Unprecedented Money Creation - What Is The Impact?

 I am a great fan of behavioral, as opposed to “classical” economics. Richard Thaler’s Misbehaving (2015) is one of the few economic theory books that I truly enjoy reading. The author went on to win the Nobel Prize in 2017, so he’s no slouch. 

In a nutshell, the main premise of behavioral economics is that people make decisions based mostly on fast, emotional reactions (gut feelings) instead of rational analysis. Importantly, this premise has been tested and proven on the field in hundreds of experiments - unlike “classical” economics which is mostly based on theoretical econometric models.

Thus, we are in fact not homo economicus.  Despite this, almost every economic theory in the world is based on a strict human “rationality” that just isn’t there.

So... will the current unprecedented monetary flood taking place in the US, EU and UK affect economic behavior? And if so, how?  It’s important because these economies combined account for about 40% of global GDP. Furthermore, how will this behavior affect China, which accounts for another 20%?

First, let’s look at the size of new money creation. I’m using the US as a proxy because of its global economic power and because the dollar is (still) the undisputed reserve currency of choice.

Within just one year the US has exploded money creation (M3) from a bit under $1 trillion per year to $4 trillion (chart below). The Treasury/Fed has “printed” more dollars in one year than the previous six years combined. This shock to the system is surely altering people’s behavior - but, how?

US Dollar Money Creation Explodes Upwards

For one, direct payments to all Americans (helicopter money) is causing a labor shortage, mostly at the low end of the income scale.  Even though this heli money was definitely a one off, people are behaving as if it will go on forever.  Those who “rationally” need jobs and income the most are being offered jobs, but choose to remain unemployed. 

Another effect is the immense popularity of extreme speculation.  Millions who got heli checks are not using the money for insurance against uncertain times but for wild bets on meme stocks and dodgy cryptos, despite acknowledging that their actions are highly irrational.  

The Fed/ECB/BOE themselves acknowledge that such enormous money creation leads to higher inflation (and CPI/PCI are already spiking up), but choose to continue pumping more money into a flooded system.  How rational is that? (Unless, of course, their ultimate  goal is to create high inflation..).

Put those three observations together... those of us who know market history understand that markets can exhibit irrationality, particularly at their manic, delusional stages.  Even Adam Smith understood “animal spirits”. But, right now, this irrational misbehavior is extending to the entire economy. From workers choosing to remain unemployed to central bankers refusing to perform their monetary policy duty,  this irrational behavior is gripping the entire economy.  

This situation looks to me like a train going downhill at breakneck speed towards a dangerous bend in the tracks.  Its passengers are flushed with the thrill while the engineers are stoking on, never mind the brakes..

We have gone way beyond Mr. Greenspan’s partial irrational exuberance, we are now in total Misbehavior Economics territory..