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.


Noah Smith is clueless about Monetarism

Israel Arroyo on Twitter alerted me to a new comment BloombergView by Noah Smith titled “Monetarists Are Out of Ideas”. The whole thing is complete nonsense and shows that Noah Smith has absolutely no insight into monetary theory and particularly no knowledge at all about monetarism.

In fact there is basically nothing about monetarism in the article. Most of the article is about views of the so-called Neo-Fisherians (in itself a misnomer), which has nothing to do with monetarism and none of the economists mentioned in the article are monetarist or call themself monetarists.

In fact there is only one paragraph in the article that actually mentions monetarism. Here is the whole thing:

Monetarism — broadly defined as the idea that monetary policy influences inflation and output in the standard, textbook way — is at the core of mainstream New Keynesian models, and still dominates central bank thinking. There’s evidence for it, and there’s evidence against it, but in the end, I think its prominence endures because it represents a compromise between the Keynesian interventionists and the opposing coalition of anti-interventionists. It posits that technocratic central bankers, manipulating a single price in the economy (the interest rate), are all we need. This is a minimal intervention that liquidationists can stomach and that Keynesians can grudgingly accept.

All of that is basically wrong.

Noah Smith argues that “It (monetarism) posits that technocratic central bankers, manipulating a single price in the economy (the interest rate), are all we need.”

I guess Noah Smith never read anything any monetarist ever wrote about monetary policy, but he could for example start with reading Milton Friedman’s 1967 presidential address to the American Economic Association The Role of Monetary Policy:

… the monetary authority could assure low nominal rates of interest-but to do so it would have to start out in what seems like the opposite direction, by engaging in a deflationary monetary policy. Similarly, it could assure high nominal interest rates by engaging in an inflationary policy and accepting a temporary movement in interest rates in the opposite direction. These considerations not only explain why monetary policy cannot peg interest rates; they also explain why interest rates are such a misleading indicator of whether monetary policy is “tight” or “easy.” For that, it is far better to look at the rate of change of the quantity of money.

Noah Smith should of course know that this is the monetarist position since any student of economics will be introduced to Friedman’s classic article i  Macro 101, but maybe Noah Smith skipped that class. In fact it seems like Smith completely skipped reading anything ever written on monetarism or by monetarists.

It is at the core of monetarist thinking that interest rates tell us very little about the monetary stance. Furthermore, monetarists for decades have argued that central bankers should use the money base to control the monetary stance and that central bankers should not use the “interest rate” as a monetary policy instrument. In fact monetarists argue “the” interest rate is not a instrument at all – it is an intermediate target.

So it is very clear that Noah Smith is completely clueless about what monetarism is and consequently it is very hard to take his views on whether monetarists are out of ideas serious.

In fact I would say it is hard to take anything serious Noah Smith says on monetary matters when he so clearly demonstrates that he didn’t study any monetary theory at all.



The cost of the Sino-US FX deal: Surging money market rates (in Hong Kong)

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.



In a deflationary world at the ZLB we need ‘competitive devaluations’

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:

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’


Iceland moves to abolish capital and currency controls

Some very, very good news out of Iceland. This is from a press release from the Icelandic Ministry of Finance:

Individuals’ and companies’ freedom to transfer funds to and from Iceland and to carry out foreign exchange transactions will increase greatly, according to the bill of legislation that the Minister of Finance and Economic Affairs will present before Parliament tomorrow.

The bill is part of the authorities’ capital account liberalisation strategy, introduced on 8 June 2015. With it, important steps are being taken to lift the capital controls in full. The bill has been prepared in accordance with recommendations from the International Monetary Fund (IMF), with economic stability and the public interest as guiding principles.

Read more on the details here.

In my view this is a decisive move towards the total liberalisation of capital and currency mobility in and out of Iceland. Finance Minister Bjarni Benediktsson deserves a lot of credit for getting this through.

I am very happy to see this and  I am optimistic that this will have significantly positive effect on the long-term growth perspective.

The question of course is how the global financial markets will take this. Overall I believe that the Icelandic króna is trading fairly close to what we could think of a “fair value”, which should reduce the risk of currency outflows over the medium-term. In fact the free movement of capital will make Iceland significant more attractive as a destination for foreign direct investments. Furthermore, it should be noted that Iceland presently is running 5% current account surplus.

The graph below shows the real effective exchange for the Icelandic króna. The red line is the average value for exchange since 2000.




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:




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