Printing more money

The idea that there could be some economic benefit in printing money completely misses the point and nature of money.

One role of money is to eliminate the obvious inefficiency and limitations of barter by facilitating far more flexible trade of goods and services. In this role the numeric scale of the currency is practically irrelevant. For example, the Turkish government knocked six zeros off the lira in 2003; this had no real effect on the economy.

However, the second use of money is as a store of value which effectively allows exchange to occur across time. This is incredibly important; for example, if you have no need or use for a bushel of wheat today you can sell it and keep the money until next year and buy a bushel when you do need one. It doesn't require much imagination to see the advantages that money confers on a society where this is possible. For money to work in this regard it needs careful management to ensure that the value of money is preserved over time. In crude terms central banks achieve this by ensuring that the supply of money matches the amount of "stuff" that can be bought.

If the money supply grows beyond this you get inflation which means money loses value as a store - the money you raise from selling a bushel of wheat now will not buy you one in a years time; conversely if the money supply does not grow enough, then the opposite happens - selling now will allow you to buy more than a bushel next year.

Both create distorting incentives - one to spend money as fast as possible (consume), the other to hoard it for as long as possible (save). These incentives are created purely by the mechanics of the money supply and not by the effects of economic activity and so distort the economy and creating huge economic inefficiencies. These inefficiencies are enough to destroy economies - this has been observed countless times in history. For example, paradoxically Spain's economy in the 16th century was practically destroyed when it was flooded with South American gold and silver as the inevitable inflation took its toll.

Gold has some advantages as a basis for money but the disadvantages considerably outweigh the advantages. The supply cannot be controlled so you cannot avoid uncontrollable periods of inflation or deflation. It is also difficult to store, transfer, etc. Admittedly, it was the best we had for millennia.

Anyway, we can't print money. Only the ECB can do that.

Given that most money is electronic these days, that would involve some sort of Quantative Easing sort of jobbie. In a QE situation, the ECB would buy bonds issued by the national governments increasing the amount of electronic money in circulation. They would not sell bonds in the international markets to sterilize this purchase.

The question is, would the amount that is being eased (the amount of new money created) exceed the amount of money that is being destroyed due to deleveraging and asset writedowns (actually, mostly due to asset writedowns, as, as far as I can see, deleveraging on its own is zero sum).

To my mind, the inflation has already happened - financial innovation recognised future revenue (bringing tomorrow's dollar to today to make it available to spend), marked assets to market (as their values were inflating) and recognised that as profit that was distributed to shareholders. So the inflation has already been happened, the money is in circulation.

If you accept this, you have to ask is it really a good idea to keep these inflated asset value monies in circulation? Would it not be better to deflate them to realistic values, take the pain and then work from a realistic price of assets (including, for example, the cost of labour)? This is what happened in the 1930s. I believe it was an inevitable result of the 1920s, notwithstanding all the fluff about the Fed keeping rates too high too long. I think the same is true now, whatever a flight to safety into TIPS and gold says about individual investor mentality and fear.

yoganmahew said:

... exceed the amount of money that is being destroyed due to deleveraging and asset writedowns (actually, mostly due to asset writedowns, as, as far as I can see, deleveraging on its own is zero sum).

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Beg to disagree. Asset write downs have no impact on Money Supply. Bank credit is the main source of Money Supply. When a bank lends to a developer to build a house, the bank balance sheet inflates by a loan to the developer on the assets side and deposits of, say, the construction workers on the liability side. These deposits are Money Supply. Deleveraging is reversing the process and therefore reduces Money Supply, it is not zero sum.

Asset values impact on the so called Wealth Effect, but not directly on the Quantity of the Money Supply. A falling WE will transmit to lower Velocity in the Money Supply which would have a similar deflationary impact to lowering its Quantity.

Even more pertinently and more recently Alan Greenspan said "Gold still represents the ultimate form of payment in the world. . . . Fiat money, in extremis, is accepted by nobody. Gold is always accepted" (Speech to Senate Banking Committee in May 1999). [/quote]

Capall: "I wouldn't be quoting Greenspan these days. He is largely responsible for the current economic crises and is totally discredited"

Greenspan is entirely discredited and rightly so but that does not mean that you can dismiss everything single statement he made. His above quote is one of the truer and more perceptive statements that he has made in recent years.

Maybe Ernest Hemingway's quote is more apposite:

"The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists."

Duke of Marmalade said:

Beg to disagree. Asset write downs have no impact on Money Supply. Bank credit is the main source of Money Supply. When a bank lends to a developer to build a house, the bank balance sheet inflates by a loan to the developer on the assets side and deposits of, say, the construction workers on the liability side. These deposits are Money Supply. Deleveraging is reversing the process and therefore reduces Money Supply, it is not zero sum.

Asset values impact on the so called Wealth Effect, but not directly on the Quantity of the Money Supply. A falling WE will transmit to lower Velocity in the Money Supply which would have a similar deflationary impact to lowering its Quantity.

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I agree. The problem is, however, that banks and companies have been marking those assets to market as their value has risen, for example in Ireland - where the value of the landbank used as security for the loan has risen, the company that owns it has remarked the asset value as a gain. This, for a company, just makes the books unreliable. When a bank does this, they create money as the asset is now worth more to repo with the central bank (i.e. to get new money that didn't exist before). An increase in bank assets pretty much equals an increase in money supply (whatever M number it is!). So a reduction in market value of bank assets equals money destruction. Likewise when future revenue is recognised or interest roll-ups are added to loan values. This is my understanding, anyway!

ClubMan said:

Inflation.

No and yes.

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Inflation isnt the danger but hyper-inflation, if the current crisis is mis managed then the recession we are currently in will just be the tip of the iceberg. Now that the reductions in Interest rates are having little effect and the rates are so low that the effect each future rate cut may have is reduced, Gordon Brown, the US and other countries are looking at "quantative easing" pumping money that doesnt exist electronically into the banking system in the hope that this will stimulate the banks to lend and people/businesses to start buying again.

The problem is (IMHO) that recession is the natural reaction to a boom bubble, the economic situation should be allowed to right itself and it will do this when we return to the traditional model of people living within their means, paying off their debt and saving more, when this happens confidence will return to the banking sector and the banks will be more inclined to start lending sensibly again.

What the governments are trying to do is artificially prop up their economies by encouraging more debt, this is not a sound foundation for sustainable growth. The fundamentals for recovery are not in place, banks are not lending because the risk is much higher during a recession, house prices are dropping so banks are reluctant to give mortgages secured against these depreciating assets, businesses are seeing their revenues reduced and many more will be going to the wall, couple that with the difficult situation for exporters due to the strength of the euro and you can see why the banks are closing their doors. Quantative easing and Interest rate drops are going to have little effect in changing that.

deflation is the problem here, not inflation for good ness sake

jimbobman said:

deflation is the problem here, not inflation for good ness sake

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The inflation will come after the deflation! Basically the theory is the 'world' will have deflation first, a number if steps will be put in place to counteract this by pumping money into the system, but this will over shoot the mark and we end up with high/hyper inflation.

Anyone who believes hyper inflation is around the corner should fill their boots with 30 year index linked bonds. These are pricing an inflation rate of less than 3% to persist for the next 30 years.

Duke of Marmalade said:

Anyone who believes hyper inflation is around the corner should fill their boots with 30 year index linked bonds. These are pricing an inflation rate of less than 3% to persist for the next 30 years.

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I think thats what people are beginning to do. Demand for TIPS is soaring because they are so cheap. I seem to remember reading something recently that firms like PIMCO and Vanguard are buying heavily. Pay off won't happen overnight but as soon as there is clear evidence that all the Governments and Central Banks moves are taking hold, inflation expectations will soar. I would certainly buy them.

we wont have hyper inflation. why would we? this would only happen if demand starting to shoot up. this is not going to happen. look at japan after their housing bubble and stock market burst, they had / still have deflation for over a decade. money being printer or not, it wont change consumers behaviour when they are in negative equity.

japanese interest rates have been near zero during all this time and it didnt help so when people say wait until the central bank moves take hold are just wrong. it wont be any different this time around. history repeats itslef all the time and the US fed are doing the exact same thing as the japanese central bank did so it will have the same outcome.

deflation for years with recesssion, then a little growth, and recession again. nowhere fast basically for 10 years.

jimbobman said:

we wont have hyper inflation. why would we? this would only happen if demand starting to shoot up. this is not going to happen. look at japan after their housing bubble and stock market burst, they had / still have deflation for over a decade. money being printer or not, it wont change consumers behaviour when they are in negative equity.

japanese interest rates have been near zero during all this time and it didnt help so when people say wait until the central bank moves take hold are just wrong. it wont be any different this time around. history repeats itslef all the time and the US fed are doing the exact same thing as the japanese central bank did so it will have the same outcome.

deflation for years with recesssion, then a little growth, and recession again. nowhere fast basically for 10 years.

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Can't argue with what you say. It is certainly the view of the majority. However, the FED and the US Government have acted alot quicker than Japan did. It took Japan years to even admit there was a problem (actually hid the problem) and then took even longer to make the necessary moves. The US is moving alot quicker and a lot more aggresively than Japan ever did. Not saying it will work but it has gone about things in a different way.

its not. the hyper inflation story is the view of the majority.

jimbobman said:

its not. the hyper inflation story is the view of the majority.

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Actually its not. As someone mentioned above, look at what the inflation protected bond market is telling you about inflation expectations. In the US, TIPS are pricing in about 11% deflation from what I can remember

Hyperinflation is far from the view of the majority. Not sure if you know what hyperinflation is. Might be worthwhile to read http://en.wikipedia.org/wiki/Hyperinflation or read up on Zimbabwe where inflation was recently estimated to be over 231 million percent per annum.

If the majority of people thought hyperinflation was coming you would see people getting rid of all paper currencies and buying tangible assets and tangible goods that would retain value. U would also see bonds sell off aggressively, even inflation protected bonds, as these bonds would become worthless in hyperinflation as the currency that they are denominated would become worthless. Commodities, property gold and other hard tangible assets would soar in value as the purchasing power of currencies plummets.

of course i know what it is . turn on cnbc and its all they talk about. buy gold cos we are going to have hyperflation. they are all saying it at this stage.

Not sure if you are correct there. Of the 100's of guests on CNBC only a handful have warned of the possibility of hyperinflation and importance of owning physical gold - Peter Schiff, Marc Faber and George Soros' ex partner Jim Rogers. Most on CNBC are clueless and are fixated on trying to buy the bottom of the stock market for the last 12 months! Good luck with that!
And that is in the US, not sure if I have ever heard any financial or economic pundit in Ireland warn of the risk of hyperinflation. The mantra in Ireland is now "cash is king". Very similar to the mantra of 2 years ago when "property was king".
Real contrarians such as Schiff, Rogers and Faber are preparing for very high inflation by late 2009 and in coming years.

george.shaw said:

...even inflation protected bonds, as these bonds would become worthless in hyperinflation as the currency that they are denominated would become worthless.

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Not so. The payments would be increased by the hyper inflation.

Lets not get too carried away. The US is not going to be the next Zimabawe

Highly unlikely U.S. will become the next Zimbabwe (UK looks more likely ;-) ) but double digit inflation as experienced in the 1970's looks very likely in the coming years (once the current deflation spiral abates).

Index linked government bonds would be murdered in hyperinflation as would all paper assets. In hyperinflation government's default on their debt, bond holders get shafted and the IMF gets called in.

Even in serious inflation, index linked bonds will underperform as government statisticians have a habit of "hedonically adjusting" and underestimating real inflation which the man in the street knows is much higher than the government statisticians let on.