Breaking out of the lecture theatre, the idea of whipping the money supply made sense to politicians and voters alike. It had first been put forward by the “Bullion School” of British economists at the start of the 19th century. Milton Friedman confirmed it with his “monetarist” theories of the 1950s. The German Bundesbank and Swiss National Bank then applied it — successfully — to keep inflation at bay right through the late ‘70s. U.S. and U.K. households, meantime, suffered double-digit growth in the cost of living each year.

Now in spring 2008, Zimbabwe offers the latest example of monetary inflation in action. There the cost of living is rising by 165,000 percent per year as the central bank prints 10 million-dollar notes. But here in the developed West’s inflation-free dream world, the idea of targeting money itself — its supply and quantity — has lost out entirely to the idea of controlling its outcome, the cost of living, instead.

“Most people think economics is the study of money, but there is a paradox in the role of money in economic policy,” as Mervyn King, now governor at the Bank of England, noted in a lecture first given at the University of Birmingham, England, in Oct. 2001.

King repeated his findings the following spring at the Banque de France in Paris. But not even he was listening.

“As central banks became more and more focused on achieving price stability [in the ‘80s and ‘90s], less and less attention was paid to movements in money,” he explained. “Indeed, the decline of interest in money appeared to go hand in hand with success in maintaining low and stable inflation.”

This Zen Buddhist approach to monetary policy — ignoring money and thereby controlling it — was also noted by Prof. Glyn Davies in his A History of Money (University of Wales, 2002). During “the overt acceptance of monetarist policies, inflation [was] far worse than when Keynesian policies prevailed.” Overlooking the money supply seems the answer to delivering low, stable inflation.

Well, stable in a way that nobody noticed. The U.S. Dollar, along with the Pound Sterling, still lost half its value for consumers and savers between 1981 and today. But annual rates of inflation held below three percent, with occasional dips towards one percent growing evermore frequent at the start of this decade.

And all this while, with no one daring to mention it beyond a few cranks at the European Central Bank in Frankfurt, the supply of money worldwide has surged once again.

Over the last 12 months, the money supply in Australia has expanded by 16 percent, in Canada by 13 percent and in the United Kingdom by 12 percent. China’s supply of money grew 18 percent, Singapore’s 14 percent, and in both India and Saudi Arabia it grew 22 percent.

The Eurozone, stuck with those old Bundesbank cranks, got a mere 11 percent surge in money supplies. The United States, which stopped reporting such outdated things in March of 2006, is estimated to have got a 15 percent expansion.

Might it matter? On Mervyn King’s analysis, yes. The correlation between annual money-supply growth and rates of inflation, he found, reaches 0.99 if you track the three-decade period ending in 1999. It would stand at 1.00 if they moved absolutely in lock-step.

But that research was done before King got top-dog position at the Bank of England. Since then, he’s overseen (and overlooked?) double-digit growth in the U.K.’s money supply, running now for a full 37 months.

“Habits of speech not only reflect habits of thinking, they influence them too,” King went on in that long-forgotten speech about money. “So the way in which central banks talk about money is important.

“My own belief is that the absence of money in the standard models which economists use will cause problems in future… It would be unfortunate if the change in the way we talk led to the erroneous belief that we could turn Milton Friedman on his head, and think that ‘Inflation is always and everywhere a real phenomenon.’

“Money, I conjecture, will regain an important place in the conversation of economists,” the current Bank of England chief concluded six years ago.

That day still remains a long way off yet. Meaning there’s plenty more room for mayhem in money ahead.

By Adrian Ash For Whiskey & Gunpowder April 24, 2008

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