Deflation Talk

By John Mauldin 


If you could ask the world’s top central bankers what really terrifies them, I think the honest answer would usually be “deflation.” 

It is their greatest nightmare. 

They think a little inflation is good (thus the 2%+ target), and they’re confident they can subdue it if necessary. 

Deflation is a bigger problem.

Let’s note, however, that these aren’t either/or conditions. 

They have degrees of severity. Indeed, the last four decades we’ve seen disinflation—a mild form of deflation—in many segments of the economy. 

Compared to that, even relatively mild inflation looks quite concerning. And many smart people are concerned, as I described in last week’s review of SIC inflation talk.

Today we’ll consider the other side of the SIC inflation/deflation argument. 

And when I say “argument,” I don’t mean the harsh kind. 

One of the SIC’s nicest features is the way people with vastly different viewpoints engage civilly and thoughtfully. 

Unlike “debates” that generate more heat than light, we sincerely look for the best answers—a refreshing rarity in this divisive era. 

It’s All Just Math

Dr. Lacy Hunt of Hoisington Management is a perennial SIC favorite, and for good reason. 

He’s been consistently right about inflation (little or none), interest rates (flat or down), and Treasury bonds (bullish) for decades. 

He built that track record by simply standing his ground. 

To Lacy, it’s all just math: The equations have specific answers and thus do his investment choices. 

That may sound easy but it takes a lot of courage.

In Lacy’s view, today’s core problem is that excess debt suppresses economic growth, without which demand can’t rise enough to generate inflation or push up interest rates over the medium term. 

This is a structural problem, which at this point we really can’t fix.



Source: Hoisington Management


Going back further, Lacy showed the US has experienced five major debt bubbles in the last two centuries, all of which led not to inflation, but to disinflation or deflation.


Source: Hoisington Management


Lacy also pointed out that inflation is actually a lagging indicator. It doesn’t usually turn higher until well into a recovery phase


Source: Hoisington Management


This runs counter to today’s popular narrative (discussed last week), which says to expect strong recovery and rising inflation at the same time. Lacy explained why that doesn’t happen.

The typical lag between the start of a recession and the low point of inflation is almost 15 quarters and even when the lags are shorter, only six to seven quarters, in those particular two cases, the inflation rate was still near its low, two and three and four years later. 

And there's a good reason why inflation's a lagging indicator

If you go into a recovery or attempt to recover, and the inflation rate takes off, that will truncate the recovery. 

You'll have a wider trade deficit, inflation will push up interest rates and that will work against the recovery. 

And since prices rise faster than wages, you reduce real income. 

In other words, to have a major acceleration in inflation means that the expansion will not hold.

Lacy also explained why he isn’t worried about the increased money supply. It gets back to his point on debt. 

The amount of money is less important than the speed with which it circulates, or “velocity,” which is at the lowest level ever.


Source: Hoisington Management


At least 10 years ago Lacy and I were talking about what it would take to get the velocity of money lower than during the Great Depression or post-World War II. 

We were both watching velocity slow significantly and I was curious as to when that would end.

Lacy explained at the SIC:

We have to take into account what's happening to the speed at which money turns over and the velocity of money hitting an all-time low. 

And what is causing velocity to decline is that we're taking on too much debt, it's triggering diminishing returns and non-linear relationship and this pulls the marginal revenue product of debt down and it also takes the banks out of the process and that pulls velocity lower.


Another problem, Lacy believes, is that debt reduces savings. 

His next chart takes some explaining. 

I’ll quote him right below it.


Source: Hoisington Management


The critical variable for the macro-economy is net national saving. 

And net national saving has three components. 

It has the gray shaded area which is the private sector; household incorporated; and then the government deficit which is the red line and the green line is the sum of the two Now, look at the little equation at the top of the page. 

This is one of the most important fundamental relationships in economics and it says (in effect—JM) "I, physical investment, must equal saving out of income."

If you do not have saving out of income, you cannot get sustained growth in investment. 

Without sustained growth in investment, the standard of living does not rise. 

Now, the deficit as a percent of national income, the red line, was over 14%. 

That took out the percentage peak during WWII 

The green line is the sum of the three and you'll notice it's just barely above zero. 

And if you look at the chart, which goes back to 1929, you'll see there's only two situations that are worse, during the 1930s and also during the late 2000s. 

We simply do not have the resources to fund ourselves and to obtain a higher standard of living, which means that the economy will falter as we go forward, inflation will move lower.


Lacy is the rare PhD-holding economist who doesn’t hedge. 

(President Truman once complained he wanted a one-handed economist.) 

He looks at this almost like physics: Gravity always wins. 

So when he says the economy will falter and inflation will move lower, he is confident in the same way astronomers are confident about planetary orbits. 

While in theory something could interfere, the odds are (astronomically) low

Lacy agrees we could see some transitory inflation this year. 

He doesn’t see it lasting long, and Fed policy doesn’t especially matter. 

We are beyond that point.

Here’s Lacy wrapping up.

If the Fed wants to raise interest rates, they can slow economic activity down. 

However, when economies become extremely over-indebted and debt levels are rising very dramatically, the velocity of money falls. 

And that keeps shifting the aggregate demand curve inward. 

The fact of the matter is there is no mechanism other than for a very limited period of time by which the inflation rate can go higher.

In other words, as long as excess debt is pushing velocity lower, aggregate demand will keep falling. 

Sustained, broad inflation is impossible under those conditions—though there could well be temporary inflation in certain segments.

I would love to tell you why Lacy is wrong. 

I can’t. 

Many have tried and he’s outlasted them all.

A Price Level Adjustment

Dave Rosenberg isn’t in the inflation camp, either, for some of the same reasons as Lacy Hunt and a few others, too. 

On the idea that rising commodity prices will drive inflation, Dave had two responses. 

First, commodities actually have no correlation with inflation. 

We have many examples of one rising without the other.


Source: Rosenberg Research


Dave thinks the present commodity gains are mainly speculative demand, driven by the pandemic money that is burning a hole in investor pockets. 

And to the extent there really is new commodity demand, it comes mainly from China, where the kind of growth that needs raw materials seems to be waning.

On wages, Dave says the growth we hear about must be anecdotal because it’s not yet evident in the data.


Source: Rosenberg Research


Nor does Dave expect to see much wage pressure, given the large number of workers still on the sidelines. 

Aside from the many officially unemployed, millions more are working part-time and would expand their hours if possible. 

Another 6–7 million left the labor force but say they want a job.


Source: Rosenberg Research


The number of available workers should grow considerably in the next few months as vaccinations make jobs safer, schools reopen, and enhanced unemployment benefits expire (which is already happening in many states)

That should, at the very least, cap aggregate wage pressure without even counting the many ways businesses have become more efficient and automated. 

Certain industries like restaurants and hotels are indeed seeing wage pressure, but Dave thinks it isn’t enough to affect the broader picture.

Finally, Dave pointed out that the CPI pressure we see right now is almost exclusively a US phenomenon. 

The rest of the world just isn’t feeling it.


Source: Rosenberg Research


This might be related to the US emerging from the pandemic faster than most others. 

But CPI elsewhere (the local versions of it, at least) is still well below ours even in places where COVID-19 had a smaller effect. 

The US is the world’s largest economy, but we don’t stand alone. 

It is hard to imagine a scenario where the US has significant inflation and the rest of the world doesn’t.

Dave is sticking to his guns on this. 

In his May 25 daily letter, he argued we are seeing a “price level adjustment,” not real inflation.

It seems as though, out of the blue, we have gone from talking about deflation to inflation. From depression to an economic boom. From the Bubonic Plague to the “Roaring Twenties…”

As for the inflation situation, what I come away with is that what we are seeing is a price-level adjustment coming out of the pandemic and the price data can easily be explained by an economy reopening in the face of several supply constraints. 

The Fed has made a great case and prepped the markets and the general public prior to the data as to why this is not a lasting supply-demand imbalance. 

This is not real inflation we are seeing; we are seeing tremendous distortions and disturbances in the data that are being skewed by the lingering effects of the pandemic and everything that has followed

And I have to say that the Fed has been masterful in laying this out; whether you want to agree with them or not is a different matter, but this is one of those times when I do.

If Dave is right that we’re just seeing “disturbances in the data,” it ought to clear up in the next few months, and certainly by year-end. 

I suspect he will rethink his position if CPI is still rising in December. 

But for now, his points are hard to dispute.

Cathie Wood on Deflation

The name Cathie Wood of ARKK fame typically makes you think of technology stocks, not macroeconomics. 

Yet she has serious macro chops, having studied under Art Laffer at USC and her first job was as an economist. 

At the SIC Cathie talked about the deflationary pressures she sees in her technology research. 

Let’s read from the transcript, with my editing (I really wish I could give you the whole powerful transcript).

Just one more thing on interest rates and inflation, I think we're going into a deflationary period after this supply chain related and base effect related bounce in inflation…

Today's inflation numbers, I'm sure to many people, were shocking. 

Just looking through it, it seemed very much supply chain oriented. 

Car rental, transportation costs, and so forth. 

We think that the core CPI inflation will stay in the 3% to 4% range for the next few months, and PPI inflation headline could be anywhere from 6% to 10% on a year-over-year basis.

But I think we've never seen such serious supply chain issues as we're seeing now. 

Think about it. 

A year ago, the economy effectively just shut down. 

During '08, '09, it was shutting down. 

It was a slow move into that cathartic moment. 

This was just cold turkey. 

Businesses cut off all orders, and what happened was the consumer saving rate soared to 34%, 35% and the consumer had very few places to spend. 

Goods. 

Goods were the spaces to spend, right? 

Durables and non-durables, especially for the home and so forth. 

Well, that's where they spent a disproportionate amount of their budget relative to normal.

Goods are only one-third of consumption in the GDP accounts. 

Services are two-thirds. 

What I think is going to happen now is businesses are scrambling like crazy to keep up with demand. 

They can't. 

They got way behind. 

They're… double and triple and quadruple ordering. 

That's the first thing. 

The consumer, yes, has been spending aggressively on goods, but probably is about to shift the mix back towards services, maybe disproportionately. 

I think we're going to end up with a massive inventory problem towards the end of this year or into next year. 

We see three sources of deflation on the horizon. 

The first is that one, and that's inventory-driven and very commodities-oriented.

The second is what we call good deflation. 

Good deflation is associated with technologically-enabled innovation. 

Wright's Law is really important to us. 

It says for every cumulative doubling in the number of units produced, costs associated with technologically-enabled innovation decline at a consistent percentage rate.

Huge deflationary forces that are going to increase access as prices come down, and unit growth therefore will explode in those areas. 

The bad deflation is the corollary to that, and that is, we believe as much as 50% of the companies in the S&P 500 are going to be disintermediated or disrupted by the five innovation platforms around which we have centered our research: DNA sequencing, robotics, energy storage, artificial intelligence, and blockchain technology. 

They are in harm's way, and they probably, because they are more mature, since the tech and telecom bust and the '08, '09 meltdown, they have basically complied with short-term-oriented investor demands. 

They want profits, they want them now. 

They want dividends, they want them now.

To do so, companies leveraged up. 

Now many of them are going to be in harm's way. 

In order to service debt, they'll have to cut prices. 

We see major deflationary forces evolving here. 

I know on a day where the CPI has gone up 0.8 and then 0.9 in core, many people might be looking at this and wondering. 

But this is what we do all day long. 

We know the good deflationary forces are in place, we know the bad deflationary forces are in place, and now we believe, given what we're seeing with inventories, double, triple ordering, that there's another deflationary bias that's being built into the system, but probably won't play out until later this year, next year.

To Cathie’s point, much of the recent inflation is coming from “goods inflation.” 

Here’s a chart from Sam Rines on the year-over-year core services and core goods inflation. 

Notice the steep rise in core goods.


Source: Avalon Advisors


The important takeaway here is the concept of year over year (YoY). 

Twelve months ago we were in a deflationary collapse, as Cathie noted. 

I think we will likely see “wage inflation” over the next 3 to 6 months. 

I personally think that’s good, since it will mostly be in the lower income tiers.

It’s reasonable to assume those wage increases will be “sticky.” 

But the balance will swing back to management as unemployment benefits diminish. 

They may be stuck with those past sticky wages (pardon the pun), but I doubt wages will keep rising. 

So a year from now, services and wage inflation may both return to levels more like the disinflation of the past few decades, because we are looking at year-over-year numbers and not five years over five years or whatever. 

It’s just the way we measure things. 

The Fed will declare victory and go home.

If that’s not what happens, the Fed will have to do more than think about thinking about rate increases, and actually do it. 

This has nearly always led to an eventual slowdown in the economy, and disinflation. 

Either way, we end up at the same place over time. 

The Fed should start the tapering process and then slowly raise rates, trying to get someplace that looks more like normal. 

Given the massive budget deficits Congress seems hell-bent on running, I am not certain how we get there. 

Trying to raise rates in this environment will be excessively volatile.

The Right Question on Deflation/Inflation Is When

So where does this leave us? 

Can we somehow reconcile these widely varying inflation forecasts? 

Maybe.

On the last day of the SIC we heard from William White, former Chief Economist at the Bank for International Settlements and holder of many other global economic honors. 

I call Bill my favorite central banker because he is one of the few who can actually speak clearly. 

He cuts through the jargon and makes complex ideas seem simple.

On inflation, Bill explained all these forecasts could actually be right. 

The key is to consider the sequence in which they will happen.

  • In the near term, we could well see significant inflationary pressure for the reasons outlined by Peter Boockvar, Jim Bianco, Louis Gave, and others…
  • But in the medium term that follows, the math Lacy Hunt describes will catch up, squelching inflation and maybe forcing deflation…
  • While in the long run, monetary excess and the need to liquidate debt could send inflation sharply higher, possibly to the point of hyperinflation.

That makes sense to me. 

I’m not as worried about hyperinflation as Bill is. 

However, if Treasury, Congress, and the Fed should somehow institute actual MMT (as opposed to QE) I would become hyper-worried, pardon the pun.

Of course, identifying the transition points between each phase will be critical, and likely difficult. 

But it’s an important reminder not to treat your inflation outlook like unchanging religious dogma. 

The world economy is a “complex adaptive system,” to use one of Bill White’s favorite phrases. 

Its behavior evolves as it reacts to new events.

So if someone asks, “Do you expect inflation?” maybe answer with a one-word question of your own: “When?”

New York, Florida? And a Book Recommendation

I will be in NYC mid-June and thinking about Florida and/or DC later this summer, as well as Maine. 

All of the latter to be determined. 

I look forward to seeing friends again.

As you all know, I am bullish on the future. 

And that is the point Marin Katusa—my go-to guy in the natural resource sector and a presenter at this year’s amazing Strategic Investment Conference—makes in his just-released book, The Rise of America

Marin provides the reader with a host of reasons to be optimistic, while detailing the unstoppable trends that will make individual investors wealthier. 

It’s a welcome counterpoint to today’s ubiquitous gloom-and-doom chatter, especially in the US.

And with that, I will hit the send button. I see more gym time in my life, and am finally starting to take creatine. 

Extensive research on its effectiveness and safety persuaded me to add it to my regimen. 

Have yourself a great week!

Your inflation first then deflation analyst,



John Mauldin
Co-Founder, Mauldin Economics

Swapping notes

Will going digital transform the yuan’s status at home and abroad?

Don’t count on it: the new yuan will be a lot like the old yuan


WITH A FEW taps on her phone, Lu Qingqing, a 24-year-old office worker, leapt into the monetary future. 

She was one of 50,000 people in the city of Shen­zhen selected late last year for a trial of China’s digital currency, officially called eCNY. 

She downloaded an app, received a gift of 200 yuan ($30) from the government and went shopping for books. 

The app’s display showed a traditional banknote and her balance, which ran down as she made purchases. 

“It felt like real money,” she says.

Legally, it is as real as hard cash. 

All the money in an eCNY app, offered by one of six commercial banks, is backed by an equivalent amount deposited at the People’s Bank of China. 

Just as the central bank issues and stands behind any paper yuan circulating in China, so does it guarantee eCNY. 

If, say, the commercial bank that made Ms Lu’s digital wallet went bust, her eCNY—linked to her personal-identity number—would be transferred to a new wallet.


Central banks worldwide are considering issuing digital versions of notes and coins. 

Although China will not be the first (that honour goes to the Bahamas), it is the most important launching ground. 

It is the world’s leader in mobile payments, processing about $67trn-worth of transactions last year, nearly 400 times more than in America (see chart 1). 

More than half a million people have already got their hands on eCNY, in a manner of speaking, in trials since last year. 

China’s central bank is studying how to spread it abroad. 

Niall Ferguson, a historian, has called on America to wake up to the peril of letting China “mint the money of the future”.

China’s digital currency was first conceived as a way to curb the dominance of the big mobile-money providers. 

Now three bold claims are being made about it: that it will dramatically enhance China’s surveillance capabilities; that it will allow the state to wield far more control over money; and that it will challenge the dollar for global prominence.

Within China, however, many economists and bankers are far less bullish. 

The design of the eCNY, and the very nature of China’s economic system, mean that each of these claims is unlikely to be realised soon. 

“The digital yuan is not magic, so we don’t expect magic from it,” says Gary Liu of the China Financial Reform Institute in Shanghai.

Start with the first claim, that digitisation offers unmatched surveillance abilities, letting the state track people’s spending in real time. 

It is not entirely wrong. 

But it is a limited gain for the central bank compared with its existing powers.

Most mobile payments today involve a bank card, tethered to users’ accounts on Alipay or WeChat. 

These must pass through NetsUnion, a central clearing platform. 

Similarly, any foreign-exchange transaction in China takes place on the China Foreign Exchange Trade System. 

In both cases regulators can see how people spend in real time. 

For mobile payments that do not touch the banking system, officials can demand a record and, says an industry insider, may soon require real-time reporting, too.

The upshot is that, even without eCNY, regulators have no real blind spots left, apart from old-fashioned cash. 

And so long as millions of older citizens do not much like paying for things with smartphones, the government will not phase out cash.

Centrally unplanned

A second bold claim about eCNY is that it will reshape monetary policy in China. 

According to this view, the central bank will, among other things, have more control over money, programming it to be used for specific purposes and at predefined times. 

This, however, both understates what the central bank can already do and overstates what the eCNY will let it do.

China already manages both the money supply and interest rates with different sectors in mind. 

Since 2015, for instance, it has created hundreds of billions of yuan for the construction of affordable housing. 

More recently it has tried to lower interest rates for small firms, giving cheaper funding to banks that provide such loans.


The eCNY, one might assume, will make this targeting more precise. 

But its design is such that its role will be far more circumscribed. 

The central bank will replace only a small portion of base money, known as M0, with eCNY, leaving the rest of the money supply undisturbed (see chart 2). 

It will distribute eCNY through a two-tiered system, issuing the currency to commercial banks, which in turn will make it available to the public. 

It will not pay interest on e­CNY. 

And it will probably place low ceilings on how much people can actually hold.

Granted, the central bank may in time expand the eCNY’s role. 

But the limitations exist for a reason. 

The government is wary of undermining the financial system. 

It does not want savers to switch out of bank deposits en masse into eCNY. 

That would make it harder for banks to fund themselves, thereby slowing lending growth. 

Moreover, few serious economists in Beijing like the idea of a 100% eCNY money supply, in which the government could directly control how banks lend. 

“We don’t want to go back to central planning. 

That would be a mistake,” says Yu Yongding, a former adviser to the central bank.

A different world

A final bold claim is that eCNY will catapult the yuan to global status. 

But that misunderstands why the yuan accounts for just 2% of international payments today, about the same as the Australian and Canadian dollars. 

When deciding which currencies to use, companies and investors around the world consider how easily they can make conversions to other currencies; how freely and widely they can invest them; and whether they trust the issuing countries’ legal systems. 

China’s insistence on maintaining far tighter capital controls than any other major economy, as well as deep-seated doubts about its one-party political system, blunt the yuan’s international appeal. 

The limiting factors are policy and politics, not technology.

Even the technological case for eCNY is far from clear-cut. 

When companies transfer money in and out of China, they already use currency in a digital format: electronic messages on the SWIFT payments network instruct banks to credit accounts in one country and debit them in another. 

What slows things down is complying with China’s capital controls and with international regulations such as those aimed at stopping money-laundering.

The eCNY will not eliminate such checks, and the Belgium-headquartered SWIFT system, which connects more than 11,000 financial institutions, is likely to remain the most efficient conduit for sharing payment information across borders. 

“Even in the long term, SWIFT will remain indispensable,” says Liu Dongmin of the Chinese Academy of Social Sciences.

The three more radical claims about it may not be realised, but will the eCNY at least fulfil authorities’ original aim, of giving the central bank a foothold in the digital-payments universe? 

Probably, but not a giant one. After the eCNY trial in Shenzhen, Ms Lu said that she would use it for some payments, but that Alipay and WeChat were far more convenient because of how they tie into much wider commercial and social-messaging networks. 

Mr Liu of the China Financial Reform Institute expects others to reach the same conclusion. 

In three years he predicts that eCNY will account for less than 5% of mobile payments.

Western governments and central bankers mulling digital currencies of their own may wonder if the outcome of the e­CNY experiment will contain any lessons for them. 

But China is unusual in so many ways—from its sheltered financial system and intricate capital controls to the size of its mobile payments—that its experience could well prove to be unique. 

Other countries might not, for instance, seek to design their digital currencies along the same lines. 

Yet the caution with which China’s authorities are proceeding with the eCNY, if nothing else, hints at how disruptive the technology, if unconstrained, could be.

Chile’s Constitutional Revolution

The 155 members of Chile’s new constitutional convention must cast aside everything they stand for in order to do their job well. A generation reared on direct participatory politics – whether via Twitter, on university campuses, or in the streets – now must build a representative democracy

Andrés Velasco


LONDON – A revolution is the overthrow of existing political arrangements. 

A successful uprising builds new and better ones. 

There have been many revolutions in Latin America, but few have succeeded. 

Can Chile buck that age-old trend?

If zeal to throw out the old and bring in the new is the standard, then Chile’s election of a constitutional convention earlier this month was revolutionary. 

In selecting the 155-member body that will write a new constitution – the result of a political deal to end the unrest and rioting that shook the country in 2019 – Chileans gave their current political establishment an embarrassingly diminished role.

The ruling conservative coalition behind President Sebastián Piñera had expected to win one-third of the seats, which would have enabled it to block sweeping constitutional changes. 

But it secured barely one-quarter. 

The center-left parties that have governed Chile for 24 of the last 30 years fared even worse and will control just one seat in six – fewer than a new alliance of the Communist Party and other far-left parties, and fewer than the People’s List, a motley assemblage of radical groups that grew out of the 2019 protests. 

Independent candidates – environmentalists, feminists, local leaders, and advocates of devolution to Chile’s regions – were the overwhelming winners.

The results mark a clear shift to the left, but the international media’s preferred narrative – that this was an electoral revolt against Chile’s so-called neoliberal economic model – is too simplistic. 

Among those failing to get a seat in the convention were the Communist Party member who runs Chile’s largest labor confederation, the former head of the national teachers’ union, and the leader of the hugely popular movement pushing to abolish the country’s privatized pension system. 

All three embody opposition to anything that smacks of market-based economics.

The election was about left versus right. 

But it was even more about young versus old, novel versus outdated, and autonomous versus institutional. 

Voters rejected not only the political and business elites, but also every other elite – academic, NGO, union, and media.

The good news is that the convention looks like the country. 

Half of its members are women. 

Indigenous peoples hold a sizeable block of seats. 

Predictably, there are many lawyers. 

But the body also includes schoolteachers, shop owners, veterinarians, dentists, a car mechanic, a deep-water diver, a professional chess player – and only one economist. 

Chile’s traditional political class, chock-a-block with the private school-educated offspring of politicians, does not look like that. 

If Chile’s political institutions had been suffering from a legitimacy deficit, a new constitution written by such a body should go a long way to plug that gap.

The bad news is that the 155 convention members must cast aside everything they stand for in order to do their job well. 

A generation reared on direct participatory politics – whether via Twitter, on university campuses, or in the streets – now must build a representative democracy. 

United in their distrust of political parties, they need to craft rules that allow parties to thrive. 

Tipsy with the elixir of absolute moral certitude, they now must create institutions where negotiation and compromise can take place.

At stake in the convention is nothing less than the nature of democracy. 

Latin Americans have been trying their hands at it for two centuries now, but have chalked up more failures than successes. 

Chile’s is the oldest and among the most stable in the region, but even there, decades of tranquility have been punctuated by civil wars, spasms of violence, and General Augusto Pinochet’s ferocious 17-year dictatorship. 

Moreover, many Chileans think that the democracy rebuilt in the three decades since the dictator was voted out of office is overcentralized and unresponsive to citizens’ demands.

The constitutional convention is a chance to right those wrongs. 

But building a better political system requires understanding the shortcomings of the old one.

In the presidential regimes common across Latin America, chief executives are elected directly by voters, serve a fixed term of office, and can influence the legislative agenda. 

Thus, on paper they have strong powers. 

Hence the talk, common in Chile and elsewhere, of ending “hyper-presidentialism.” 

But practice is very different from theory. 

Proportional electoral systems produce fragmented parliaments in which presidents seldom command a majority. 

Lame ducks from day one, they are unable to pass laws or deliver on their promises.

Furthermore, parties themselves are weak. 

Members of parliament are chosen under an “open list” system that prevents party bosses from rewarding loyal party members by placing them at the top of a “closed list” – common in European democracies – where they have a high probability of being elected. 

And candidate primaries, while supposedly great for accountability and internal party democracy, are terrible for party cohesion. 

A media-savvy outsider with exotic ideas or no ideas at all (think Donald Trump) can easily upstage the hard-working activist who has spent a quarter-century helping to build the party up from the grassroots.

Progressive politicians from the old parties and the independents and radicals who are now trying to displace them have one thing in common. 

Ask them why they are in politics, and they will all say they are proud to participate in a collective endeavor to defend the public interest – implicitly contrasting this calling with the individualism that markets presumably foster.

In fact, the opposite is true. Chilean parliamentarians are often described, tongue firmly in cheek, as single-owner business enterprises, forever switching allegiances and flip-flopping on policies when it profits them politically – whether by a lift in the polls or 15 minutes of social-media fame. 

New parties and movements break into splinter groups and factions the day after they are born. 

Anti-capitalists (but not only them) have brought into politics some of the worst habits of the capitalist culture they deplore.

If Chile’s constitutional revolution is to succeed and show the way forward for Latin America’s other democracies, all of that must change. 

The adolescent dream of direct democracy must give way to the lackluster adult reality of representative democracy. 

Independents must be willing to build institutions that enable parties to wield real power and give rise to governments that are strong enough to govern. 

Talk of collaborative endeavors must translate into the kind of public-spirited politics that focuses on the next generation, not just the next election. 

Can it happen? 

Perhaps. 

But don’t hold your breath.


Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.  

Why CBDCs will likely be ID-based

Central banks are realising CBDCs will have to be intimately linked to identity to deal with illicit finance and bank disintermediation risk.

Izabella Kaminska

    © REUTERS



Goldman Sachs’ econ research division, headed by Jan Hatzius, has a status report out this week on central bank digital currencies, and it inadvertently homes in on two factors that are increasingly becoming understood as essential in CBDC structures worldwide.

The first pertains to anonymity; the second, to how balances might be treated or capped to avoid the interest arbitrage that bleeds funding from the conventional banking system.

As the report notes:

Central banks have been cautious to avoid two key risks that CBDCs could pose. 

To avoid disintermediating banks by depriving them of their deposit base, central banks have imposed caps on balances, paid no interest on CBDC, or considered imposing a penalty interest rate on holdings above some threshold. 

To avoid facilitating illicit activity, central banks have mostly decided against fully anonymous accounts or capped anonymous transactions, and have tasked commercial bank intermediaries with monitoring customers and transactions.

While none of that may sound controversial upon first reading, it’s worth considering the wider picture.

What CBDC research and experimentation appears to be showing is that it will be nigh on impossible to issue such currencies outside of a comprehensive national digital ID management system. 

Meaning: CBDCs will likely be tied to personal accounts that include personal data, credit history and other forms of relevant information.

There are a number of reasons for this, but the most important one relates to the longstanding argument that without CBDCs cash would cease to function as a public good in the digital era. 

The rationale further dictates that if western central banks don’t come to market with cost-effective digital cash substitutes, private sector competitors will issue them within walled-garden structures instead. 

This would be bad, the theory goes, because it might endow private entities with the ability to extract oversized rents from the system or to disenfranchise many vulnerable segments of society.

One need only look at conventional digital payment services, and the prevailing financial exclusion problem, to understand how much worse it might get if instead of many banks competing against each other (and excluding people one by one over time but never universally), a single private-sector provider with a monopolistic footprint were to dominate.

But to solve this problem CBDCs would have to be structurally designed to be universal and accessible to everyone, regardless of their credit history or record.

And herein lies the challenge for central banks, which are also supposed to be subscribed to FATF standards on anti-money laundering and know-your-customer regulations.

If the system is universal and cannot discriminate, it cannot also prevent the facilitation of illicit activity.

Exclusion or blacklisting in such is a system is simply not an option. 

And that means other mechanics would have to come into play to solve the moral hazard inherent in such a set-up.

Which brings us to problem two. 

If CBDCs are to be universal and available to anyone, they are likely to have an unfair advantage in terms of funding over the conventional banking sector. 

And that, as we have often written about, risks turning central banks into state-banking type institutions.

Regarding the disintermediation risk Goldman notes:

. . . central banks have designed their CBDCs to not pay interest or are considering setting a penalty on holdings above a certain threshold. 

Some central banks have also imposed caps on total balances or allowed commercial bank intermediaries to limit the degree to which customers can exchange existing deposits for CBDC.

As for the illicit finance risk:

To address this, central banks have mostly decided against fully anonymous accounts or have capped the size of anonymous transactions. 

Governments have varying degrees of insight into transactions and have generally put the burden of monitoring CBDC customers and transactions on commercial bank intermediaries.

As the following table summarises, this is why most central banks are designing their CBDCs to be account-based or ID-verified.


But if money is to be identity-based rather than token-based and fungible, this introduces a whole new set of ethical dilemmas and social questions, which aren’t really being asked at the moment on a wide enough social level.

The conversations we should be having relate to who do we as a society really entrust with our personal data?

The current choice includes private companies like Facebook, highly regulated private institutions like banks, “independent” central banks, government-directed central banks, a bit of everyone or nobody at all.

When money goes ID-based, one also has to consider the broader parameters of the potential data creep. 

Just how far should that personal file reach? 

What sort of non-monetary information should or shouldn’t be contained within it? 

To what degree should account-holders be able to refuse access to their data to third parties? 

Who might the government entrust to manage and operate these schemes, and how can we hold them to account?

In many CBDC iterations, as Goldman Sachs notes, it’s the broader banking system that is expected to manage the related identity systems and customer-facing relations. But if that’s the case, what’s in it for the banks? 

How are they likely to be remunerated for offering these at-cost if not loss-making services?

In the end one size is unlikely to fit all, not least because what works for authoritarian countries like China, which have both the inclination and the power to impose intensive surveillance-based money systems on their people, is unlikely to suit longstanding democracies like Britain, which famously have an aversion to national identity document schemes.

One indicator of democratic will for such schemes comes in the shape of the outcome of the recent Swiss referendum on the introduction of a potential national electronic identity system. 

The final results saw 64.4 per cent of voters coming out against the scheme. 

Interestingly, however, opposition to the proposal was centred not on rejection of an eID system outright but on the idea that it should be provided entirely by the government under full democratic oversight and not by private companies as originally envisioned.

However CBDCs evolve over the long run, what this tells us is that it is of paramount importance that politicians and central bankers engage the public in the development of ID-based money systems more broadly. 

As it stands, the state of the discussion is so specialised and technical, new monetary systems risk being swept in without any democratic oversight at all.

Is the US Economy Recovering or Overheating?

The fact that core inflation is rising on the back of substantial GDP growth and declining unemployment should not come as a surprise. Those who are wringing their hands about economic "overheating" should remember that an absence of price increases would reflect an economy that is still struggling.

J. Bradford DeLong




BERKELEY – The financial and economic news in the United States lately has been dominated by concerns about inflation. 

“Runaway inflation is the biggest risk facing investors, Leuthold’s Jim Paulsen warns,” according to the cable news channel CNBC. 

As a potential hedge against inflation, “Bitcoin’s time to shine is fast approaching,” reports Fortune’s Robert Hackett. 

According to US News and World Report, “There is a lot of talk about inflation in 2021 as fears of high government spending creep in and the recent rebound in prices from pandemic-related levels has some investors worried that the trend will continue for some time.”

And yet, one also reads that “US Treasury yields hold ground even as inflation picks up.” 

After growing at an annualized rate of 33.4% in the third quarter of 2020, 4.3% in the fourth quarter, and 6.4% in the first quarter of this year, the US economy is on track for a full recovery. 

The second-quarter growth rate is expected to be at least 8%, and perhaps significantly higher, which means that the US economy, in aggregate, will have fully returned to its pre-pandemic production level by the third or fourth quarter of this year.

In this context, it is no surprise that core inflation (which excludes food and energy prices) rose 0.4 percentage points over the past month. 

That rate implies nearly a 5% annual inflation rate. 

But looking back over the past 12 months, the core inflation rate (as measured by the consumer price index) was 2.3%, which is in keeping with the US Federal Reserve’s 2-2.5% target.

The question is not whether there will be some inflation this year, but whether it will represent “overheating” of the economy as a whole. 

Most likely, it will not. 

The amount by which economic output in 2021 exceeds potential output will be less than zero. 

And as the Fed makes clear with every statement it issues, it will not allow a transient wage-price spiral to become embedded in inflation expectations. 

The outlook for 2021 and beyond is that inflation will hover around the Fed’s target, rather than consistently falling short, as it has for the past 13 years.

Moreover, the US economy is emerging from the pandemic recession with a fundamentally altered inter-sectoral balance. 

Spending on durable goods currently accounts for an additional 1.7 percentage points of GDP, relative to its 2019 level, and spending on housing construction is running at 0.5 points above its 2019 share. 

At the same time, business spending on structures and consumer spending on energy are both running at 0.5 points below their 2019 shares, and spending on services (hospitality, recreation, and transportation) is 2.2 points below its 2019 share.

These sectoral dynamics will be the most important determinants of inflation this year. 

By the end of 2021, some 4% of all workers will have moved not only to new jobs but to entirely different sectors. 

In an economy where businesses very rarely cut nominal wages, the pull of workers from sectors where demand is relatively slack to sectors where it is more intense will require firms to offer wage increases to encourage workers to make the jump.

But we cannot know how much inflation this reshuffling will cause, because we have not really seen anything like it before. 

Economists will have a lot to learn this year about the short-term intersectoral elasticity of employment supply.

One thing that should be clear, however, is that an uptick of inflation this year is nothing to be upset about. 

After all, wage and price increases are an essential part of rebalancing the economy. 

Real production, real wages, and real asset values will all be higher as a result of this year’s inflation, whereas the price level will remain far below what it would have been had the Fed managed to hit its inflation targets in the years since the Great Recession following the 2008 global financial crisis.

While some commentators worry that we may be returning to the 1970s, this is highly unlikely. 

That decade’s stagflationary conditions followed from a perfect storm of shocks, and were exacerbated by the Fed’s conflicted and confused response under then-Chair Arthur Burns. 

Today’s Fed leadership is very different, and there is no perfect storm of repeated shocks to match the effects of the Yom Kippur War, Iran’s Islamic Revolution, the 1970s productivity-growth slowdown, and so forth.

Burning rubber to rejoin highway traffic is not the same thing as overheating the engine.


J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.