Possibly the most important economic question to emanate out of the global financial crisis is the choice between two evils.
For the United States and to a lesser degree, continental Europe policy makers, a decision may need to be made between deflation or hyper-inflation. At the moment, the vast majority of experts, from ‘Helicopter’ Ben Bernanke to Nobel prize-winning Joseph Stiglitz to the usually excellent Niall Ferguson are suggesting another round of quantitative easing in the United States to prevent deflation from occurring.
Most of the same economists claim that the Great Depression was exacerbated by the decision of the US Fed to exacerbate the reduction in money supply in the early 1930s. The only problem with this path is that it may lead to the worse situation of hyper-inflation.
As Karen Maley reported last week, voting member of the Federal Reserve, James Bullard, last week warned that “the U.S. is closer to a Japanese-style outcome today than at any time in recent history…a better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.”
Bullard’s comments raise two questions: first, is a Japanese-style outcome a good or bad result from the current predicament, and second, what is worse for living standards — deflation caused by collapsing asset values or hyperinflation caused by irresponsible governments?
In relation to the Japanese question, while Japanese asset prices have been in a near 30 year malaise, the actual living standards of the Japanese have remained relatively stable. The Nikkei is trading at the same level as back in 1983 –- that means that in 27 years, an investment in the overall Japanese share market has made no money at all (by comparison, the Dow Jones has risen by almost 900 percent during that time). Remarkably, the Japanese share market remains at less than a quarter of its 1989 peak.
Similarly, Japanese property encountered a monumental boom and bust –- as Steve Keen notes, “Japan’s real house price index rose by 54 per cent between 1986 and 1991 during its Bubble Economy phase, peaked at 154.75 in February 1991 in the early days of the Bubble’s bursting. By March 2009 had fallen to 63.961 – a fall of 58 per cent over 18 years.”
So while Japanese asset values have fallen, so too have prices –- that means the actual living standards in Japan haven’t slumped like they did in the United States during the Great Depression (which also suffered falling prices, but coincided with a general liquidation and higher unemployment). In some cases, deflation actually benefited parts of Japanese society. Whereas purchasing a property in Japan was out of the reach of many in 1989, after the property correction, buying a dwelling has become far more affordable. Japanese life expectancy (for women) is also the highest globally.
In 1989, Japan’s economy faced a similar predicament to what the US is encountering (and what Europe most likely will face) –- too much debt supporting asset prices which have become far removed from their intrinsic values. When the asset bubbles popped, the Japanese didn’t allow the market to properly clear and the creative destruction process to fully complete. Instead, it undertook decades of fiscal stimulus and easy monetary policy. This has led Japan, once a nation of savers, to amass a debt which is equivalent to 200 percent of GDP.
While the Japanese have witnessed assets and price deflation, it never undertook widespread quantitative easing (other than an unsuccessful attempt during the early 2000s) as suggested by Bullard and friends. As a result, while Japan has seen two ‘lost decades’, the living standards of Japanese people have remained relatively stable.
It is therefore somewhat strange that many financial journalists warn of the evils of deflation, when the alternative, rampant quantitative easing, may lead to the far less satisfactory scenario: hyper-inflation. (Deflation is feared because it leads people to delay purchases in anticipation of falling prices – this has the unfortunate side effect of stunting economic growth given the importance of consumer spending on the economy, and higher unemployment.)
Even Niall Ferguson, usually one of the most percipient finance writers, supported quantitative easing recently when he noted:
“What we in the Western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not ‘save’ us half so much as monetary policy — zero interest rates plus quantitative easing — did. First, the impact of government spending (the hallowed ‘multiplier’) has been much less than the proponents of stimulus hoped. Second, there is a good deal of ‘leakage’ from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect.”
While Ferguson was most likely correct in his criticism of a Keynesian free lunch (there is certainly no such thing) – his support for QE should not go unnoticed.
The problem with quantitative easing, or ‘printing money’, is that in essence it remains the purest form of theft from the general population (inflation allows Governments to pay for their fiscal spending by simply printing money, rather than raising money from taxation or issuing bonds). While an initial period of quantitative easing (like what the US undertook in 2009) may have a negligible real effect on price levels (due to deflationary expectations of the population), eventually, if not controlled, it may lead to hyperinflation as people adjust their expectations from falling to increasing prices.
As German citizens found out in 1923 (or the people of Zimbabwe are still tragically discovering), the onset of hyper-inflation destroys the middle class and the livelihoods of those on fixed income (like pensioners). For example, German hyper-inflation caused such depreciation that one required 4.2 trillion German marks to purchase one dollar. Hyper-inflation, like deflation, is not necessarily bad for every person but is a negative for the economy as a whole.
So while quantitative easing may seem like the lesser of available evils, in reality, it may be the most evil path of all.
There is of course the sensible, yet politically difficult option of living for the United States and Europe — the outlandish notion of living within one’s means. Of not spending more on government programs (such as military or social security or fiscal ‘stimulus’) than the economy will be able to generate in taxation revenue. But no one ever seems to seriously suggest that.
This analysis is completely economically illiterate.
To cause hyperinflation, you need foreign debt denominated in a foreign currency which is not negotiable combined with a collapse in your real production base. Weimar Germany lost most of their industrial heartland in the Ruhr to France and had to pay war reparations denominated in pounds, francs and US dollars. They had no source of foreign exchange with which to pay the debt and so had no choice but to print money ever-faster to keep ahead of the rising exchange rate. Mugabe similarly had massive foreign debts and destroyed Zimbabwe’s production base with his nationalisation campaign.
By contrast, the US has debts denominated in US dollars and has a vast and currently underutilised production base. Quantitative easing would not possibly result in hyperinflation (or even regular inflation) until current capacity was exceeded. At 10%+ real unemployment, that is a long long long way away.
As well as the grand narrative, all Adam’s details are way off as well:
A bubble and bust in one (or even several) sectors is not necessarily deflationary unless it causes general economic contraction.
I would be extremely impressed if Adam can show some causal relationship between the life expectancy of women and the cost of property on the Tokyo market.
Deflation is not feared because “it leads people to delay purchases in anticipation of falling prices ” – a far more significant fear is that deflation causes the real cost of existing debts to skyrocket as the price of credit becomes the interest charge + the deflation rate; this means no one will borrow and the credit system freezes, then the banks melt down.
“This has led Japan, once a nation of savers, to amass a debt which is equivalent to 200 percent of GDP.” Japan is still a nation of savers – they’re investing their savings in government bonds, dumbass. Private aggregate saving – private aggregate spending = government aggregate debt.
Exactly how is raising money without taxes more “theft” than raising money with taxes?
“Of not spending more on government programs (such as military or social security or fiscal ‘stimulus’) than the economy will be able to generate in taxation revenue.” Governments are not households. Governments make the money; if you look at a bill in your wallet, it says so right there. They are not constrained by taxation. Governments have a responsibility to maintain aggregate demand. Even if they were constrained by taxation, with corporate and individual taxes at record lows across the anglosphere, the suggestion that we are exceeding capacity is ridiculous.
Don’t write anther column until you restudy macroeconomics.
Adam,
Here’s a quick guide to Modern Monetary Theory
http://mq.academia.edu/FrankAshe/attachment/940787/full/A-Kindergarten-Guide-to-Modern-Monetary-Theory–Days-1-3-
Let’s try to keep the debate at a level where we don’t call things like unfunded government deficits are “the purest form of theft” , especially as you then say “eventually, if not controlled, it may lead to hyperinflation “. We are so far from that situation that to make such a statement is pure scare-mongering. Why would we assume that governments would not control that tendency? In Australia they always have. Further, in the modern system there is no way in which the government taxation finances the government spending. When governments tax they decrease the amount of dollars in the banks’ reserve accounts; when governments spend they increase the amount of dollars in the reserve accounts. There is no vault in Treasury where the money sits bewteen being collected and then spent.
We need to change the debate world-wide so that we argue about the effect on the economy of government taxation and spending, not on the meaningless question of “financing” the spending.
Frank Ashe
For another view see:
http://www.moslereconomics.com
Counter Insurgency, Deficit Terrorist Unit
James H FTW
1. Remember that from a technical point of view, currency is a form of government debt – one that pays no interest.
2. Printing more money dilutes the value of the money already in existence – in that sense, I can see why one could call it theft, though I’d personally describe it as a tax on cash.
3. While printing enough money will lead to hyperinflation (something much worse than a mild dose of deflation) surely the actual outcome depends on the quantity of money printed? Are there any case studies of a mild dose of quantitative easing?
4. Remember that the Japanese working population is declining as the population ages. (Overall decline is close but not quite here yet, I believe.) So total Japanese GDP or even GDP per person isn’t a perfect guide to wealth per person.
Funny how the previous comments make Adam’s point. So many economists can only see the world through their own favoured theories and viewpoints so when an alternative view is talked about it is completely wrong – yet economic theories aren’t an exact science – and lots of times the experts get it wrong.
A lot of the functioning economic aparatus relies on confidence – and we can see the problems with waxing and waning confidence at the moment.
There is no real structural problem with most of the economies that come under attack – like Spain and Italy and Portugal – yet it was intangible confidence that left Spain and the others vulnerable to attack. Of course Greece is different because confidence is justifably removed from it’s economy as its been lying and hiding its problems for decades.
I don’t think the experience of Japan can be so easily dismissed. Nor is confidence in the US so solidly based. It has let its manufacturing base deteriorate over the past 30 years and with so much private and personal debt racked up – it wouldn’t take much withdrawal of confidence to change things.
Look at how quickly the GFC happened – went from all good to completely bad – and only confidence had changed – there was no change to the productive capacity or underlying demand from the world population as a whole.
Also Japan is an interesting country. With living standards staying constantly high and no stress from a placid domestic economy who is to say that health benefits are no derived by the population from such peaceful life. It looked good when I was last there 10 months ago.