Ben Bernanke, and the Keynesians were right: Quantitative Easing has not caused the kind of inflation that the non-mainstream Austrian economists claimed that it would. The theory was that a soaring monetary base, and the zero-interest-rate-policy would lead to easy money flowing like a tsunami, and creating such a gush that inflation on goods and services — the change in cost from month-to-month and year-to-year — would soar, making life impossible for those on fixed incomes, and in a worst-case-scenario — like Zimbabwe, or Weimar Germany — forcing consumers to use an armful or wheelbarrow of cash to purchase a loaf of bread. Let’s look at the monetary base:
That is a huge spike! But what is the monetary base? The monetary base — also known as M0 — is the total amount of coins, paper and bank deposits in the economy. Quantitative easing injects new money into the monetary base, and as we can see above, has great increased it. So why can I still buy bread without a wheelbarrow? That is because the monetary base and the money supply are two different things. In a fractional-reserve banking system, deposits in banks can be lent, re-deposited, and lent again. Government policy determines the number of times that money can be lent — in the United States, total credit cannot exceed lending by more than ten times. The money supply — which accounts for fractional reserve lending — is known as M2. Let’s look at it:
So banks must be hoarding cash? That’s right. They are:
And what effect has quantitative easing had on prices? Here’s the CPI (inflation for consumers):
And the PPI for raw goods, intermediate goods, and finished goods (inflation for producers):
We are not experiencing an inflationary storm, not by any means. More like struggling over a mild deflationary slump. Hyperinflation is characterised by inflation in the thousands or millions of percent, and although the monetary base has increased fast enough to hugely inflate the currency, that hasn’t materialised. To understand why, we have to understand the phenomenon that quantitative easing sought to combat. Ben Bernanke’s academic career was characterised by his study of the Great Depression, and specifically the idea that following from the Wall Street crash of 1929, deflation made debt much harder to repay, leading to bank failures, leading to a credit contraction on fears of more deflation, leading to even more deflation, and so on in a kind of spiral of death. Quantitative easing has sought to prevent that spiral of death, and to prevent deflation from causing the real value of old debt from spiking, which would cause even more defaults, even less lending confidence, and even more deflation. And it has been relatively successful. But — very much like the Japanese response to its housing bubble in the 1990s — it does not seem to have done enough to allow a resumption in growth. From Dr. Housing Bubble:
The collapse in housing prices has been similar in both [the United States and Japan] and the path of each bubble seems extremely similar. For example, the above chart looks at Japan real estate starting in 1984 and aligns U.S. home prices starting in 1997. So a decade sets both bubbles apart but the path is unmistakable. Japan gave up all gains in their housing bubble bust and the U.S. housing market has yet to reach that trough. Does this mean a baseline of 1997 is where a true bottom will be reached? Hard to say yet there is little evidence to show for a rise in home prices. There is still over 6,000,000 homes in the shadow inventory that need to be liquidated at some point and will add pressure to home prices on the downside. In terms of bank housing lending collapsing and real estate values imploding we are two for two between Japan and the United States.
Essentially, in both the United States and Japan, credit bubbles fuelling a bubble in the housing market collapsed, leading to a stock market crash, and asset price slides, triggering deflation throughout the respective economies — much like following the 1929 crash. Policy makers in both countries — at the Bank of Japan, and Federal Reserve — set about reflating the bubble by helicopter dropping yen and dollars. Fundamental structural problems in the banking system that contributed to the initial credit bubbles — in both Japan and the United States — have not really ever been addressed. Bad businesses were never liquidated, which is why there has not been aggressive new growth. So Japan’s zombie banks, and America’s too big to fail monoliths blunder on. Policy makers “saved the system”, and ever since then have gradually dealt with slowdowns through monetary and fiscal easing.
Hyperinflation is an entirely different phenomenon. It tends to occur not when countries print too much money, but when they produce and circulate too few goods and services. The money printing is usually a desperate after effect. The classic examples of Weimar Germany and Mugabe’s Zimbabwe confirm this idea — Weimar Germany was devastated by the production standstill in the Ruhr industrial region, and Robert Mugabe obliterated Zimbabwe’s agricultural infrastructure. So — as Japan enters its third lost decade — is the United States headed for a growth-free and deflation-heavy future?
In my view the answer is no, for one very simple reason. Japan has been in a state of stasis supported by debt. While its government has massive debts — over 220% of GDP — these debts are predominantly owed to domestic creditors. Japan also has a very high personal and household savings rate. America, on the other hand, is in huge debt to hostile foreign creditors, but not only this, monetary easing is not so much a domestic policy as it is an international one, because of the dollar’s role as the global reserve currency. Essentially Japan’s slowdown and life-support was never quite as threatening to its ability to produce the necessary goods and services as America’s. Japan is less dependent on imports than America, which relies on its largest creditor to export vast quantities of consumer goods, basic materials and components. Japan does not have the same corrosive trade deficit with China.
So will we ever get to see hyperinflation in America? It depends on China’s response to America’s slouch. If — as mainstream economists hope — China can be patient enough to allow America to resolve its debt problems, eradicate its trade deficit, and manufacture more at home then hyperinflation is very unlikely. America may stumble through a lost decade, before new technologies, and new business models finally pull America out of the slump. American policy makers might even have the foresight to let failed business models fail and liquidate failed businesses, allowing for new growth to take root, and avoiding Japanese zombification.
If China, on the other hand, decides that it is sick of being America’s foot stool, then America has a massive problem. Entering into a trade war with a nation that holds so much of America’s debt, and produces so much of the goods that sit on American shelves is an extremely risky proposition. A drastic fall in goods circulating in America — as the result of Chinese export tariffs, yuan flotation, or an outright export ban — could be a hyperinflation trigger. Bank reserves accumulated during QE would quickly be lent out as more and more money chases fewer and fewer goods.
But a greater danger still might be an oil slowdown. Is it any coincidence that Saddam Hussein’s Iraq was invaded by the American Empire very shortly after turning his back on the dollar and demanding payment in Euros? Certainly, the case can be made that Saddam was being petty and vindictive, but with a slumping American economy, with a devalued dollar, and with mounting American debt concerns, Arab patience with America — and Arab willingness to sell oil for dollars, rather than yuan, roubles, or gold — will certainly be tested. If both China and Arabia turn their back on America, hyperinflation would be almost a certainty.
Of course, the American strategy since Nixon and Kissinger has been that American military supremacy is enough to essentially give America a free lunch. But there ain’t no such thing. That policy has depleted American manufacturing, and piled-on American debt to the point where the dollar is almost certain to be dethroned as the international reserve currency. And it is at that point that all the models break down.