Old wine

As regular readers of these scribblings have hopefully come to appreciate, this is not the place to come to slake your thirst for mechanistic ‘models’ and fancy-dan macro-correlation studies (for the technically-minded, this is precluded by the subjectivist, methodological individualism of the Austrian School to which we adhere).

The only exception to this—if, indeed, an exception it is—is to be found in our penchant for mapping out developments in money supply and, in particular, real money supply and relating these to potential changes in the revenue stream percolating through the economic structure and, hence, to the implications for income, returns on invested capital, and the supportability or otherwise of the accumulated debt burden.

To an Austrian the credit cycle IS the business cycle, while, more generally, the many disruptions to the progressive delivery of greater material satisfaction we suffer — outside of those forcefully visited upon us by the political process — are almost inevitably the result of some unlooked-for departure in the rate of provision of new money from that to which people had become accustomed. Just occasionally it is rather a departure of the eagerness with which that money’s recipients hold on to that which comes their way — in other words, once in a while it may be a question of a changed appetite for, rather than a changed helping of, cash-at-hand which disrupts.

Either way, once ‘monetary disequilibrium’ breaks out, look out below!

If there is one incontrovertible thing about monetary matters, it is that they offer a field rich in misunderstandings, obtuseness, half-reasoned suppositions, and outright crankdom—much of it a wearily reworked canon of old fallacies dressed up in (terminologically) new clothes by a profession which has long since decided that mathematical dexterity and political expedience is far more important than an awareness of its own history, meaning it never manages to build cumulatively on past insights, unlike the physical sciences which its practitioners so envy, alas!

Among the latest vogues is the so-called ‘Modern Monetary Theory’ – a truly laughable epithet, given that Mises was deriding its Chartalist founding father Knapp’s use of the same term almost exactly a century ago.

Among its supposed ‘breakthroughs’ is the truism that a government which issues its own fiat currency can never go bankrupt — at least in an accounting sense — and so should never shrink from commandeering ever more resources from its subjects (we shall overlook the mere trifle that it may well be able to set the nominal terms of its actions, but has little control over the real ones; or that there do, in fact, exist limits to its seignorage, not least of which the one which arises when the mass no longer accepts the money which it has so determinedly debauched, taxes or no taxes to be paid in it!)

One of the classic examples of faux reasoning disported by this soi disant school of innovative thinkers is one which leaps from the tautological observation that a flow-of-funds reckoning of an economy  conveniently, if  rudely, carved up into vast, faceless blocs labelled, ’Public’ and ’Private’ — must see a net private surplus offset by a net public deficit (ignoring the external ’sector’ for the moment) and hence, that the overspending state is doing all its subjects a favour by living beyond the means honestly voted to it, otherwise their aggregate desire to acquire net new ‘assets’ could never be fulfilled!

On this reckoning, the Greeks, far from being the most fiscally benighted and sorely afflicted of peoples, should rejoice in the effulgence of their status as beacons of true MMT enlightenment and prosperity!

Suffice it to say that we can put this canard — one equivalent to saying that we benefit from paying protection money to the Mob if only the Capo holds the monthly dinner party for his lieutenants in our pizza parlour — firmly to rest after carrying out only the most trivial of disaggregations.

Absent the predations of the Provider State, individuals may well, on balance, engage in saving (with a view to better providing for their future needs) by acquiring claims on entrepreneurial endeavours, these latter being happy to put the funds so raised — and, by extension, the resources so spared — to a hopefully profitable, productive use.

Under these circumstances, the consolidated balance sheet of the private sector will certainly still show a zero balance but the twin aggregates which comprise this will show an expanding count of genuine capital accumulation, even without some insistent spendthrift in office to ’remedy’ the associated joint lack by throwing a good war, or an equally useless Olympics!

Moreover, they also bruit about the ludicrous idea that such grossly confiscatory measures as are entailed by government spending and borrowing are easily justified because they ensure that an otherwise elusive medium of exchange is called into existence.

Are we really asked to believe that, short of this paternalistic blessing conferred upon us by our selfless Platonic Guardians, it would be utterly beyond the wit of Acting Men to devise some alternative means of lubricating their frequent, voluntary, and so value-enhancing transactions?

As part of this insidious idea that no government can be too big, no deficit too wide — saving only that Leviathan has not foolishly ceded control of the printing press to some party beyond the reach of his coercion — the MMTers also insist that the gargantuan programme of monetisation being undertaken as part of the global bank rescue attempt has not and, moreover, cannot, under any circumstances, lead to ‘inflation’ (by which they conventionally mean sustained price rises in goods and services, of course).

Well, let us here quote the words of an early 20th century thinker on such matters, Harry Gunnison Brown, in the slightly different—but still relevant—context of denying that there can ever be such a phantasmagorical creature as a ‘liquidity trap’.

…it has been argued… [that] it is impossible for banking policy — or any purely monetary policy devoted to increasing the circulating medium — to bring business back near to normal in any reasonable period, once depression has become acute. For, it is contended, the increased money  will in any case merely be hoarded. Depression psychology will prevent borrowing from banks for business expansion, however large…  reserves become through favourable Federal Reserve policy. Depression psychology will prevent any person or persons from whom the Federal Reserve banks purchase securities, from either investing or spending the money so received! And if the federal government directly supplements Federal Reserve policy, printing billions of dollars of new money which it then pays out to buy back or redeem federal government bonds, this new money will also be hoarded, every dollar of it, and so will have no effect toward increasing the demand for goods and restoring employment!

In this view it would appear that if each person in the country, during a period of depression, were put into possession of more money than before whether twice as many dollars or 100 times as many or 10,000 times as many-there would nevertheless be no appreciable increase in spending, no increased demand for goods and no stimulus to business and employment! Instead, production would remain low or even sink lower, spending would remain low or even become less, prices of goods would remain low or fall even lower. All this, of course, is preposterous nonsense but it is to such a conclusion that those economists must inevitably be driven who do not admit that monetary policy can possibly promote recovery from depression.

Now it may well be the case that what Brown is here exploding is the nonsense associated with the ineffable Paul Krugman and his fellow-travellers, but the MMTers seem to be even more precariously balanced, straddling as they are, the Great Deflationary Abyss — within one foot planted firmly in a land where live those who believe that money can be effective in reigniting a temporarily slackened desire to spend, but with the other dangling in mid-air, well short of the opposite bank where reside those who take this to the logical conclusion that too much money can likewise easily lead to far too much spending, vaulting us readily from the frying pan (or the freezer cabinet, as may be the more suitable image) and into the fire of inflation.

Memo to those who espouse this rehashed mumbo-jumbo: inflation is alive and well; central banks have been furiously expanding base (or outside) money and a good deal of that has gone into supporting the addition of new quantities of deposit (or inside) monies, to boot.

Unsurprisingly, this undertaking has seen the prices of bonds, stocks, and commodities increase, even if the usual concomitant of rising property prices has not yet become universal (largely by the happenstance that this was the pre-eminent medium through which the last inflation was given vent and hence its overhang remains largely unliquidated and its components in widespread oversupply in several of the worst offending markets).

Just look at the evidence. Despite the unquestioned disruption of the Crash itself and the fire-in-a-theatre rush for liquidity which it occasioned, the central bank expansion programmes at just six prime exemplars have seen their combined balance sheets doubling in the past four years, with more than half that expansion coming since the first emergency injections began in earnest, in early 2009.

Money supply has risen by a not incomparable amount, even if the efficacy of the marginal bank reserve in generating bank demand deposits has been reduced lately to below unity (partly, one suspects, because the pre-LTRO ECB was expanding more by providing its stricken and mutually-distrustful banks and sovereigns with an intermediate, ‘credit-wrapper’ than by a deliberate recourse to the money-spigot: now, under the aegis of Draghi, that may well have been changed).

As a direct consequence, prices have risen — i.e., whatever temporarily elevated desire there has been to hold more money; whatever difficulty in accessing credit with which to economise on the stuff; whatever reduction in ’velocity’, if you must, an expansion of the money supply has lead inexorably to a rise in prices, fiscal austerity and output gaps and other such Keynesian mental clutter notwithstanding!

To understand why we are here is one thing, of course: it is yet another to try to work out where we seem to be heading next.

If aggressive monetary easing has pushed the likes of the US Small Cap index to all-time highs and triggered renewed buying of high-yield and emerging markets over the past few months, can we expect yet more largesse ahead?

Just as the world economy seems to have divided into three camps — a more ebullient US of A, a bemired Europe, and an obscured Asia — so we have a triad of central bank actors to second-guess in each of these if we are to attempt a little divination regarding this question.

In the first of them, the Fed seems to have truly let the dogs out: even without the launch of what seems an increasingly-redundant QEII, the aggregates are surging ahead as domestic banks eat into their excess stockpile of reserves (cash down $135 billion, bank credit up $375 bln to a new high, C&I loans up $100 bln).

We have previously shown that the rate of money creation is currently further above its 30-year real trend than at any time in that sample, but, for the sake of variety—and with a firm injunction not to take the projections as anything other than broadly illustrative—we can look instead at money supply per capita. Here, too, a clear pattern emerges.

Zero growth in the halcyon days of the 50s and early 60s saw CPI typically around 1.5%. 5.5% compound money growth in the rather less complaisant two decades which followed saw average CPI lurch up to 5.7% before a deceleration to 4.2% per head in money and a coindicent 3% rate of price increase.

Fast forward to the QE-Era and we have been running at nothing short of 10% per annum — an outpouring which risks — on the showing of the previous regimes — a typical CPI rate somewhere in excess of 7%. It will also serve to acclimatise the economic structure to a level of laxity which cannot indefinitely be sustained, something which therefore sets us up for a nasty setback whenever the Fed finally moves to regain control of the stampede it seems to have unleashed.


As for our second main player, the ECB, next week will surely set the stage as the second confusion of capital with liquidity comes to its multiple-hundreds-of-billions second instalment. Expectations are high — as they were ahead of the apparently successful (but yet to be implemented) negotiation of the Greek debt accord. Your author, however, cannot entirely suppress the nagging suspicion that, just as that ostensible landmark brought only grumbling, not relief, perhaps Super Mario will also fail to excite jaded palates and a disappointment might be the result. Perhaps there is just enough Bundesbank left in the Councils of the Wise to draw back from full Weimarization. We shall see.

Further out in Asia, where the world’s marginal consumer of and producer of stuff has slipped into the statistical Lunar shadows of the New Year holiday, all is meant to be on the up again as the PBOC has unveiled not one, but two successive cuts in reserve requirements.

The act has not exactly been greeted with dancing in the streets, however, one reason for which may be that it has simply addressed a touch of overkill in cranking up the ratios last year. More binding at this stage may be the loan:deposit ratio which seems to have surged to six-year highs to reach the point where an average only 3 points below the mandatory ceiling must leave a sizeable tail of the distribution scrambling to avoid sanctions and so hardly best placed to swell its constituents’ already engorged loan books.

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3 replies on “Old wine”
  1. says: Tom Mueller

    Begging your indulgence Sean, but I fear you did not cast your net far enough when identifying those culpable for the creation of ersatz-legal-tender.

    Here are some excerpts from Charles R. Morris’ recent edition


    Scarey scarey stuff!!!!!

    page 146 is my favorite:

    “Financial markets built an investment paradigm that applied high leverage to long-term illiquid instruments. Then compounded the danger by funding those instruments in the short-term debt markets. Then doubled the bet again by building the base portfolios from unusually risky securities, like subprime mortgages and leveraged loans. Then, finally, embraced a class of credit derivatives that ensured the swift propagation of any local collapse through the whole system. If a band of brainy terrorists had been hired to destroy western finance, they could hardly have designed a more efficient assault.”

    Mind boggling. So in fact it was the PRIVATE sector which created phoney money ex nihilo while those conniving central bankers at the behest of foolhardy governments merely backstopped UNREGULATED private sector lunacy.

    At least that is my naive and simplistic way of understanding the problem.

    To push the point:

    Reserve requirements on fractional-reserve banking were supposed to put limits on the amount of money banks were permitted to lend thereby limiting money creation leaving central bankers in theoretical control of how much money is being created in the economy.

    PhD’s and modern computer technology allowed banks to indulge in financial econcromancy which Morris credits David Roche as coining the “new monetarism”. Swaps and securitization increase the money supply by converting more and more real assets into tradable instruments. In other words – not only are banks able to move liabilities off their balance sheets thereby permitting them to recycle these illegitimate windfalls into even more shakier and shakier loans… banks are even able to transform “liabilities” into “assets” thereby magnifying the problem and rendering balance sheets fantastic fictions.

    Banks perversely and without control created liquidity out of thin air… unfortunately their resulting debt resulted in today’s fiscal “solvency” problem.

    My naive understanding: Unregulated private bank debt constitutes money creation. Debt destruction constitutes money destruction. Ergo deleveraging generates deflation in the short term. However – the private debt generated so far is far far in excess of any possible broad money supply (as created de novo by obliging treasuries) and that is why we are in deep inflationary doo-doo!

    We are still in agreement – n’est-ce pas?

    I like Morris – because he slags Keynesian acolytes-lites who pervert his original insights but by the same token Morris slags the other extreme, the so-called Chicago school, whose tenets sometimes remind me of Austrians gone too far afield.

    I say this with all due respect – the Austrian School qua economics is compelling, but goes a bridge too far when simultaneously embracing Libertarian principles thereby conflating consistently good economics with inconsistently cogent politics.

  2. says: Tim Lucas

    ‘Fast forward to the QE-Era and we have been running at nothing short of 10% per annum — an outpouring which risks — on the showing of the previous regimes — a typical CPI rate somewhere in excess of 7%. It will also serve to acclimatise the economic structure to a level of laxity which cannot indefinitely be sustained, something which therefore sets us up for a nasty setback whenever the Fed finally moves to regain control of the stampede it seems to have unleashed’

    Given that this is happening at a point at which the government bond is market is at unprecendented size, issuance and monetisation at an unprecendented level and yields at unprecedented lows, I feel scared.

    Is it reasonable to suggest that government bond yields rising are the possible trigger for hyperinflation?

    A possible scenario is:
    As inflation moves up bond yields begin to rise, which sets off selling which begets more yield rises. In order to maintain bank solvency, government attempts to fix asset prices at their current prices, through printing and monetising. Faced with this combintation of events, the average person would likely sell his financial assets, particularly his government bonds to buy real goods. Seem fair?

    In this case, the 7% inflation that you mention here would be far too low an estimate.

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