Money has to go somewhere, inflate something

  • European and US broad money growth is picking up, Chinese and Japanese is weaker.
  • Unless private sector demand to hold cash is limitless, money has to go somewhere.
  • This means continued asset price inflation, or rising consumer price inflation, or both.

Late 2020 saw a dichotomy in global broad money growth. In the US, the 12-month growth of our own ‘Broad money’ measure (similar to the long since discontinued M3) continued to ease. But at 11.3% in the year to December, it remains very strong by historic standards. Moreover, on a three-month annualised basis, a better guide to recent trends, it accelerated to an eight-month high of 10.2%. The latest likely stimulus package, including, notably, $1,400 cheques to households, will boost broad money growth further. (Remember, bank deposits are they by far most important component of broad money.)

In the Euro Area (EA), M3 growth accelerated to 12.3% in the year to December. This is not only faster than earlier in 2020, it is in fact the fastest rate since late 2007. On a three-month annualised basis, EA M3 stood at a six-month high of 10.5%. Meanwhile, on this side of the English Channel, the growth of M4x has accelerated steadily during the autumn, reaching a 30-year high of 14.1% in December (M4x only dates back to 2007, previous data refers to M4).

This starkly contrasts with developments in the Far East. Chinese M2 growth has fluctuated narrow between 10% and 12% throughout most of 2020, easing to 10.1% in December; while three-month annualised growth was down to 4.3%, the weakest since early 2019. The Japanese situation is somewhat more complicated. M3 growth has been above 7% since August, reaching a 30-year high of 7.6% in December; but three-month annualised M3 growth has slipped to 5.1% from a high of 20.2% in August. Yet, where the Chinese monetary trends are very weak in a longer perspective, the Japanese numbers are historically still quite strong. 

The continued current weakness of the world economy, with most major economies still locked down to various extents, implies that monetary policy will remain loose and both fiscal and monetary stimuli will continue. However, as vaccination continues to spread, it is ultimately a matter of time (and, hopefully, no new vaccine-resistant mutation of the COVID-19 strain) before the pandemic is overcome and economies can begin to open up again.

At that stage, the strong broad money growth and the large excess money balances that have been built up since the late spring of 2020 argue for two consequences. First, pent-up demand points to strong output growth, hopefully already by late 2021 but certainly in 2022. Second, unless households’ and companies’ demand to hold cash is limitless (which is highly unlikely), those excess money balances have to go somewhere; and that also means that they have to inflate something. Those somewhere and something can only mean either goods and services – and therefore consumer price inflation; or assets – and therefore asset price inflation. We have, of course, already seen substantial asset price inflation in the second half of 2020. This could continue, but it is more likely that locked-up economies will instead see a surge in spending on goods and services and thus consumer price inflation. 

In fact, we are already seeing some early, admittedly faint, signs that this is happening. The European Commission’s monthly business and consumer survey shows selling-price expectation in industry edging up to their highest levels since the second quarter of 2019, in the EA as a whole, as well as in Belgium, Germany and Italy (although in France, the numbers are moving in the opposite direction). In the US, the prices component of the ISM (Institute of Supply Managers) manufacturing index reached a 9-year high in December, although the non-manufacturing index’s prices component is edging up more slowly. But consumer inflation expectations are also rising, with the University of Michigan monthly survey showing inflation expectations next year at 3% (highest reading since mid-2018) and in five years at 2.7% (joint highest since the spring of 2015).

These are not yet high numbers. But they are straws in the wind that investors should be aware of. Moreover, as with all ‘unexpected’ events, the outturn is likely to overshoot, rather than undershoot expectations. Consumer price inflation around 5% in the largest western economies in the autumn and next year, is a very likely prospect.

Gabriel Stein 

gabriel@gabrielstein.com