Inflation, money printing and the theory of relativity
Posted on 08 September 2010
The great grey afro was onto something – everything is damned relative. Developed world versus emerging economy. Baby boomer versus generation xyz. Capital versus labour. The dividing of the economic pie is nearly always subject to rivalries between the Contrade. When the flan is an overcooked economy, these rivalries tend to intensify.
The printing press and the redistribution of wealth
Over the long term, the growth of an economy is defined by its population’s growth rate and changes in its productivity. Over a more practical timeframe, it can be influenced by temporal factors – such as the accumulation of debt. New debt invested in productive capacity or in consumption will stimulate the economy. Conversely, when aggregate debt stops growing, or worse still contracts, then economic growth can stall or even decline.
The government can try its hand at managing the economic cycle. The difficulty for the US in the current circumstances is that the resultant government deficit cannot be financed through real savings. Instead it is to be financed through the printing press.
The hope of course is that the new money will encourage the economy to resume its growth. The jury is out on how well this works in practice. It depends on how the recipient of the new dollar spends it – and whether the debt accumulation engine can be reignited. What is irrefutable though is that the printing press, like most government intervention, serves to redistribute wealth.
Is QE inflationary?
Inflation in its original economic sense referred to an expansion in the money supply. Given that the very tangible result of more money is likely to be higher prices, the latter has come to mean ‘inflation’. Whether higher prices are the result of how the government distributes new money, or simply the fact that there is more of it, is a moot point.
This does not mean that higher ‘consumer’ prices are an immediate and inevitable outcome of the current government stimulus. Far from it, we are skirting through Irving Fisher’s ‘debt deflation’, with accumulated debt still weighing against asset prices and spending. The US government’s actions are not sufficient to counteract the flight to cash and the deleveraging impulse. Still if the government persists in ‘spending for purposes that do not expand the productive capacity of the economy’ (as John Hussman puts it in his latest weekly commentary – here), prices in general will ultimately respond.
In the meantime, some ‘things’ can go up in relative value – it depends on where the new money is flowing to. Which ‘things’ go up in value determines who wins and who loses.
If for example, first home buyers are given a lump sum to assist them in buying a new home, where does the new money go? It becomes part of that buyers bid. The vendors of the new homes are the winners here. This is ‘new home’ price inflation – the new money will directly lead to higher new home prices (at least relative to where they might otherwise have been).
So when we see articles like this one (here) in the New York Times “Housing Woes Bring New Cry: Let the Market Fall” – we should understand it as the intergenerational battle lines being drawn. The average baby boomer has no debt and perhaps has already sold the family home. The younger cohort are the mortgage bearers, and they bought those mortgages at higher prices. This argument isn’t about growing the pie – it’s about who gets the bigger slice.
We now live in an era of relativity – where ‘keeping up with the Jones’ has a whole new meaning. Which things go up in value ultimately depends on how the new money is distributed. The government decides who will benefit from its monetary beneficence. In and of itself, creating a new dollar does not increase the size of the productive economy. If it ultimately leads to general price inflation, then the relative gain is between the leveraged asset owner and those that have a more hand-to-mouth existence. Regardless, the relative interests of different groups come to the fore when times are tough and the government is distributing alms.
Not sure whether this is what Keynes was thinking about when he said, “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” But it bears thinking about.
5 responses to Inflation, money printing and the theory of relativity
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Very nice work, as usual. Without doubt one of the better reads in the blogosphere.
I find it hard to see how QE won’t ultimately be inflationary, but I guess it depends on the extent to which it is done. But I find the concept that the powers that be want to get the world’s economies out of a problem of too much debt by printing money very bewildering. This should end badly. But I can’t help but think that it’s all gone so far down the tube that governments have little choice but to continue papering over the cracks until such time that the mirror cracks and the smoke lifts. Too late now for ‘organic’ solutions.
Thanks Ralph,
Agree wholeheartedly – the endpoint of the current strategies all seem to be increased tensions one way or another. With the Republicans set to takeover the Congress, it doesn’t look too good for the US middle class. In some ways, Australia might have dodged a bullet with a hung parliament. We can have 3 years of filibustering instead.
By the way I like the juxtaposition of ‘organic solutions’ with our economic predicament – given our growing love affair with all things organic (I got myself a bottle of organic water while in the UK!) Thankfully in Australia we have compulsory savings that hopefully will give us a good organic base to work off.
Cheers
Rohan
“it doesn’t look too good for the US middle class”
Yet Obama claims this is the class he is trying to help expand with the latest round of stimulus!
With the Republicans likely to storm Congress looks like Obama has blown his chance at rebalancing the scales. Pity, he seemed like such a nice guy.
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