This article was written by Richard Horswill. All views and opinions expressed are strictly his own.
Where did all the money go? This may seem a strange question since the Central banks of the world are on a monetary tightening cycle driven by the premise of runaway inflation. Primarily, Central banks are concerned that the possibility of a wage price spiral could ignite demand pull "inflation" brought about through the already hot cost push “inflation"; however this seems a highly unlikely scenario with average wage increases well below CPIs. As we all know well, inflation is a "monetary phenomenon”: therefore, if currently money isn't the cause of the “inflation", which if it were, would be driven by an increasing money supply fuelling demand, it must be continuing supply side dynamics of the twin supply shocks of firstly COVID and then the energy crisis which have been clearly the reasons behind the elevated CPIs. In particular, the cost of energy feeds into all human needs, and thus the nature of this inflation should still be seen as purely driven by supply difficulties and should ultimately still be seen as transitory in nature. Of course, transitory in the minds of many is short term, but much depends on the ongoing conflict in Ukraine and how Russian energy supplies are distributed over the longer term whilst the war continues to rage and sanctions remain in place. Thus, transitory could mean some time well into the future but the terminology of transitory has certainly been discarded for political reasons.
Transitory inflation timescales may be altered by the actions of Central banks and the only real tool in their inflation busting tool kit is interest rates. Fighting supply side inflation with interest rates will ultimately lead to demand destruction, leading to dis-inflation, which is already evident, and finally deflation, at which point we will likely see the necessity for Central banks to cut rates and enter back into the world of quantitative easing again in an attempt to avoid the deflationary bust. (As explained in my previous article "The vapours are overpowering " the world will likely follow in the footsteps of Japanese model of debt financing via yield curve control.) Monetary policies work with "long and variable lags" and the indicators of over tightening are evident in the significant yield curve inversions we see across all of the major sovereign debt issuers; we have done so for months now indicating that markets are hedging for continued low future growth expectations at best. Thus, the cliff edge for recession and a potential monetary/financial/sovereign debt crisis are ever present.
The media has gone somewhat quiet on the current quantitative tightening cycle in which Central banks are in the process of engaging. Balance sheet shrinkage, also supposedly monetary tightening - in the minds of many - but seemingly a non-event for the simple reason that Central bank reserves are not money or particularly useful when commercial banks are not engaging in lending to the wider economy, and thus have no need for the collateral on offer from the Central bank.
Thus, getting back to the question of where did all the money go? We can safely say that in our debt based system where commercial banks provide the liquidity for global commerce, the provision of the necessary finance has been to a great extent withdrawn. This withdrawal of liquidity has been as a consequence of the fallout from the 2008 monetary crisis and has completely altered the trajectory of the global economy ever since. Unnecessarily higher interest rates are impacting borrowing in both retail and commercial sectors and also on the disposable incomes in the retail sector. Businesses have also had to start to cut their cloth accordingly. Seemingly, the last shoe to drop is likely to be how the picture of employment plays out. We have already seen tech companies cutting their workforces globally as debt servicing becomes highly problematic, but across the board cutbacks will eventually lead to significant lay offs and the spiral into a significant global recession. The synchronised nature of the global economy since the pandemic will mean that no country will be unscathed but also no country will likely lead us out of a recession as China did after the 2008 crisis with its massive infrastructure programme which will mean that a prolonged recession is highly likely. But does it have to be this way?
The next question therefore is where will the money supply come from to fuel future global growth if the commercial banks will not provide the necessary liquidity to support the global economy. Fiscal policy (government borrowing) will have to pick up the slack in order to help fix liquidity issues. As we can see from debt to GDP ratios particularly since 2008, governments have been filling the financing gap in order to maintain global financial stability. Bailouts however are not popular mechanisms particularly in the arena of "corporate bailouts" so maybe an alternative mechanism could come in the form of the CBDC. (Central bank digital currency - a digital currency issued by a Central bank rather than a commercial bank which is also a liability of the Central bank in the same way physical bank notes and coins are).
Money is mostly created through the global commercial banking system, and the limitations or elasticity lost in this system since the 2008 monetary crisis have been due to banks being significantly more risk averse. CBDCs may be a way to increase money supply directly into the economy without needing to go through the process of retail lending that a bank would typically undertake. This would offer the Central banks the ability to supply money directly to consumers to help maintain money supply and thus maintain demand in the economy alleviating the risk of deflation and the economic busts/bankruptcy that accompany deflationary cycles. This would thus change the Central banks role from the lender of last resort to the now spender of last resort. This change would certainly provide the foundation for the Central bank to be able to "print" digital money and distribute it to the masses as and when required rather than rely on the private banking cartels to maintain their their monopoly on money creation or not as the case may currently be. The Central banks would now be something of a competitor to the commercials. Of course, this ability does come with potential problems as the provision of free cash if provided in the wrong quantities could produce actual demand driven inflation that may exceed what is perceived as reasonable, currently an annualised 2% level. Also, a mechanism would have to be introduced in order for the free money not to be saved but spent which could mean that time limited funding for the new money to be introduced into the economy. It may also be that certain types of spending may not be allowed such as precious metals purchases which may be seen as a form of saving or fuel products in order to account for the green agenda. Also, any implementation of a digital currency from one Central bank would likely have to be matched by other Central banks in order to alleviate currency devaluation issues and possible bond market upheaval meaning that co-ordinated monetary issuances will maintain global synchronisation and potential for runaway inflation as monetary devaluation could well create a consumer psychology of spend today as the product will be more tomorrow providing for possible hyperinflations.
To conclude, we are seemingly some way off a global roll out of CBDCs; however, there is a definite move towards this possibility. The current global monetary situation unfolding may just have to play out with Central banks and governments utilising the existing play books which is why zero interest policies are still very much a possibility in the event of at least a prolonged recession or at worst a deflationary crash which could well impact and lead to yet another banking or sovereign debt crisis. The long and variable lags in monetary policy will eventually hit our doorsteps with Central banks ultimately hoping that their current interest rate policies are not going to sink them completely and that they will be able to manipulate the elusive soft landing. Hope however is no strategy and the bond market is providing insight into an alternative ending backed by historical president.
