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.