by Alasdair Macleod, GoldMoney:

With stockmarkets barely ruffled, few are thinking beyond the very short-term and they are mostly guessing anyway. Other than possibly the very short-term as we emerge from lockdowns, the economic situation is actually dire, and any hope of a V-shaped recovery is wishful thinking or just brokers’ propaganda. But for now, monetary policy is to buy off all reality by printing money without limit and almost no one is thinking about the consequences.

Transmitting money into the real economy is proving difficult, with banks wanting to reduce their balance sheets, and very reluctant to expand credit. Furthermore, banks are weaker today than ahead of the last credit crisis, and payment failures on the June quarter-day just passed could trigger a systemic crisis before this month is out.

Sooner or later bank failures are inevitable and will be a wake-up call for markets. Monetary inflation will then become an obvious issue as central banks and government treasury departments become desperate to prevent an economic slump by doing the only thing they know; inflate or die.

Foreigners, who are incredibly long of dollars and dollar assets will almost certainly start a chain of events leading to significant falls in the dollar’s purchasing power. And when ordinary Americans finally begin to discard their dollars in favour of goods, the dollar will be finished along with all fiat currencies that are tied to it.

Introduction – monetary transmission problems

Between different schools of economics there is much confusion over the link between changes in the quantity of money and prices, exposed afresh by the collapse in GDP due to COVID-19 and the aggressive monetary response from the authorities to contain the economic consequences.

Neo-Keynesians appear to understand the link exists, but for them inflation is always of prices which can be managed by adjusting monetary policy subsequently.

Monetarists follow a mechanical quantity theory leading to a relatively straightforward relationship between changes in the quantity of money and of prices after a time lag of a year or so. The principal difference with the neo-Keynesians is in the timing: monetarists see monetary inflation occurring long before the price effect, and neo-Keynesians in charge of central bank monetary policy assume rising prices can be controlled subsequently by varying interest rates.

The Austrian school, which is banished from these proceedings, explains that inflation is of money and nothing else, and the effect on the general price level is determined by a combination of changes in the money quantity and of consumers’ relative preferences for holding money relative to goods.

But central banks operate exclusively on neo-Keynesian lines. They feel free to expand the money quantity so long as the general level of prices does not exceed a targeted 2%; except when it does there is usually an excuse not to restrict money supply growth immediately. Keynesian Inflationism offers problems on so many levels, not least being it is rather like driving a vehicle using a rear-view mirror for guidance. But importantly for our analysis, central banks do not seem to realise current monetary policies guarantee the death of their currencies.

Central bankers act as if money supply increases after prices, which is what monetary policy amounts to. They have other nonsensical beliefs, such as through an inflation tax despite robbing consumers of their wealth, it stimulates them to buy. Whoever thought that one up as a lasting policy beyond short-term distortions deserves an Ignoble prize for idiocy.

Ah! That was Lord Keynes. And perversely, his disciples are today’s main recipients of the Nobel prize for economics. We are now seeing central banks, like some latter-day Aztec priests, trying to appease their gods with human sacrifices. We are the sacrifices, lesser mortals trying to do the best for our families and ourselves, being slaughtered by monetary means.

Figure 1 indicates the alarming debasement of our savings, earnings, and pensions so far through monetary expansion and explains why the dollar’s purchasing power has been declining faster than the CPI suggests.

The fiat money quantity reflects not only money in circulation, that is to say true money as defined by Austrian economists, but additionally the banks’ deposit reserves held at the Fed, the last data being for 1 May. It captures fiat money both in circulation and theoretically available for circulation.

From 2009 it shows the excess monetary inflation that followed the Lehman crisis in 2008, which until 1 February this year grew at an annualised monthly compound rate of 9.5%, compared with the pre-Lehman average long-run rate of about 5.9%.

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