Sunday, 9 January 2011

What causes inflation?

The Telegraph reports on the Bank of England's central projection that CPI will peak at 3.6%, while pay rises are running at 1.1%:
Prices are being pushed up by the growing cost of commodities, such as oil and food, as global demand recovers, as well as the feed-through effect of this month's VAT increase.
So don't worry about the BoE's massive money-printing binge. Inflation occurs because of one-off tax rises, and external factors like "global demand".

Liam Halligan
is one of the few mainstream commentators to see QE for what it is. In his latest article, he responds to accusations from Tim Congdon that he is a "monetary conservative of the backwoods persuasion":
A heavyweight monetary economist of international repute, Congdon served on HM Treasury's panel of independent economic forecasters during the 1990s – the so-called "wise men".
Critiquing my use of the term "money-printing", Congdon highlights that the nominal value of notes in circulation in the UK has risen only 2pc since early 2009. This is disingenuous. Everyone arguing against QE, at least everyone serious, has been careful to describe it as the expansion of "virtual" or "electronically-created" credits ex nihilo by central banks – as I did in the very next sentence of the column from which Congdon lifted the quotation above.
So the Bank of England has created the means to spend, from nothing, despite not issuing more physical notes. To say that QE isn't money-printing is a distinction that would make even Bill Clinton blush.
The Bank of England's balance sheet has tripled, from around 6pc to 18pc of GDP, in only 18 months. That's unprecedented. The last time such expansion took place it was over 40 years – from Edwardian times to the end of the Second World War.
QE is a short-term expedient with friends in high places. It has allowed Anglo-Saxon banks to re-capitalise themselves via a back-door bail-out, with many QE proceeds rebuilding bank balance sheets rather than being leant on. By propping up gilt and US Treasury prices, it has also allowed weak governments, for now, to keep spending. But at what cost?

In my view, the main cost is inflation – and the related debasement of savings. By inflating away our debts, the UK is also imposing "soft-default" on our creditors, implying higher future borrowing costs. For some time, QE-advocates had a lot of fun deriding those of us who warned UK inflation would outstrip the Bank of England's estimates. We've been proved right – yet the inflation has only just begun. The vast majority of that QE money in the shadow-banking system, on both sides of the Atlantic, has yet to enter circulation. When it does, and is leant against many times over, we'll see QE's true inflationary impact.
I'm sceptical of Halligan's acceptance that "the best arrangement is for the state to manage the quantity of money", but something along the lines of what Ben Dyson proposes sounds like an improvement on the status quo. With money printing under direct political control, abuse of this power would be much more obvious. And with fewer variables to worry about, monetary policy would no longer involve walking a tightrope, "with hyperinflation on one side and a deflationary spiral on the other".

Halligan concludes,
Modern capitalism, at its core, relies on the public's trust of fiat money and the sanctity of contract. QE is seriously undermining both those cardinal concepts. We're not supposed to call QE "money printing" because money printing is the last refuge of declining economic empires and banana republics. It also amounts to state-sponsored theft. And against that, yes Professor Congdon, I declare an "implicit prejudice".
The whole article is well worth reading.

(H/T Andy Duncan)

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