Irregular Roundup, 17th September 2024

We begin today’s Irregular Roundup with monetarism.

Monetarism

Joachim Klement does not believe in monetarism.

• He’s written about it many times before and calls it a dead theory.

According to Joachim, a new paper shows that the quantity theory of money hasn’t worked since 1985.

• The paper calculates regression coefficients for 18 developed countries between inflation and the change in the money supply.

If monetarism worked perfectly, the coefficient should be 1.0

• Above 1, we get more inflation than expected and below 1, less inflation.

The real problem is when the coefficient turns negative – here money printing lowers inflation.

The bars cover four time periods:

• 1870 to 2020 = blue
• 1870 to 1945 = red
• 1945 to 1985 = green and
• 1985 to 2020 = yellow

The first chart looks at the narrow money supply and the second chart at the board money supply.

Joachim draws three conclusions:

• The regression coefficients are almost always less than 1.0 indicating that the theory is overstating the amount of inflation
• In general, monetarism has worked best between 1945 and 1985
• Since 1985, the quantity theory of money has failed completely. The regression coefficients became negative for almost all countries

The period when the theory worked was when it was formulated, and then popularised by Milton Friedman.

There’s certainly been a “problem” in creating inflation since 1985, and in particular since 2008.

• Central banks are supposed to keep inflation relatively low, but since the GFC they have been more worried about deflation.

On the other hand, doling out money to unproductive people during Coivid seems to have done the trick, and inflation is back one more.

• The study doesn’t look past 2020, but I suspect the last few years will have been more kind to monetarism.

GDP targeting

A second article from Joachim looked at nominal GDP targeting by central banks.

Changes in nominal GDP come from the combined change of real GDP and inflation, so when real growth is low, inflation can be higher to stimulate future real growth and when real growth is high, inflation needs to be lowered to reduce nominal GDP growth.

This means that short-term fluctuations in inflation can be ignored, and the medium-term growth trajectory can be focused on instead.

Joachim doesn’t like this proposal as he sees it as monetarist.

• More importantly, the impact of GDP targeting seems to depend on heroic assumptions about the public’s ability to understand economics.

If this [Nominal GDP Level] target were understood by the publice, it would create expectations of stable money spending growth that would become self-fulfilling.

And:

“This concept can be better understood by noting that changes in the supply of money are automatically offset by changes in the demand for money under NGDPLT.” 

I hope the average man and woman on the street get the memo that they must demand less money whenever the central bank decides to cut the supply.

The theory also required money printing at the zero bound (when interest rates are zero).

• This didn’t work after the 2008 crash, so probably won’t work next time.

Joachim also notes that the Fed has only one tool – interest rates.

• But Scott Sumner – ” the inventor of market monetarism” – is proposing some more:

He thinks the Fed should introduce a nominal GDP futures market. The Fed can then use the prices of these futures to understand what kind of nominal GDP growth markets expect. The Fed adjusts money supply until the futures market reflects the desired nominal GDP growth rate. The Fed would essentially trade against the hedge funds. 

Joachim doesn’t think this would end well.

Return Stacking

Return Stacking (essentially, the use of leveraged diversified portfolios) has reached the mainstream, with a none-too-positive article on Bloomberg entitled “Levered Trade That Blew Up in 2008 Gets a $600 Million ETF Redo”.

• The article’s author – Lu Wang – also describes RS as “portable alpha” (a 1980s term) for the masses.

This is presumably because it’s available to US investors (and UK investors with US accounts) as a suite of ETFs.

RSST was the example fund used.

• It mixes stocks with trend following (managed futures), offering $1 of each for each dollar invested (100% leverage).

The leverage works against you in a downtrend, but the diversification across asset classes should mean that volatility is lower to begin with.

• That’s assuming the historically observed correlations persist.

As we saw recently when stocks and bonds fell at the same time, this won’t be the case across all economic regimes.

RSST is also expensive, at more than 1% pa, though that’s cheaper than standalone managed futures funds.

• A 100% allocation to RSST would be quite risky, but that isn’t the idea.

Optimal leverage for long-term private investors is probably at least 15%, though I expect few are targeting that, and few tools are available (particularly within tax shelters).

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The original fund in this class, for which a better term is “capital efficiency” is the WIsdomTree Efficient Core fund (NTSX) which takes the traditional 60/40 stock bond portfolio and levers it by 50% to make it a 90/60 portfolio.

• This is also the only fund available in the UK.

It’s my largest holding, at 5% of my portfolio (I won’t hold more than that in a single fund).

• That means I only have leverage of 2.5%, a long way short of my 15% target.

VCTs

The EU has given the green light to another 10 years of VCT and EIS schemes.

• This is being spun as good news for the venture industry, though I’m not sure there was ever a real threat to the tax breaks.

Chris Lewis, chair of the VCT Association, said:

This a very good day for the UK’s VCT community. The VCTA has continuously sought to demonstrate the positive impact made by our members through their investment in the next generation of early-stage businesses. The European Commission was informed by not only the VCTA’s own research, but also by a body of research from other associations across the industry.

Labour watch

The government net borrowing figures for July came in hot at £3.1 bn.

• This is £3bn more than predicted by the ONS and more than a billion higher than the consensus economist forecast.

The total for the four months of the current tax year is £51.4 bn, the fourth highest since records began.

• So anyone who still believes Rachel Reeves’ claim that there is a £22 bn black hole to fill with the October budget must now think that we have a £25 bn problem.

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We also had more updates on the counter-intuitive way that Labour is pursuing its proclaimed “growth agenda”.

• We’ve had cancelled investments in roads and AI supercomputers and the public sector pay rises (that are largely responsible for the fiscal black hole) n not tied to productivity gains (or indeed, simple reforms to outdated working practices).

Last week we had Angela Rayner’s “right to switch off”.

• This would prevent employers from contacting their staff outside of work hours.

It’s not hard to imagine scenarios where not speaking to someone with crucial information – and being unable to recall them back to the workplace – could impact productivity.

• Labour also seems very keen on giving people the right to work from home.

This will apparently make them happier – perhaps because they can get more of their own stuff done and less of their employer’s tasks.

• If WFH really helped with productivity, wouldn’t we have noticed in the four years since the Covid lockdowns began?

In fact, public sector productivity is at a 30-year low.

• It’s all very reminiscent of the way things were done in the 1970s (ie. pre-Thatcher).

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We should mention Ed Milliband’s brainchild (no, not the EdStone), GB Energy.

This publicly owned company has four somewhat conflicting objectives:

1. boosting clean energy supplies
2. reducing emissions
3. greater energy efficiency
4. increased energy supply efficiency.

And all this for £8.3 bn (which Labour claims will unlock another £60 bn of private investment).

We’re back to the “picking winners” idea which failed so badly in previous decades (British Leyland, British Steel, British Shipbuilders).

• Chuck in more natural (for a time at least) state monopolies like British Rail and British Telecom, and perhaps we can see why Labour prefers the Olympic-style prefix “GB”.

It’s only a matter of time before that one is tarnished, too.

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Back to growth, and following the big pay rise for teachers and NHS workers, we have a 15% pay rise for train drivers (with no productivity or efficiency linkage).

• Tough on pensioners, and easy on unions is the track record to date, but it’s hard to square these above-inflation pay rises with the growth agenda.

Automating the trains would make more sense.

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Finally, the Independent ran a poll which found that a majority of voters would like to increase income tax on top earners (as if they don’t already pay enough).

• Those on more than £125K pa now number close to a million, which is still just the top 2% of earners.

The article noted such an increase would be breaking an election promise, but its bizarre solution was to suggest a tax rise for an even smaller group – those earning more than £1M pa.

• There are just 25,000 of these people, and they paid £28 bn on an average income of £2.8M each.

In contrast, 18M people earning less than £30K pa paid £27 bn in tax between them.

• A new top rate of 50% for the £1M+ earners would raise £3.4 bn – which the Independent would use to abolish the cap on benefit payments!

Let’s hope Rachel Reeves is reading a different newspaper.

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• Until next time.