Does QE have to mean inflation?
There’s been much comment about the very unusual practice of so-called ‘quantitative easing’ and the expectation that we are in a period that simply has no precedent.
Neither view is entirely accurate, but to assess the relevance of quantitative easing or QE as it’s often called, and to determine the probable route forward from here, we must begin with an assessment of the sort of situation that we presently face.
Our conclusion is that what we are in the midst of is a period of unwinding and addressing overblown debt built up in an extended and extravagant boom period, and there have been many periods of de-leveraging throughout history. The consequence is that it is not difficult to look back on prior episodes to see how they work and what steps can be taken to address the challenges.
History shows that in periods of de-leveraging, there is always a mix of austerity, restructuring, wealth transfer and “printing” money. Importantly, the printing of money is virtually always the main tool for dealing with generalized de-leveraging – so ‘quantitative easing’ is actually the plat du jour rather than an oddity.
As for why this should be, the need to print money reflects the reality that periods of austerity cause extreme pain, and big restructurings wipe out large amounts of wealth and very fast. In such periods, conventional transfers of wealth from the haves to the have-nots do not happen in an adequate time frame or in reasonable size without revolutions. The peaceful solution is to print money,
It is argued that printing money is inflationary and on that basis should be avoided, but again this is not entirely true.
Printing money is not inflationary if the size and character of money creation offsets the size and character of credit contraction. In virtually all past de-leveraging periods, policy makers have had to discover this for themselves. We can see that they first tried other perceived solutions, but eventually chose to print a lot of money in order to prevent or reverse what would otherwise be a deflationary credit market collapse. The focus must be on getting the nominal growth rate marginally above the nominal interest rate. That is the path to spreading out the adjustments so that the degree and pace of austerity, restructuring and wealth transfer restructuring are tolerable.
We can also observe that in periods of money printing associated with de-leveraging, there is typically currency weakness, especially against gold, but not unacceptably high inflation because the reflation effort is simply negating what would otherwise be outright deflation.
That said, if taken too far, the printing of money and decline in currency values will cause changes in capital and investment flows that then lead on to inflationary contractions, such as was seen in Germany with the Weimar Republic in the early 1920s and the Latin American debt crisis in the 1980s.
We cannot therefore be wholly relaxed about the printing of money but it is evident that it takes a lot of “money printing” to shift a deflationary de-leveraging into an inflationary de-leveraging. We shall need to watch for any signs that the climate is shifting but for now, we continue to face deflationary tendencies and we should expect and hope for much more money printing before this de-leveraging period is over.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla