One of the arguments made defending increases in the money supply, such as the recent quantitative easing in Britain, is that such money inflation does not always result in price inflation. Paul Krugman, a Nobel prize winning Keynesian economist, argued this recently in his New York Times column:
Wouldn’t that cause inflation? Probably not: whatever the likes of Ron Paul may believe, money creation isn’t inflationary in a depressed economy. Furthermore, Europe actually needs modestly higher overall inflation: too low an overall inflation rate would condemn southern Europe to years of grinding deflation, virtually guaranteeing both continued high unemployment and a string of defaults.
However, do standard economic laws not apply in a recession? As William Andserson states on his amusingly titled Krugman in Wonderland blog,
The cynicism drips off the column with that one, and his comments are a dream come true for those who claim (falsely) that governments are “not revenue constrained,” as though the printing press can erase the Law of Opportunity Cost.
[An aside – quantitative easing is just the obvious time when central banks increase the money supply, and I think its safe to say most people are (rightly) very suspicious of this. But it goes on all the time through a mix of lowering interest rates and fractional reserve banking. If you oppose QE, then logically you have to also oppose any other process that increases the money supply. There has been a huge increase since the end of Bretton Woods in 1971, and most of it wasn’t the result of QE. If you oppose QE but support central banks in theory/principle, how do you justify this?]
But the key problem is that we are missing the other problems caused by money inflation. Price inflation is certainly a problem, for those on fixed incomes especially. There are two fundamental problems with increasing the money supply which are well explained by the Austrian school.
Firstly, money inflation creates imbalances in the structure of production, ultimately causing the boom-bust cycle. The lower interest rates that result from the new money suggest to businesses that plans that were previously unprofitable are now profitable. (Just imagine financing a new factory – you’d need to take on fair chunk of debt to build it. Perhaps at 5%, you would make a loss, but at 3% you’d make a profit.) However, since the resources to do this aren’t real, the illusion eventually ends.
This is known as the Austrian Theory of the Business Cycle, and deserves further elaboration in later posts. Suffice to say that this is the root cause of the housing bubble, the dot-com bubble, and the Great Depression. In all these cases, there is clear pattern of central banks lowering interest rates to kick off a boom, allowing for unsustainable business ventures activities to take place (known as malinvestments). Blaming the free market for boom and bust is premature considering at the heart of all modern Western economies is a central-planning government agency artificially setting prices. Might this not have an effect?
As the rapping Hayek describes in the videos on the about page,
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few
Without central banks, credit must come from savings – underconsumption. This is part of the principle of opportunity cost. Creating new money attempts to deny this, and so consumption continues at it’s previous rate, and investment increases. These imbalances can be masked over for a while, but eventually come unstuck.
The second reason is that the new money finds it way to certain privileged groups, usually banks and governments. This is nothing less than political favouritism. Can it be fair that bankers have access to huge sums of money at no cost? And governments have frequently used the printing press to fund wars, in the knowledge that people would be unlikely to accept tax rises for overseas adventures. Of course, this is the real reason for the fiat money system that we have. For all the arguments that it helps the economy at large, what is really going on is that two of the biggest vested interests in society use it for their own ends. If you could print money at zero cost, wouldn’t you?
Distributing the new money equally wouldn’t be of any benefit, since, on average, prices would just increase in proportion to the increase in the money supply. If QE really was great for the economy, wouldn’t it be better to divide it equally and pay in each of our bank accounts?
In order to put food on the table and a roof over my head, I have to do work that others actually demand. Why should the elite be allowed to buy luxuries just because they printed a few special pieces of paper?
There is only one solution – to both the unending boom bust cycle and the immoral ‘free lunch’ the elite enjoy at our expense. We must abolish the Bank of England.
This column was inspired by a speech given by Alasdair Macleod, the transcript of which can be found at the Cobden Centre.
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