If Only We’d Kept A Pet Monetarist

We should’ve left at least one seat at the table for the monetarists.

If we had, we wouldn’t be in this inflationary mess. And we wouldn’t be hurtling headlong towards a deflationary crash on the other side, either.

So said… I don’t know. So said some monetarists somewhere, I imagine.

I’ve talked a lot about monetarism over the years, and particularly during the pandemic era, when it enjoyed a minor renaissance. The sequencing of events was difficult to ignore. An explosion in money supply growth presaged surging inflation across the developed world. Maybe there’s something to that!

I find it exceedingly difficult to pretend this debate is somehow complicated. As a practical way of conducting day-to-day policy, monetarism simply doesn’t work. We’ve established that, and it’s not like we didn’t give it a shot. Milton Friedman is, arguably, the most famous economist in all history, a distinction he surely deserves on some measures and surely doesn’t on others. The idea that monetarism was somehow treated unfairly or given short shrift is a canard. I don’t want to say it had a “good” run, but it certainly had a run.

In a more general sense (i.e., outside the narrow confines of conducting policy and away from Friedman’s voluminous contributions), there’s not a lot that’s especially controversial about monetarism if you assume a cartoon version of alternatives and competing theories. We’ve just witnessed back-to-back-to-back experiments in just the kind of cartoonish policy forays that might be expected to make monetarism look good. So, it’s no surprise that monetarism is getting some traction again.

When we say things like “money growth figures can have useful information content for inflation,” we’re not really saying anything if money growth is taken to extremes. If we send everyone in America $15 million in the mail next week, then money growth won’t just contain “useful information” for inflation, it’ll be the only damn thing that matters.

We didn’t send everyone several million dollars from 2020 to 2021, but we did send almost everyone several thousand dollars, and that’s to say nothing of myriad additional government transfers associated with the pandemic fiscal response. At the same time, we monetized the associated borrowing in a way that made it obvious even to the densest of interested citizens what it was we’d been doing since the financial crisis — namely, perpetuating a Ponzi scheme.

As it happened, the disaster which compelled us to flip the emergency switch introduced a severe supply shock, which meant all the money wasn’t just chasing “too few” goods and services, it was in some cases chasing no goods and services. If you were building a house in 2021, for example, there were entire weeks or even months when no amount of money could secure for you a garage door. There simply were no available garage doors.

It was a perfect storm. We were handing out money financed by debt which was in turn financed by the creation of reserves, and all against a backdrop of acute scarcity for everything that money can buy. Lo and behold, inflation!

Would having a monetarist around have helped? I don’t know. Maybe. It’s a question worth asking. Like, “Are currants just snobby raisins?”

SocGen’s Albert Edwards weighed in on Thursday. “When I started work in financial markets in 1982, monetarists were considered to have won the economics argument,” he said, adding that since the 90s, they’ve been relegated to obscurity, “excluded and often ridiculed by the mainstream.”

“It is no surprise,” Albert wrote, “that just as the monetarists who accurately called the current inflation take-off were ignored, the current shocking decline in the money supply is also being ignored.” He thinks that could be a mistake. And not just any mistake. “A mistake of the highest order as ‘higher for longer’ may yet cause a surprise economic and financial collapse.”

As noted here on too many occasions to count by now, M2 growth in the US is falling at the briskest pace since the Depression, and it’s falling in the UK and the EU as well.

I called the figure above a “canary” a couple of months ago. Apparently, the US will be experiencing acute deflation in no time.

Edwards went on. If the monetarists are right, “economic growth and inflation may soon collapse as central bankers make yet another huge policy error,” he said. Such an outcome would “also come as a big shock to investors who, as usual, are giving up on their forecasts of recession, just as one looms into view.”

Lest you should get the wrong idea, Albert is no monetarist. “Sometimes M2 growth merely tells us nothing more than interest rates have changed, and shifts have occurred between the various monetary aggregates,” he wrote. That’s why he likes to look at “the counterparties of money supply.”

As you can see, bank lending is “waving a big red cyclical warning flag,” as Albert put it. He also adjusted the series to account for QT and still got what he called “a very recessionary,” albeit “not depressionary,” vibe.

What to make of it all? I don’t know. About the only thing I can say for sure is that when policymaking involves soft sciences like economics, mistakes will be made. Then they’ll be made again and again and again. Because try as we might, we can’t derive axioms and laws for soft sciences.

In fairness (and I say this without sarcasm), we really should’ve made a little room for monetarism while crafting the policy response to the pandemic. Maybe there wasn’t enough time initially, but successive rounds of “bridge liquidity” (as a tone deaf Steve Mnuchin once described COVID rescue measures) ended up being a bridge to sky-high inflation. The point of the above (and all similar arguments) is that although we clearly want to climb down from that bridge, we need to be careful not to tumble from it.