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Sunday, July 2, 2017

Book Review: What's Wrong With Money?

Michael Ashton is a inflation product specialist who was involved in the development of the inflation derivatives market. He published What's Wrong With Money: The Biggest Bubble of them All last year. I essentially answered the question in his title with the title of my last report -- "Abolish Money (From Economics)!" The problem with money is that it leads to dubious economic analysis. Ashton is a relatively old school Monetarist, and the book inherits the weaknesses of Monetarism. However, the financial/personal finance aspects of the book are interesting.

Book Description

What's Wrong With Money was published in 2016 by John Wiley and Sons. It is 178 pages (excluding end matter), and is divided in 14 chapters.

The level of discussion is introductory, at about the same level as articles in the business press.

Mixed Review

Books like this explain why I avoid a simple rating system ("5 stars!") on my reviews. I think the book is worth reading, but I have reservations about the contents. The discussion of the relationship between personal finances and inflation is good. The weakness is the economic behind the discussion. If one is interested in Monetarism, it gives a modern, readable spin on the topic. However, I think the book is a step backwards from Milton Friedman's popular work. His ideas had obvious problems (and would have been hard to reconcile with Quantitative Easing), but Friedman's work was closer to a coherent theory. (I reviewed one of Friedman's books in "Would Eliminating Money from Monetarism have Stopped it from Jumping the Shark?" in "Abolish Money!", which better explains my mixed views on Friedman's popular work.)

Interestingly, he makes no reference to the academic remnant of Monetarism: Market Monetarism. This is perhaps deserved; Ashton worked in financial markets, and appears to be practically minded. Whereas Market Monetarism has devolved into mysticism regarding the ability of the central bank to determine economic output by an alleged ability to plant economic expectations wherever it desires.

Inflation-Linked Bonds and Personal Finance

The book discusses the usefulness of inflation-linked bonds for personal finances. For a retiree, inflation is presumably one of the larger financial risks you face. He updated the Trinity Study, which looked at the risk of your portfolio running out based on withdrawal rates as a function of the portfolio stock/bond mix (Ashton added inflation-linked bonds to the mix).

The thing to keep in mind with such analysis is valuation; adding inflation-linked bonds if they are extremely expensive is not going to be helpful. (Current valuations are not a particular issue, but could be an issue if you blindly follow portfolio construction rules.)

The problem with inflation-linked bonds from a portfolio perspective is that they trade like a risk asset, and they will probably not have the negative correlation with equities that floating currency government bonds exhibit during a financial crisis*. Depending on how often crises will hit going forward, such a negative correlation matters.

However, as Ashton notes, the widespread belief that equities are a good inflation hedge is questionable. Equity returns were a disaster in the 1970s. (From a Canadian perspective, commodity producers may indeed be a better inflation hedge.)

If you are a long way from retirement, inflation risk is less of a worry. It is difficult for consumer prices to sustainably rise without wages also rising. Your wage income probably provides the inflation hedge you need.

Old School Monetarism

The economic analysis is standard Monetarism, although some aspects are somewhat loose. Ashton argues that Quantitative Easing will present future inflation risks. However, his explanation is somewhat lacking.
  • He writes that he (and other Monetarists, although I am unsure who else he would be referring to) did not expect an immediate inflationary impact from Quantitative Easing, as M2 matters, and not the monetary base. However, this limits the usefulness of his theory. Broader monetary aggregates (M2, etc.) increase as the result of increased borrowing. From a post-Keynesian perspective, faster nominal GDP growth is directly tied to increased borrowing; the rise in M2 (or whatever) is just a symptom of rapid growth. This means that Ashton's version of Monetarism has no predictive power, beyond repeating the well-known empirical regularity that rapid growth is associated with greater inflation.
  • He argues that the large amount of excess reserves represents the potential for future inflation. However, as he also notes, lending is constrained by bank capital as well as the lack of creditworthy borrowers. The United States will only experience rapid growth as a result of bank lending if there is an upswing in the willingness of non-financial entities to borrow. This potential inflation risk will always exist, even in the absence of excess bank reserves. The inflation in the 1970s took place in the absence of excess reserves; the reserves will always be created by the central bank.
  • He gives a mistaken view of how the central bank sets interest rates. He calls back to old school American textbooks of how the quantity of reserves is set to get interest rates on target. This description does not apply to other countries (such as Canada), where bank reserves have been abolished, and is a poor description of how the United States operated earlier. The amount of excess reserves was always negligible in economic terms; expectations are what ensured that risk-free interest rates would remain at the target.
These objections are relatively straightforward, and are not addressed (in my view) within the book. As a result, it limits its usefulness as an introduction to Monetarism. (Whether or not Monetarism can be converted into something more coherent is an open question.)

Parts of the text appear somewhat more alarmist ("hyperinflation!") than what is suggested by the main line of analysis. My feeling is that this was tacked on as publishing gimmick; as I have noted in other book reviews, hyperinflation sells books. The book notes that all the currencies that do not currently exist failed; however, that is the same thing as noting that every democracy has failed (other than the ones that currently exist...). A fiat currency is tied to a country; if the country fails, the currency will as well. Unless you have a plan to flee societal collapse, one can do very little in such events -- other than working to prevent your country from collapsing. 

I have a number of technical disagreements with statements Ashton makes. For example, in Chapter 14, he suggests that tax collections would go to zero in a crisis because commerce is being conducted with barter. As the IRS helpfully observes, barter transactions create a tax liability(If barter could legally avoid taxes; the financial sector would have designed products to eliminate income tax liability decades ago.) How that idea got through the editing process is a mystery. (There are other points of disagreement, but I do not want to drag them all out here. Some were already covered in Abolish Money!)

Concluding Remarks

This book provides yet another  example of why money needs to be abolished from economics. If money was abolished as a concept, most of the problems with the book would disappear. It may be that fiat currencies have a tendency towards excessive inflation in the long run. However, our present problems seem to stem from small-minded fiscal conservatism (partly to preserve purchasing power), at the cost of damaging the social contract -- which poses the existential risks to society that would lead to the ultimate demise of the currency.


Footnote:

* Negative returns correlation with equities is the holy grail of modern portfolio theory. You want assets with reasonable expected returns that go up in value when equities fall, giving opportunities for gains from portfolio rebalancing.

(c) Brian Romanchuk 2017

1 comment:

  1. "Whereas Market Monetarism has devolved into mysticism regarding the ability of the central bank to determine economic output by an alleged ability to plant economic expectations wherever it desires."

    Haven't all central bankers and their cabals done the same? All you see are ever increasingly desperate Wizard of Oz routines.

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