Scott Sumner faced off against Peter Schiff yesterday on the Kudlow Report discussing inflation, QE, government spending and macro in general. You can see the full interview here. Some brief thoughts on the blow by blow:
– Kudlow starts by saying that the inflation doves (people who said inflation wouldn’t be a big problem) have won. He called out the hyperinflationists, the gold bugs, the high inflationistas, etc. So, score one for everyone who said inflation would be low.
– The interview got off to a bad start when Kudlow asked Sumner why the “printing press” money from QE didn’t cause inflation. Sumner said: “when interest rates fall close to zero you can put a lot of money into the system and it doesn’t have much inflationary effect. This is especially true since they started paying interest on reserves back in October 2008 and that further encouraged banks to hold onto the money”. This is way off base. First of all, most of the money via QE is getting into the system by non-bank Treasury Bond and MBS sellers. The banks are merely operating as middlemen issuing deposits in exchange for securities which are then traded on to the Fed. A much smaller portion of QE is done ONLY with the banks in what I’ve described as a clean asset swap (reserves for t-bonds). I don’t know what Sumner means by banks “hold onto the money” because the reserves the banks hold end up in the interbank market no matter what. The reserves don’t “get out” of the interbank system in what sounds like some sort of money multiplier concept.
– At the 2:30 mark Peter Schiff says the BLS has changed the way inflation is calculated (which Sumner promptly smacks him down over with the Billion Prices Project) and then states the Austrian position that inflation = more money creation (no, inflation is a rise in the price level). Printing money and burying it in holes, for example, tells us absolutely nothing about “inflation” or anything for that matter. Defining “inflation” as an increase in the money supply ignores a multitude of real-world factors.
– At the 6:20 mark Sumner reiterates his position that QE is causing money to “just sit in the banking system”. Of course it just sits in the banking system. The reserve deposits are only exchanged in the interbank market. They don’t leave the banking system. You or I can’t use reserve deposits. Once again, he’s reverting to some traditional money multiplier argument which is wrong. But again, this comment ignores the fact that there is real money creation (bank deposit liabilities increase) via QE because most of QE is done via non-banks who swap t-bonds for deposits (which results in no change in private sector net worth).
– At the 7:50 mark Peter Schiff digs in on his high inflation bet and states that the US government might “have trouble paying the interest on the national debt”. He then says the only reason we can afford to pay the interest is because rates are low (because the Fed set them there because inflation is low). He also reiterates the tired old argument made by guys like Bill Gross when QE2 was ending that interest rates will rise if the Fed stops buying bonds. Of course, Gross was dead wrong as rates tanked after QE2 ended. There was no shortage of buyers of government bonds. In fact, Treasury auctions showed STRONGER bid to covers just as I predicted they would.
– Sumner finishes off strong saying that Schiff is wrong about default and that rates are likely to remain low if QE ends.