The Bogus Hyperinflation Threat

Dire warnings of Zimbabwe-style hyperinflation have been leveled against quantitative easing (QE) ever since the Federal Reserve embarked on it in 2008. When the European Central Bank announced in January 2015 that it, too, would be engaging in QE – along with the US, the UK and Japan – alarmed commentators warned of currency wars, competitive beggar-thy-neighbor devaluations and hyperinflation. But QE has been going on since the late 1990s, and it hasn’t happened yet. As Bernard Hickey observed in the New Zealand Herald on August 30th:

“The US Federal Reserve cut its Official Cash Rate to almost 0 per cent in 2008 and has left it there. It launched three rounds of so-called quantitative easing and has only just stopped printing money to buy Government bonds.

The Bank of Japan has been printing for years and only recently ramped that up to try to lift its economy out of decades of perma-recession. The European Central Bank has cut its deposit rate to minus 0.2 per cent to try to force savers to invest. That means savers have to pay the bank to mind their money...

China has blown $310 billion propping up a stock market that has fallen at least 43 per cent from its peak. It pushed the Chinese yuan lower and spent another US$200b to stop further falls.

This week the People’s Bank of China cut its main lending rate to 4.6 per cent and loosened lending rules for banks.”

Yet there is no sign of the threatened hyperinflation:

All this rate-cutting and money printing has made it attractive to buy stocks, property and bonds that produce a regular income greater than the near-zero interest rates...

But, curiously, all this money printing and 0 per cent interest rates have yet to unleash the inflation dragon, at least for goods and services. Asset prices are pumped up and juicy, but goods manufactured in factories and in cloud services are firmly in deflationary mode.

Why? According to conventional economic theory, increasing the money in circulation has only one effect: when the quantity of money goes up, more money will be chasing fewer goods, driving prices up. Why hasn’t that happened with the massive rounds of QE now gone global?

A Flawed Theory

Conventional monetarist theory was endorsed until the Great Depression, when John Maynard Keynes and other economists noticed that massive bank failures had led to a substantial reduction in the money supply. Contradicting the classical theory, the shortage of money was affecting more than just prices. It appeared to be directly linked to a massive wave of unemployment, while resources sat idle. Produce was rotting on the ground while people were starving, because there was no money to pay workers to pick it or for consumers to buy it with.

Conventional theory then gave way to Keynesian theory. In a March 2015 article in The International New York Times called “Keynes Versus the IMF,” economist Dr. Asad Zaman writes of this transition:

“Keynesian theory is based on a very simple idea that conduct of the ordinary business of an economy requires a certain amount of money. If the amount of money is less than this amount, then businesses cannot function — they cannot buy inputs, pay labourers or rent shops. This was the fundamental cause of the Great Depression. The solution was simple: increase the supply of money. Keynes suggested that we could print money and bury it in coal mines to have unemployed workers dig it up. If money was available in sufficient quantities, businesses would revive and the unemployed labourers would find work. By now, there is nearly universal consensus on this idea. Even Milton Friedman, the leader of the Monetarist School of Economics and an arch-enemy of Keynesian ideas, agreed that the reduction in money supply was the cause of the Great Depression. Instead of burying it in mines, he suggested that money could be dropped from helicopters to solve the problem of unemployment.”

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