Why no inflation?

How times change. In the mid-1970s, UK inflation as measured by the Retail Price Index hit 27%. The general consensus was that this was a very bad thing. This week, inflation in the UK, as measured by the government’s preferred metric, the Consumer Price Index, hit 0%.

This is also considered a very bad thing, so much so that the UK’s monetary policy – lots of money printing (QE) and super-low interest rates – has been specifically designed to prevent it from happening. So what’s gone wrong? Why have super-low rates and QE not created even a little bit of inflation?

The answer is partly about demographics. As we have written before, the older your population, the harder it is to force it to consume (see our interview with Paul Hodges). But there is more to it than that.

We’ve all been taught that QE instantly causes inflation, says market strategist Ed Yardeni. Not so. Keep very easy money in place for too long (as the UK and US arguably have) and it stops doing what you want it to.

Borrowers are eventually “maxed out. They can borrow and buy no more – so demand just can’t be stimulated.” Instead, easy money stimulates supply: the free flow of cash allows “zombie companies to stay in business”, even if they lose money.

Projects that would never have got off the ground with normal interest rates (in the shale industry, for example) find raising money all too easy. The result is “zero inflation with a whiff of deflation”.

This is a disaster for all sorts of reasons. The most obvious is that heavily indebted societies can’t cope with deflation (we need inflation to erode our debt for us), but the other is that when central banks see deflation, they don’t see that it might be caused by easy money – they think it’s because there hasn’t been enough easy money.

So they call for more. Which will end up giving them even more of a deflationary problem. The truth is that it is only when they stop QE (which they have to one day), or when they do so much of it that we all lose faith in paper currency, that they’ll get inflation. And possibly rather too much of it.

Tim Price picks up the story. As far as he is concerned, monetary policy is broken. “The lunatics have taken over the asylum” and “the world of capital has been turned on its head”. Why else would we find ourselves in such a spot that Danish sex therapists are actually being paid to borrow money by their banks? Why else indeed.

For a more optimistic take, we have an interview with James Anderson of Scottish Mortgage Trust. He isn’t worried about inflation, deflation or negative interest rates in Denmark – none of that matters in the face of the stunning innovation he sees around the world today.

As far as he’s concerned, we should ignore central banks and get ourselves to Berlin or the west coast of the US to buy ourselves a piece of the future. It’s good advice.

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