Last Wednesday, fund manager M&G held an inflation conference. It featured Andrew Sentance, former member of the Bank of England’s monetary policy committee, talking about the folly of a super-low interest-rate policy in the face of the regular and predictable breaching of the Bank’s 2% consumer price index (CPI) target.
It also had someone from Incomes Data Services talking about how odd it is to see such high inflation at a time of such weak wage growth. And, rather presciently, given Thursday’s announcement of a new round of quantitative easing (QE) from the Bank of England – £75bn is to be created and spent, probably on gilts, over the next four months – it included Weimar Germany hyperinflation expert Adam Fergusson. He doesn’t really approve of QE – which, given his knowledge of what happens when it gets out of control, isn’t particularly surprising.
However, it is worth running through a few of the reasons why it is, as George Osborne said himself back in 2009: “the last resort of desperate governments when all other policies have failed”.
First is the fact that the one thing we expect our central banks to do is to keep our money sound. That means maintaining its purchasing power and also keeping us confident that it will continue to do so. Most central banks entirely fail to manage the former: the pound has lost 85% of its value since the 1970s. Mostly, though, they cover it up pretty well, and therefore have some success with the latter. QE blows that cover: we all know the more units of something there are, the less each unit is worth.
It’s hard to know what level of inflation makes people lose their faith in any given central bank. But I can’t see why we’d experiment with finding out. The problem is that when you play around with money printing, you are playing with more than a couple of computer screens. You are playing with trust. And if trust goes, so does control.
You can stop increasing the money supply whenever you like. What you can’t do is stop a rise in the velocity of the circulation of money already in issue (known as “the money multiplier”). These days, money is sluggish stuff. Anyone who has it is keeping it: they aren’t lending it out and they aren’t spending it. But that can change fast.
And once it gets going, and pounds start changing hands faster and faster, “velocity can contribute more than the printing press to inflation, with every pound, dollar or euro doing the work of two, ten, twenty or a hundred,” says Fergusson. This can be a dangerous business. Ask anyone living in any of the 29 countries that have seen hyperinflation (prices rising over 50% a month) in the last 100 years.
So given the risks, what’s up with the Bank of England and money printing?
For Mervyn King, the answer is all about deflation. He knows – surely – about the longer-term risks of high inflation as a result of QE. But right now he is too worried about deflation to care. CPI might be high – but that isn’t the number that worries him. Instead, he is focused on inflation as measured by broad money supply (or, for the experts, M4 excluding intermediate other financial corporations).
Back in 2009, he suggested that broad money growth of around 6-8% is consistent with good growth. At the moment, it isn’t anywhere near this. Instead, it is running at just over 2% and falling. So the idea behind this round of QE is to flood the system and force the growth rate of, first, money and, then, GDP back up again.
The problem? It didn’t appear to work last time. Look at a chart of broad money in the UK and you will see that, thanks to the low money multiplier, it remained almost entirely flat throughout the huge QE programme of 2009.
It is possible, of course, that without the QE, broad money would have turned properly negative, plunging us into a spiral of deflation and disaster. But there is no evidence to prove this either way. So we don’t know if QE will work as King wants it to.
What we do know is that it has had a couple of other effects already. The FTSE 100 rose 3.7% on Thursday and the pound plummeted. That’s nice for anyone with a long position in equities and short position on sterling. But not for the rest of us. In the UK, we have seen high imported inflation slamming real wages. The recent fall in commodity prices had offered hope that this might soon change. No more. The new weakness in our currency means that consumer prices will rise yet again.
QE might well help the stock market to end the year well. And it might work to stave off monetary deflation. I can’t tell you for sure either way. However, one thing I can be pretty certain of is that the pound in your pocket is worth less now than it was on Wednesday. And there is a very good chance that, as the money multiplier picks up, it will be worth much less in a few years. See what Osborne meant by “last resort”?
• This article was first published in the Financial Times