A Virtue of the Modern Monetary Theory: A Global Macro COT Report for Dollars
Wouldn’t it be lovely if there were a commitment of traders report for the entire economy? Well, there is one: it’s described by the Modern Monetary Theory (MMT).
Money is the lifeblood of an economy. If you trade anything, you’re probably trading money as well. Money is to profit-seeking individuals as the sea is to fish. So, as a contrarian global-macro investor, you’ve got to be concerned with the monetary system. COT reports document what certain groups of traders are doing at any given time. They tell you who’s long and who’s short. The MMT provides a framework for understanding who’s short money and who’s long money. The groups used in the MMT framework are; the private sector, the government sector and the external sector.
Hang on, what does it mean to be ‘short money’?
Lets quickly review what shorting a stock involves. One borrows a stock, sells it for dollars, and hopes that the (dollar) price of the stock falls. That is, one hopes that dollars appreciate against stocks. Now consider any debt taken out against any item. One borrows money and sells it for – say – a house. One then hopes that the (house) price of dollars falls. That is, one hopes that the house appreciates against dollars. You see, there is a symmetry in all prices, (in my opinion) money shouldn’t be enshrined in the realm of the preconceived. If this is understood, it should be clear that debt is a short position on money. Just as with any other short position, it must be closed out at some point via a reversal of one’s position. In other words, you have to buy back money (‘sell things’). In our peculiar stage of history, people have – en masse – engaged in the ‘short money long house’ trade. They have aimed to close that position via selling their labor services (i.e. working in a job) over a long stretch of time.
[Understanding the above gives us a glorious insight into the optionality of the famous Paulson trade. While virtually all of the US (and the world) were engaged in the ‘short money long house’ trade, he went ‘long money short house’. The beauty of it was that he was opposing (implicit) traders that were unaware of the fact that they were trading! In the spirit of a true contrarian, he didn’t need to formulate a self-generated ‘vision’ of the future. Rather, he simply found asymmetry in betting that the consensual ‘vision’ of the future might be incorrect (‘houses always go up’).]
Sectoral Balances in the MMT Framework:
So, the MMT gives us a clear and interesting context. We can find out – in a very broad sense - who’s long and short dollars and how long and short they are. As contrarian investors, we should ask the usual questions: who’s long and who’s short? Why did they execute their positions? Who’s execution decisions were based on false and/or dogmatic premises? Who’s got the weak hand? Who’s going to give up their position first? Could the implication be a cascading set of trades?
The typical chart that is shown by the MMT protagonists is something like this:
However, I think that this is slightly misleading. It includes the Federal Reserve (a supplier of an irredeemable fiat currency) in the ‘Private Sector’. In my mind, the Federal Reserve is not – in any intelligible sense – part of the private sector. The Federal Reserve doesn’t have a profit-motive. They don’t have to buy or sell anything to pursue a profit. Furthermore, the above chart might tempt one to believe that the private sector has comfortably adjusted its imbalances and is ready to re-lever. Thus, I have made a chart that plots the Fed’s holdings of government debt and uses the remainder to determine the ‘true’ private sector [note: I would do the same for foreign central banks if I had the data]:
Suddenly, things aint looking so rosy, right? This chart captures the historically huge short-dollar position that culminated in the 2000 TMT bubble. Let me briefly answer some of the questions posed above: Ever since then, the tendency has been toward an unwinding of those short dollar positions. The government sector – which is the antithesis of a profit-seeker – has been taking the other side to those unwinding positions to ‘ease the squeeze’. However, there have been periods of time where traders (including ordinary people) have been executing on the other side of this long-term trend (i.e. taking on debt). The results have been evident over the past decade, with epic (but brief!) ‘bubbles’ in real estate, Oil, the Dow, Junk debt, etc. In my opinion, such miniture bubbles have been against trend, and thus each of them have been opportunities to oppose people who were going to have to give up their longs (once they capitulate into the long-term trend). Particularly during the past two years, we’ve seen capitulation after capitulation into long-positions as the market has cunningly ticked higher. This leaves a prospect for a profound cascading of trades that leaves people saying; ‘Gosh, I was right at the start after all!’.
However, there’s more…
This isn’t like a normal futures market. The old adage “He who sells what isn’t his’n, Must buy it back or go to pris’n” doesn’t apply here. In the futures markets, a short squeeze is a frequent occurrence that is regarded as part of the game. In the macro world, a short squeeze in dollars is usually deemed so unacceptable that the yardstick is altered to ‘ease the squeeze’. When people are forced to buy back the dollars that they sold short (all at once), the ‘social costs’ are usually deemed to be so unpalatable that the appointed leaders change the terms of the original contract: they debauch the dollar. I am not saying this to complain, rather, I am pointing out that this feature must be taken into account by the contrarian speculator. We’re here to get rich. We’re not here to wish that people didn’t do certain things. [The analogy to the futures markets is this: Suppose that some certain group of people get caught in a vicious short squeeze in – say – copper. For whatever reason, the exchange owners allow those who are short to only deliver half of the original contract. Their woes are thus alleviated. The goal-posts have been moved.]
My hunch is that the people that have taken long equities positions in the late end of this particular rally will have to give up soon. In particular, I think it’ll pay to oppose those who consider QE2 to be ultra-loose monetary policy. In my opinion, it is more like an attempted clean-up operation. Perhaps they’ll call it QE minus 1 in years to come?
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012