We are living in very unusual times. This week I will be celebrating the festival of Passover, a commemoration of the Jewish peoples freedom from slavery in Egypt more than 3000 years ago; but can I say this year we are free?
I don’t know the answer to the question. I do however want to say that for me personally I am experiencing a different kind of freedom that I haven’t experienced for many years, maybe even my entire life.
My life feels like it has slowed down and I am not on this perpetual treadmill from the moment I open my eyes. Each of us have our own challenges so I don’t want to suggest my experience is the same for everyone, as I know we are all facing differing degrees of hardships. It is just that perhaps in some ironic kind of way by not having the “freedoms” that I have become accustomed to, I am in fact more free. Free to think, free to learn, free to spend more time with my family, free to look after my health and here I am going to say it, free of mindless social interaction.
As someone who is proudly Libertarian I find myself in a very awkward philosophical quandary. Many of you would have read there are a growing number of people arguing against the government imposed lock-downs on the economy and civil society at large. Of course the Austrian School of Economics is at the forefront of this argument. While I hear the argument against government involvement making the cure worse than the problem I am still unable to reconcile the following:
Economies can recover, the dead can’t.
Unemployment is temporary but death is permanent.
It is interesting to listen to one of the main thought leaders from the Austrian School who has a similar view to mine on the lock-down, because one of his children has a severely compromised immune system. It is quite amazing how having to contend with severe consequences can soften our fundamentalist approach to theory.
Ok enough of the philosophy lets talk markets and trading.
I recently did an interview about quantitative easing. I want to explain it in a super simple way along with the question of how government finances these bailouts; in other words where does the money come from?
Let us start with what is the role of a central bank?
Its primary role is to provide the countries currencies with price stability by controlling inflation and to act as the lender of last resort.
To achieve this goal the central bank has a number of tools at its disposal, the main one we are all familiar with is its ability to control the supply of money in the economy through interest rate policy. The central bank weary of inflation can increase the rate of interest it charges to commercial banks (repo rate) to lower the demand of borrowed money and therefore slow the economy down in order to keep inflation in check. The opposite is also true when the economy is sluggish, lacking in general demand, the central bank can lower the interest it charges commercial banks to stimulate these banks to lend to its customers who then borrow to invest in technology, infrastructure, business, property etc.
As you know central banks have effectively used this tool to such an extent that interest rates are in many developed countries at zero, or in extreme cases negative. This means that it is no longer as an effective tool as it was when in a higher interest environment.
As I am writing this letter I am realizing that I don’t think it is appropriate to go into anymore detail as it will be too long and probably boring for most. I am working on a major article for publication that deals with this subject in detail and will provide the usual Berman twist, so let us just tackle the question I started with.
Where does the money come from to do QE and Fiscal bailouts?
All you need to know is that Government can create unlimited amounts of its own currency. If you want to understand better the mechanism you will need to read the article I am working on.
Yes you read that correctly, unlimited. The “printing press” can metaphorically and practically create money out of thin air. Isn’t that amazing? No not really. The reason, why, I will restrict to two reasons.
The first reason is that it is likely to make government too big and controlling of our lives. Hence my brief introduction into the debate by libertarians on state enforced lock-downs. There is ample evidence throughout history to suggest that big government leads to interference with Adam Smith’s Invisible Hand and is therefore likely to do more harm than good.
The second reason I am sure is the one that you were all thinking of and that is inflation. Inflation can be defined as too much money chasing too few goods. This excess demand forces prices to escalate too quickly in comparison to ones earnings/livelihood leading to a decrease in the standard of living.
Inflation fear is on the lips of almost every person I know who understands the massive monetary stimulus taking place in the world economies right now. I am hearing on a daily basis that you need to stick your money into gold, property or any hard assets.
Let me be clear I certainly believe that all this printing of money out of thin air is eventually going to lead to inflation. However, for reasons I will discuss in the article I am working on we are facing more deflationary pressures than we are inflationary.
In order to understand my reasoning why I don’t believe inflation is our main concern right now, we need to learn about a new concept for some of you.
Velocity of Money
The velocity of money is the rate at which people spend cash. Said simply, it is how hard each dollar (pick your currency) works to increase economic output. When velocity is low it means that goods are not being purchased in the economy like they were in the past.
The above chart is of money velocity in the USA. It is a statistic that is produced quarterly and in our chart is up until 31 December as GDP figures for end of March are not yet available.
The formula for velocity of money is.
VM = PQ / M
VM = Velocity of Money
PQ = Nominal GDP
M = Money Supply
I am actually quite amazed how few people in the financial press are talking about money velocity, when the latest numbers print, I am quite sure we will be seeing a further collapse in velocity.
For those of you who think we are about to experience inflation as a knee jerk to the enormous amounts of money being printed I believe that we will not see the kind of overall inflation most are expecting, at least for the next few years. I must however, qualify that I am not saying that we will not experience inflation in certain areas of the economy that experience lasting effects due to supply chain shocks. My comments are generalized across the broader economy.
I hope this has provided you with some velocity of thought.