(Bloomberg Opinion) — Britain’s money-supply economists, who emerged from obscurity in the pandemic by correctly anticipating sky-high inflation before anyone else, are sounding the alarm again.
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Money supply growth is collapsing in the UK, the Eurozone and the US, which is interpreted as a warning of recession and deflation. The central bankers have raised interest rates too high and if the so-called monetarists are right again, they say there should be a “cleaning up” of officials.
Those views are held by British economists Simon Ward, an economic adviser to Janus Henderson, and Tim Congdon, the UK’s leading voice on the issue and once an adviser to Margaret Thatcher when she was prime minister.
His analysis clashes with the widespread consensus that economies are starting to recover and that inflation was caused by supply shocks and energy prices. But for monetarists, growth and inflation are a function of the amount of money in circulation and its speed, the number of times it changes hands. Those measures now point to a decline.
Congdon and Shaw have argued that central banks’ vast quantitative easing programs and sharp rate cuts in the pandemic led to double-digit money supply growth in the US and Europe. A year later, inflation was above target and on its way to 10%.
Today, the money supply is collapsing. In the eurozone, the six-month broad money M3 exchange rate, which measures deposits and cash equivalents with maturities of up to three years, is the weakest since the aftermath of the 2010 financial crisis. M1, money strictly speaking, cash and demand deposits, is negative for the first time since the birth of the currency bloc in 1999, strategists at RBC Capital Markets said.
In the UK, real growth in M4 (cash and sterling liabilities of up to five years) has fallen sharply below trend, Ward said. “Annual growth rates of broad money in the UK and the eurozone are well below their 2010s averages, associated with below-target inflation,” Ward said by email. “This is extremely worrying and suggests recession, disinflation and deflation.”
Vincenzo Inguscio, London-based volatility strategist at Nomura, warned that a recent US contraction of M2, which measures cash in circulation plus dollars in bank and money market accounts, suggests the Federal Reserve has pushed too much monetary brakes. . “People need to be aware of the dynamics of the money supply when it swings around so much,” he said.
To cope with the highest inflation in four decades, central banks have raised rates at the fastest pace since the late 1980s and are winding down QE to write off the money they created. Congdon says the money data shows they should have stopped walking some time ago.
Similarly, Ward wants officials to stop shrinking their balance sheets through so-called “quantitative tightening.” He should even consider cutting rates, “probably by a lot.”
“They need to restore positive money growth,” Ward said. “The monetarists won the inflation forecasting contest, but the central bankers claim it was a fluke. Now for the revenge. If the central bankers lose this and we go into recession or deflation, will there finally be a reckoning and liquidation?
The fall in the money supply may anticipate deflation, but it may also simply reflect the recent banking crisis and instability in financial markets caused by the aggressive rate hike cycle.
RBC says eurozone money is simply rotating to other areas of the banking system, but even so, “loan and money creation is slowing dramatically in the eurozone.” The trends are most worrying in the US, he added, where deposits are “leaving the banking system” and putting “liquidity pressures” on banks.
Ward said the banking turmoil threatens to worsen the money supply squeeze as lenders “become risk averse” and tighten credit. For Congdon, the problem is serious enough to warrant a change in the central bank’s framework.
He wants the BOE’s open letter system, whereby the governor must explain to the finance minister why inflation is more than 1 percentage point off target, to incorporate a reference to broad money.
“The amount of money should be on the board of the central bank. If it’s not there, central bankers will be just as dangerous as people who drive cars without looking at the speedometer,” he said.
Congdon believes that “the Fed, the ECB and the Bank of England are to blame for the well-above-target inflation rates their economies are now suffering from.” And he added: “They will also be to blame for the recessions that will hit these economies starting in mid-2023.”
BOE officials have backed down. Silvana Tenreyro, an external member of the monetary policy committee, says it is wrong to blame QE for skyrocketing prices. “QE affects the economy only to the extent that it affects interest rates. There is no separate ‘money’ channel that can trigger inflation,” she told the Scottish Economic Society annual conference in Glasgow last Tuesday.
In a speech last year, wryly titled “What did the monetarists do for us?”, BOE chief economist Huw Pill argued that modern economics embraces some monetarist ideas, but rejects how he sees the policy being conveyed because that “is considered widely discredited.” since the mid-1980s, when Congdon was most influential.
“I doubt monetarism will be embraced by the academic or central bank communities in the next few years,” Pill added. A BOE spokesman declined to comment.
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