THE DEADIF THESIS
MORE CASH PLEASE
Last week, BOOM referred to the phenomenon of slowing GDP growth globally and in the USA. The other major economic phenomenon to take note of is the slow but steady disappearance of CPI inflation worldwide. Are they connected?
BOOM has referred to his DEADIF thesis in the past, an explanation of our economic woes. It is time to review it to see if it still explains our current macro-economic world in the advanced economies. It was first formulated by BOOM about 5 years ago and the basic elements have not changed since then. So what are those elements?
D = DEBT SATURATION
E = ENERGY SATURATION
A = AGING DEMOGRAPHICS
D = DIS-INFLATION & DEFLATION
I = IMPACT OF INNOVATION
F = FAILURE OF FINANCE
Debt saturation refers to private debt. In our economic system, 97% of fresh new money has to be created as private commercial bank loans. If borrowers are declining in number and don’t apply for fresh new loans or if they apply for loans of less and less value than previously over time, the supply of fresh new money slows and may theoretically stop. Because old money is being simultaneously destroyed as old bank loans are repaid, this creates the potential for a relative shortage of money to develop overall.
The result must be a falling CPI inflation rate. Why? Because, over time, less and less money is chasing more and more goods and services. This dynamic is exacerbated if the supply of goods and services is rising due to the impact of improved technology. Thus the prices of those goods and services must tend to fall (or stay stable) for the market to clear. If this doesn’t happen, then the inventory of goods will begin to rise and, again, the prices needed to clear the inventories must fall.
If the velocity of money is falling while the money supply is falling, then the tendency towards a falling rate of CPI inflation will be enhanced. In these circumstances, the nominal GDP of an economy must also tend towards a decline or stagnation. This occurs because of the Money Velocity Equation MV = PY. In the equation, M is the Money Supply, V is the Velocity, P is the overall Price Level and Y is Real GDP = Total Nominal GDP
These dynamic circumstances are now present and clearly observable in most advanced economies such as Japan, the USA, Western Europe, the UK and Australia.
In China, due to the impact of the two-child policy from 1970 – 1980 and the one-child policy from 1980 – 2015, approximately 400 million births were prevented in total (Chinese government estimate). This has had the effect of reduced consumer demand relative to what may have happened if the child reduction policies had not been instituted. In China, however, there is no problem boosting the money supply annually because it is the sine qua non of central planning. Thus, because the centrally controlled Chinese economy can continually refresh the economy with fresh new money supply, then the GDP growth continues but at a lower and lower rate over time as the number of consumers slows relatively due to the impact of the one and two child policies.
Energy saturation arises when new technology increases the supply of energy or when more and more energy sources come on-stream. That is exactly what has happened over the last decade. The supply of all energy sources has increased such as oil, natural gas, shale oil and gas, tight oil and gas, wind, solar, nuclear, geo-thermal and hydro. While this has been happening, the efficiency of using energy has increased. In the advanced economies, the energy use per capita has been stable or falling steadily.
With energy saturation comes relative energy cost falls in most economies. Energy suppliers have increased competition and abundance of energy. Gasoline, for example, is now cheaper per liter than milk or bottled water in advanced economies. As energy prices fall relatively, the impact on CPI inflation must be negative. Thus it becomes hard to maintain positive CPI inflation rates. Why? Because energy is at the very core of every transaction of goods and services in an economy. Dis-inflation must occur — falling rates of positive CPI inflation.
Aging Demographics (caused by increased longevity combined with lower birth rates) has a growing negative impact on consumer demand over time because, comparatively, elderly people do not raise new families, do not establish new homes, do not buy more new cars and new household items, do not spend on entertainment or clothing as much as younger people. This progressive loss of consumption over time must cause a fall in the number and size of transactions, leading to a tendency towards lower rates of nominal GDP growth.
The simultaneous fall in CPI inflation that is occurring hides this dynamic over time because Real GDP growth numbers initially look OK. As Real GDP growth numbers look solid, central bankers are continually convinced that “CPI inflation is a looming threat”, thus they tend to set official interest rates at too-high levels and, thus, they have to continually lower them over time. They also make the mistake of continually over-estimating the direction of nominal GDP growth.
After looking at the first three DEA elements of the DEADIF thesis, we can clearly see the synergistic scenario effect that MUST emerge on advanced economies over time — from lower and lower CPI inflation rates, lower and lower interest rates, lower and lower nominal GDP growth rates.
Let’s turn our attention to the last three elements — D = DIS-INFLATION & DEFLATION, I = IMPACT OF INNOVATION, F = FAILURE OF FINANCE
Dis-inflation and deflation occurring persistently over time will both cause a natural fall in the growth or total value of nominal GDP transactions. We measure GDP in terms of prices multiplied by total transactions. Dis-inflation means that CPI inflation is still positive but is falling in magnitude. Deflation is where the rate of CPI inflation is negative on an annual basis (prices are actually beginning to fall right across the board).
If prices are reducing or not increasing as fast as previously for goods and services, then the total of nominal GDP growth must begin to slow down in its rate of advancement and then actually begin to fall (a recession is where the Real GDP growth rate is negative and the GDP calculation contracts).
Impact of Innovation is the next element, describing the fact that improved technology boosts productive output over time. That technology (such as robotics and computers) is dramatically reducing in cost as this is taking place. So, again, more goods and services can be produced at progressively lower prices. The result is that lower prices of finished goods and services are then required to clear markets and reduce inventories. Modern information technology, in particular, is falling in price dramatically especially when hedonic factors are considered. All of us can now store our data in secure cloud services for very little cost as compared to previously. And all of those cloud data bases are mirrored and redundant.
The impact of dramatic innovation must be dis-inflationary or deflationary over time and that impact is also occurring in an exponential sense (it is increasing at a faster and faster pace).
It is beginning to look like progressively falling rates of CPI inflation over time are the cause of our macro-economic conundrum. It appears reasonable to expect that negative CPI inflation must inevitably come our way.
Failure of Finance is the last DEADIF element. Finance is the means by which we boost the fresh new money supply in our advanced economies, allowing for more transactions to occur and at higher prices over time. Failure of finance is an economic tragedy that will exacerbate everything else if allowed to happen. Increases in fresh new money are critical in a system where money destruction is persistently occurring due to the repayment of bank loans.
Central bankers around the globe have realized this and responded by lowering interest rate settings dramatically towards Zero (called ZIRP — Zero Interest Rate Policy) and engaging in asset purchase programs (called QE — Quantitative Easing). Since the great Global Financial Crisis of 2008, it has all been arguably Too Little, Too Late …….. so far.
Governments have almost all responded by increasing their deficit spending, issuing large amounts of fresh new bonds and expanding their budget deficits significantly. While this has had some effect on increasing the number of transactions occurring in an economy, it is not significantly effective at increasing the money supply. Thus, it has no significant effect on falling CPI inflation rates which, as I have explained, is at the very core of the economic conundrum we are all facing.
The future — BOOM expects central bankers and Governments to continue boosting the fresh new money supply and boosting the number of transactions in as many ways as they can possibly think of in future. This will have very little, if any, effect on boosting CPI inflation because they are initiatives that do not attack the base causes of the CPI Conundrum. The end result should be higher and higher asset prices as the fresh new money flows move towards asset purchases. The prices of houses, stocks and bonds should all continue to rise over time as more and more money gets thrown at the problem.
BOOM cannot see any other future than what we have had since this whole process began way back in 1981. Soon, we will be approaching the 40th year of this dynamic and all of the elements that caused it are still in place. The DEADIF thesis is well established and unlikely to be broken any time soon. Declining CPI inflation is at the very core of the problem.
MORE CASH PLEASE
BOOM is an advocate of increased supply of Sovereign money towards 50% of the fresh new money supply per annum. Sovereign money is money created by the Treasury and pushed into circulation by the Government. Our system of creating 97% of our fresh new money supply only through bank credit (loans) is no longer fit-for-purpose. That means increased production and circulation of CASH and LOTS of it. Governments must revert to using Cash (for example, in pay packets) and accepting Cash for payment of government services and taxation. They must also encourage its relative use (by discouraging the use of debit and credit cards). A substantial tax on card transactions would be a great first step.
It’s a radical thought in a world where Cash transactions are disappearing fast.
In economics, things work until they don’t. Until next week ………… Make your own conclusions, do your own research. BOOM does not offer investment advice.
Return to the BOOM Main Website – BOOM Finance and Economics at http://boomfinanceandeconomics.com/
EMAIL: gerry [@]
HOW MOST MONEY IS CREATED
BANKS CREATE FRESH NEW MONEY OUT OF THIN AIR
(but they always need a Borrower to do so)
THERE IS NO SUCH THING AS A DEPOSIT
BANKS PURCHASE SECURITIES, THEY DON’T MAKE LOANS
BANKS DON’T TAKE DEPOSITS, THEY BORROW YOUR MONEY
How is Most New Money Created ?
LOANS CREATE DEPOSITS — that is how almost all new money is created in the economy (by commercial banks making loans).
From the Bank of England Quarterly Bulletin Q1 2014 —
“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.“
“Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves”.
Quarterly Bulletins Index
Most economists are unaware of this and even ignore the banking & finance sectors in their econometric models.
On 25th April 2017, the central bank of Germany, the Bundesbank, released a statement on this matter —
“In terms of volume, the majority of the money supply is made up of book money, which is created through transactions between banks and domestic customers. Sight deposits are an example of book money: sight deposits are created when a bank settles transactions with a customer, ie it grants a credit, say, or purchases an asset and credits the corresponding amount to the customer’s bank account in return. This means that banks can create book money just by making an accounting entry: according to the Bundesbank’s economists, “this refutes a popular misconception that banks act simply as intermediaries at the time of lending – i.e. that banks can only grant credit using funds placed with them previously as deposits by other customers”. By the same token, excess central bank reserves are not a necessary precondition for a bank to grant credit (and thus create money).”
The Reserve Bank of Australia (Australia’s central bank) has also contributed to the issue in a speech by Christopher Kent, the Assistant Governor on September 19th 2018.
“…… the vast bulk of broad money consists of bank deposits”
“Money can be created …….. when financial intermediaries make loans”
“In the first instance, the process of money creation requires a willing borrower.”
“It’s also worth emphasizing that the process of money creation is not the result of the actions of any single bank – rather, the banking system as a whole acts to create money.”
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