Further to Quantitative Easing Explained, Inflation Explained:
So inflation is a policy which hurts the poor while it helps certain types of rich people?
Indeed, which is why we need fundamental bank reform: the banking system is institutionally inflationary and that is ruining society.
Further reading here.
A great lesson on inflation from Frank Shostak appears on mises.org, including this quote from Ludwig von Mises:
Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term “inflation” to refer to the phenomenon that is an inevitable consequence of inflation, that is, the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. …
As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.
The point is that our monetary system is designed to produce inflation by encouraging bank lending and, when money creation through that mechanism falters, “Quantitative Easing” takes over. A better term would for all this would be be “robbery”.
Read the rest of the article here: Inflation Is Here, and It Is Going to Get Worse – Frank Shostak – Mises Daily.
You may also enjoy The Crime Known as Quantitative Easing and the Violation of Mr Smith at The Cobden Centre.
Fortunately, these ideas are taking off. See for example the Adam Smith Institute’s What is inflation?
Via The Cobden Centre, The Crime Known as Quantitative Easing, a superb article by Robert Sadler:
Rather helpfully, on the Bank’s website there is an explanation of how Quantitative Easing was supposed to improve the economy. Quite clearly, the Bank explains that they purchased British Government bonds (gilts) and high quality (investment grade) bonds from private sector companies (banks, pension funds, insurance companies and non-financial institutions). The Bank’s concern was that there was too little money “circulating” in the economy. Using this method, the Bank was able to inject the much needed money directly into the economy and the companies that needed it. The idea was two-fold; a) asset prices increase, wealth increases and spending increases; b) more money, means more spending, bank reserves increase, meaning more lending, spending and income increases, inflation arrives at the magic 2% rate and we all live happily ever after, growing fat off of the magic wealth creation machine at the Bank. But there is a dark side to this fairy tale and at the risk of sounding clichéd, it is because in this case, more money really does mean more problems.
I recommend the entire piece.
Later, I’ll set out the case against inflation, which is caused by the instutional design of the banking system. For the moment, here’s a relevant article from the Cobden Centre:
Mr Smith works hard, plans carefully, and saves what he can, putting his money into a building society. He pays his credit card bills off each month, and tries to overpay his mortgage when he can.
Mr Smith got a 3% pay rise last year – inflation was only 2% – so he felt good about that. But… he doesn’t feel any wealthier.
Year after year, the government had said that the economy was growing strongly, but still, things seemed harder for his family and him. Train ticket prices up again. Heating bills rocketed when the price of oil went up, but never seemed to come down. He swears a loaf of bread and a pint of milk were much cheaper in years gone by.
When he changes his cash for Euros, he realises that his holiday in France is now unbearably expensive. His tax rates didn’t go up, but still, after all his bills were paid, he seemed to have less and less spare cash than he remembers a few years ago.
There are Mr Smiths everywhere. Careful folk, who plan, save for a rainy day and have a sense of personal responsibility.
Smith is the target.
I had the pleasure this morning of visiting a medium-size third-generation Wycombe family business. These were the issues which came up:
* Inflation is now distorting their business at all levels, from customers’ needs, through staff pay to input costs.
* Over-regulation is grotesque in their industry. They must comply with over 12000 pages of rules introduced in the last ten years to protect consumers. Those rules don’t protect their customers; they protect the business and their suppliers. Meantime, the long local history of the business is testament to the fact that looking after their customers is in their own interests.
* Employment law appears to have been designed to work for large, flabby organisations, not SMEs, which are the mainstay of our economy.
Still, at least their customers in manufacturing are doing well but I wonder to what extent that is due to currency debasement.
All in all, it was a great demonstration of the poisonous effects of government intervention in money and in the rich panoply of relations that comprise social cooperation through production, exchange and consumption: that is, the market.
The sooner the state confines itself more closely to preserving the institutions of property, contract, the classical Rule of Law and good money, the better things will be for us all.
Compare and contrast:
Via Bond bubble burst will gut gilt investors, warns Merrill Lynch – Telegraph Blogs:
Never mind what the Bank of England monetary policy committee says about interest rates on Thursday. One of the biggest wealth managers in the world is discretely warning its income-seeking clients to beware of bonds issued by the British Government; generally known as ‘gilts’.
Merrill Lynch Wealth Management fears that despite the apparent security of gilts, a combination of rising inflation – already underway – higher interest rates and the cessation of quantitative easing – both widely anticipated – could create a “perfect storm” for investors who buy these bonds at current market prices.
And via Friedrich August von Hayek’s Nobel Prize Lecture (emphasis mine):
In fact, in the case discussed, the very measures which the dominant “macro-economic” theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable. The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate. What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity. The fact is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing; not because, as this view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to occur as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.
Hayek’s remarks about the affect of new money on unemployment are of general applicability and might be considered an extension of the Cantillon Effect (PDF). Money is not neutral: where it is injected into the economy matters. New money – whether through QE or credit expansion in excess of real savings – certainly creates economic activity, but it also distorts the structure of activity into shapes sustained only by the injection of new money.
And so now we see that QE – injecting new money into the bond market – has created a problem in the bond market.
You can find out more about the errors of QE here.
In researching a piece on QE, I found this from Mises’ Socialism, which can stand alone for the moment. Here, by “inflation”, Mises means an increase in the money supply, which causes price rises. For Mises, “Destructionism” is the socialist strategy of tearing down the existing order in the hope that the socialist utopia will emerge. The work dates from 1932 and it tells us most of what we need to know today.
Inflation is the last word in destructionism. The Bolshevists, with their inimitable gift for rationalizing their resentments and interpreting defeats as victories, have represented their financial policy as an effort to abolish Capitalism by destroying the institution of money. But although inflation does indeed destroy Capitalism, it does not do away with private property. It effects great changes of fortune and income, it destroys the whole finely organized mechanism of production based on division of labour, it can cause a relapse into an economy without trade if the use of metal money or at least of barter trade is not maintained. But it cannot create anything, not even a socialist order of society.
By destroying the basis of reckoning values—the possibility of calculating with a general denominator of prices which, for short periods at least, does not fluctuate too wildly—inflation shakes the system of calculations in terms of money, the most important aid to economic action which thought has evolved. As long as it is kept within certain limits, inflation is an excellent psychological support of an economic policy which lives on the consumption of capital. In the usual, and indeed the only possible, kind of capitalist book-keeping, inflation creates an illusion of profit where in reality there are only losses. As people start off from the nominal sum of the erstwhile cost price, they allow too little for depreciation on fixed capital, and since they take into account the apparent increases in the value of circulating capital as if these increases were real increases of value, they show profits where accounts in a stable currency would reveal losses. This is certainly not a means of abolishing the effects of an evil etatistic policy, of war and revolution; it merely hides them from the eye of the multitude. People talk of profits, they think they are living in a period of economic progress, and finally they even applaud the wise policy which apparently makes everyone richer.
But the moment inflation passes a certain point the picture changes. It begins to promote destructionism, not merely indirectly by disguising the effects of destructionist policy; it becomes in itself one of the most important tools of destructionism. It leads everyone to consume his fortune; it discourages saving, and thereby prevents the formation of fresh capital. It encourages the confiscatory policy of taxation. The depreciation of money raises the monetary expression of commodity values and this, reacting on the book values of changes in capital—which the tax administration regards as increases in income and capital—becomes a new legal justification for confiscation of part of the owners’ fortune. References to the apparently high profits which entrepreneurs can be shown to be making, on a calculation assuming that the value of money remains stable, offers an excellent means of stimulating popular frenzy. In this way, one can easily represent all entrepreneurial activity as profiteering, swindling, and parasitism. And the chaos which follows, the money system collapsing under the avalanche of continuous issues of additional notes, gives a favourable opportunity for completing the work of destruction.
The destructionist policy of interventionism and Socialism has plunged the world into great misery. Politicians are helpless in the face of the crisis they have conjured up. They cannot recommend any way out except more inflation or, as they call it now, reflation. Economic life is to be “cranked up again” by new bank credits (that is, by additional “circulation” credit) as the moderates demand, or by the issue of fresh government paper money, which is the more radical programme.
But increases in the quantity of money and fiduciary media will not enrich the world or build up what destructionism has torn down. Expansion of credit does lead to a boom at first, it is true, but sooner or later this boom is bound to crash and bring about a new depression. Only apparent and temporary relief can be won by tricks of banking and currency. In the long run they must land the nation in profounder catastrophe. For the damage such methods inflict on national well-being is all the heavier, the longer people have managed to deceive themselves with the illusion of prosperity which the continuous creation of credit has conjured up.
In the course of writing a presentation on bank reform, I rediscovered this from Keynes’ The Economic Consequences of the Peace:
Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
And then there is this:
More anon.
At The Telegraph, Ambrose Evans-Pritchard calls for a further extension to our binge:
Tight fiscal policy offset by ultra-loose money is the only option for Europe, the US, and Japan.
At The Cobden Centre, Professor Kevin Dowd says that Calls for further monetary expansion are cuckoo, and James Tyler, Chief Executive of Tyler Capital, describes the article as Monetarist whitewash.
Contemporary economic thinking takes too many aggregates, amongst its other faults (see for example Money, Bank Credit and Economic Cycles, pp 519-583). Monetarists generally ignore the structure of production. A consequence is policy which is bound to cause worse problems later. As Hayek said in his Nobel lecture:
The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate. What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity. The fact is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing; not because, as this view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to occur as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.
In the course of scheduling a series of articles for The Cobden Centre on the Theory of Money and Credit, I found this quote which seems apposite after our recent spell of “quantitative easing”, the injection of new money into the economy, also known in some circles as inflation of the money supply:
A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, i.e., of antidemocratic, policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. It explains why inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. When governments do not think it necessary to accommodate their expenditure to their revenue and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism.
Emphasis mine.
