The Monetary Contraction of 2008-09: Assessing UK Money Supply Measures in Light of the Financial Crisis

0:00First of all I must declare amongst a bunch of academics, I have no real academic pedigree of any description whatsoever. I'm an entrepreneur, actually retired entrepreneur, now investor. And it's very interesting to listen to what Peter Klein had to say because of course he's quite right, when you're an entrepreneur you're dealing with uncertainty. And I've never actually Considered myself to be a risk taker and when you become an investor, my personal view is that your ability as an investor is to pick out the best entrepreneurs of which to place your money in and they are people who run fantastic companies with great barriers to entry, beautiful products, they're building companies for the long term, good cash flows producing positive cash and strong balance sheets.

0:57etc. etc. etc. etc. When you go and approach wealth managers, they talk to you in languages of risk, they talk to you in languages of probabilities and they talk to you in languages of asset classes and asset allocation and they advise you, you should be 2% in this and 5% in that and I know you're in the business as well, you're in the business as well, yeah, and they advise you that you need to be underway USA USA stocks or overweight USA stocks or underweight this and underweight that and they deal in languages utterly alien towards me. They deal in risk and probability and I can only conclude that they don't actually know what they're talking about. But anyway, to the paper, the reason why I have a passing interest in Austrian economics is because I like to understand, And I like to try and understand and it's very hard to understand because everything is so uncertain, a little bit about the world, to make my life as an entrepreneur and now

2:05as an investor much easier. So talking to my friend and colleague Anthony Evans, I used to ask him why, and I remember as a student of economics when I was 16, why do we have so many definitions of money? Not definitions, I beg your pardon. Why are there so many different measures of money? Why can't you have thought after hundreds of years of the economics profession being in existence, they would have worked out how to count money. And you would have thought money should be able to be counted in nice easy chunks. But no, we have various M's and various indices. And Joseph Salerno actually, I'm glad he's here because he provides the initial inspiration for the thought process that I and Anthony then went down.

3:02Measures of the US money stock in current use in economic and business forecasting and in applied economics and historical research are flawed precisely because they're not based on an explicit and coherent theoretical conception of the essential nature of money. Given the all-pervasive role of money in the modern market economy, existing money supply measures therefore tend to impede rather than to facilitate a clear understanding of the past or future development of actually economic events. So he's bang on the money, that's a beautiful quote, and that's what I, in my entrepreneur and investor role, I seek to understand what that money and the money creation is doing and how I can either protect myself from the destruction that has been unleashed upon us and all the false price signals that are unleashed upon us and or benefit from that situation.

4:03So we then need to find out what is money, how do we define money? And the most clear exposition is a very short little one sentence by Murray Rothbard. Money is the general medium of exchange, the thing that all other goods and services are traded for, the final payment for such goods on the market. So that is very, very clear. Now it's the final good for which all things exchange. So why do we struggle to count it? If we know exactly what it is, I think that to me is a perfect working definition, why do we struggle counting it? So we then go about devising a method of how to define what is that final good for which all things exchange.

5:05And Frank Szostak, I think, has been the most helpful in this in the quarterly journal of Austrian Economics in 2000. He distinguished, he uses an inspirational passage in The Theory of Money and Credit by Mises in 1912 to help him distinguish between what a claim transaction and a credit transaction is. And for those who are not familiar, A claim transaction is a transaction where you have instant command over the money and you can use it to purchase instantaneously goods and services. And a credit transaction is where you forego your ability to use that purchasing power and you give it to a third party.

5:55That's what you do when you do savings. You're essentially relinquishing your purchasing power, someone else is investing it, you hope to give you a better return. So that distinction is critical towards us looking through the fog of all these money measures to find out what is actually a correct definition of money Money and how the existing money supplies are affecting our economies. Now, Murray Rothbard, he did create what he called MA, Money Austrian, and I think he's aware of the credit and claim distinction, and I don't think he applies it to his own is the definition. In fact I think he's erroneous and I'll go through the reasons why.

6:53But you know, you build on people who inspire you. Murray Rothbard's definition of money actually is total supply of cash and cash held at banks plus total demand deposits plus total savings deposits in commercial and savings banks and total shares in savings and loan associations and time deposits and small CDs at Current Redemption Rates, plus Total Policy Reserves of Life Insurance Companies, Policy Loans Outstanding, Demand Deposits Owned by Savings Banks, Saving Loans Associations, and that equals money actual. Now, I think the Ludwig von Mises Institute here uses a similar definition, Joe might be able to elaborate on that, total money supply, But some of those measures in there I would say are inappropriate and should not be included in a definition of money supply because they are credit transactions and they have to be converted into a claim transaction before they actually become money.

7:53A very simple example is if you take your savings past book or whatever it's called in America, I don't know, if you take your identification of your savings account and you go into a newsagent and try and buy a US Today with it, They'll tell you, no, we don't accept that, can you change it into money? And you have to then go and put it into your checking account and you can then pay for it either in cash or via your demand deposit. So we have some problems with the money supply definition of Rothbard. But we agree with Rothbard that currency and circulation, cash, that's the nice easy thing. is an easy thing, that's definitely money.

8:40Site deposits, I think they're called in this country, you might have to help me, they're demand deposits in the United Kingdom, they are definitely money, you can pay a check out of them and receive goods in return, you can transfer from there to a retailer to receive goods and services back. Time deposits, even if you have instant access to them, which is a bit of a, you know, a strain, I think it's a bit, well, I don't think they should be called time deposit, should be called instant access deposits when in fact they are savings deposits which you can liquidate immediately, but you have the person on the receiving end, the person who is managing that time deposit has to actually sell the underlying assets before it can be converted into money. So it's a pure credit transaction, time deposit, so these should all be excluded from any working measure of the money supply.

9:43Money market mutual funds are a very fashionable thing for economists nowadays to put into their definitions of money, but at the end of the day, same problem with time deposits. If you want to get anything out of your money market mutual fund, you have to instruct your There's a strange anomaly as well. Government, for some reason, they view that in notes and coins definition, sorry, the MO definition in the United Kingdom, which used to be just made up of notes and coins, government always excluded itself, because it worked on the assumption that if it's made up of notes and coins, it's not going to be made up of money, it's not going to be made up of money.

10:29If it was extracting taxation from you, it's effectively pulling money out of the system. But then it just sticks it back on its own deposit account and then spends it. So we include government in the notes and coins definition when we calculate it. I don't know the status of how government is treated in this country. So, the simple definition that we've come down to, and it's building on Shostak, is firstly it's the cash, secondly it's the demand deposits, and thirdly it's the government's deposits.

11:14And that's all we can conclude, is what's worthy of counting as money. Now, empirically, that's the theory. I think it's always wise to, after you've established your theory and you're satisfied that you're satisfied as much as you can be that you're on solid ground, it's worthwhile having an empirical workout of your assumptions. So I will show you.

11:52So it's nice when the empirics come good and can tell you something useful. Money Actual measured in the UK. You see there, that's the end of 1998-99, long-term capital management crisis. Our good governor there, I think it was Eddie George still, he decides to massively pump up the money supply and there we have the dot-com boom. We then have the huge contraction.

12:43I call this the Greenspan area although it has nothing to do with our country but fundamentally the sheer size and scale of the expansion of the United States monetary base had effects over onto our monetary base in the United Kingdom and the banks did have a low interest rate policy and you can see us kind of jigging about a bit, in business at the time there There was a little minor correction in 2003. And the interesting point here, Lehman, right, Lehman is etched in my mind, they're one of my customers at the time and on the morning of the 15th of September at 7.58, 100 hours exactly they went bust and I remember it because we just released 1500 pounds of goods I used to supply their fish to their staff canteen and directors dining so we lost that money Instantaneously, plus all that they owed historically for us.

13:46But if you look here, our money supply measure was telling us before, it was telling us actually nine months before Lehman's collapse, that we were going through a massive deceleration and actually down to a money deflation was happening in the economy. economy. So I was kind of forewarned and forearmed that we were, I've never seen anything like that in anything I've ever ever studied in in economics, that we were we were in for some trouble. But obviously you don't know, you don't, you know you're going to have a car crash, but you kind of just don't know when. But it's not, it is good to be forewarned that you're going to have a car crash. And then, and then you can see here, here to here we've had a massive, this is This is the QE. This is all the various QE nonsense that's going on.

14:41It's the same in your country. You have the same there. But look what we're seeing ahead of us now. We're seeing a huge contraction. And that contraction is getting to be the same kind of size as after the dot-com bust. So in terms of uncertainty and what Peter Klein was talking about, and what I'm, you know, attempting to arm myself with a ways and means of looking through that uncertainty in the economy. And a correct definition of the money supply is enormously helpful. If you're forewarned of the car crash or of the boom, you can adjust your activities accordingly.

15:27So, Mr. Bagus, I think I've run out of time now, is that correct? Thank you very much.