Welcome to Finance and Fury, the Furious Friday edition. In today’s episode I want to explore the effect of monetary inflation (in other words the increase in the money supply) on GDP growth

  1. Covered GO compared to GDP in Wednesdays episode this week –
  2. To go one step deeper – want to look at the fact that nominal GDP looks to be directly inflated by additional money introduced into an economy – essentially in the form of credit – therefore – GDP growth is simply a reflection of additional money introduced into the economy

And if this is the case – GDP is really not a good macroeconomic tool to use to make policy decisions – as it gives no real indication as to the underlying health or real growth of an economy – as it can just be artificially inflated whilst having debt elsewhere that offset the real growth

 

This may come as a bit of a surprise – it did to me when looking at some of the figures –

  1. as it is rare to find any economists covering the relationship between monetary expansion and GDP
    1. Yet – there is a pretty strong relationship between the money supply growth (measured by M2) and GDP growth over the past few decades since Fiat currencies were implemented worldwide –
    2. Especially when Government spending (both as a component of GDP) is now funded through an increase in the monetary supply by fiscal deficits – which are funded through the issuance of bond and in turn these are now funded through CB programs like QE
    3. The corporate side isn’t too much better – you have massive zombie companies that have funded investment through the issue of debts
  2. Under normal circumstances – how should the economy grow based around classical economic theories?
    1. If you have listened to this podcast for a while – it shouldn’t come as any surprise that I fall into the supply side of economic thinking – and as part of classical economics thinking – there is a thing known as Say’s law – also known as the lawof markets
      1. That is that creation of a product creates demand for another product by providing something of value – which can then be exchanged for that other products – it relies on production being the source of demand
      2. in a market economy, goods and services are produced for exchange with other goods and services – this is known as “employment multipliers” – these arise from the production of goods and services and do not come from the exchange of these goods alone
  • This goes back to the concept of GO versus GDP – many businesses in the economy exist to be business to business services – that form parts/components that go into the final output that GDP gets measured
    1. So there are many economic interactions that don’t get measured
    2. So through the market – with additional companies being in demand to produce additional components for other companies that provide goods and services – additional employment growth can occur – with this comes additional incomes and the cycles of consumption can go on
  1. So through the process of creating many different types of economic activity – a sufficient level of real income is created to purchase the economy’s entire output, due to the truism that the means of consumption are limited by the level of production
  2. with regard to the exchange of products within a division of labour of different employees working in different businesses – the total supply of goods and services in a market economy will equal the total demand derived from consumption during any given time period
  1. However – For this type of economic functioning to be present – there are some assumptions that need to be present –
    1. flexible prices—that is, all prices can rapidly adjust upwards or downwards – this is the price of the exchange medium as well – which is money
      1. Goes into both interest rates as well as wages in economic activity – both of which are set with floors
    2. no government intervention – which doesn’t exist
  2. So this theory quickly falls apart – but it is important – as it can only holds true as long as governments don’t regulate the function of businesses and the consumers exchange – as well as monetary officials – such as central banks messing around with the medium of exchange – the money 

 

  1. Now comes an important question – why does an economy need to grow? Especially when measured by GDP?
    1. Does it matter that GDP goes up for you? Compare the economies of Japan and Qatar – looking at GDP per capita – Qatar has had a rise in GDP – very oil rich nations – has $69k USD per capita – however – Japan $41k USD per capita – but Japan’s average net worth is double that of the average Qatari – and living standards are higher in Japan – in a relative economic sense – so who is better off?
    2. But total level of GDP – Japan has a GDP of $5trillion USD – Qatar has a GDP of $190 billion USD – the per capita GDP figures are different due to the population levels
  2. In classical economic terms – A healthy economy is not one that “grows”, but one that does not have its production and consumption interfered with.
    1. If the money is sound and its quantity unchanged there might not be any change in GDP year after year – but at the same time – there would be no inflation – or devaluation of the medium of exchange as well as increasing living standards through additional technology and supply of goods and services
      1. This is creative destruction – which is a process of any healthy economy which can satisfying the demand of consumers
      2. In the modern economy – the state has carved out a major role for itself – and they have turned human and by extension economic activity into a representation of statics and averages
  • Hence- any policy that gets the desired outcome of increasing these statistics is deemed appropriate – even though it might not be the case for the individual –
  1. There is a good article on goldmoney that shows some graphs in the US between the relationship of nominal GDP and the broad money supply – measured by M2 – compares the increase in GDP from its base level in 1980 to end-2019 with the increase in broad money – then shows the difference between them
    1. These two lines go out at the same sort of rate – and the difference in them is essentially zero
    2. The small variations in GDP less the increase in M2 are wholly due to the fact that GDP does not capture all economic activities, only those that are decreed eligible by the statisticians
    3. Starts to show that nominal GDP may actually not be measuring economic growth at all – just the amount of money in the economy that forms part of transactions
    4. Where this gets interesting is when looking at the recent slumps in GDP around the world – at the same time there has been an increase in the money supply – likely due to a few reasons
      1. The money supply increase has not gone into productive areas – for instance – buying up debts that already existed
      2. For those funds going to consumers – Not being spent and is instead being saved –
        1. People are probably worried about financial security and are saving instead
        2. Plus lockdowns and people not being able to travel may have dampened spending
  • The GDP data is lagging – timing differences between the deployment of extra fiat money and its full reflection in GDP
    1. there is always a lag between the increase of money supply and its wider circulation in the economy
  1. The true affects are worse than what the GDP figures resent –
    1. effect of yet higher rates of money supply growth will only serve to further conceal the seriousness of the true position
  2. It has been fairly evident that monetary planners simply think that extra money should stimulate GDP
    1. Created a policy where the solution is always to increase the quantity of the money supply – when economic growth is low – you need to increase the money supply by more and as a secondary effect decrease interest rates –
      1. These types of policies all works around the assumption that they can control inflation statistics through these policies – and with lowering interest rates- debt goes up
      2. So the end result of additional money in circulation can help to add to the GDP number – but can have the result of destroying the personal wealth upon which an economy thrives through reducing the PP of the individual – and getting nations into more and more debt – the debt level growth isn’t reflected in GDP – otherwise GDP might actually be negative
        1. As an example – take Australia – Mortgage debt of about $2.5 trillion, Gov debt at all levels is about $1 trillion – corporate debts about $4.5trillion– some estimated range total Australian debt between $6.5-$7.5 trillion – our GDP is about $2 trillion
        2. We are not alone – most developed nations with very large GDP figures also carry very large levels of money supply and with it – large levels of debts – greater than the economic output of nations
        3. It is almost like if you borrow $100k with one bank and transfer the balance to another bank account – has your wealth gone up? Well if you only look at the bank balance that shows the positive $100k and ignore the negative balance in the other bank it has
      3. Trying to get the economy out of this debt is impossible – as in most cases what is debt measured against? – you have debt to GDP figures – resented as a percentage – but you don’t really see broad money to GDP – and when taken in isolation they tend to not look so bad – you have Gov debt to gdp, household debt to gdp – but looking at the whole picture – debt is many times larger than the economic outputs – wouldn’t be bad if GDP grew quicker than debt – but it is the other way around – with the growth being many time greater each year for debt (being in double digits) when compared to GDP – being in the single digits
        1. however the relationship between changes in M2 and GDP are present – and this relationship also extends to GO – includes the intermediate consumption of production that make up the final products bought by consumers
      4. This raises the question as to whether these forms of monetary policies can continue without a substantial increase in interest rates – as at some point it may need to be slowed down – but that is a catch 22 – raising interest rates with this much debt would destroy both the ability to increase the money supply and the bills on the existing debts would be unaffordable – creating a true economic crash through massive levels of defaults at all levels

Summary –

  1. It is important to understand the need for an ever-increasing money supply – to help provide the facade of economic growth when measured by nominal GDP
    1. Helps to make sense of what might seem like irrational policies – however – when statistics and numbers such as GDP are used as the measure of how well a country is doing – rather than the individuals economic situation – starts to make sense
    2. Helps to understand why we are on the inevitable road towards the continued debasement and devaluation of fiat currencies world wide – through the continuation of inflationary policies only serves to bolster the statistic while the underlying economic condition worsens considerably
  2. But knowing this won’t stop monetary authorities from pursuing these types of policies – but being aware that you need to utilise your own resources to help offset this – through investing in assets that can benefit from these policies is key as to not be left behind
  3. Central banks and especially the Fed have committed themselves to supporting all economic and financial activities with the only tools they have – newly issued money, lowering rates and buying assets back off the market to help asset prices
    1. In turn – they give the ability for Governments and for individuals to get into further levels of debt and ensure financial markets (particularly for government debt) remain in demand and with it – don’t collapse in prices
  4. So whether the monetary planners know it or not, targeting GDP growth with monetary expansion is a key policy in economic planning due to fact this can be done via fiat currencies –
  5. But in the end they have the effect of covering up a deeper recession through kicking the can down the road for future devaluation of currencies and declines in the consumers purchasing power
    1. But it allows for future GDP numbers to be artificially increased allowing policy makers to claim some success

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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