Irving Fisher, the well-known monetary expert made the following remark in 1911 “Irredeemable paper money has almost invariably proved a curse to the country employing it.” Nobel laureate Milton Friedman, while analyzing this quote, said “Inflation… has always been an attractive source of revenue (for governments), since it enables governments to impose taxation without anyone voting for it.”
Now, over a century after the remark by Fisher, we have witnessed the two largest central banks in the world join SNB in pledging unlimited expansion of their balance sheets at zero lower bound rates. Whether this unlimited creation of money results in inflation immediately or with some time lag depends on how governments respond to this bonanza from their central bankers.
For this purpose we need to look at some major differences in the two recent pledges by the Fed and the ECB. While the pledge by the ECB is conditional on apriori political action, the pledge of the Federal Reserve is conditional on real economic growth. Also, while the Eurozone periphery is supposed to be implementing austerity, the US economy is experiencing unprecedented fiscal stimulus.
Given that the “austerity” in Eurozone periphery is widely disliked by the populace, one can safely assume that the “political action” required for operationalizing ECB’s balance sheet expansion will not be much different from the “adherence” to Maastricht Treaty by Eurozone members.
Given the experience of the BOJ in attempting to revive the Japanese economy using its balance sheet at zero bound rates, we should be skeptical why the Fed should be successful in its attempt. However, there is one major difference between the US of 2010s and Japan of 1990s - the JPY was undervalued, as depicted by persistent external surpluses; while the USD is overvalued, as depicted by persistent external deficits. The rise of the JPY from 360 to 75 in a matter of four decades unleashed massive deflationary forces in domestic Japanese economy, countervailing the actions of the BoJ. Evidently, this countervailing force will not operate on the American or the Eurozone economy for the next few years. An increase in geopolitical risks could, however, change the equation completely.
Hence, most likely we may witness a strong bout of inflation. Bond markets have started to get worried about this, as seen in rise in the 10-year US treasury yield from less than 1.50% to near 1.90% in less than a month.
It may be the right time for investors to Inflate their “Hopes” and stay with this inflationary hope till the human folly of the lack of self control remains in play in the hollowed corridors of global central banks. Alas, today we do not have an “Odysseus” amongst the central bankers, willing to recognize his weak soul, and willing to tie himself to the “mast” of positive real interest rates, in the face of “siren songs” of the printing presses. Until this Odysseus emerges, inflation will keep making the lives of the poor miserable every passing day. But the wealthy will see the nominal values of their assets rise at a rate beyond expectations, and this rise will happen irrespective of the level of economic activity. So, friends, rejoice – you will have many more pieces of the much loved currency (how-so-ever worthless) in your pockets.
To conclude, as Friedman put it – the key challenge before us is to “find a substitute for convertibility into (gold), that will serve the same function: maintaining pressure on the governments to refrain from …(having) inflation as a source of revenue.”