Wednesday, March 30, 2016

This is what "printing money" looks like

Since late 2008, when it launched the first of its three Quantitative Easing programs, the Fed's accusers have bemoaned its massive money-printing, sure that it would lead to the debasement of the dollar, the advent of hyperinflation, and the end of the world as we know it. I was part of that crowd initially, but soon realized that the Fed's massive expansion of bank reserves was not inflationary because it simply offset the banking system's incredible demand for safe, dollar liquidity. I've had many posts over the years which have expanded on this theme.

I've been an avid student of monetary policy and inflation ever since I spent four years living in Argentina in the late 1970s. As I recall, inflation averaged about 125% a year while I lived there, and during a visit to the country in the mid-1980s I was fascinated to watch hyperinflation unfold: prices almost tripled within the span of three weeks. A year ago I wrote a post on the subject of inflation and Argentina, in which I explained that the conditions in Argentina that allowed a huge increase in inflation don't exist here in the U.S., fortunately. The government of Argentina relies on direct printing of money to finance its deficit, whereas the U.S. government finances its deficit by selling bonds. When the Argentine government needs to finance a budget shortfall, it can "borrow" money directly from its central bank in exchange for an IOU, which in practice is never repaid. This shows up on the central bank's books as "Loans to the Federal Government." In essence, the Argentine central bank simply runs the printing presses whenever the government needs money, and the government pays its bills with funny money.

Here's what it looks like when a central bank "prints money" and high inflation results:

Argentina's most recent bout of money printing and high inflation started back in 2009, when the government started running a deficit that needed to be financed by money printing. By early 2010, the growth in the supply of currency in circulation in Argentina was nearing 30%. Currency in circulation has grown at an annualized rate of about 30% ever since, as the chart above shows—in the past six years, the supply of currency has expanded almost five-fold, from 82 billion to 400 billion pesos. In the U.S., in contrast, currency in circulation has been growing at a 6-7% annual pace for decades, and strong offshore demand for greenbacks has been the main driver of that growth.

True money printing results in higher inflation because there's basically too much money chasing too few goods and services. Printing money with no solid backing and in excess of the public's need for money simply causes the value of money to fall and prices to rise. We see this in the chart above, with the early signs of money printing showing up in the black market (referred back then as the "blue" rate of exchange) in mid-2010. Since March of 2010, the peso has fallen by almost 75% against the dollar, and inflation has been running around 30% per year. We don't know for sure how much inflation there's been, because the government office charged with measuring inflation was long ago told to just make up the numbers. The government of Cristina Kirchner didn't want to acknowledge what it was doing, but everyone who lives there knows that inflation was been very high for many years.

The new government of Mauricio Macri has vowed to stop the money printing, but it hasn't happened yet. The problem is that Argentina still can't finance its deficit by borrowing money legitimately. That may change soon if the government is able to mend relations with its foreign creditors and if it manages to rein in its excessive spending. I'm optimistic it will happen, and if it does we should see slower growth in currency, a gradual stabilization of the peso, and stronger growth in the economy. Big changes are afoot in the southern part of Latin America, and it could get pretty exciting if Brazil joins the reform movement.


Benjamin Cole said...

Interesting post.

Entering the world of monetary economics is to venture into a land of totems, nostrums, atavistic beliefs in pretty metal, and rampant fear-mongering.

The Bank of Japan has persisted with a QE program in recent years with little inflationary effect.

Is there such a sustained global demand for safe liquidity in yen?

The globe is awash in excess supply in nearly every commodity and manufactured good. This is actually great news!

Allowing demand to finally escape monetary suffocation is a good idea at this point. The central banks have been fighting inflation since the 1980s, and they can't seem to get that topic off their minds.

10-year Treasuries are under 2%. In Japan even less. In Switzerland you pay banks for the privilege of giving them your money.

The Fed could do a few more trillion dollars in QE with much positive effect.

As I always say, "Shoot for Full Tilt Boogie Boom Times in Fat City and wake me up tomorrow afternoon."

Scott Grannis said...

Argentina is a great example of how inflation and money printing destroys an economy. Are you sure we need to try this experiment here? Are you sure that the US economy is sluggish because the Fed has done enough QE? Are you sure it wouldn't make more sense to try fiscal policy instead of monetary policy to stimulate the economy?

Chuck Reynolds said...

Since WWII, we have had a national debt that we have not tried to repay. So, now we have the interest payments on that debt to service, as well as every other debt we have accumulated. If Argentina had a problem with borrowing money from its central bank that it did not intend to pay, and that created a problem, I am inclined to think that the USA is only getting away with it for now. I wish I had a crystal ball to see where this game ends.

Christophe said...

Chuck it will not end till something looks safer than a treasury bond... We will have shocks (maybe even a 1987) but we will probably not see the day US treasury bonds lose credibility for an extended period of time.

Lawyer in NJ said...

In the US, the issue is how best to stimulate demand via fiscal rather than monetary policy.

Scott Grannis said...

On the subject of debt: I suggest reading a post of mine from last year:

Debt is not necessarily a bad thing, as I explain in the post. Our federal debt is not too large to service, and repaying it will not necessarily be a huge burden on our economy. The most important issue with debt is how the borrowed money was spent. If spent on something productive, then debt is a boon to the economy. But if the money was wasted, weak growth is the result. One of the reasons we are still in a weak recovery is that we borrowed lots of money (trillions) in the past 7-8 years, and much of it was wasted on transfer payments. We've had a mini-Greece problem here. The damage has been done. What we do going forward is the only thing that needs attention now.

William McKibbin said...

Unbridled national, state, and local debt -- vast deficit spending at every level of government -- stock market gains without earnings -- zero interest rates -- horrific trade imbalances -- lingering long-term declines in real working wages, real home values, and the employment to population ratio -- continuing wars on the other side of the planet -- all real right now -- take cover...

Thinking Hard said...

Scott - Any suggested reading of personal accounts of hyperinflation in Argentina?


William McKibbin said...

I see little chance of inflation -- the worry is deflation...

Lawyer in NJ said...


Didn't transfer payments (as a subset of automatic stablizers) reduce the depths of the Great Recession? So even if they might be suboptimal policy in periods of relative normalcy, don't the play an important role in crises?

Scott Grannis said...

I think it's safe to say that just about everything the government did to "help" the economy before and during the Great Recession only made things worse.

See the book "FDR's Folly" by Jim Powell for the gruesome details.

One automative stabilizer that makes sense is unemployment insurance, provided it is privately financed.

Benjamin Cole said...

Scott: the US also spent $8 trillion on "national security" in the last eight years. DoD, VA, DHS, black budget, pro-rated debt. From a classical economic view point, all of that $8 trillion was wasted.

Benjamin Cole said...

Scott--I favor fiscal policy but only on the form of tax cuts. I would prefer to shrink the federal budget down to about 10% of GDP, eliminating the Department of Agriculture, HUD, DOL, Commerce and a minimum 50% cut in "national security" outlays. A FICA tax reduction offset by QE is a good idea too. Eliminating the corporate income in appealing, although over at CBI they say If you eliminate corporate income taxes but maintain personal income taxes you will see a lot of income suddenly become corporate income.
So yes--- cut taxes, cut spending, gun the presses.

Is there a global demand for yen? They are conducting QE without inflation.

Scott Grannis said...

When talking about cutting government spending, it is very important to keep in mind that currently 74% of federal government spending ($3.7 trillion in the past 12 months) is in the form of transfer payments ($2.7 trillion in the past 12 months). This is the elephant in the living room that must be addressed since the bulk of this spending is non-discretionary.

Benjamin Cole said...


Yes, but you must carve out Social Security and Medicare spending from the federal budget. I understand, and egads even remember, when LBJ went to a "united budget" and lumped in FICA taxes and Social Security and Medicare outlays with the rest of the federal budget. That was before I got my toupe.

But the FICA-tax financed outlays are really not the same animal as the federal budget, the latter financed by income and capital gains taxes.

If you want to cut income and capital gains taxes (a good idea!) I think we have to take suggestions of the Cato Institute seriously, and take a hard long look at US foreign policy-military structure and expenses.

Worth noting, that of all the candidates, only Don Trump (an outsider- business guy) is willing to ask questions about the US offshore military footprint, and to state clearly that Iraq was a "$5 trillion waste of money."

Hillary Clinton, in contrast, has a 17-point program (or some such nonsense) for resolving Syrian-Iraq snags. I bet only a few more trillion dollars are needed, with Hillary in there. A few trillion taxed from you and me.

I think Mancur Olson had it right. Ossification sets in, no matter what party is in power.

I do wish we had a more-sensible, or less bombastic choice than Trump, but at least he might break up some cozy spending circles. The GOP, and worse the Donks, have proven they will not stop the gravy train, even while wrapping themselves in the American flag, or other glorious mantles. If a woman anywhere on the planet is mistreated (Hillary) or if a terrorist anywhere kills someone (the GOP), they want a few more trillion dollars from you.

David Stockman has termed DC the "welfare-warfare state."

William McKibbin said...

Scott, you said, "Debt is not necessarily a bad thing... Our federal debt is not too large to service, and repaying it will not necessarily be a huge burden on our economy." Well, my guess is that paying back $19 trillion will be a "huge burden on our economy." In fact, I doubt the money will be back except perhaps by the 2% annual inflation target (which comes to a 100% reduction of debt over 50 years). Of course, inflation will not cover interest and new borrowing.

Let's think this through. If we agree with you that paying back debt is not a burden, then why shouldn't every America immerse themselves in as much debt as possible under the assumption that the debt will be paid back in the indefinite future with future borrowing (?). What's good for the Federal government, states, and cities, should be good for ordinary citizens, right? Herein lies the moral dilemma for government.

A government that is unable to set the example for borrowing is doomed, perhaps not economically, but definitely morally. I would prefer to live in a country where the nation sets the example for its citizens and other countries of the world. The indiscriminate borrowing of $19 trillion that is unlikely to be paid back except via future borrowing and inflation is not an example that our people or other nations should or can follow, tolerate, or endow.

Assuming that the status quo is infeasible morally (and therefore politically), the alternatives are harsh and unavoidable. My preferred approach would be to cut government spending immediately by: a) passing a balanced budget amendment; b) redeploying our nation's military forces back home for homeland security, national emergencies, population control, and border patrol duties); c) resuming conscription and lowering pay and benefits for active duty military; d) making all non-uniformed government jobs volunteer positions without pay and benefits (including politicians); e) passing a 'right to work' amendment that guarantees every American the right to work throughout their lives (or until such time as they have the personal resources to retire); f) outlawing defined benefit plans; g) limiting future Social Security and Medicare payouts to the fully disabled exclusively; and h) redirecting all the nation's qualified retirement plan assets into treasuries. The process would be painful, but would pay huge benefits for future generations.

Of course, I am open-minded to other approaches as long as the plan is to retire the national debt and outlaw deficit spending forever.

Again, morality dictates that the Federal government set an example for its citizens and other nations by retiring the national debt and outlawing deficit spending. Anyone hoping to avoid this reckoning is delusional as to the outcome. I see no hope for the current economic status quo in America.

Thanks for considering my views...