While the Federal Reserve and European Central Bank’s message on rate cuts appears clear as they reiterate their commitment to reducing inflation, the market expects between five and six rate cuts, between 125 and 150 basis points , the next twelve months.
This shows us the tendency of investors to overlook bubbles. We live in a world where two generations of market participants have only seen interest rate cuts and massive liquidity injections.
Central banks have created massive disincentives in markets that should have been prevented if they had actually followed their mandate to maintain price stability.
In addition, the ECB faces another risk. It must avoid following the siren calls of interventionist monetary policy advocates if the euro plan is to survive.
The euro is the biggest monetary success of the last 100 years, and the ECB’s overly loose policy could destroy its position as the world’s reserve currency. The interventionist policies of European socialism want the central bank to become an instrument in the hands of governments to nationalize the economy and destroy the purchasing power of the currency.
Those who demand “expansionary monetary policy” are seeking exactly what they advocated in Argentina, Venezuela and Cuba: expropriation of wealth through the dismantling of the purchasing power of the currency. It would be completely irresponsible to implement massive rate cuts for a number of reasons.
The price and quantity of money – Inflation will not fall
Central banks pay all their attention to the price and not the quantity of money. Ignoring monetary magnitudes is very dangerous, and focusing decisions only on interest rates can create a bigger problem: a market bubble and a contraction of the real economy.
Ignoring monetary figures, central banks may cut interest rates without any real effect on productive economic activity and solve nothing. There may be a significant contraction in economic activity even if interest rates fall, as the availability of credit worsens even as interest rates fall, but markets continue to bet on a financial bubble.
Inflation is not persistently declining. Since the consumer price index is calculated on an annual basis, starting from a very high percentage, the base effect accounts for up to 85% of its reduction. The base effect could weigh on inflation in the coming months if the path of year-on-year price increases remains stable.
The greatest economic diversion of our time, negative interest rates, actually exacerbated the structural weakness of the economy, causing it to slow down. The economy has been accumulating the negative data of poor and indebted growth for years in which misguided so-called “expansionary” monetary policies were applied.
Negative interest rates and extreme liquidity inflows into the economy have not created more or better growth, but have left countries with huge imbalances.
Consumers are still suffering from the monetary disaster created in 2020. We’re talking cumulative inflation of over 22% since 2018 and rising prices that continue to be alarming, particularly in durable goods.
The recession in private economic activity
Monetary figures show that there is a private sector recession masked by accumulated debt. Between January 2020 and July 2022, the money supply (M2) jumped by $6.3 trillion. It’s down nearly a trillion dollars since its peak.
The impact of this reduction in the money supply on the availability of credit and the broader economy will not be apparent until 2024, when it coincides with a massive wall of debt maturities.
Central banks have gone from oversupplying money to ignoring what will happen if the cannula closes. Both are equally negative. One created a burst of inflation and the second leads to a private sector recession that will be suffocated by debt.
Inflation is a side effect of monetary policy. What some economists call cost inflation, commodity inflation, or supply shocks are nothing more than more units of currency issued than actual economic growth going into relatively scarce assets.
Unit prices may rise for exogenous reasons, but they do not create a sustained and cumulative rise in overall prices, which is what inflation measures. If one price soars due to an exogenous factor, the rest of the price does not rise immediately if the currency issued remains stable relative to economic growth.
They wrongly blame inflation for everything except the one thing that can cause overall prices to rise immediately, cement that annual boom and keep rising: the decline in the purchasing power of the currency.
Those who understand the principles of monetary policy predict inflation and warn of the current danger. Several studies have warned of the rise of inflation from excess money supply and interpret it based on this empirical data. Some argue that in 2009-2019 there was no inflation and that money was also printed massively, but they do not understand the quantity theory of money and ignore that the monetary expansion of 2020-2022 was up to five times that of the previous period through the plans to stimulate the economy and increase government spending.
If we look at the shrinking of monetary quantities, inflation should have fallen faster and the economy would have been in recession. However, the cumulative effect of massive money growth added to an unstoppable debt-fueled government deficit makes the impact of the 2020-22 liquidity burst temporarily mask the risks. Inflation was created by faulty monetary policy and negative central bank measures can have lasting negative effects on the economy.
The goal is to increase the public sector at any cost
The first result is obvious: governments continue to squeeze the real economy and households and businesses bear the full brunt of interest rate hikes.
Perhaps the aim was always to increase the size of the public sector at any cost and implement a gradual nationalization of the economy. Market participants should stop encouraging bubble-creating policies and central banks should focus on monetary figures to avoid violent reversal of business cycles.
The negative effects of the current recession on the money supply may burst, immediately as the debts mature. Even if we avoid a recession, it will likely be a false exit with a debt-inflated rate of government consumption, weak productivity and anemic private sector growth.
