WHERE IS THE MONEY?

--Trends Global, Dec 2015.

As Krugman might say, "...it's in the market, stupid." The most influential economy in the world is poised to raise interest rates, but not because of inflation. Central banks in major parts of the world are still at the zero bound, and core prices are behaving as they should when targeted only because liquidity is trapped on balance sheets as inventory. What happened? Why did monetary easing take half a decade to jump-start the US dollar economy? The answers are common knowledge: banks bought banks with the money, main street lending didn't increase, dealers expanded balance sheets, corporate savings stayed high, investment stayed low; and only now, six years later, is money supply warming up wages and consumption, if it isn't fiscal expenditure.

Economists have been discussing causality (or lack thereof) between money supply and prices for the entire last century (see here in the context of viable central bank tools); but, theoretically, the accounting identity MV = PY is supposed to remain valid in the long-run--more dollars chasing the same goods push prices up. And this is exactly why central bankers should be worried, and interest rates could have gone up earlier. Today the relationship between money supply and output is like nothing it has ever been. By traditional measures, money velocity relative trend has all but stopped. To visualize this recall the chart from Friedman's 2004 article, "The Fed's Thermostat" (now you have to sign-in to read it, so see both of his charts below). His somewhat concessionary admonition, that central bankers since the late 80's had done a better job by targeting inflation, was contingent on a trend-bound money velocity indicator.

Here is a remake of the same chart using current data (a remake of his other chart is also available below).

BIS WARNS OF LOW RATES

The Bank of International Settlements (BIS) continues to reprimand contemporary central banking culture for easy money fixes it argues feed instability by creating global economic conditions that foster bubbles. As the story goes, demand side policies are band-aids slapped on top of deep structural wounds. This is especially the case in a world where financial intermediation dominates money channels with a vast array of levers, ropes, and pulleys that push the lag between easing and higher demand more and more unmeasurably into the future.

What's the right thing to do?

"central banks' obsession with controlling short-term economic output and inflation must be replaced by policies - both national and international - that rely less on demand management and more on structural policies so as to abandon the debt-fuelled growth model that has become a substitute for meaningful reforms." ~ BIS paraphrased by Central Bank News

Why won't it work?

Structural policies reap slow rewards while easy money quenches thirsty power mongers. A structural policy could take ten to fifteen years to start paying off. By that time the guys who put it in place will probably be dead. What's in it for them? Good luck mustering the political will to do the right thing.

On the other hand, it is a good thing the Pope sings a conscientious tune, and the same can be said for the BIS. Without somebody somewhere branding leadership with responsibility we can all of us be assured a life below the belt---a moment of silence for John Nash.

Here's the CBN article:

http://www.centralbanknews.info/2015/06/central-banks-fumble-in-dark-as-they.html


Trends-Global,
June, 2015.

Warren Buffet's Annual Letter to Shareholders.

http://www.berkshirehathaway.com/letters/2014ltr.pdf

TO RAISE OR NOT TO RAISE?

US indicators out this week, like the Chicago PMI and the CPI estimates, support both sides of a US turn-around, the output side and the consumption side. Yet still the FED, though widely expected to raise rates in the summer, remains tight-lipped about it, downplaying positive economic indicators. This sounds like policy speak for 'we want to keep the option in our pocket,' and there is good reason.

While the UK and the US have been running the money tap seemingly forever, at least since 1929 part-two, the great depression strikes back, the rest of the known world, and the unknown world, is starting to catch up. The euro area and Japan are the prime late-comers to the easy money party, but actually, of some 72 policy move making economies, followed by Central Bank News, 48 lowered rates during the last year. 

Everybody wants to crash their currency and tweak their current account to surplus by pushing the demand side with exports. 

Yet, as Martin Wolf pointed out in his Feb 17th Financial Times article, "...income and spending has to add up across the world economy." Somebody will have to widen their trade and current account deficits to fund those surpluses. That somebody is the US and that is one reason Janet Yellen may want to keep her options open.