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Rather obviously, the world in its entirety cannot be in debt, let alone drowning in the stuff

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debtDebts have continued to build  up over the last eight years and they have reached such levels in every part of the world that they have become a po- tent cause  for mischief,” according to William  White, former chief  economist at the Bank  for International  Settlements in  an interview for the Daily Telegraph on January 20. According to White, “the situation is worse than it was in 2007.  Our macroeconomic ammunition to fight downturns is essentially all used up.” White’s pessimism chimes with warnings from Goldman Sachs last year. Andrew Wilson, chief executive of one of its fund management businesses, was reported on May 26, again  in the Daily Telegraph, as saying  that excessive debt represents “a risk to economies” and is a “major issue”. Specifically,  in mature industrial nations populations are ageing  and  the proportion of working-age people to the total population is falling, presenting “us” with the question of how “we” are “going to pay down the huge debt burden”. The combination of the Bank for International Settlements, Goldman Sachs and the Daily  Telegraph ought to be intellectually overwhelming. But they have  indulged in rhetoric and used words sloppily.  To whom does “us” refer? Who exactly are “we”? And, although the image of “the world drowning in debt” is often invoked, what is it supposed to mean?  

Money matters: post-Great Recession reappraisal

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Evidence from the  years  of the  Great Recession justify renewed attention to  a broadly defined concept  of the quantity of money  in central  bank  research

money mattersControversy  over the use of monetary aggregates undermined the impact of the monetarist  counter-revolution  of the  1970s and early  1980s. Top central  bankers  accepted  Milton  Friedman's   dictum  "money  matters" was  valid  in some  sense,  but  they were  unsure  exactly  how  and why it mattered. Practical application was elusive when their research departments produced data on half-a-dozen  monetary aggregates.  Which concept  of money was of greatest  importance  -  or at any rate of some relevance - to the determination  of macroeconomic  outcomes? Anthony Harris,  one of the Financial  Times' leading commentators,  compared the quarrel to that between the 'Big-endians'    and 'Little-endians'    about the best way to open a boiled egg in Jonathan  Swift's  Gulliver's  Travels. Some economists  favoured  'broad  money',  which included  all bank deposits  and  occasionally  even  included  liquid  assets  that  had  arisen outside  the  banking   system.    Others  supported   'narrow   money'    -   generally taken  to mean  notes  and coins  in circulation  plus   sight deposits.  The majority of monetary  economists  did not regard the monetary  base (the liabilities  of the central bank) as equivalent  to 'the  quantity  of money'  based on any definition. Instead,  they believed   the change  in the base  influenced  the change  in narrow money  and  hence  affected  expenditure   at  a  further  remove.   However,   some participants  in the debate thought that the monetary  base by itself, regardless  of its role in banks'  creation  of money,  had a significant  bearing  on spending  and the economy.  

Comments on UK monetary policy and its global context

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The following note – or rather set of notelets – is heavily based on my latest submission to the Shadow Monetary Policy Committee, a body set up by the Institute of Economic Affairs in July 1997. In my comments on the UK, I argue that recent monetary trends argue for the validity of the monetary theory of national income determination. Hence, they do not justify alarmism about the inflation outlook, although it is true that the supply-side performance of the UK economy has been poor in recent years. This has been a key reason that low growth of national output in nominal terms has been accompanied by disappointing inflation numbers. I also discuss output growth trends at the world level, to see whether similar concerns about supply-side performance apply more generally. The results came as a bit of a surprise. Of course it is well-known that growth was strong in the global boom of 2004 – 07. In fact, the global boom of 2004 – 07 was the most powerful since that of the early 1970s, which also had to be aborted as rising commodity prices were accompanied by a more general inflation problem. 2009 was the first year since the Second World War in which world output fell. However, the last decade has in fact been an outstanding one for growth. Despite the 2009 dip, the ten years to 2012 saw an average annual growth rate of output of 3.8%. That is a fantastic rate of growth by any past standards. (A 3.8% annual rise in real incomes would imply an almost 14-fold rise in a lifetime of 70 years.)  

Will the Draghi bazooka boost Eurozone M3 growth?

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Mario Draghi became president of the European Central Bank on 1st November, 2011, at a critical moment for the euro. Banks – particularly banks in the Club Med countries (i.e., Italy, Spain, Greece) – were having difficulty rolling over their inter-bank lines. As the lines matured with little prospect of renewal, the banks were being forced to sell liquid assets. As these included bonds issued by Club Med countries, the price of the bonds fell and their yield increased. A surge in Italian and Spanish government bond yields was taken to constitute “the  Eurozone  sovereign  debt  crisis”.  The  media  were  full  of  talk  of  “a bazooka” of some sort to bring the crisis to an end. In October last year such talk usually focussed on the expansion of the European Financial Stability Facility,  a  back-up  fund with  resources  provided  by all  Eurozone  member states and able to extend credit to particularly hard-pressed governments. A widely-held view was that the EFSF might need to exceed 900b. euros, or even 2,500b. euros, if it were to have the fire-power to meet the crisis. In the event, negotiations for the EFSF have not got far enough, while its credibility in financial markets has been undermined by the credit rating agencies’ downgrading of several member states. But Draghi has found a big, powerful bazooka and aimed it with precision. Between 4th November 2011 and 20th January 2012 the ECB’s lending to banks has jumped from 580.0b. euros to 831.7b. euros, or by over 43%. The new lending has taken the form mostly of three-year facilities at 1%, which – on the face of it – are extraordinarily privileged loan arrangements for the banks. Further large expansion of such lending  is  to  be  envisaged.  The  banks  have  stopped  selling  government bonds, the yields on Italian and Spanish bonds have fallen, and the sovereign debt crisis is over, at least for the time being. This weekly e-mail analyses the effect of the Draghi bazooka on Eurozone M3 growth, because of the importance of money to macroeconomic outcomes more generally.  

US equity market still running on empty

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In my e-mail note of 8th April I argued that the bull market was “running on empty”. The argument was that the nominal level of equity prices could be viewed as the product of

  1. The quantity of money allocated to equity funds by investors, and
  2. ii. Equity fund managers’ desired ratio of money to their total assets (i.e., their “bullishness” or “bearishness”, or indeed their “liquidity preferences”, as Keynes would have put it).
(This formulation was a little naive and begs many questions, but it gets the ideas over.) My worry in that note was that in the USA the bull market from March 2009 had depended almost entirely on a fall in fund managers’ desired ratio of money to assets (i.e., on medium-term bullish sentiment). Money growth had been negligible at best since early 2009. On some measures – such as the old “M3”, no longer published by the Fed, but easily enough guesstimated – the quantity of money had in fact started to fall in late 2009. Since peaking in late April, most equity markets (including the US market) are off by about 10% and are lower than at the time of the 8th April note. Of course many other factors influence the direction of markets, with alarm about the potential break-up of the Eurozone certainly being a major negative at present. However, I thought it worthwhile in this weekly e-mail to update the numbers in the 8th April note. The main point is straightforward, that the US banking system remains gripped in a regulatory vice which has stopped it from expanding. M2 is going sideways, while M3 – which consists of M2 plus other money balances (notably the “institutional money funds” which are the main form of cash for the USA’s long-term savings institutions) – continues to fall. So the US equity market is still “running on empty”. Perhaps most worrying of all, there is little evidence that the Federal Reserve’s research effort pays much, if any, attention to the money trends which I have been analysing.  

Inflation nuttiness in the ECB

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Consumer prices in the Eurozone were static for most of 2009, but the latest annual rate of change has been affected by large increases in oil and other energy prices. The price of crude oil virtually doubled in the year to December 2009/January 2010, as the OPEC member states restored production discipline after the mayhem of late 2008. Despite the oil and energy price movements, the increase in Eurozone consumer prices (i.e., “prices in the shops”, roughly) in the year to February was only 0.9%, while in the year to January producer prices (i.e., “prices at factory gates”) were down 1.0%. Underlying inflation pressures are non-existent. In fact, over the next few months more companies plan to cut prices than to raise them. Regardless of fact, some economists are always worried about a future rise in inflation. The late Lord George, governor of the Bank of England from 1993 to 2003, famously ridiculed such people as “inflation nutters”. A recent speech given by Jurgen Stark, the ECB director responsible for economic and monetary analysis (i.e., “the ECB’s chief economist”), has to be described as a bad case of “inflation nuttiness”. Despite a reputation as an economist who believes in the macroeconomic importance of the quantity of money, the speech (given on the 16th March to the European Parliament) said almost nothing about the current collapse in Eurozone money growth. It did not draw the conclusion that the – largely because the M3 money measure has not changed in the last year – the Eurozone could face deflation in late 2010 and 2011. Many Eurozone banks are still anxious that they would be unable to fund their assets if the ECB withdrew its refinancing facilities. Stark’s message – that these facilities, which he termed “non-standard measures”, must be phased out “to avoid risks to price stability at a later stage” – must be characterised as inflation nuttiness of a high order.  

The effects of throwing money at a large number of apparently deserving causes are self-cancelling

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Britain must produce as much food as possible," Hilary Benn, Secretary of State for the Environ­ment, Food and Rural Affairs, told the Ox­ford Farming Conference in January. For Mr. Benn, who rounded off the proposition by adding "no ifs, no buts", nothing could be more obvious. Wasn't Mr. Benn uttering a mere platitude? Who would dispute that every nation must produce "as much as pos­sible", the maximum, of everything? Well, Adam Smith, the founder of eco­nomics, would. His key argument in the Wealth of Nations, published in 1776, was that a nation had a finite quantity of resourc­es, which were to be allocated between in­dustries in the most efficient way. Although that may sound banal, it quickly leads to the refutation of Mr. Benn's maximization idea. In his chapter "Of restraints upon the im­portation from foreign countries of such goods as can be produced at home", in book IV of the Wealth of Nations, Smith conjures up the image of wine-making in Scotland. "By means of glasses, hotbeds and hot walls, very good grapes can be raised in Scotland, and very good wine too can be made of them."  

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