Venezuela can’t defy gravity

This is from my latest article over at Geopolitical Intelligence Services:

It wasn’t that long ago that socialists all over the world were celebrating Venezuela as an economic success story. But economists knew the country was less a success than a mirage.

The semblance of success was supplied by dumb luck, in the form of a sharp and continuous rise in oil prices during the 2000’s. That created a windfall for Venezuela, which has the biggest proven oil reserves in the world.

By now it should be blatantly obvious to even the most diehard socialist that Venezuela’s “Bolivarian revolution” has been an economic and social disaster.

Since 2013, the country’s real gross domestic product has dropped nearly 20 percent. Inflation has spiked and could very well explode into hyperinflation if President Nicolas Maduro’s regime does not change course – and soon. The Venezuelan bolivar has plummeted and ordinary citizens are above all anxious to get their hands on some good old U.S. doll

Read the rest here.


It’s time to rediscover ECB’s reference value for M3 growth

A couple of days ago I read an interview with ECB’s former chief economist Otmar Issing about the euro crisis. I frankly speaking didn’t find the interview particularly interesting and Issing brings little new to the discussion.

Issing rightly repeats the worries about moral hazard problems and he is critical about the ECB’s credit policies even though it is clear that he fails to point to the difference between credit policies (which central bankers should stay far away from) and monetary policy (which central banks have a mandate to conduct).

Even more depressingly Issing completely fails to recognize the monetary nature of the euro crisis.

This is particularly depressing given Otmar Issing certainly knows his monetarist theory and he used to be know as the monetarist at the ECB.

It was Otmar Issing who famously put monetary analysis based on the quantity theory of money at the centre of thinking in the ECB’s early days. Hence, Issing was the main architect behind ECB’s so-called two pillar strategy. The one pillar was that the ECB should look at a broad range of economic indicators when assessing the monetary policy stance. The second pillar was the monetary pillar which emphasized monetary (essentially montarist) analysis.

What happened to the reference value for M3 growth?

At the core of the monetary pillar was what came to be known as the reference value for M3 growth.

This is how the ECB (read Otmar Issing!) used to define the reference value:

This reference value refers to the rate of M3 growth that is deemed to be compatible with price stability over the medium term. The reference value is derived in a manner that is consistent with and serves the achievement of the Governing Council’s definition of price stability on the basis of medium-term assumptions regarding trend real GDP growth and the trend in the velocity of circulation of M3. Substantial or prolonged deviations of M3 growth from the reference value would, under normal circumstances, signal risks to price stability over the medium term.

So what we are talking about here is the growth rate of M3, which over the medium-term will ensure 2% inflation given the trend-development in money demand (trend real GDP growth and trend-velocity growth).

We can operationalize this by looking at the equation of exchange (in growth rates):

(1) m + v = p + y

Where m is M3 growth, v is the growth rate of M3-velocity, p is inflation (in the GDP deflator) and y is real GDP growth.

If we define v* as trend growth in M3-velocity and y* as trend/potential real GDP growth and finally assume inflation should hit the inflation target of 2% then we can re-write (1):

(1)’ m + v* = 2% + y*

Re-arranging further we can get a target for M3 (m-target), which will ensure 2% inflation over the medium-term:

(2) m-target = 2% + y* – v*

The ECB used (2) to calculate the reference value for M3 growth by assuming v* was around -1/2% and y* was 2%, which would give you a reference value of 4.5%.

The ECB kept this target constant over time despite the fact that neither the trend in velocity nor the trend in real GDP growth are constant over time.

If we instead want to take into account changes in v* and y* over time we can try to “estimate” these variables by applying a Hodrick–Prescott filter (HP filter). Somewhat simply said a HP filter is just a sophisticated moving average.

Introducing the policy-consistent M3 growth rate

While Otmar Issing might have given up on monetary analysis I have not. In fact monetary analysis is at the core of the new publication on Global Monetary Conditions, which my advisory – Markets & Monetary Advisory – will start to publish in the coming months.

In this publication we in fact calculate what we term the policy-consistent M3 (or M2) growth rate for the 25-30 countries, which will be covered in the publication (see more here).

The graph below shows actual M3 growth (the blue line) in the euro zone compared with the policy-consistent M3 growth rate (the red line).


The grey bars are the a 3-year weighted moving averages of the difference between actual and policy-consistent M3 growth and as such is a measure of the monetary policy stance. Negative (positive) bars indicates that M3 growth is too slow (too fast) to ensure that the ECB will hit the 2% inflation target over the medium-term. We can here term this as the ‘money gap’.

In our new  monthly publication we will focus on four different monetary measures to put together one monetary conditions indicator (M3 growth, nominal GDP growth, interest rates and the exchange rate), but if we only focus on our measure of the policy-consistent M3 growth rate we nonetheless get great insight about monetary conditions in the euro zone.

Looking at the development in the ‘money gap’ we see that monetary conditions were broadly speaking from the euro was established in 1999 and until 2006. However, from 2006 monetary conditions clear became too easy.

That, however, change dramatically as M3 started to slow rather dramatically in early 2008 and already at the time should have been clear that soon the M3 would drop below the ECB’s reference value for M3 (and our policy-consistent M3 growth rate). Despite of this the ECB hiked its key policy rate in July 2008! This is of course was the first major policy major the ECB made in the crisis. More disastrous policy mistakes of course followed in 2011 when the ECB hiked interest rate twice!

Hence, had the ECB only focused on M3 the ECB would certainly have tightened monetary policy more aggressively in 2006 and 2007, but even more importantly it would never have hiked interest rates in 2008 and 2011. Rather judging from M3 growth relative to the ECB’s own (old) reference value or our policy-consistent M3 growth rate the ECB should have slashed interest rates aggressively in the Autumn of 2008 and in 2009 and should have initiated quantitative easing once interest rates hit zero.

Otmar Issing should be angry (but for the right reasons)

Hence, Otmar Issing is indeed right to be angry with the ECB, but he should be angry for the right reasons. Issing might point to problems of moral hazard and I certainly share these concerns, but what Otmar Issing really should be angry about is that the ECB complete have given up on taking Issing-style monetary analysis seriously as a result at least six years after 2008 monetary policy far too tight!

Unfortunately Issing seems to have given up on his own analysis as well. That is deeply regrettable.  So we can only hope that Otmar Issing will go back to proper monetary analysis of the typical ‘Calvinist preaching’, which unfortunately is so common among German policy makers – both in Frankfurt and Berlin.

If he did that he would continue to criticize the ECB for trying to distort bond market pricing and encouraging moral hazard, but he would also recognize that ECB chief Mario Draghi has been right pushing for quantitative easing and that it should be continued as long as necessary to keep M3 growth around at least 4.5-5% as this ensures that inflation will be close to ECB’s 2% inflation target.

PS I don’t think re-introducing the reference value for M3 growth would be the best policy framework for the ECB, but it certainly would be better than the present non-policy-framework and very much doubt that we would still would be talking about a euro crisis had the ECB taken the reference value serious.

Rational investors and irrational voters

It seems like there is a bit of a gap opening between prediction markets and opinion polls when it comes to the likely outcome of the US presidential elections in recent days.

Hence, the prediction market Predictit now has a 81% (19%) implied probability that Clinton (Trump) will win, while the opinion poll aggregator over at Nate Silver’s FiveThirtyEight-side has a implied probability of 88.1% (11.9%) that Clinton (Trump) will win.

If we look at the last couple of months it seems clear that the polls have been somewhat more extreme in both direction than the prediction markets.

This to me is interesting as it seems to indicate there is more “animal spirits” in the opinion polls than in the prediction markets. Or said, in another way this could be an indications that when we act as investors – betting on the outcome of presidential election – we behave more rationally than when we are voting?

Obviously opinion polls and prediction markets are not measuring the same thing. Prediction markets “predict” what the outcome will be of an election at a future date, while opinion polls measures how voters think they would vote today. That said, Nate Silver’s models try to do something in between the two.

Anyway, to me it is interesting that it seems like we are voters are much more inclined to be driven be “mood swings”, while we as investors seem a lot more cool-headed. This is of course also what we could learn from Bryan Caplan’s The Myth of the Rational Voter.

PS note that I am not here discussing whether opinion polls are better or worse than prediction markets at forecasting the outcome elections. I am discussion the different decree of rationality we have as voters and investors (or consumers for that matter).

Russia’s economy dodged a bullet, no thanks to Mr. Putin

Se my latest article at Geopolitical Intelligence Services on how a floating exchange rate have helped Russia avoid economic collapse here.

Re-visiting: “Towards a new monetary regime for Iceland”

The question of what is the best monetary policy regime for Iceland has come up in the Icelandic election campaign and particularly it has been suggested that Iceland introduce a currency board.
It is well-known that I am not a major fan of pegged exchange rates but there is also a trade-off in choosing the “optimal” monetary policy regime between on the one hand having a strongly rule-based regime and having the “correct” anchor.
I discussed these issues at a seminar in Iceland hosted by Islandsbanki back in early 2015.
See my presentation “Towards a new Monetary Regime for Iceland” here (after 15 minutes)

M&M Advisory to launch new publication on Global Monetary Conditions

Dear friends,
Within the next 1-2 months my advisory Markets & Money Advisory will be launching a new monthly publication on Global Monetary Conditions.
The purpose of the publication will not be to predict or forecast monetary policy in different countries. Rather the purpose will be to correctly measure the monetary policy stance and as well as interpret monetary developments across 25-30 countries.
This means that we will publish a monthly Monetary Condition Indicator on each of the 25-30 countries in the report. In addition, we will publish an aggregate version of the this for Global Monetary Conditions.
Overall the indicator is calibrated so that it is zero when monetary conditions are such that the central bank should be expected to hit its inflation target in 18-24 months. The global indicator will be published both in the monthly version and in a daily/real-time version.
Overall, the publication will reflect a Market Monetarist take on global monetary conditions meaning special focus will be paid to what the markets are telling us about monetary conditions as well as on monetary aggregates as well as nominal demand/nominal GDP.
The results from the indicator are very encouraging and it shows that the indicator for the Global Monetary Conditions is highly correlated with global asset prices and commodity markets as well as with the global macroeconomic developments.
In that sense the publication will be useful for both investors and traders as well as for policy makers.
We would be very interested in feedback already now. Could this be of interest to you? What would you like to see in such report?
We plan to price a 12-month subscription at around EUR 2000 with the possibility of special deals if more than one subscription is purchased or if it is part of an overall advisory agreement with Markets & Money Advisory.
The publication will be launched when we in the near future launch the new Markets & Money Advisory website.
Feel free to share.
For comments, requests and feedback feel free to drop me a mail (
Lars Christensen
CEO and owner, Markets & Money Advisory

PS Here is a sneak preview of the indicator to US monetary conditions.


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