Recession? Don't Ignore MMT

'Cos it's coming, ready or not...

"PRIDE goeth before destruction," warns the Book of Proverbs..."and a haughty spirit before a fall," recalls Brian Maher, managing editor of The Daily Reckoning.

The Federal Reserve might keep this biblical reproach close by.

For as one Federal Reserve magnifico boasted recently – pridefully and haughtily:

"If there's a recession, don't worry."

Don't worry, that is, because "the Fed is very powerful."

This information we gathered through our vast web of spies.

The Federal Reserve hosted a recent banking conference on the Caribbean island of Puerto Rico.

Old Daily Reckoning hand and "sovereign man" Simon Black dispatched an agent to listen in...who wired back the transcript.

Says Simon, via his man in San Juan:

"One very senior Fed official...told the audience, 'If there's a recession, don't worry,' because 'the Fed is very powerful' and has all the tools it needs to support the economy."

To which instruments of power does this grandee refer?

We have no specific information. But interest rates cannot be among them...

History argues the Federal Reserve requires rates of 4% or 5% to vanquish a recessionary foe.

Only these elevated rates give it the "space" to slash rates sufficiently – to zero if necessary.

But today's federal funds rate ranges only between 1.50% and 1.75%.

Thus the central bank's last trench line – the zero bound – lies dangerously close in back of it.

That is, the Federal Reserve presently lacks the strategic depth to mount a successful rate-based defense...and wear down the enemy in its protracted meat grinder.

Should the enemy puncture the Fed's shallow defenses, the vast rear is currently open to it. And recession would have the entire economy in siege.

What weapons, then, might remain in the Federal Reserve's arsenal?

Additional quantitative easing? Perhaps "forward guidance"? They are on hand, yes.

But what about negative interest rates, previously confined to the drawing board? Why make the zero bound your last line of defense?

Why not stretch the barbed wire behind it, lay down mines...and dig additional trenches in negative territory?

Negative rates would deepen and stiffen the defense, their boosters argue.

Former Federal Reserve Field Marshal Ben Bernanke insists these are formidable anti-recession armaments. He sets great store by them, in fact.

Quantitative easing, forward guidance and negative interest rates – combine them one with the other, says this strategic genius...

...and they equal three full percentage points of rate cuts. Three full percentage points!

By his lights then, today's federal funds rate is not as low as 1.50%...but as high as 4.75%.

That is...the Federal Reserve presently enjoys nearly all the strategic depth required to fight back recession.

We suppose these are the weapons our anonymous central banker has in mind – those that render the central bank "very powerful".

But we are not half so convinced. We see not an impregnable defense...but a Maginot Line, vulnerable to a superior strategy.

We envision a flanking attack, with enemy armor snaking its way through the Ardennes, bypassing the forts.

We further envision a thrust through the Moselle Valley...and into the defenseless economic interior.

Place no faith in the Federal Reserve's Maginot Line, argues Jim Rickards:

"QE2 and QE3 did not stimulate the economy at all; this has been the weakest economic expansion in US history. All QE did was create asset bubbles in stocks, bonds and real estate that have yet to deflate (if we're lucky) or crash (if we're not).

"Meanwhile, negative interest rates do not encourage people to spend as Bernanke expects. Instead, people save more to make up for what the bank is confiscating as 'negative' interest. That hurts growth and pushes the Fed even further away from its inflation target."

What about "forward guidance"?

"Forward guidance lacks credibility because the Fed's forecast record is abysmal. I've counted at least 13 times when the Fed flip-flopped on policy because they couldn't get the forecast right.

"So every single one of Bernanke's claims is dubious. There's just no realistic basis to argue that these combined policies are equal to three percentage points of additional rate cuts."

Generals prepare to fight the last war, it is often argued. We suppose central bankers prepare to fight the last crisis.

Meantime, the relentless enemy is preparing to wage the next recession. It learns, it adapts. It originates new tactics, new weapons...new strategies.

It bypasses Maginot Lines.

And so we expect the next recession to catch our hidebound central bankers unaware...facing straight ahead while the tanks roll in from their flank.

But we expect a new war plan to emerge from the next recession, once all existing defenses are flat.

At its center will be the wonder weapon of Modern Monetary Theory, or MMT.

Up it will go in its Enola Gay...and the fiscal authorities will unload it high above Main Street.

Cash will come raining down upon the unsuspecting residents below, like so much confetti.

They will then vanish into stores, into restaurants, into theaters to disgorge their newfound bounty.

The secondhand recipients of this bounty will proceed to exchange it for autos, boats and houses.

The third-hand recipients will in turn send the money on its way, fanning out in greater circles yet.

The entire economy would soon be on the jump...and recession thrown headlong into rout, permanent and humiliating rout.

But this super-weapon packs greater wallop yet.

It can furnish the wherewithal for a "Green New Deal", universal health care, free college for all...and guaranteed employment.

If John is unemployed, if Jane cannot meet tuition, if Joe lacks health care...then simply print the money to make them whole.

Send it marching off for duty in the general economy, where it will make all shortages good.

MMT says unemployment, for example, is direct evidence that money is overtight.

Print enough and you have the problem licked.

But didn't the government print money like bedlamites after the financial crisis? How can money possibly be tight?

Ah, but QE's trillions were funneled off into credit markets, where they liquified the financial system.

They did not enter the Main Street economy. That is why inflation never got its start.

But with MMT, the money goes straight from the print press to the Treasury.

It can then be spent into public circulation – on a New Deal, for example. Green, red, blue, purple or pink...the choice is yours.

Or for free college, universal Medicare...jobs for all.

But you raise an objection. MMT is a cooking recipe for massive inflation, you say...even hyperinflation.

Yes, but the MMT crowd has anticipated your objection and meets you head on.

They actually agree with you. They agree MMT could cause a general inflation, possibly even a hyperinflation.

In fact, inflation is the one limiting factor they recognize, the one potential monkey wrench jamming the gears.

But they have the solution: taxation.

If inflation begins to bubble, to gurgle, the government can simply drain the excess Dollars out of the system.

Under MMT the economy is the tub. Taxation is the drain.

Under the theory, in fact, stifling inflation is taxation's central purpose. It is not to raise revenue.

Is the theory crackpot? Yes, we are convinced it is.

But desperate times invite desperate measures. And when recession rolls on through the Federal Reserve's defenses...desperate measures we will see.

We cannot say when of course. Nonetheless...

"[It] is coming," warns analyst Kevin Muir. "Ignoring it would be foolish."

Yet these are foolish times...inhabited by foolish people.

Do you require proof?

Simply recall the recent counsel of a senior Federal Reserve official:

"If there's a recession, don't worry."