Michael Scally MD

Doctor of Medicine
Now Even Goldman Sachs Is Challenging U.S. Debt Dogma
Now Even Goldman Sachs Is Challenging U.S. Debt Dogma

Goldman Sachs economists are wading into the deficit debate, and they don’t seem to be sounding any alarm bells about U.S. federal debt.

Tax season is here, and with it comes renewed worries about the effect of recent corporate tax cuts on what is now $16.2 trillion in public debt (including Treasuries held by government accounts, the tally recently passed $22 trillion). The Congressional Budget Office now forecasts that the annual federal budget deficit will grow 15% to $897 billion this year, exceeding $1 trillion in 2022.

Here’s what the Goldman Sachs economists concluded in a note this month: The current path of U.S. deficits is manageable, but “some fiscal prudence—particularly during economic expansions—is likely still warranted.”

The very fact that Goldman Sachs found it necessary to argue for “some fiscal prudence” shows just how radically the government-budgeting discussion has changed in the past decade. During the financial crisis, ambitious fiscal stimulus plans were scaled down after prominent economistswarned that economic growth suffers when a country’s government debt levels exceed 90% of its gross domestic product.

This era is clearly different. The U.S. has introduced fiscal stimulus (in the form of corporate tax cuts) with unemployment near 50-year lows. And the Goldman Sachs note is a response to a few high-profile academics who have recently made the case that governments can sustain larger deficits than previously thought.

One reason for this shift in thinking is the experience of Japan. Its debt has climbed to more than 200% of its GDP with no inflation to speak of, and steady (albeit slow) economic growth.

Another is the growing influence of economists who advocate for “modern monetary theory,” or MMT. Essentially, MMT argues that government spending is constrained by a country’s real resources, not its tax revenues, and says explicitly that governments borrowing in their own currency have no reason to go bankrupt.

Goldman Sachs did not mention MMT in its note, and took a more conservative approach. The bank’s economists focused on the idea that deficits are sustainable as long as interest rates are lower than growth rates, which was discussed by former IMF official Olivier Blanchard in a 2018 paper.

While they didn’t disagree with Blanchard, they warned that interest costs for the U.S. could rise “significantly” if interest rates rise and the deficit grows. If U.S. interest rates are an average 3.75% over the next 30 years, the cost of interest payments could rise to 6% of GDP, up from 2% this year, they found.

U.S. rate increases are not a guarantee, however. It is difficult to imagine that the Federal Reserve would hold short-term rates high if they were hurting economic growth. And when it comes to longer-term yields, “the impact of higher debt levels on rates are somewhat uncertain,” according to the note.

The bank’s economists also argued that high debt levels may “constrain a country’s ability or willingness” to introduce fiscal stimulus in a recession, and that growth could slow afterwards as a result.

But “none of this necessarily means that higher debt-to-GDP is a hard constraint,” they wrote.

What’s more, their results were different for countries that issue debt in their own floating currency.

“When we rerun our analysis restricting to countries that issue debt in their own independent currency the effects are considerably weaker,” they wrote. So their research might not conflict with MMT’s thesis, after all.

That conclusion also fits with Goldman Sachs research on U.S. debt from last September, when the bank said it was “not particularly concerned about the growth or market implications of the U.S. federal debt.”

Write to Alexandra Scaggs at

Michael Scally MD

Doctor of Medicine
Magical thinking
Magical thinking - TheMoneyIllusion

Paul Krugman has a couple of posts criticizing MMT. He tries to be polite, pointing out that at the zero bound their policy recommendations are less bad than those of advocates of austerity. But deep down he must know that this model is sheer madness.

Stephanie Kelton responds, and continues the long MMTer tradition of being unable to provide a clear explanation of the ideas. Here she responds to Krugman’s concern that massive deficits might eventually push the public debt so high that interest rates rise to a level that puts a big burden on taxpayers.

First, “there is a devil in the interest rate assumption,” as economist James K. Galbraith has explained. Preventing a doomsday scenario is not difficult. As Galbraith explains, “the prudent policy conclusion is: keep the projected interest rate down.” Or, putting it more crudely, “It’s the Interest Rate, Stupid!”

And just how is the government supposed to “keep the projected interest rate down”? By magic?

Yes, by magic:

Since interest rates are a policy variable, all the Fed has to do is keep the interest rate below the growth rate (i<g) to prevent the ratio from rising indefinitely. As Galbraith says, “there is no need for radical reductions in future spending plans, or for cuts in Social Security or Medicare benefits to achieve this.”

Rather than presenting this as a problem for functional finance, Krugman should be wondering why the Fed would ever maintain an interest rate that would put the debt on an unsustainable trajectory. I don’t believe it would. If i>g, then debt service grows faster than GDP, which Krugman argues would be inflationary.

So his hypothetical scenario begs the question: Why would an inflation-targeting Fed permit i>g with a debt-to-GDP ratio at 300 percent?

Notice that she doesn’t tell us how the Fed is supposed to keep the market interest rate down. It doesn’t just happen by magic. Market interest rates are not a “policy variable”; they are impacted by various policies. While the Fed directly controls the discount rate and the interest rate on reserves, the rates that really matter are market interest rates on public debt. How does the Fed keep them down?


Michael Scally MD

Doctor of Medicine

A couple of weeks ago, Paul Krugman decided to write about modern monetary theory. He didn’t cite the scholarly literature written by any of the academic MMT economists (books, book chapters, published articles or an abundance of other writings).

Instead, he declared that MMT was pretty much just the economist Abba Lerner’s “Functional Finance” approach from the 1940s and offered a critique of Lerner that he maintained was effectively a critique of MMT. I pushed back, situating modern monetary theory in a broader intellectual history.

Krugman returned, accusing me of moving the goal posts and asking for straightforward answers to four questions. I responded with what I thought was a well-reasoned, respectful and direct set of answers.

So-called “finance twitter” buzzed as the tension between mainstream Keynesian analysis and MMT was put on display. Krugman then took to Twitter with a series of tweets calling my analysis “a mess” and declaring MMT to be “a losing game.” He also reminded us of his own record when it comes to “denouncing austerity policies.”

I want to address what Krugman claims I got wrong and also compare the record.


Michael Scally MD

Doctor of Medicine
Wrong in a very confusing way
Wrong in a very confusing way - TheMoneyIllusion

There are lots of macro models out there: old monetarism, market monetarism, old Keynesianism, new Keynesianism, supply-side economics, Fiscal Theory of the Price Level, NeoFisherism, Austrian, Real Business Cycle, etc., etc. People who believe in one tend to view the others as being at least partly wrong. But where they disagree, it’s usually possible to pin down some specific points of disagreement.

MMT is not like that.

Michael Scally MD

Doctor of Medicine
America’s Most Profitable Export: Money
Opinion | America’s Most Profitable Export: Money

America’s most profitable export product is not oil or medicine or Hollywood movies or Boeing airplanes. It is a small green piece of paper with Benjamin Franklin on the front.

Last year, the United States exported $65.3 billion of its currency — mostly $100 bills.

The world needs an international currency, and the dollar is the obvious candidate because the United States, for all its economic troubles, remains the hub of the global economy. United States government debt is the world’s most popular investment, and the bonds can be purchased only with dollars. Oil is the world’s dominant trade good, and it also is priced and sold in dollars. Much like Facebook, everybody uses dollars because everybody uses dollars.

The popularity of paper dollars, however, requires a little more explanation. Most modern money is notional: Wealth is stored on computers; payments are made electronically.

I cannot remember the last time I owned or even held a $100 bill.

Yet foreign demand for the bills known as Benjamins has surged even as the domestic use of dollars has declined. The number of $100 bills in circulation roughly doubled between 2008 and 2017, and experts estimate a vast majority are in foreign hands.

Remarkably, the Federal Reserve recently reported that at the end of 2017, the number of $100 bills in circulation exceeded the number of $1 bills for the first time.

The available evidence suggests large numbers of $100 bills are stuffed in mattresses or other hiding places — particularly in nations where people lack confidence in the value of the domestic currency, or the integrity of the financial system, or the safety of private property. Dollars are hoarded like diamonds, except dollars are easier to spend.

Even America’s enemies hoard American money: American soldiers searching one of Saddam Hussein’s palaces in 2003 found about $650 million in fresh $100 bills.

The $100 bill is the preferred currency for illegal transactions: gambling, drug deals, sales of weapons. ...

Michael Scally MD

Doctor of Medicine
Should You Fear the Yield Curve?
Bond investors don’t know more than the Fed, but listen to them anyway
Should You Fear the Yield Curve?

10-year Treasury yield falls to a fresh 14-month low as the bond market sours on the US economy
Part of 'yield curve' inverts as 3-month yield tops 10-year rate

U.S. government debt yields added to the week's steep losses on Friday as bond traders lost confidence in the strength of the U.S. and global economies just days after the Federal Reserve downgraded its own forecast.

The recent downturn in long-term debt yields exacerbated inversion of the Treasury yield curve, the plot of interest rates at a set point in time of bonds having equal credit quality but differing maturity dates.

At 8:30 a.m. ET, the yield on the benchmark 10-year Treasury note fell to 2.474 percent, off lows around 2.469 percent, its lowest level since January 2018. The 30-year yield fell to 2.913 percent while the yield on the 2-year Treasury held at 2.47 percent.

Treasury 3m-10y Yield Curve Inverts For First Time Since 2007.


The more closely watched 2-year -10-year spread still positive (though below 10 basis points).



2s minus 10s is all that matters to us finance guys, we could care less what the 3m does. Fed got ahead of itself on rates and now has to stop.

Michael Scally MD

Doctor of Medicine

Recession Outlook Summary
  • Our Recession Probability Model rose across all horizons in the first quarter of 2019. While near-term recession probability is limited, the probability of a recession occurring over the next 24 months has more than doubled.
  • The deterioration in leading indicators, inversion of the yield curve, and tightening of monetary policy all contribute to rising recession risks. As we expect these trends to continue in 2019, we should see recession risk rise throughout the year.
  • We maintain our view that the recession could begin as early as the first half of 2020, but will be watching for signs that the dovish pivot by the Federal Reserve (Fed) could extend the cycle.
  • The next recession will not be as severe as the last one, but it could be more prolonged than usual because policymakers at home and abroad have limited tools to fight the downturn.
  • Credit markets are likely to be hit harder than usual in the recession. This stems from the record high ratio of corporate debt to GDP and the likelihood of a massive fallen angel wave.
  • When recessions hit, the magnitude of the associated bear market in stocks is driven by how high valuations were in the preceding bull market. Given that valuations reached elevated levels in this cycle, we expect a severe bear market of 40–50 percent in the next recession.

Michael Scally MD

Doctor of Medicine
BLACKROCK: "There is not enough monetary policy space to deal with the next downturn: The current policy space for global central banks is limited and will not be enough to respond to a significant, let alone a dramatic, downturn."

Dealing with the next downturn: From unconventional monetary policy to unprecedented policy coordination


Unprecedented policies will be needed to respond to the next economic downturn. Monetary policy is almost exhausted as global interest rates plunge towards zero or below. Fiscal policy on its own will struggle to provide major stimulus in a timely fashion given high debt levels and the typical lags with implementation. Without a clear framework in place, policymakers will inevitably find themselves blurring the boundaries between fiscal and monetary policies. This threatens the hard-won credibility of policy institutions and could open the door to uncontrolled fiscal spending.

This paper outlines the contours of a framework to mitigate this risk so as to enable an unprecedented coordination through a monetary-financed fiscal facility. Activated, funded and closed by the central bank to achieve an explicit inflation objective, the facility would be deployed by the fiscal authority.

• There is not enough monetary policy space to deal with the next downturn: The current policy space for global central banks is limited and will not be enough to respond to a significant, let alone a dramatic, downturn. Conventional and unconventional monetary policy works primarily through the stimulative impact of lower short-term and long-term interest rates. This channel is almost tapped out: One-third of the developed market government bond and investment grade universe now has negative yields, and global bond yields are closing in on their potential floor. Further support cannot rely on interest rates falling.

• Fiscal policy should play a greater role but is unlikely to be effective on its own: Fiscal policy can stimulate activity without relying on interest rates going lower – and globally there is a strong case for spending on infrastructure, education and renewable energy with the objective of elevating potential growth. The current low-rate environment also creates greater fiscal space. But fiscal policy is typically not nimble enough, and there are limits to what it can achieve on its own. With global debt at record levels, major fiscal stimulus could raise interest rates or stoke expectations of future fiscal consolidation, undercutting and perhaps even eliminating its stimulative boost.

• A soft form of coordination would help ensure that monetary and fiscal policy are both providing stimulus rather than working in opposite directions, as has often been the case in the post-crisis period. This experience suggests that there is room for a better policy – and yet simply hoping for such an outcome will probably not be enough.

• An unprecedented response is needed when monetary policy is exhausted and fiscal policy alone is not enough. That response will likely involve “going direct”: Going direct means the central bank finding ways to get central bank money directly in the hands of public and private sector spenders. Going direct, which can be organised in a variety of different ways, works by: 1) bypassing the interest rate channel when this traditional central bank toolkit is exhausted, and; 2) enforcing policy coordination so that the fiscal expansion does not lead to an offsetting increase in interest rates.

• An extreme form of “going direct” would be an explicit and permanent monetary financing of a fiscal expansion, or so-called helicopter money. Explicit monetary financing in sufficient size will push up inflation. Without explicit boundaries, however, it would undermine institutional credibility and could lead to uncontrolled fiscal spending.

• A practical way of “going direct” would need to deliver the following: 1) defining the unusual circumstances that would call for such unusual coordination; 2) in those circumstances, an explicit inflation objective that fiscal and monetary authorities are jointly held accountable for achieving; 3) a mechanism that enables nimble deployment of productive fiscal policy, and; 4) a clear exit strategy. Such a mechanism could take the form of a standing emergency fiscal facility. It would be a permanent set-up but would be only activated when monetary policy is tapped out and inflation is expected to systematically undershoot its target over the policy horizon.

• The size of this facility would be determined by the central bank and calibrated to achieve the inflation objective, which could include making up for past inflation misses. Once medium-term trend inflation is back at target and monetary policy space is regained, the facility would be closed. Importantly, such a set-up helps preserve central bank independence and credibility.

Michael Scally MD

Doctor of Medicine
The Last Recession?
The Last Recession? – Nature Bats Last

Technically, we are not headed into a recession, not even a brutal one. We are in the midst of the Greatest Depression. All this chatter about the coming recession from the corporate whores corporate media is clearly intended as a distraction. The industrial economy never recovered from the Global Financial Crisis of 2008-2009. Nor will it, despite clever attempts to “paper over” financial challenges with a wide array of tricks rooted in monetary policy.

The Limits to Growth have arrived, as forecast in 1972. The notion that we can experience infinite growth on a finite planet is believed only by fools and economists (and I repeat myself).

The Federal Reserve and equivalent banking systems around the world work with the governments of the world to maintain the illusion of a healthy economy. This approach has the unaware masses in the United States believing all is well with the infinite-growth paradigm, although the industrial economy is quite obviously in poor condition. This system of lies, which the masses really want to believe, keeps the populace steadily grinding away on the Treadmill of MiseryTM so that the banksters can continue to enjoy their enormous privilege. George Carlin calls these latter people our owners.

Michael Scally MD

Doctor of Medicine

Campbell Harvey is a Professor at Duke University and a partner as Research Affiliates. He sat down with Michael Batnick and Josh Brown of Ritholtz Wealth Management to discuss the meaning of the inverted yield curve indicator, which he discovered in 1986 while working on a dissertation.

Campbell cites the fact that 7 out of the last 7 recessions had been presaged by a yield curve inversion - which is what happens when it longer term bond yields fall below shorter term bond yields in the Treasury market. He believes that this phenomenon occurs when the market participants begin to grow more pessimistic about the economic outlook. The behavior of executives, lenders, borrowers and investors can change enough during these times to actually become a self-fulfilling prophecy - producing a negative feedback loop that drives a weakening economy into a full-blown recession.

Recessions are a normal part of the business cycle, although they can be painful to live and invest through. They can also vary greatly be degree. Campbell fields questions from Michael and Josh about all of the ways in which this time might be different. He acknowledges that it is always possible that the yield curve indicator might stop working as a recession signal, but he believes that because it hasn't yet, this might be a good time for people and corporations to rethink the risks they're taking.

Michael Scally MD

Doctor of Medicine
Topic: The Armageddonists

While recessions and bear markets are a fact of life, something peculiar happened after the Global Financial Crisis: the rise of the Armageddonists, which refers to the market-watchers, forecasters and money managers whose apocalyptic comments spread like wildfire in print and online financial news. I understand why: by 2010, investors had experienced two consecutive bear markets, each with equity declines of over 40%. It took several years for equity markets to recover each time, unlike the shallower, faster-recovering bear markets of the 1960’s and 1980’s. The dismal performance of consecutive 2001/2008 bear markets hadn’t been seen in decades, and is only comparable to parts of the Great Depression.

I also understand that mega-bearish news appeals to human negativity bias, a topic examined by Nobel Prize winner Daniel Kahneman in his 2011 book on the brain and human survival instincts1, by political scientist Stuart Soroka who has illustrated the inverse relationship between magazine sales and the positivity of a magazine’s cover2, and in a 2014 experiment in which a city newspaper lost two thirds of its readers on a day when it deliberately only published positive news.

That said, what are the consequences for investors that reacted to dire Armageddonist predictions which have flooded the airwaves and internet since 2010?


Member Supporter
@Michael Scally MD I wrote a piece on this very topic. The majority of financial media (and the general media) promote fear-based stories and topics of discussion. Simply put, it sells and gets the audiences attention. History is littered with prognosticators calling for the end of time. Heck, scroll back through all the posted topics in just this thread. I’m not saying that all these stories are false alarms. It’s the challenge of investors to determine what news matters and what does not.

What all this leads to is the very real situation of talking ourselves into a recession. If you heard enough talk of a recession on the news, tv, your phone, gossip from other individuals, you may start thinking that a recession is coming. As a consumer, your first reaction is to slightly cut your consumption - as simple as going out to eat one less time per month than you normally would. If enough of us consumers behave this way, and there are millions of us, it will lead to smaller profits for businesses and higher unemployment. Thus, recession.

Now thinking ahead, we have a presidential election happening this time next year. The media hates the President. People vote based on how they feel at the moment they vote. If you are employed and generally in a good spot in your life, you are less likely to vote out the guy in office. The opposite is also true. So, don’t be surprised to start to hear the media beat the recession drum this coming summer (just before the election).


Member Supporter
The meltup in the U.S. stock markets can be now attributed to one event - the very likely re-election of Trump later this year. Impeachment - markets up. Post-Democratic debates - market up. Delivery of articles to the Senate - market up. The markets are a very powerful discounting mechanism.

Use this to your advantage.

Michael Scally MD

Doctor of Medicine
There’s a 70% chance of recession in the next six months, new study from MIT and State Street finds
There's a 70% chance of recession in the next six months, new study from MIT and State Street finds
  • A new study from the MIT Sloan School of Management and State Street Associate says there’s a 70% chance that a recession will occur in the next six months.
  • The researches used a scientific approach initially developed to measure human skulls to determine how the relationship of four factors compares to prior recessions.
  • The index currently stands at 76%. Looking at data back to 1916, the researchers found that once the index topped 70%, the likelihood of a recession rose to 70%.
There’s a 70% chance that a recession will hit in the next six months, according to new research from the MIT Sloan School of Management and State Street Associates.

The researchers created an index comprised of four factors and then used the Mahalanobis distance — a measure initially used to analyze human skulls — to determine how current market conditions compare to prior recessions.

“The Mahalanobis distance was originally conceived to measure the statistical similarity of the values of a set of dimensions for a given skull to the average values of those dimensions for a chosen group of skulls,” the researchers explained.

It measures the distance between a point and a certain distribution.

Using this principle, the researchers analyzed four market factors — industrial production, nonfarm payrolls, stock market return and the slope of the yield curve — on a monthly basis. They then measured how the current relationship between the four metrics compares to historical readings.

What Method Implies 80% Probability of Recession by Nov 2020?
What Method Implies 80% Probability of Recession by Nov 2020? | Econbrowser

Kinlaw, William B. and Kritzman, Mark and Turkington, David, A New Index of the Business Cycle (January 15, 2020). MIT Sloan Research Paper No. 5908-20. Available at SSRN: A New Index of the Business Cycle by William B. Kinlaw, Mark Kritzman, David Turkington :: SSRN or A New Index of the Business Cycle by William B. Kinlaw, Mark Kritzman, David Turkington :: SSRN

The authors introduce a new index of the business cycle that uses the Mahalanobis distance to measure the statistical similarity of current economic conditions to past episodes of recession and robust growth. Their index has several important features that distinguish it from the Conference Board’s leading, coincident, and lagging indicators. It is efficient because as a single index it conveys reliable information about the path of the business cycle. Their index gives an independent assessment of the state of the economy because it is constructed from variables that are different than those used by the NBER to identify recessions. It is strictly data driven; hence, it is unaffected by human bias or persuasion. It gives an objective assessment of the business cycle because it is expressed in units of statistical likelihood. And it explicitly accounts for the interaction, along with the level, of the economic variables from which it is constructed.

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