Terminal Velocity (2) – “Casino Britain”

Written by Adam Whitehead, KeySignals.com

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In Part 1[i], it was suggested that the inappropriately named Velocity of Money was falling, at a time when Central Banks were doing their most to boost monetary aggregates. The flow of liquidity into Capital Markets was suggested as the reason for this observation.

The classic example provided by the United Kingdom was described as follows:

And then there is Good Old Blighty; which may perhaps be a better model for the Fed than Japan. Britain created Five Pounds of Debt for every One Pound of GDP. Gordon Brown sold nearly all of its Gold. Exter’s Pyramid for Britain has a tiny Golden Base and many Wide Layers that are crushing it. It is therefore in dire straits compared to America. It tried QE and it nationalized the banks, so the Pyramid is still standing but it’s very unstable. Britain has therefore started tinkering with the inflation picture, so that incomes and profits (The GDP numerator) appear to grow faster than liabilities (The Layers of the Pyramid). It will also start to target the GDP numerator through Nominal GDP Targeting; which in practice means that the Bank of England will expand the Money Supply denominator because GDP is deemed to be below potential. The Velocity of Money in the UK will thus fall like a stone; and the Monetarists will call for the creation of more money, whilst remaining ignorant of the fact that it is this money creation that is reducing the Velocity of Money. The Bank of England will be happy to comply and will print even more. Britain however has neither Gold nor a reserve surplus like Japan, to make good on the cheques that Mark Carney is going to be writing. Neither is it linked to the constrained monetary orthodoxy of the ECB. If one is looking for a hyperinflation candidate in the Developed Markets, the UK is it. Britain is betting that once it moves first, that everyone else will follow. Given that Britain has an open economy and there will be more liquidity in the global economy, if all follow suit, Britain can then leverage off everyone else having first encouraged them to provide the leverage. It’s a massive wager, which will require the skilful manipulation of domestic and international public opinion to carry off. Hats off to David Cameron though; he has started his road show in Brussels and North Africa pretty well so far and observers are falling for it.

Following the recent UK Budget, a great deal of analysis has been done on the economic implications of the latest changes in policy. Thomson Reuters Alpha Now[ii], has drawn the conclusion that the Chancellor wishes to expand the Private Sector Deficit, to maintain aggregate demand, so that the Public Sector Deficit can be reduced. It’s a kind of rob Private Peter to pay Public Paul.

Looked at through the prism of Terminal Velocity, fiscal incentives and the Bank of England are supposed to get the dice rolling again. Private Peter will be fiscally incentivized to take economic risk (speculate), with funding supplied by Quantitative Easing. Speculation in UK assets will create the illusion of prosperity, that was the hallmark of Rip Off Britain during the Brown-Blair Boom.

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Rip Off Britain will now become Casino Britain. The graph above shows how the “chips” stack up. Britain needs to create the mother of all casinos, if this is going to be the only source of revenue for the Exchequer.

The UK Velocity of Money is about to fall again, at a time when the Bank of England is “QE’ing” like mad. Monetary Economists will see this as a risk of Deflation; and call on the Bank of England to do more QE, which of course it will be happy to do. The money missing from the real economy will be playing the casinos in UK Gilts, UK Property and UK Equities.

Seasoned gamblers will wager on Gilts, Real Estate and Equity; with hedged Sterling exposure.

But remember:

“If one is looking for a hyperinflation candidate in the Developed Markets, the UK is it.”

The Weimar Period of UK History, complete with weak coalition governments and high debt “reparations” is set to ensue. It is going to be a great party, but we suggest you leave early.

Pass go and collect two hundred pounds from the Bank of England, but make sure you don’t go round the board too many times and increase the risk of ending up in Jail.

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[i] https://econintersect.com/wordpress/?p=34000

[ii] http://alphanow.thomsonreuters.com/2013/03/news-in-charts-uk-chancellor-fires-up-the-doomsday-debt-machine/