years really wanted to think of central bankers as our modern wizards, fine-tweaking the economy with their monetary policy dials, while we breathlessly hang on every word of their forward guidance. But they've been more accurately caricatured as the kid in the passenger seat with a fisher-price steering wheel & pedals who thinks they're the one driving. The only awkward part is that the adult who is actually driving (fiscal policy of spending & taxing, which have enormous clear 1st-order effects) is often actually looking at the kid and also thinks they're the one controlling the car.
As for "monetization" inflation theories: Anyone who still thinks of interest-bearing government debt in the form of central bank reserves as "money" but interest-bearing government debt in the form of treasury securities as "not-money" has been exposed as having an incoherent understanding of the accounting fundamentals. QE not being stimulative or inflationary broke a lot of those brains awhile back, but people come up with cope or just conveniently forget about it and go back to their old textbook understanding years later ('gasp, you shouldn't monetize the debt, that would be inflationary!'). Some mainstream economists like Summers & Krugman finally came around in the mid/late 2010s to notice that in a zero-rate environment, there is no 'money' difference, and the deficit is effectively printing money regardless of what form it ends up in, be it reserve balances, securities balances, physical coins/notes, etc. They still didn't seem to note that in the post-2008 world, the monetary policy regime switched to hitting their interest rate target by paying interest on reserves directly (a much better & simpler system than using reserve requirements and OMOs to drain all excess reserves all the time from the banking system), so there's no 'money' difference between reserves and securities even if the policy rate isn't zero.
Fiscal dominance for American citizens has been happening for 250 years, so I would anticipate more of that general trajectory. Especially similar is the last 90 years with a central bank that got modernized based on the experience of the great depression, and the introduction of income taxes which are a massive fiscal automatic stabilizer where taxes paid go up & down with the state of the economy without any active intervention needed by congress. Just because it's the water we swim in, doesn't mean it's less important; that's the steering wheel that's actually attached to something.
To the extent that you actually have to check empirically to find that raising the policy interest rate to 50% (meaning the government effectively increases the size of all bank accounts constantly with a bunch of free money), turns out to shocked pikachu drive inflation up to 50% rather than 'taming' it down to 0...well I would say you're learning which 'channels' are more powerful in the real world, free money vs cost-of-borrowing, rather than needing to get too creative speculating about whether we've transitioned between monetary vs fiscal dominant worlds at any given moment. And it starts to click why the Fed couldn't get inflation up to 2% no matter how low they set rates, and now can't get it down to 2% no matter how high they set them. I haven't read the econ blogs in awhile, but I know of at least John Cochrane as still trying to get the 'fisherian' word out that interest rates are positively causally correlated with inflation, as well as MMT's Warren Mosler.
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Argentina is a basket case. Let's focus instead on a closer comparison: Japan.
Japan's debt-to-GDP is much higher than the US. And they grow slower. And they have fewer children. And they are older. So any problems the US might have in the future, Japan already has today.
How does Japan handle its debt? They monetize it. The central bank of Japan owns roughly 42% of Japan's debt. That means they created Yen out of thin air to buy the government debt. And it doesn't stop there. Another 40% of the debt is held by banks, insurance companies, and pension funds that are legally mandated to own it.
You might think this is bad for Japan's currency and you'd be right. Its value against the U.S. dollar has declined by 50% since 2012. That's a common theme. Almost all currencies decline against the dollar over time. Some decline slowly. Some decline quickly. But, except for the almighty Swiss Franc, decline they must. .
The U.S. will monetize the debt. The consequences of that might be hard to predict. But there is enormous capacity for the U.S. to do that given our extremely strong currency and extremely large trade deficit. It's likely that the damage will fall mainly on countries that rely on U.S. exports for their economic growth.
Long term, the health of the US economy will depend on its economic productivity. The important thing is not to take actions that curtail economic growth as they have done in Europe. Fiscal concerns are secondary.
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