Why money printing hasn't led to inflation

Mar 24, 2015

- By Vivek Kaul

Vivek Kaul
In response to the last column Janet Yellen's excuses for not raising interest rates will keep coming a reader wrote in asking why all the money printing that has happened since September 2008 in the aftermath of the financial crisis, hasn't led to inflation.

In this column I try and answer that question. Economist John Mauldin estimates that central banks have printed $7-8 trillion since the start of the financial crisis. In another estimate, author and financial derivatives expert Satyajit Das points out balance sheets of the major central banks have expanded from around $5 trillion prior to 2007-2008 to over $18 trillion.

The central banks printed this money (or rather created it digitally through a computer entry) and used it to buy government and private bonds and this has led to the expansion of their balance sheets. In fact, the amount of money pumped into the financial systems of the developing countries has been so huge that it would be suffice to purchase a large flat-screen TV for every single individual in the world, points out Das.

By buying bonds, central banks pumped the printed money into the financial system. This was done primarily to ensure that with so much money floating around, the interest rates would continue to remain low. At low interest rates people would borrow and spend. This would help businesses grow and in turn help the moribund economies of the developing countries.

But money printing should have led to inflation as a greater amount of money chased the same amount of goods and services. Milton Friedman, the most famous economist of the second half of the twentieth century, wrote in Money Mischief - Episodes in Monetary History: "The recognition that substantial inflation is always and everywhere a monetary phenomenon is only the beginning of an understanding of the cause and cure of inflation...Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation. There is probably no other proposition in economics that is as well established as this one."

Nevertheless that did not happen. Inflation remains very close to 0% in large parts of the developed world. Why is that the case? Japanese economist Richard Koo perhaps has an answer.

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Koo calls the current state of affairs in the United States as well as Europe a balance-sheet recession. Japan had seen a huge real estate as well as stock market bubble in the 1980s. In fact, such was the confidence in the high home prices continuing that by the end of the 1980s Japanese home buyers were even taking out 100-year home loans or mortgages.

As Stephen D. King writes in When the Money Runs Out: "By the end of 1980s, it was not unusual to find Japanese home buyers taking out 100-year mortgages, happy, it seems, to pass the burden on to their children and even their grandchildren. Creditors, meanwhile, naturally assumed the next generation would repay even if, in some cases, the offspring were not more than a twinkle in their parents' eyes. Why worry? After all, land prices, it seemed, only went up."

That did not turn out to be the case. The stock market bubble started bursting in December 1989, and the real estate bubble followed. Koo feels the current Western situation is very similar to that seen in Japan in 1990, when both the stock market bubble and the real estate bubble had burst.

What does this imply in the current scheme of things? People in the developed world had taken on huge loans to buy homes in the hope that prices would continue to go up in perpetuity. But that wasn't to be. Once the bubble burst, housing prices crashed. This meant the asset (i.e., homes) people had bought by taking on loans had lost value, but the value of the loans continued to remain the same. Hence, people needed to repair their individual balance sheets by increasing savings and paying back debt. This act of deleveraging, or reducing debt, brought down aggregate demand and threw the economies in the developed countries into a balance-sheet recession.

A similar thing happened in Japan as well in the 1990s. In the aftermath of the bubbles bursting the Japanese carried out quantitative easing where they bought bonds in the hope of maintaining low interest rates, so that people would borrow and spend. Nevertheless, that did not happen because people were busy paying off their old loans.

A similar dynamic is at play in the developed countries at this point of time. Hence, people are not borrowing and spending at the same rate as they are expected to, because they are busy paying off old loans. As Tim Harford explains in The Undercover Economist Strikes Back: "Printing money creates inflation only if people want to spend the money right away. And perhaps they don't."

While, there has been no inflation in the conventional sense of the term, what the world is seeing instead is asset price inflation. A lot of the printed money has been borrowed at very low interest rates by institutional investors and has found its way into financial markets all over the world.

Other than this money briefly went into gold and then into other physical assets as well. As Gary Dugan of RBS told me in an interview sometime back: "Gold went up as much as it did in its last wave. If you look at Sotheby's and Christie's, in the art market, they are doing extremely well. The same is true about the property market. Places which are in the middle of a jungle in Africa, there prices have gone upto $100,000 an acre. Why? There is no communication. No power lines."

This explains why there is no inflation but there is asset price inflation for sure. To conclude, it is important to understand something that Harford writes: "The Federal Reserve (and other central banks) spent decades ... acquiring a reputation for waging a ruthless, unending war against inflation. That reputation is so powerful and so valuable that people naturally wonder whether the Federal Reserve really would encourage inflation once the slump ended. The trouble is that if people don't believe that threat, they won't start spending and the slump will continue."

Do you see all the money printing in the Western world leading to inflation? Post your comments or share your views in the Equitymaster Club.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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10 Responses to "Why money printing hasn't led to inflation"

Faiz

Oct 16, 2015

Thaks, very informative article. Prior to reading this article even I wondered why there isn't any Inflation in US but you have cleared my doubt. I like articles realted to Inflation, Printing Money, International Econkmics etc. Write more of it. Thank you.

Like 

Harish Kumar

May 20, 2015

Dear Mohan,

Most of the bad assets created by banks from 2001 to 2007/08 were off-loaded from the banks balance sheet through securitized products like RMBS, MBS. So, I think that most of these assets are not there in the banks balance sheet.

Like 

Chandra

Mar 25, 2015

When (time frame) you think Americans (or Developed countries) pay off their debt and return to spend money on consumption?

Like (1)

Gopalan

Mar 25, 2015

Dear Mr Kaul,
Many thanks - wonder whether I was the one who posed this question.
would also like your thoughts on whether shale gas/ oil production would change the complete economic landscape for the USA and place it in an unassailable position alongwith relentless growth and being a pioneer and leader in Technology - in the global economy. The low energy price may help reverse the personal credirt excesses and lead to consumer spending ?

Like (1)

MOHAN IYER

Mar 25, 2015

Dear Kaul,
I like your writings but for the first time iam amazed to note that even a knowledgeble person like you should maintain a false notion that there is no inflation. Come on give me a break. Just three main area where inflation is absolute: 1. Real Estate 2. Health and 3. Education. Its not just food & clothes anymore.
The key issue which is rarely discussed in the media is what to do with the pre-2008 bad loans that still remain on the balance sheet fraudulently as assets.
1. All those bad loans that were made leading up to the 2008 crisis still remain on the balance sheets as assets.
2. Accounting rules were changed in order to avoid marking these bad loans to market (If they had to mark to market based on pre-2008 rules, then would have had to reduce the loan amounts on the asset side of the balance sheet and take an expense). This accounting rule scam allowed institutions to avoid balance sheet bankruptcy and show fake accounting profits.
3. To avoid cash flow related bankruptcy (where is the money to pay the next bill), the Fed provided liquidity to the institutions that hold these bad loans. In the last few years, I'm guessing some of these bad loans were re-sold to governments around the world so that tax payers can pay the price in the future. How many of these loans were repackaged into funds bought by the Fed, we don't know thanks to the lack of transparency.
4. Raising of interest rates will merely increase the cost of avoiding bankruptcy since to hide the poor assets, new money will be needed at higher rates impacting income.
Finally the trust on which the entire credit based economy works will lead to defaults, collapse of the institutions & chaos.
can u please elucidate answers in your next article.
thanking you,
regards,
Mohan Iyer

Like (1)

Aditya

Mar 24, 2015

One more point I would like to add to this article - more to confirm my understanding (and would invite feedback).

The money that the Fed is printing is going into banks. These banks are not releasing the money to the public, instead they are using the money to trade and buy assets or push up asset prices. Inflation happens when the man on the street gets money to spend (ultimately every B2B has to sell B2C) but that is not the case currently. It was the case pre-2008.

The money is also finding its way, potentially through PE or VC route into 'service' businesses like taxi-for-sure and OLA, which then pay the consumer to buy the service. Basically there is so much credit floating around now and so little getting to the man on the street that most 'product' businesses are reporting a sales and profitability decline and most successful services businesses are paying consumers to buy their services.

The desparation for the money to be consumed is so high that Switzerland is offering negative interest rates (is this fact correct?) - they may money to take money??

What kind of statistics can we analyze to test this hypothesis??

Like (1)

Sadasivan

Mar 24, 2015

Because the USA,especially EXPORTS its Inflation to the other
countries of the World.Its weak Dollar is mad e to look stronger
by massive QEs by the likes of BoJ,BoE and ECB.
Developing and Third World nations depend for their earnings
on exports to the developed economies at very cheap
rates,suffering hyper-inflation themselves.
Cheap goods from China and others mentioned above, reduce
inflation in the developed economies,despite massive printing of
money.

Like (1)

S S Naik

Mar 24, 2015

Dear Mr Kaul
I agree that the current monetary system is so skewed in favor of asset bubble creation that when it bursts so many innocents people, will lose their wealth but they don't seem to understand however much you explain,. I think you should ask them to watch zeitgeist movies to get a hang of what mess the world is in,

Regards
S S Naik

Like (1)

k.s.sashikumar

Mar 24, 2015

The USD enjoys the status of international reserve currency and there is a lot of appetite for it around the world. The USD is the only thing in the world which defies demand and supply theory. If this printed money floats in US inflationary trends can be witnessed but, as you said, it goes to all parts of the world creating asset bubbles.Now, Fed"s monetary policy has become more important than the monetary policies of all other central banks. The appetite for USD is so much around the world so that it would take a very long period for the inflation to be perceived locally in US.

Like (1)

Deeapk Padher

Mar 24, 2015

No ! I dont think that money printing will lead to inflation. I do agree with authors view.
Printed money has raised asset prices and stock prices only.
I am worried that these money may raise inflation in India.

Like (1)
  
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