Modern Monetary Theory and Your Portfolio

For this edition of my latest market commentary, I would like to revisit an idea and policy that is popular and timeless. This idea is widely implemented today by central banks all around the world. What I am talking about is Modern Monetary Theory. The idea of Modern Monetary Theory is that governments and central banks can spend as much as they want and in order to pay for it, they “print” the money to do so. Over the last year, our elected officials in Washington have used the pandemic as a reason to spend trillions of dollars for economic expansion and financial relief for pandemic effected people and businesses. The first piece of legislation was the CARES Act, which I explained thoroughly in one of my previous letters. It was a $2.2 Trillion dollar bill passed in 2020 with little to no tax increases. Then again in 2021, the American Rescue Act was passed and this $1.9 Trillion pandemic relief bill was also paid for with a “blank check.” Congress is currently working on the American Jobs Plan estimated to be over $2 trillion for infrastructure. There is also the possibility they will pass the American Families Plan which would be another $1 trillion. [i] The US government has clearly spent way more than they are taking in via taxation or trade surplus and the US government now has a large trade deficit, budget deficit, and large National Debt. It should be noted these pending bills have not been finalized and we should get more clarity in the coming weeks and months.

 

The tentative framework for the American Families Plan has lead to some market volatility. It is reported that the Biden Administration will be looking to increase Capitals Gains Taxes as well as the top federal tax rate on wealthy Americans. While the final details of this bill have not yet been released, below is table showing current and proposed capital gains tax rates for highest earners in a select number of states. As we get to know more about this bill, I can assure you that my office will send a follow up letter.

 

Top Marginal Capital Gains Tax Rates Under Current Law and Biden Capital Gains Tax Proposal

	Top Capital Gains Rate (current)	Top Capital Gains Rate (proposed)
Minnesota	33.7%	53.3%
Wisconsin	29.2%	48.8%
Florida	23.8%	43.4%
South Dakota	23.8%	43.4%
California	37.1%	56.7%

Source: Tax Foundation

 

Modern Monetary Theory stipulates that governments today are able to spend as much as they want, when they want, and that they can do so because they “own” the central banks. Our central bank, the Federal Reserve can create as much money they want with the push of a button. In March of 2020, Minneapolis Fed President even proclaimed on 60 Minutes that the Federal Reserve has as “infinite amount of money.” The Fed simply creates money on their balance sheet, loan it to the US Treasury.  and Congress is then able to pay for whatever they want. The only limit to how much money can be printed (digitally created) is when inflation gets too high. Once inflation happens, Modern Monetary Theorists argue that the simple solution to slowing inflation is to raise taxes in order to reduce demand.

When newly printed money starts chasing too few goods, the government taxes the money back and slows down the inflation. They argue that once prices get too high, they can tax them back into submission. Modern Monetary Theory is not modern and has been done repeatedly throughout history. Debasing currency in order to spend money has been done over and over again. When governments expand the amount of money in circulation via a central bank, all other money that was already in circulation loses value in proportion to the newly minted money. Our Founding Fathers were very aware of Modern Monetary Theory. They knew that government’s that could make their own money would always be corrupted and take advantage of their own people.

 

Benjamin Franklin said:

“When the people find that they can vote themselves money that will herald the end of the republic.”

 

Thomas Jefferson said:

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around (these banks) will deprive the people of all property until their children wake up homeless on the continent their fathers conquered." He then followed: "The issuing power of currency shall be taken from the banks and restored to the people, to whom it properly belongs."

 

Article 1 Section 10, Clause 1 of the United States Constitution states:

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

 

 

The Federal Reserve keeps track of the amount of money available in the economy at any point in time. They provide this data with what is called “m2 money supply.” I have shown this chart before in previous newsletters but I am sharing it again. The Federal Reserve has recently stopped reporting this key metric. M2 Money supply is one the most accurate charts depicting money in circulation and can be a good indicator for inflation. The Federal Reserve says they would like to have an annual inflation rate of 2% a year. On May 12^th it was reported that CPI is now at 4.2%, the sharpest increase since 2008. The Fed claims to not be worried about inflation as it has been below 2% for several years now. [ii] While they may say that inflation is 4.2%, a high number for even their metrics, the real word disagrees. Over the past week alone, the price of corn rose 8% to the highest level since 2013, while soybeans and wheat prices hit their highest points since 2014. The CRB foodstuff index, which includes hogs, butter, and sugar, in addition to grains and other agricultural commodities, is up 15% this year and trading at the highest level since summer 2012. Grocery prices are at 7-year highs. Meanwhile, the price of an existing home surged 17% in March from a year ago, the fastest pace on record.[iii]

 

The Federal Reserve does not include, food, energy, healthcare prices or home prices in their core inflation measure. They are considered too volatile of assets and therefore not a valid measure of inflation. While our policy makers are telling us that inflation or CPI is only at 4.2%, the real word is telling us that the price of almost every asset has increased at much greater multiples.

 

The consequence of governments engaging in Modern Monetary Theory is two-fold.

1. The things that the rich own get more valuable.
2. The price of the things that everyone else buys get’s more expensive.

According to the Dorey Wright Dynamic Asset Level Investing, or DALI, commodities are now the second strongest asset class behind US Equities. The last time commodities were this high was back in 2016 and only for a brief period. The last commodities bull market peaked in 2011 and the last 10 years have been tough going for this investing the commodity sector. Here at Carlson Asset Management, we saw this trend reversing and have been allocating client accounts towards commodities and materials for some time. Inflation is a strong driver for commodities and where we currently see strong relative strength.

In the meantime, Summertime is finally here, COVID is over here, and life is pretty much back to normal. If you have any questions or concerns, or would just like to chat, please give my office a call at 651-287-2160. I would also appreciate it if you would share this content with anyone you think would find it of interest.

 

Sincerely,

Bruce Carlson, CFP®

President

Carlson Asset Management