Hoisington Wades Into MMT Debate, Sounds Alarm on U.S. Borrowing

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One of the bond market’s most committed bulls has a few cautionary words for those putting their faith in fiscal policy as the new engine of U.S. growth and prosperity.

Expanding U.S. debt is weighing on the economy and additional government spending will exacerbate the problem, according to Hoisington Investment Management Co. Government debt is likely to grow faster than gross domestic product over the coming years, Van Hoisington and Lacy Hunt wrote in their quarterly outlook report. And contrary to a widely held view, they see Treasury yields being dragged lower by stagnating growth rather than higher on the back of increased bond supply.

“This increased debt level will weaken economic activity, thus inflation, pushing long-term yields lower, thereby continuing the now almost three-decade long trend to lower long-term Treasury yields,” Hoisington and Hunt wrote.

Their analysis is a warning to those -- including former Treasury Secretary Lawrence Summers -- who have advocated more government borrowing to finance infrastructure and social programs. It also stands as a rebuke to exponents of modern monetary theory who see an enabling role for the Federal Reserve. The Hoisington report cites Japan’s four recessions over the past decade as a cautionary tale and highlights the risk that high government indebtedness will crowd out the private sector. Additionally, it notes that the growth benefits of America’s recent tax cuts are already fading.

“Last year, this stimulus lifted the GDP growth rate in the second quarter,” Hoisington and Hunt said. “However, by the fourth quarter the stimulus was hard, if not impossible, to detect in the broad economic aggregates.”

The yield on 10-year U.S. Treasuries declined for a second day Wednesday to 2.49 percent. It has fallen 77 basis points from a peak seen last October as markets priced in an increasingly dovish Fed. Investors will focus on any comments about a flattening yield curve, the economic outlook and any indication for a rate-cut threshold, when minutes from the Federal Open Market Committee discussions of March 19-20 are out later Wednesday.

Imagining MMT

A significant portion of the Hoisington report is devoted to criticism of Modern Monetary Theory -- a longstanding fringe concept that’s surfaced in recent debate among Democrats on how to fund policies related to climate change and social welfare.

Criticisms of MMT aren’t hard to come by. But Hoisington’s paper envisages how it might work in practice, requiring first a rewrite of the Federal Reserve Act to allow the U.S. central bank to directly fund government expenditure. In the scenario outlined by Hoisington and Hunt, the U.S. Treasury would issue zero maturity and zero interest rate debt to the Fed, which would then credit the government’s balances in the central bank system, thereby “funding its parent with a worthless IOU.”

“In historical cases of money printing, the countries were not the reserve currency of the world, as the U.S. is today,” Hoisington and Hunt write. “Thus, the entire global system could be destabilized in very short order if this were to occur.”

They describes that destabilization as a chain of events ending in hyperinflation that “would be difficult to stop.”

Some other key points from the Hoisington report:

  • The inversion of the Treasury yield curve “is suggesting that the Fed’s present interest rate policy is nearly 50 basis points too high and getting wider by the day”
  • The Fed has steered the U.S. economy toward recession by paying too little attention to measures of money supply and velocity
    • “Historically, many lags of two years can be found between the peak in M2 growth and the peak in economic activity”
    • “The year-over-year growth in M2 and bank credit peaked in October 2016 and then decelerated sharply thereafter”
  • Policy makers have paid too much attention to the “esoteric so-called neutral rate” and the output gap measured by the Phillips Curve, “which has been empirically and theoretically shown to be an unreliable guide to policy”
  • “It appears that history is being repeated -- too tight for too long, slower growth, lower rates”

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