Have a look at my comments on yesterday’s Fed hike.
And see our “country page” on the Fed, which will also feature in our soon-to-be-published Global Monetary Conditions Monitor. (In PDF here)
Have a look at my comments on yesterday’s Fed hike.
And see our “country page” on the Fed, which will also feature in our soon-to-be-published Global Monetary Conditions Monitor. (In PDF here)
Posted by Lars Christensen on March 16, 2017
The Federal Reserve is widely expected to hike the Fed funds target rate by 25bp today. The real question is how much more the Fed will deliver going forward.
To get an idea about we are happy to give you a sneak preview on the “country page” for the US monetary policy from our soon to be launched Global Monetary Conditions Monitor (GMCM).
See here (in PDF here):
Just to explain what we are doing in GMCM we do not try to forecast what central bankers will do, but rather we assess or measure monetary conditions. This is a lot less straight forward than people often think. For example the actually level of the key policy rate – in the case of the Fed the Fed funds target rate – on its own says very little about the monetary stance.
Overall, the price level and nominal demand in the economy is determined by the interaction between the money supply and money demand.
It is the task of the central bank to use whatever instrument(s) it uses to to ensure that this interaction between money supply and money demand causes the target – for example inflation – to be hit.
Therefore our starting point in GMCM is to assess monetary conditions relative to the given central bank’s target. In the case of the Fed a 2% inflation target.
Said in another way in our composite indicator for monetary conditions a zero “score” indicates that the Fed will hit its 2% inflation target in the medium-term (2-3 years). If the score is above (below) the then it indicates that the central bank will overshoot (undershoot) its inflation target.
Similar we say that monetary policy is too easy (tight) if the composite indicator is above (below) zero.
The composite indicator is a weighted average of four sub-indicators – broad money supply growth (in the case of the US Divisia M4-), nominal demand growth (often nominal GDP, but in the case of the US Private Consumption Expenditure growth), exchange rate developments and finally the key policy rate (the Fed funds target rate in the US).
For all of these sub-indicators we calculate a growth rate or level, which we believe is what we call “policy-consistent” meaning the growth rate of for example broad money supply growth, which is necessary to hit the central bank’s inflation target.
In the case of the US we see that broad money supply growth (here measured as Divisia M4- growth) presently is more or less in line with the policy-consistent growth rate meaning that looking at money supply growth along we should expect the Fed to hit it’s 2% inflation target in the medium-term.
For the money supply we calculate the policy-consistent growth rate based on the Equation of Exchange (in growth rates):
(1) m + v = p + y
Where m is the growth rate of the broad money supply, v is money-velocity growth, p is inflation and y is real GDP growth
We can re-arrange that:
(1)’ m-target = p-target + y* – v*
m-target is our policy-consistent growth rate for broad money growth, p-inflation is the inflation target (in the case of the US 2%), y* is the strutural trend in real GDP growth and v* is the structural trend in money-velocity. We generally use HP-filters to estimate y* and v*.
In the graph broad money supply growth on the US “country page” the dark green line is actually broad money supply growth and the light green line is m-target (the policy-consistent growth of m).
The difference between the two is essentially a measure of the monetary stance. This is the bars in the graph. Taking into account that monetary policy works with “long and variable lags” we take an 3-year weighted moving average of this gap. That is also the input into the composite indicator.
We use the same kind of method for the three other sub-indicators.
In the case of the US we see that money supply growth and nominal demand growth are pretty much in line with the policy-consistent growth rates, while the rate of appreciation of the dollar is (or rather has been) slightly too fast and the interest rate level is slightly too high.
Overall, we see that the composite indicator for the US is quite close to zero, but still below. This indicates that US monetary conditions are what we term “broadly neutral”, but also that inflation risks in the medium-term are twisted slightly to the downside relative to Fed’s 2% inflation target.
We also see this from our inflation forecast graph. The inflation “forecast” is essentially a simulation of the most likely path for inflation given the present monetary stance (not to be confused with Fed’s key policy rate) and the recent trends in inflation.
We see that the forecast is for US inflation to continue to inch up, but it will not quite get to 2%. This is pretty much also what for example TIPS breakeven inflation expectations show.
What does this mean for market pricing?
When assessing the overall monetary stance it is always very important to remember that we have to look at for example interest rates or the exchange rate relative to expectations. Hence, a 25bp interest rate hike today from the Fed in itself is not monetary tightening is it is completely priced in already.
Therefore, if we want to assess future monetary developments in the US we need to look at market pricing.
Overall the markets are presently pricing in somewhere between two and three 25bp hikes from the Fed this year – including the hike expected for today.
The purpose of our framework in Global Monetary Conditions Monitor is not to forecast how many rate hikes the Fed will deliver this year. But it can tell us about the consequences of difference paths for interest rates.
Hence, one can say that since our composite indicator for US monetary conditions indicates that the Fed is likely to slightly undershoot its 2% inflation target then it would be better for the Fed to deliver a little be less in terms of rate hikes than is presently priced by the markets.
This is not a forecast as central banks often do things they shouldn’t – if they didn’t it would be very easy to forecast their actions – but it nonetheless tells us something about the potential risks relative to market pricing if we assume that the Fed at least in he end will end up doing the right thing.
Looking for reviewers
We are looking forward to publishing Global Monetary Conditions Monitor very soon, but we are also still looking for input. So we are looking for “reviewers” of what we call the country pages of the 25 countries covered in GMCM.
So if you are interested in getting a sneak preview on parts of the GMCM in return for comments please let us know. Mail LC@mamoadvisory or LR@mamoadvisory.com. We prefer policy makers/central bankers and market participants, but don’t be shy to drop us a mail.
Posted by Lars Christensen on March 15, 2017
I generally don’t think I can beat the market, however, right now there is something, which worries me and that is that the “Trump rally” in the US stock market could be about to end.
It seems to me that what US stock market investors are really focusing on is the potential for deregulation and tax cuts (and infrastructure investments). And we might of course get that and deregulation and tax cuts and certainly should be welcomed news both for the US economy and the US stock markets.
But if you get supply side reforms then it will be because of the Republican majority in the House and the Senate (might) want this – not because of Trump. Trump continues to pay lip service to these ideas, but he has certainly not be consistent. There is nothing in Trump’s past that tell us that he is a “free market guy”.
Where he has been consistent – even very consistent – is on his protectionist message and his China bashing. Presently the markets are ignoring this and that might not be the wrong thing to do, but I must say Trump’s 35% tariff talk scares scares me a lot and so does his persistent attempt to “pick a fight” with China.
Another factor, which could spell the end of the “Trump rally” is that not only will the Federal Reserve hike interest rates next week, but the FOMC could also send a more hawkish signal than presently being priced by the market.
In this regard I would particularly focus on inflation expectations, which essentially have stopped rising since 5-year/5-year breakeven inflation expectations broke above 2% a couple of weeks ago. Meanwhile the US stock markets generally has continued to trade (moderately) higher. To me that there seems to be a bit of a disconnect.
Hence, investors expected some Trumpflation as long as (medium-term) inflation expectation, where below 2%, but from here on investors are likely to increasingly think that there will be full monetary offset of any “fiscal stimulus” from the Trump administration.
So did I just say that the “Trump rally” might soon come to an end? I don’t know and I am not giving investment advice here, but…
Posted by Lars Christensen on December 6, 2016
On Monday Donald Trump met with John Allison the former CEO of the BB&T and former CEO of the libertarian think tank The Cato Institute.
It has been suggested that Allison might be in the running to become new US Treasury Secretary.
Allison is widely known to be an staunch advocate of deregulation of the banking sector and in favour of a rule-based monetary policy. Many had taken his support for a rule-based monetary policy to mean that he favours a gold standard.
However, Allison ultimately would like to see a Free Banking system in the US, but also acknowledges that that is not realistic anytime soon. Instead watch what he says on this interview on Fox & Friends.
“We need discipline, we need somekind of rule, I like the Taylor rule, I like some kind of GDP indexing rule…”
Posted by Lars Christensen on November 29, 2016
It is hard to find any good economic arguments for protectionism. Economists have known this at least since Adam Smith wrote the Wealth of Nations in 1776. That, however, has not stopped president-elect Donald Trump putting forward his protectionist agenda.
At the core of Trump’s protectionist thinking is the idea that trade is essentially a zero sum game. Contrary to conventional economic thinking, which sees trade as mutual beneficial Trump talks about trade in terms of winners and losers. This means that Trump essentially has a Mercantilist ideology, where the wealth of a nation can be measured on how much the country exports relative to its imports.
Therefore, we should expect the Trump administration to pay particularly attention to the US trade deficit and if the trade deficit grows Trump is likely to blame countries like Mexico and China for that.
The Yellen-Trump policy mix will cause the trade deficit to balloon
The paradox is that Trump’s own policies – particularly the announced major tax cuts and large government infrastructure investments – combined with the Federal Reserve’s likely response to the fiscal expansion (higher interest rates) in itself is likely to cause the US trade deficit to balloon.
Hence, a fiscal expansion will cause domestic demand to pick up, which in turn will increase imports. Furthermore, we have already seen the dollar rally on the back of the election Donald Trump as markets are pricing in more aggressive interest rate hikes from the Federal Reserve to curb the “Trumpflationary” pressures.
The strengthening of the dollar will further erode US competitiveness and further add to the worsening the US trade balance.
Add to that, that the strengthen of the dollar and the fears of US protectionist policies already have caused most Emerging Markets currencies – including the Chinese renminbi and the Mexican peso – to weaken against the US dollar.
The perfect excuse
Donald Trump has already said he wants the US Treasury Department to brand China a currency manipulator because he believes that China is keeping the renminbi artificial weak against the dollar to gain an “unfair” trade advantage against the US.
And soon he will have the “evidence” – the US trade deficit is ballooning, Chinese exports to the US are picking up steam and the renminbi continues to weaken. However, any economist would of course know that, that is not a result of China’s currency policies, but rather a direct consequence of Trumponomics more specifically the planed fiscal expansion, but Trump is unlikely to listen to that.
There is a clear echo from the 1980s here. Reagan’s tax cuts and the increase in military spending also caused a ‘double deficit’ – a larger budget deficit and a ballooning trade deficit and even though Reagan was certainly not a protectionist in the same way as Trump is he nonetheless bowed to domestic political pressures and to the pressures American exporters and during his time in offices and numerous import quotas and tariffs were implemented mainly to curb US imports from Japan. Unfortunately, it looks like Trump is very eager to copies these failed policies.
Finally, it should be noted that in 1985 we got the so-called Plaza Accord, which essentially forced the Japanese to allow the yen to strengthen dramatically (and the dollar to weaken). The Plaza Accord undoubtedly was a contributing factor to Japan’s deflationary crisis, which essentially have lasted to this day. One can only fear that a new Plaza Accord, which will strengthen the renminbi and cause the Chinese economy to fall into crisis is Trump’s wet dream.
Posted by Lars Christensen on November 18, 2016
Today I was asked to do an interview with a Danish radio station about Donald Trump and about whether one could say anything positive about him or rather about his economic agenda. I declined to do the interview. I frankly speaking has nothing positive to say about Trump.
To me Donald Trump is an absolutely vile person and and his views on immigration and trade are completely the opposite of mine. However, I have also in the run up to the election in presentations and comments stressed that the presidential election from an overall financial market perspective would not be a big deal and judging from the market reaction today this indeed seems to be the case.
Reading the markets
But what exactly are the markets telling us today about the economic consequences of a Trump presidency combined with the fact that GOP now has the majority in both the House and the Senate?
First, of all we should concluded that the markets are fairly relaxed about the outcome of the election. This to me is an indication that Trump really will never be able (or seriously want to) implement many of the bizarre “promises” on trade and immigration he made during the election campaign.
Second the markets certainly do not expect the outcome of the election to cause a US recession or a global economic crisis. After all US stock markets are in fact trading in positive territory today. We get the same message from the currency markets where the dollar is little changed over the past 24 hours.
The Republican Keynesians
However, there is one market where we have seen a significant reaction to the outcome of the election and that is in the bond market. Just take a look at the graphs below.
The first graph is the yield on 10-year Treasury bonds and the second graph is 2-year yields.
We see that the 10-yield has increased around 10bp overnight. This certainly is a significant reaction, but it is equally notable that 2-yields in fact is slightly down.
What this is telling me is that more than anything else the markets expect Trump to be an old-school Keynesian. We know that Trump has already promised to increase Federal spending on infrastructure and he has of course also promised major tax cuts. With the Republicans controlling both the House and the Senate he should be able to deliver on some of these promises.
In fact there would be nothing unusual about having a Republican president who is also a “keynesian” (yes, I know he has no clue about what that is). In fact historically public spending has grown faster under Republican administrations than under Democrat administrations. Just take a look at the graphs below.
Since the Second World War public spending has grown by around a quarter of a percent per year faster when the president has been Republican than when there has been a Democrat president.
The picture is even more clear when we look at Federal government investments:
…and on the budget deficit:
So based on history we can certainly say that Republican presidents tend to be less fiscally conservative than Democrat presidents and judging from the action in the bond markets today there is little reason to believe that Trump should be any different from former Republican presidents.
And what will Trump spend money on? There is little doubt what the markets think – infrastructure! This is from Trump’s victory speech:
We are going to fix our inner cities, and rebuild our highways, bridges, tunnels, airports, schools, hospitals,” he said. “We’re going to rebuild our infrastructure, which will become, by the way, second to none. And we will put millions of our people to work as we rebuild it.
And see what effect that kind of speech had on copper prices today:
Keynesian president + Keynesian Fed chair = No monetary offset
So it seems like the markets expect Trump to push for an expansionary fiscal policy agenda and this is visible in the bond market. However, it is also notable that it is only long-term bond yields, which have increased while 2-year yields haven’t increased overnight.
That tells me that the markets do not expect the Federal Reserve to (fully) offset the impact on nominal demand from a more expansionary fiscal policy.
This effectively means that an easier fiscal policy stance will cause monetary conditions to be eased. The reason is that if fiscal policy is eased then that will push up the equilibrium interest rate level. If the Fed does not hike interest rates to reflect this then it will automatically ease monetary policy by keeping the fed funds rate below the equilibrium interest rate.
This of course is the standard result in a New Keynesian model when interest rates are at the Zero Lower Bound (see for example here).
Does this mean that the so-called Sumner Critique does not apply? According to the Sumner Critique an easing of fiscal policy will not have (net) impact on aggregate demand if the central bank has an inflation target (or a nominal GDP) as the central bank will act to offset any impact on aggregate demand from a easier fiscal policy.
However, the Sumner Critique does not necessarily apply if the central bank’s inflation target is not credible and/or central bank is not willing to “enforce” it. And this seems relevant to the present situation. Hence, US core inflation continue to be below the Fed’s inflation target so one can certainly argue that there is room for an increase in aggregate demand without the Federal Reserve having to tighten monetary conditions.
Obviously the Fed could have done this on it own by for example not signaling a rate hike in December or signaling that it would re-introduce quantitative easing if inflation once again started to trend downwards.
However, the Fed clearly has “mental” problems with this. It is clear that most key Fed policy makers are worried about the consequences of keeping interest rates “low for longer” and more QE clearly seems to be a no-go.
In other words the Fed has put itself in a situation where further monetary easing is off the table and this is of course the reason why a number of Fed officials in the last couple of months have called for old-school keynesian fiscal stimulus.
It all seems to have started in August. This is Janet Yellen at the Jackson Hole symposium on August 26:
Beyond monetary policy, fiscal policy has traditionally played an important role in dealing with severe economic downturns. A wide range of possible fiscal policy tools and approaches could enhance the cyclical stability of the economy.25 For example, steps could be taken to increase the effectiveness of the automatic stabilizers, and some economists have proposed that greater fiscal support could be usefully provided to state and local governments during recessions. As always, it would be important to ensure that any fiscal policy changes did not compromise long-run fiscal sustainability.
Finally, and most ambitiously, as a society we should explore ways to raise productivity growth. Stronger productivity growth would tend to raise the average level of interest rates and therefore would provide the Federal Reserve with greater scope to ease monetary policy in the event of a recession. But more importantly, stronger productivity growth would enhance Americans’ living standards. Though outside the narrow field of monetary policy, many possibilities in this arena are worth considering, including improving our educational system and investing more in worker training; promoting capital investment and research spending, both private and public; and looking for ways to reduce regulatory burdens while protecting important economic, financial, and social goals.
“Promoting capital investment” of course means government infrastructure spending.
Since August we have heard this again and again from Fed officials. This is Federal Reserve Vice Chairman Stanley Fischer at the New York Economic Club on October 17:
Some combination of more encouragement for private investment, improved public infrastructure, better education, and more effective regulation is likely to promote faster growth of productivity and living standards.
Said in another way – the Fed chair and the Vice chairman are both old-school keynesians and now we will have a keynesian in the White House as well.
The consequence is that if we get massive government infrastructure investments then that will push up the equilibrium interest rate, which will allow the Fed to hike interest rates (which they for some reason so desperately want to) without really tightening monetary conditions if interest rates are increased slower than the increase in the equilibrium rate.
This means that we de facto could have a keynesian alliance between the Trump administration and the Federal Reserve, which would mean that will get both monetary and fiscal easing in 2017 and this might be what the markets now are realizing.
Just take a look at what have happened in 5-year/5-year inflation expectations over the paste 24 hours:
Over the past 24 hours long-term inflation expectations hence have increased by nearly a quarter of a percentage point.
Hence, Donald Trump just eased US monetary conditions significantly by pushing down the difference between the Fed fund target rate and the equilibrium rate. Paul Krugman should love Donald Trump.
The Sumner Critique strikes back – A future conflict between the Fed and Trump?
Obviously this is only possible because the Federal Reserve has not been willing to ensure nominal stability by clearly defining its nominal target and has been overly eager to increase interest rates, but I do think that this keynesian stimulus implemented could increase aggregate demand in 2017 and likely push core inflation above 2%.
But if this happens then the keynesian alliance between the Federal Reserve and Trump Administration might very well get tested. Hence, if fiscal-monetary easing push unemployment below the natural rate of unemployment and inflation (and inflation expectations) start to accelerate above 2% then the Federal Reserve sooner or later will have to act and tighten monetary conditions, which could be setting the US economy up for a boom-bust scenario with the economy initially booming one-two years and then the Fed will kill the boom by hiking interest rates aggressively.
Knowing Trump’s temperament and persona that could cause a conflict between the Fed and the Trump administration.
This is of course pure speculation, but even though the Trump administration and the Fed for now seem to favouring the same policy mix – aggressive fiscal easing and gradual rate hikes (slower than the increase the in equilibrium rate) it is unlike that this kind of old-school keynesian stop-go policies will end well.
2017 – a year of inflation?
Given these factors and others I for the first time since 2008 think that we could see inflation increase more significantly in 2017 in the US. This is of course what we to some extent want, but I am concerned that we are getting higher inflation not because the Federal Reserve has moved towards a more rule-based monetary policy framework, which ensure nominal stability, but because we are moving back towards old-school keynesian stop-go demand “management”.
PS I apologize to serious (New) Keynesians about using the term “keynesian” here. I here use the term as to refer to the kind demand management policy, which so failed during the 1970s. They where inspired by Keynesian economic think and was as such keynesian. However, that is not say that present day keynesians would necessarily agree with these policies.
PPS See also my comment over at Geopolitical Intelligence Service on why the US is “Still the Greatest”– also after Trump has become president.
Update: Read my follow-up post here.
Posted by Lars Christensen on November 9, 2016
This is from Financial Times’ FT Fast this morning:
A key lending rate between Hong Kong banks jumped to its highest level since February, potentially making it more expensive to short the renminbi.
The overnight CNH-Hong Kong Interbank Offer Rate (Hibor), a daily benchmark for offshore renminbi interbank lending, jumped to 5.446 per cent on Thursday – its highest level since February 19 – from 1.56767 per cent yesterday, write Peter Wells and Hudson Lockett.
Hong Kong banks do not rely on Hibor to anywhere near the same degree that global banks rely on Libor, the more famous US-dollar counterpart that is a crucial benchmark for loans that global lenders rely on for trillions of dollars of funding each day.
As such, the spike in CNH-Hibor has little practical impact on the banks themselves, but it has recently been viewed as more of a deterrent to speculators betting on CNH, the offshore renminbi.
On January 12, CNH-Hibor hit 66.815 per cent, the highest level since the benchmark was introduced in 2013, amid heavy speculation the People’s Bank of China, acting through state-owned banks, was soaking up liquidity to make the cost of shorting the renminbi more prohibitive as the currency came under pressure from speculators.
Ahead of this month’s G20 summit Commerzbank analyst Hao Zhou was among those predicting the PBoC would hold the line at Rmb6.7 against the dollar for a number of reasons, including a desire to facilitate special drawing rights (SDR) operations set to begin on October 1. However, he noted that “of course, politics tops the agenda again, especially as China is keen to show its ability to manage the whole economy and financial markets although the country still faces strong capital outflows.”
The central bank today weakened the currency’s midpoint fix for the first time since the end of G20, a move in line with analyst predictions that efforts to shore up the renminbi’s value would dissipate when the summit was over.
A spike in Hibor would track with a scenario in which the central bank either intervened itself or had mainland banks sop up liquidity on its behalf. It also has other options – as Commerzbank’s Zhou noted late last month: “We also expect that China’s central bank will allow the local banks to trade CNH in September, in order to narrow the CNY-CNH spread.”
This happens after China and the US over the weekend agreed to “refrain from competitive devaluations and not target exchange rates for competitive purposes”.
As my loyal readers know I am very critical about this deal (see my post on that topic here) as I believe that it is an attempt to quasi fix global exchange rates to avoid ‘currency war’ effectively limits the possibility for monetary easing – both in the US and China.
Ending China’s crawling devaluation will be bad news
Since the Federal Reserve in December hiked the fed funds target rate the People Bank of China effective has tried to decouple Chinese monetary policy from US monetary policy by allowing a crawling devaluation of the Renminbi.
This in my view has played a positive role in offsetting the negative impact of the Fed’s foolish attempt to tighten US monetary conditions.
However, the Sino-US ‘currency peace’ deal limits the PBoC’s possibility of continuing this policy and this is why HIBOR rates are now surging. This obviously is bad news for the Chinese economy – in fact it is bad news for the global economy and markets.
China does not need tighter monetary conditions. Chinese monetary conditions in my view is still quasi-deflationary and if the PBoC abandons its unannounced crawling devaluation policy it will cause a excessive tightening of Chinese monetary conditions, which could push back the Chinese economy towards recession.
It is too bad that policy makers from the ‘Global Monetary Superpowers’ believe that limiting currency flexibility is the right policy. Instead they should embrace floating exchange rates and instead focus on avoiding the biggest risk to the global economy – deflation.
Posted by Lars Christensen on September 8, 2016
Sunday we got some bad news, which many wrongly will see as good news – this is from Reuters:
China and the United States on Sunday committed anew to refrain from competitive currency devaluations, and China said it would continue an orderly transition to a market-oriented exchange rate for the yuan CNY=CFXS.
…Both countries said they would “refrain from competitive devaluations and not target exchange rates for competitive purposes”, the fact sheet said.
Meanwhile, China would “continue an orderly transition to a market-determined exchange rate, enhancing two-way flexibility. China stresses that there is no basis for a sustained depreciation of the RMB (yuan). Both sides recognize the importance of clear policy communication.”
There is really nothing to celebrate here. The fact is that in a world where the largest and most important central banks in the world – including the Federal Reserve – continue to undershoot their inflation targets and where deflation remains a real threat any attempt – including using the exchange rate channel – to increase inflation expectations should be welcomed.
This of course is particularly important in a world where the ‘natural interest rate’ likely is quite close to zero and where policy rates are stuck very close to the Zero Lower Bound (ZLB). In such a world the exchange rate can be a highly useful instrument to curb deflationary pressures – as forcefully argued by for example Lars E. O. Svensson and Bennett McCallum.
In fact by agreeing not to use the exchange rate as a channel for easing monetary conditions the two most important ‘monetary superpowers’ in the world are sending a signal to the world that they are in fact not fully committed to fight deflationary pressures. That certainly is bad news – particularly because especially the Fed seems bewildered about conducting monetary policy in the present environment.
Furthermore, I am concerned that the Japanese government is in on this deal – at least indirectly – and that is why the Bank of Japan over the last couple of quarters seems to have allowed the yen to get significantly stronger, which effective has undermined BoJ chief Kuroda’s effort to hit BoJ’s 2% inflation target.
A couple of months ago we also got a very strong signal from ECB chief Mario Draghi that “competitive devaluations” should be avoided. Therefore there seems to be a broad consensus among the ‘Global Monetary Superpowers’ that currency fluctuation should be limited and that the exchange rate channel should not be used to fight devaluation pressures.
This in my view is extremely ill-advised and in this regard it should be noted that monetary easing if it leads to a weakening of the currency is not a beggar-thy-neighbour policy as it often wrongly is argued (see my arguments about this here).
Rather it could be a very effective way of increase inflationary expectations and that is exactly what we need now in a situation where central banks are struggling to figure out how to conduct monetary policy when interest rates are close the ZLB.
See some of my earlier posts on ‘currency war’/’competitive devaluations’ here:
Posted by Lars Christensen on September 4, 2016
We hear it all the time – central banks are printing money like no time before and it is not working and now there is nothing more central banks around the world can do to fight deflation.
However, this is all a myth and this is what I will demonstrate in this post by looking at global money base growth.
We start by looking at the level of total money base of the G20 countries measured in US dollars.
The graph is clear – since early 2014 the G20 money base (denominated in US dollars) has flatlined.
Contrary to the popular perception there is not massive global money creation. Rather it is hardly surprising that we continue to see strong deflationary tendencies many places in the world as there essentially is no global money creation.
Now lets look at the same data now just in yearly growth rates instead of in levels.
Again the same picture emerges – G20 money base growth has come to a grinding halt particularly from early 2014, but in fact since early 2012 G20 money base growth has been below the pre-crisis growth rate of 15½% y/y.
Hence, it is very clear that judging from the G20 money base global monetary conditions have been tightening at least since early 2014. This of course coincide with when Janet Yellen became Federal Reserve Chair in February 2014 and US quantitative easing was coming to an end.
Ending quantitative easing in the US might or might not have been the right thing for the US economy, but it is clear that the impact on global money base growth has been significantly negative.
Tremendously stable global money base-velocity
Obviously one can question whether the money base is a good measure of monetary conditions. For this to be the case we would need to have a fairly stable development in global money demand and hence in global money base-velocity.
The graph above shows that G20 money base velocity in fact has followed tremendously stable development for the past 15 years.
Hence, over the past 15 years G20 money base-velocity has closely followed a downward trend declining on average 2,75% every quarter.
That said, since 2000 we of course have seen one major negative shock to G20 money base velocity in relationship to the onset of the Great Recession in October 2008 as the graph below shows.
However, from 2009 G20 money base-velocity developments more or less has been in line with the pre-crisis trend and as long as this continues to be the case I think it is fair to consider G20 money base growth as a reliable indicator of global monetary conditions. Not the only indicator, but certainly a very important indicator.
Money base slowdown at the core of the EM crisis and the drop in commodity prices
Having the sharp slowdown in G20 money base growth in mind it is hard to ignore that this more or less have coincided with a sharp drop in global commodity prices and considerable turmoil in Emerging Markets around the world.
Just have a look at the graph below.
There is far from a perfect correlation between commodity prices – he measured by Reuters CRB index – and G20 money base growth, but it is nonetheless notable that as G20 money base starts to slow down in early 2014 commodity prices fall of a cliff.
For the same reason I also think that it is wrong to attribute the drop in global commodity prices only to supply factors – such as Saudi Arabia’s oil policy or the return of Iran to the global oil markets. In fact I think the tightening of global monetary condition is the main cause of the drop in commodity prices since early 2014.
In the last couple of months we have seen a bit of a rebound in global commodity prices. This to some extent reflects supply side factors – such as increased tensions between Saudi Arabia and Iran – but again it is hard to ignore the fact that the outlook for G20 money base growth has changed in a slightly more positive direction as the Fed has softens its hawkish stance a bit.
That said, we haven’t seen a pick up in actual money base growth yet and unless we see that it is hard to see a more sustained recovery in commodity prices.
The question, however, remains whether we will actually see a pick-up in G20 money base growth going forward.
Three ways to higher G20 money base growth
Essentially there are three ways to higher G20 money base growth.
First, the Federal Reserve could re-start quantitative easing. That obviously would increase global money base growth, but right now it seems rather unlikely that the Fed is about to increase money base growth and the Fed still is overly hawkish.
Second, a sharp drop in the US dollar would by definition increase G20 money base growth denominated in US dollars, but again unless the Fed softens its rhetoric further we are unlikely to see any major correction in the dollar in the near-term.
Third, the other major central banks of the world could move into action and here I believe that it will be of particularly importance what the People’s Bank of China (PBoC) does with monetary policy. Here it is particularly notable that the PBoC has started to de-link the renminbi from the dollar and as such is gaining a larger degree of monetary sovereignty.
These three ways to increase money base growth also illustrate why the ‘dollar bloc’ is falling apart and more and more countries are likely to give up their close link to the dollar.
China has already started the process and a number of commodity exporters such as Kazakhstan, Azerbaijan and Angola have devalued their currencies substantially again the US dollar and other ‘dollar peggers’ are very likely to give up their close link to the dollar in the coming year – particularly if we do not see an increase in G20 money base growth either as a result of high US money base growth and/or a sharp drop in the value of the dollar.
Conclusion: Global monetary conditions have tightened considerably
So the conclusion is that global monetary conditions have been tightening significantly over the past two years and it is therefore hardly surprising that we have seen turmoil in Emerging Markets, collapsing commodity prices and continued global deflationary pressures.
We can see this by observing global financial markets, but as I have shown in this blog post the signal from G20 money base growth is also very clear and unless the major central banks of the world do not move into action to spur money base growth the global economy will continue be in a state of deflation.
It is about time for central banks around the world to acknowledge that they are far from helpless and take responsibility for ensuring nominal stability. Today central banks around the world unfortunately are failing to do so.
And no, negative interest rates will not do this – only more money creation will curb global deflationary pressures.
HT Jens Pedersen.
Update: the good thing about writing a blog is that you don’t have to worry about formalities, but on this one I would have put a source on the data. The source is IMF, local central banks, MacroBond and own calculations.
Posted by Lars Christensen on May 15, 2016
It is no secret that I am quite fascinated by the the idea that social media data might be very useful as early/leading indicators of macroeconomic variables. Said in another way I think that social media activity can be seen as a form of prediction markets.
So recently I have been tracking what Google Trends is saying about the development in searches for different terms that might give an indication about whether we are heading for a recession in the US economy.
Lets start with the world ‘recession’.
The picture is not dramatic and the Google searches for ‘Recession’ clearly is much lower than at the onset of the Great Recession in 2007-8. That said, there has recently been a relatively clear pick up in the ‘recession indicator’ that could indicate that ‘Google searchers’ are increasingly beginning to worry about the US economy entering a recession.
How about the labour market? This is Google searches for ‘Unemployment’.
This is much more alarming – there has been a very steep rise in Google searches for ‘Unemployment’. In fact the rise is more steep than it was in 2008. This certainly is an indication of a very sharp deterioration of US labour market conditions right now.
The question then is whether Google searches have any prediction power and here the evidence is quite clear that, that is indeed the case. At least that is the conclusion in a recent paper – The Predictive Power of Google Searches in Forecasting Unemployment – by Francesco D’Amuri and Juri Marcucci.
The evidence is in – the Fed should re-start QE rather than hike rates
Janet Yellen’s Federal Reserve have been extremely eager to say that inflation would soon rise due to the continued decline in unemployment and has essentially ignored all monetary and market indicators, which for a long time have indicated that monetary conditions should not be tightened as fast as the Fed has signaled.
That in my view is the main reason why US economic activity now is slowing significantly in and paradoxically that will now very likely push up unemployment. In fact if we trust the signals from Google searches then we are in for a significant deterioration in labour market conditions in the US very soon.
So while the Yellen-Fed seems to ignore monetary indicators at least the fact that unemployment might soon shoot up again should tell the Fed that it is time to dramatically change course.
In fact it now seems more likely that we will have a new round of Quantitative Easing in the next couple of quarters rather than more rate hikes. Or at least that is what the Fed should do to avoid another recession.
PPS I seriously thought that Janet Yellen was well-aware of the dangers of repeating the mistakes of 1937. Apparently I was wrong.
If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: firstname.lastname@example.org or email@example.com.
Posted by Lars Christensen on February 4, 2016