Last week I attended a workshop at the ECB on Global Liquidity. Global Liquidity of course refers to money flowing throughout the world as a result of western central bank money printing—especially Fed printing. I thought it might be beneficial to highlight some insights gained.
1. Attended mostly by central bankers, the group of 40-50 people seemed to be in agreement that their—and particularly the Fed’s—monetary policy is a key driver of financial asset prices, including commodities and real estate.
I learned that while there is no consensus among central bankers that increased bank credit is the sole driver of higher asset prices (though I’m told many say that it is, and one economist I spoke with said that it was), there is a consensus that it is the sole driver of inflation in the long run. The short-run drivers are rather insignificant. One that I agree with is changes in the supply of imports. As a booklet I bought states: “Inflation is ultimately a monetary phenomenon.”
Why central bankers agree that rising consumer prices are ultimately a monetary phenomenon, but believe rising asset prices are only a partial monetary phenomenon is beyond me.
Just to be clear, I asked one central banker about the theory that unions can drive up prices. He said that they could—if there was an increase in money. He was spot on.
An very interesting insight came about when he said that I sounded like a monetarist. I said that I was actually more aligned with Austrians. He immediately replied that the school is not much different than monetarists with respect to what we had been discussing. Of course he was right, but it impressed me that he was that intimately familiar with Austrian views. After all, one Italian central banker I spoke with a few years ago asked: “what is an Austrian?”
2. The group also discussed that monetary policy has both a supporting and a destabilizing effect on the economy and financial system (we, of course would argue that it is the sole driver of asset prices and of GDP and consumption in the long run). One PPT presentation by an economist from the Bank for International Settlements, regarding the financial crises concluded: “Who to blame? Model says the Fed.” I agree with him. But it’s shocking that they actually state/admit this.
Another statement was “the central bank can create distortions.” Again, to us they are—absent acts of nature—the only ones creating distortions, but that they accept their influence as matter of fact is surprising to say the least.
3. The group kept commenting that it was increased credit driving leverage. They agree that it is leverage driving asset prices. As one person said “increased leverage has to come from somewhere” (i.e., you cannot create new leverage without creating more money/credit). (They defined leverage as total bank assets over bank equity and as equity of banks times leverage). Interestingly, several people discussed that the leverage of banks is inversely related to the VIX.
4. There is a whole area of research related to the following information that I too have previously learned the importance of: the transmission channel of money flow into consumer prices (i.e., bank loans) is a completely different transmission channel of money flow into asset prices. For asset prices, money flow is originated in the interbank market (money market) with the large banks and hits the hedge funds/brokerage houses/institutional investors in the form of “non-monetary bank liabilities such as money market papers, certificates of deposit, commercial papers, structured notes, or bonds, which [are bank credit but] not recognized as the common medium of exchange.”
As part of this, there is a large debate about which side of bank balance sheets are responsible for rising prices: the asset or liability side. This is known as the money view vs. the credit view. The money view is the liabilities view that argues that the creation of money in the form of bank deposits pushes prices higher. The credit view is the asset view (or loanable funds theory) that argues that the creation of credit in the form of bank loans is responsible for rising prices. They noted that credit has grown much more rapidly than money over the last 25 years.
This explains why both GDP growth and consumer prices have had low growth rates while asset prices of boomed (asset inflation has been high). It also explains why performance of the financial market is unrelated to the performance of the real economy (money can flow into asset prices without flowing very much into consumer prices, causing GDP to stay low).
5. Though there was some debate on this, it was said several times that “the U.S. is the global provider of liquidity.” I thought that Europe and parts of Asia were also providers, by way of coordinated monetary policy. But somehow the US is supposed to be the driver. Perhaps they simply mean that the Fed initiates policy first, and that other central banks follow in the footsteps of the Fed unofficially so as to keep their currencies aligned. By intentionally keeping their currencies at parity, they suck in capital flows pushing their asset prices higher. Thus, US liquidity evolves into global liquidity.
6. One paper argued that Europe is as large of a driver of US asset prices, but it’s not registered on the radar screen as such because the Eurodollars they use are held in the names of US banks, and thus show up as US assets. If this is the case, European banks affect our asset prices much more than previously expected.
7. I was surprised at how their language was so similar to that of Austrians, since mainstream economists usually cloak their points with obscure, “roundabout” language. These monetary economists spoke regularly of the central bank creating money, and kept noting that it was only possible in a fractional reserve system. They even used the term “Ex nihilo” as Austrians do. They also spoke of misallocation of capital, distortions, and booms and busts. Interestingly, one paper presented distinguished between “aggregate demand” and “aggregate real demand” differentiating between aggregate demand caused by money printing and true aggregate demand in the real economy (which, of course, can rise only with more production).
8. Though they know that they are aware causing rising prices, boom and bust asset movements, and financial crises, they still support fractional reserve banking and credit creation. They really, truly believe that economies need new credit in order to grow. That, is their originating flaw.
The main takeaway is that it is very surprising how aligned with Austrians these monetary economists are. I think this is so because these people focus in such a detailed fashion on money and prices that they cannot avoid the real facts. Within the scope of their daily work, they are not political propagandists; they are merely seeking—as are Austrians—to understand how things really work. It’s just too bad they don’t advocate different policy actions based on their conclusions.
{ 22 comments }
Fascinating post, many thanks for sharing this amazing info with us.
The different routes which new money takes into asset markets and general markets is fascinating insight.
Do these guys represent a previously undiscovered tribe of “Austro-Statists”?
Interesting stuff. indeed, I can personally relate I suffered a similar pleasant shock/surprise when recently telling my somewhat monetarist leaning macroeconomics lecturer that I would favour doing away with the central bank he said he’d largely agree!
In the New Testament you read about Jews who secretly believed in Jesus for fear of being put out of the synagogue. Maybe something similar is going on here–secret Austrians.
Or maybe they’re like Christians who secretly didn’t believe in Jesus for fear of the inquisition.
Are you saying that central bankers are Crypto-jews? (Which I think is my favourite term for a religious group ever)
Channelling Kevin MacDonald, per chance?
I don’t think there are that many central bankers in scotland.
and praise be for that!
If Scotland gets independance, it’ll need some. Just imagine the chaos of two governments competing to each print more than the other of the same fiat currency.
thinking about it, we have an empirical example; the Dodo…
Or perhaps they are just waiting for somebody to turn water into wine walk on water, raise the dead, or feed the PIIGS?
Hmmm. Maybe like a visit to the factory floor, where the “real” workers make it happen and are confronted with real problems everyday, and they give you an earful about the MBA punks (and punkettes) up front who are completely clueless…
Very good post!
(You should proof read it once, it deserves that)
It’s too easy and common to dismiss state bureaucrats as evil or stupid. But they are often quite reasonable as individuals. They’ve simply chosen comfortable careers. The minds of these individuals are much more important for the future of the state, than the views of most other people. They are interested. They are informed. They do influence the policies actually implemented by the state. They should be the primary target for organizations such as the Mises Institute! Subversion is the business model here.
Thanks Bjorn. You are right – I should have proofed it. I was in such a hurry.
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If the trillions invented by the Fed is being spent into retail sales and causing price inflation of consumer goods . . . who is spending it? NOT union members!
Actually, it’s more like they get it at the very end of the “chain”, where it’s worth less, but hey, it’s not like you will ever learn anything, am I right?
Bill,
It looks like the only union members close to the source will be in raw materials producing industries, like mining, petroleum, and corporate farming.
The bidding up of raw materials can only squeeze those in the lower stages of production (closer to the consumers).
Although what I’m writing would appear to recommend getting a job in one of those areas, in order to be closer to the point which the money is being injected into the economy, I would advise against it on the basis of painful experience.
- if you’re chasing the band wagon; that means it has already left you behind.
“The group also discussed that monetary policy has both a supporting and a destabilizing effect on the economy and financial system (we, of course would argue that it is the sole driver of asset prices and of GDP and consumption in the long run).”
Who are “we” here? I certainly wouldn’t make that argument.
Jrgen: yes, perhaps I did assume too much. I would certainly argue the statement, but perhaps not everyone in the free market world would. To be clear, though, I should have written “sole driver of RISING/INCREASING asset prices, GDP, and consumption”
Why not?
Hm, it seems you’re assuming Austrian theory is somehow way different than mainstream economic theory. There isn’t anything too unique about Austrian economics other than the ABCT and the ridiculous methodological squabbles. I would suspect that these economists would have more in common with people like Scott Sumner than any Austrian. I could easily take what he writes out of context and spin it to sound ‘Austrian’.
I think you don’t know much about Austrian economics past ABCT. Mainstream economic theory is completely opposite to Austrian theory.
“The money view is the liabilities view that argues that the creation of money in the form of bank deposits pushes prices higher. The credit view is the asset view (or loanable funds theory) that argues that the creation of credit in the form of bank loans is responsible for rising prices.”
The old “to much money chasing to few goods” is ancient history? So much for “supply side.”
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