Elon Musk's (mis) understanding of economics

In this interview with Sean Hannity, Elon Musk shows his understanding of economics is not grounded in the real world.  His two main points in this clip focus on inflation and interest rates.  His explanation of inflation relates to one of Milton Friedman's old dictums: "Inflation is caused by too much money chasing too few goods".  As I used to tell my students, this says everything and nothing.  I'll address this simpleton's guide to inflation in a future post.  

Here, I want to focus on his second point, that interest rates are high because of large government deficits. As Musk suggests, if we simply lower those deficits, then interest rates will come down. The problem with this view is the evidence is extremely weak, as can be seen in the figure below.  The figure shows the relationship between government deficits as a percent of GDP (right side scale) and the 10-year US treasury interest rate (left side scale).  According to Musk, as deficits get larger (a drop in the green line here), interest rates should rise (the blue line) because "government borrowing competes with the private sector for scarce funds".  If this is the case, the lines should move in opposite directions; instead, they move (roughly) together.  For example, since 2020, deficits have declined as a share of GDP but the 10-year interest rate has been increasing.

In the economics literature, this relationship is known as crowding out, which suggests government borrowing "crowds out" private sector borrowing by causing interest rates to rise when it competes for limited funds in capital markets.  However, more often than not, larger deficits are associated with falling interest rates.  

So, why is Musk (along with many economists) wrongheaded on this point?  For one, in my view, the most important factor influencing long-term interest rates is inflation and expectations of future inflation. For example, from 2012 to 2019, the 10-year rate hovered between 2-3% because inflation hovered around 2%, and was expected to remain low.  In 2020, the Covid shock caused inflation to increase, leading to an increase in the 10-year rate.  The 10-year rate never went as high as the inflation rate, because investors expected the inflation shock was temporary, as it turned out to be.  

If inflation and expectations are the primary factor moving long-term rates, then there is a mechanism for how cutting deficits could lower the 10-year rate, but it's due to the impact deficits have on growth and inflation. As an economy grows and incomes are rising, deficits naturally fall, as tax revenues are rising. However, if a government decides to slash and burn based on a false belief "we need to balance our budgets", then these austerity measures can cause a reduction in growth, if not a recession.  This piece shows the austerity policies pushed by EU countries after the 2008 crisis "negatively affect(ed) economic performance by reducing GDP, inflation, consumption, and investment".  In other words, the main way Musk's view would be right is because cutting deficits would lead to lower growth or a recession, which would then cause inflation and interest rates to a decline.  Most inflations are tamed via recessions.

Relatedly, in this view, the impact government deficits have on long-term interest rates has more to do with how those deficits might impact inflation and not so much on the demand for scarce funds in the capital markets.  In the next post, I will explain why government deficits (mostly) have little impact on interest rates which is related to the somewhat controversial view of Modern Monetary Theory.

https://x.com/elonmusk/st9330434

https://x.com/elonmusk/status/1892443739949330434

Un-retiring...

 I retired from my academic position as of September 1, 2024.  Now that I am a man of leisure, I intend to re-activate my blog. While much of what I previously wrote focused on economics, especially the oil market, I intend to include more writing on "political" economy going forward (or left....:-), emphasis on political.  We are in strange (interesting) times in this world, and I know a majority of the population has been fed information that is designed to support the political status quo, which is designed to keep us in endless, costly wars to enrich themselves.  It will be interesting to see if Trump indeed tries to break from these entrenched interests, or if he is simply the con that many believe?

So, Happy New Year all! 

I'm looking forward to much more blogging activity in 2025.

One last "I told you so"...

While I did not formally make a prediction on oil prices this year, the same forces I've described have continued to play out: since the WTI oil market is dominated by speculators, every attempt to push prices higher ends in a collapse when inventories "unexpectedly" rise. 

In mid April, based on geopolitical issues, WTI was trending toward $70, driven by speculative bulls of course.   As inventories started rising, the bulls pulled back starting in late April.  And now, as this Wall Street Journal article suggests, oil is on the verge of a bear market, approaching $50.

Despite our president's attempt to extol the virtues of "molecules of freedom," fossil fuels, oil especially, are facing long term headwinds of green energy that will keep prices in check.  However, I doubt this will dispel the best efforts of Hedge Fund speculators to hype another oil bubble....

Good luck fellas.

It's so predictable..

Just see my last post, "Lather, rinse, repeat."  While there has been geopolitical turmoil, the Iran sanctions, the problem is STILL investors--Hedge Funds--driving prices up to quickly, beyond CURRENT fundamentals, leading to inventory builds. 

Take note: a good sell signal is when so-called "analysts" claim oil will hit $100/barrel again.  They are much like bitcoin and gold enthusiasts who need additional buyers to maintain their ponzi scheme, so they can bail and take profits...

Lather, Rinse, Repeat...

Nothing earth-shattering to report; it's the same 'ol, same 'ol....

After breaching $70--the top end of my prediction for WTI this year, we are now seeing the usual pull-back in prices which is, as usual, being driven by Hedge Funds. As it became apparent a peak was reached in mid-July (just over $74), the hedgies unloaded 178 million (paper) barrels of oil the week of July 17th (see this Reuters article). 

Adding insult to injury, this week's inventory data showed an unexpected rise: the "consensus" was a draw of about 2.5 million barrels, however inventories rose by 6.8 million, which was the third increase in the past five weeks.

As we move out of the summer driving season, I think it's safe to say WTI will remain in my predicted trading range for the remainder of the year (always with the caveat no unexpected geopolitical event occurs...).

Moving forward, I have been meaning to write some posts on the economy in general.  As I mentioned in a previous post, I expect a recession sometime in late 2019 or early 2020.  I will expand on those thoughts in the near future.

A brief Oil Market brief

Having recently just eclipsed the $70 high end of my price range, WTI appears to be receding back into range. According to a Reuters article today:

 "A sea of red is washing over the energy complex as rising U.S. production coupled with a looming relaxation in OPEC-led cuts sends bulls scurrying for the exits," said Stephen Brennock, analyst at London brokerage PVM Oil Associates.

In addition, the article notes the most recent COT report shows that Hedge Funds have decreased their long positions, which signals they believe the price rise has run its course. This belief is based on the above noted recent increases in oil output by both US shale and OPEC, specifically the Saudis and Russians are relaxing the production cuts that were put in place a year ago to help re-balance global markets.

Barring further geopolitical issues (the odds of which are getting higher that one will occur with Iran!), WTI prices should remain on the high side of my range, from $60-$70.

Trump and the Jimmy Carter Experience

WTI oil has breached the $70 mark, the high point of my 2018 range.  As with any prediction, one can't forecast "events" that influence prices. The oil market is probably the most notorious market for having political events influence significant market moves. While the fundamentals have caused prices to move above $60, the $70 breach is a consequence of Trump's decision to abrogate the Iran nuclear deal.  This was a no-brainer to predict, as Trump is so easy to manipulate, especially for a puppet master like  Netanyahu (Iran is the big prize for Neocons and Israel).

Interestingly, there was a fairly significant rise in oil inventory last week, and if today's data show another build, then prices will be pitted between the fundamentals and the geopolitics. Fundamentals will win in the long run, but the geopolitics can wreak havoc on supply in the short run. That said, Trump's decision is going to compound the economic issues surrounding his re-election bid for 2020. I've predicted (elsewhere) that his tax cuts and spending increases near the end of the business cycle will lead to a recession toward the end of 2019.  In my view, the juiced up economy will cause the Fed to raise rates faster than expected, generating a slowdown as we move into the 2020 election cycle.  However, if the decision to rescind the Iran deal maintains oil prices above $70, higher gasoline prices will take a bite out of the tax cut stimulus.

One way (high interest rates) or another (high gas prices), the US economy is in for a slowdown when 2020 rolls around.  If this is the case, Trump might have a "Jimmy Carter experience."  In 1979, Carter appointed Paul Volcker as Chair of the Fed, and while he initially supported Volcker's policy (higher interest rates) to restrain inflation, realizing the impact would hit during the 1980 election year, he pushed Volcker to reverse policy, too late of course...