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Also, if the government continues running 5% annual deficits AND the Fed buys up a large percentage of the treasuries required to fund the deficits then the market will expect inflationary pressure. Fed buying of Treasury securities does not fund the deficits. US Treasury deficit spending 'pre-funds' the Treasury security issuance. There is no "crowding out". The US Treasury spends, then issues securities to replace the reserves/deposits its spending creates. It's a circle of asset replacement for the private sector (reserves created by spending then being replaced with Treasury securities). Think of it this way. A bank gives you a free $100 in your checking account. It then comes in and replaces the $100 in your checking account with a $100 in a time deposit. This is what US Treasury security issuance is = moving the same amount of money from a checking account to a time deposit so the private sector can earn a higher interest rate on the free $100 that started the process. But the $100 time deposit (ie US Treasury bond) does not require new money - it was already there in the free $100 you received in your checking account. Thus = no "crowding out". Fed open-market buying of US Treasury securities serves a different and separate goal; which is to shrink the supply of US Treasury securities along the yield curve in the private sector's hands to force longer-term interest rates lower. But this lower rate is not needed by the US Treasury (see next comment below) to issue its securities. It issues them with or without these Fed actions at any interest rate it wants. interest rates will reflect people's expectation of future government deficit spending as well as the degree in which debts will be repaid with devalued currency. Treasury security interest rates are whatever the Federal government wants them to be (even without Fed buying). That's because the US Treasury spends first, creating both deposits & reserves in the banking system, then issues securities to withdraw the reserves and replace them with interest-earning assets for the private sector. If the US Treasury didn't issue securities, then reserves & deposits would choke the banking sector and interest rates would fall to zero (or less). Thus, US Treasury security issuance can be properly seen in this context as more of a reserve maintenance/hygiene function than "borrowing". The "borrowing" is the initial US Treasury spending. It's important to remember that the Federal government has three types of liabilities to the private sector (currency in circulation, reserves, Treasury securities). Why are US Treasury securities the only one of three that we consider liabilities/debt of the Federal govt? We saw this effect in 2021, when the US Treasury ran down its general account at the Federal Reserve from $1.7t to $150b in 5 months & didn't issue much in Treasury securities. I shake my head at what is written in mainstream publications about how the monetary system works. Bill

1.) how high do you see interest rates getting in the coming months? Do you think we could see 3% right across the curve (2 year to 10 year)? Is 3.5% possible (likely?) for the 10 year in 2H should inflation remain elevated? I think the 10-yr yield will go over 5% by end of 2022. I predicted this on another forum in January of this year. I say that because short-term rates will be ~ 3% and the yield curve will uninvert/unflatten as the year progresses. 2.) when the Fed raises rates, is housing not the main mechanism to slow the economy? So if housing continues to rip in the US does this not suggest the Fed will be forced to raise rates much higher than what is currently ‘priced in’ by the market? I think the Fed believes this but I don't. I have said before I think a lot of what the Fed does makes very little difference - except when they go to extremes (zero rates, rates >12% where it makes sense to liquidate productive assets that earn 10% ROEs). 3.) balance sheet run off: how do you see this impacting interest rates/the economy? Especially if it happens quickly? I think you posted on this in the past… can you point me to what thread you posted your thoughts in? I think people way overstate in negative ways the effect of the balance sheet run-off. The Fed does nothing but asset swaps. When it does QT, in effect, it is removing reserves (useless assets) in exchange for Tsy securities (productive assets). The private sector benefits from QT - it loses from QE. 4.) where do you get your information? Web sites? Podcasts? Your thesis that the current environment most closely resembles the US 1940’s is also shared by Lyn Alden. I've been reading about this stuff (monetary plumbing) for 20 years. Only just starting to make sense. I don't read anything from Lyn Alden after I initially read some of her stuff in late 2019. I thought that she didn't understand how the Fed works when she claimed "the Fed was pumping liquidity into the stock market". Not many worth reading anymore, IMHO (not just Lyn). Bill

BTW - I also believe inflation has crested and will start to fall (regardless of what Fed does - which most of what it does is pretty useless anyway, LOL). My mental model of what is going on with inflation is still the US post WWII. During the war, the US govt suppressed consumption to divert resources to military production. In addition, the Fed purchased Treasury securities directly from the US Treasury in order to fix 10-yr yield at 1% as the Federal govt ran deficits = ~ 12-14% of GDP. Many similarities to the recent pandemic response. After the war, CPI ran up to 10% as consumption resumed and demand outstripped supply. There was no Federal Reserve response to the burst of inflation since its hands were tied by its agreement to fix the rates on US Treasury debt. But inflation fell to basically zero by 1949 anyway. Essentially the free market delivered increased supply to meet demand. I think this is where we are now. The US economy is ripping. Household balance sheets are in great shape. As I said, upthread demographics in the US are creating a tailwind of demand. Federal tax receipts are booming which indicate strong employment and employment incomes. Even Fed hikes are bullish because the US household sector is positively positioned to short term rate increases (more money market type assets than consumer debt (which is fixed anyway)). Even the Fed QT is bullish as the private sector needs more US Treasury securities (and can't use the bank reserves that the Fed created). Very bullish here on US economy. Equities will have a headwind due to rising rates - but the Fed doesn't care about the stock market. Its attitude is "we gave you zero rates for two years and you apes bought crypto, NFTs and shitcos and made money. What more do you animals want? We are going to take some of that back now, thank you, very much" Bill

That will be the end of the housing boom, imo. I don't think so. US demographics are a tidal wave of demand that still has not crested, IMHO (45m 25-34 yo - that is prime household & family formation age). US household sector has the balance sheet and the income to keep buying. Income (not rates) is the no. 1 determinant of home purchase decision. Also, 95% of US mortgages are 30-year fixed (unlike GFC) - so rate rises cause no stress to existing homeowners. Housing starts still setting multi-decade records at 1.7m (numbers not seen since early aughts). I am very bullish on US economy (not necessarily on equities - the two can go in different directions). Bill

interesting article on the situation in 1948 which indeed seems similar to what we have today: That's what I've been saying as well, that today's situation is more similar to post WWII rather than the 1970s for the same reason - government suppressed consumer demand in both cases (WWII, pandemic). Bill

Fed tightening into a slowdown can cause a recession. I may be a voice in the wilderness on this - but I think Fed "tightening" is actually bullish for the US economy. Most commentators have got this wrong because they don't actually think carefully about what the Fed is doing when it is "tightening". And when I say tightening I mean two things: 1) Fed raising the rate it controls (interest on excess reserves and/or fed funds rate which is basically moribund in a world of excess reserves). 2) Fed shrinking its balance sheet by letting its Treasury securities mature without rolling them over into buying new replacements and/or selling its Treasury securities outright before they mature. Let's take these one at a time. 1) Raising rates At this point, most forecasting models are guessing that the Fed will take short-term rates to 3% by sometime in 2023. Do we really think the US economy can't handle 3% rates? The US household sector has never been in better shape from a balance sheet perspective in several decades. HH Debt to GDP, HH Debt Service to Disposable Personal Income, and Household Net Worth - all best they've been in at least two decades or more. But another fallacy in the raising rates theory is that US households are hurt more due to the rising cost of their liabilities outweighing the interest income on their assets. So let's take a look at aggregate US household balance sheets from the Fed's quarterly Z1 report. I've highlighted in yellow the important assets & liabilities. Most households' main asset is their principal residence ($38t). In addition, households have a total of $17.5t in interest-earning assets (checking deposits, time deposits, & money market funds). As rates rise, these interest-earning assets will add to household incomes. Now let's take a look at the liability side of the household balance sheet. Main liability is the mortgage on the principal residence ($11.7t). As rates rise, refinancing activity may stop, but payments won't increase. That leaves consumer credit (credit cards, auto loans, student loans). Here too, most of this consumer debt is fixed in the short-term. So rising rates do not directly lead to rising interest expense. Net, net - I reckon, US households have ~$17.5t POSITIVE EXPOSURE to rising rates. If short-term rates go from zero to 3%, that's an additional $525m in new household interest income! 2) Shrinking the Fed balance sheet: Here too, if one thinks about what the Fed is actually doing in detail, one can't help but come to the opposite conclusion. The Fed shrinking its balance sheet is not really "tightening" liquidity -- at the margin, it is actually increasing "liquidity". When the Fed does QE it is pulling a Treasury security from the private sector and replacing it with a reserve balance. But as I've said before, reserve balances are frozen at the Fed and pretty useless to the private sector since only banks can hold them. So to control long-term rates, the Fed is tightening the supply of Treasury securities by reducing the quantity available to the private sector and replacing them with frozen, illiquid assets. Proof that the Fed went too far is that it had to open the reverse-repo window so that the private sector could borrow $1.6t of US Treasury securities daily lest the lack of interest earning assets for the private sector would cause rates to go below zero. Thus, now as the Fed is shrinking its balance sheet, the supply of US Treasury securities available to the private sector will increase. This adds liquidity and supply. The Fed is probably late on this and so its rate hikes are spiking the short-end of the curve upwards while the long end is still low because the Fed won't start adding to the supply of Treasury securities until May. Bottom line - increasing the supply of US Treasuries is a good thing for the US economy. One final comment, in recessions, Federal tax receipts always fall since 80% of all tax receipts come from payroll deductions (income tax, social security, medicare taxes). Thus tax receipts give one a real-time indicator of employment and employment income. So how are Federal tax receipts doing (in real-time)? In a word, they are booming! This is data I scrape from the US Treasury's Daily Statement (basically a daily cash flow statement for the US govt) and is through yesterday's report. Don't let the talking heads and their discussions about Fed tightening and yield curve inversion confuse you. I am bullish on the US economy and you should be too. Consumption was suppressed for two years due to the pandemic and now US households have the balance sheet and the employment income to spend and they will spend. That's why commodity prices are rising - demand is strong. One example is housing. Look at US demographics. The fattest part of the US population pyramid is 25-34 year olds. That is bullish for peak household formation - people marrying, having families, buying houses and filling those houses with stuff. We are going to set a multi-decade record for housing starts this year (1.7m) and its only going to go higher over the next 5 years. (That's why lumber is spiking and I am long a lumber saw mill.) Sure - there will be some hits due to commodities, but the US economy will absorb them easily. Of course, rising rates particularly at the long end will be a headwind for equities since they affect discount rates. How equities will do will depend on whether profit growth can outpace the depressing effect of a rising discount rate on those earnings. Bill

What's the right way to think about it? From the seller POV. The sellers we're talking about are smart & and as they look out, they see falling bond prices (and equity values). Not much fun when you are holding a large bond (and to some degree equity) portfolio. Bill

This one seems pretty small to make much of a difference That's the wrong way to look at it. Bill

I would like to point out that Buffett/BRK seems to buy these leveraged bond portfolios (ie, P&C insurers) at the tippy-top of aging, multi-decade bull markets right before big equity market declines. 1966- National Indemnity 1998 - Gen Re 2022 - Alleghany (?) coincidence... or cue ominous sounding music.... Bill

Good to see that Buffett is making an all-cash acquisition and not issuing any BRK stock. I wonder if a superior bid to BRK's offer comes in and, if so, what the break-up fee is. Buffett must really be worried about inflation - he's putting the cash pile to work w/ OXY, Y. What else will he go after next? Bill

Spek - I think you understand it better than 99% of the people out there (even some PhD economists). Bill

Oh no! We're all making more money. The economy is going to crash! Bullish! Bill

Is this a good level to get into DJCO given the BABA blow-up?? No. Bill

Wow - I love this view - I hope you are right!! Think about it - this has been a debacle for Russia. But as bad as it has been for Russia, it has also been bad for China who quietly was neutral/supportive of Putin. But China must be getting increasingly alarmed at the 180-degree outcome from what was expected. Rather than a bolstering of Russia as a strategic rival to the West, Russia is failing militarily, its economy is being destroyed - and even worse, a strengthening of NATO around the US. But what really hits close to home is the focus this invasion has placed on Taiwan. If Russia ceases to be a strategic competitor to the US, the world world swings around US leadership to Taiwan. That's not in China's best interest. So I expect China to make a move to force Putin's hand. China will join the US and other Western countries to force a negotiated peace in Ukraine before this gets any worse for them (both Russia and China). As for the US economy - just look at real-time employment income (via Fed tax receipts on the US Treasury Daily Statement). US households have never been in better shape from a balance sheet & income perspective. They are going to spend now that their consumption is no longer suppressed by pandemic restrictions. Just my 2-cents. Bill

FWIW - no US recession. 1) US economy is ready to boom and will absorb the hits due to commodities. 2) Russia/Ukraine war will be over in 1-2 weeks -- Russia has already lost, strategically speaking. You want to be positioned for the rally in equities that is coming and you don't want to be in commodity plays. Just my 2-cents. Bill

Also - Buffett repurchased a further 4.5m B-share equivalents in the 2 weeks since the 10-K came out. I reckon another $1.4b in common stock at ~ $315-$316 avg price per B-share. Good to see him still buying at prices well above $300 per B-share -- though pace this Q will definitely be lower than last couple of years. Bill

What you describe as « incorrect » may simply be a matter of perspective or even accrual. CB - why you are overly focused on deposits/reserves & coin/banknotes as "money" but not Treasury securities? Treasury securities are money, too. That's why M2 concepts are flawed. Alternatively, why are US Treasury securities considered debts of the government, but currency in circulation and bank reserves are not? If you are going to throw around accounting terms like accrual, then I think you are obligated to think in terms of the domestic private sector's balance sheet and debits/credits. You have to ask yourself a couple of questions. 1) At what point does the private sector's aggregate balance sheet net equity (assets - liabilities) expand? That's what's important - not individual balance sheets but the private sector's balance sheet in total. Think this through in that example of yours. 2) What is the right way to think about the issuance of Treasury securities? As for examples from previous monetary eras - you have to remember that most of those times, the central government's money was subordinate to gold. Thus, any time a breaking of a peg to gold happened due to any number of reasons, it was a devaluation that released the safety valve on bottled up inflation all in one go. That's not the monetary regime we are in today. Always enjoy these conversations, CB! Bill

The bank creates an asset (government debt) and simultaneously creates a matching liability deposit, ie new M2 money that ends up in private bank accounts, ready to be spent. This is an incorrect statement. The key question is not what creates a deposit. The more important question is what creates a net financial asset for the private sector. Let's go through all four types that can affect deposits. First, it is important to consolidate the Fed and the US Treasury as one entity (the central govt sector as fiat obligation issuer) and the private sector (including the domestic banking sector) as the other. 1) The Fed does QE by exchanging a reserve deposit for a US Treasury security with the private sector. Clearly no net financial asset is created. Private sector had a US Treasury security asset, after the exchange it has a reserve deposit. 2) The US Treasury issues a Treasury security. Again, no net financial asset is created. Private sector had a deposit balance and exchanged it for a US Treasury security. 3) A bank lends thus simultaneously creating an asset (loan) and a liability (deposit). It's true a deposit has been created out of thin air. But what I think gets missed is that for the private sector, its net financial assets haven't increased. From a balance sheet equity perspective before the loan and after the loan, the net equity is the same for the private sector - so again, no net financial asset has been created. 4) The US Treasury spends. This (and only this transaction) creates a new net financial asset for the private sector. Just think of your net equity position right before and right after the stimmie check gets deposited into your deposit account. Clearly this transaction has increased your net financial assets. So from my perspective (which is the MMT perspective) - deficit spending by the US Treasury is the only one of these four transactions that creates a net new financial asset for the private sector. The net equity position of the private sector increases by the amount of US Treasury deficit spending. This is why the folks that focus on deposits (ie M2) get it wrong so often. They focus on the wrong thing. It's not the amount of deposits that counts - its the portion that is the direct result of US Treasury deficit spending. After that, the central govt sector (Fed + US Treasury) merely changes the composition of that new net financial asset by offering the private sector three forms in which to hold that new net financial asset (ie. currency in circulation, settlement reserves at the Fed, or US Treasury securities -- or as I like to call them in equivalent banking terms - a choice between cash, demand deposits, or time deposits). It is really conceptually very simple - but few really understand it and so a lot of confusion gets spread around. The final point is that a growing private sector economy needs more new, net financial assets from the central government (ie, deficit spending) - it is the natural order of things. But its a balancing act, too much leads to inflation, too little (or even running a surplus) leads to deflation. There I just summarized Kelton's poorly written book in one post. Bill

China is the second largest economy by US-denominated GDP and the largest by purchasing power parity, so I wouldn't be so quick to write them off. I'm not - I just don't get why they are biting the hand that feeds them. If they get their wish and the US becomes isolationist and withdraws, their economy would get crushed in the ensuing chaos while the US would do just fine. They are huge beneficiaries of the current world order but they are arrogantly trying to subvert it. Good luck with that. We are already seeing a glimpse into what the world looks like when the US appears weak cosmetically (but not in reality) just in the past week. Russia invades Ukraine, Germany re-arms, Japan builds (or installs US) nukes. You really think China prospers under that scenario? My point isn't to be anti-China or to "invite war". Quite the opposite, I really am hopeful that everyone comes to their senses and doesn't miscalculate. It's also to hope that the US resumes its strong global leadership rather than "leading from behind". It's getting quite scary, actually. "Peace through strength" Ronald Reagan Bill

Japan's 2020 Self Defense Force report. Peaceful pink image of Mount Fuji with cherry blossoms in the foreground. Japan's 2021 Self Defense Force report. A stark charcoal image of a Samurai on a charging stallion. Not too subtle... FWIW. It's becoming a scarier world unfortunately. Bill

Japan and South Korean end up nuking up and that's seems like a wholly unmitigated disaster for his foreign policy push. Speaking of nuking up.... Ex Japanese PM Abe has really been making headlines in the last few days. https://www.japantimes.co.jp/news/2022/02/27/national/politics-diplomacy/shinzo-abe-japan-nuclear-weapons-taiwan/ "' 'Japan should consider hosting U.S. nuclear weapons,' Abe says" Japan is taking the growing Chinese threat seriously and the world is quickly moving to contain China next. Japan is also pushing the US to end its policy of strategic ambiguity over Taiwan's defense & are pledging to come to Taiwan's defense. (Japan sees a PLA invasion of Taiwan as an existential threat to their homeland.) Russia has really scrambled the world in just a week. Bill

Russia is dealing from a position of economic weakness. China isn't. I wonder what the poor performance of the Russian military says about the PLA's capabilities. They rely on Russian military technology and like the Russians, rely on conscript armed forces that have not been involved in a military conflict since 1979 (much like the Russians whose last real military invasion was in the late 70s in Afghanistan). Meanwhile the US military has been honing its lethal fighting skills almost continuously since the 1991 Gulf War. It's easy to project a myth of invincibility until you actually have to use it and it turns out that its a Potemkin village in the face of a superior American force. As for China. More than any other country, China depends on the US's stewardship of the global trading system where the US Navy keeps all of the shipping routes around the world safe and clear for merchant shipping. Is it an accident that China's rise has coincided with the Pax Americana that pushed all of China's historic rivals to the sidelines militarily (Japan, Russia, etc)? I don't think so. China has large demographic and geographic problems that limit it's potential. It's aging (and male-skewed) population will rapidly decline by 30-40% over the next few decades (we can't be sure since China fudges its numbers - my guess is their population is smaller than they claim). It needs to import energy and food because its agricultural lands are limited and flood-prone. It is bordered by potentially hostile countries on all sides that force it to spend enormous sums on its military just to defend its borders & sea lanes. The US on the other hand still has favorable demographics and will also benefit from immigration. It's population is slated to continue growing well into this century. It is self-sufficient in energy and food production thanks to the world's largest agricultural breadbasket located in its Midwestern states. It is bordered by two oceans and two friendly countries on either side of its two land borders. Not needing to defend its borders, it can forward project all of its military force globally. Choose your fighter. My bet - the United States will continue to be the pre-eminent global hegemon well into the next century as its rivals (Russia, China) decline due to poor governance systems, demographics and geography. It's an accident of history that the best governance system the world has ever seen (a free market-oriented constitutional republic) landed on Plymouth Rock and took over the world's best geography (the continental United States) but a fortunate one for the world. Bill p.s. - I sincerely hope that the world comes to its senses & goes back to the Pax Americana where everyone can trade freely and co-exist peacefully.

I predict that the Ruble could collapse tonight or tomorrow morning once it starts trading. With collapse I mean >20% loss against USD/ Euro. Early forex quotes by a Russian bank I've never heard of are indicating that the Ruble has been cut in half vs USD (now 171 rubles to the dollar from 83-84 on Friday. But I'm sure that's just the ask of a very wide bid-ask of a suddenly illiquid market. Bill

If they had adequate anti-ship targeting capability, I believe the Chinese would implement their blockade of Taiwan with land-based anti-ship missiles, not submarines. So convoys with submarine escorts would be ineffective. Depending the capabilities of the Chinese missiles, convoys with surface combatant escorts may also be ineffective for the same reasons that even a carrier battle group may not survive attacks from sufficient numbers of advanced satellite-guided anti-ship missiles. You may be right. But the central point is that this would unfold over weeks and months. So the US and its Allies would have ample time to carefully formulate and implement a counter-strategy with lots of options to choose from. Bill

But wouldn't blockade be China's strategy with Taiwan? I think you are right that this might be China's most likely strategy to try to force Taiwan's surrender. But blockades rarely work in practice, if history is any guide. From what I've read from Easton's book and others, China would indeed, threaten Japanese and US Navy ships and bases in Okinawa and Japan with cruise missiles in order to create an "umbrella" around Taiwan. Then, the strategy would be to unleash the PLA's submarine fleet into the Taiwan strait to sink merchant shipping as well as the air force over the island to prevent air cargo landing into Taiwan's airports. The Taiwanese air force would counter - but let's assume the PLA prevails and creates a "no-fly zone" over Taiwan. The main threat would come from PLA subs sinking merchant ships - much like the German U-boat campaign during WW II that tried to blockade England. But submarine campaigns, even when they have complete air and sea superiority only take down 10% of cargo. Of course, the PLA's hope would be to scare merchant ships out of the area completely. Meanwhile, the US (and its allies) would have weeks and months to consider their options (as opposed to the very short reaction time required to counter an invasion) and rally the world into opposition to the blockade. My guess is that in addition to sanctions and financial measures, the US could deploy its submarine force to attack the PLA subs and escort merchant shipping through the strait - a strategy not without risk but probably low risk to the US Navy. The US nuclear subs would just loiter silently in and around the Taiwan strait, wait for the "noisy" Chinese subs to expose themselves in order to enforce the blockade and then take them out and scoot out of the area. This is what ended the German U-Boat campaign after the Allies launched their anti-submarine campaign. As you've noted, the US could also itself (along with its allies) put in place a counter-blockade by cutting off shipping from the Middle East and the through the Stait of Malacca to all inbound Chinese merchant shipping. China is a country that can't feed its population without imports and also must important significant amounts of petroleum. This would put serious strains on the Chinese economy as further pressure. The blockade strategy would probably end up in a huge stalemate with costs on both sides but not be a decisive victory for China. In the end, there's no doubt that both sides can unleash a lot of destruction and death on each other - even with just conventional high tech weaponry. So hopefully this situation just stays in a kind of perpetual Cold War stasis, as uncomfortable as that may be. Just my 2-cents. Bill I would also add another non-military but related point. Russia and China both suffer from terrible demographics. Both of these populations are now in steep decline (Chinese stats understate the real numbers as they do for most "official" statistics). I think the geopolitics of nations is largely based on two big factors that are beyond their control - demography and geography - both of which are hugely in the US's favor. Anyhoo - I think I've emptied my tank on this subject and will only end up becoming boring and repetitive. Thanks for the interesting conversation, y'all.