March 23, 2023

You Think the Global Economy Is Brightening? Beware: The Big Hit Is Yet to Come

While President Joe Biden’s White House continues to provide happy talk about the economic climate, some major economic thunderstorm clouds are brewing

Reduction is spreading among economic analysts and stock market experts. Energy prices are decreasing noticeably.

The energy supply this particular winter seems secure; within Europe, government support for consumers and producers can be obtained if needed. China is turning away from its zero-covid policy, and production is ramping up again. High products price inflation is still a major concern for consumers and producers, but central banks are delivering at least several interest rate hikes to hopefully reduce currency devaluation. Therefore should we bid goodbye to crisis and economic downturn worries? Unfortunately, no .

Because there is an overall economic development that is tantamount to a storm but remains unnamed by many experts and investors. And that is  a global contraction of the real money supply . What does that mean? The real money supply represents the particular purchasing power of money. One example is: You have ten dollars, and another apple costs one money. So with your ten dollars, you can buy ten apples. If the apple price increases in order to, say, two dollars for each piece, the purchasing energy of the ten dollars falls to five apples. It becomes obvious that the real money provide is determined by the interplay between the nominal money supply as well as the prices of goods.

The real money supply in an economy can decrease when the nominal money supply goes down or goods prices rise. This is exactly what is currently happening around the world. The chart below displays the annual growth rate of the real money supply in the Organization for Economic Cooperation and Development (OECD) from 1981 to October 2022. The real money supply recently contracted by 7. a few percent year on calendar year. There has never been anything like this before. What is the cause?

The massive rise in goods prices, i actually. e., the high inflation, is really a consequence of central banks’ monetary policy. In the course of the politically dictated lockdowns, main banks have increased the cash supply enormously. For example , the US Federal Reserve has expanded the M2 money stock by around 40 % since the end of 2019, and the European Central Bank has increased the M3 money supply by 25 percent. Since the growth in the supply of items has not kept pace, a huge money supply overhang provides emerged, which is now fulfilled with cost-push effects— such as the consequences of green policies, lockdowns, and the Ukraine war— unleashed in sky-high goods price inflation.

In the meantime, however , nominal money supply growth has fallen sharply again. In the US, it fell by 1 . a few percent year on year in December 2022 and to four. 1 percent in the euro region. The reason: loan demand is definitely declining, commercial banks are granting fewer loans, and therefore, the new money supply generated by bank lending is usually falling. Furthermore, central banking institutions are no longer buying government provides, which is one reason why the particular inflow of new money in to the economy is drying upward.

It may audio paradoxical, but in economic conditions, the current high goods cost inflation is reducing the cash supply overhang, and along with now significantly reduced cash supply growth, downward pressure on future inflation is already increasing.

Nevertheless , if the real money supply is constantly on the shrink as sharply as it is currently, the signs point out at least an economic slowdown and, more likely, a recession. When the real money supply in the economy reduces, those holding cash turn out to be poorer. They can now no longer purchase the quantities of goods these people previously bought and have to adjust their spending: end buying more expensive goods, or continue buying more expensive items while forgoing other things. The end result is a drop in aggregate demand.

This particular phenomenon is, by the way, popular in theory as the “ genuine balance effect. ” This goes back to the Israeli-American economist Don Patinkin (1922– 95). Patinkin wanted to show, many other things, that the national economy can, so to speak, heal itself within crises without the need for govt intervention. If, for example , items prices fall in a recessionary depression, this strengthens the particular purchasing power of marketplace players if and when the money provide remains unchanged. They can increase their demand for goods, and the economy works the way out of the crisis more or less automatically.

Placed on current conditions, we can see that a rather powerful  damaging   money balance effect is unfolding: The first increase in the quantity of money leads to a rise of the real money supply, which fuels consumption and production. Then, goods price inflation takes off, and, simultaneously, monetary expansion slows down. The end result is a very sharp decline in the real money stock, which, in turn, leads to lower economic exercise, even recession.

The contraction of result and employment, in turn, exerts downward pressure on increasing goods prices, establishing a brand new relation between the outstanding cash stock and goods prices in accordance with peoples’ preferences. As soon as this adjustment has run its course and the small money stock remains unchanged, goods price inflation dies out. The economy winds up with a higher level of goods prices when compared with the situation before the nominal money supply had been improved.

So why do central banks want to raise interest rates even further? Monetary regulators fear that doing absolutely nothing and waiting in the current routine of sky-high inflation could erode peoples’ trust in unbacked paper currencies. That, in turn, would push up market participants’ inflation expectations— which, incidentally, is already happening— and create a level bigger inflation crisis further down the road. Moreover, central financial institution councils usually base their monetary policy on current inflation; they typically have little or no regard for the development of the actual money supply.

The central banks thus— consciously or unconsciously— trigger a stabilization recession, a fiscal contraction to break the inflationary wave. At first glance, their strategy could most likely work out. If the demand for goods drops, companies can only reduce their inventories by reducing prices. The leeway designed for passing on costs plus speculation on future cost increases diminishes. Higher wage demands fail to materialize. And most importantly, credit and cash supply growth ebb aside in a recession, mitigating upcoming inflationary pressure. But from second glance, this is a really explosive approach in the current monetary environment.

The recession will likely put highly indebted economies under serious stress. Many debtors will no longer be able to service their financial obligations. Loan defaults increase. Consequently, banks become reluctant to grant new loans plus demand repayment of expiring loans. Investor confidence in debt-ridden economies and monetary markets is dwindling. The end result would be a fulminant credit crisis, at least at the scale of the one in 2008/9. Investors fear that their curiosity and principal payments will not be made. Credit markets freeze and the unbacked monetary strategy is headed 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 foreseeable. In the hr of need, governments as well as the public at large will likely see the policy of the least bad in increasing the money supply. Even a sky-high inflation policy becomes acceptable from their perspective to escape a perceived increased evil. There are quite a few examples of this tragic handling from the unbacked paper money program.

Just think of 2008/9 (the global economic and economic crisis) plus 2020/21 (the crisis following the politically dictated lockdowns). Toward off the crises or place them as small as possible, central banking institutions lowered interest rates and significantly expanded the money supply. The end result was inflation— asset price inflation from early this year or consumer goods cost inflation, which reared the ugly head toward the final of 2021. From this viewpoint, it is not unlikely that background will repeat itself.

If central banks are not stopped from doing what they are doing— causing booms and busts by manipulating market interest rates downward plus relentlessly expanding the quantity of money created out of thin air— their actions will eventually lead to a level of pumpiing well beyond what we possess witnessed over the past year . 5. From this perspective, the dramatically contracting real money stock in the world economy is— it has to be feared— the harbinger of a new round of super-easy monetary policy and super-high inflation, even hyperinflation, further down the road.

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