The great achievement is yet to come: the truth without silence

(by Thorsten Polleit | MisesWire) – The relay is spreading between economic analysts and stock market experts. Energy prices are dropping significantly. This winter’s energy supply seems secure; in Europe, government support for consumers and producers is available if needed. China is moving away from its zero covid policy and production is rising again. High inflation in goods prices remains a major concern for consumers and producers, but central banks are offering at least some interest rate hikes in order to reduce currency devaluation. So should we say goodbye to the worries of crisis and recession? Unfortunately not.

Because there is a global economic development that is equivalent to a storm, but which many experts and investors do not yet have a name for. And this is the overall contraction of the real money supply. What does it mean? The real money supply represents the real purchasing power of money. For example: you have ten dollars and an apple costs one dollar. So with your ten dollars, you can buy ten apples. If the price of the apple rises to, say, two dollars a piece, the purchasing power of the ten dollars falls to five apples. It becomes obvious that the real money supply is determined by the interaction between the nominal money supply and the prices of goods.

An economy’s real money supply can decrease when the nominal money supply falls or the prices of goods rise. This is exactly what is currently happening around the world. The chart below shows the annual growth rate of real money supply in the Organization for Economic Co-operation and Development (OECD) from 1981 to October 2022. Real money supply recently contracted 7.3% year-on-year. There had never been anything like this before. What is the reason?

The enormous increase in the prices of goods, that is to say, high inflation, is a consequence of the monetary policy of the central banks. In the course of politically dictated lockdowns, central banks have vastly increased the money supply. For example, the US Federal Reserve has expanded the M2 money stock by about 40 percent since the end of 2019, and the European Central Bank has increased the M3 money supply by 25 percent. As the growth in the supply of goods has not kept pace, a large overburden has emerged in the money supply, which now has cost-push effects, such as the consequences of green policies, lockdowns and Ukraine war, unleashed in the sky. high inflation of goods prices.

Meanwhile, however, nominal growth in the money supply has fallen sharply again. In the US, it fell 1.3 percent year-on-year in December 2022 and to 4.1 percent in the euro area. The reason: the demand for loans decreases, commercial banks make fewer loans, and consequently the new money supply generated by bank loans decreases. Also, central banks are no longer buying government bonds, which is one of the reasons why the flow of new money into the economy is drying up.

It may seem paradoxical, but in economic terms the current high inflation of goods prices is reducing the excess money supply and, together with the growth of the money supply which has now been significantly reduced, the pressure on the discount on future inflation is already increasing.

However, if the real money supply continues to shrink as sharply as it is now, the signs point to at least an economic slowdown and, more likely, a recession. When the economy’s real money supply shrinks, those with cash become poorer. Now they can no longer buy the quantities of goods they previously bought and must adjust their spending: either stop buying more expensive goods or continue to buy more expensive goods while giving up other things. The result is a fall in aggregate demand.

This phenomenon is, by the way, well known in theory as the “real equilibrium effect”. It goes back to the Israeli-American economist Don Patinkin (1922–95). Patinkin wanted to demonstrate, among other things, that the national economy can, so to speak, heal itself in crises without the need for government intervention. If, for example, the prices of goods fall into a recessionary depression, this strengthens the purchasing power of market players if and when the money supply remains unchanged. They can expand their demand for goods and the economy comes out of the crisis more or less automatically.

Applied to current conditions, we can see that a rather powerful negative money balance effect is developing: the initial increase in the quantity of money causes an increase in the real money supply, which fuels consumption and production. Then commodity price inflation takes off and, at the same time, monetary expansion slows. The result is a very sharp decline in the stock of real money, which in turn leads to less economic activity, even a recession.

The contraction in output and employment, in turn, exerts downward pressure on rising goods prices, establishing a new relationship between the outstanding money stock and goods prices in accordance with preferences of people Once this adjustment has run its course and the nominal money stock remains unchanged, goods price inflation is extinguished. The economy ends up with a higher level of goods prices compared to the situation before the increase in the nominal money supply.

So why do central banks want to raise interest rates even further? Monetary authorities fear that doing nothing and waiting in the current regime of sky-high inflation could erode people’s confidence in backless paper currencies. This, in turn, would raise market participants’ inflation expectations—which, by the way, is already happening—and create an even bigger inflationary crisis later on. In addition, central bank boards tend to base their monetary policy on current inflation; they usually have little or no regard for the development of the real money supply.

Thus, central banks – consciously or unconsciously – trigger a stabilization recession, an economic contraction to break the inflationary wave. At first glance, his plan could probably work. Because if the demand for goods falls, companies can only reduce their stocks by reducing prices. The room for maneuver to pass on costs and speculation about future price increases is reduced. Higher wage demands do not materialize. And most importantly, credit and money supply growth slows in a recession, mitigating future inflationary pressure. But on second glance, this is a very explosive approach in today’s monetary environment.

A recession is likely to put heavily indebted economies under severe strain. Many debtors will no longer be able to pay their debts. Loan delinquency increases. As a result, banks are reluctant to make new loans and demand repayment of maturing loans. Investor confidence in indebted economies and financial markets is waning. The result would be a fulminant credit crunch, at least on the scale of that of 2008/9. Investors fear that their interest and principal payments will not be made. Credit markets freeze and the unsupported monetary system heads for collapse.

The economic pain would be enormous, and the political pressure on central banks to lower interest rates again and keep the economy afloat with new credit and more money would be predictable. In times of need, governments and the general public will likely see the policy of least harm in increasing the money supply. Even a policy of very high inflation becomes acceptable from their point of view to escape an even greater evil. There are quite a few examples of this tragic handling of the backless paper money system.

Just think of 2008/9 (the global economic and financial crisis) and 2020/21 (the crisis after politically dictated lockdowns). To avoid crises or keep them as small as possible, central banks lowered interest rates and dramatically expanded the money supply. The result was inflation: asset price inflation in early 2009 or consumer goods price inflation, which reared its ugly head towards the end of 2021. From this perspective, it is not unlikely that history will repeat

If central banks don’t stop doing what they are doing, causing booms and busts by manipulating market interest rates down and endlessly expanding the amount of money created out of thin air, their actions will eventually drive at a level of inflation far beyond what we have. have witnessed over the past year and a half. From this perspective, the sharp contraction in the stock of real money in the world economy is—one should fear—the harbinger of a new round of super-easy monetary policy and super-high inflation, until and all hyperinflation, later.

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