For inflation, where the money supply goes, matters a lot too

Sir, I refer to Martin Wolf’s “The monetarist dog is having its day”, FT February 23.

Yes, the money supply impacts inflation, no doubts but, when it comes to how much, that also depends on where that money supply goes.

If central banks inject liquidity through a system where, because of risk weighted capital requirements, banks can leverage more, meaning easier obtain higher risk adjusted returns on equity with Treasuries and residential mortgages, than with loans to small businesses and entrepreneurs, does that not favor demand over supply?

It does, and you should not have to be a Milton Friedman to understand that sooner or later that can only help inflate any inflation.

Wolf holds that “Central banks must be humble and prudent” Yes, and that goes for bank regulators too.

“Humble” in accepting there are huge limits to their knowing what the real risks in an uncertain world are; and “prudent” as in knowing bank capital requirements are mainly needed as a buffer against the certainty of misperceived credit risks and unexpected events, and not like now, mostly based on the certainty of perceived credit risks.

@PerKurowski

FT, perhaps you should incorporate “and with humility” in your motto, just as a reminder

Sir, in “After Rev Flowers”, November 20, you write that “UK bank’s woes have lessons for politicians and regulators”. You forgot to include financial journalists in that list. 

For instance, you write that Mr Flowers “overestimated a key capital ratio by a factor of two”. Do you really want me to list all of your journalists who at the outset of this crisis wrote of bank capital ratios seeming to be in line with historical ratios, ignoring that the current were based on risk-weighted assets and not as previously on total assets? Doing so your own journalists (and politicians and regulators), often underestimated European bank capital ratios by a factor of five. 

Be sincere… when did you yourself discover that in fact European banks had real asset to capital leverages of way over 30 to 1 sometimes even over 50 to 1? 

John Gapper was one of the very first to understand what was happening with his “How banks learnt to play the system”; but it took a long time for many others to do so, and some might not even have done so yet. 

But Sir, do not be ashamed, you are not alone. Other actors like the IMF reported on Iceland in December 2008 the following “The banking system’s reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient.” And that clearly shows IMF had no real idea either about what risks risk-weighing could be hiding or causing. 

But, Sir, perhaps you should incorporate “and with humility” in your motto, just as a reminder.