Newsletter 3: U.S. Politics, China and Monetary Policy

My newsletter is intended for readers with high IQs, well developed erudition and, most importantly, a life goal of acquiring an objectively supportable world view.  I suspect that nearly everyone will say that their world view is based upon evidence.  However, even a cursory consideration of the most widely held world views as expressed by the major media outlets are predicated upon demonstrably false assumptions. 

I recently got a question from a subscriber who wanted to know how the Federal Reserve's REPO facility might affect future Quantitative Tightening.  Great question.  It may have an effect.  He, like most of my readers, constantly strives to acquire a higher level of general knowledge and then use it to modify their view of things.  That makes them unusual at a very fundamental level.  In today's world, it is extremely difficult to not be tainted by partisan misinformation, which is rampant on both sides.  Here, however, I assiduously commit to following facts to conclusions without regard to what I may want to be the answers.  Reality has no obligation to conform to my sensibilities, or yours, or President Macron's or Putin's.  As the saying goes, "It is what it is" and that is what we should embrace.

Three political parties in the U.S. appears inevitable

It appears that the U.S. is about to evolve into three political parties.  This is critical to its operations because the U.S. does not have a parliamentary system.  It has no practical way to deal with three empowered constituencies at the Federal or State level.  This is an intermediate step toward the inevitable breakup of the country.  As I emphasize at every opportunity, making North America similar to Europe with many sovereign nations affiliated through a spectrum of treaties, is healthy for Western civilization as a whole.

The process that is underway begins with the seizure of the Republican party by MAGA.  There is no doubt that this is happening.  In one tranche of primaries, 22 of 22 Trump endorsed candidates won.  The strong tendency for establishment Republicans to be anti-Trump has transformed into an awareness among many Conservatives that establishment Republicans are better described as elitists (sometimes called 'country club Republicans) than as Conservatives.  Their objections to Trump were not, and still are not, political.  Rather he was seen as a threat to their power structure.

That is how MAGA views it and it has only strengthen their resolve to fight against 'the swamp'.  Estimates are that about 80% of Republicans have transferred their allegiance to MAGA from the 'establishment' Republican National Committee.  The nature of majority rule is that it tends to exaggerate majorities.  In other words, the Republicans of the 117th Congress will likely contain more than 80% MAGA House members.

In the 2022 mid-term elections, there is a high probability that MAGA Republicans will comprise more than 50% of all the House of Representatives.  Their policies are fundamentally incompatible with the establishment Republicans and the overwhelming MAGA majority within the Caucus will completely disenfranchise them.  We will know whether or not this is done successfully if Kevin McCarthy does not ascend to the Speakership.  The most likely MAGA candidate would be Jim Jordan.  If Jordan ascends to the position of Speaker, a torrent of anti-establishment legislative activity will ensue and a profound backlash will result among not just the Democrats and MSM, but from the establishment Republicans, as well. 

At that point, the establishment Republicans won't have much choice but to switch parties.  While they are definitely right of the establishment Democrats, they are closer to them than the MAGA crowd.  This is fundamentally different from what happened with the 'Gingrich Revolution' and the Tea Party movement.  While both brought in Republican majorities that contained many Conservative reformers, in reality, in both cases, the establishment Republicans retained control.  It is likely to be different this time.  It appears that the MAGA reformers will actually take over the Republican Caucus in the House.

There seems little doubt that Mitch McConnell, Mitt Romney, Lisa Murkowsky, Susan Collins, et alia will switch, should MAGA take over the Senate Republican Caucus as well.  There will undoubtedly be establishment Republicans in the House who will switch, but it is more difficult to determine which ones will survive the MAGA primary challenges, so the scope of the switch is uncertain.  According to many MAGA supporters, this party switch would simply be acknowledging the reality that moderate Democrats and moderate Republicans are, in fact, the Uniparty of the elites.

This Uniparty, or the Centrists, quite reasonably may assume that it will constitute a new majority.  It may in the Senate, but it looks unlikely that it will do so in the 117th Congress in the House even with likely Party switching.  While the Centrists may lose the House of Representatives for two years from 2022 to 2024, they may believe that, with the consolidation of Center Left and Center right, they will acquire control of both the House and the Senate in 2024. 

The problem with that scenario is that while they will cement their control of the middle, the 'woke' wing of the Democratic party may feel betrayed.  They are already complaining that the Biden Administration and the Democrat controlled Congress haven't governed enough to the Left.  They actually believe that, if it had governed more to the Left, it would keep the House in 2022.  The problem is that if there is an influx of Center-Right Senators and Representatives in the Democratic Party, the progressives in the Democratic Party will be even further marginalized.  In other words, while Democratic leadership has felt the need to accommodate 'the squad', with new Center Right members, they may not feel that it is necessary.

One might think that the far Left wing would stay with the Democratic party and work from within to get more done.  They may, but the polls suggest that doing so will be futile unlikely.  It is actually very likely that they will find more power in leaving the Democrats and forming a new, Progressive Party.  The demographics are surprising and different previous attempts at third parties.  On the few occasions that third parties have arisen in the past, they have been unable to gain even one member in Congress and save for George Wallace in 1968, even one Electoral College vote for President.  That is because their support has been diffuse and comprised a insignificant minority everywhere.

That would not be the case for a new 'Progressive Party'.  While it would be a relatively small percent across all of the U.S., it would likely constitute the majority in California, Oregon and Washington.  While not likely a majority in any Northeast Liberal State, it would likely win some House seats there that would compensate for the few that they would lose on the West Coast.  The Progressives might feel, as a meaningful swing vote in Congress and in Presidential elections, that it would obtain more power as a third party than as a relatively small minority within a new, more Centrist Democratic party.

It could be a meaningful third party with, perhaps, six Senators and 15% of House seats which could eliminate a functioning majority in both chambers.  There would be three caucuses that, as we have seen, strongly tend to vote along party lines.  This is primarily the case because Party leaders control committee assignments which, in turn, control the strings of power.  While it is likely that the Progressives would still support the proposed legislation of Democrats in the House, as the lesser of two evils, in the Senate, the lesser representation of the Progressive party might put the Republicans in effective control of that Chamber. 

The situation in the Presidency is different, because the approximately 13% of the Electoral College that would likely go to the Progressives would guarantee that no candidate reached a majority.  In this scenario, no Presidential race in the 21st Century would have been decided in the Electoral College and it is unlikely that they would going forward.  Virtually all Presidential elections will be thrown into the House.  There, because voting is done by State delegations, the Republicans would likely invariably win.

While these situations are fundamentally untenable, it is not clear how the outcome can be short circuited.  Political strife, which has been increasing anyway, would become, as it was during the Civil War, regional, ideological and rancorous.  This is both good news and bad news.  The tension that was felt between Trump and the EU would become more or less permanent.  Domestic polarization would continue to increase.  However, as I have been saying for over 20 years, the U.S. is headed for a divorce and this potential 2022 outcome could get it closer to that point.  Right now, the core of the MAGA region of the U.S. is becoming progressively more defiant and is tending toward outright disregard of Federal rules and regulations.  However, the political dynamic for the West Coast may favor secession for the West Coast, as well.  It unnerves many Americans, but it would make EUNA a geopolitically healthier place.

China is at risk, economically and politically

In 1986, virtually everyone believed that the Soviet Union was solid.  Five years later, it fell apart.  Today, a similar opinion seems to apply to China.  Is China, as a cohesive nation state, safe from substantial stress as the result of economic or cultural forces?  I do not believe so.  While the vast majority of its 1.4 billion population identifies as Hahn and has a strong sense of cultural and ethnic identity, its national identity, I think, is weaker.

There are actually many regional identities within China.  These are primarily linguistic, cultural, and ethnic. 

The largest is Cantonia, which is a region in the Southeast of China comprised of Guangdong, Guangxi, Hong Kong, Macau and Hainan.  Genetically, it is about 50% Han, primarily from male ancestors and is approximately 50% descended from local populations, primarily from female ancestors.  It is therefore, ethnically distinct, but also linguistically distinct, traditionally speaking Cantonese.  This is being mitigated by a large influx of Mandarin speaking and ethnically pure Han.  There is a discernible cultural difference as well..  It has a total population of about 190 million, however, as previously stated, many of them are transplanted Mandarin speaking Han.  That confuses the matter, but, still, there is a fairly well developed separatist movement in Cantonia.

The delta region of the Yangtze river is dominated by Shanghai, with a metropolitan population of about 40 million.  It is ethnically Han but, linguistically, its residents mostly speak local variants of Wu.  However, during the period of European colonialism, it was substantially westernized.  The qipao dress, began in Shanghai as a fusion between the Manchu traditional dress and French fashion.  When the Communists took over, they didn't approve of them, but the style quickly moved to Taiwan and to Hong Kong where they were given the Cantonese name, Cheongsam.  They are returning to Shanghai as it becomes defiantly more culturally Western.

If one watches Korean, Japanese and Taiwanese TV, it is immediately clear that the modern business class views its cultural universe to be these three countries but also encompassing Singapore, Shanghai and, to a degree, Australia.  They still view the U.S. and France as reasonable extensions, if a bit exotic.  What I mean by this is that the show's protagonists may go to Paris, San Francisco, Shanghai, Singapore, etc. as an unremarkable turn of events.  The inclusion of Shanghai is emblematic of a conflict among Shanghainese between their Han heritage and the more worldly cultural outlook that came from trade and the years of European colonialism.

Lastly, Shanghai is larger than Beijing, has a higher standard of living and from a reasonable historical position is establishing itself as the cultural capital of China.  Taken in total, it may feel that taking a politically subordinate position to Beijing is improper. 

Obviously, three regions that are not ethnically Han, Tibet,
Xinjiang (Uighur) and Nèi Měnggǔ Zìzhìqū (Mongolian) all have strong independence movements.  This means that if Beijing loses its political control of China, the country could easily fragment and do so quickly.  In other words, it could be a replay of the Soviet Union.  However, while the dissolution was completely peaceful with the Soviet Union, I wouldn't expect it to be so in China. 

This becomes a serious concern because, currently, China is in an economic meltdown.  As of April, 2022, building construction is down 57% year over year and young adult unemployment is approaching 20%.  The Chinese government is trying to mask this economic collapse with a sudden devaluation of the Yuan around April 15, with the intent to cover domestic economic shortfalls with increased exports.  Despite this tactic, economic activity is slowing dramatically.  The stated explanation of COVID lockdowns is not completely wrong, however, it is masking deep, underlying economic problems.

There is significant speculation that Xi cannot survive a substantial recession and one certainly appears to be on the horizon.  The question becomes, "Can the CCP survive?"  If the Chinese people blame Xi, perhaps the CCP can survive.  But, they may blame it on the CCP Communist system, itself.  As we see, there are cracks in the solidarity of China, so, if the powerful central control of the CCP and Beijing begins to falter, it is quite possible that the Yangtze river delta and the Pearl river valley will attempt to weaken the authority of the central government.  While Beijing finds itself struggling with that, Tibet, Xingjiang and Nèi Měnggǔ Zìzhìqū may attempt to take advantage of the distraction to loosen ties as well.

It is difficult to determine if this will happen and, if it does, if it will be a complete destruction of a unified China or, perhaps, just a move to greater local autonomy.  Either way, it would seem unlikely that any attempt to reunify Taiwan or maintain a firm grip on Hong Kong will be feasible, especially with a growing disapproval from the community of nations. 

Either way, I am not backing off on the assessment that the primary feature of 21st Century global geopolitics will be a struggle between EUNA and China for world preeminence.  However, the nature of the struggle may undergo a fundamental transformation.

For those who wish to follow Chinese events more closely, I do suggest on YouTube China Uncensored and China Update.  They present news, analysis and commentary that is from a Western perspective but is much more accurate than what is being presented within either the Right or Left information silos.

Understanding the Value of a Deficit

There is strong political sentiment within the U.S. in favor of a legally required balanced budget.  Several European countries already have instituted a balanced budget requirement.  This is very short sighted and rather typical of the tendency for Populist movements to force simplistic and imprudent actions.  Herein, I will explain why deficit spending is not a completely bad thing.  By the way, my arguments are not, as some will assume, at all Keynsian.  It stems from monetary considerations, not politically motivated arguments for growing government.

Suppose that there is 20 trillion dollars of GDP.  For our purposes and for simplicity, we will assume that the velocity of money is exactly 2.  The money supply is 10 trillion dollars.  That works out very nicely.  There is 20 trillion dollars of stuff to buy and there are 10 X 2 = 20 trillion dollars of money to buy it with.  Now, suppose that  next year's GDP is 21 trillion dollars.  Now, if nothing changes, 20 trillion dollars will be chasing 21 trillion dollars of stuff.  Either 1 trillion dollars of stuff will need to go unsold or prices must fall by about 4.8%.  

On the surface, that might not appear to be a problem.  However, Economists have been able to firmly establish that it is.  Since this has already been explained relatively well by Paul Krugman, I will simply link the explanation.  Paul Krugman is blatantly of the Left, but in this case, this is just basic Economics and not politically driven.

If you look for an expert in Economics who thinks deflation is good, you will have a difficult time finding anything more encouraging than the occasional assertion that some kinds of deflation may be OK.  Also, in the usual case where an Economy has underutilized capacity, a bit of inflation actually stimulates real economic growth.  So, there are not just arguments against deflation, there are arguments for inflation.  Consequently, most central banks shoot for a bit of inflation.  The U.S. Federal Reserve historically has set a target of about 2%.  2% inflation plus 3% economic growth, if achieved, means that money supply needs to grow 5% in order to hit their target of 2%. 

Actually, nearly all of the major, modern economies have governments and central banks that are converging around about the same money growth target of 2%+real economic growth. As of 2019, the U.S. GDP was around 21 trillion USD and money supply was around 15 trillion USD.  A 5% increase in nominal GDP would translate to 15 trillion USD X 5% = $750 billion of required increase in money supply.

The question becomes, 'How do you create this $750 billion increase in USD money supply'?  By the way, the Euro has approximately the same requirement.  The two ways that are being used are fractional reserves on bank lending and Quantitative Easing (QE).  When I was young and I first learned about this issue, I definitely didn't like fractional reserves because the unavoidable financial benefit to printing money accrued to the owners of banks and QE was not significant at the time.  My thought was that the Federal Reserve would take the amount that money supply needed to increase and divide it by the number of adults.  They would create new money and send it to all adult citizens equally.  With these numbers, that would be a check for $2,885 to every adult.  That is somewhat like the 'stimulus checks' that Americans periodically got through the Pandemic.

That, however, is not something likely to happen regularly.  It just appears too much like profligate spending, aimed at buying votes.  Demagoguery would kill it as an idea. Historically, money has been created by utilizing the fractional reserve rules.  As Investopedia explains, if someone deposits $100 in a bank, the bank must hold 10%, or $10, in reserve.  So, on the surface, it appears that they can only lend out $90 of the $100 and to many, that likely appears prudent.  However, that is not how it really works.  Because money is now electronic, what happens is that the bank can lend out $1,000 and they need to have $100 in reserves, which they do.  The net effect is that they pay interest on $100 but receive interest on $1,000.  This is why banks really like this tool as the primary driver of monetary policy.  That is why we, as citizens, not banks, should not. 

The fact is, however, that the reserve is typically more than 10%.  This is because, historically, the supply of bank deposits is more than 10% of the demand for loans.  Consequently, while the bank is allowed to lend out $1,000 on $100 deposits, in reality, it may lend out only $500.  Now, suppose interest rates fall, something that the Fed can make happen.  The demand for loans may go up to $600.  They still have enough deposits to cover that, but they have just created $100 of new money supply.  It's actually just a accounting transaction.  They book a receivable for an additional $100 and a liability for the same amount.  However, they will never need to pay that liability.  It is just carried on their balance sheet.

Quantitative Easing creates money in a completely different way.  The Federal Reserve, by law, cannot bid on Treasury bonds at auction.  However, they can buy them in the after market and they do.  That just adds a wrinkle that we won't delve into right now.  The important part is that the Federal Reserve settles the purchase with created money and puts the bond on their balance sheet as an asset.  They have no intention of selling the vast majority of their bonds.  When they mature, they buy more.  It was done to create money supply.  Only if they need to reduce money supply, will they sell them.

The bonds carry interest and the Treasury must remit those interest payments to the Federal Reserve on a regular basis.  However, because the Federal Reserve is, by statute, limited to 6% return, most of the profits from QE are just remitted back to the Treasury.  In 2020, they sent $86.9 billion to the Treasury.  With massive increases in interest rates in 2022, that number will likely jump substantially.

Money supply, as we see, needs to increase about $800 billion and about 700 billion Euros in order to hit M2 (the most followed measure of money supply) targets.  Those are the breakeven amounts to assure economic health.  If the governments do not engage in deficit spending, the Central Banks will be forced to buy up existing debt.  That might seem good, and it is not bad, but eventually, there will be no debt left to buy.  In reality, the amount of money supply increase that is required has become impossible to implement through fractional reserves.  While bank deposits are shrinking over the long term, so is the practice of borrowing money from banks.  If the system tried to rely entirely upon fractional reserve lending to create money supply, it would likely fail and deflation would become a real risk.

While we have focused on the Central Banks buying government debt, they can buy up mortgage backed debt as well.  In fact, in the aftermath of the 2008 financial crisis, the Federal Reserve did exactly that with the intent to stimulate a collapsing housing market.  Also, there may be times when the Central Bank may need to decrease the money supply and they can do this by selling some of their Treasury bonds.

The problem with that, if it is a problem, is that when a Central Bank sells government debt, it takes money out of the system, but the increased supply of debt will likely also increase interest rates.  Right now, for example, Federal Reserve could sell about $1.2 trillion of its Treasuries, thereby reducing the money supply by that amount, and assuming that velocity doesn't change, completely eliminate the excess projected inflation for 2022.  Why don't they do that?  Because,  in order to sell them, they would need to discount them and interest rates would go through the roof.  Rather, they are projecting Quantitative Tightening of about $95 billion per month.  That is, in theory, just about enough to compensate for the inflation.  However, because interest rates will be going up, lending through fractional reserve will likely decrease taking money out of the system.  Also, higher interest rates are a feedback to inflation.

I can't emphasize this enough.  Economics is far from intuitive and far from simple.  The Republicans lie in one direction to encourage you to vote for them and the Democrats lie in a different direction with the same intent.  This should definitely not be part of a well functioning democracy, but I have no idea how to fix it.  For my subscribers, I try to compensate for this demagoguery, but realistically, my articles are beyond most voters.

I keep refining and, hopefully, improving

I am very sensitive to the value of time.  I sometimes wonder about public intellectuals who produce 3 hour podcasts that, necessarily involve a whole lot of repetition.  That is why I try to limit my newsletter to about a 10 to 15 minute read and concentrate on just the most egregious and/or consequential misrepresentations of the Left and Right media.  All of my first three newsletters have contained three short articles.  I may, in the future,  write longer articles, but usually also limit the number contained in a newsletter.  I will not be a slave to this format.  If newsletters can be shorter, I will make them so. 

I continue to work on my books, 1) A Polymathic Subculture, 2) A New Enlightenment: Political Philosophy for the Information Age, 3) The Death Of Capitalism: Economics for the Information Age and 4) The Rise of the Microstate: Geopolitics for the Information Age.  I am also working on several white papers that will be available to my subscribers at no extra charge.  As with my Newsletter, I am jealous of your time and strive to keep everything as brief as possible but no briefer.

Do subscribe if you have not done so already and feel free to share.