The End of Milton Friedman’s Monetarism

by Dr. Emanuele Canegrati and Dr. Keith Weiner*

According to the latest data released by the European Central Bank on September 2, the outstanding amount of the central bank’s outright operations touched nearly €1.3T, with the lion’s share going to the public sector purchase program (nearly €1T). Table 1 shows the outstanding amount for every instrument used by the ECB (source: ECB website).

Instrument:  Reference date – Outstanding amount
Covered bond purchase programme:  2 Sep. 2016 – 16,412 mn
Securities market programme:  2 Sep. 2016 – 108,404 mn
Covered bond purchase programme 2:  2 Sep. 2016 – 7,442 mn
Covered bond purchase programme 3:  2 Sep. 2016 – 190,735 mn
Asset-backed securities purchase programme: 2 Sep. 2016 – 20,142 mn
Public sector purchase programme:  2 Sep. 2016 – 1,001,947 mn
Corporate sector purchase programme:  2 Sep. 2016 – 20,497 mn

In governor Draghi’s view, the biggest injection of euros in the ECB history, associated with the negative interest rate policy undertaken by the central bank, should have brought Eurozone inflation back to the ECB 2% policy target. Many times, Draghi’s rhetoric inflamed investors. “We have shown we are not short on ammunition”, he swore last March, when the ECB cut the deposit rate by 10 basis points to a historic low of -0.4% and stepped up the pace of its quantitative easing program from €60bn to €80bn a month. Results? Quite disappointing.
The latest figures released by Frankfurt showed that the Eurozone inflation rate was only equal to +0.2% in August, unchanged from July and at only 1/10 of ECB target rate. A failure for the central bank. Figure 1 shows the monthly increase of ECB balance sheet (assets for Euro Area) compared to the Eurozone Harmonized Index of Consumer Prices (HICP) over time. Looking at these two trends, one may hardly say that a positive correlation exists.
Let’s consider another example: the quantitative easing program by the U.S. Federal Reserve. Since 2008, there has been a massive increase in the money supply. M0 has increased from about $875B to $4.07T in 2014 (all time high); M1 surged from $1.4T to $3.2T in July 2016 (all time high), or 2X and M2 sky rocked from $7.8T to $12.9 in July 2016 (all time high), or about 1.5X. But prices haven’t followed the same trend. The Bloomberg Commodity Index fell from about 175 to 83 on September 6, while the rate of inflation, as calculated using the Consumer Price Index, published monthly by the Bureau of Labor Statistics, was +0.8% in July 2016 and the average rate for 2015 was a meager +0.1%.
Finally, Japan. Last August Bank of Japan Governor Haruhiko Kuroda stated the bank will approve more quantitative easing or lower negative interest rates “without hesitation,” and that he felt that between quantitative easing and negative interest rates, the bank has an “extremely powerful policy scheme” and “will act decisively as we move on” in order to raise inflation to 2% policy target. And yet, notwithstanding the ¥80T ($733B) in government bond purchases per year, the Japanese inflation rate was -0.4% last July and the Tokyo’s secular decline in prices is far from being abandoned.
This international evidence is useful to demonstrate, amongst other things, the fallacy of the monetarist’s quantitative theory of money, which hypothesizes the existence of a positive (linear) relation between money supply growth and prices. According to this theory, if money supply increases by 1% prices should increase by approximately the same percentage, as monetarists believe that the excess of money supply in the economic system transforms to rising prices. “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”, wrote Milton Friedman, one of the biggest promoters of monetarism, in The Counter-Revolution in Monetary Theory (1970).
Contrary to Milton Friedman’s prediction, ECB and FED excessive expansion of the money supply did not drive prices up. Evidence also showed that the current deflationary spiral cannot be attributed to the reverse effect of a failure of central banks to increase the money supply during a liquidity crunch. Would Milton Friedman ever have written his theory in modern times with these data available? We can only wonder. Friedman had insisted upon the strong relationship between changes in the monetary aggregates and movements in the overall level of prices by observing statistics during the heyday of monetarism for many economies and for many time periods. And, for many years, evidence seemed to be by his side. But, after the Great Financial Crisis, the situation and data have changed and Friedman’s theory seems not to hold anymore.
Having not much faith in monetarism, Friederich von Hayek maintained that monetary expansions disrupt the market process, causing resources to be misallocated. It is not difficult to find evidence of Hayek’s prediction in the ECB’s quantitative easing program. The recent commitment by Frankfurt to extend the buying program to corporate bonds generated a rapid increase in the issuance of these securities. In just the month of August, traditionally a very calm one, the total issuance was €49.7B (€833.4B year-to-date). U.S. corporates switched to euro-denominated issuance, with very high-yield issuers amongst the most active in this rush, taking advantage from the higher risk appetite by investors for risky assets. Exactly what von Hayek defined with the term “malinvestments”, or investments undertaken by investors as a consequence of artificially low interest rates decided by central banks. The origin of bubble and financial crisis.


*Dr. Emanuele Canegrati is a PhD at Catholic University of Milan, economist at Department of Treasury, Head Market Analyst at BlackPearlFX and Fellow of the Liechtenstein Academy Foundation.

Dr. Keith Weiner is president of the Gold Standard Institute USA in Phoenix, AZ, and CEO of gold investment company Monetary Metals. He speaks and writes about free markets, money, credit, and gold.

Cheap money policy does not fool citizens

GIS Statement by Prince Michael von Liechtenstein

The socialist idea of a planned economy is gradually being made a reality by the monetary policies of central banks, such as the United States Federal Reserve and the European Central Bank. The idea is also promoted by a considerable number of western economists and politicians. The conventional wisdom within that group is that economies are driven mainly by consumption. They blissfully ignore the importance of investment and savings – even of the kinds that help people set money aside for retirement.
The purported logic behind the banks’ current monetary policy is that extremely low to negative interest rates will discourage savings and boost consumption, fanning economic growth. This is superficial, short-term thinking from ideologically misguided people.
The policy, if successfully applied, would lead to an increase of the indebtedness of households in the affected countries. Indebted peoples tend to be less free than societies with savings, which give individuals freedom and independence. One is tempted to start suspecting that a hidden agenda might play a role here – a politically motivated desire to push private households deeper into debt in order to gain better control of consumption and to be able to centralize investments by institutions. This would amount to a triumph of economic planners over markets.

yellen-draghi-2016

Fortunately, people have not been responding as expected. Citizens understand mathematics and they know that they need a financial cushion in hard times, and for retirement. They are aware that low to negative interest rates are eroding their financial reserves and the value of their nest eggs and retirement entitlements. Those negative effects are exacerbated by planned inflation. Inflation is biting already, but that is obscured by statistics that do not reflect the purchasing structure of a typical middle class household. Rightfully, people worry of being impoverished in their old age.
And they are acting on their concerns. Demonstrably, people in the countries with extremely low to negative interest rates have been saving more. They are bucking the trend that many politicians and central banks are irresponsibly trying to spawn.
The savings rate (the ratio of the disposable income that private households put aside as reserves) increased in Sweden from some 5 percent in 2006 to more than 16 percent in 2016. In Denmark during the same period, it shot up from a negative rate to more than 8 percent, and it has remained stable in Germany at around 10 percent. Even the U.S., normally not a savings champion, has seen a stable savings rate of some 5 percent. Switzerland, on the other hand, long a nation of big savers, increased its savings rate during that decade from about 15 percent to some 20 percent.
A danger exists that once the misguided monetary policy fails, as it must, some of the money-hungry governments will then try to confiscate large chunks of these savings. They also may be wiped out by inflation as soon as the huge money supplies created by central banks hit the economies.

Read the original GIS statement here ->
Cheap money policy does not fool citizens


*GIS is a global intelligence service providing independent, analytical, fact-based reports from a team of experts around the world. We also provide bespoke geopolitical consultancy services to businesses to support their international investment decisions. Our clients have access to expert insights in the fields of geopolitics, economics, defense, security and energy. Our experts provide scenarios on significant geopolitical events and trends. They use their knowledge to analyze the big picture and provide valuable recommendations of what is likely to happen next, in a way which informs long-term decision-making. Our experts play active roles in top universities, think-tanks, intelligence services, business and as government advisors. They have a unique blend of backgrounds and experience to deliver the narrative and understanding of global developments. They will help you develop a complete understanding of international affairs because they identify the key players, their motivations and what really matters in a changing world. Our experts examine the challenges and opportunities in economies old and new, identify emerging politicians and analyze and appraise new threats in a fast-changing world. They offer new ideas, fresh perspectives and rigorous study.

Consequences of faulty central bank policies

Essay by Dr. Tillmann C. Lauk; presentated at the ECAEF Workshop, in Bratislava on September 8, 2016 

Since the GFC1 of 2008 all central banks of the Triade are pursuing the same monetary policies. All central banks of the advanced-/over-indebted economies stick to this recipe. The main tools are QE2, ZIRP3 and NIRP4 and possibly in the future „helicopter money“ and a ban of cash. All tools have in common that they are highly repressive, malicious for the economy (mal investments), they stealthy expropriate savers, and massively hurt retirees. What the tool-kit of central banks is targeting at:

• Quantitative Easing means buying assets from the commercial banking system which in return gives cash to the private banking sector. The money required for those purchases is simply „printed out of thin air“.

• 1st Rationale: increase credit to the economy in order to stimulate aggregate demand = what is supposed to spur productive investment and employment.

• 2nd rationale: create a wealth effect through raising asset prices = equities and other (financial) assets.

• 3rd rationale: through this increase of the money supply try to create controlled inflation and to devalue currencies in the hope to stimulate exports.

• 4th rationale: ZIRP or even NIRP aim at (a) bringing down the debt service obligations of the ever increasing sovereign debt and (b) forcing savers to spend.

Now, let’s check whether data support that statement …

Continue reading -> Download PDF: “Consequences of faulty central bank policies”

Market economies, regulation and crony capitalism

GIS statement by Prince Michael of Liechtenstein

It has been the intellectual fashion among commentators, politicians and some economists to claim that the financial crisis of 2008 and the ensuing economic downturn were caused by excessively free markets, or “turbo-capitalism.” From this they deduce that free markets foster inequality, and that inequality is the main source of today’s social and economic problems.
The result is a cry for more regulation and government intervention whose aim, in the words of one German finance minister, is to put the markets on a leash. We certainly need sensible regulations. But in this context, we should not forget the best and most efficient regulator. That would be competition, which keeps markets clean, honest and working for the best interests of all stakeholders and society in general. It must also be admitted that the biggest problems arose in the most highly regulated sector: the global financial industry. The tangled thicket of regulations favored large players (“too big to fail”) and led to concentration. This encouraged cartels and unethical price-fixing, as shown in the Libor scandal. Such malpractice by a handful of big players appears to have been silently tolerated by the regulatory authorities.

Market distortions

Meanwhile, irresponsible and populist overspending by governments over the past 30 years led to large budget deficits and sovereign debt. One of the main reasons why central banks adopted a policy of easy money was to alleviate this fiscal burden. Money is the raw material of the financial system. As in any industry, government intervention to keep raw materials cheap will distort markets, exaggerate profits and encourage waste and abuses. The problems in the financial sector were created by a regulatory concentration of the industry combined with cheap money. Capitalism, based on competition and free markets, was replaced by regulations and government intervention. In order to camouflage the crony system between governments and big banks, the term “turbo-capitalism” was coined. True markets and capitalism took the blame.
It did not stop there, however. Capitalism and free markets were also blamed for inequality, which was identified as the fundamental problem. This diagnosis is totally false. It is true that inequality is rising. But one has to analyze the reasons carefully before jumping to populist, ideological conclusions. Liberalization of markets for labor, goods and services has helped approximately 1 billion people escape from poverty over the past 25 years. In both magnitude and speed, this is an unprecedented step.
But an era of cheap money has brought huge problems. Zero to negative interest rates have destroyed the personal savings of vast numbers of people, encouraged a culture of debt and threaten to wipe out pension savings. Poverty may again become the norm among elderly people in the developed world.
A side effect of cheap money is asset bubbles, which drastically increase inequality on paper even if they fail to make the rich richer on a lasting basis (because bubbles burst). With so much money sloshing around, the equity and real estate markets are too expensive, reducing investment in the economy and hindering growth.
The real reason for today’s economic malaise and rising inequality is overregulation. This creates inefficiencies and encourages politicians to intervene in the economy for short-term, populist aims. Unfortunately, they will find cronies in the private sector, because market inefficiencies can be very profitable to a privileged few – to the detriment of business and the broader public.
Politicians and regulators should not be putting markets on a leash. They should be devising lean and efficient rules to allow free markets to do their work. Competition and innovation lead to prosperity, from which everyone benefits.

Read the original statement here -> GIS

Democracy and populists: a misconception

GIS* statement by Prince Michael of Liechtenstein

It is almost impossible to listen to politicians, intellectuals and media personalities lately without hearing the lament that liberal democracies are being threatened by populists, usually of an authoritarian bent.
At face value this assessment seems correct. But on closer examination, doubts grow about whether Western political systems can still be called democratic and liberal.
Representative democracy depends on legislators who represent the public interest (res publica), not that of a party or its ideology. In practice, however, this only works if most parliamentarians are independent people rather than professionals who view politics as a career. Unfortunately, in nearly all Western democracies, the latter predominate.
We commonly refer to parliamentarians as lawmakers. Today this is doubly true, as parliaments have evolved into factories belching forth new legislation, to the detriment of their true role of representing the nation’s long-term interests.
The political system has also evolved, as established parties do whatever it takes to uphold the status quo and maintain their grip on power. In so-called Western democracies, this has meant the established parties have become extremely populist themselves.
A myopic focus on the next election has led to strong uniformity within the political mainstream. Many people have stopped voting because they no longer see any differences. Without a real opposition, there is an absence of vigorous, fact-based debate – a vital ingredient of any democracy.
One way of stifling debate is the concept of “political correctness,” which excludes alternative thinking or raising ideas labeled as “radical.”

democracy-switzerland

Absurd system

Meanwhile, the tsunami of laws and regulations has led to a “nanny” state that little resembles its liberal roots. The powers of government have become increasingly centralized, to the detriment of individual responsibility and autonomy which would be better invested in regions and municipalities. As is well known, democracy functions best in smaller entities, where issues are closer to home and the individual voter can still be heard.
In Europe, countries like Switzerland and Liechtenstein – which uphold strong traditions of local autonomy, direct democracy by referendum, and a militia system requiring members of parliament to earn their own livings – are not threatened by authoritarian movements.
What we now call “liberal democracy” has in fact traveled a long way down the road toward centralized bureaucracy. It is a system that cannot be trusted. No longer liberal, it cannot really be called democratic, either.
The system’s absurdity became painfully obvious during the presidential campaign in the United States. Neither of the two major parties was able to select a convincing candidate after a lengthy series of primaries. Instead, we have been offered the political equivalent of mud-wrestling – an appalling spectacle on both sides.
According to a Reuters/Ipsos poll, 66 percent of American voters are convinced that the U.S. is on the wrong track, while 22 percent think things are headed in the right direction. The situation in Europe is not much different.
What ordinary people have grasped, consciously or subconsciously, is that the current political system is populist and ridden with self-interest. Its resistance to change and decentralization is palpable, as is its hostility to notions of personal responsibility and freedom of thought and expression. No wonder voters are looking for alternatives.

Read the original GIS statement here ->
Democracy and populists


*GIS is a global intelligence service providing independent, analytical, fact-based reports from a team of experts around the world. We also provide bespoke geopolitical consultancy services to businesses to support their international investment decisions. Our clients have access to expert insights in the fields of geopolitics, economics, defence, security and energy. Our experts provide scenarios on significant geopolitical events and trends. They use their knowledge to analyse the big picture and provide valuable recommendations of what is likely to happen next, in a way which informs long-term decision-making. Our experts play active roles in top universities, think-tanks, intelligence services, business and as government advisors. They have a unique blend of backgrounds and experience to deliver the narrative and understanding of global developments. They will help you develop a complete understanding of international affairs because they identify the key players, their motivations and what really matters in a changing world. Our experts examine the challenges and opportunities in economies old and new, identify emerging politicians and analyse and appraise new threats in a fast-changing world. They offer new ideas, fresh perspectives and rigorous study.