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
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?
In a note on 29th September last year (see the Appendix) I called the turn on US monetary trends. I accepted that banks were still being hampered by the regulatory assault on their industry. Nevertheless, my view was that most American banks had sufficient capital to be able, once again, to expand their balance sheets and hence their deposit liabilities (i.e., the quantity of money). I argued that 2012 could see trend or even above-trend growth in the American economy, given that the helpful effect of positive money growth on balance- sheet strength and asset prices would be reinforced by virtually zero interest rates. That was a long way from the consensus at the time, but the 29th September note now looks prescient. (As I am inordinately proud of it, the Appendix version is in the loveliest gold frame allowed by Microsoft software.) But what about the future? A continuing problem is intellectual. In the USA as elsewhere, officialdom believes the private sector deleveraging (i.e., shrinkage of banks’ risk assets relative to their capital) is benign, regardless of the resulting destruction of bank deposits. All the same, the signs are that US banks are growing again and, despite the usual ifs and buts, a positive rate of broad money growth is to be expected in the rest of 2012. The annual rate of money growth will be positive, but probably in the low or mid- single digits, not in the high single digits or double digits seen in some cyclical recoveries. Given that the USA appears to be on the threshold of a dramatic transformation in its energy supply capability, and is now far advanced in the application of the new telecom and computer technologies, several good years lie ahead for the American economy. A widening contrast between American economic success and European economic failure is to be envisaged.
Unemployment in the USA remains at almost 10% of the workforce. Apart from a few quarters in late 1982 and 1983, the current level of joblessness is the highest since the 1930s. Policy-makers could justify high unemployment in the early 1980s by the need to reduce the annual rate of inflation, which had moved well into the double digits in 1979 and 1980. No such justification is available for the pain of unemployment today, as inflation is negligible. When President Obama was elected in November 2008, the unemployment rate was 6.9%. Unless unemployment falls significantly in coming months, his presidency will be blighted by the worst unemployment record since the Great Depression. Obama is clearly desperate to see unemployment on a downward path before the Congressional elections in November 2010, in which the Democrats are expected to suffer heavy losses. He has therefore sought advice from a group of well-regarded economists of known Democrat sympathies, including Larry Summers, who is head of the White House National Economic Council, Paul Krugman and Joseph Stiglitz. Krugman and Stiglitz won the Nobel prize for economics in 2008 and 2001 respectively, and their contributions to economics are much admired in the academic world. Summers, Krugman and Stiglitz are Keynesians, who believe in the effectiveness of fiscal policy and deny that the quantity of money is relevant to macroeconomic outcomes. Their recommendation to Obama has therefore been to engineer large increases in public expenditure and the budget deficit, in order to boost demand, output and employment. Obama is showing signs of frustration with the results of this fiscal expansionism; he will undoubtedly be disappointed if above-trend growth and falling unemployment are not restored soon. Evidently, the question “does fiscal policy work in the USA?” is fundamental. This note surveys some of the evidence.