March and April have seen a marked 70% rebound in the oil price from the January lows of about $26 a barrel. The move owes much to the dynamics of the energy market itself, but it is being interpreted by financial markets as a sign that global demand should be sufficient to deliver at least trend growth (say, 3% - 3½%) in world output in 2016. The mood has changed sharply from January’s alarmist hysteria, much of it due to so-called “analyses” from the Bank for International Settlements, the International Monetary Fund and leading investment banks. (These organizations ought to have known better, bluntly.) The line taken in International Monetary Research Ltd. notes has been that recession in 2016 is extremely unlikely. Only hopelessly incompetent monetary policy decisions could cause a recession to start from a situation in which upward pressures on inflation have been and remains weak, and the price level has been and remains more or less stable. I don’t have much respect for the top brass in the major relevant institutions (i.e., the Fed, the ECB, etc.). But, to initiate a recession, they would have had to be yet crasser than they were in the last period of idiocy, in late 2008. In practice, the absence of upward pressures on the price level has allowed significant monetary-policy easing in China and the Eurozone. It seems that in China M2 growth has run about 1% - 1½% a month (i.e., at annualised rates of 13% - 20%) in early 2016. In the four major developed “countries” (i.e., taking the Eurozone as a country) – the USA, the Eurozone, Japan and the UK – the annual rates of broad money growth are currently 3.9%, 5.0%, 2.6% and 4.5%, and the three-month annualised growth rates are 5.1%, 4.4%, 2.8% and 5.0%. If asked for an ideal rate of money growth, Milton Friedman would typically reply – at least for the USA – “5% a year”. The Bank of Japan seems unable to see the light in the “broad money vs. monetary base” debate. But in truth money growth trends in the main countries are not far from perfection at present.
More on the structural flaws of the EurozoneThe following note is in response to the call for evidence on ‘”Genuine Economic and Monetary Union” and its implications for the UK’ from the House of Lords’ European Union Committee, made on 24th April 2013. The main points of the note are
- banks’ risks of future loss, and hence their need for capital to protect depositors, depend heavily on future movements in asset prices, since these asset price movements determine the value of loan collateral,
- ii. a single set of capital rules (such as the Basle III rules now being imposed on advanced country banking systems) cannot be appropriate for all countries at all times, and undermines the flexibility of national regulators to deal with specifically national problems,
- banks’ loan losses in the Eurozone periphery nations are so large that depositors can be repaid in full only by capital injections from the state which affect these nations’ credit rating,
- the interaction between banks’ solvency problems and their host nations’ sovereign default risk has created a vicious downward spiral of fiscal and monetary retrenchment, and losses of output and employment, and
- this downward spiral is much worse than in a traditional monetary jurisdiction because governments in a multi-government monetary union such as the Eurozone cannot borrow from the central bank
Four years ago, at the worst point in the Great Recession, several leading American economic gurus said that the Fed’s easy monetary policy risked higher inflation which might imperil the recovery. In some of the early commentaries from International Monetary Research (in the spring and summer of 2009), I argued that these gurus – who included the revered Alan Greenspan and Martin Feldstein, a prominent adviser to President Reagan – were seeing ‘ghosts’. I brought together evidence from earlier recoveries to show that the typical US recovery was accompanied by the continuation of low inflation and indeed often by falling inflation. In other words, the macro news tended to be excellent during recoveries, with above-trend growth in output and profits associated with declines in inflation. This sort of macro backdrop usually saw strong gains in equity prices. Monetary policy is nearly always controversial, and the last four years have seen even more bitter and intense controversies than usual. Expansionary open market operations of a traditional kind have been labelled ‘quantitative easing’, and described as ‘unconventional’ and innovatory. Silly rants – such as those from Liam Halligan in his Sunday Telegraph column – have claimed that by its very nature QE (and regardless of the quantities and timing involved) is inflationary, redolent of ‘banana republics’, ‘the last refuge of dying empires’, etc. In fact, QE has barely failed to offset the contractive effect on money growth of tighter bank regulation and officialdom’s determination to raise banks’ capital/asset ratios. Anyhow, the latest American data show that inflation is under good control, and is in fact much lower than in 2007 and 2008. (It is not lower than in 2009 when the price level, not the level of inflation, was falling, and observers were understandably concerned about deflation)
A recurrent theme of media commentary and punditry in recent years is that ‘extra bank lending’ (in some sense, usually left vague) is a condition of wider macroeconomic recovery. This contention tends to be the prelude to another round of bank-bashing, with politicians and others blaming banks’ actual or alleged reluctance to lend as the reason for the sluggishness of demand, high unemployment and so on. The whole approach depends on the existence of a relationship between bank lending to the private sector and aggregate expenditure (or perhaps some subset of aggregate expenditure with an assumed powerful influence over the total). The claim that there is a relationship of this sort has no place in standard monetary theory, but has become fashionable in the last 20 years or so largely because of papers written by academics from the leading universities on the USA’s East Coast (Harvard, Princeton, Columbia, New York University and so on). Arguably, the current chairman of the Federal Reserve, Ben Bernanke, is the principal exponent of ‘creditism’, the set of ideas that pivots on the lending-expenditure relationship. The current weekly e-mail note is the first of a series that will criticize ‘creditism’. (In my opinion they will demolish it, but others must decide for themselves.) My focus here will be on the UK in the period of the Great Recession, but I believe the arguments to have wider validity. At any rate, I will show both that no relationship holds between bank lending to the private sector and nominal GDP in the UK in recent years, and that there are good reasons why a relationship between the two variables is not necessarily to be expected. (I do not deny that, in the normal course of events, new bank lending creates new bank deposits, which are money, and that a relationship holds between the quantity of money and nominal GDP. But it is the quantity of money as such, not bank lending, that is doing the vital work in the determination of nominal GDP.)
A recurrent theme in the e-mails from International Monetary Research Ltd. since early 2009 has been that sudden, large-scale bank recapitalizations – of the kind implemented in the UK particularly (but also elsewhere) in late 2008 – are deflationary. (See, for example, the weekly e-mail of 14th September 2009, with its account of ‘the paradox of excessive bank regulation’.) This has often puzzled people, since – surely – recapitalization makes banks safer and the safer are banks, the less likely are crises. (As far as I am aware, no evidence has been produced [by e.g., Mervyn King, John Vickers, the Basle regulatory bureaucracy etc.] for the theory that macroeconomic instability [as measured, e.g., by the standard deviation of GDP growth] is inversely related to the banking system’s capital/output ratio. I am indeed pretty confident that – when tested against data – the theory does not hold up, but let this pass for now.) So this week I explain, again, why bank recapitalization is deflationary. What evidence can I call upon to substantiate my argument? Well, in effect the whole sorry financial and macroeconomic mess in the leading industries countries since mid-2007. Officialdom has repeatedly demanded that banks have more capital and, for all their problems, banks have higher capital/asset ratios today across the industrial world than they had in mid-2007. Yet the four years have been a misery and officialdom wants the banks to raise still more capital! How many more times does it have to be said that the key to macroeconomic stability is steady growth of the quantity of money at a low, non-inflationary rate? That is what matters, not the current rigid and ideological approach towards banks’ capital being taken in the Bank of England, H M Treasury, the US Treasury, etc. (Mercifully, not every country’s official economic policy agencies have been captured by the unfortunate and false doctrine that ‘the more capital banks have, the better for the world’.)
As in the USA’s Great Depression of the 1930s, its Great Recession of the last few years has been accompanied by a collapse in the growth of the quantity of money. Analysis of money data – in the USA, as in other countries – is bedevilled by institutional arcana, as well as the extreme difficulty of differentiating erratic shocks from underlying trends. In my work I emphasize broadly-defined money, including all relevant bank deposits, although I concede that this notion is itself ambiguous and elusive. In the USA my preference is for the M3 money measure which the Federal Reserve stopped publishing in March 2006. Fortunately, an alternative series is prepared by the Shadow Government Statistics research company and I am using its data in the present note. For all the data problems, the M3 numbers published by SGS tell an alarming story. The annual growth rate of M3 – which peaked in the high teens in late 2008 – had crashed to a negative value less than two years later. On the historical record, more or less constant growth in the quantity of money – at a moderate but positive rate – is a condition of macroeconomic stability. Last summer M3 was still dropping. Although the Federal Reserve denies that it pays any attention to broad money, the weakness in money growth had been associated for some quarters with a disappointingly sluggish recovery. In early November Fed chairman, Ben Bernanke, announced a ‘QE2’ programme. Heavy purchases of long-dated US Treasuries (with five or more years to redemption), amounting to $600b., were meant to boost the US economy. The present note surveys the evidence of QE’s effects. It shows that – as would be expected with a QE programme – banks’ cash holdings have increased dramatically, in fact pretty much in line with the targeted amount. But US banks’ non-cash assets have fallen a little since last October and showed no meaningful sign of returning to growth. When QE2 ends, M3 is likely for some quarters to grow very slowly or not at all.
Recent announcements from the Bank of England on “quantitative easing” and interest rates are encouraging in substance. Official policy is clearly to ensure that broad money growth stays positive enough both
- to deliver an economic recovery, and
- to prevent the UK being visited by the deflation that already afflicts most of the industrial world. This is good news for UK equity and real estate markets, but unhelpful for gilts.
For all the difficulties in the subject, most sensible people accept that the USA’s Great Depression demonstrated the positive growth of “the quantity of money” must be sustained, if policy-makers are to avert another big slump. But from 26th January to 6th July M2 rose from $8,270.6b. to $8,348.7b., giving an annualised growth rate in the 23 weeks of a mere 2.1%. The question arises, “why did the Fed allow this to happen?”. (M2 growth from September 2008 to January 2009 was explosively fast, as the Fed expanded its balance sheet rapidly.) This week’s e-mail offers no definite answer, but such worriers as Alan Greenspan and Anna Schwartz have suggested that the rapid growth in the Fed’s balance sheet is potentially inflationary. At any rate, if financial markets have another relapse and the American recession threatens to continue, the Fed has available $1 ¾ trillion of asset purchase and loan schemes. Although advertised as “credit easing”, their full activation would boost the quantity of money on the M2 definition. In that sense, the American economy and asset markets are now protected by a “Bernanke put”.
Worries about inflation are misplaced – indeed extraordinarily misplaced – in current conditions. Output is further beneath trend in the major advanced economies than at any time in the post-war period. Rising inflation will not return until after a global boom or an extended period of above-trend growth. Nevertheless, Mr. Alan Greenspan – the revered former chairman of the US Federal Reserve – published an article in the Financial Times of 26th June under the title ‘Inflation is the big threat to sustained recovery’. The argument of this note is that Greenspan is seeing ghosts. There is little or no risk of a significant rise in inflation until after – probably several quarters or even years after – output has returned to its trend level. The main point is simple (and is indeed much the same as in our weekly e-mail of 22nd May), that on average inflation has fallen during US recoveries. Just to reiterate the fundamental point being stated here, typically in the recovery phase of an American business cycle falls in inflation accompany above-trend growth. Within the space allotted by the Financial Times, Greenspan was hardly able to develop a meaningful economic model. He reported that, “annual price inflation in the US is significantly correlated (with a 3 ½ - year lag) with annual changes in money supply per unit of capacity”. If Greenspan were referring here to M2 or M3 per unit of output, his claim would be both understandable and backed by a large amount of evidence over many decades. But had he not noticed that so far in 2009 M2 growth has decelerated sharply compared with 2008? (See our weekly e-mail of 11th June on "US M2 – The Bernanke flip-flop".) Greenspan then highlighted the USA’s large budget deficit and the danger that it might be monetized, with eventual inflationary consequences. There are two problems with this argument.