Thursday, June 25, 2009

Quantitative Easing - Monetizing UK Government Debt

It is a long time since I have taken a look at quantitative easing (QE -printing money). Long term readers of the blog will know that I have have offered objections to the policy from the outset, and I have seen it as a barely hidden method of 'monetizing' government debt (printing money to pay the government bills). I have also warned of the potential risk for hyper-inflation that is inherent in the policy.

I have written this many times, but it is worth repeating what inflation actually is. If you have an output of 100 units, and 100 units of currency and increase the units of currency to 110 units, the only outcome is that there are more units of currency chasing the 100 units of output. That is inflation. In the case of the UK at present, there is a fall in output at the same time as an increase in currency issuance, thereby making the currency issuance more potent. This is a simplistic explanation, and there are complications that I discuss here. However, those complications do not directly impact on what is being discussed in this post, which is related to the mechanism of QE.

Before moving forwards, is QE the same as printing money? One of the most amusing things I have seen regarding the policy of QE is the attempt by Charles Bean, Deputy Governor for monetary policy of the Bank of England, to try to suggest that QE is not the same as printing money:
Quantitative easing has been described in some quarters as “printing money”, though it is not literally that. It is more akin to us buying the asset with a cheque drawn on the Bank of England, which the seller then deposits with his own bank. As a consequence, the quantity of bank deposits in the economy goes up, while the claims that the banks hold on the Bank of England also increase.
This is simply disingenuous. The method of QE is as follows, and this is from a Bank of England paper:
The aim of quantitative easing is to inject money into the economy in order to revive nominal spending. The Bank is doing that by purchasing financial assets from the private sector. When it pays for those assets with new central bank money, in addition to boosting the amount of central bank money held by banks, it is also likely to boost the amount of deposits held by firms and households. This additional money then works through a number of channels, discussed later, to increase spending.
You will note the term 'new central bank money'. Whilst there is no physical printing press, the Bank of England literally creates the money. Any suggestion that this is not 'printing money' is disingenuous nonsense. It is exactly the same effect as running a printing press to create new £50 notes.

For those unfamiliar with the mechanism of QE, the Bank of England buys an asset such as a government bond and credits the institution from whom they buy the asset with the value of the asset, by 'creating' the credit in the account of the seller. They have literally just created the money, and that money now sits in the account of the seller, ready to be used in the market.

As an illustration of the underlying principle, if you were to imagine that the Bank of England decided to buy your house for £250,000, it is doing the equivalent of printing enough notes for the £250,000 and giving you the notes fresh off the printing press. You could then go and spend that money as legal tender, and the amount of money in the economy has increased by £250,000. To reverse the increase in money, the Bank of England could then sell your house. Once they received the £250,000 they would then put the notes in a furnace and burn them. As such the £250,000 of additional money would disappear. This is the way in which the Bank of England can try to control the money supply, but they simply 'credit' the account of a bank rather than actually physically printing the money.

If we use the house example, in the modern sense of printing money, rather than getting cash, you would find that £250,000 appeared in your bank account from the issuance of a credit from the Bank of England.

The most interesting point is that the QE policy was justified as a fight against deflation, and that this justification is still being trotted out. I will quote from Mervyn King at the February select committee just to confirm that the excuse for QE is fight deflation and maintain inflation:
The reason we are doing that is because our judgment is that since last autumn, with the remarkable change in conditions last autumn, the amount of money in the economy is simply not growingfast enough to enable us to reach a sustainable growth rate with inflation close to the target. [question 11]
This from the Bank of England website on why they are implementing QE, as it is even more explicit:
The instrument of monetary policy shifted towards the quantity of money provided rather than its price (Bank Rate). But the objective of policy is unchanged – to meet the inflation target of 2 per cent on the CPI measure of consumer prices. Influencing the quantity of money directly is essentially a different means of reaching the same end.
It is worth just briefly noting the actual nature of the inflation policy, and the parameters within which the Bank of England works. This is from the Bank of England website:
If the inflation target is missed by more than 1 percentage point on either side - in other words, if the annual rate of CPI inflation is more than 3.0% or less than 1.0% - the Governor of the Bank, as Chairman of the MPC, must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank proposes to do to ensure inflation comes back to the target. This does not mean that the Bank has a target of 1.0 - 3.0%. The target is 2.0%. But if inflation varies by more than 1 percentage point from the target, the Bank has to explain why.
In the meantime, the CPI measure of inflation (the one that the Bank of England is targeting), has not dropped below 2% in the entire period of the QE policy, has not required a letter to be written, and the current rate is a fraction above 2%.

You will also note that the RPI measure of inflation has dropped, but RPI includes housing costs, which are dropping due to low interest rates. I explain the circularity of consideration of the RPI measure as a driver of interest rates (or QE) in more depth here and the problem of the circularity is presumably why it is not used for Bank of England policy guidance. In any case, RPI is not the inflation measure that the bank uses.

As such, under the terms of inflation targeting, it is apparent that the Bank of England is undertaking a policy which is 'unconventional' at a time when they have not even come close to the point where the bank needs to even report any concern over inflation rates. It is evident that there has been, and still is, no justification for the policy of QE if the policy is based upon CPI inflation. However, the policy has been justified on the possibility of future deflation. Again, an answer from Mervyn King from February:
The aim at present, with the concern about inflation being below the target in the medium term, is we are trying to bring the future outlook for inflation back up to the target. That is why we are engaging in the quantitative easing, but we have absolutely no interest or wish to see inflation go above that. [Question 12]
The quote dates from February and, as yet, there is still no evidence of the CPI falling in any way that might justify such an unconventional and untested policy. As I have said, the CPI has not even moved out of the boundaries that require a letter of explanation.

The next interesting point to consider is the method of QE. The official policy of QE allows for purchase of commercial assets or government debt (gilts). However, the implementation of the policy has seen gilts being the asset that is being purchased in (by far) the majority of the cases. The following chart makes the point (from the Bank of England here):

Why purchase government debt? This is the argument presented by Mervyn King:
In order to ease policy, therefore, we have adopted what is a relatively standard approach, which is to buy government securities [gilts] in the market. That way we do not distort private sector yields or take a judgment on which private sector assets we should buy, and this increases the amount of money in the economy. [Question 11]
Contrary to the assertion that buying gilts will not 'distort private sector yields', it is clear that this will not be the case. If people have a choice of investments, the condition of one asset will have an impact upon the other investment, and the Bank's purchase of gilts is specifically designed to make private assets more attractive (or that is the official view) than gilts.

With regards to the argument about which private sector assets to buy, this has been exactly what the Bank of England has been doing with the Special Liquidity Scheme - buying private sector assets. It is not apparent therefore that there is not any squeamishness over buying private sector assets. Also, as you will note, despite this statement, they are still buying a token number of bonds, indicating that it is indeed 'do-able' to buy private assets. In any event, as has been admitted by the Bank of England, this is not a conventional policy, and therefore there are no boundaries to what might be purchased.

A further explanation from the Bank of England is that if they buy gilts, then the sellers will have money to buy other assets (see here, page 96). However, in order to increase the money supply, it really does not matter what the bank spends the money on. Whatever it is used to purchase, the money supply has increased in the economy, as it will land in the hands of someone or some organisation. They will then have a new reserve of cash to use to spend or save. Bearing in mind that the aim of the bank is to prevent deflation, it really does not matter what the money is used for. If we take the earlier imagined example of the Bank of England buying your house, then it is apparent why this is the case.

If you decide to spend the money given to you by the Bank of England for purchase of your house, then the money will be used for the purchase of goods and services, thereby increasing demand for goods and services by £250,000. The amount of goods and services have more money chasing them than before the bank made the purchase and created money, and that is quite literally inflation. Once you have spent the money, the money will either be spent by the recipients or the money or will be deposited as savings in a bank. The money supply in relation to the total output of the economy has increased.

Alternatively, if you decide to save the £250,000, then you will deposit it in the bank. The bank will then likely use that money for fresh lending, which will means somebody else will use it for the purchase of a good or service, thereby again increasing the amount of money chasing goods or services. Even if the money is used to buy government debt (gilts) directly, the government will spend the money and the same thing will occur. The money will be used to pay nurses, who will spend the money on goods or services, or pay for a new road which will mean more expenditure on goods and services.

In other words, whatever the Bank of England purchases, one way or another, it will end up being used to purchase goods or services, and will create inflation in the goods or services for which it has been used. The Bank of England would not buy your house or bother with such a small amount of new currency issuance, but the principle is illustrated in this example.

The point about why it is not important how the money enters the economy is made clearly by Ben Bernanke, with his quote of the idea of using a helicopter to drop freshly printed money into an economy:
In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.
In short, however money enters the economy, it will still have the effect of arriving in the hand of somebody and will be available for spending, thereby increasing the supply of money in relation to goods and services.

So why is the Bank of England buying government debt?

When the policy was first proposed, it was at a time when markets were looking at the UK debt issuance with increasing concern, due to the exploding size of the debt. It would also have been evident to the UK government that they were not alone in issuing so much debt, as this process was being replicated around the OECD. In this situation, it was likely that the market for government debt issuance was about to be far more competitive, with the market flooded with debt. As a result, the possibility of lack of sufficient demand for the massive issuance of UK debt was being discussed by some analysts (and in this blog), which would translate into UK bankruptcy and a visit to the IMF. If the UK debt was not sold, the result would be a run on the £GB and national insolvency.

If we look at the nature of the problem, it is apparent that using QE to buy government debt simply does not make sense on any level, except that it is being enacted because it is the only way that government borrowing might be paid for. It is clearly unnecessary to buy gilts, but the purchase of gilts raises exactly the kind of worries that I am expressing here. It will, at the very least, raise concerns that the policy is the monetization of government debt (e.g. Warren Buffet on QE), and that will shake confidence in the economy overall. If it was the only method of increasing the money supply, then it might just make sense, but the problem is that all asset purchases will have the same effect.

Whilst I have presented (I hope) a logical argument against the use of QE for purchase of government debt, it might be argued that the Bank of England is just misguided. They genuinely believe in the threat of deflation, and genuinely believe that buying gilts is the best way to enact QE. However, it is when we view the latest thinking on the so called 'exit strategy' that such a suggestion becomes questionable.

When using the example of purchasing your house, I pointed out that the reversal of a policy would be for the bank to sell the house, and then burn the money to take it out of the money supply. This is a very important point, as the Bank of England will need an exit strategy, and the logical strategy would be to do the equivalent of selling the house - sell the gilts back on to the market. However, it is now apparent that this is not the strategy. This from the Bank of England Quarterly Bulletin for 2009 Q2 for the 'exit strategy':
As the economy recovers, the medium-term outlook for inflation will improve. As in normal times, the Committee will be guided by the medium-term outlook for inflation relative to the inflation target. Given that the inflation target is symmetric, if inflation looks set to rise above the 2% target, then the Committee will want to tighten monetary policy to slow spending and reduce inflation.

Monetary policy could be tightened in a number of ways. It could involve some combination of increases in Bank Rate and sales of assets in order to reduce the supply of money in the economy. Alternatively, the supply of reserves could be reduced without asset sales, through the issuance of short-term Bank of England bills. The MPC will decide on the most appropriate way to withdraw the policy stimulus based on the circumstances prevailing at the time.
You will note here that there is no commitment to sell the gilts back into the market, and instead a suggestion to use Bank of England bills. The Bank of England's description of the short-term Bank of England bills is as follows:
The Bills will constitute direct, unsecured, unconditional and general obligations of the Bank of England and will rank pari passu with all other unsecured and unsubordinated indebtedness of the Bank of England from time to time outstanding and without any preference one over the other, by reason of priority of date of sale or otherwise. "Indebtedness" means all indebtedness of the Bank of England in respect of moneys borrowed by the Bank of England and guarantees given by the Bank of England for moneys borrowed by others. The Bills will not be obligations of any person other than the Bank of England.
In other words, the Bank of England is proposing issuance of its own debt in place of selling the gilts. Whilst this might have the effect of reducing the money supply, the question that arises is to the reason why they would not just sell the gilts, and therefore restore the bank balance sheet to something like normality? Why would they want to hang on to the gilts?

The answer quite simply is that the market is already being flooded with gilts, and any move to sell the gilts held by the Bank of England would result in even greater supply, and an even greater risk of a failed bond auction.

What we therefore have is a highly unconventional policy in QE, with no rules or boundaries or precedent, resulting in the purchase of government debt (albeit through intermediaries). The purpose given is to fight a deflation that has not taken place. The method of enactment of the policy is of no consequence to the final result, but nevertheless the Bank of England has gone to considerable lengths to justify why buying government debt is the best way to enact the policy. As Bernanke recognises, a helicopter drop of money would achieve the same impact in fighting deflation. Furthermore, the exit strategy potentially leaves the gilts in the hands of the Bank of England even once the policy is abandoned.

None of this adds up. The only logical conclusion is that the government is being financed through the printing press, and such funding has unhappy precedent. In light of this, I do wonder how Mervyn King and the other officials at the Bank of England might justify this policy. I can only imagine how the discussions might have played out at the outset of the policy. I would guess that the conversations involved expressions from the government such as 'for the good of the country' and 'temporary measures in extreme circumstances'. At the time of implementation of QE, it is easy to see how such action might have momentarily seemed to be essential.

I am also guessing that the officials at the Bank of England are now having sleepless nights. I can not believe that they can not see where this policy is leading. As such, it can only be hoped that they will have the courage of their convictions and refuse to cooperate further. I am hoping that they will see that prolonging the idiocy of current government policy is wrong, and is taking the country towards economic disaster.

It is apparent now that Mervyn King is having severe doubts about the government fiscal policy, and it is to be hoped that this will see him resisting any further extensions of QE. As such, I am hoping the Bank of England has the leadership with the courage to call an end to this.


  1. CE

    You refer briefly of a visit to the IMF. I keep hearing this from many less informed commentaters who strangely believe the IMF could bail out the UK.
    In 1976 the IMF loaned the UK 2.36billion. According to the BofE inflation convertion chart equals 12.4billion by todays standard.
    What sort of bailout figure might we be looking at? The mind boggles

  2. Mismo,

    You are quite right. Who will bail out the 'bail-outer' to provide enough. It was a point I made a long time ago on the blog.

    I am not sure the IMF could raise the necessary money, and also think that once one of the 'major' economies falls, the rest will follow.

    The mind should indeed boggle at the sums that would be needed.

  3. Hello

    An important leg of your argument is that there is no evidence of deflation. You point out that the CPI has not fallen below 2% for the entire period of the QE policy.

    Might that not simply be owing to time lags whereby the effects of economic conditions and policies are not revealed in statistics right away? Might it not be that the reason CPI is still within the Band of England's 1-3% is precisely owing to its policy of QE? Without QE, might not the CPI be considerably lower?

  4. What mystifies me about all of these discussions is that this worst crisis since 1929 has now settled into a non event. Nobody's bovvered.

    Most people, those who are in reasonably secure employment, are very relaxed about our phantom economic crisis, apparently the worserest crisis since records began.

    There are no riots or protests, Andy Murray and Michael Jackson are the headline news, folk are not very pleased with politicians and their expenses but other than that, the world is still going round.

    For the last three years I have been reading about the coming crash (WTSHTF) and now it's here there's hardly a murmur. Don't get me wrong, but those who have even lost their jobs don't seem to be too downhearted.

    I read an article about how unemployment has now become both respectable and acceptable. The political class have accepted we have moved into a permanent post industrial, post work era, and we'll have to get used to it.

    My own take is, economics is a man made thing (not a result of nature) and as such man can shape, repair, fashion, influence, print money or do practically anything he wants and the roof won't fall in.

    Just a thought, how come Mervyn King is still in a job?

  5. Robin,

    A fair point. However, it was always suggested by the BoE that it would take several months of QE to take effect. As such, they can not claim success in maintaining inflation. It has happened regardless of QE.

    The problem they the BoE is confronting is that they were predicting serious deflation, and that has not taken place.

    As it is, elsewhere in the blog, I present a case that is deflation is not a bad thing in any case. However, even by their own standards, they have no excuse for QE at the moment.

    Thanks for bringing this up, as I meant to include it in the post.

  6. Some quick replies to the comments made against my last post here:


    You asked a question in the comments section of my last post about disparity of wages between different countries. This returns to the cigarette lighter problem that I wrote about when I first started the blog.

    I think your point deserves a more up to date answer, but I hope that this post helps to partly answer the question.

    In the meantime, wages for some kinds of work are moving closer together. The mechanism that will accelerate this will be exchange rate movements....

    As for a global currency, I will cover that in my fixed fiat currency article when I (eventually) finish it.

    Lefty Feep:

    Thanks for the link. I am convinced that there is plenty of carnage yet to be revealed in the banking system. My own personal worry of the moment is the coming crisis from commercial property, but there are plenty more areas that might implode. There are lots of black swans out there....

    I read a great article recently, in which the author showed how distant from reality the quants are. Sadly, I have been unable to find it to link to. The point of the article was that, in their models, the quants have no appreciation of the human element....

    That is all I have time for at the moment, so will leave it there..

  7. @Anon:3:46:

    Economic laws are not the same as natures laws, correct. You step off a high building, you fall to your death immediately. No exceptions.

    However you can ignore economic laws for a while, because economic law is based upon human nature. And humans can ignore reality and convince themselves of many irrational things for a fair while. Hence why tulip bulbs where worth fortunes in 1636, why shares in the South Sea company reached £550 each in May 1720, and was given $135m to launch a website to sell clothes in 1999.

    We are ignoring economic laws right now. And the effects are being masked by other factors temporarily. We are doing the equivalent of Wile Coyote running off the cliff and continuing in a straight line for a while. Until he looks down. Then reality reasserts itself.

    Sooner or later reality will reassert itself with regard to the UK economy. QE cannot continue forever, ergo it must stop at some point. That will cause a funding crisis. The amount of money being pumped into the economy by QE and govt borrowing WILL push up inflation at some point. Interest rates WILL have to rise from the current lows.

    The longer the govt refuse to grasp reality, and try to convince themselves that everything is fine, that we can go back to the good old days in a year or so, that there will be no price to pay for the huge debt bubble of the last 5-10 years, the worse the crash will be when it comes. Just translate what is currently happening in California, where the State govt is being forced to issue IOUs because it has run out of cash, to the UK. Imagine the panic if benefits could not be paid. If state employees where not paid, or laid off in mass redundancies. The consequences are massive.

    Do not mistake the current calm for the storm being over. We are in the eye of the storm. The Banking crisis of last autumn was the first half, solved by the State taking on the responsiblity for the losses. The government funding crisis is the second half to come. There is no one big enough to bail out the governments if they fail. That alone should be enough to worry anyone. It terrifies me.

  8. You don't get it, do you?

    The deflation they are scared of, is asset deflation. They don't care about the value of your pound, they don't care about prices going up. They care about assets in their books loosing name value. They QE to kick-start that market. What happens to the rest of you, doesn't matter at all.

  9. CE
    RE: your global currency article.

    I guess you will discuss a purely electronic currency so might find Jordan McLeod's proposed solution interesting. He comes at it from a v. different perspective to yours (as I understand it) -- his starting premise is that the underlying system is absolutely not fine.

    There seems one striking flaw in his argument I'll get back to later.

    I think this crisis shows globally that the model that pairs National Governments and Central bank is potentially disastrous (if not actually in process of collapsing) so your reaction could be interesting.

    He sums up the argument of his book here:

  10. Hi Cynicus.

    I googled the words "quants human element" and came up with at least a dozen articles promising to be "the one"....any use?

  11. Steve Tierney left the following comment, which I have copied here due to accidentally clicking on the reject link rather than the publish. Sorry, Steve:

    A really good post, CE.

    I don't know if you are interested in suggestions for posts, but if you are I for one would love to see a "What If?" post, where you suggested what you would do if you were Chancellor.

    I have tried to think my way through this questions and believe I have some ideas, but I'd love to compare them to yours.

    Actually, I'd like to compare them to ideas from some of the other regular posters too! Imagine the variations we'd get!

    Here's an interesting video about the U.S. Bailouts:-

  12. @ sobers. June 28, 2009 5:57 AM

    Thanks for that.

    Yes, I agree TSWHTF but it's a long time a comin'. It's true though, the MSM keep us looking the other way with their celebrity obsessions - feelings trump the rational.

    Keep a look out for all those green shoots sprouting everywhere.

    I'm a self confessed conspiracy nut (Shhh!) and keep reading where it's all a deliberate take down.

    I read Jim Kunstler (for my sins) for three years now and he saw it coming before that.

    It's astonishing that the people who are in the driving seat of this juggernaut didn't see any of it coming - nor the pundits and talking heads. LOL.

    I'm no economist, I'm a fly on the wall of the political scene and am waiting to see where it is all going. Careful what I wish for.

    Hyper inflation is gaining traction.

    What are the shares like in wheel-barrows?

  13. Regarding the link to McLeod's electronic currency and negative interest rates, this turned up recently regarding Japan:

    Governments would love this idea - no more undeclared cash jobs for builders et al!

  14. Saw a commentator on a Telegraph article post this link which claims “the danger of hyperinflation lies in a dramatic increase in the velocity of money due to a loss of confidence, not in changes in the money supply”:

    Not sure if this has already been discussed but I have read a number of people on other comment boards mention the possibility that due to the increasing shortage of hard money relative to electronic money, the vale of real money could rise so that purchases made on a card would cost more than if paid for in cash. Given the potential loss of confidence in a currency (eg GBP or USD), how feasible is this?

    One other unrelated question: would the Japanese carry trade have registered in Japan’s GDP figures or would it be totally disregarded as foreign investment?

    Good fortune to all.

  15. The fear that we are entering an economic contraction as severe as the beginning of the Great Depression is confirmed here:

    The detailed article of Barry Eichengreen and Kevin H. O’Rourke can be found here:

  16. Thanks for another interesting post, Cynicus.
    I discovered Henry Hazlitt's 'Economics in One Lesson' via this blog, and with regards to inflation, this book of his published in 1960 seems a great source of concise and clear information.
    (in the into he says the first six chapters are a good primer on inflation, however the rest of the book game me more good insight into the dynamics that drive human behaviour and economics)

  17. Jonny,
    It was I who posted the link in the Telegraph, and I am glad that it has been useful. It is my daily read along with Cynicus's and he publishes very useful information.

  18. Steve Keen has a good point about the possibility of hyperinflation:

    "The only way that Bernanke’s “printing press" ... would work to cause inflation in our current debt-laden would be if simply Zimbabwean levels of money were printed—so that fiat money could substantially repay outstanding debt and effectively supplant credit-based money. Measured on this scale, Bernanke’s increase in Base Money goes from being heroic to trivial. Not only does the scale of credit-created money greatly exceed government-created money, but debt in turn greatly exceeds even the broadest measure of the money stock—the M3 series that the Fed some years ago decided to discontinue."

  19. Monetizing Government Debt Can Work: the Experience of Japan in 1931–1933

    For those who believe that monetizing debt can never work, and that it only leads to hyperinflation, take a look at Japan’s experience of the Great Depression.

    Japan’s experience also proves the success of Keynesianism. The recovery was masterminded by Takahashi Korekiyo, Japan’s Finance Minister, the Japanese “Keynes” (Myung Soo Cha 2003).

    Japan abandoned the gold standard on December 13, 1931, and then devalued its currency, and implemented effective foreign exchange controls. It then engaged in large government deficit spending to stimulate the economy, including public works (Flath 2000: 59). By 1933, Japan had emerged from the Great Depression.

    Japan did not levy new taxes to pay for deficit spending, but issued bonds. The Bank of Japan lowered its discount rate and lent more money to the banks.

    But Mark Metzler in Lever of Empire: The International Gold Standard and the Crisis of Liberalism in Prewar Japan describes the bond policy:

    [the deficits were funded by government bonds] and in November 1932 the government began to sell entire issues of its deficit bonds to the Bank of Japan rather than to private institutions. That is, increased government spending was funded by the direct creation of money by the BOJ. Takahashi’s idea was first to boost the money supply and stimulate industry, and then, as conditions improved, to have the private sector buy government bonds from the Bank of Japan, soaking up money from circulation and controlling inflation. (Metzler 2006: 250).

    From November 1932, the government’s deficit was financed by issuing bonds directly to the Bank of Japan, and then later the Bank sold these bonds to private banks.

    Not only was there no hyperinflation but no significant inflation. If Japan had renounced its militarism and liberalised some trade later in the decade, it could have had access to raw materials to continue development.

    I would be interested to see how Cynicus Economicus can explain the success of this policy, given that Japan used fiat money and monetized its debt.

    Of course, the Japanese economy had a productive manufacturing sector.and no large private debt bubble to liquidate in 1931, unlike the US and the UK today.

    But clearly simple monetarizing of state debt is not the inevitable catastrophe as you think it is.


    Myung Soo Cha, “Did Takahashi Korekiyo Rescue Japan from the Great Depression?” The Journal of Economic History 63.1 (2003): 127–144.

    David Flath, The Japanese Economy, Oxford University Press, Oxford and New York, 2000. pp.58–60.

    Mark Metzler, Lever of Empire: The International Gold Standard and the Crisis of Liberalism in Prewar Japan, University of California Press, Berkeley, 2006.

  20. Strains in physical Gold and Silver supply chain showing.

    I posted on this blog a while ago about the possibility of the supply of gold collapsing due to over demand and other factors.

    While this was only supposition, (and I only posted the link that referenced it to comment on another point) I wondered if the theory might have some merit, so have kept an eye out for other evidence, so here is a link that shows that COMEX is having difficulties, with late delivery, delivery of metal with the wrong serial number or weight and doubtful stock figures.

    Granted, mistakes in paperwork can be made, and the system could be antiquated and inefficient, but if the most trusted dealer in precious metals cannot be fully trusted with their main line of work then it doesn't bode well whether or not it is due to error or lack of stock.

    I do not know too much about the precious metal trade, so ill just leave the link and let you make your own mind up.

    Thanks for keeping us updated about QE cynicus btw. Some posters have argued that the amount of money conjured out of thin air is not enough to seriously effect inflation, which could be correct in purely monetary terms but I personally feel that lack of confidence in the money supply as Jonny pointed out is likely to cause the same effect rather than just the money supply.

    Not to mention what effects an overdose of bonds will end up having on that market and government debt in the future.

    Perhaps if those who support the view that hyperinflation will not come about could explain reasons why it couldn't happen due to other reasons than purely monetary theory, it may help support their case.

  21. Steve Keens has an excellent new blog entry:

  22. Here is a fascinating video of Barry Eichengreen explaining the role that deregulation played in the present financial crisis:

  23. Gilts sales by foreigners fuels deficit fears

    A record sell-off of UK government debt by overseas investors is fuelling City anxieties over the Treasury’s ability to fund soaring public borrowing that is set to top £150 billion over this year and next.

    The surge in foreign selling of gilt-edged bonds and short-term UK Treasury bills is also reinforcing growing fears over the effectiveness of the Bank of England’s controversial quantitative easing (QE) scheme to pump newly created money through the economy.

  24. Wasn't this Japanese monetization accompanied by a 60% depreciation in the Yen?

    If so the that indicates that the piper has to be paid by some method. Due to the monetization the Yen devalued. Japan then suffered massive inflation in raw material costs due to it's devaluation.

    Japan then couldn't afford to buy commodities it needed from abroad. Hence the need for militaristic expansion and the seizure by force what could not be bought by it's devalued currency. Suddenly their change aggressive foreign policy in this period makes a little more sense.

    I wonder what will we be able to buy from abroad with our currencies in the future?

  25. Reply to Acca

    Wasn't this Japanese monetization accompanied by a 60% depreciation in the Yen?

    No, it wasn’t. The yen devalued by about 40% (Cullen 2003: 251), and most of this devaluation occurred in 1932 and 1933. After 1933 the value of the yen stabilized (Myung Soo Cha 2003: 130). By 1934, the yen started to appreciate against the US dollar (Drysdale and Gower 1998: 223).

    Furthermore, the yen had been significantly overvalued in the 1920s (Teranishi 2005: 130-133), and this had seriously harmed Japanese exports and caused trade deficits in the 1920s.

    Japan then suffered massive inflation in raw material costs due to its devaluation. Japan then couldn't afford to buy commodities it needed from abroad.

    Again, no, it didn’t. The yen depreciation in 1932 stimulated demand for Japanese exports overseas, especially for Japanese textiles in Asia. Thus the yen devaluation allowed a surge in Japanese exports, and this actually improved Japan’s current account. By 1935, Japan was moving to a trade balance, not to a massive trade deficit. It could have paid for raw materials by concentrating on further development of its manufacturing sector.

    It was not until 1935 that inflation started to build up, and Takahashi Korekiyo, the Finance Minister, reduced government spending, especially military spending, to rein in inflation and to sterilize his previous budget deficits.

    Takahashi Korekiyo’s attempt to reduce military expenditures caused a conspiracy of army officers who assassinated him and the Prime Minister on February 26, 1936. They did so because they disagreed with his policy of reducing military spending.

    The policies of Takahashi Korekiyo’s successor gave the army a free hand in budget spending and by early 1937 there was a balance of payments and inflation crisis.

    But the turn to militarism in 1936 was the result of the internal power of the army and the failure of the civilian politicians, not the need for raw materials or a balance of payments crisis.

    Myung Soo Cha, 2003 “Did Takahashi Korekiyo Rescue Japan from the Great Depression?” The Journal of Economic History 63.1: 127–144.

    Cullen, L.M., 2003, A History of Japan 1582–1941: Internal and External Worlds, Cambridge University Press, Cambridge and New York, 2003.

    Drysdale, P. and L. Gower (eds), 1998, The Japanese Economy, Routledge, London and New York, 1998.

    Teranishi, J., 2005, Evolution of the Economic System in Japan, Edward Elgar Pub., Cheltenham, UK and Northhampton, MA.

  26. Addendum for Acca

    I forgot to say that Japan actually had a trade surplus in 1935, because of greater earnings from exports due to the yen depreciation. This totally demolishes the theory that a surging trade deficit in raw materials caused Japan’s militarism in the 1930s.

    See Fletcher, W. M., 1989, The Japanese Business Community and National Trade Policy, 1920-1942, University of North Carolina Press, Chapel Hill. p. 98.

  27. Brendan O’Neill

    Why unemployment is no longer a political issue.

    Thousands are being thrown on to the dole queue, yet there are no mass uprisings, no widespread strikes, no marches for jobs. Why?

  28. Great blog.

    But, ignore what they say and watch what they do.

    The rest is just an attempt to paint a veneer of credibility, the central bankers are not the solution as they are the creators of this mess in the first place. Their actions will compound and spread the problems, deepening the economic malaise and removing the chance of natural rebound at some stage in the future.

    My dog could have done better.

  29. China: neoliberalism's last fix:

  30. I'm still having trouble understanding the role of separate currencies in economics.

    Talking to someone about how some Asian workers slave for £7 a day he replied "Ah yes, but what can £7 buy you in Asia?" and surely he does have a point.

    Lord Keynes, you explain how devaluation helped Japan to boost exports. Wouldn't just cutting prices have achieved the same effect? (Or is the aim to get the country's general population to subsidise an effective price cut whether they want to or not?)

    How can a currency be over- or under-valued? Isn't this just another variable which obscures economic fundamentals and prevents the capitalist system, such as it is, from working properly?

  31. On Classical Economics and Inflation of Money Supply

    Here is an article called "Deflation and Liberty" by Jörg Guido Hülsmann on the Mises website, which points out that the Classical economists thought that, under certain circumstances, inlftaion of the money supply was a good thing:

    David Hume believed that inflation could stimulate production in the short run. Adam Smith believed that inflation in the form of credit expansion was beneficial if it was backed up with a corresponding amount of real goods, and Jean-Baptiste Say similarly endorsed expansions of the quantity of money that accommodated the needs of commerce. Smith and Ricardo suggested increasing the wealth of the nation by substituting inherently valueless paper tickets for metallic money.


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