1. When you look at the Covid shock and the answers delivered by the authorities, it is difficult to not pick up that specific graph = YoY % change of US M2:
It is making the post-GFC safety net looking like a drop in the ocean.
2. Talking about GFC: as my long time readers know by heart, the below graph tells the full story in my opinion:US M2 vs V (Velocity of M2) vs House Prices vs Russell/Nasdaq vs US 30yrs nominal yield:
What stands out??
=> It took 5 years for house prices to climb back to their 2007 levels. Covid? A few months. Implications:
** US Households net worth recovered immediately in 2020 and is now standing 36 trillions above early 2020 levels. Consumer Credit: 4 years versus 2 quarters post-Covid:
Reminder: banks have been elected as THE scapegoats for the GFC crisis. Regulations / cost of balance sheet = not able / keen to fulfill their prime role: providing credit to the real economy
** GFC: tepid recovery + slow recovery of both housing market and equity markets = sluggish growth and the well-known private balance sheet recession (households and corporates in deleveraging mode)
=> Increase of M2 / QE from the FED but money not going into the real economy = ongoing down trend of V, the velocity of M2 = subdued inflation and below par growth = juicy bone for the long end of the curve and supportive for the outperformance of the duration proxies in the equity sphere vs small caps as Central Banks kept alive their ultra-accommodative monetary policies. The big fear in between GFC and Covid: the global Japanification….
=> Crux of the matter: the explosion of M2 post-Covid has been marked by also an inflection of V = cash going into the real economy. Look at the above carefully: the inflection of V (white line) coincides with the start of the rise of the US yields (red line) as inflation started to show its ugly face….
=> The relentless domination of the US large techs despite the pick-up of V and US yields? The 2022 revenge of the small caps has been abruptly killed by the emergence of A.I…on that note: it didn’t take too long to erase the early June outperformance of the US Small Caps:
Russell/Nasdaq back to its time lows:
It has been a very short-lived attempt of convergence. Below: Russell/Nasdaq vs Term Premium
3. The difference between GFC and Covid
=> We will be quick here: the HUGE difference has been the unprecedented partnership between the monetary and fiscal easing post-Covid while the authorities’ answer to GFC has exclusively relied on the DM Central Banks and the use of unorthodox monetary policy tools (LSAP: Large Scale Assets Purchase). This time around, US consumers (and more generally Western Households) received direct checks, supporting the US animal spirits despite the initial cash flows’ disruptions.
=> As it happened, the disaster which compelled the world leadership to flip the emergency switch introduced a severe supply chock, which meant all the distributed cash wasn’t just chasing too few goods and services, it was in some cases chasing no goods and services at all…..
=> In other words: a perfect storm…..
4. Taking into account all the above: what has been THE mistake of the DM Central Bankers in 2022, convinced that inflation pressures were essentially temporary? Believing that post-Covid will be like post-GFC. Forgetting that the fiscal push delivered in 2020 and 2021 would avoid the dreaded private balance sheet recession. In a context where the nature itself of the pandemic followed by the Russian invasion of Ukraine triggered acute shortages and supply-chain disruptions
5. Interestingly enough, the explosion of inflation across the world has been seen as a revenge from the Monetarists. Milton Friedman would have told you when looking at the first graph displayed in this comment (M2 YoY % change): “Beware guys, inflation can only surge like a maniac from the bottle….”
6. Now, this is the question: the same way the concerns expressed by the monetarists throughout 2021 and 2022 have been ignored, are the current concerns expressed by the same monetarists also ignored, paving the way for a second horrendous monetary policy mistake?? What am I talking about?
=> US M2 YoY % Change vs Headline CPI (15 months lag):
=> EU M3 YoY % change vs Headline CPI (18 months lag):
=> UK M3 YoY % Change vs Headline CPI (18 months lag):
Conclusion:
1. I have one strong conviction: we gave far too much credit to the DM Central Bankers over the past few decades for the muted inflation regime. They have in fact benefitted from powerful deflationary forces that have made the work for them (tech innovation – globalisation – 2 successive workforce shocks – budgetary austerity). The reality: their efforts to revive real inflation failed dramatically. I strongly believe that Draghi’s ultra-accommodative monetary policy has been deflationary by nature by favouring inadequate capital allocation + zombies + mispriced output gap.
2. Would they succeed now to tame inflation in a context where the deflationary tailwinds of the past few decades have been altered at best since Covid??
3. That said, The big questions of course:
=> The impact of A.I
=> And, to conclude with what I wrote above, the abrupt money supply and its counterparties’ reversal. One illustration:
Will the monetarists be right again?? If yes, we can only expect the DM Central Bankers to acknowledge their mistakes far too late….once again….