WEBVTT NOTE The Monetary Contraction of 2008-09: Assessing UK Money Supply Measures in Light of the Financial Crisis 1 00:00:00.000 --> 00:00:07.160 First of all I must declare amongst a bunch of academics, I have no real academic pedigree 2 00:00:07.160 --> 00:00:17.200 of any description whatsoever. I'm an entrepreneur, actually retired entrepreneur, now investor. 3 00:00:17.200 --> 00:00:21.800 And it's very interesting to listen to what Peter Klein had to say because of course he's 4 00:00:21.800 --> 00:00:27.560 quite right, when you're an entrepreneur you're dealing with uncertainty. And I've never actually 5 00:00:27.560 --> 00:00:57.560 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. 6 00:00:57.560 --> 00:01:27.560 etc. 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 7 00:01:27.560 --> 00:01:35.560 USA stocks or overweight USA stocks or underweight this and underweight that and they deal in 8 00:01:35.560 --> 00:01:41.880 languages utterly alien towards me. They deal in risk and probability and I can only conclude 9 00:01:41.880 --> 00:01:50.080 that they don't actually know what they're talking about. But anyway, to the paper, the 10 00:01:50.080 --> 00:01:56.280 reason why I have a passing interest in Austrian economics is because I like to understand, 11 00:01:56.280 --> 00:02:00.640 And I like to try and understand and it's very hard to understand because everything 12 00:02:00.640 --> 00:02:05.880 is so uncertain, a little bit about the world, to make my life as an entrepreneur and now 13 00:02:05.880 --> 00:02:10.120 as an investor much easier. 14 00:02:10.120 --> 00:02:18.640 So talking to my friend and colleague Anthony Evans, I used to ask him why, and I remember 15 00:02:18.640 --> 00:02:24.480 as a student of economics when I was 16, why do we have so many definitions of money? 16 00:02:24.480 --> 00:02:28.480 Not definitions, I beg your pardon. Why are there so many different measures of money? 17 00:02:28.480 --> 00:02:35.480 Why can't you have thought after hundreds of years of the economics profession being in existence, 18 00:02:35.480 --> 00:02:38.480 they would have worked out how to count money. 19 00:02:38.480 --> 00:02:44.480 And you would have thought money should be able to be counted in nice easy chunks. 20 00:02:44.480 --> 00:02:50.480 But no, we have various M's and various indices. 21 00:02:50.480 --> 00:02:57.880 And Joseph Salerno actually, I'm glad he's here because he provides the initial inspiration 22 00:02:57.880 --> 00:03:02.600 for the thought process that I and Anthony then went down. 23 00:03:02.600 --> 00:03:07.640 Measures of the US money stock in current use in economic and business forecasting and 24 00:03:07.640 --> 00:03:12.400 in applied economics and historical research are flawed precisely because they're not based 25 00:03:12.400 --> 00:03:17.640 on an explicit and coherent theoretical conception of the essential nature of money. 26 00:03:17.640 --> 00:03:22.960 Given the all-pervasive role of money in the modern market economy, existing money supply 27 00:03:22.960 --> 00:03:28.320 measures therefore tend to impede rather than to facilitate a clear understanding of the 28 00:03:28.320 --> 00:03:33.120 past or future development of actually economic events. 29 00:03:33.120 --> 00:03:40.320 So he's bang on the money, that's a beautiful quote, and that's what I, in my entrepreneur 30 00:03:40.320 --> 00:03:47.120 and investor role, I seek to understand what that money and the money creation is doing 31 00:03:47.120 --> 00:03:55.120 and how I can either protect myself from the destruction that has been unleashed upon us 32 00:03:55.120 --> 00:04:03.120 and all the false price signals that are unleashed upon us and or benefit from that situation. 33 00:04:03.120 --> 00:04:10.120 So we then need to find out what is money, how do we define money? 34 00:04:10.120 --> 00:04:18.120 And the most clear exposition is a very short little one sentence by Murray Rothbard. 35 00:04:18.120 --> 00:04:24.120 Money is the general medium of exchange, the thing that all other goods and services are traded for, 36 00:04:24.120 --> 00:04:28.120 the final payment for such goods on the market. 37 00:04:28.120 --> 00:04:31.120 So that is very, very clear. 38 00:04:31.120 --> 00:04:35.120 Now it's the final good for which all things exchange. 39 00:04:35.120 --> 00:04:38.120 So why do we struggle to count it? 40 00:04:38.120 --> 00:04:40.960 If we know exactly what it is, 41 00:04:40.960 --> 00:04:46.080 I think that to me is a perfect working definition, 42 00:04:46.080 --> 00:04:47.720 why do we struggle counting it? 43 00:04:47.720 --> 00:04:58.000 So we then go about devising a method of how to define 44 00:04:58.000 --> 00:05:05.240 what is that final good for which all things exchange. 45 00:05:05.240 --> 00:05:13.240 And Frank Szostak, I think, has been the most helpful in this in the quarterly journal of Austrian Economics in 2000. 46 00:05:13.240 --> 00:05:22.240 He distinguished, he uses an inspirational passage in The Theory of Money and Credit by Mises in 1912 47 00:05:22.240 --> 00:05:27.240 to help him distinguish between what a claim transaction and a credit transaction is. 48 00:05:27.240 --> 00:05:31.240 And for those who are not familiar, 49 00:05:31.240 --> 00:05:40.240 A claim transaction is a transaction where you have instant command over the money 50 00:05:40.240 --> 00:05:45.240 and you can use it to purchase instantaneously goods and services. 51 00:05:45.240 --> 00:05:52.240 And a credit transaction is where you forego your ability to use that purchasing power 52 00:05:52.240 --> 00:05:55.240 and you give it to a third party. 53 00:05:55.240 --> 00:05:58.240 That's what you do when you do savings. 54 00:05:58.240 --> 00:06:08.240 You're essentially relinquishing your purchasing power, someone else is investing it, you hope to give you a better return. 55 00:06:08.240 --> 00:06:22.240 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 56 00:06:22.240 --> 00:06:29.040 Money and how the existing money supplies are affecting our economies. 57 00:06:29.040 --> 00:06:43.440 Now, Murray Rothbard, he did create what he called MA, Money Austrian, and I think he's 58 00:06:43.440 --> 00:06:48.640 aware of the credit and claim distinction, and I don't think he applies it to his own 59 00:06:48.640 --> 00:06:53.640 is the definition. In fact I think he's erroneous and I'll go through the reasons why. 60 00:06:53.640 --> 00:06:57.640 But you know, you build on people who inspire you. 61 00:06:57.640 --> 00:07:03.640 Murray Rothbard's definition of money actually is total supply of cash and cash held at banks 62 00:07:03.640 --> 00:07:09.640 plus total demand deposits plus total savings deposits in commercial and savings banks 63 00:07:09.640 --> 00:07:15.640 and total shares in savings and loan associations and time deposits and small CDs 64 00:07:15.640 --> 00:07:29.640 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. 65 00:07:29.640 --> 00:07:39.640 Now, I think the Ludwig von Mises Institute here uses a similar definition, Joe might be able to elaborate on that, total money supply, 66 00:07:39.640 --> 00:07:53.640 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. 67 00:07:53.640 --> 00:08:08.640 A 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, 68 00:08:08.640 --> 00:08:12.640 They'll tell you, no, we don't accept that, can you change it into money? 69 00:08:12.640 --> 00:08:15.640 And you have to then go and put it into your checking account 70 00:08:15.640 --> 00:08:21.640 and you can then pay for it either in cash or via your demand deposit. 71 00:08:21.640 --> 00:08:31.640 So we have some problems with the money supply definition of Rothbard. 72 00:08:31.640 --> 00:08:37.640 But we agree with Rothbard that currency and circulation, cash, that's the nice easy thing. 73 00:08:37.640 --> 00:08:40.520 is an easy thing, that's definitely money. 74 00:08:40.520 --> 00:08:44.000 Site deposits, I think they're called in this country, 75 00:08:44.000 --> 00:08:45.920 you might have to help me, they're demand deposits 76 00:08:45.920 --> 00:08:50.320 in the United Kingdom, they are definitely money, 77 00:08:50.320 --> 00:08:53.720 you can pay a check out of them and receive goods in return, 78 00:08:53.720 --> 00:08:57.880 you can transfer from there to a retailer 79 00:08:57.880 --> 00:09:01.640 to receive goods and services back. 80 00:09:01.640 --> 00:09:06.640 Time deposits, even if you have instant access to them, 81 00:09:07.640 --> 00:09:13.120 which is a bit of a, you know, a strain, I think it's a bit, well, I don't think they 82 00:09:13.120 --> 00:09:17.680 should be called time deposit, should be called instant access deposits when in fact they 83 00:09:17.680 --> 00:09:24.000 are savings deposits which you can liquidate immediately, but you have the person on the 84 00:09:24.000 --> 00:09:27.720 receiving end, the person who is managing that time deposit has to actually sell the 85 00:09:27.720 --> 00:09:35.720 underlying assets before it can be converted into money. So it's a pure credit transaction, 86 00:09:35.720 --> 00:09:43.520 time deposit, so these should all be excluded from any working measure of the money supply. 87 00:09:43.520 --> 00:09:49.080 Money market mutual funds are a very fashionable thing for economists nowadays to put into 88 00:09:49.080 --> 00:09:55.000 their definitions of money, but at the end of the day, same problem with time deposits. 89 00:09:55.000 --> 00:09:59.880 If you want to get anything out of your money market mutual fund, you have to instruct your 90 00:09:59.880 --> 00:10:29.880 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. 91 00:10:29.880 --> 00:10:37.880 If it was extracting taxation from you, it's effectively pulling money out of the system. 92 00:10:37.880 --> 00:10:41.880 But then it just sticks it back on its own deposit account and then spends it. 93 00:10:41.880 --> 00:10:49.880 So we include government in the notes and coins definition when we calculate it. 94 00:10:49.880 --> 00:10:56.880 I don't know the status of how government is treated in this country. 95 00:10:56.880 --> 00:11:14.880 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. 96 00:11:14.880 --> 00:11:22.880 And that's all we can conclude, is what's worthy of counting as money. 97 00:11:22.880 --> 00:11:27.280 Now, empirically, that's the theory. 98 00:11:27.280 --> 00:11:30.560 I think it's always wise to, after you've established your theory 99 00:11:30.560 --> 00:11:33.320 and you're satisfied that you're satisfied as much as you can be 100 00:11:33.320 --> 00:11:35.160 that you're on solid ground, it's 101 00:11:35.160 --> 00:11:42.720 worthwhile having an empirical workout of your assumptions. 102 00:11:42.720 --> 00:11:45.040 So I will show you. 103 00:11:52.880 --> 00:12:14.000 So it's nice when the empirics come good and can tell you something useful. Money Actual 104 00:12:14.000 --> 00:12:23.080 measured in the UK. You see there, that's the end of 1998-99, long-term capital management 105 00:12:23.080 --> 00:12:32.240 crisis. Our good governor there, I think it was Eddie George still, he decides to massively 106 00:12:32.240 --> 00:12:43.040 pump up the money supply and there we have the dot-com boom. We then have the huge contraction. 107 00:12:43.040 --> 00:12:47.620 I call this the Greenspan area although it has nothing to do with our country but fundamentally 108 00:12:47.620 --> 00:12:58.620 the sheer size and scale of the expansion of the United States monetary base had effects 109 00:12:58.620 --> 00:13:05.400 over onto our monetary base in the United Kingdom and the banks did have a low interest 110 00:13:05.400 --> 00:13:11.200 rate policy and you can see us kind of jigging about a bit, in business at the time there 111 00:13:11.200 --> 00:13:15.440 There was a little minor correction in 2003. 112 00:13:15.440 --> 00:13:20.600 And the interesting point here, Lehman, right, Lehman is etched in my mind, they're one 113 00:13:20.600 --> 00:13:29.240 of my customers at the time and on the morning of the 15th of September at 7.58, 100 hours 114 00:13:29.240 --> 00:13:34.640 exactly they went bust and I remember it because we just released 1500 pounds of goods I used 115 00:13:34.640 --> 00:13:41.120 to supply their fish to their staff canteen and directors dining so we lost that money 116 00:13:41.120 --> 00:13:46.120 Instantaneously, plus all that they owed historically for us. 117 00:13:46.120 --> 00:13:54.120 But if you look here, our money supply measure was telling us before, 118 00:13:54.120 --> 00:13:58.120 it was telling us actually nine months before Lehman's collapse, 119 00:13:58.120 --> 00:14:04.120 that we were going through a massive deceleration and actually down to a money deflation 120 00:14:04.120 --> 00:14:07.120 was happening in the economy. 121 00:14:07.120 --> 00:14:12.600 economy. So I was kind of forewarned and forearmed that we were, I've never seen 122 00:14:12.600 --> 00:14:16.820 anything like that in anything I've ever ever studied in in economics, that we were 123 00:14:16.820 --> 00:14:20.740 we were in for some trouble. But obviously you don't know, you don't, you 124 00:14:20.740 --> 00:14:24.940 know you're going to have a car crash, but you kind of just don't know when. But 125 00:14:24.940 --> 00:14:28.400 it's not, it is good to be forewarned that you're going to have a car 126 00:14:28.400 --> 00:14:36.760 crash. And then, and then you can see here, here to here we've had a massive, this is 127 00:14:36.760 --> 00:14:41.760 This is the QE. This is all the various QE nonsense that's going on. 128 00:14:41.760 --> 00:14:46.760 It's the same in your country. You have the same there. 129 00:14:46.760 --> 00:14:53.760 But look what we're seeing ahead of us now. We're seeing a huge contraction. 130 00:14:53.760 --> 00:14:59.760 And that contraction is getting to be the same kind of size as after the dot-com bust. 131 00:14:59.760 --> 00:15:04.760 So in terms of uncertainty and what Peter Klein was talking about, 132 00:15:04.760 --> 00:15:13.760 and what I'm, you know, attempting to arm myself with a ways and means of looking through that uncertainty in the economy. 133 00:15:13.760 --> 00:15:19.760 And a correct definition of the money supply is enormously helpful. 134 00:15:19.760 --> 00:15:27.760 If you're forewarned of the car crash or of the boom, you can adjust your activities accordingly. 135 00:15:27.760 --> 00:15:32.760 So, Mr. Bagus, I think I've run out of time now, is that correct? 136 00:15:32.760 --> 00:15:34.760 Thank you very much.