The resource cost of a gold standard

We are currently incurring costs akin to having a gold standard – in that we are using gold for monetary purposes, as an inflation hedge. But we don’t get any of the benefits. 

In my City AM column on September 4th 2012, I discussed the resource costs of a gold standard. This was triggered by reading Lawrence White's estimate that the benefits of a commodity standard outweigh the costs once inflation hits around 4%. Due to space constraints, the calculations were not included in that article. I thought I'd provide them here. The basic analysis is (White, 1999, p.42-50).

Following Friedman and White we first need to know the ratio of gold to money. This is equal to the typical reserve ratio (like White I used 2%) multiplied by the ratio of currency notes and demand deposits to M2 (52.7%), plus the ratio of coins to M2 (0.18%).

G/M = R + Cp/M = [(R/N)+D][N+(D/M)] + Cp/M

(Where R is bank reserves, Cp is gold coins held by the public, M is M2, (R/N)+D is the ratio between gold reserves and demand liabilities, (N+D)/M is the ratio of notes and deposits (but not coins) to M2).

Assuming the marginal reserve ratio is equal to the average reserve ratio, the resource cost is equal to this ratio (1.2%) multiplied by the change in money supply that would keep the price level unchanged, multiplied by the ratio of M2 to GDP.

ΔG/Y = (ΔG/ΔM) (ΔM/M) (M/Y)

I used 4% for the former (as a rule of thumb), and 176% for the latter (from the World Bank). All in this suggests that a gold standard would cost 0.085% of GDP, which amounts to around £31bn, or £512 per capita. 

Back of the envelope calculations, to be sure. I encourage others to give it a better stab.

Towards a NGDP futures market

Kaleidic Economics has been flirting with prediction markets since our launch. I have also been intruiged by Scott Sumner's proposal for an NGDP futures market (see this proposal for the Adam Smith Institute), and the impact this would have on the discretion of central bankers. As I said in my brief review for Money Marketing:

Targeting the level removes a large amount of discretion from the Bank of England. Monetary policy stops being an arbitrary policy lever and provides a macroeconomic foundation upon which economic activity can build. 

Some time ago I set up a prediction market for NGDP using Inkling Markets. Here are the details:

The main problem with this is the difficulty of finding NGDP figures for the UK. Britmouse provides this useful guide to UK GDP but my suggestion is to start off with Table A1 of the Quarterly National Accounts (published by the Office for National Statistics). It would be handy if there was a stable link for the most recent release, but the best I can find is going to "All releases of Quarterly National Accounts". You can then click on the most recent, and eventually "select series from this dataset". Table A1 has what you need.

I think that it's easiest to think of NGDP in terms of quarterly growth rates that are compared to the previous year. This was what I had in mind when I posed the question, and here are the components (the red and blue lines should sum to the orange one):

NGDP = Real GDP + GDP Deflator

IHYO = IHYR + IHYU

The chart below shows the composition of NGDP over the last decade.

You can also do this for annual figures (YoY change)

IHYM = IHYP + IHYS

Or quarterly figures (QoQ change)

IHYN = IHYQ + IHYT

As Lars Christensen rightly pointed out it is the level of NGDP rather than a particular growth rate that "market monetarists" care about. One of the downsides of NGDP targetting is that people tend to think in terms of growth rates rather than levels. But that can change. Therefore it would probably be better to focus on the level of NGDP:

The prediction market question should probably be in relation to this figure, therefore Kaleidic Economics will endeavour to update it on a quarterly basis as part of our data. The series code is YBEU. I'm open to suggestions for what that question should be - for example an annual figure on an annual basis? Or a quarterly figure on a quarterly basis? For now I've done the following trial:

Finally, for the absolute amount of NGDP: 

  • Table C1: Quarterly National Accounts - Gross domestic product: expenditure at current market prices = YBHA

 Other Kaleidic resources:

Thoughts on UK employment data

I've just received by email the following chart from Ewen Stewart, of Investec (source). It shows long terms changes in UK employment by sector.

As he points out, some of the striking features include:

  • The decline in Manufacturing 
  • The cyclicality of Retail, Construction, and IT & Comms
  • The structural increases in Health and Social Work, and Education

It certainly ties into the view that the UK economy has been shifting from a manufacturing to a strong dependency on public services. Finance and Insurance is minor compared to state funded industries.

The April 2012 Labour Market Statistics also provide some interesting insights. Table EMP13 shows employment by industry sector, and I wanted to see what's been going on during the "recovery". Unfortunately they only provide 3 years worth of data, so it doesn't help us compare the boom and the bust. This would be useful though, because Paul Krugman has argued that US employment fell in a balanced way across all sectors (I can't find the presentation online but it was very simlar to this(.pdf)). This would suggest that the recession is due to an aggregate demand shock.

For the UK, however, there are clear structural differences. Some industries are contracting, others are gorwing (and indeed quite strongly).

To see this in more detail I focused on the five biggest sectors (those that employ more than 2m people each) and what does it show? Massive falls in Construction, but clear differences between the different sectors. 

 I also wondered about Public vs. Private sector employment. Table EMP04 provides a breakdown, and I've just taken the absolute numbers (note that private sector employment is on the RHS, it is around 80% of total employment whilst public sector is around 20%).

It is likely that these numbers underestimate the scale of the public sector, because if a local council outsources cleaning to a private contractor, for example, this will be treated the same as people switching from public to private provision of goods. We see a large increase in public sector employment from 1999 - 2005, and this isn't simply because it's growing from a lower base. During this period public sector rises from 20.2% of total employment to 21.3%. But the ratio then inverts with (relatively) high private sector growth just prior to the financial crisis.

The fiscal stimulus of 2008 led to a spike in private sector jobs, but most of those have now been reduced. This is exactly what a "stimulus" is supposed to do in theory - provide a temporary boost. But it seems odd that people complain about falling public sector employment, now that we're 4 years after the stimulus. It's impossible to continue that temporary growth permanently. In reality what we see is the failure of that policy. At the very least, the unwinding should be treated as part of the costs.

Austerity and the passage of time

Following the fourth meeting of Kaleidic Economics, we have released a report on the UK's austerity plans. Three main arguments are made:

  1. Temporary changes in the tax code are inconsistent with both sides of the debate
  2. We cannot ignore the historic state of the UK economy when discussing fiscal policy
  3. Alternative forecasts for GDP can make a dramatic difference to austerity measures

This chart shows government spending as a proportion of GDP, using a GDP forecast lower than the official OBR figures. It reveals that government plans to reduce spending are based as much on over optimistic growth forecasts as they are on actual spending cuts.

You can read it in full here (.pdf).

Quarterly Report No. 3 released

Following the March meeting of Kaleidic Economics we have released the 3rd Quarterly Report. The topic is the economic development of China and how it fits into business cycle theory. We identified and discussed the following key questions:

  • What is the right historical parallel?
  • Are GDP figures accurate?
  • How much growth is due to a housing boom?
  • Does economic growth translate into raised living standards?
  • Where are the brands?
  • Will China democratise?
  • Can policy errors be exported?

You can download the report here.

A comparison of monetary aggregates

The image above shows a range of measures of the UK money supply. Because of the scale it is hard to make out changes in any given measure, but the purpose is to see how they relate to each other in terms of scale.

It demonstrates how MA (in blue) is a narrow measure that incorporates more deposits than M1. I was surprised that M4ex is smaller than M2. We have also been playing around with a very broad measure, which is shown as MB. More news on that soon.

Update: the previous version used an area chart and showed the cumulative money stocks. We've now changed it to just show the money stock per measure (2/3/12)

Important updates to MA compilation

In January 2012 we made some important updates to our measure of the money supply (MA). These were primarily an attempt to simplify the compilation and ensure that the series we were using were compatible across various reporting institutions. Whilst the previous measure used various asset classes from the Bank of England's Divisia tables as the starting point, the new measure is simply defined as:

MA = Currency + Demand deposits

MA is really a measure of the money stock, as opposed to the money supply, and the chart below shows the total amount for as far back as the Bank of England data goes (Janaury 2010).

The chart below shows the difference between the growth rates in the 2011 measure of MA and the 2012 measure. This is obviously a major difference since the new compilation method is now pointing to a steadily increasing rate of monetary expansion, as opposed to a continued monetary contraction. We will continue to look into these issues and provide updates.

Kaleidic Economics publishes new indicator on private investment

In last week's City AM I published an article comparing private and government investment:

When private sector investment declines, then the reasons need to be identified and a solution found. The key policy question needs to be “why aren’t businesses investing?” Attempting to offset it with government spending is just an accounting deception. And too much government intervention can be the underlying cause, not the cure – through high tax rates, burdensome regulations and policy uncertainty.

The data I used came from the "Gross Fixed Capital Formation" of the National Accounts (Table F). There are four components:

  • business investment (NPEL)
  • general government (DLWF)
  • public corporations (KLQ9)
  • private sector dwellings (KLQ5)

In compiling the chart I added business investment and private sector dwellings to create "private investment", and used general government as "government investment". I excluded public corporations. The chart below shows the results, and this will be updated in the data section of our website.

October 2011 MA falls abruptly

In October 2011 our MA measure fell by 6.6% compared to the year before as the turmoil in the financial markets from the Euro crisis accelerated. This decrease is more accentuated than the 3.8% fall we calculated for September 2011. 

The Notes and Coins figure released by the Bank of England for October 2011 increased by 6.2% compared to the year before while M4 for the same period decreased by 2.9%. 

September 2011 MA continues decline

Our September 2011 MA figure accelerated its decline when compared to the readjusted* value for August 2011. In September, MA fell by 3.7% compared to 3.5% the month before. This was somewhat expected given the turmoil in financial markets at the time. 

Notes and Coins fell by 5.3% while M4 accelerated its decline from -0.8% in August to -1.6% in September.

*Note: As of November 2011, the Bank of England has readjusted some of the components we included in previous MA computations which naturally resulted in slight changes for some of our calculations.

Coverage in the House of Commons

Steve Baker MP in a speech to Parliament:

My argument, which is one Hayek advanced in his Nobel lecture, is that when employment comes from an increase in the money supply, that employment lasts only as long as the money supply increases, or perhaps only as long as it continues to accelerate. My preferred measure of the money supply comes from Kaleidic Economics. If we look at it, we find that from 2002 the money supply not only increased, but accelerated in its increase—the level was above 10% from 2004 and in 2007 it went as high as 27% by that measure. The money supply is now contracting at a rate of about 5% a year.

August 2011 MA falls by 4.3% YoY

August saw another YoY fall in MA, our money supply measure, though again at a decelerating rate compared to the previous two months. The figure was at -4.3% which is less than the -4.7% and -5.1% we saw in July and June respectively. This is an interesting result given that August was the month when the turmoil in the financial markets picked up. 

M4, the broad money supply published by the Bank of England also fell but only by 0.6% while N&C grew by 5.6% YoY.