Notes From Underground: Whatever Happened to the Taylor Rule?

First off, I’d like to thank everyone who contributed to the Santa Mike/Covid relief at St. Vincent de Paul, a long-standing charity that gives every penny to those seeking help for hunger, clothing and medical assistance. Thanks to you, we have contributed more than $30,000 and for that Santa Mike is very grateful. As Mike keeps telling me, “Do you know how much $30,000 dollars of food is when bought in BULK?” This truly makes a difference for those struggling to get by in these extremely difficult times. SO THANK YOU ALL SO MUCH. Every donation matters and there are multiples because Peter at St. Vincent de Paul has procured some donors who are doing matches. That only makes NOTES FROM UNDERGROUND worth doing in even bigger ways.

***The weekend news keeps pointing to a flattening of the COVID CURVE, leading the equity markets to breath a sigh of some relief. Many commentators have noted that the stock markets are running far ahead of the real economy (we agree). There is much discussion about the potential for a deflationary feedback becoming ensconced not so much a potential of super-charged inflation.

The ever prescient Dr. Lacy Hunt maintains that if the lenders don’t lend and borrowers don’t borrow then all the liquidity fails to attain any velocity resulting in a stagnant outcome. As Dr. Hunt said many times in his recent letter: “Use of these reserves will depend, as they always have, on the bank lender reaching a deal with the bank borrower.”

In the podcast we recorded a few weeks ago, Dr. Hunt and I discussed this issue in depth citing the works of Minsky, Schumpeter and others, especially Dr. Hunt’s respect for the great Irving Fisher. Joseph Schumpeter chronicled the Great Depression in his essays noting the concept of PUSHING ON A STRING. It is easier to forestall a boom by raising interest rates to a level to slow borrowing but more difficult to ignite economic activity by lowering interest rates if entrepreneurs/business women fail to see an opportunity to generate profits greater than the cost of capital.

If all money is going to shore up firm and household balance sheets in a time of great stress then the velocity of money won’t ignite any inflation. This is the world we now face so the discussion is about deflation versus inflation because of all the liquidity being pumped into the economy, both domestic and foreign. It doesn’t matter whether it is deflation or inflation because the precious metals suggest that there is genuine concern about the credibility of the world’s major central banks.

The CNBC narrative is that Federal Reserve Chairman Jerome Powell is brilliant and a man of great action because the STOCK MARKETS have rallied in response to the FED. The DOLLAR is also a positive barometer for the FED because it’s still in rally mode. However, I disagree that this is a positive because if the FED‘s desired goal is the stability of the global financial system a strong dollar is a detriment. The extended foreign central bank swap lines reveal the FED is indeed concerned about the world’s need for DOLLARS to keep on meeting debt payments.

GOLD is the barometer of global concerns for all fiat currencies since the key store of value has made all-time highs against everything but the dollar. The strength of the U.S. currency continues to be a story of massive emerging market dollar-denominated debt coupled with collapsing commodity prices over the last eight weeks as the global economy grinds to a halt. Many say the DOLLAR isn’t an issue but I disagree because this is a financial crisis, not a trade dispute. The world needs a weaker dollar to aid its ability its debt payments denominated in the world’s reserve currency.

The discussion about the DOLLAR moved to twittersphere as Hugh Hendry and Raoul Pal voiced opinions (Hendry bearish/Pal Bullish). Powell ought to be paying attention for the FED should take a TRILLION DOLLARS and sell them against a basket of foreign currencies mimicking the Swiss National Bank. Diversify the FED balance sheet for a depreciating dollar outcome.

For NOTES FROM UNDERGROUND the issue has always been central bank credibility and for that outcome it is always 2+2=5 in the realm of political economy. The deflation argument is critical only in the way that fiscal and monetary policy responds to prevent it in a debt-burdened economic structure. The rest is commentary. Our efforts involve planning trades/investments in order to profit from the actions of the FED, ECB and BOJ.

***Lastly, a question for the peanut gallery: If the Taylor Rule was in effect where would interest rates be today? This is an effort to discuss theory in a real world environment.

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11 Responses to “Notes From Underground: Whatever Happened to the Taylor Rule?”

  1. Michael Temple Says:

    Lacy Hunt will “win” over the next several news, while you will probably win over the longer term.

    It is not just EM debtors bidding for dollars.
    Here in US, personal and corporate bankruptcies are rising and the destruction of those debts extinguishes dollars.

    A lot of the stimulus funds are more akin to sustainability than stimulus efforts.

    Commodity price action is reflective of deflation, not inflation, for now.

    King Dollar reigns supreme

  2. Michael Temple Says:

    Yes, Taylor Rules probably puts us at huge negative interest rates, probably near to -250bp given the additional QE

    Meant to say that Mr Hunt will win over the next several months, not news

    Typo. Sorry.

    UST yields will continue to grind higher

  3. asherz Says:

    Yra- All the trillions created by the Fed has had little effect on GDP. The post- Great Recession period was followed by the weakest recovery since World War ll. Where did the funds go? Asset inflation- stocks, bonds real estate, art, etc. Little went into capital spending, infrastructure and investments that created economic growth.

    Instead stock buybacks made corporate managements look forward to a very comfortable retirement. John Maynard Keynes in his 1930s “pushing on a string” had little of the abundant liquidity going into 20-teens job creation.

    Yra what would the Fed do with a trillion dollars of foreign currencies? Swiss National Bank reported a $50 billion profit in 2019 based on dollar investments in Apple, Microsoft and Amazon. (What will they report in the next bear market)? Buy European stocks or Japanese real estate or Italian ECB backed bonds?

    The dollar will weaken when the supply of dollars will exceed the EM dollar debt demand. And that will happen as US is heading to towards 150% plus of its GDP which will happen in the next few years.

  4. Michael Temple Says:


    I’m with you. The fact that UST 10 yr yields are still 65ish bp with S&P near 2900 shows that the bond market ain’t buying what stocks are selling.

    Not sure it takes as long as you outline for USD to capitulate.

    I believe a move towards DXY 105 sets in motion some of what Yra believe will take place to soften the USD.

    But, for now, advantage USD.

    Remarkably, gold will do just fine

  5. Says:

    Gosh, Ira. Thank you so much for your overthink and your hyperthink; And the perspectives you bring to us constantly! Wayne



  6. kevinwaspi Says:

    Remember, John Taylor laid out his ‘rule’ in the 1993 work, “Discretion Versus Policy Rules in Practice.” As the title implies, discretion is the better part of (you fill in the blank).
    In his concluding remarks, Taylor said of his ‘rule’, “This paper has endeavored to study the role of policy rules in a world where
    simple, algebraic formulations of such rules cannot and should not be mechanically followed by policymakers.”
    Even John knew that 2 + 2 = 5 in Central Bank Land.

  7. David Richards Says:

    Michael, Yra, et al…

    I will be ornery and postulate that yeah, it’s “King Dollar” but actually “Aussie King Dollar”, up 18.3% against USD lately and in a technical breakout. Numerous other currencies are up double-digits as well.

    Currency weakness is largely a Latin and European thing. Interesting that some commodity FX are strong even as commodities languish.

    It’s most appropriately “King Franc” or “King Yen”, as USDJPY has collapsed from 360 to 106 in fifty years, whilst USDCHF has fallen from 4.3 to below parity today. Strong dollar, my arse. Mr Mnuchin, who’s the real currency manipulator?

    Raoul Pal has been a USD perma-bull since starting Real Vision, a great market call he made in 2014, but USD peaked in 2016 and is well short of that level today in most currencies, even Euro.

    Raoul Pal’s market advisory partner, Julian Brigden, publicly flipped Bearish USD a few weeks ago, particularly against non-Euro currencies. Major swing-high and double-top in USD mid-March, into a secular USD bear market now.

    So two misleading US-centric narratives are: 1) strong dollar and 2) global dollar shortage.

    The biggest dollar shortage is actually in the US, which is why the Fed is funding the spendthrift US gov’t, that has nationalized the US credit market. Outside US, many are aware that China had a nett dollar surplus again since she began paying for Russian and Middle East oil in yuan instead of dollars (per Luke Gromen , another secular USD bear and gold bull).

    The real monetary shortage is in physical gold, because it’s difficult to obtain physical gold with dollars, but very easy to obtain dollars with gold.

    • Michael Temple Says:

      Yes, nice bounce back for AUD and even CAD.

      On the other hand, UST yields remain stubbornly low as though bonds aren’t buying the song and dance of stocks.

      Stock market is back to a valuation of 135% of GDP, which is extraordinary in the face of a GDP that is likely going to be lower by year end.

      Nor have we heard much from such icons of Wall Street such as Buffet and Icahn crowing about what great investments they have recently made (Buffet was not shy in 2009 when he bought all his wonderful convertible stakes in Goldman, GE etc etc)

      My point? As Risk On has set back into markets for the past month, USD overall hasn’t much rolled over.

      So, while individual charts such as AUD do look terrific, their beauty is just a one-month affair, so far.

      If stocks are due for a turn back down as the economy DOES Reopen (buy the rumor sell the fact) to less than glorious conditions, I think USD strength may pick up again.

      Either way, I do agree that gold is in a bull market and in a bull market, all news is interpreted bullishly.

  8. Ronald Ferrill Says:

    First, thanks to you for supporting the charity and alerting us to it. I’ve known and donated to St. Vincent DePaul since I was a kid in Chicago, and as I moved about (18 times to “permanent” addresses). Makes me think of Paul (Saul)…
    You mention the COVID CURVE. It’s been a hoax from the beginning and my wife and I said so in February as the media grabbed hold and started using it for ratings (read, advertising revenue) and political disruption.
    Since my childhood I’ve been a reasoned skeptic, Public education and personal reading of the Great Books and Bible will do that – public education being the comedic yet boring and life-sapping foil of great readings.
    First, I looked up Flu records. One example is enough for me, though I looked at many. In the 2017-2018 flu season, the U.S. had around 35 Million cases and 60,000 deaths; in the same season, China (the commies version) had over 500 Million cases and 800,000 deaths. Where was the economic shutdown then? Next I asked who and what is to gain? Aha! Ambulance Chasers!! Money! Of course. Politically, Trump was immediately on the defensive. Since he did not drain the swamp, he was left with swamp dwelling medical bureaucrats to advise him. They love worst case (greater than 3 standard deviations) scenarios to throw out for self-aggrandizement and the media. This all played very well into a game plan for the demoncrats. Then all state and local nomenclatura jumped on board, even though they had no reasonable volume of data to support an economic shut-down.
    My wife has two Masters in healthcare and focused on acute elderly rehab, home health and education. I’m just a mathematician, engineer and computer scientist who wrote modelling projects for defense department. and passed the first couple of actuarial exams before becoming an investment “executive”, before trying to save American Manufacturing.
    COVID-19 Shutdown is an economic disaster AND a HOAX.

    Naturally, as an investor I’ve lost a great deal of wealth in the past 2 months, but also was somewhat prepared, having one Tranche in short term treasuries and selling some high gainers in late December.

    I am tempted to load up on equities of Petroleum sensitive companies, have decided against Boeing (maybe options), am short long term treasuries, long variable loans.

    I believed in the TAYLOR Curve – What do I do now?

    Good luck and health to all. Cover your cough, cover your sneeze, wash your hands often and don’t be touching your face or the orifices around it. That is why my wife and I are out and about constantly pissing off the true believers.

    MAD Magazine would do one of their old parodies using “I’m a Believer” for both sides of this: I’m a Denier! We’re all Primates (Monkees)….

  9. The Bigman Says:

    Speaking of banks not lending, I spoke with a good friend who is a real estate broker. He told me that there is now only one lender in California making jumbo mortgage loans. Further, for conventional loans, banks are now requiring 20% down (over 100k in San Diego) and 700 credit score. This eliminates most first time buyers. Looks like my escape from California is on hold
    The destruction of capital from stock buy backs (see Boeing IBM etc)and malinvestment(see Solyndra) fostered by low interest rates are the chickens (no offense Chicken) coming home to roost. We saw no inflation in the last decade due to almost no barrier to market entry as the cost of capital was almost zero. So goods and services out stripped all the money creation(as I noted much was burned on the bonfires of capital destruction) But now demand has been severely blunted far more so than supply(see oil- I bought 1000 barrels for $20 last week) so again I do not see inflation. I agree with Yra the increase in gold is due to the lack of trust in our highly leveraged currencies. Most people sense that you can’t spend 4 trillion dollars that you don’t have without some problems FWIW

  10. Michael Temple Says:

    Strong USTs and strong USD

    Big man….Don’t be so quick to say demand is falling more than supply.

    Stressed and breaking supply chains are already producing idiosyncratic price increases in many channels and this is while demand has been reduced.

    As for the way forward, also I am not sure that the latest QE will see dollars simply circulate back into financial assets

    Corporate stock buybacks are now a big No No.

    And if we are about to see onshoring Of supply chains, coupled with the rejection of lean and mean “just in time” inventories, corporations may actually spend $$ on capes/PPE and higher labor wages which would increase monetary velocity, unlike in the original post Lehman QE

    But, for now, stronger USD and bonds

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