Posts Tagged ‘nobel laureate’

Germany’s head central banker calls it the work of the devil. Last year, Jens Weidmann, Germany’s answer to Mervyn King, told a story from ‘Faust’. A king is running out of money, and the devil disguised as fool persuades him to solve his problem by printing new money. The result was hyperinflation. And that, says Mr Weidmann, is why QE is like the work of the devil.

It is just that QE is not really money printing at all. When the Bank of England buys government bonds it is assumed that it will sell the bonds at a future date.  So if QE looks as though it is leading to inflation, the effects can be reversed.

That’s the theory.

The reality is that that QE doesn’t seem to be doing an awful lot. Sure it may have stopped the recession from becoming  worse, but given the sheer size of this measure – £375 billion in the UK so far – it seems remarkable how low inflation is, and how tiny growth is.

The snag is that debt is the key to the banking system we have these days.  When we borrow money from a bank, we spend it and the recipient of our money pays it into a bank. So when a bank lends money, the money it lends reverberates around the economy. In this way, by their lending, banks create money.

But if we all suddenly decide to borrow less, or if banks decide they can’t afford to lend so much, the broad money supply may well contract faster than an anaconda on speed. QE has had the effect of mitigating this contraction. But it certainly has not had the effect of creating massive growth in the broad money supply.

Perhaps then it is time to really engage in money printing and hand the resulting money out across the land. Milton Friedman pretty much suggested such an idea once. He said that in times of a depression if all else fails, why not scatter money from a helicopter. Before he was chairman of the Fed, Ben Bernanke once said he thought Friedman may have been right.

But that’s where the devil comes in: wouldn’t money printing in this way just create inflation?

For that matter, this whole idea of running a large government deficit is also seen as pretty much akin to devil worship – by some.

Well, maybe. But explain why it is that in times of war – World Wars 1 and 2 for example – governments suddenly found that they could print money to fund the war effort, and could run-up huge deficits. And why is it that the post war periods were not followed by inflation, rather than economic boom, which was often the result. Sure, Germany had hyperinflation, but that was down to the Treaty of Versailles. The UK limped along in the 1920s, but that was largely because adherence to a gold standard removed the Bank of England’s ability to create money. The argument continues to say that periods in history when governments ran surpluses were invariably followed by economic depression. See: conspiracy theories, free lunches, and the theory that banks are destroying wealth .

Some go further – they say the insistence that governments run prudent fiscal policy is a conspiracy, forced upon us by banks who are trying to protect their nice little way of making money. Is the conspiracy theory right? Probably not. But the point is that there is an alternative idea to the established view. The idea suggests that instead of the money supply growing via debt created by banks, the government boosts the money supply by creating new money, and banks’ ability to create credit is then curtailed by legalisation.

The argument may or may not be right. But we may be getting an opportunity to test the theory soon.

As US politicians refuse to compromise, and Republicans and Democrats blame each other for the US’s woes, Obama may have come up with a solution.

Under US law the US government cannot print money – that job is entrusted to The Fed. Except, thanks to legislation from 12 years ago, the government is allowed to create platinum coins. The legislation was designed simply to enable the US government to create commemorative coins.

So why not make a one trillion dollar platinum coin, deposit it with the Fed, and then withdraw money against it, thereby abolishing the US government’s need to have approval from Congress before raising its fiscal debt? Friedman and Bernanke will get their money drop, and the conspiracy theorists will have their chance to put their theories to the test.

But such a measure, unlike QE, can’t be reversed. Critics say such a move really would create inflation.

Paul Krugman, the Nobel Laureate who pens a highly influential blog for the ‘New York Times’, has suggested he is in favour of the idea. But it seems he really sees this as kind of a warning shot. He doesn’t really want to see a one trillion dollar coin; rather he reckons the threat of taking such an action will be enough to ensure that the Republicans compromise with Obama.

Perhaps what we can say is that that we are seeing a very interesting development in the story of our times.

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