Time to take control (of my portfolio)

For several years now, I’ve been skeptical about the stock market and valuations with all the easy central bank policies and QE pushing prices to crazier and crazier levels.  With such a view, my long term investments were primarily linked to gold.  I held steadfast in my belief that gold would eventually have a substantial rise while stocks would endure a series of ever bigger rallies and busts.  This is not a good mindset to play the markets – you have to be open minded to learn about where things are going and why.

I tried a put option play in January, bearish in my own macro-view of where things were headed, and it ended expiring worthless (down $890).  I started reading about market timing and technical analysis, and a few months later heard a presentation on a very compelling setup in Wal-Mart.  I bought a $355 call option and sold it only 3 weeks later at $1,335.  This really piqued my interest.  Stockcharts.com became a favorite read for me (I’m not a paid subscriber, though I recently started a free 30-day trial).  In the following months of reading articles I’ve had many more trades, typically risking $300-$500 per trade, and staying somewhat market neutral (about an equal number of puts and calls).  I’m up $2,650 at the moment for whatever that means – but more importantly I really felt I’d learned more about the markets in the last 6 months than I had in the prior decade.

The other day I saw some compelling reasons for a pullback in Gold.  Here was the big one: https://stockcharts.com/articles/tac/2019/09/tim-taschler-why-i-watch-the-c-348.html

COT report Gold

This long-time trader in the CBOE explained the behavior of “smart money” commercial hedgers vs traders, and that hedgers tended to be right more often than not.  The logic works like this … commercial hedgers have a pretty good idea for the market of the goods they produce.  They have a lot of money and a lot of physical backing, so when they are short they often hold the shorts to expiry and settle the contract with physical supply.  On the other hand, the big CBOE traders are technical analysts.  If they think the direction as switched, they will sell their longs and go short – selling pressure which is better to get out ahead of.  To top it off, some of the analysts I followed were getting out, a head-and-shoulders was forming, and there were good technical reasons to expect a retest of lower support.  The next day I sold everything from my accounts (except my option plays) and decided to start from scratch.  The ISM was low that morning, the market was going down dramatically, and I was selling into a rise in Gold (Tuesday).

After work, I went over all of the gold plays I had, as well as some new ones, to see how they reacted in relation to the rise in GLD this past year.  I came up  with a list of 10 different gold stocks that went up significantly with the rise in gold – the exposure I was looking for.  These are ready for when I get back in.

The next day, the overall stock market dropped significantly.  I sold off a couple of my puts – including one (DPZ) which was a loser play but at least the timing got me some money back at that exit point – and went home to get a feel for the signals.  What really interested me was this one: https://stockcharts.com/articles/tac/2019/10/mark-young-wall-street-sentime-383.html

Exact quote: “What’s really got me wanting to stay bullish is the never-before seen reading from our Wall Street Sentiment Survey. We had ZERO Bulls in our weekly survey. I’ve been running this survey since the early 1990s and I’ve NEVER seen a 0 reading before.

Other readings, oversold measures and such, had me convinced and I put $8,500 into MTUM the next morning.  I chose this play for two reasons … one is that a reversal tends to go towards the stocks that big investors were already interested in allocating towards, and the other is that in the last stock downturn (last year), MTUM didn’t go down any more than the bulk S&P – which makes sense because it builds on defensive stocks when momentum heads that direction.  Decent rallies followed and I’m curious to see where markets are headed.  My gut says that this week will launch us toward the 3,000 S&P mark – a significant line of resistance lately – and it may or may not break through.  I won’t wait to find out … at S&P 2,980 or so I’m dumping MTUM and waiting to see some confirmation signals.  I might get some more put plays going if the price is right at the retest.

Back to precious metals … I haven’t given up on them and I still think next year will be a fascinating one as all the Democratic candidates as well as Trump will be giving investors reasons to be bullish on gold.

Despite the recent gold advance on market worries however, I expect more consolidation in the price.  Here’s my logic …

  1. The dollar is still trending higher for a number of reasons.  The federal reserve even re-instituted short-term repo’s (both overnight and 14-day) to allow big banks to overcome short-term cash crunches ( https://wolfstreet.com/2019/10/04/repos-boost-feds-assets-by-181-billion-most-will-unwind-next-week/ ) which shows a significant shortage in US dollars in the system.
  2.  Emerging markets (including China) tend to be focused in much more cyclical industries such as manufacturing, mining, etc. for exports.  Gold is much more popular among EM investors – particularly in Asia – and the drop in exports is putting downward pressure on their currencies.  I’ve heard the claim that China is manipulating its currency lower to retaliate against tariffs, but I think this is dead wrong.  China wants a strong currency and a reserve currency, and it struggles from capital flight.  They are trying to shore up their currency with capital controls, including restricting gold purchases.  In other words, demand for precious metals will be constrained a bit from this sector.

Here’s a chart showing a definite consolidation pattern:

GLD

It looks like a bull flag – a declining consolidation pattern in an overall up-trend which will complete by breaking through the upper resistance line shown.  I also drew a line from previous resistance where we would see very strong technical support.  If the price reaches to test this level I’ll start to buy back in.  If the price jumps the top of that trend channel it would be very bullish and I would buy back in.  While it stays in consolidation mode I think I’ll wait. 

Last notes …

As part of taking control of my portfolio 100%, I decided to start recording my own weekly balances to get a benchmark performance.  No more waiting in out, no more doing it later – Now’s the time.

One thing I’d also really like to say about my current view on markets … it may seem ironic, it’s definitely contrarian, but I strongly believe that the biggest money fleeing active management for low-cost ETF’s comes at a time when active management has more value than ever.

With low and even negative interest rates worldwide, combined with regular expectations of different forms of QE, it is nearly impossible to hold any asset for long term growth in a way that beats inflation.  Combine that with more and more trading done by computers (algo’s) and the heavy favoring of stock buybacks over dividends, and I really think we’re entering a period where we’ll see a choppy chart like the decade of the 1970’s except with much lower dividends.  Opportunities for trading will be fantastic, as cash flows from one asset class to another will become drastically more important than fundamentals and earnings.  The markets are definitely defensive at the moment, having moved from high-risk overall revenue growth as king (think tech unicorns, Netflix, Uber, Lyft, Wework, and so on) to a market which shuns those in favor of defensive sectors like consumer staples and utilities or cash-flow & earnings giants like Apple.

One big word of caution when you invest using technical signals however … technical signals tend to be very short-term.  If you bet on any technical signal and wait out a year – or even a quarter – you’re doing it wrong.  This is a hands-on approach that requires vigilance, an open mind, and the ability to admit to yourself when a trade has gone wrong.

You need to be sharp enough to cut your losses, re-analyze the market, and try again.  I’ve made some great trades lately involving calls in utilities lately, but it worries me that such a defensive sector has been on such a tear, and that many of them aren’t reaching their late-August tops.  The outlook is still bullish, but the risks outweigh the rewards for me in this sector at the moment.  In other words, what works one moment won’t work the next so you need to stay vigilant.

I’ll end by repeating one of my favorite taglines, used by Carl Swenlin in his posts:  “Technical Analysis is a windsock, not a crystal ball.”

 

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Recession Overhype?

There are a lot of articles on signals of a coming recession, pointing to slowdowns in a number of different areas including manufacturing, automotive, semiconductors, oil, base metals, trucking/freight, and so on. Throw in the slowdowns in Europe and emerging markets as well. The biggest signal they all point to is the inverted yield curve, where 2 year treasuries yield more than 10 year notes.

Meanwhile, US stocks are still near all-time highs and have been chopping through a range, often jumping a percentage point up or down based on the latest sentiment regarding trade talks.

US stocks still show a number of bullish trends including leadership of consumer discretionary stocks, along with significant breadth in the number of stocks hitting new highs. If I had to bet on it today, I’d say the S&P is more likely to re-test it’s highs than correct lower at this point. In other words, I’m still bullish on US equities and I don’t think the US will see a technical recession.

As it goes, I’m trying to stay somewhat neutral buy having the same number of bullish bets (using calls) as bearish bets (using puts). The idea is to make money when the market moves either way, so I can be just as excited about a 1.5% drop as a 1.5% rise, just hoping that they don’t stay flat.

Back to the no-recession call though … my main reasoning behind that is that the US economy today is dominated by sectors that are non-cyclical. The biggest sectors of our economy such as finance, insurance, medical, technical/scientific/professional services, information services and so on are still growing at a decent clip. Manufacturing and base metals mining are down, but these sectors are much smaller parts of the US economy today. Oil is relatively cheap but it isn’t causing our producers to shut down or anything. In other words, the largest parts of our economy seem to be growing more than enough to offset the sectors which are slowing.

As for the inverted yield curve – when central bank intervention is crazy enough to have trillions of dollars in negative-yielding bonds, it makes it hard to rely on technical signals in these markets.

Does that mean stocks will shrug off recession fears and go wildly bullish? I’m not sure. Changing opinions on the underlying economy can easily lead to fear that the Fed won’t jump in with more rate cuts, which could certainly spark a correction downward. So the stock market could go either way – I just don’t expect markets to be flat.

One last thing I thought was interesting… There are a number of momentum strategy based ETFs. The largest is MTUM, which started in 2013 and has $10.6 billion in assets. Since inception, it has typically beaten the S&P handily without overshooting to the downside on market corrections. I really think momentum investing and chart analysis are going to get more popular than ever in future years, which will ironically make them work even better. The idea is you hold stocks hitting highs and dump them when they turn so that others look more bullish. If a lot of money does this, we should expect stocks to push their up-trends even higer and their down-trends even lower, increasing volatility and driving fundamental analysts bonkers.

Ill end on that note. Have a pleasant evening.

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Lessons from a beginning technical analyst

I’ve come a long way since my beginning foray into technical analysis.  Right now I’m up about $1,500 on all my options trades to date, but it’s important to know whether it’s luck or whether I’m onto something.  I spent the last few hours analyzing over all of my trades and thinking about my evolving strategies, and here’s what I’ve come up with…

  1. Trading is very emotionally driven – there is no way around that.  Everyone has their own gut feelings on when to buy and sell.  This has two implications:
    •  Having a strategy with set guideposts is important.  This helps you learn to stay patient when you would otherwise jump, so that you aren’t building up trading costs for nothing.  Example:  I bought puts in LYFT on Friday Aug 9.  The stock went down a bunch on Monday, Aug 12 and I got overexcited and sold them for a lousy $43 gain after trading costs.  I bought puts again on 8/16 because I still ultimately wanted that negative exposure.
    •  Don’t work against your emotions if you can help it.  Everyone will be pulled in their own ways … some people like me tend to take profits early, others wait too long, and most people tend to ride losers too long.  As you record and evaluate your trades you can begin to see what strategies are actually working for you based on your own reactions, and gear toward those.  Some people trade intra-day, others trade in 2 week timeframes (it looks like I’m around there now), and some tend to trade with scales on days or months – or even just quarter to quarter.  The chart formations you’re looking for won’t necessarily be the same for each timeframe.
  2.  The  strategy I’m currently excited about is called “sector rotation”.  The basic idea is that I lay out a comparison chart of all 9 major market sectors and look at performance in the past week, past month, past 3 months, past 6 months, and past year.  Some sectors will be at the top of the chart for almost all of these periods – that means institutional money is flowing into the sector.  These are where you pick your bullish plays.  Likewise, other sectors will nearly always be at the bottom and that is where you pick your bearish plays.  The magic here is that I’ve found my bullish plays staying roughly flat on big down days in the market while jumping higher on the up days, and vice versa for my bearish plays.  This means I tend to make money on any big market move.  Also, I like to have both bullish and bearish plays in mind so that I can get more bullish on a big down day and more bearish on a big up day.  Last Friday, the S&P went down 2.6%.  I sold a put in NFLX (cash-burning tech) and bought calls in ETR (utility), ending the day with 3 long plays and 2 short plays.

Now lets look at some charts…

My first options trade recorded here was one I wrote a blog post about in January.  I purchased some June puts in TOL figuring that following the government shutdown we would have 2 months of negative housing data driving the stock lower.  Here’s the result:

IMG_20190825_150526905

Since that initial purchase, I read a lot about technical analysis, went through all the lessons on stockcharts.com, and now I can easily see that I foolishly bet negatively on an obvious consolidation wedge in an uptrend.  The stock never even got close to a $32 strike price during that timeframe.

My second trade was based on a very compelling bullish call from a technical analyst on Walmart.  I remember he underlined the recent rising bottoms noting that the bulls weren’t even waiting to hit the lower trendline before jumping in, and it was just about to test and break through a significant near-term support level.

IMG_20190825_151545517

As you can imagine, this result got me a lot more interested in the potential for technical analysis.  I remember feeling that I was selling a bit on the early side, but wanting to change that loss from the last trade into an overall gain  … something that everyone feels and only the seasoned pros can build up the conviction to control.  One more thing I should say on this … the technical analyst called for a test around the $115 level once resistance was breached – that’s why I bought the calls at a 115 level, where they happened to be cheap.  I have more to learn before I can target a price level like that.

I’m only going to put in 1 more of these charts, though I printed out and analyzed 11 total.  Here’s a particularly interesting one:

sunrun

I think this shows some of where luck comes into play.  I heard a bullish thesis on SunRun and figured it was a good bet – followed my initial tendencies of selling on a quick gain, and straight up got lucky with the timing.  After reviewing this one, I looked at my early sell in Walmart in a different light – particularly since that big win was on calls at $115 and the stock never really passed the $115 level.

For all my trades, here’s a quick summary:

chart

My current take on this…

I feel comfortable with a risk around $200-$400 per play.  More than that is too much for me right now.

If a stock moves significantly my way over a timeframe of two weeks or less, I’m inclined to take profits.  I don’t see reason for changing that at this time.

It’s very possible that I’m just benefitting from a recent rise in volatility.  I’m totally fine with this … before a market peak there is often increased volatility.  I really don’t feel comfortable sitting with large long exposure an anything but gold related stocks right now – the threat of a significant correction is just too high.  Note this doesn’t mean I think a crash is imminent, I just think it’s possible and if it does happen it will be as steep as it was between October and December of 2018.

Much of my portfolio has been tied to gold for a few years now.  My current approach with technical analysis has me thinking about timing.  I heard an investor say that silver is like a risk-on play for precious metals.  I think he’s right … at least the last time around, the big peak and drop for silver happened 4 months prior to the gold peak.  I’m going to sit long gold until silver shows a similar spike and drop, then I’ll probably sell off.

After that, I’ll probably do a strengthening sectors approach, and purchase longs only in sectors that are rising with a rebalance every few months.  I haven’t worked out all of the details yet … I’m counting on learning more before then.

I hope you enjoyed this and that it helps build your confidence in trading.  The abundant professional literature can give the illusion that the market experts are way beyond your reach.  Here you can compare your thinking with some real life lessons of an early stage amateur.

 

 

 

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A great time for charting

Intro:

I’ve been delving a lot into theories about technical analysis and such, while dipping my toes in using options. Simply put, I’ve been making microbets (around $200-$400 each) and selling them off after a move (could be as low as a $100 gain or as high as $950, with most falling in the $200-$300 range). As of now I’ve got 26 trades with a cumulative profit just under $1,000. My first options trade was a big loser bought in January (-$900) and my second a big winner bought in May (+$950). I went for lower stakes after those to get more experience and build a bit of a method or strategy.

Why charting?:

Fundamental analysis attempts to calculate the underlying value of an asset and make purchases accordingly. This sounds great in theory, but after years of worldwide QE/asset purchases and low to negative interest rates I can’t imagine a process of price discovery actually playing out.

Add some history – I’ve heard plenty of stories of people shorting tech too early before the 2000 crash or shorting homebuilders and banks too early in the 2008-9 crash. A trader axiom I liked: being early is equivalent to being wrong.

Technical analysis focuses on money flows. No matter what part of the cycle we’re in, money is moving into and out of asset classes and values adjust accordingly. This tells you in turn when is a good time to bet, not just which direction.

Technical analysis itself is more of an art than a science … the market always changes so a trend will work until it stops. That being said, I think the best way to explain some of the lessons I learned is through snippets, which I’ll number and explain.

1. Don’t bet a percentage of your total – stick with roughly fixed amounts for a given time frame.

Technical analysis is about placing bets with an edge. Consider an exercise – you have a 50-50 shot at winning, but you win 60% or lose 50%. You bet $100 win and bet $160 then lose at have $80. The other way $100 loses to $50 then wins to $80. Either way you’re losing despite your edge. Now imagine you have $100 but you do 10 bets of $10 each. 5 winners get you $16 each for a $30 total gain while 5 losers get you $5 each for a $25 loss. You win $5 on average.

2. Don’t bet too much.

Chance happens in streaks. You can win 10 in a row or lose 10 in a row. You don’t want a losing streak to do outsized damage. In addition, betting too high gets your emotions worked up so that you have trouble making rational decisions on the play.

3. Keep a journal of what you purchase, when, why, why you sold it, and what you gained. The idea is to not only learn how the market works but to learn how your trading style works. Lately I’ve been putting limit sell orders in all my options the day after purchasing them, so that if it goes up enough it sells automatically. I adjust these targets based on market conditions. With a day job I can’t watch the market for the perfect moment, and it helps me stay calm instead of thinking “it jumped, quick, take profits” – which is something I’m prone to do. It’s not about finding the perfect method but what works for you, and adjusting it when it stops working.

4. Always remember to check for sector rotations.

There are 9 major stock market sectors with SPDR ETFs tracking them. I like to compare them all over 1 week, 1 month, 3 months, 6 months, and 1 year – writing down the top and bottom performers of each. Scan this and you can see when institutional money is rotating out of one sector and into another. Be bullish where money is going and bearish where it is leaving, simple as that. This helps you to build a market neutral portfolio so that whether the overall market spikes or plummets you can win on the move.

5. The trend is your friend.

Chances of a trend continuing are generally much higher than chances of it reversing. This is for good reason for this: most stocks are moved primarily by large players such as institutional investors or corporate buybacks. These large players don’t buy or sell all at once because they don’t want the market to spike when they’re trying to accumulate or plummet when they’re trying to divest. As such, they tend to buy on weekly schedules over a period of months.

Knowing this, if you want to bet against a sector, you can compare some of the major stocks and pick the ones that have been performing the weakest. Money has been flowing out of these, and your bet is simply that it will continue through another down leg. Vise versa for the bullish plays.

Last notes:

The markets have had some wild weeks. No one’s sure if it’s going to spike next or plummet next, but there are a lot of catalysts for movement. Charting can help you create a strategy that will be safer either way.

Valuations of every type are insane right now. There is talk of recession on the horizon. Sounds like a good time to short, right? But consider a couple of things first:

1. Institutional investors HAVE to invest. If they sit on cash they’ll lose their jobs.

2. Central banks around the world are making sure that these investors have very few choices and most of them are terrible (low and negative interest rate policies). They are even intervening with direct asset purchases in many cases.

So a recession hits … how much can the overall market tank when the money has very few places to go? It’s anyone’s guess, but my bet is this phenomenon will make sector rotation extremely powerful as an analytical tool because money flowing out of tech high flyers looking for safety has to flow somewhere, and it often simply moves to sectors considered safer such as consumer staples and utilities. However, all the intervention can make the valuations can get so crazy that money rushes right back to growth at any cost fuelling the tech high flyers even higher.

In short, it’s hard to predict how markets will react to any situation, but simple analysis can show where money is currently moving. Institutional investors can’t change strategy on a dime, they do it over an extended period. Remembering this will make all the difference.

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Do office perks make sense? A look at tax rates on labor.

Direct taxes on labor shape a lot of relevant decisions on how best to reward employees. Large tax rates make non-cash benefits such as free lunches, free coffee and snacks in the break room, or paid vacation time more valuable in comparison to direct pay increases.

I’m going to dive into the the US tax system, specifically in my home state of California, to see what tax rates really are and how progressive they are. I’ll start with some charts, then explain my methodology and cite some sources.

The above chart shows marginal tax rates based on income level. The x-axis here is not scaled – the dollar amounts selected are those that affect the direct tax rate on income going forward. If it was a line graph, the lines would be horizontal with a discrete jump at each of the income levels shown. As you can see, the tax rates start at 19.8% and peak at 53.1%.

The line chart above shows the percentage of actual income taxed. Again it starts at 19.8% because that first dollar earned hits the basic payroll taxes (social security, medicare, unemployment insurance). It takes a while to ramp up because the federal and state income taxes are more progressive and start with zero rates (aka the standard deduction).

Methods:

The table above shows all of the different rates I calculated. The payroll tax rates tend to start at zero income and hit a dollar cap per employee. The standard deduction for a single taxpayer with no dependents is subtracted from both the state and federal returns. The reversion in marginal income tax rates hits when the FICA (Social security plus Medicare) tax rate drops to zero.

There are a number of notable simplifications I made here in order to make the chart simpler. Credits and deductions affecting special groups are ignored for example (EIC, child tax credits, education credits, dependents, etc). None of these affect payroll taxes, only federal and state. The bulk of these are itemized deductions for higher earners so they won’t effect decisions on rewarding young median workers anyway.

Thoughts:

My goal here is to get as close to a pure tax rate for labor as possible – meaning if an employer directly pays $50,000/year for your labor, how much of that do you get to keep. Payroll taxes are very much a part of this; whether they are hidden on the employers side of the ledger or visible on the employee’s side, they are still percentage based on what the employee actually makes.

For an employer, you can see that spending extra money to have little perks like free coffee or the occasional catered lunch can make a lot of sense. Not only do you get the business write off and bring people together, but you would also have to pay double that cost for that median worker to purchase that same item.

It was fun putting this together. I hope you find this interesting and thought provoking in your own way.

Sources:

Payroll taxes (the second one’s easier to read but both give the numbers):

https://www.edd.ca.gov/Payroll_Taxes/Rates_and_Withholding.htm

https://www.thebalancesmb.com/payroll-taxes-3193126

Federal tax brackets:

https://taxfoundation.org/2019-tax-brackets/

CA state tax brackets:

https://www.bankrate.com/finance/taxes/state-taxes-california.aspx

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Policy implications of Modern Monetary Theory

Modern Monetary Theory (MMT) is often thrown about like a political football, with the two sides painted as responsible cries to reduce the debt versus the big spending basic income and free college for all types who see free money within their grasp. In reality it is neither.

The national economy is often simplified on a dollar-and-cents basis as a debt and GDP. However, this simplification is inaccurate. The national economy is actually a collection of 327 million people, 240 million of working age, and their productions and interactions.

The key difference here is that these people will be in place and aging regardless of national policy. An austerity-driven effort to cut costs and repay debt functions by cutting jobs and excluding people from economic activity- which is cruel, wasteful, and misguided. When Greek austerity forced the young to leave the country and reduced their GDP by 25%, it actually made the debt problem worse.

The government needs to stop thinking of labor as a simple commodity that can be stored in the ground or pumped out like oil. Instead, labor is a resource that must be directed relentlessly toward the public good year after year – and if this labor is not used then it is wasted in a way much more damaging than spoiled fruit.

Key thoughts on MMT:

1. The money created by a central bank is not free, and where it is spent matters a great deal. Think of it as economic rebalancing when this policy is used. Though the money does come from elsewhere in the economy, most will agree that our economy is highly off balance.

2. We have a very low labor force participation rate of 62.8%. This hit an all time high a bit under 68% in the late 1990’s and never recovered from the drop in the Great Recession. Traditional economic theory tends to see this as structural unemployment which is a permanent fixture to be ignored. MMT says that structural unemployment is due to government policy and needs to be actively addressed.

3. There are obvious causes of structural unemployment that anyone can take to mind. Unfortunately this whole line of thinking is often brushed aside by moral judgments against people who are “unwilling to work.” Here are some causes of structural unemployment that can be addressed:

A. Employers heavily favor those with strong work histories. The longer a person is unemployed, the more this bias will stick. This creates a sub-class of unemployable people who are effectively locked out of the national economy.

B. Employers heavily disfavor criminal histories. Misdemeanors and Felonies make a worker seem more dangerous and risky, so a youthful mistake can easily lock a person into an unemployable sub-class.

C. The number of jobs available is limited and highly concentrated. This is because jobs flow around where money is being spent and private sector money is highly concentrated. Cities like San Francisco often struggle to fill $20/hr jobs because the earners have to live in their vehicles, while cities with ample housing have little money being spent and very few jobs.

4. A core principle of MMT is that government policy directly affects unemployment. Contractionary government policy (higher taxes, lower spending to pay off debt) aims to pull money from the private sector. Those who control this money aim to keep it while those depending on labor to earn their living are tossed aside. Result: high unemployment. The opposite extreme of highly expansionary government policy (Like the “Great Society” initiatives combined with Vietnam War spending), cause an excess of jobs and a cycle of wage inflation alternating with price inflation. Note that the resulting inflationary 70’s did not happen because of debt levels, but because of excess spending levels.

Final Thoughts:

I encourage everyone to think outside the box for a bit. Throw your labels and ideologies aside and think about the problems of the world today, specifically in the US. Does it make sense to care about the conditions of immigrants at the detention center only to throw their concerns aside once they enter the country? Does it make sense to morally condemn those who live in tent city poverty without providing them any path towards gainful employment?

As I jumped into in my previous article, right-to-work legislation bringing back a CCC type labor force makes a lot of sense. People could sign up, get room, board and a uniform, and go out towards infrastructure and environmental cleanup projects. The work would not be easy and the pay would not be high, but it could reverse some dangerous trends and foster national unity among those who feel discarded.

Also, and I hope others agree with me here, I see Social Security as an essential feature of the US system and not something for the budgetary chopping block. Means-test it, tax the payouts progressively, but make sure that we don’t re-create the miseries of leaving defenseless elderly to die in shameful poverty.

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Modern Monetary Theory explained

There is a lot of talk about MMT and it’s political ramifications, so I think it’s important to understand the basics. Like anything else, it is actually much simpler than it appears. Technical terms about how the government spends money before it covers the expense make what is essentially a revolving credit line with the federal reserve sound complex and throw you off the real questions.

Anyway, here’s my take on it.

1. A central bank is a branch of the government. This has certain ramifications including that governments will always be able to pay off debts held in their own currency.

2. Central banks have a monopoly on the supply of currency in the system. They can and do create money at will. Quantitative easing is a fancy term for increasing the supply of currency as seen by the size of the Federal Reserve’s balance sheet. Now the Fed is reducing the size of its balance sheet, sometimes referred to as quantitative tightening.

3. Governments create the ultimate demand for a currency in the form of tax liability. A newly minted currency has no direct value. The government needs to pay for services in that currency, so they create a demand for it by requiring tax payments.

4. Inflation can be managed by adjusting the supply and demand of the currency. This takes some explanation.

When the government spends money, it is initially sent from the central bank. This increases the size of the Fed’s balance sheet which increases the money supply. This increase is then offset by collecting taxes to pay back to the Federal Reserve and by selling debt securities to the private sector, which both reduce the size of the Fed’s balance sheet. That’s how normal operations work.

Increasing the supply of currency can be done by having the government spend more money. MMT lumps the central bank under the government label for simplicity in this regard. When the central bank purchases treasuries, bonds, stocks, etc., the overall monetary effect is the same as the US government raising federal salaries or building infrastructure.

Increasing the demand for currency is most simply done by raising taxes and fees. Simply put, raising taxes is deflationary and cutting taxes is inflationary.

Relative values of currencies are a bit more complex, but the forces here are powerful and worth mentioning. Raising interest rates tends to increase the value of a currency in two ways. First, it increases foreign investment demand for a currency (Banks have to hold government debt as top tier collateral, and earning 2.25% on a US Treasury can be preferable to a negatively yielding German bund). It also encourages reductions in private sector debt which reduces the money created by the fractional reserve banking system. The trade balance also effects foreign demand for currency, as purchases from a foreign country require an exchange for that country’s currency. This is a big part of the reason Japan was able to increase its money supply for decades without causing inflation.

5. Unemployment according to MMT is a bit more unique. According to the theory, taxes create unemployment by causing a demand for currency which must be met by working. Spending reduces unemployment by creating jobs allowing the currency to be earned. Simply put, the government controls the supply and demand for money, so it can always push towards “full employment” (meaning everyone looking for a job gets one) by spending more and it can always manage inflation by pulling money from the private sector both by raising taxes and selling debt securities.

The last point there has the politically charged words “tax and spend.” I urge you to keep focus on the theory and not let those words derail your train of thought. Consider how Keynesian economics is used to justify crazy government spending in recessions even though the theory itself calls for government austerity in good times which never happens. What the money is spent on, how it is spent, and where it comes from make an enormous difference and they are mainly political questions.

6. Right-to-work laws.

Now I will delve into politics by mentioning the biggest political suggestion by MMT economists. Right to work laws are not new. The French had them (for a few years at least) after the revolution in 1848. Franklin Roosevelt used agencies such as the CCC and TVA to directly increase employment. China today uses government-owned corporations to employ large numbers of people even if they operate at a financial loss. The point here – this idea isn’t new or unprecedented.

One of the main flaws that MMT proponents see in the current US system is that big recessions cause employment which pushes many people from the lower working class into tent city squalor. These tent city residents soon become unemployable as no one in the private sector will trust them to become good, reliable employees. The government could allow these people to come into an office, sign up for a job, then get room, board and a small paycheck for work they have available then these people would be able to return to private sector employment in the future. The work could involve infrastructure, environmental cleanup, or a number of other areas … think of what the CCC and TVA did.

Final note.

The whole MMT explanation of how the government spends and procures money (in that order) is mainly a debunking of the common reasons to push austerity. The government will not run out of money and go bankrupt. Hyperinflation is not just around the corner. On the other hand, common austerity measures of higher taxes combined with lower government spending does cause unemployment to rise, which can have devestating effects on both the economy and the political climate.

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