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Hi Matt. I have been following you for many years and enjoy what you write. I think you really knocked it out of the ballpark with this essay.

I have been struggling to understand the post-Volcker economy - with divergence of the regular main street economy and financial economy - for many years. The transition to ‘debt as money’ with debt expansion and falling interest rates has inculcated in me a concept of ‘the primacy of debt.’ With the US’s massive debt creation, I anticipated inflation – only to be perennially wrong. Expected inflation has failed to manifest generally through a sterilization of the funds at the money center bank level. It does not bleed into the real economy, apart from real and financial asset prices, higher education, and healthcare, probably since the latter two are essentially stealth jobs programs for the educated middle class. I think it’s because of banks’ refusal to lend to all except the largest entities; witness the mREITs which keep mortgages off the bank’s books.

Recently panic selling tanked issued debt 15% (g.o. bonds) -60%+ (mREITS). With an infusion of 2T, lowering of interest rates to zero, QE infinity and debt asset purchases by the Federal Reserve, we have decided, for now, to maintain the primacy of debt. This suggests that in short order, rents, costs of medical care, pharmaceutical prices, and education prices will continue to rise. But main street couldn’t afford them before. With medical care tied to employment and 20 million out of work from coronavirus, only the lucky few with secure corporate jobs and seniors with Medicare have old-style insurance which drives this price model. College students are rebelling at paying full price tuition for online schooling. We’ll see how the housing market shakes out, particularly in high cost of living states.

Kaldor’s quote terrifyingly resembles our own economy: An Instagram-led echo chamber where any disposable income is spent on frenetic airline or cruise travel, hotels, and restaurants; travelling to conferences trying to be selected to participate in the patronage economy or taking the same picture in front of the reflecting sphere at the Chicago Museum of Art as everyone else. How does our economic activity legacy of digital photos differ from the Chinese building ghost cities? It does not. And now, this entire throwaway economy predicated upon waste (wasted fuel, wasted food, wrappers, etc.) grinds to an abrupt halt, and we feel poor.

As we make our global competitors wealthier, the eventual specter of geopolitical rearrangement is raised. Unless billionaires think they will have an equivalent degree of control relocating to another nation, I don’t understand their actions. Perhaps that is a billionaire’s function – to sterilize wealth beyond the ability to spend it. How many yachts can you own? – Paul Allen had three. Being subjugated by another country in a war or losing reserve currency status tends to destroy great wealth–Barton Biggs wrote about that, with formerly wealthy families still fighting for their assets 75 years after the end of World War II.

With WTI at $20/bbl, it primes the pump for a major inflationary input into the global economy. But coronavirus is overwhelmingly deflationary. At some point, perhaps it be realized that the only way to create persistent inflation is through wage-price spirals (hard to realize when nobody works anymore due to AI but could be done through UBI). Then we can repeat the 70’s, get long term rates at double digits, and start the whole process over again for the next American century (inflating away the debt in the process). Rinse and repeat, as they say.

Finally, an observation. Cantillon was a successful 18th century banker, and funded John Law’s Mississippi company - the equivalent of today’s private equity barons. But he was dogged by lawsuits and even murder plots to his death in 1734. His writings were published formally in 1750. One would also be reminded of another 18th century event – the French Revolution, who’s economic origins resided in the expenses of foreign wars, rampant borrowing, and refusal to tax the wealthy on political grounds.

“plus ça change, plus c’est pariel”

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Production couldn't be expanded as rapidly in the 17th or 18th century like it can today. Inflation is seldom the result of 'too much money' (chasing too little goods, as the flawed theory goes), but almost always a supply shock: OPEC oil price hike crisis, Zimbabwean nationalisation of productive farms, US sanctions on almost all Venezuelan imports, ... Weimar Germany devalued its currency purposefully to get out under the Versailles reparations., etc.

So the monetarist theory that more money (money supply) leads to inflation, is a lie. Usually more production will result from additional government spending, with firms competing for market share. Of course with monopolies this becomes a problem, but then it's again a supply shock with the price artificially boosted because of lack of competition.

We should have no fear for inflation when government uses its power to issue currency (which it always has with a sovereign currency but usually has ceded to technocrats because the theory goes politicians aren't to be trusted). As if technocrats don't look after their buddies.

And democracy has the best chance of giving most people a voice, even in the US with all its autocratic structures and nepotism.

People should be informed about the power of currency issuance and demand it to be under the control of Congress by default. The FED should just manage daily monetary operations but not decide who gets any money. The current situation with the FED trying to grow the economy through QE only came to pass precisely because ordinary people have so little income and domestic demand has been decimated for most. Give the QE money to regular folk and you won't have much trouble growing the economy with all the unemployed looking for something to do, mostly in the poorer pockets of the US.

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Matt, as you point out, the Cantillon effect occurred while most currencies were on the gold standard. Now the commodity that most affects the global economy is oil. I was wondering whether you agree with the common analysis that petrodollar demand has allowed the US to finance deficit spending for decades. We're nearing the end of the petrodollar system as other currencies become more commonly accepted by oil-producing countries, while at the same time the price of oil is plummeting. Does this affect the US ability to deficit spend in the near term? I don't have my own theory on this, just wondering if you think about it. I've seen you refer to the petrodollar before, but I don't see any indication of whether you believe it supports deficit spending.

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I learned something here! Thanks, Matt!

I may have missed it, but there’s a second aspect to the import thing. It’s not just shipping out money to foreign nations to buy their products because a nation focuses on extracting and selling resources. But when the focus shifts to avoiding self-sufficiency because it’s more profitable for our masters to outsource businesses. Satiating greed is more important than the commonweal. So being prepared for an epidemic isn’t financially justifiable because it deprives our masters with a pittance. (Economically, being prepared for the epidemic was now provably justified. Being prepared would have cost a small fraction of the couple of trillion dollars being spent or made available to delay with otherwise avoidable crises.)

So what you can call state-sponsored financialization has been hollowing out the US since Reagan gave it his blessings in the 1980s. And now we have the coronavirus doing real, lasting harm to our parasitical leaders’ host body (the nation’s people).

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Abc fox jumping over

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This is great Matt, thanks

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Good background and well-written, but wouldn't a simpler conclusion be that redistributing wealth is an inherently dangerous and flawed method, rather than "we can do a better job of it"?

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Thank you for explaining that process Matt. I have read about how those closest to money supply benefit the most, but it was never explained how or why it happens. This is the first time I have seen an explanation of the phenomena.

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Great piece. Australia avoided recession during the GFC by developing a mantra of "Go hard, go early, go to households." which feels like a necessary (though probably inadequate) counterweight to the Cantillon Effect. More here: https://www.youtube.com/watch?v=N5UHT2hBGdk

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Cantillon lambic is very nice. I am looking to have some nice gueuze shipping to me in USA, but I cannot find any Cantillon online.

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Economists who study emerging markets identified this phenomenon a long time ago, and called it Dutch Disease: https://en.wikipedia.org/wiki/Dutch_disease

I myself have been wondering whether the shale oil "miracle" (a poster child for Fed-sponsored capital destruction) may have pushed the US much farther in this direction

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Debt jubilee (as Michael Hudson has often written about) would be very fast and efficient.

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Thanks for writing this, but I'm a bit confused over your discussion of Yellen's speech. Where does she say something approximates "the bigger and powerful get money first, and the small and weak get money last?" The paragraph you quoted, as I read it, does not resemble this statement - just that economic models understand central banks affect households through changing the real interest rate available to them, but there are other possible indirect channels to affect households that we need to research more. Heterogeneity in this case means that households differ in key aspects e.g. if one is credit constrained, they will react differently to economic pressures or monetary policy).

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The velocity of money is more important than the amount of disposable assets you have0. Just ask new retirees on a pension who have paid their mortgages and they will tell you about their struggles with managing their cashflow.

No need for big economic theories or Congress(wo)men's speeches to understand this phenomenon.

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Companies continuing to pay minimum wage employees to not work so that the company qualifies for the small business forgivable loan. The company pays wages based on the average of the last 8 weeks of work, even though many businesses are somewhat seasonal, and there may have already been a decrease in work during the past 8 weeks thanks to the pandemic.

Company profits, while the minimum wage employees don't qualify for the unemployment PLUS $600/week bonus.

The Cantillon effect when a larger player has the ability to damn off a tributary stream of monetary flow.

https://old.reddit.com/r/bestoflegaladvice/comments/fxy54j/laop_thinks_a_paid_vacation_isnt_fair_and_would/

(note that this particular minimum wage employee isn't very sympathetic, but still the point stands)

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