"Monetary Policy Is Bankrupt" Dr. Lacy Hunt Warns "Bonds, Not Stocks, Are A Good Economic Indicator"

Tyler Durden's picture

Submitted by Erico Matias Tavares via Sinclair & Co.,

In Search of Solutions – An Interview with Dr. Lacy H. Hunt

We had the great pleasure of speaking with Dr. Lacy H. Hunt on the current state of the economy, the limitations of monetary policy and potential solutions to the overindebtedness problem in the main global economies.

Erico Tavares: Dr. Hunt, thank you for being with us today. Your firm manages over $6 billion in treasuries. With the S&P500 at record highs, do you share equity investors’ enthusiasm with the economic prospects of America?

Lacy Hunt: I think the S&P is disconnected from the fundamentals in the US economy. Growth last year was a quarter slower than it was in 2013. We’re on the cusp of either zero inflation or deflation. Corporate profits using the Bureau of Economic Analysis numbers, compiled using data from the Internal Revenue Service, showed year over declines in all the first three quarters of last year (4Q is not yet available). In the third quarter, the after-tax profits adjusted for inventory gains/losses and over/under depreciation were 7% below a year ago.

The standard of living declined again in 2014. And a lot of the growth we had in 2014 really was a massive building of inventories, which is often the case when stock prices are high and top line is decelerating.

The economy enters 2015 in very weak shape. None of the big ticket sectors are doing well. Capital spending is declining, being paced by extreme weakness in oil & gas drilling, which has really been the driving force in manufacturing over the last four years. The best you can say about the housing sector is that it is flat. Not a very important sector.

Vehicle sales are below the best levels of last year and the trade sector is deteriorating. It is very difficult to move the US economy forward by selling things over the counter and through the shopping cart. The US economy is very fragile. And the fragility is highlighted by the fact that firms simply do not have pricing power.

ET: Historically the S&P used to lead the economic cycle by a few months, sometimes there was a lag. In a sense the signaling of equity markets has been muffled by the excitement about central bank intervention. Is that correct?

LH: Well I’m not an equity investor but I don’t believe in the wealth effect. While a theoretical possibility, it is not supported by economic fact. Let’s go back and look at a few historical examples.

The stock market did not turn down in 1927 and then the Great Depression started two years later. The stock market only turned down in 1929 in the same year as the economy. The stock market didn’t turn down in 1998, two years before the recession. It turned down coincidentally. The fact of the matter is the stock market is not a very good indicator. The wealth effect is a theoretical possibility but no one can really measure it for the reasons that I discussed.

Another problem here is that the threshold studies done by econometricians who look at folks that have income less than $130,000 can’t even find a wealth effect and for good reason. These folks don’t have equity holdings. Upper income individuals do, but they are not income constrained. So the fact of the matter is the wealth effect is a theoretical possibility but nothing more than that. And the stock market is not a good guide to the economy.

ET: In a sense the search for yield pursuant to major central banks around the world pushing interest rates all the way down to zero has largely placed investors in the same side of the market. Just being moderately cautious has caused many equity fund managers to underperform their benchmarks, particularly since early 2013.

As long as central banks continue to pump money and maintain interest rates at zero, do you see it as inevitable that equities will just have to keep going higher?

LH: I’m a treasury investor and I can be anywhere in the curve. The Federal Reserve has made very significant pronouncements about economic growth. They have been overly optimistic at their final forecast in 2013 for 2014, projecting 3.2% growth which turned out to be 2.5%, and that may even be revised lower. Their inflation forecast was wide off the mark.

As treasury investors we can’t afford to listen to the Fed. As a matter of fact we positioned ourselves at the long end of the curve, and have been there for a long time, and during this whole time period they were talking very optimistically about the economy, inflation and so forth, and none of those materialized.

I’m only going to defend what is going on in the bond market and the bond market is a very good economic indicator. When bond yields are very low and declining it’s an indication that the same is happening to inflation and that economic activity is weak. The bond yields are not here for any fluke of reason. They are here because business conditions in the US and abroad are quite poor.

ET: Keynesian theory has pretty much dominated macroeconomic thinking over the last thirty years. Its “consume now, pay later” policies provide a short-term boost and fit well with politicians’ desire to prop up the economy on their watch. A large number of economists in government, private sector and academia, believe that adding more debt to a debt-inspired crisis is the only solution, and that at some point the economy will reach escape velocity and help pay down those debts.

Do you subscribe to this view, especially at these very high debt levels in the economy?

LH: I think that monetary policy at this stage of the game is largely bankrupt. There is certainly nothing that they can do.

Monetary policy works through price effects, quantity effects, the potential wealth effect and the currency depreciation effect. None of those mechanisms are operative.

The price effects don’t work because the short-term interest rates are at the zero bounds, so that’s out of the picture.

The US central bank, the ECB and the Bank of Japan have greatly expanded their balance sheets, but that’s not printing money. Money is an increase in deposits that are available to households and businesses. US monetary growth today is under 6% in the last 12 months, which is lower than when quantitative easing started. The Bank of Japan has doubled the monetary base in the last two years and yet M2 growth is 3% and a little bit more. The same is true in Europe.

Moreover, money alone does not determine economic activity. The velocity of money has fallen to a six-decade low in the US. It has been falling substantially in Europe, as in Japan. When you look at money growth and velocity it’s hard to see where nominal growth can be much better than 1% in Europe and Japan and no better than 2-2.5% in the US. Monetary policy does not benefit from quantitative effects when economies are extremely over indebted. The velocity of money falls and the banks are undercapitalized – banks don’t make loans based on excess reserves, but rather based on capital.

The currency depreciation option by excessive monetary liquidity does provide a transitory benefit. We saw this one when quantitative easing 1 was started in the US, but that’s a transitory benefit: other countries eventually retaliate making everyone worse off.

And the final option is the wealth effect but there is no empirical support for it.

So there’s really nothing that monetary policy can do and the fact that inflation in the US is substantially lower than when all of these quantitative easing efforts started is an indication that such policies are a bankrupt effort.

ET: So it seems that we are coming to the end of the rope here. We tried this one out, it did not quite work as the central bankers had expected it would, certainly the inflation is not here, but it did avoid a deflationary crash right?

LH: That’s not clear because the results are not in and the fact of the matter is that according to new research by the McKinsey Global Institute, as well as others like the Geneva Group, the world is substantially more levered now than at the time of the failure of Bear Sterns and Lehman. They calculate that public and private debt is now $57 trillion greater than in 2007, or 17 percentage points higher relative to GDP.

The overindebtedness buys a transitory gain in economic activity in lieu of a decline in future spending and, moreover, extreme overindebtedness cuts into the economic growth, it increases the risk of disinflation, if not deflation, and the fact of the matter is that the monetary efforts have probably made the world more unstable.

ET: It is said that organizations in crisis tend to repeat the same mistakes, only faster and with more intensity. Japan certainly seems to be following down that path with their latest rounds of aggressive quantitative easing.

LH: I think that’s an excellent example. In their panic of 1989 public and private debt was about 400% of GDP, more or less. It’s currently at 650% of GDP. They have greatly increased the indebtedness of the overall economy but the level of nominal GDP is no higher than it was 23 years ago. The results have been very, very poor.

ET: A grounded perspective might have prompted a rethink of the current stimulative policies, but it seems too many people are vested in the status quo. Given your extensive experience as a senior economist across a number of prominent institutions, including the Federal Reserve system, is this resistance to change something that concerns you?

LH: I’m not in the mind changing business; I’m in the investment management business. I am just trying to execute a fiduciary responsibility to our clients and we are operating under the assumption that quantitative easing will not be successful. We’ve operated under that assumption in the US.

Those who believed that economic growth would accelerate and that inflation would go up thought that investing in long treasuries would be a bad idea, and that notion did not pan out. Investors who saw the failure of quantitative easing, poor economic performance and low inflation were amply rewarded by being long long-term treasuries.

And so it is not my objective here to change how the world thinks. I’m trying to execute a fiduciary responsibility and that’s all.

ET: OK but let’s consider a non-conventional solution and how that might impact your current assessment. The major central banks could get together and say you know what, we have too much debt in our books, our economies are overindebted, let’s write off a chunk and move forward from here.

LH: Unfortunately those excess reserves are owned by the banks. If you wrote them off you would destroy a substantial portion of bank assets and the commercial banks and the other holders would go into a negative situation.

It is a flight of fancy to assume that these debts can be written off. That’s certainly not an option in the US, maybe the Europeans could do it but it would likely have the same effect. It is just not a realistic choice and it’s not practical. The banks are already terribly undercapitalized, you could not take away $3 or $4 trillion dollars’ worth of assets from the system.

ET: What about some good ol’ fashion money-printing? In other words, why doesn’t the government settle its debts with cash envelopes as opposed to having to issue more bonds? Of course this is highly inflationary, but isn’t deflation what the central banks are desperately trying to avoid?

LH: Here again, in the case of the US you would have to abandon the fractional reserve requirement system which I don’t think is doable. And I’m doubtful it is doable in Europe. We can talk about it as a theoretical possibility but it does not really exist as an option.

The fact of the matter is that a debt is an increase in current spending and decline in future spending unless the debt generates an income stream to repay principal and interest. More debt that is either unproductive or counterproductive is the path towards instability, disinflation and poor economic growth, not better economic performance.

ET: So how do you see all of this unfolding given the dearth of solutions at this point?

LH: I think it means we are in a protracted period of underperformance, minimal inflation, possibly deflation.

There are fiscal policy solutions, but they require shared sacrifice, explaining complex ideas to a public that is ill informed and strong political leadership, and we don’t have that in the US, you don’t have that in Europe, they don’t have it in Japan.

So for all intents and purposes fiscal policies is out of the game and in that environment the political sector turns to the central banks, but the fact of the matter is that the central banks’ bag of tricks is empty.

ET: Can you give an example of a fiscal policy that should be considered to address the problem?

LH: Well, you have to take advantage of the fact that we learned a great deal about the government expenditure multipliers and government tax multipliers.

We’ve learned that contrary to Keynesian theory the government expenditure multiplier is zero, if not slightly negative. So there may be a transitory benefit to deficit spending but it is so quickly reversed that ultimately an expansion in government expenditure financed with debt will make economies weaker. So what you have to do is scale back government spending, particularly those types of spending that go to finance daily needs. But that’s politically impossible to do.

And at the same time you basically need to shift income based taxes to consumption based taxes, but you have to address the regressivity of the consumption based taxes. The multipliers of consumption based taxes are minus one, the multipliers on income based taxes are in the minus two to minus three.

These concepts are too difficult for the general public to understand. So they really can’t be explained to them. And furthermore you don’t have the strong political leadership and it has to be done in the context of shared sacrifice.

So there are fiscal policy options but they are not achievable. Now occasionally you get into an unusual circumstance where an exceptional individual steps forward and the country understands the nature of its problem. A number of years ago Canada had a very far-sighted financial leader by the name of George Martin who developed a program of shared sacrifice and was able to turn the country around. But people bought on to the program because everybody’s ox was getting gored a little bit, and Martin had the rare capability of being able to explain the efficacy of the overall program.

I don’t see that happening in the US and Europe. Hopefully I am wrong on that, but the fiscal policy options are there although simply not achievable in the current environment.

ET: So a concern is that in Southern Europe people have been asked to make the sacrifice and implement austerity, but the results have been very dubious, where Greece provides an extreme example.

LH: I don’t think that was an effective program. You have to move away from the government expenditure programs, but at the same time you cannot contract your economy. You need to make a shift from income based taxes, which have a high negative multiplier, to consumption based taxes, which have a low negative multiplier, and you have to do this in the context of not increasing the debt of the government institutions. And that’s like trying to take a camel through the eye of a needle.

ET: You need a very good driver for that!

LH: Yes you do.

ET: Dr. Hunt, thank you very much for your time and your insights. This has been a really insightful discussion.

LH: That’s great, nice to be with you.

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Thirst Mutilator's picture

 'Policy' & 'Monetary' are two words which, (for free society seekers &/or enthusiasts), should not collide in the same sentence.

Deathrips's picture

Cliff Notes.


Its All Paper and Fantasy Digital Numbers!


But it wasnt him.



nope-1004's picture

Bond rates are low because of a weak economy?  Or is the economy weak because the Fed is manipulating bond rates lower commensurate with their unprecedented bailout printing binge?

I vote for the latter.  Lump PM's in there too.

Amazing how easily fooled some people are.  There are no free markets.  Give it up already.


Eahudimac's picture

Why you got a down vote I do not know. Of course the fed is manipulating bond rates. QE never really ended. That is why the 10 year is at 2.0%. It's gone nowhere since QE supposedly ended.

saveandsound's picture

Bondrates are low, because of financial repression. There is almost no price discovery function left.

kaiserhoff's picture

I tend to agree, but both can be true.

These low rates have made things way too easy for the big, sloppy, and stupid who can get them, and damned hard for genuinely new approaches.  It's hard to know where we should be by now.  Interesting times.

bwh1214's picture

I agree with several things Dr. Hunt says but I don't think he is as smart as he thinks he is.

Mr. Ed's picture

He gort one thing right: the negative economic impact of the income tax vs. a consumtion tax such as the FairTax (a.k.a. House Resolution 25, currently before the Ways and Means committee with around 80 sponsors.)

FreedomGuy's picture

The article is correct about bond rates. They are weak not just because of a weak economy but because of no confidence in the economy.

Where the Fed (and central bank) bond manipulation comes in is arguing what the real bond rate would be without Fed intervention. I would guess it might be a point higher but the Fed has backed out of the market although it holds a bunch on it's spread sheets.

However, the main point of the article is still correct. Bonds tell the story of the market. The interesting thing about then next crash is that it is not impossible that both bonds and stocks will crash at the same time. It depends on how the crash occurs.

BeanusCountus's picture

Assuming the down vote is from someone that hates sensible thinking. I agree with you: how the hell do we know that current prices of anything reflect proper risk premiums? We dont. Things are f'd up, too much intervention.

eatthebanksters's picture

Truly amazing that fund managers can figure this shit out but the head of the Fed is clueless or a liar.  Same as 2008.  

FreedomGuy's picture

Well, the Fed is like the high priest of Keynesian central planning. Even if you are agnostic, if you get appointed as high priest you will have to practice the rituals.

venturen's picture

A candidate for the nail gun award

disabledvet's picture

500 billion in student loan debt  to be written off according to Reuters with Chicago on the verge of being downgraded to JUNK.


The Banks will gladly take that stupendous amount of liquidity coming from Texas and North Dakota and stick "the member Banks" with the debt.


Incredibly this massive increase in supply could cause an even more massive increase in demand.


Has been argued that Treasuries are the biggest bubble of all...from "un-poppable" to "unstopable."


As the dollar surges and Banks start dropping like flies again I see no other asset class to go long and levered with.


And now we do know in fact these yields can go negative.


The size of the short position in this asset class is truly stupendous.


That was no "fat finger" last fall when US yields plunged massively in mere minutes.  You can't "bust the trade" in the treasury complex.  If the ten year suddenly goes from two percent to .2 percent...well, let's just say your Bank is kaput at that point.


And I ain't talkin "the First Pioneer Bank of Waukwagen Minnesota" either.

cossack55's picture

Can someone who still pays attention to CNBS tell when this guy is scheduled. Thanks

knukles's picture

He's with Van Hoisington who's been long of long treasuries and has some great bond performance.  Needless to say, neither Van nor Lacy will be on CNBS.  You can check them out via this fund they run through Wasatch ... Van is an olde time Bond Daddy from way back.


kaiserhoff's picture

Poor business conditions?  Yes.

Having all of your interest income and most of you dividends stolen will do that.

q99x2's picture

Hi Lacy you have too much clout to mock. I will shall show some self respect for the Q99x2 and respond with a great appreciation for your insightful interview. Long live the intellectuals and all sparks in the gaps between their synapses.

The Limerick King's picture

The Canadian Finance Minister was Paul Martin...not George Martin. Other than that...the guy is bang-on!

Thirst Mutilator's picture

C'Mon Man!... Limerick me my king!

lunaticfringe's picture

I thought quite honestly, this was the best piece I have read on the site all month. In fact, Mr. Hunt changed the way I view things just a little and he offered up why just cancelling debt (ala these fucked up coin ideas) simply won't work. Imma actually gonna bookmark this piece.

Chief Kessler's picture

Yes, it was good wasn't it? Now he may just be a sock puppet for the last man standing- .gov. And their pppprrreeeccciooouuusssss. Bond market. Once support for bonds goes, it's all over. Foreign support for bonds is waning. The fed gooses Nasdaq as bread and circuses. But this guy is pimping the last ho in town, the only ho that matters, cause when the biggies no longer buy bonds, it's bye bye beatches. Enjoy deflation while you can , when this one cracks up its gonna be a doozy.

buzzsaw99's picture

garbage garbage garbage. wanted to like it. didn't. all wrong in every way imo.

FreedomGuy's picture

Then you did not understand anything you read. This is one of the best most insightful articles to date.

You just got an accurate analysis of all that is wrong and why central bankers have nothing left but dead ends for monetary policy. There is no way out. Their ideas are about to fail in front of all and in real time.

Duc888's picture



Central Bankster = leach.  They produce nothing.

FreedomGuy's picture

I actually agree. Cental bankers are the monetary central planners of the State. They produce nothing but will claim to produce everything.

It is like a botanist claiming they can manage a rain forest to a superior result and claiming credit for anything that remotely looks good.

Hohum's picture

George Martin produced the Beatles, who are not from Canada.

delacroix's picture

shift from income based taxation to consumption based taxation= make the poor pay more, while the rich pay less. the elite solution is always the same. fuck lacy hunt, and the horse he rode in on.

Joe Wazzzz's picture

The Fair Tax addresses this issue by giving a flat rate cost of living rebate to everyone which compensates the poor for the taxes they have to pay. So this issue can be fixed.

Duc888's picture




Wazzzzz: The Fair Tax addresses this issue by giving a flat rate cost of living rebate to everyone which compensates the poor for the taxes they have to pay. So this issue can be fixed.


Why go through the reach around of taking something from someone and then giving it back to them?

How about everyones first $60K is "free" from taxes.  Pop a consumption tax on the rest.  Then we stop playing games with the allocation of other taxes such as the Gas tax which mysteriously never goes to the upkeap of the roads and instead gets put into the general slush fund.

You "use it" you pay for it.

You don't use it, you don't pay for it.  Of course this means we would likely cut the MIC right in half, concentrating on protecting out country instead of blowing the shit out of other countries for no fucking reason....

Mr. Ed's picture

Duc888: "Why go through the reach around of taking something from someone and then giving it back to them?"

Here's the reason: to assess the condition of having reached 60K of income (or whatever), it would be necessary to assertain income

We already have a 4th Ammendment-busting gang of snoops with a pechant for social engineering masquerading as a gang of tax collectors to assertain income!  We need a simple, progressive consumption tax!  We need the FairTax.  I'd like a tax system that sticks to collecting taxes!

I'd also like my 4th Ammendment rights back please.

Other than that I like your thinking!  ...the MIC thing and the burden-shifting that goes on in the rest of the tax system is completely nutty.

saveUSsavers's picture

A fking consumption tax only would have to be 40%+ without eliminating the wealthy's deductions like mortgage, for example and that would be defended by armies of NAR etc lobbiests.

Mr. Ed's picture

...mmmm, not sure I understand what you're saying.

FreedomGuy's picture

Your ideology is only fit to clean up after the horse.

Obama and the real elitists are counting on your continued myopic support.

Mr. Ed's picture







You work in the collections division of the IRS by any chance? ...and what is it with all these horse remarks?

Duc888's picture



delecroix:  shift from income based taxation to consumption based taxation= make the poor pay more, while the rich pay less.


How about a 50-60K base exemption on all income.  If someone like me can get along fine on 35K a year living in my little cabin...so what?  If someone wants to pay property tax up the ass and live in a 12,000 SQ FT house, let 'em go for it.

Mr. Ed's picture

Ditto the above: to assess the condition of having reached 50-60K of income (or whatever), it would be necessary to assertain income

We already have a 4th Ammendment-busting gang of snoops with a pechant for social engineering masquerading as a gang of tax collectors!  We need to go in the other direction!  I'd like a tax system that just sticks to collecting taxes!

(BTW: If you want to live in a little cabin, you'll need to be sure the covenants in your subdivision allow for a low square footage dwelling.  Most of the time, the minimum floor area requirement (inserted into the covenants by banking and RE interests) is so high that it forces you to go to a bank for a MORTGAGE... and, it's done for a good reason: bankers have to make a little money for that extra vacation home and a bug-out property... ya know, for shtf, don't they?  Who's back are they going to do that on if not on yours?  /sarc)

waviator's picture

Maybe you were too busy fucking Hunt's horse to notice, but he rightfully acknowledged that a consumption tax has an inherent regressivity that needs to be addressed.
Other than switching to an asset backed currency, a consumption tax is the best idea out there for restoring health to our economy.

Mr. Ed's picture

The FairTax (HR25) is a consumption tax which has a built-in progressivity that unburdens people with minimal income through the prebate system - and it doesn't make them jump through paperwork hoops or violate their rights of privacy!


PS: let's watch it with the comments about Hunt's horse, okay?

delacroix's picture

my personal feeling, hoisington is in trouble. lacy knows he's got a big pile of shit on his plate, looking for the greater fool.

Thisson's picture

Your critique of Hunt lacks reason (or at least you haven't shared any so far).  And how can you say Hoisington is "in trouble" when they've had good performance by being invested in the long end of the curve?  Did you even read the interview??

Mr. Ed's picture

I have seen a lot of posts on ZH in the past few years where the author appears to be talking their book while looking for a "bag holder" (re:delacroix)... don't know if that's the case here.

But, I liked the post.  It's given me some things to think about.

FreedomGuy's picture

Right, this interview will move the whole market. Do you understand anything you read, comrade?

Creepy A. Cracker's picture

Bonds.  James Bonds, Ms. Pussy Galore.

Againstthelie's picture

And at the same time you basically need to shift income based taxes to consumption based taxes, but you have to address the regressivity of the consumption based taxes.

Even lower taxes on the incomes of the Buffets, Soros', Einhorns, Icahns and alike. Less taxes for the 1%, higher taxes for those that have to spend most of their low income.

Wow, what a Chutzpah from the financial parasites.

Thisson's picture

You're completely missing the point.  For the economy to grow, production has to be rewarded, saving (and consequently investment) has to be rewarded, and consumption penalized.

Our current system has it largely backward, where income (production) is penalized. 

Of course, we can complain with certain types of income (e.g. capital gains) receiving preferential treatment, but you haven't done that.

Duc888's picture

Thisson: You're completely missing the point. For the economy to grow, production has to be rewarded, saving (and consequently investment) has to be rewarded, and consumption penalized.


OK, ya got me.  If we must "produce" but not "consume".....what is the outcome?  

I think the toilet gets plugged up there.

MagicMoney's picture

He's right. US productivity is not meeting the population's need. Investments requires savings, which is a deferment of consumption. Without savings, there is no investment. There is a crucial time period which funds must be used to initialize production before the first sale even occurs. Production is a time based process, not just money based. How money is allocated and used is very important. Borrowing money to pay for consumption today does not bring in future productivity and wealth. It's the other direction. Production must be funded, all with the uncertainty of the market economy today, so people can consume stuff tommorrow. Keynesians think that businessmen are created out of thin air that somehow bring goods to consumers simply by consumers spending all their money. Doesn't work that way.  The larger the funding pool, the longer duration of production process can occur. If funds are short, only short term investments, or short production process must be shorter or less elaborate. The goal of production is consumption. Printing money does not increase the pool of savings either.

Mr. Ed's picture

And I can add that: the Internal Revenue Code is crazy and inefficient when applied to businesses since they just turn right around and pass the tax they pay onto consumers through higher prices.

And what is the result?

1. higher production costs asssociated with tax compliance,

2. allocation of resources, buy v. rent, etc to fit the tax code, not to FIT REALITY,

3. attention to similar concerns in the consuming public which has to live and make purchases under the same insane system of taxation!


Creepy A. Cracker's picture

Thisson has the correct answer.