Wednesday, October 23, 2019

Money and Inflation

Traditional economics taught that when governments print money, inflation always follows. There is plenty of evidence from history to confirm this theory, and many nations have been seriously damaged by government-induced inflation. It does not matter if it is disguised with fancy words like “balance sheet expansion” or “quantitative easing”.

Following the GFC, central banks engaged in the largest monetary expansion that the world has ever known, but the inflation does not see to have occurred. Several things have made this event different. Price inflation is never even. It always affects some parts of the economy more than others.

  • Shifting industrial to China and the rest of Asia has brought a massive reduction in the prices of consumer goods. This has eliminated the risk of consumer goods inflation, that is measured by the standard consumers' price index.

  • Labour unions are weak, and many workers are in precarious employment with big debts, so they have not been able to push up wages.

  • Banks used a significant chunk of the new money to get rid of bad debts on their books and to strengthen their balance sheets. They did not expand their lending, when the central banks made it easy for them. So, the money did not slop out into the rest of the economy.

  • A significant part of the massive increase in money has flowed into the share market and bond markets. Companies have been able to complete extensive share buybacks and other activities that benefit their owners with cheap debt. A significant part of the increase in share prices is the consequence of the expansion of money, just like the increase in consumer price inflation of previous monetary inflations.

  • These inflationary effects cannot be identified and quantified. During consumer goods inflation, we do not know how much is the result of monetary expansion, and how much is the result of changes in supply and demand. The same applies to the monetary influence on share and bond prices, except in this case, time will expose the difference.

The difference in this inflation is that the rich benefit from the monetary inflation, and the poor do not understand, because they are blinded by cheap consumer goods, so there is no one to complain about the monetary inflation.

Unfortunately, government-induced inflation always distorts markets in a way that eventually leads to subsequent problems. I expect that it will not be different next time.

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