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Mario, Tim and me…

From Ambrose Evans Pritchard at the Telegraph:

Mr Draghi has won high praise from monetarists around the world, convinced that he has acted just in time to head off a dangerous contraction of the money supply and a full-blown banking disaster. “Draghi has been very astute, and has given the single currency project another lease of life,” said Professor Tim Congdon from International Monetary Research.

“It helps enormously that banks have time to recover. Cheap loans will boost M3 money growth and drive a wider economic recovery this year. Needless to say, the Draghi Bazooka doesn’t solve the external imbalances in the Club Med countries. They will still have to go through internal devaluations, and the question is whether they can endure the agony,” he said.

“Draghi may have saved the euro,” said Lars Christensen from Danske Bank. “What they have done is not optimal. They are acting arbitrarily with no fixed rules and no transparent exit strategy but at least they are acting. If the ECB had done this a year ago, we wouldn’t have had the latest crisis in southern Europe and they would have saved European taxpayers billions.”

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Evans-Pritchard on the Latin Bloc’s “monetarist avenger”

The resident market monetarist at Britain’s Daily Telegraph Ambrose Evans-Pritchard has a comment on European monetary policy under the leadership of the new ECB chief Mario Draghi.

Here is Ambrose:

“Those of a monetarist bent are less alarmed by fiscal contraction (than Keynesians). I have no doubt that monetary stimulus a l’outrance – the classic remedy of Britain’s Ralph Hawtrey, Sweden’s Gustav Cassel and America’s Irving Fisher in the 1930s – can counter the effects of fiscal tightening if conducted in the right way. The debt-to-GDP burden falls faster that way and deflation is averted, a lesson that Japan forgot.

The great question is whether Mario Draghi is embarking on just such a policy, covertly, through his Long-Term Repo Operations (LTRO), starting with €489bn in three-year loans to 523 banks December and to be followed by another blast in February.

The LTRO is not entirely a free lunch. It is replacing funding that has dried up, but to the extent that banks in Italy, Spain, France and Portugal use the cheap money to buy government bonds at rich yields – the Sarkozy “carry trade” – they are not lending to business, as newly bankrupt Spanair can attest…

…Yet, monetarists think Draghi is quietly pulling off a remarkable coup. “This is stealth QE: the impact is dulled because they are not making it clear what they are trying to do, but in the end it may ultimately be as powerful as QE in America and Britain,” said Lars Christensen from Danske Bank.

Tim Congdon from International Monetary Research said Mr Draghi had already boosted total credit to banks from €580bn to €832bn since early November, entirely reversing the Trichet tightening of late 2010.

This may rise to nearer €1.5 trillion this year. While it does not lead to a rise in broad money at first (just the monetary base), it is likely to feed through over coming months in complex secondary effects. “My conclusion is that the Draghi bazooka is such an aggressive example of monetary easing that Eurozone M3 growth will run at 5pc or more [annualized] in mid and late 2012.”

“I (Tim Congdon)remain sceptical about the viability of the European single currency in the long run, but the day of the execution has been postponed once again,” he said.

If Mr Draghi really is the Latin bloc’s monetarist avenger, the Germans will find out soon enough. It is Germany that will overheat, inflate, and suffer a “Latin” credit bubble as EMU’s wheel of fortune turns. Europe’s crisis will take on a whole new political turn. But that is a chapter for tomorrow.”

Needless to say I tend to agree with most things that Ambrose says (and I also find it hard to disagree with Tim). I particularly like that Ambrose mentions Hawtrey, Cassel and Fisher.

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Update: For those interested in my view on fiscal policy see here.

David Friedman on the price of money

I always considered David Friedman to be very special. I have read all his books and I seldom find myself disagreeing with him (we even have a odd interest in Iceland in common). However, I have a slightly controversial interpretation of David Friedman’s thinking – I think his views really is a reflection of what Milton Friedman really would have liked to say if he had been truly free to express his views. Milton Friedman was the one who with his writings both turned me into a monetarist and a libertarian, but David Friedman’s views in many ways are probably closer to what I think about most things. David Friedman as his father of course also is a fantastic writer and thinker.

David’s thinking in my view is the best illustration of what I in my book on his father called the pragmatic revolutionary. His views might on the surface not be all that radical, but once you understand the logic of his thinking you yourself become a radical. David is the best example of this and I hope I am as well.

David, however, has been carefully not writing or speaking too much about monetary issues – his dad’s speciality. However, his latest post on his blog is exactly about that.

David comments on a very import topic – the general misunderstanding that interest rates is the price of money. This is a key monetarist insight that Market Monetarists often also would put forward. Unfortunately David’s comments in Tim Congdon’s new book “Money in a Free Society”. David seems to think that Tim does not understand that money is the price of money. Contrary to this I think that Tim is very much aware that it is a fallacy to say to low interest rates is the same as easy money. I think the misunderstanding is due to Tim’s discussion of the institutional difference between UK and US monetary policies in the 1980s, but I don’t want to be the judge on that. Therefore, I will just concentrate on David’s argument, while I don’t think Tim should be held accountable for a fallacy that he obviously don’t believe in.

Here is David:

It is said that “interest rate” is “the price of money.”

“This is a very common error, and one that is not only wrong but dangerously wrong…If the price of an apple is fifty cents, that means that if I give a seller fifty cents he will give me an apple in exchange. If the interest rate is five percent and that is the price of money, I ought to be able to buy money for five cents on the dollar. I doubt … anyone else, will be willing to sell it to me at that price…The price of money is what you have to give up to get it—the inverse of the price level. If the price of an apple is fifty cents, the price of a dollar is two apples. The interest rate is the rent on money, measured in money. A change in the price of money affects both the money you are renting and the money you are paying as rent, leaving the ratio of the two unchanged…Suppose that at midnight tonight every dollar bill in the world twins, along with a similar change in the accounting entries for bank deposits, other forms of money, and all obligations denominated in money. By morning, there is twice as much money as before—and nothing else has changed…I would ask Congdon (it should be Mr. X!) whether, under those circumstances, he would expect the interest rate to drop. If his answer is yes, my next question is whether he would expect a much more extreme drop if we relabeled pennies as dollars and dollars as hundred dollar bills, thus increasing the money supply, measured in “dollars,” a hundredfold…The reason the description of the interest rate as the price of money is not only wrong but dangerously wrong is that it implies a simple relation between money and the interest rate—in the extreme (but not uncommon) version, the belief that interest rates are set by central banks, with high interest rates the result of a tight monetary policy…A central bank can create money and lend it out, increasing the supply of loans (which reduces the interest rate) and increasing the money supply. That is the one element of truth to the relationship. But what is affecting the interest rate is not the amount of money but the amount of loans; the government could get the same effect by collecting more in taxes than it spends and lending out the difference…The interest rate is a market price—the price paid for the use of capital—and the central bank controls it only in the same sense in which the government can control the price of wheat by choosing to buy or sell some of it. The central bank does not have an unlimited amount of capital from money creation to lend and so has only a limited ability to shift interest rates from what they would otherwise be. Furthermore, a continued expansion of the money supply creates the expectation of future price rises, which pushes the nominal interest rate up, not down.”

I wish more people would understand this, but most of all I would hope that David would write much more about monetary theory.

For those interested I have a discussion of the price for money and interest rates in my paper on Market Monetarism.

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Update: I was a bit too fast – I did not read David’s none-economic books like Harald and Salamander.

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