We’re now 7 years out of the grand monetary experiment and there’s still no inflation on the horizon. In fact, we seem to be coming to an increasing consensus that monetary policy and QE just hasn’t done much. These are all things I expected from the start of QE – it wouldn’t cause high inflation, wouldn’t cause rising interest rates, wouldn’t really do much of anything. If you worked through the accounting and the scenario analysis of the flow of funds, high inflation just didn’t add up. But some people still believe the risk of hyperinflation from “money printing” is real. For instance, here’s a Bloomberg view writer saying that hyperinflation could break loose like a bank run if the government spends too much money.¹
The Bloomberg article says that the deficit could cause hyperinflation in the case where the Fed just prints up money to finance the deficit directly or pay off the national debt because expectations could get out of control. Basically, if people believe the US government is bankrupt then it becomes a self fulfilling prophecy. But this is a misleading comparison. First, the Fed can’t legally fund the Treasury directly and the Treasury can’t just issue cash directly. Second, a bank run does not occur because people merely believe a bank is in serious financial trouble. Bank runs occur because banks actually are in serious financial trouble. It’s not like someone just walks up outside the bank and starts spreading nasty rumors. That’s just not how this works. This idea that currencies just collapse because people get emotional about them is not backed up by sound empirical evidence. Hyperinflations always have logical fundamental reasons for occurring.
The same point is true at the government level. If people believe the government is just printing up worthless notes then the equivalent of a run on the currency could occur. But anyone who has a good understanding of the US government’s finances and the strength of its revenue sources knows that the government is not bankrupt. In fact, the US government is probably the most credible entity in the entire global financial system which is why its liabilities are seen as a global safe haven.
What about “money printing” though? We have some pretty solid evidence on what QE and “monetizing the debt” actually does after the last 7 years – not much! When QE1 was implemented there were widespread concerns about high inflation and hyperinflation. The Fed printed $3.5T into the private sector. It did nothing. That’s because, as I explained many moons ago, QE is just an asset swap.² Spending is a function of current income relative to desired saving. QE reduces private sector income by reducing the amount of income earned from T-Bonds and swaps privately held bonds for cash. There is no net change in private sector net financial assets or saving so it actually makes sense that QE is marginally deflationary because it reduces income in the long-run while the quantity of net financial assets remains the same.
But what about just printing the money to pay off the national debt? This idea conflates the accounting at work here.³ First, the only way the national debt can get paid down in a sustainable manner is if the Congress decides to run a perpetual budget surplus. Otherwise the Treasury will have to reissue new bonds to finance the same spending every time old bonds mature. And in the case where the budget deficit remains the national debt continues to grow regardless of what the Fed does. Now, the US Treasury could print up its own notes (as it has done at times and assuming law changes) and retire the national debt. But this is just an accounting gimmick which changes one government liability (a bond note) for another (a cash note). The quantity of government liabilities doesn’t change, they simply get relabeled. So, paying down the national debt means running massive surpluses that would likely be deflationary (and unsustainable because the inevitable recession would cause a budget deficit automatically) or swapping current bonds for cash notes (which would be no different than what QE does). So the Bloomberg piece is not coherent on the operational facts here.
But what about Trump who has caused this stir in the first place? Would Trump somehow make the government’s actions inflationary? Perhaps, but we can’t really know since Trump doesn’t have a well known agenda on, well, anything. But as I said previously, I suspect that the programs Trump advocates for would result in a larger deficit. Which is exactly what the economy needs today! We’re living in a time of extraordinarily low inflation, a shortage of safe financial assets, weak household balance sheets and a period where monetary policy is obviously weak. We need an increase in fiscal policy and it still blows my mind that substantive tax cuts and infrastructure aren’t on the table since they seem like the biggest no-brainer policies in the world. We’ve been running about a -2.5% deficit the last few years with disinflationary trends so I suspect that we could easily run a larger deficit without causing very high inflation. Sadly, this persistent misinformation about the deficit is not helping anything. In fact, it’s hurting the chances of the US government implementing the one policy that might actually help get this economy going again.4
¹ – This Bloomberg piece is interesting because it cites the MMT people associated with Bernie Sanders whose policies and views I don’t really agree with. At the same time, the conclusions in this article strike me as unrealistically fearful over the impact of what even the most extremist Democratic socialist could actually get implemented in today’s political environment. Then again, the author has a well established history of misunderstanding and misinterpreting even the most basic Post-Keynesian views.
² – It’s important to note that the Bloomberg piece is operationally wrong about the impact of banking here. It states:
“If Fed money creation is balanced out by private banks withdrawing money from the economy, then money-printing almost certainly won’t cause hyperinflation. This is exactly what has been happening in the past few years.”
Banks haven’t “withdrawn” money from the economy. Consumers can repay loans which contracts the money supply. This has not been happening in the past few years.
³ – It’s actually worse than that. The author says:
“the Fed can keep printing money to pay off the national debt, and banks will just stick that money in their vaults, keeping a lid on inflation. The school of thought that believes this goes by the name of modern monetary theory, or MMT.”
I am often critical of the MMT school, but this is not at all what they say. In fact, the MMT school would agree with me that the Fed operation is just an asset swap. Banks don’t lend their reserves and the MMT people understand endogenous money very well. I don’t think the author of this piece understands the MMT position at all.
4 – I hope none of this makes you think I am in favor of perpetual or unfettered deficits. I simply believe we’re in an economic rut and that consumers could use a boost. A tax cut would be the ideal approach to solving the safe asset shortage and weak consumer balance sheet issue. In my view that should be something that could garner bi-partisan support.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.