Larry Kudlow/Mike Pence/Steve Mnuchin
1600 Pennsylvania Avenue NW
Washington DC 20500

Re: Mitigating economic effects of CoVID19


08/28/2020

Dear Mr. Kudlow:

It was interesting to watch your interview with Margaret Hoover on PBS' Firing Line. She is a very sharp person, and challenged you about implementing MMT with the PPP payments and the apparent incongruence with your previous positions. I was surprised that you did not respond that at least a part of it was a "purchase of cooperation" with coronavirus "social-distancing" recommendations rather than victim support. Understandably there are some serious political correctness traps about directly saying something like this, but even Alameda county health officials in the SF Bay area are now comfortable saying it. I think it was very successful until the George Floyd incident, at least outside New York state; and the United States managed to avoid scenes like we saw in China - where people were welded shut into their homes - or were falling dead in the streets. Just the promise of financial compensation helped make the implementation of self quarantine nearly instantaneous. And the strategy got copied all over the world.

If you want to paint an interesting analogy picture of your work, here is one I like! I dont know exactly what happened internally, but the Breitbart article by Carney on March 9th proposing the basic elements of the PPP plan was like attaching one end of a bungee cord to the American people/economy as they prepared to jump off a bridge (which California and SF Bay Area counties started doing with "stay at home orders" on March 16th). Getting Congress to pass PPP was like securing the other end just before it also was dragged off. The market has now almost bounced back up to the bridge, and the President is urging the people to grab on again by reopening as soon as possible. Chaos!! Excitement!! Bravo!!!!

Continuing the analogy, it is likely they will not grab on, and we will have to figure out how to retrieve them when eventually the bouncing around stops.

Of course we want life to resume, and the economy restarted. This is true whether or not we have a vaccine for the virus. The question is how we do that with the virus still there and still capable of causing a lot of death. Also, we want to know how we recover the debt that we are incurring.

We now know a lot more about the virus. Draconian "one size fits all" steps made sense when we still knew very little about the virus. For exactly the same reasons that we want to avoid a centrally planned economy, we want to avoid a detailed centrally directed CDC health plan - there is no way the CDC (or Dr. Birx - may God bless her soul) can take into account all the various situations people find themselves in. Trump, and all of you in his administration, did make most everything a "recommendation" instead of an "order" - and let our governors and local health officials (rightly or wrongly) push it differently in their jurisdictions. Unfortunately Democratic politics have also caused unnecessary fear, making return to normalcy difficult. Normal human drives to "live" (food, shelter, but also pair formation in young adults) will eventually overcome fear and even defy authority to bust quarantine; it would help us to find a way to facilitate the consummation of these drives rather than to frustrate them.

I suppose it is politically and/or practically infeasible to have a strategy of encouraging CoVID to spread among young people while protecting at-risk people ensuring widespread pre-existing "herd" immunity when winter comes. To make this work, we would need to find a way to separate them into semi-isolated communities (like college campuses/basic training/service corps) where they can satisfy their social drives safely by freely interacting amongst mostly themselves. (Sometimes I think this might already be the unspoken policy.)

A danger I note is that people have been using the extra cash from PPP to save and pay off debt (possibly because credit card companies are reducing credit limits). To prevent that bungee cord from breaking we will need to persuade the credit card industry to start lending to them again.

What we really need before cold weather (the election?) is a clear call to all businesses (and schools) to "look for ways to allow people to get closer together while still staying safe, especially indoors". This is a numbers game, "closer and more indoors" economically equates to more profitable businesses, medically to more contagion. We need to break the anti-correlation. We need to explain that we realize individual business situations are very different, and so the CDC can't make specific recommendations. At the same time we should have directed local health authorities to be open to proposals, and to gear up to be able to analyze if proposed arrangements are equivalent to "staying 6ft apart while outside", or "6ft apart indoors in still but clean air", (i.e. maintain the same R as those situations). I believe the CDC has teams to vet proposals, so this part is already done. To help businesses design solutions, we should point out why indoors is tough today - reused air or indoor airflow with eddies larger than the interperson distance carry particles with live virus from one person to another. Large particles need to be filtered out, and particles small enough to pass thru the filters need to be subjected to sunlight or UV that kills the viruses on them. There is a minimum throw distance associated with coughing or full throated singing. Also point out the importance of not panicing when somebody breaks the rules or somebody tests positive. Emphasize having a plan for quick and safe continuation of business.

The directive to health authorities to be open is especially important for small, woman owned service businesses like salons - they usually feature high personal interaction as part of the service, and are most likely to be dismissed as "non-essential". For some, traceability and KYC (know your customer) rules, plus strict liability to ensure the necessary questions get asked may be part of the solution. Note that this group is a set of small business proprietors that have not mostly recovered in their support for this administration after the push to open up started. (And the heat wave here in California caused some of them to be defiant and flout the Governor's rule to only operate outdoors, and operate indoors regardless). I think this is OK if they accept the liability - clearly I am not in favor of the additional liability immunity in McConnell's proposed bill.

Then to set the tone we should provide example solutions that people have already come up with. This should be done regularly by somebody other than the CDC - maybe like Kayleigh - each example with the proviso that it needs to be verified as safe/good enough. For some concrete examples, 1) there was a 1940s technique developed for schools fighting a measles epidemic called "upper room UV" (discussed on a May 19th radio show on NPR) - where rooms with high ceilings (like gyms) had the entire space above people height illuminated with UV light that killed pathogens - effectively turning the indoor space into an outdoor like space; 2) some restaurants in Italy had a clear divider between people facing each other at a booth style tables; 3) hugging booths at some senior centers; 4) porn industry procedures for STDs and HIV.

Going beyond that, at some point we will have to shrink the Fed balance sheet and retrieve much of all the debt we incurred. Otherwise our children will have to pay it. Here are some arguments and ideas for you to think about and consider.

First I think we need to convince the Fed that it should consider "mild deflation", instead of "mild inflation" as the most perfect implementation of its charge to stabilize prices. Additionally, it should act to very publicly favor industry investment in labor over investment in capital to promote its goal of "full employment", whatever that may be.

I have some arguments from a layman's perspective that you could use. They were made earlier to Draghi, but there were other considerations driving him...

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First of all, from a layman's point of view, the postulate supporting "QE", i.e. that deflation is bad for the economy, is based on bad assumptions, and is the self-serving view of people who have a lot of non-cash assets, or have debt. As a layman, lower prices for food, clothing , and shelter (and gasoline) are an unalloyed plus. Most of us could care less about the price of stock, gold, or other such financial assets since we are unlikely to have much, and if there was a crash in their prices we might even cheer. Of course, we hear in the media that that would lead to mass layoffs, so indirectly we worry about those because we "trust" our media, at least to some extent. But some of what is posited in the media about our behaviour simply does not make sense, in fact seems like outright nonsense!

Consumers:

The primary assumption is that people with inflationary expectations, seeing that their money will be worth less in the future than it is worth at present will accelerate expenditures. This may be true if inflation (or deflation) is bad enough, or if the person making the spending decision is an accountant. Most ordinary people are not like that. First, with a small amount of inflation or deflation (like your 2% a year inflation target) people are not going change their timetable for purchases. Most expenditures come with their own built-in timetable. You can not eat everything you need for the next month today. Festivals and holidays dont move. Education of your children follows a set timetable. It would take something like a 10% change in price over the short time horizon most people have (a few months, maybe even a few days!) before they will even consider shifting the timing of their expenditures. That works out to inflation or deflation exceeding 40% per annum, i.e. a hyperinflationary or hyperdeflationary scenario. If you dont believe these numbers, just try this experiment - postulate that there is going to be a 10% step decrease in the cost of a good on a particular date, and see how long people are willing to postpone a purchase. Then try it with a 0.1 percent step - you will find that almost nobody will bother with postponing the purchase - not even a day. Another way of stating this argument is that most people have less discretion over timing than what is commonly assumed. Additionally, inherent in this hypothesis is the fact that inflation and deflation only timeshift consumption, and do not change the overall level long term. I see that you are already saying this - "QE" only time shifts consumption, if it does anything.

Savers:

Which brings us to an even bigger flaw in the postulate. Most people realize they will be unable to work when they get older, or some emergency could happen, and that they have to provide for their future. They cannot put aside the assets they want to have - food spoils, they cannot afford to buy their shelter outright, and they do not even know what they will need in the future. Tangible assets like gold are costly to liquidate when traded in small quantities. So they have to save money - cash, or promises denominated in cash. The prospect of mild inflation over a long period is going to cause them to REDUCE(!!) their expenditures (to the extent necessary to provide the additional funds they anticipate they will need when they retire). Conversely, the prospect of long term deflation will cause them to INCREASE their consumption NOW, as they will expect they will need to set aside less for that time. I think we have a prime example of this effect in the current scenario - the US economy started improving only once it became possible to think that the Fed was actually going to unwind its balance sheet expansion. Another example - Greeks, not trusting their money in the past, tended to accumulate property, so they are property rich and cash poor; while Germans are cash rich and property poor, tending to live in leased apartments rather than in owned condos, because they trusted their money and the stewards of their financial system. Taking all this further, 30 to 50 years is the time needed to carry over value earned during a person's productive years into the time he or she is living off past earnings, so this is a long term change in spending behaviour. Given that a change in value greater than 10% is meaningful, the implication is that real perceived inflation should not exceed a number like 20 to 30 basis points - i.e. 0.2-0.3 rather than 2-3 percent per annum - otherwise the compensatory reaction of the populace is going to result in behaviour that is the exact opposite of the commonly postulated behaviour, until you get to hyperinflationary (or hyperdeflationary) conditions.

Investors:

We then come to the worst part of the postulate. The notion that price deflation discourages economic activity or investment is complete bunk. We have to be careful about measuring things using just one commodity (even money) - e.g. retail sales were down last year in the US - but only because the price of gasoline was low. Even if you just took gasoline sales in December - they were down 6.5% in dollar terms according to the Wall Street Journal, but the price of gasoline was down 25%, so actual consumption in gallons must have been vastly greater! Walking the malls mid-January, the modern equivalent of the miniskirt - the yoga pant - was in fashion. Instead of seeing shoppers entering with bags returning unwanted presents, I saw them looking content and leaving with small purchases. They had money left over after the Christmas season, and they spent it. An even better example is the semiconductor industry, which suffered tremendous unit price deflation between the 70s and 90s, but is one of the greatest examples of economic success and growth. The price deflation encouraged increasing unit volume to the point where total return increased so much that there was wild appreciation of stock and total economic activity.

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Obviously, Powell is under a lot of pressure to support a very, very large debtor - the US Government. So he can not accept the above argument to raise interest rates, or even accept deflation, unless we can show him how to take care of this stakeholder.

I think there is a way to do this that can work.

There is a old concept called seignorage that a government can use to generate cash without incurring the obligation to pay interest. Use in the US context means the US Congress will have to approve the minting of the "coin". I don't think we are limited to metal coin, any token that can be limited in its availability, is resistant to hoarding of large amounts, and is not duplicatable by others can be treated as the coin for our purposes. The coin needs to be DIFFICULT to store in bulk and to transport. An example such coin I like to think about is a small bit of plutonium embedded in synthetic diamond. Put enough of it together, and you have an active nuclear reactor that kills anybody in the vicinity. Obviously ridiculous, but a coin with enough weight can also serve, and simultaneously discourage hoarding. So lets see how this will work.

The US debt is approximately 26T. We have approximately 330M people. That is a debt of about 80K per person. To provide for 30 years of retirement at current rates a person needs to accumulate housing costs of about $360000 (1000x12x30), and maintenance costs of about $312000 (200x52x30). There are some other costs that need to be covered, like health care. But the point is, a person needs to accumulate way more than 80K by the time he or she retires. If people can be persuaded to physically accumulate the "coin" to cover retirement, we have more than enough demand for "coin" to cover the seignorage. The accumulation process gives us a way to slowly transition our financial system into a government debt free system.

So we issue two "coin". One comes with a promise to provide one month's worth of housing. The other comes with a promise to provide one week's worth of food and energy. We expect each person to accumulate 360 of the former and 2000 of the latter. The country as a whole needs to have the required housing and food/energy supply, so the government spends the "coin" acquiring the infrastructure. People acquire the "coin" helping to build it, and use the accumulated coin to meet their housing and food/energy needs.

The 360 housing coins should weigh about one person - and so should the 2000 maintenance coins - i.e. ~1/2 pound per "housing" coin and ~1/10 pound (oz?) per "maintenance" coin. This kind of weight would make it possible for a person to physically accumulate and transport his/her retirement needs if they choose to do so. But it makes hoarding of larger amounts costly, and the weight and bulk make the coins effectively radioactive for large organizations like banks.

Bank "reserves" should be the amount of coin on deposit with them. Coin deposits should be guaranteed to be retrievable, any other deposit has no guarantee. The banks will need to store them someplace; the weight and size will make this costly. With adequate safeguards and laws, the banks may be interested in leaving the coin with the person who "deposited" it! Banks then perform their normal functions of speeding up transfers, multiplication of the money supply via reserve ratios set by the Fed, and aggregation of small amounts into large pools where risk is shared across multiple investments. The "maintenance" coin should be the fundamental money unit, since it is used with the highest frequency. Banks can also offer to do transactions with book entry fractional amounts, and the minimum fraction (set by the Fed) becomes the smallest unit of money. The exchange rate between the "housing" coin and the "maintenance" coin is set by the market.

One issue with tying the unit of money to fundamental needs is that it is politically impossible to deny people basic support if they are destitute. So the guarantee associated with the coin needs to provide a quality of housing or maintenance that is comfortable (more than basic), and the minimal support offered by "welfare" (if any) should be significantly less.

The total market capitalization of the US stock market is approximately 35T. Another thing we could do is convince asset holders sitting on large capital gains to liquidate their positions, recognize their gains, and pay the capital gains tax now. Public discussion of credible proposals to raise capital gains taxes (e.g. to ordinary income rates) in the future will cause many to cash out. The trick would be to get them to reinvest without a market crash.

I hope this was a useful set of ideas, and that with them you all are able to rescue our economy like you did temporarily with PPP.

Sincerely,

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