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Wildebeest is a PhD MBA who invests primarily in resource stocks such as base metals, iron ore and coal.
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  • Does a growth in M2 cause or imply an increase in inflation?
    We've recently seen a growth in M2 in the USA. Should we expect a growth in M2 to lead to an increase in inflation?

    M2 and CPI data can be obtained from St Louis Fed:

    Here is a plot of growth in M2 and seasonally adjusted CPI

    Taking data back to the start of the M2 series in 1980 the equation of line of best fit is 3.14488 - 0.00672425 x and the data has an R squared of 0.000152817.

    For the USA there is no link whatsoever between M2 growth and CPI over the entire period of M2 data being published.

    Interestingly, visually the FRED chart looks to be showing an inverse correlation between the CPI and M2 growth from about 1996/97 through to 2010. Rises in M2 growth seem to coincide with falls in the CPI. That (negative correlation) is indeed the case, though weak, as the plot of data from that period shows:

    What of the possibility that inflation lags M2 growth? In other words isn't it reasonable to expect that as M2 growth increases the "surge" in inflation would be observed at some point later on rather than being coincident to the M2 growth?

    In the next plot I take a lag from zero to 120 months and measure the correlation (blue line slope, purple line r squared). We can see that a weak positive correlation begins to exist from a period of 45 months through to 90 months. Could we attribute causation to a correlation with such a long lag? Beats me, but I would have thought it was doubtful.

    I've also made plots of 12, 18, 24, 36, 48, 60, and 90 month rolling correlations. Here are a couple of samples:

    It seems to me that no case can be made that growth in M2 is likely to lead to an increase the CPI. On the contrary the data suggests if anything the reverse is more likely to be observed. Myth busted.


    Post script: it was put to me that it is not surprising that I am not seeing a relationship between M2 growth and the CPI because I am using headline CPI. So without further ado here are the charts using CPI ex food & energy.

    M2 growth and inflation? Nothing to see here. Move along.

    Tags: M2, inflation
    Oct 14 6:47 PM | Link | 7 Comments
  • What Sovereign Wealth? Part 2
    Imagine you are walking down the street and you see a guy drive past in a really nice car. You think to yourself "gee I should have one of those." Guess what? He earns more than you do.

    There almost seems to be a kind of sovereign envy. People look at sovereign wealth funds (SWF) and figure "we should have one of those." The basis for this, apart from the outright envy, seems to be that Australia is experiencing a mining boom and generating windfall cash flows. But as I have written previously, a sovereign wealth fund has to be funded from sovereign wealth. Unlike countries with SWFs such as Norway, Australia is a sovereign debtor, it runs persistent current account deficits, as we can see in the chart below.

    The chart also shows that a resources boom is not a prerequisite to running a current account surplus. Also one could consider that for a country with persistent surpluses, creating a SWF by "quarantining" money in an investment fund might actually be required as a way of controlling inflows of money and possible inflation resulting from those inflows.

    The chart shows that Norway has had surpluses for an extended period of time, reflecting the life of its North Sea oilfields. For Australia the mining boom is shorter and more transitory but Chile, another country benefiting from mining, is also mentioned as a SWF model for Australia. But Chile has also run current account surpluses as we can see below:

    Chile is the worlds largest copper producer. We can see from the chart that as the mining boom took off, and copper prices rose, Chile went into surplus. For the year ending 2008 it went into deficit as copper prices fell when the global markets collapsed but returned to surplus when copper prices recovered. The charts shows an extrapolation through to the end of 2012 in which the IMF appears to be forecasting a return to deficit, perhaps due to an expectation of a correction in commodity markets.

    The performance of Chile during the mining boom is in stark contrast to that of Australia over the same period. Why should there be such a difference? Well we could ask ourselves whether Chilean banks borrowed large amounts of money offshore to fund a housing bubble. Australian banks did, and interest payments to service those loans represent outflows that contribute to Australia's ongoing CAD at a time when Chile was able to generate sovereign wealth during a commodities boom.

    To have a sovereign wealth fund you need to be generating sovereign wealth. Discussions about the creation of a SWF in Australia should begin by focusing on how first to generate current account surpluses.

    Related articles:

    An Australian Sovereign Wealth Fund. What Sovereign Wealth?

    What sovereign wealth?

    What sovereign wealth? Continued...

    Current account deficits and house prices

    Aug 05 10:46 PM | Link | 2 Comments
  • An Australian Sovereign Wealth Fund. What Sovereign Wealth?
    Should Australia have a sovereign wealth fund (SWF)? Whenever I hear this discussed my first thought is what do you mean by sovereign wealth? The Australian government can set aside a pool of funds at any time and call it whatever it wants. For example the “Future Fund” is listed in wikipedia as being an Australian sovereign wealth fund. The discussion in recent times seems to be linked to the once in a generation mining boom. Mining by definition extracts a non-renewable resource, so at a time when windfall profits are being made in mining, due to the demand from China, people understandably feel that some portion of that money should be set aside for the future. But does Australia actually have “sovereign wealth” from which a SWF can be funded?


    There is a national accounting identity:

    CA = (T – G) + (S – I)

    This says that taxes, T, minus government spending, G, plus private savings, S, minus private investment, I, must equal the current account CA. If (T - G) is positive then the government is running a surplus, if it is negative a deficit. (S - I) can be thought of as the net private sector savings. If it is positive then wealth is being accumulated. This accounting identity is what it is independent of ideology or political beliefs: the identity is the same whether you are progressive or conservative, or regardless what brand of economic belief system you subscribe to.


    If the government sets up a SWF it could be funded from existing money:


    CA = SWF + (T – SWF – G) + (S – I)


    or it could be funded by raising taxes


    CA = SWF + (T – G) + (S – SWF – I)


    Australia has been running current account deficits for ever and a day:

    current account balance

    So the left hand side of the equation is negative, has been negative for a long time, and is likely to be negative for a long time. By definition the right hand side must equal the left hand side so must be negative. Now imagine that the government was to “quarantine” money in an investment fund which, we'll call a SWF. Prior to the formation of a SWF we know that (T – G) + (S – I) is a negative number. In order to create the SWF the net government and private sector balances have decreased by an amount equal to SWF:


    (T – G) + (S – I) – SWF


    If follows that while Australia runs a current account deficit, if money were to be placed in an investment fund by the government the rest of the government and private sector would be further indebted by an amount equal to the SWF. In such circumstances a sovereign wealth fund would be an inappropriate name since the fund would in fact be funded by driving the rest of the economy further into debt.


    Contrast this with Norway which runs current account surpluses from which it follows that (T – G) + (S – I) is a positive number. As long as their SWF does not exceed the current account surplus, then money can be set aside while still leaving the net government and private sectors in surplus. Norway is accumulating sovereign wealth and is able to set aside this wealth in a SWF without making its economy indebted. Australia on the other hand, by running current account deficits is not accumulating sovereign wealth. While one sector of the economy, mining, may be doing very well, as a nation you have to ask “what sovereign wealth?” If an investment fund was created it would be from money which drives the remainder of the economy further into debt. Perhaps “sovereign debt fund”, SDF, would be a better description of such a fund. Creation of a SDF would have a negative effect on GDP growth.


    This analysis of the national accounts also ties in to discussions about balanced budgets. We can see that if T – G = 0, i.e. the government balances its budget, then the private sector must carry the debt burden arising from the current account deficits. This presumably hasn't occurred to politicians from either persuasion who thump the table about the need for the budget to be balanced, or even worse for the budget to go into surplus. A balanced budget in these circumstances of endless current account deficits is likely to hamper GDP growth.


    However should it be decided, for whatever reason, political or ideological, that Australia needs to run a sovereign investment fund, or needs to balance its budget, then the national discussion would be better off focussing on the structural reasons for continued current account deficits, since mandating a balanced government budget merely shifts the debt burden to the private sector rather than addressing the source or cause of the debt.

    On the other hand the purpose of this article is not to make a case for or against current account deficits, but to note that if they exist it follows that an equivalent deficit must exist among the private and government sectors.

    In summary while Australia is experiencing a mining boom it doesn't have sovereign wealth in the same sense as other countries that run successful sovereign wealth funds. So to the question of whether or not Australia should have a sovereign wealth fund I say “what sovereign wealth?”

    Aug 01 12:11 AM | Link | 2 Comments
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