Sweden on the Brink

I left my native country, Sweden, in 1999. It was the same summer that I handed in my doctoral thesis at my Danish alma mater. After the usual haggling, rewriting and turf peeing by dissertation committee members, I defended it in the spring of 2000. By then, Ashgate, a reputable British publisher of quality academic work, had approached me asking if they could publish my thesis. The book, Uncertainty, Macroeconomic Stability and the Welfare State, was my first concerted effort at understanding the systemic problems with the welfare state.

I enrolled in the Ph.D. program at Roskilde University in late 1995, going full scholarship the following spring, while commuting back and forth across the border. I spent every other week in Denmark, every other week at home, immersing myself in economics and political economy at a level I could only have dreamed of doing at a Swedish university.

Part of my reason for leaving Sweden was that the country offered practically no useful graduate education in economics. Under a centralized regime run by the Institute for International Economics in Stockholm, all Swedish graduate programs had been aligned in the image of new classical macroeconomics (Lucas-Sargent and Kydland-Prescott for you nerds out there) which meant that all you learned as a grad student was advanced correlative statistics. Oh yes, and two years’ worth of eclectic optimization problems.

All of this has destroyed the ability of the practitioners of economics in Sweden to even remotely approach pertinent economic policy issues. While it is impossible to practice political economy in Sweden, you can easily become a full professor in the discipline by spending your entire career studying how one consumer interacts with one consumer product. You can also become a full professor if you spend your entire career studying non-linear taxation of trees as they are being chopped down in some forest somewhere.

What you cannot do is earn a doctorate actually studying economics.

As a result of the new classical, contagious intellectual illness that started spreading through the economics profession in the 1980s, everything analytical has been thrown out the window. All they worry about are econometrics and Walrasian algebra (my apologies for taking the great science of mathematics in vain), both of which are as useful in real-world economic analysis as astrology is to engineers. Econometricians can do a fair amount of good work in isolated microeconomic studies, but if you are in any way interested in the systemic nature of our economy, the interaction between the free market, political ideologies, economic institutions, government spending, taxes and money, you can forget a graduate program in economics. Especially in Sweden.

In fact, you are even better off reading Murray Rothbard.

I did not read Murray Rothbard, at least not back then, but I left Sweden for greener pastures. After having thrived in Denmark for a few years, teaching macroeconomics and the welfare state at my Danish alma mater, I moved to America. Here, I have had the opportunity to actually practice what I learned in grad school, and I have found a plucky and thriving – albeit intellectually somewhat shallow – vegetation of political economists, centered primarily around think tanks.

America is a better country thanks to her free-spirited mindset. Sweden, on the other hand, is a country in macroeconomic decadence, and the fault for that falls in no small part on the shoulders of my old econ friends from college. Many of them are now prominently placed in politics, or spend their days regurgitating multivariate regressions, all in the service of their almighty government.

As a result of the intellectual desert that has engulfed the economics profession in Sweden, for the past 30 years the country has been on a slow but inevitable economic downslope. After a tepid 1980s, with economic growth so slow that the Social Security-style ATP pension system imploded, the country was plunged into the Great Big Dungeon of 1992. Starting in late 1990, the economy collapsed at such a pace that unemployment went from two to 15 percent in 18 months. The economy contracted for three years in a row.

Having graduated college and done a brief stint in airport rescue putting out fires, I was working in economic policy, trying to put out less conspicuous but more devastating fires. I was contracted as a writer and speaker with a small publication that nominally leaned left, but was mostly anti-establishment in its editorial practice. I traveled around the country talking and opining about how the government’s efforts to balance the budget was choking the economy to death. It was a line of work that predictably made me a persona non grata in certain circles of power.

It was considered impolite to criticize the prime minister and his cabinet for its Greek-style destruction of the economy. Hence, another reason to set my eyes on Denmark.

Alas, I was proven right. The Swedish economy never recovered from the implosion back in the early ’90s. In my book Industrial Poverty from 2014, I reported in detail on the destructive austerity policies of 1995-1998, and how they ended the budget deficit but choked the economy half to death in the bargain.

Since then, the Swedish government has used all sorts of artificial policy measures to keep the economy alive. They marginally eased the tax burden, in part with its own version of the American EITC (Earned Income Tax Credit), which of course has only led to higher marginal effects in the income-tax system. They have not really reduced the top tax rate (despite some ill informed libertarian pundits on this side of the Atlantic trying to claim the opposite) and they have secured a firm grip on the economy by means of a value added tax that applies to everything from cars and train tickets to food and tap water.

Sweden competes with Denmark for the most burdensome taxes in the world. They are doing a fine job with it, so fine in fact that they have depressed economic growth to a point where households increasingly depend on government to make ends meet. Figure1 reports the share of household income – technically “production factor income” which refers to households as the labor force – that comes from workforce participation. (I used this chart a year ago in an article for a Swedish publication, hence the Swedish references.) In short: this chart shows how the Swedish government, through fiscal policies hostile to economic growth and productive workforce participation, has depressed wages and salaries as a source of income.

Figure 1*

Source of raw data: Statistics Sweden (scb.se)

In short: Swedes have become more and more dependent on government, and less and less able to feed themselves.

To still maintain some kind of industrialized standard of living, Swedish households have been forced to go deep into debt. As of 2019, Swedes had the second highest debt-to-income ratio reported in the EU. While Eurostat does not produce this statistic for all EU member states (a glaring deficiency) the sample is big enough to point out how miserably indebted Swedes are. Figure 2 compares them to the only country with a more indebted population – equally tax-burdened Denmark – and to Spain, for a reason we will return to in just a second. It is noteworthy how the debt burden on the shoulders of the Swedes has increased steadily since the austerity years of the 1990s:

Figure 2

Source: Eurostat

If it wasn’t for growing debt, the Swedes would be stuck in a sub-industrial standard of living. It is not the debt itself that is the problem, but the rise in the debt ratio. Thanks to a combination of onerous and bureaucratic zoning and housing-standard regulations on the one hand, and an extremely high immigration rate on the other, housing prices have increased beyond what is even remotely reasonable.

At the same time, without household access to expanding debt, the Swedish economy would not have done half as well as it is has over the past 25 years. As Figure 1 indicated, Swedes cannot live on work alone, but have to find other ways to afford a standard of living in resemblance of that of their neighboring countries.

Speaking of which, the Danes are even more indebted than the Swedes. The reason is two-fold: that they are an even more cramped for land to develop for housing (Denmark is nothing but subdivisions and farmland) and that they have a car-registration tax that doubles the price of passenger vehicles.

However, as Figure 2 reports, the Danes reversed the rising debt ratio a few years ago by reforming the interest deduction in their income-tax code. By gradually reducing the deduction, the Danes keep household finances relatively stable while also creating an economic incentive toward better financial sustainability.

The Swedes followed suit a couple of years later, but not with a smart dynamic solution. Theirs was a one-time reform with higher down payment requirements and other changes to real-estate financing. Now, though, they are worried that their reform is going to bring the housing market into a downward spiral. If that happens, it will rip the entire Swedish economy with it – and when that happens, it will not be pretty.

To keep household debt as cheap as possible, the Riksbank – the Swedish central bank – has operated with negative interest rates for almost six years. They recently returned to zero rates, which led to a policy backlash: as Tyler Durden over at ZeroHedge reports in a good summary, the Swedish economy – together with Europe as a whole – entered into a second artificial economic shutdown because of the coronavirus hype.

Durden also explains that the Riksbank responded with an “unexpected” new Quantitative Easing strategy, while trying to keep its interest rate at zero (instead of going negative again). While Durden, a ranking financial expert, sees the policy as unexpected from a strict monetary perspective, the deeper reason for a new, massive round of money printing: deficit monetization. This, in turn, is necessary to avoid the two policy moves that would throw households into debt default:

  1. Higher taxes – an otherwise popular go-to strategy for Swedish politicians, especially when the economy is in a deep recession (because what is better for an economy in a recession than higher taxes?); and
  2. Higher interest rates – which would come in response to a plummeting currency.

The latter would happen if the former happened. The country’s economy is perennially weak – only exports have done well – which has led to constant stress on public finances, both in terms of weak revenue and in terms of high demand for tax-paid entitlements. Swedish fiscal rules prescribe hard budget balancing, to which the political leadership will gladly respond with tax hikes. In a situation where household debt is basically more important than work-based income to keep consumption above the industrial-poverty level, any tax hike can poke a fatal hole in the debt bubble.

When the economy shows its first signs of implosion, foreign investors will be lightning quick to withdraw their money from the country. As capital starts flowing out, the currency plummets. This triggers an uncontrollable import-price spiral, to which the Riksbank can only respond with sharp increases in interest rates.

At which point the real estate market gets its guts kicked out.

The Riksbank knows that all that stands between tenuous macroeconomic stability and a Greek-or-worse style implosion of the country, is Quantitative Easing.

If I were thusly preferenced, I would repeat today what speculators did to the Swedish krona in 1992. I would take a loan in their currency, deposit it into a U.S. account and wait for six months. By then the krona will have depreciated with the declining economy, enough so to allow for a neat little profit.

Back in 1992, just before the Great Big Collapse of the Swedish currency, the krona stood in a five-to-one exchange rate with the dollar. If you took out a loan of one million kronas, you had $200,000; once the krona collapsed you paid back the loan, but since the exchange rate was now eight to one, you only had to use $125,000 to be free of the debt.

That’s a neat little profit of 37.5 percent.

It remains to be seen what the profits will look like today. One risk factor, of course, is the U.S. monetary policy. If Trump’s election-fraud challenges turn out to be as solid as Sidney Powell says they are, he will be sworn in again on January 20. In that case we can expect a moderation of U.S. fiscal and monetary policy. If, however, Biden prevails we can most certainly expect Mad Monetary Theory on steroids, whereupon the dollar will be significantly weakened. However, all other things equal, the Swedish krona is ripe for another implosion – and therefore a grateful target for speculators.

*) The color codes are linked to political majorities in the Swedish parliament. The choice of color is not translatable to an American context.

Hyperinflation: Still A Threat

With the outcome of the 2020 election still in limbo, so is the fiscal future of our country. On the one hand, it looks like the Democrats may be down to a slim nine-seat majority in the House, a majority that could easily fracture with continued ideological battles within that party. On the other hand, the outcome of the presidential election remains unclear, with investigations continuing of what role the Dominion election software played in the vote count.

Then, of course, there is the Senate majority, which hinges on the outcome of runoffs in Georgia.

If the Democrats secure both chamber in Congress and the presidency, we are likely going to see a tidal wave of new spending, funded in part by much higher taxes, in part by the application of Mad Monetary Theory. If the Republicans hold on to the Senate and the White House (assuming that there is substance to the Dominion-related accusations), there will be some measures taken to dampen excessive deficit spending. It is also possible that if the Republicans prevail, the moderates in the Democrat party will be emboldened, enough so to start working with Republicans on spending containment measures.

That is what America needs. It will, however, require Congress to be on quick feet in order to contain our fiscal crisis, primarily because doing so will help us reduce the threat of high, monetarily driven inflation.

I have written about this threat in the past, pointing to monetization as one of three bad ways to deal with a runaway debt crisis. I have also pointed to the threat that excessive money printing poses to our very free-market capitalist economic system, and to how exorbitant money-printing helps inflation the stock market.

This last point is crucial. Vastly inflated equity markets is the first step that an over-monetized economy takes on its route to hyperinflation. The next step is that the money flows into the real sector of the economy and ends up being spent by government and by households. When that happens, the transmission mechanisms of hyperinflation go to work.*

We are not there yet, but the stage is set for it. All we need to do is continue down the current path of completely irresponsible, monetized entitlement spending. (If we really want to fuel the inflation fire, we add tax increases to the mix, as MMT proponents want.) In fact, this transmission mechanism is nothing new: we have seen glimpses of it in the past, partly – curiously – in relation to two supply-side driven tax reforms. This tells us that it is a bad idea to continue down the same path; if we want to get our current fiscal crisis under control, we need to address the spending side of the equation.

Figure 1 reports the velocity of money in the U.S. economy. This metric, which is the ratio of GDP to money supply, shows how “often” we use the same money in order to pay for all our economic transactions in a given time period (usually a year; here the data is reported quarterly). The higher the velocity, the smaller the money supply relative GDP, and vice versa.

A decline in monetary velocity means that more money is idling in the economy. The real problem occurs when the velocity falls below 1, as it means that part of the money supply is not being used at all for the purposes of economic transactions. That money is not going to just lay idle in some bank account somewhere, but will find its way to profits. If there is no transactions demand for it, banks and investors will put it to speculative use. And, as mentioned, in a monetized welfare state, where a big chunk of government spending is paid for with printed money, inflated equity markets are the preamble to high inflation in consumer prices.

Figure 1

Sources of raw data:
Federal Reserve (Money); Bureau of Economic Analysis (GDP)
  1. The Reagan tax reform, which was necessary to end the punitive taxation of personal income, did not come with the necessary spending reforms. Furthermore, as David Stockman so pointedly explains in his book The Triumph of Politics, the Laffer Effect upon which the tax cuts relied, was in turn dependent on high inflation to yield the surge in tax revenue needed to close the budget gap. That inflation did not materialize; since spending continued to grow uninhibitedly, the budget deficit prevailed. In response, America had her first encounter with money printing for the purposes of covering up Congressional fiscal excesses.
  2. In sharp contrast to the 1980s, the ’90s offered fiscal restraint on the spending side, but not on the tax side. Presidents Bush Sr. and Clinton both signed into law new tax brackets, thus destroying the clear, transparent federal personal-income tax code that Reagan put in place. Clinton’s spending restraint worked to his and to America’s advantage, conspiring with a long growth period to close the federal budget gap entirely. Hence, the fiscal demand for newly minted dollars went away and monetary velocity increased again.
  3. The Bush Jr. tax cuts adjusted some of the errors that his father and Clinton had made. At the same time, the 9/11 attacks injected a big chunk of uncertainty into the economy, causing Congress and the White House to run over to the Federal Reserve and ask for help. The decline in velocity was brief, though, and to Bush Jr.’s credit the economy grew reasonably well during his White House tenure. In fact, if the Great Recession had not happened, we would likely have seen a balanced budget in 2009.
  4. Then came the Obama years, with the most ridiculously tepid economic recovery in recent memory. That was only partly Obama’s fault – by this time the welfare state had begun permanently suppressing U.S. economic growth – but his administration’s regulatory spree and onerous Obamacare reform certainly did not help. Thanks to the slow growth, the Treasury again started tapping into the Federal Reserve to plug its budget hole: for Congress and the President, Quantitative Easing became a way of life. And monetary velocity started plummeting.

However, all of that pales in comparison to what the coronavirus packages have done to our money supply. The velocity free-fall during the QE years, which was brought to an end by Janet Yellen, has been concentrated into a free-fall this year. For two quarters in a row our velocity has been below one. While the plummet seems to have tapered off, it does not take much to cause it to decline again. Another artificial economic shutdown would certainly do the trick, but even without that we are at great risk if Congress decides to do more “stimulus” spending.

We need a new fiscal doctrine in Washington: structural spending reform.

*) In my soon-to-be-published Socialism or Democracy: The Fateful Question for 2024, I point to this very mechanism: excessive, monetized welfare-state expansion causes hyperinflation.

Monetary Expansion: An Update

In his illuminating The Triumph of Politics: Why the Reagan Revolution Failed, perennial fiscal truth teller David Stockman summarized hyperinflation as (p.65):

the deliberate debauching of the nation’s money in a futile effort by politicians to compensate for the shortfalls of capitalist growth that their own misbegotten bureaucratic enterprises had caused.

In plain English: politicians compensate for welfare-state overspending by printing money. I have pointed repeatedly to the signs of inflation pressure building in our economy, and how it is traceable back to the excessive money printing that has fueled recent government spending.

As I previously reported, money supply is now at such a level that the velocity of money in the second quarter fell below one. This means, plainly, that there is money idling in the economy that is not being used; wherever there is idle money, there will be inflation.

A review of third-quarter data on money supply shows that money velocity remains below one:

Figure 1

Sources: Federal Reserve (M1); Bureau of Economic Analysis (GDP)

The fact that money supply has continued to outpace GDP means that it has also outpaced the transactions demand for money. Some of it will be absorbed by equity markets and contribute to a speculative bubble, but part of it will also find its way back into the real sector of the economy.

That transmission mechanism is known as deficit monetization, or government spending money fresh off the Federal Reserve printer. This transmission mechanism between the monetary and the real sectors is a dangerous source of inflation. So far, in the American fiscal-policy debate, it has been widely under-appreciated.

We have only had a velocity this low at one point previously in recorded monetary history. That was in the early 1960s:

Figure 2

Sources: Federal Reserve (M1); Bureau of Economic Analysis (GDP)

Back then, the velocity was low because the Federal Reserve had just started implementing new policy instruments and was attempting to shift from classic to accommodating monetary policy. That policy, in turn, was incompatible with the gold standard, the formal remains of which evaporated during the 1960s.

Since then, monetary policy has been focused on providing liquidity for the U.S. economy. Up until the late 1970s there was little focus on monetizing budget deficits, but as the gaping hole in the federal finances grew bigger in the ’80s, monetization slowly became an accepted practice. In the 2000s that policy became systematic under the label of Quantitative Easing; in reality, QE was more of an excuse to turn an ad-hoc approach to deficit funding into a formal, open practice.

Today, as Figures 1 and 2 demonstrate, deficit monetization is as established as the budget deficit itself. This is deeply worrisome, and it does not get better if we break down the money printing on a monthly basis. As Figure 3 explains, not only is money supply vastly bigger than it was only a year ago, but the difference is still increasing:

Figure 3

Source: Federal Reserve

There is a bit of an oddity in the difference between M1 and M2 in 2020. It is not unheard of that the two expand at different rates, but it is unusual. We will examine that in greater detail in a later article; for now, the main point is that the money supply keeps expanding, our monetary velocity remains negative and that the transmission mechanisms that cause inflation remain active.

S&P 500 and the Monetary Tsunami

It has been said that Lenin, the ruthless communist dictator of the Soviet Union, once claimed that if you want to crash a capitalist economy, you destroy its banking system. Whether or not that quote is actually attributable to him is for others to determine; the point, though, is frighteningly accurate. As I explained in my article Credit, Risk and Capitalism, the recent, violently fast monetary expansion is now threatening an essential part of the fabric in a capitalist economy: the tie between price and risk on financial markets.

Our banking system exists to master the price-risk relationship. Once these two variables are separated, the essence of free-market capitalism withers away.

Today we can report more numbers that reinforce the impression that our very economic system is in jeopardy. Before we proceed to examine how the active ingredient of this destructive process – the tsunami of a monetary expansion – affects the stock market, it is worth noting that the Federal Reserve is not the real culprit here. They have printed an inordinate amount of money because Congress wanted extreme “stimulus” spending in response to the Covid-19 economic shutdown, without having to pay the political price in the form of higher taxes.

With that said, let us take another angle to the monetary explosion. Figure 1 reports the velocity of money in the U.S. economy, a variable that tells us what the balance is between money supply and money demand. The velocity is calculated as current-price GDP (representing money demand) divided by money supply (defined as M1):

Figure 1: Velocity, M1 and GDP; Quarterly data at annual rates

Sources of raw data: Federal Reserve (M1); Bureau of Economic Analysis (GDP)

The velocity of money has virtually imploded in 2020, illustrating with chilling clarity how the increase in money supply has saturated the economy with liquidity for which there was neither need nor demand.*

Where, then, did the money go? We have been told that it was to cover much-needed stimulus spending, which in turn was needed to plug a big private-sector income hole caused by the Covid-19 shutdown. There is no doubt that many Americans suffered as a result of the shutdown, and as I have explained elsewhere it was the duty of Congress to compensate the private sector for the artificial, government-created disruption in economic activity. However, that compensation vastly exceeded private-sector losses, which in turn means that government has seriously over-sized its stimulus outlays. As a result, the Federal Reserve printed lots of money for which there was no intrinsic demand.

Where, then, did the money go? Figure 2 gives us a hint. It reports quarterly numbers for year-to-year changes in S&P 500 trade value (defined as trade volume times close index) and year-to-year changes in M2 money supply. Note how the two take off as rockets in the first and second quarters of this year:

Figure 2: S&P 500 Index (left vertical axis); M2 Money Supply (right)

Sources of raw data: Yahoo Finance (S&P 500); Federal Reserve (M2)

Here is a highlight of the past six quarters, with changes to the S&P 500 index in the left column:

In other words, a good part of the newly minted money supply has come to finance equity investments. While the economy went into a severe downturn – artificial but still – the stock market apparently thought it was the right point in time to drastically raise the value of that same economy. The close index was about ten percent higher in May, June and July this year than last year, with trade volumes exceeding previous-year figures by 38-85 percent.

The rally has subsided somewhat in recent months, but both close index and trade volumes still exceed 2019 numbers. In short: the stock market is in love with 2020, and a good part of the reason is that the Fed’s money printing presses are working overtime.

Which brings us to the dire problem embedded in these numbers. Since there is no macroeconomic value to motivate this stock-market rally, its sustainability is entirely dependent on the Fed’s decisions going forward. We know already that the central bank has no plans on turning off the money faucet, but for a host of reasons this monetary fueling of equity prices is entirely unsustainable. It will collapse by the weight of its own over-inflated might.

Unless, of course, the money printing first causes hyperinflation in the economy. Which, again, is now a possibility – not probability but possibility – we have to consider.

There is only one way to kill this monetary inflation vortex: drastic reductions in government spending. Will that happen? We’ll see.

*) The terms “need” and “demand” are used deliberately. The difference is too intricate to cover in a blog article, but will be explained upon demand.

Reckless Monetary Expansion

The excessive borrowing by the federal government in response to the Covid-19 economic shutdown is beginning to show up in economic statistics. As I have explained already, there was no need for the stimulus checks, and the combination of those checks, the unemployment bonus and excessive monetary expansion to fund the Gargantuan deficit may create a perfect storm of inflation.

The monetary component in this inflation threat is particularly serious. Other forms of inflation can usually be dampened with fiscal policy and other real-sector measures that allow the economy to return to price stability. Monetary inflation, however, creates a pricing pattern in the economy that is immune to such measures. Non-monetary inflation forms, often referred to as demand-pull and cost-push, depend on pricing of goods and services in various parts of the economy. By contrast, monetary inflation injects purchasing power into the economy that has no ground in any real-sector activity whatsoever.

Before we look at some frightening numbers on our monetary expansion, a note is needed on why high inflation is so dangerous. We have not had an experience with it in America, which very likely has insulated our policy makers against the dangers that come with it.

Technically, higher inflation means that prices are marked up by bigger percentages than usual. The higher the inflation rate gets, the larger the price increases in any given year. Furthermore, when inflation rises past a “breaking point” – somewhere in the bracket of 10-50 percent inflation – price setters start making price changes more frequently than otherwise. This results in an acceleration of the inflation rate by virtue of the “compound interest” effect.

The pricing frequency shortens because price setters do not want to be wrong in their price expectations. For every pricing period there is an expectation of how much prices will rise in general; if the price setter learns that he has under-estimated inflation, he will mark up his prices more, and more frequently, in the future. The higher inflation climbs, the steeper the price for being wrong about it: high inflation feeds expectations of higher inflation, which in turn feeds a behavior that makes those expectations come true.

Plain and simple, high inflation becomes a self-fulfilling prophecy. Monetary inflation is the most dangerous type of inflation, driving the rate of price increases up faster than any other form. Therefore, it is also the inflation type that most rapidly gains a momentum of its own. This is why our history is full of hyper-inflation episodes driven by reckless monetary expansion.

We are far away from hyper-inflation, and chances are we will never get there. However, every path to runaway prices hikes begins with a first step – and we have now taken that step. Figure 1 has a frightful story to tell:

Figure 1: M1 Annual Monetary Expansion

Source of raw data: Federal Reserve

The liquidity that has now been pumped out in the U.S. economy has to go somewhere. Transmission mechanisms between the monetary and the real sectors have already gone to work, and will continue to work their way spreading this liquidity. Since this money is printed out of thin air, it does not constitute payment for any real-sector transactions, but it just dropped into the real sector in the form of a massive line of credit.

Bluntly, spending materializes out of thin air. The real sector of the economy is suddenly supposed to respond to spending that no intra-real-sector transmission mechanisms have accounted for. The result will be a spike in prices.

I am not going to speculate in how high our inflation rate will be as a result of this monetary expansion. What we can say with certainty, however, is that our path to high inflation will be determined in the near future. If this enormous increase in money supply is at least partly reversed in the second half of this year, we may have dodged the inflation bullet. If not, we are in trouble.