The monetarists were right about inflation, but now they have a completely different warning

The monetarists were right about inflation, but now they have a completely different warning

Monetarists are suddenly new superstars, and deservedly so. The score for the last 20 months is zero points for hegemonic new Keynesian group thinking: a lot of points for the forgotten quantitative theory of money.

At the end of 2020, a small fraternity of monetarists watching the esoteric “aggregates” M1, M3, M4 warned that the money supply in the West was beginning to become loose, and that this in turn led to the incubation of double-digit inflation – or something close – with a typical delay of one to two. flight.

They rightly argued that the “speed” of money will resume as soon as Western economies reopen, overloading the increased money supply. They expected the price shock to hit more or less now.

They made these predictions before the war in Ukraine and before the global manufacturing supply chain was disrupted again by the Chinese zero-presence debacle Covid. The sheer extent of the combined fiscal and monetary stimulus would guarantee a price jump, whatever happens.

The central bank’s alibi will not withstand cross-examination. Monetarist justification is total.

It’s not that the jammed clock is right twice a day, as critics derisively claim. Real monetarists such as Tim Congdon and Juan Castaneda of the Institute for International Monetary Research supported quantitative easing after the Lehman crisis.

They did not claim that then QE and zero rates would lead to sharp inflation. How could this be when the banking system was broken and regulators forced creditors to “pro-cyclically” increase their capital reserves to the economic depression? Asset purchases were absolutely necessary to avoid a large money supply contraction (M3 in the US and M4x in the UK).

Whether or not QE is inflationary depends on the circumstances, and these were very different in early 2020, when Covid struck. At that time, the banks were in good health.

Even before the Bank of England pushed through another £ 150bn asset purchase package in November 2020, it was clear that the big money was on fire. “It was an unforgivable mistake,” said Professor Congdon.

Even the monetarists were right just before the global financial crisis, and this episode has a response today.

The newspaper published an article in July 2008 entitled “Monetarists warn of the crisis in the Atlantic economies.” It started with the next two paragraphs. I was the author, so I remember that.

“Money supply data from the United States, Britain and now Europe have begun to flash warning signals of a possible crisis. Monetarists are increasingly worried that the entire North Atlantic economic system could fall into debt deflation in the next two years if the authorities misjudge the risk.

“The key measures of US cash, current accounts and term deposits have been declining in real terms for several months. The dramatic slowdown of the British wider M4 units is triggering alarm bells here.

He quoted the ominous warnings of Professor Congdon, the shadow monetary policy committee organized by the Institute of Economic Affairs, and Roger Booth of Capital Economics. Two months later, Lehman Brothers collapsed and the Western credit system suffered an almost fatal heart attack.

What were the big central banks doing at the time? They didn’t look at money. Instead, they were plagued by high oil prices and the risk that inflationary psychology would live up to expectations.

The Federal Reserve’s Ben Bernanke tightened its policy orally and raised the yield curve by 100 basis points, even though Fannie Mae and the giant pillars of the US financial system were already falling apart.

The European Central Bank has, in fact, raised interest rates to the storm after Germany and Italy got into recession.

The central bank fraternity was catastrophically wrong. For chapter and verse, read The Great Recession by Robert Hetzel, an insider’s report by a prominent Fed economist.

The morality of the story is that monetarism may not be an exact science – dwell times are notoriously “long and changeable” – but at your own risk you ignore the main monetary signals.

Has the economic establishment learned? No, he still ignores monetary data and still rejects monetarists as little better than fortune tellers.

The Fed no longer discloses key M2 and M3 data.

The ECB has forgotten that it even has a monetary pillar under its two-pillar mandate.

They all worship at the New Keynesian altar under the canonical model of the “dynamic stochastic general equilibrium” (DSGE) of the Ivy League academic community and modern central banking.

If the monetarists have repeatedly been right at critical turning points, it is appropriate for us to listen to what they are saying now and, above all, to understand what they are not saying.

Folklore says that monetarists are evangelists with hard money, always on the hawkish side. They are nothing like that.

They follow the math star where it takes them, and in the last few months they have been increasingly worried that we will move from the currency bubble too quickly to a currency slump. They are appalled by the growing evidence that aggregates are sagging in the G7 economies.

They fear that central banks will ignore the signals again and step on the brakes after the cyclical economic downturn is already underway. Monetarists are simply today’s doves.

As you can see from the attached chart, since Julian Jessop, M4x growth in the United Kingdom has already returned to modest levels. Inflation is likely to follow with the usual lag. Prices will gradually settle without the need for scorched earth policies. Commodity prices are already falling from month to month in the United Kingdom.

The danger is that the models of DSGE employees, which have given us much of today’s inflation, will inevitably cause us to fall tomorrow. If you think the cost of living shock is catastrophic, wait for the shoe to fall.

Janus Henderson’s Simon Ward says his key money supply – six months of real money (annualized) – is now markedly negative in the fourteen largest developed (G7) and emerging economies (E7).


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