In last month’s note from International Monetary Research Ltd. it was suggested that “money growth trends in the main countries are not far from perfection at present”. Not much has changed in the last few weeks to alter that assessment, although it has to be said that in most of the six jurisdictions (apart from India and perhaps China) the signs are of a slight acceleration in money growth. (In my view, the ideal annual rate of increase in money in the high-growth developing economies [i.e., China and India] lies in the 10% - 14% bracket, while the corresponding figure for the developed countries [i.e., the USA, the Eurozone, Japan and the UK] is between 2% and 5%, perhaps 6% at most.) Contrary to much tattle from the commentariat, aided and abetted by the Bank for International Settlements, “quantitative easing” in the Eurozone has been a clear and significant success. Macroeconomic conditions have improved markedly since late 2014, with Germany in particular contributing to the demand revival. (German broad money growth in recent months has been at very high annualised rates of over 7%. No wonder the Bundesbank is worried!) As for most of 2016, the oil price is being seen in financial markets as a proxy for global demand conditions. With Brent spot moving through the $50-a-barrel level, confidence is growing that demand in the main economies should be sufficient to deliver at least trend growth (say, 3% - 3½%) in world output in 2016. In my view, nothing in the recent banking and monetary policy developments to justifies a radically different view about 2017. If anything, my surmise is that virtually zero interest rates will encourage higher money growth, but the worry remains the regulatory attack on the banks. It would, be nice if the delinquent economies of 2015 and 2016 (Russia, Brazil, Venezuela), where output has been falling, see political changes/transformations and a return to output growth in 2017 or 2018
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.
The last few weeks have seen a lifting of the storm clouds that troubled financial markets in January. Critically, monetary policy is being further eased in China and the Eurozone. In China the monetary authorities have sharply raised banks’ credit allocation limits, just as they did in 2009. Meanwhile in the Eurozone the quantity of “quantitative easing” (if you will excuse the expression) has increased by a third, from €60b. a month to €80b. Meanwhile on the other side of the Atlantic the recent pace of broad money growth in the USA has been disappointing. But very low inflation makes it unlikely that the Federal Reserve will touch Fed funds rate again until June. All things considered, banking systems are in reasonable shape and the latest trends in money growth are at worst neutral for this year’s global macroeconomic prospect. Fears that monetary policy-makers are “running out of ammo” are bunkum. The last few years have seen a clear association between low growth of money and low growth of nominal gross domestic product, confirming the validity of the long-established quantity-theory-of-money propositions on the link between money and national income. As the state can always create new money by borrowing from the banking system and using the proceeds to buy something from the non-bank private sector, monetary policy can never run out of ammo. The world economy will not suffer a recession in 2016, and it would require grotesque policy errors for one to happen in 2017 or 2018. The rebound in the oil price has cheered equity markets, as the better oil price is being viewed as a pointer to demand conditions more generally. But the ultimate determinant of the change in nominal GDP is the quantity of money. Central banks should pay more attention to the money numbers than they do to the movement of one commodity, even if the commodity is as important to the world economy as oil.
Financial markets are concerned about ‘recession risk’, or so the newspapers tell us. When the world’s leading economies are viewed objectively, it would be hard to imagine circumstances in which recession was less likely. All recessions since the 1930s have begun with monetary policy tightening to curb inflation. This is true even of the 2008 � 2009 Greeat Recession, although officialdom’s reaction was disproportionate and misguided, and led to a few months of outright deflation. (Government, central banks and regulatory agencies imposed new regulations that acted like a punitive shock on banks, and stopped the growth of their balance sheets and hence of the bank deposits that constitute most of the quantity of money.) But today inflation in the leading economies (excluding India, and also such places as Russia and Brazil beset by corruption, political adventurism, misgovernment, etc.) is virtually zilch. The concern is not too much inflation, but the danger of deflation. In effect, there is no constraint on expansionary monetary policy. Objections to this argument are two-fold. The first is that in the United States of America the recovery is so mature that the labour market is showing signs of over-heating and a normalization of monetary policy (with higher interest rates) has become necessary. The weakness of this claim is that, although the unemployment rate has dropped to beneath long-run averages, many people have left the labour market temporarily because of lack of demand. The employment rate is still well below the 2008 level. Meanwhile the strong dollar is hurting manufacturing, reducing import costs (over and above the impact of low oil prices) and dampening inflation. Talk of four Fed rate rises in 2016 is starting to look very silly.
Some commentators seem anxious that early 2016 feels like early 2007. But banking systems are not over-stretched and do not face heavy loan write-offs because of bad debts, while inflation is exceptionally low. Governments and central banks can readily implement expansionary policies (such as QE) if they have to. The overall prospect is for steady, if rather slow, growth of banking systems in the major countries, and so for moderate growth of broad money, and also of nominal GDP. There are worries (e.g., the oil market), but the world economy is not characterized by major macroeconomic instabilities In qualification, officialdom seems committed to imposing extra capital requirements on banks across the globe, in the belief that highly-capitalised banks are safe banks and that another Great Recession could not happen if all banks were ‘safe’. Key central bankers and regulators seem not to understand that the Great Recession of 2008 – 10, like the Great Depression in the USA 1929 – 33, was caused by a collapse in the rate of change of the quantity of money. They seem further not to appreciate that the effect of tightening bank regulation will be to depress the rate of growth of the quantity of money, with wider disinflationary/deflationary consequences. Although oil prices must be expected to spike upwards at some point in the next three years (as Saudi Arabia again restricts production), underlying, ex-energy inflation will still be low/negligible in 2017 and early 2018. Money growth has turned upwards in China and India in the last few months, which argues against too much pessimism about the global outlook for 2016. A truly alarming message is that officialdom still cannot see the connections between regulatory tightening in the banking industry and weak broad money growth, and then between weak broad money growth and sluggish economic activity.
The latest criticism is that Quantitative Easing has been ‘good for the rich’, but ‘bad for investment’. Even the financial advice pages of the broadsheet press seem to be going down this route, which is bizarre given that the readers are mostly rich and ought to appreciate a policy allegedly in their interests. (In the note below I quote some remarks by Merryn Somerset Webb in a 12th October article in the Financial Times.) The truth is that profits are more volatile than national income, while the equity market (which is ultimately only a capitalization of profit streams) is more volatile than profits. The large fluctuations in equity prices are partly down to changing sentiment, but also critical are wide swings in the rate of growth of the quantity of money, particularly in the money holdings of the financial institutions which specialize in asset selection. (See, for example, my 2005 study for the Institute of Economic Affairs on Money and Asset Prices in Boom and Bust for an analysis.) In the short run (i.e., in the course of one business cycle) changes in asset prices are influenced by variations in the rate of money growth. So Quantitative Easing from early 2009 did help the equity market (and in that sense ‘the rich’), but it was also beneficial for demand, output and employment more widely. In the long run changes in the rate of money growth cannot affect anything much on the real side of the economy. (A caveat is that extreme inflation or deflation causes severe economic inefficiency in various ways, and that is why inflation and deflation should be avoided.) The FTSE 100 index is lower today than it was in 1999. Is Quantitative Easing (which began in earnest in March 2009) somehow to be blamed for that? Or should the policy or policy-maker supposedly responsible for the poor post-1999 performance be thanked for keeping share prices down? Indeed, does Ms. Somerset Webb think that any policy which enriches people is, by definition, wicked and evil?
The current weekly note attachment – like the last one – is about the consequences of confusing ‘the monetary base’ and ‘the quantity of money’. This confusion has plagued commentary on both the Japanese and American economies in the last few years. (There has also quite a lot of nonsense in the UK from, for example, Liam Halligan in his Sunday Telegraph column.) In the note – which has recently appeared in Economic Affairs, a magazine published by the Institute of Economic Affairs – I recall the inflation warnings given by American monetarists in early 2009, as they bewailed the then surge in the USA’s monetary base as a result of the Federal Reserve’s asset purchases. These warnings – which were neither dated nor quantified – have so far proved silly. In fact, in the year to autumn 2013 the USA’s finished- goods producer prices index is likely to be unchanged or even to be down slightly. The failure of American monetary-base-focussed monetarism demonstrates, yet again, that the measure of money that matters in macroeconomic analysis is one that is broadly-defined to include all assets with fixed nominal value that can be used in transactions. In most countries the total of bank deposits is the best approximation to that measure of money, which has the further implication that public policy should be concerned to maintain growth of the banking system balance sheet at a low and stable rate. It should be a low rate to combat inflation, and at a steady rate to help in securing wider macroeconomic stability (i.e., stable growth of demand and output). Anyhow it is the quantity of money, not the monetary base by itself, that matters to macroeconomic outcomes.
Japan’s ‘Abenomics’ is reported to have three arrows, - a ‘revolution’ in monetary policy with ‘the Bank of Japan injecting huge amounts of “money” (whatever that means) into the economy’ (or something of the sort), - a short-term fiscal stimulus accompanied by long-term action to bring the public finances under control, and - ‘a growth strategy’ (which means in practice shaking up such over-protected parts of the Japanese economy as farming and retailing). Commentary on the last two of the three arrows has often been sceptical. Initial ‘stimulus’ (i.e., a widening of the budget deficit) is not easily reconciled with ultimate fiscal consolidation (i.e., a narrowing of the budget deficit), while Abe’s Liberal Democratic Party has drawn much of its traditional support from groups that benefit from protection and restrictive practices. By contrast, most media reporting has suggested that the Bank of Japan has definitely changed course and that a major upheaval in monetary policy is under way. This note argues that, although Japanese monetary policy has indeed shifted in an expansionary direction, the shift is far less radical than the rhetoric that has accompanied it. Japanese policy-makers and the greater part of the commentariat seem to believe that the monetary base by itself has great macroeconomic importance. This is a mistake. National income and wealth in nominal terms are a function of the quantity of money, which must be distinguished sharply from the base. Movements in the monetary base and the quantity of money may be related, but the relationship is not necessarily all that precise or reliable. It is the quantity of money, not the monetary base by itself, that matters to macroeconomic outcomes.
The rate of change in the quantity of money, broadly-defined, is the fundamental driver of the rate of change of both nominal national income and nominal national wealth. Since a nation’s wealth includes both corporate equity and the main forms of real estate (residential, commercial, rural), money trends are basic to all investment decisions. Of course the patterns of money growth vary from country to country, depending on developments in the banking system and monetary policy. This note has a quick look at the USA, Japan and the Eurozone in early 2013. I hope to expand it next week. Anyhow, to summarize, in the first half of 2013 broad money growth ran, roughly, at the following annualised rates in the three areas, 4% to 5% in the USA, - 3% to 4% in Japan, and little more than zero in the Eurozone. My verdict is that money growth rates like these are consistent with a reasonable continuing recovery in the world economy, but not with the kind of strong rebound that might be expected after the savage downturn of 2009 and the rather feeble upturn in 2010. The exception remains the Eurozone, where the reports of an improvement in recent months seem far from convincing.
The Eurozone resembles a vast dyke which is full of holes and liable to disintegrate at any moment. This note concentrates on Portugal, where the recent resignation of the very able finance minister, Vitor Gaspar, was a huge disappointment. (It must be said that the Eurozone’s holes in Greece, Spain, Italy and France also remain large and conspicuous, despite international officialdom’s attempts to patch them.) Portugal’s problems arise partly because the economy’s trend rate of growth is now very low, perhaps even zero or negative. Gross domestic product per head is lower than ten years ago. With inflation almost zero, nominal GDP is at best flat. As a result, any deficit leads to an increase in the ratio of public debt to GDP. A May 2011 bailout negotiation with the ‘troika’ extended €78b. of loan and other financing, to help the Portuguese government and banking system. It must be acknowledged that Portugal has tried hard, with Gaspar at the finance ministry, to meet the conditions attached to the bailout plan. The cyclically-adjusted budget deficit fell from 9.0% in 2010 to 4.0% in 2012. Nevertheless, the debt-to-GDP ratio has kept on rising and is now over 120%, the kind of figure that was associated with the Greek dégringolade in 2012. (A fair verdict is that a debt-to-GDP ratio of 120% is sustainable when the nominal interest rate on the debt is 5% or less, but – once the interest rate goes into double digits – the debt interest burden runs amok like a Frankenstein monster.) The Portuguese people are apparently weary with austerity, and it has to be said that – without a resumption of growth and particularly of asset price appreciation, which would help banking solvency – the danger has to be that further deficit-reduction measures would not restore fiscal sustainability or national solvency. Holders of Portuguese banks’ bond liabilities and depositors with Portugal’s banks, you have been warned! PEXIT (Portuguese exit from the Eurozone) is – almost certainly – a better option than staying in.