'Economies Are Not Watches and Money Flows Are Not Predictable'

Multiplying Europe's fiscal suicide (technical) ... The entire EU austerity plan is based on a false premise. This disastrous error is now clear beyond any reasonable doubt. The Teuto-Calvinists believe – or profess to believe, since much of their dogma is national self-interest dressed up as theory – that the fiscal multiplier is around 0.5. That is to say, fiscal retrenchment worth 1pc of GDP will cut output by half as much, or around 0.5pc over two years. There is pain, but at least there is gain. This is based on the IMF's analysis of fiscal crises over the decades. Well, it has not worked out like that. Ireland has contracted at nearly seven times the speed, Spain four times, and Greece three times. – Ambrose Evans-Pritchard/UK Telegraph

Dominant Social Theme: Technocratic approaches make the most sense. If you simply plan by the numbers you can organize everything.

Free-Market Analysis: Ambrose Evans-Pritchard is back with another try at organizing the world according to "monetarism."

Long ago, we recall reading that this adept mainstream journo did NOT consider himself a monetarist, or Keynesian, or anything else mainstream but in this article he seems to be trying on monetarist garb.

Ironically, what we draw from this article is that financial prognostication doesn't work. Evans-Pritchard, while proselytizing for monetarism, does a good job of demolishing IMF nostrums. Further down, we shall attempt to puncture monetarist ones.

We shall be left then with standard (Austrian) free markets. As Peter Schiff has asked in the past, "What else is there?" Nothing else stands up to scrutiny, in our view.

Back to Evans-Pritchard. His point is that IMF predictions about economic behavior simply don't work and are, in fact, making things worse. Here's more from the article:

As you can see, the multiplier is around 1.0 for the big countries, which is why France can expect a devastating year in 2013 as it tightens pointless by 2pc to comply with EU rules. And why the world faces a full-blown shock if the US goes over the fiscal cliff and tightens by 4pc next year. The multiplier is nearer 2.0 for part of the Club Med bloc.

So what went wrong? It is blindingly obvious. The IMF data – and indeed the more extreme theory of `expansionary fiscal contractions' (which the IMF does not endorse) – is based on past cases where individual countries were able to claw their way out of trouble by exporting to a healthy global economy, usually by devaluing first and often by slashing interest rates as well.

Greece, Spain and Italy cannot devalue. Most of Europe is tightening fiscal policy in lockstep. They are all dragging each other down. It is synchronised policy suicide. The European Central Bank has made matters worse. It has withheld the monetary stimulus desperately needed to cushion the fiscal shock. It allowed broad M3 money to contract earlier this year, in violation of its twin pillar mandate (the M3 growth target is 4.5pc).

The ECB has quite simply abandoned its monetarist heritage. What has it become instead? Just a plain-vanilla inflation targeter, even as inflation targeting is thrown on the scrap heap by everybody else. Yet that is not the whole story. Monetarists themselves have to confront an unpleasant fact. Vast amounts of QE in Britain did less than hoped to offset the fiscal squeeze. The UK multiplier has been around 1.0. (though not 2.0, thank God)

It is the same story in the US, though America's QE has been much less as a share of GDP. Richard Koo from Nomura – an expert on Japan's twenty year ordeal – argues that the monetary lever is almost useless once firms and households batten down the hatches in a "balance sheet recession".

"The Cameron government's austerity programs pushed the UK economy into a double-dip recession even as the BOE pursued a record-large program of quantitative easing, showing that the economy will weaken during a balance sheet recession no matter what the central bank does. If the government fails to administer fiscal stimulus.

This demonstrated that the impact of monetary accommodation is limited during balance sheet recessions and that fiscal stimulus is essential in preventing a deflationary spiral from taking hold."

Much of this is self-explanatory, but the statement about how the Japanese have "battened down the hatches" is certainly interesting.

Actually, what is being explained here is analogous to Austrian explanations. The issue is not whether money is available but whether people wish to use it or whether they are battening the hatches.

People won't start new ventures unless they are fairly sure the system surrounding them is solvent.

In both the US and Japan (and Europe, too) central banks have distributed massive amounts of funds. As a result, citizens do not know what enterprises are solvent and which ones are being propped up. Not knowing, people are reluctant to start risky business ventures.

And so economies languish. We can see clearly that money circulation, the velocity of money, is only part of the equation. The other part is people's willingness to invest and "use" money.

For this to happen, economies must be "cleansed." This is actually the opposite of what's going on, which is one reason why we have written that the object of "easings" is actually the opposite of its stated purpose.

The ACTUAL result is a prolongation of pain and even a deepening of the current depressive malaise.

Why should the powers-that-be want to make things worse? Well ... order out of chaos. If you want to build global governance, you need to tear down the previous system. Of course, you can't SAY that, so most of the statements about monetary policy tend to be the opposite of reality.

In any event, though the money being printed isn't circulating from a venture perspective, it is going somewhere ... some of it, at any rate.

Yes, even though the Fed in the US is actually paying banks perversely to hold onto money (so it doesn't circulate), some of that new money-from-nothing finds its way into the stock market and also into commodities. The main part of it apparently buffers banks' bottom lines.

This is exactly what Money Power seeks, in our view. All the rest is so much obfuscation.

Evans-Pritchard disagrees. In this article, at any rate, he remains a monetarist. He explains:

I don't agree with Mr Koo. Britain most certainly has avoided a deflationary spiral. It has also avoided the sort of crash now gathering speed in Spain.

Moreover, I don't think the Japanese carried out QE with much vigour or through the proper mechanism. I remain convinced that central banks can defeat a slump by purchasing assets from non-banks, working through the quantity of money theory.

Unfortunately that is not what the Fed's Ben Bernanke is really doing. He is dabbling at the margins trying to manipulate the cost of credit a fraction lower. That is a fruitless policy.

The reduced costs for borrowers are largely offset by reduced incomes to savers and pensioners relying on interest income. That is not the way to get much traction.

Evans-Pritchard here is really worried about price deflation. He believes that if central banks print massive amounts of money, they can combat lower prices. Of course we are not so frightened of lower prices as Evans- Pritchard. Once again he has headed off course.

He starts promisingly by demolishing IMF arguments regarding economic projections. But he finishes by arguing what is to us a somewhat absurd point – that the mechanical injection of money into the market can counteract current depressive tendencies.

Mr. Evans-Pritchard ... it has to CIRCULATE first! This is the grim reality.

It has to be lent out, and even then the results will not be mechanical ones. Monetarist theories that claim to predict exactly what the results of money printing shall be are surely questionable because money trapped on the bank shelf is not circulating money. And NO ONE can predict when or how much of that money is going to circulate – and how fast.

Free-market economic theory has it right. Keynesian theories, monetarist theories – money-modeling theories in general don't provide us with any accurate prognostications. The only theory that provides us with any semblance of workability is the Austrian theory of business cycles – and this is only because it is general, not specific.

Evans-Pritchard, as he often does, has given us a lot to think about. And he does us a favor by deconstructing the monetary nonsense of IMF nostrums. But in the end he wanders off into a monetarist theory that is equally pernicious, from our point of view.

Modeling simply doesn't work. Monetary "policy" doesn't work, nor can a coherent case be made for it. All that "works" is monetary competition in the free market. It is the friction of competition that produces valid value and accurate pricing.

If those at the top of the current financial food chain ever acknowledged this, the entire rationale for the current central banking economy worldwide would collapse. Money competition is the answer, a free-market in money including gold and silver. Not more central planning, even of the monetarist kind.

Conclusion: Economies are not watches and money flows are not predictable.