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Monetary Policy
DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.” Daniel Lacalle
Oversupply of Money Is Fueling Crises
Most market participants have been surprised by the past six months. The total return of the U.S. Treasury Index was the worst since 1788, according to Deutsche Bank. Stocks closed in June with one of the largest corrections since 2008. Bonds and equities are falling in unison, driven by rate hikes and the normalization of monetary policy. However, there’s no such real normalization.
The balance sheets of the main central banks have barely moved and remain at all-time highs, according to Bloomberg. The European Central Bank continues to ignore the highest inflation rate in the eurozone since the early 1990s by keeping negative rates. The Federal Reserve rate hikes have been more aggressive, but it’s still injecting billions of dollars into the reverse repo market, and monetary aggregates remain excessive.
In the United States, money supply growth (M2) is still much higher than in the quantitative easing years. M2 money supply has risen to $21.8 trillion, and yearly change shows a rise of $1.3 trillion, which is more than double the annual figure of the expansion phase of 2008 to 2011. M2 annual growth in the United States was 6.5 percent in May, and it was 6.6 percent in the eurozone. Global monetary growth in May was 9.9 percent (all figures according to Yardeni Research). In the eurozone, money supply growth is higher than in the middle of the so-called Draghi Bazooka, the famous “whatever it takes.”
Central banks have gone from “whatever it takes” to “no matter what.”
I already explained in a previous article that commodities don’t cause inflation, money printing does, and the monetary aspect of inflation isn’t being addressed properly. One or two prices may rise because of an external crisis, but the rest wouldn’t rise in unison given the same quantity of currency.
Between 2012 and 2014, we saw energy commodity prices soar, yet inflation measured as the Consumer Price Index was low because the supply of currency was in line with demand. We did see enormous inflation in asset prices, however, and policymakers didn’t pay attention to the impact on house prices and markets of enormous liquidity injections. When newly created currency stopped going to risky assets and was targeted at government current spending, inflation shot up.
Central banks seem to fear markets. However, it’s better to create a correction in bonds, equities, and risky assets after years of all-time highs than to lead the world to a crisis created by the destruction of the purchasing power of salaries and deposits.
Policymakers should be very concerned about the so-called prudent normalization because the expansion was far from prudent. The pace at which they bloated their balance sheets and cut rates is what they should have been worried about, not the normalization.
Consumer confidence is plummeting around the world, real wages are negative, and families are consuming the little savings they had just to make ends meet. At the same time, businesses are struggling with weaker margins as input prices soar.
The worst thing that governments and monetary authorities could do is to let the economy slip into a crisis where the productive sector, families, and businesses collapse just because they didn’t want to cut deficit spending and truly normalize monetary policy. By then, the problem won’t be inflation, but deflation coming from the asphyxiation of the private sector.
Once consumers and businesses fall, tax revenues will also plummet, taking government debt to new highs. Even Keynesians should be worried about letting inflation run wild because the result would be that governments face an even worse fiscal crisis when the private sector slumps.
Inflation can be addressed by properly reducing central bank balance sheets, raising rates, and cutting deficit spending. If policymakers send the private sector into a crisis because of inaction, the crisis will be far worse than in 2008. There’s still time. End the perverse incentives of excessive monetary action. It may still create another leg down in markets, but they’ll eventually recover. The destruction of businesses and families’ disposable incomes is far more challenging to restore.
