Monetarism Redefined: Crude, Fine Wine & Gold

“Inflation is Always and Everywhere a Monetary Phenomenon” – Milton Freidman

Monetarism as a theory, which states that the variation in the money supply has major influences on national output in the short run and the price level over longer periods, died during the 1980’s.   Economists noticed that the monetary aggregates,  GDP, and inflation were no longer stable in their relationship to one another.   Milton Friedman was the father of Monetarism and Paul Volcker was one of the last great Monetarists.

The rapid advances in financial innovation and the rise of of the shadow banking system made the measurement and even the definition of money increasingly difficult.   At one point, the Fed studied and even considered including equity mutual funds in one measure of money.   During the height of the bubble some were even using stock options in start up tech companies as a medium of exchange — the purest form of money.

One of the basic tenets of monetarism is the concept of dishording.   If people hold too much money, they dishord the excess balances and buy goods and services.     We would add assets to that mix and think one of the problems today is that the excess money balances are disproportionately distributed throughout the global economy.   The helicopter drop is resulting in collateral damage in higher prices for consumer necessities,  such as food and transportation fuel.

The  bulk of the excess cash, in our opinion,  has been created and held by central banks in the form of  foreign exchange  reserves.   In addition, the money created by the Federal Reserve is not being circulated throughout the wider economy because of the broken financial sector in the United States, which is the country’s  main credit creation and money machine.

Thus, all this excess money is distributed among sovereign wealth funds, hedge funds, and money management firms, which sloshes around the world looking for a home.    These managers  are smart enough to know that much of the excess liquidity and reserves in the system is in the form of “high powered money“, which can be multiplied by a fractional reserve global credit system.

In other words,  the global monetary punch bowl is heavily spiked by a monetary base which has gone parabolic in the past five years (see chart below) and when credit creation is finally added to the mix the result will be, and to some extent already is, a toxic brew of inflation.

We are already seeing this in the emerging markets and even in parts of Europe.   The dishording and search for a “store of value” is becoming  an obsession and driving  everything from equities to onions.   Throw in a supply shock or two to lather up the specs and the party really gets going.  Take a look at the charts below.

Today’s Economist published a piece on the how the price of fine wine and crude oil move together.    What the heck does crude oil and $5k bottles of Château Pétrus  have in common?  Some economists and academics can spin a story  that maybe wine demand is driven by the OPEC countries or the emerging markets.  Yada, yada, yada!

These are the same guys that told us the housing market was driven by fundamentals.  A good fundamental story is  a necessary condition for a bubble, with excess liquidity the sufficient condition.   There’s just too much money chasing too few goods.   Punto!

Ironically,  unless wages and household wealth keeps pace,  food and energy inflation is ultimately deflationary in other sectors and will depress economic growth as real wages fall.  We think the Chinese government understands this and is rapidly increasing the minimum wage throughout the country, in effect, trying to monetize the food price inflation.   This is why we believe China will have a more difficult problem containing their inflation and risks an inflationary spiral.

Inflating a stock market or housing bubble feels good for everyone x/shorts, can create temporary wealth and economic growth,  and  potentially increase the popularity of  governments.   A commodity bubble is a different story, however.   Though gold is a benign store of value and actually should be encouraged by governments, in our opinion,  higher food and energy prices are a potent political mix.   Go no further than North Africa to see the results.

We bet many governments are hoping the commodity markets roll-over with the Shanghai as we wrote about on Tuesday.  Just not the commodities they export.  Stay tuned!

Related Articles
The financialisation of commodities – VOX
Record Oil, Gas Prices Loom as Financial Reform Fails –


This entry was posted in Black Swan Watch, Bonds, BRICs, Budget Deficit, Charts, China, Commodities, Credit, Crude Oil, Currency, Economics, Monetary Policy and tagged , , , . Bookmark the permalink.

3 Responses to Monetarism Redefined: Crude, Fine Wine & Gold

  1. Anton says:

    All the money, the Fed is “creating” is staying with the Fed in the form of excess reserves. The Fed “makes sure” the money stays there by paying 25bps interest on them. The Fed is in effect sterilising QE2. There is no extra money that goes into the real economy as a result of the Fed’s action yet. As a result all this “money creation” has zero direct effect on inflation. In our modern society, the creation of the money supply has been in the hands of private institutions – the Fed and private banks
    – and as such the creation of new “money” has to come with the corresponding creation of a debt – for example draw a graph of the money supply and total household debt in the USA and you will see that they are identical – there is no conspiracy here it is simple accounting on behalf of the banks. Anyway, there is no way you can have sustained rise in inflation if you also have a continuous rise in total debt – just look at Japan for that as an example. In addition, the rise in commodity prices for the developed world is not inflationary but deflationary – without a corresponding rise in wages. For example, if you pay more for gasoline and bread and your income is unchainged you will still buy those but you will have to cut on all your other expenses. In other words, the rise of commodity prices is a relative price shock. Putting all this together, it is difficult to see where inflation in USA is going to come from in the current environment. For a sustained rise in inflation, we need to see either wages rise, or the US Treasury actually literally print money.

  2. macromon says:

    Great points, Anton. We talk in the post how the rise in commodity prices reduces real wages and hurts growth if not offset by wage increases. One scenario where inflation can take place without wage increases is a collapse in money demand, such as a massive run on the dollar. This is the hyperinflation scenario that some worry about. Thanks fro you comments!

  3. Pingback: Ugly Chart Contest: Safe Haven Swan Diving | The Big Picture

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