Changing of the guard
We have long used the stellar work of Russell Napier to frame our macro outlook, and why we are living through a secular change (notably with regard to inflation). As Dylan Grice pointed out in a recent tweet:
The market is already calling bluff on the Fed rate hike chatter, and indeed the Fed mouthpieces have started pulling in their hawkish/Volker messaging and turned more dovish. As Danny Blanchflower, the ex-BoE board member, put it "a recession is worse than inflation". Here is a recent commentary from Russell Napier detailing how the guard is changing, how big government is taking the reigns at the expense of central banks, and what that likely means (this is more a European than US experience ... at least so far): Central bankers are becoming increasingly impotent in the fight against inflation as governments strip their power (Russell Napier) (https://www.thestar.com/business/opinion/) "Who gets to create a country’s money? It may seem a simple question to answer because surely central banks create money. They don’t. Central bankers attempt to control, with tools such as interest rates, the pace at which commercial banks make money when they make loans. However, a transformation in monetary policy in 2020 to keep credit and money flowing during lockdown saw governments, through the provision of credit guarantees over loans by bankers, assume a key role in getting banks to make loans and create money in the process. These guarantees that you, the taxpayer, provided have encouraged bank lending that would not have occurred, especially during the economic freeze associated with lockdowns. As we move into a post-COVID world, new reasons are being found to justify the provision of taxpayer guarantees to bankers. Through negating any credit risk to bankers in making loans, the governments are playing an important role in getting banks to expand their balance sheets and thus create more money. Bankers may have been the problem from 2008 onwards, but since 2020 they have been the solution to the problem. It is bankers who are supposed to feed this subsidized credit into the nooks and crannies of the economy, creating money in the process, and generate growth and inflation. You, dear taxpayer, will foot the bill for this one day, but until that day the magic money tree is being shaken — hard. If the governments are determined to subsidize bank lending by underwriting banks’ credit risk, is there really much that a central bank can do to stop them? If central bankers cannot stop this more direct control over bank balance sheets and money creation, isn’t it the governments and not the centrals bankers that now control the creation of money? If the central bank has lost control of the supply of money due to this new government activism, can it really control inflation simply by raising interest rates? We are at a major structural turning point in relation to who creates money and the focus on how central banks might control money, and inflation is the wrong focus. Central bankers are becoming increasingly impotent in the fight against inflation as their key power — the power to control the growth rate of money — is stripped from them. When it comes to assessing the likely level for the growth in money, when it is created by the government, history is instructive. Governments are prone to create too much money and this is one of the reasons why, from the end of the 1970s, that power was taken from them and given to central banks. Sometimes governments get a little too enthusiastic in their money creation because it seems like an easy way to fund what needs to be funded and to get re-elected. In the long saga of who gets to control the supply of money, there have been some sorry episodes. The sorriest and most dangerous have been when governments have printed money to directly fund their own spending. In writing my first book “Anatomy of the Bear,” I read many letters to the Wall Street Journal from 1921 demanding that the U.S. follow the stimulatory money printing then underway in Weimar, Germany. That wonderful stimulation of 1921 ended with hyperinflation by 1923. The problem is that few governments that fund themselves through the printing of money can bring themselves to stop. Like an addict, they usually find themselves craving more. As early as 1720 in France, the Scottish monetary theorist, duellist, dandy and gambler, John Law, persuaded the government to introduce a paper currency unbacked by gold. That new innovation ended with economic collapse because the government of France took the experiment too far. Law’s plan as proposed in his 1705 “Money and Trade Considered” is seen as groundbreaking work as it aligns very closely to our current monetary system. However, it was a system that a desperate government can use to fund itself and, pushed to excess, is the well-trodden path to hyperinflation. Time may have passed and numerous disasters associated with governments printing money to fund their own spending have come and gone, but in the words of Rudyard Kipling, the governments “bandaged finger goes waggling back to the fire.” The scars from hyperinflation run deep and are playing a role in the problems facing the euro today. The damage that followed the hyperinflation in Weimar, Germany — the destruction of savings, political turmoil and the rise of Adolf Hitler — still scar the German psyche today. The fear of direct monetary financing of governments is so strong in Germany that the constitution of the European Central Bank (ECB) outlaws the practice. Of course with a good lawyer to provide advice, a ban can be interpreted as something else and, as we have recently seen, interpretations of constitutions can change. Today, despite the ban on direct financing of government in its constitution, the ECB has proposed that it will directly act to cap the yields of government debt in some member states of the eurozone. Capping these yields involves making an unlimited commitment to buy the government debt of that country. Is this the direct monetary financing of governments that the ECB is legally barred from pursuing? The president of the German Bundesbank thinks it is, and on July 4 he publicly proclaimed his opposition to it. That old scar from the events of 1923 still itches and it is now preventing the ECB from holding down bond yields in the eurozone. While Germany and other northern European states oppose this form of financing and the high inflation that comes with it, some of the highly indebted nations of the eurozone will continue to clamour for it. These views are likely irreconcilable, and the only long-term solution is to allow some member states to create more money than others — a solution that is incompatible with the continuation of a single currency. Perhaps soon some way will be found of depressing bond yields in the eurozone. When that process begins, the move away from a single monetary system will have begun as each government gets to declare its own interest-rate level. The recent collapse in the euro exchange rate recognizes this reality and that it is difficult to preserve the purchasing power of savings in any regime that pursues such a policy. Capital is fleeing the eurozone. Unbacked paper money, like most things, is fine in moderation. However, as we discovered as early as 1720, it proves difficult for governments — elected or otherwise — to practice moderation when the alchemy of turning paper into money is available. John Law’s legacy as one of the progenitors of paper money lives on. In Edinburgh on July 13, the Library of Mistakes will auction a first edition of Law’s “Money and Trade Considered” from 1705, and the book is valued at between £7,000 and £9,000. This issuance of paper money, particularly since the end of the Second World War, has played an important role in pushing the price for Law’s words to a level even he would have marvelled at. Proceeds will be used to finance the charitable work of this free public library to change the world — particularly the world of finance — one mistake at a time. The shelves of The Library of Mistakes already groan with the volumes that track governments dalliance with printing money to fund their spending. It is perhaps ironic then that due to the sale of Law’s book at auction, The Library of Mistakes will be able to afford the next series of books that will chart the inevitable consequences from when the finger of government is thrust back into this particular monetary flame." 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