Money printing will result in ruinous inflation

The Bank of England is financing government debt on a huge scale – and someone will have to pay

In financial markets, anticipation is often a more potent driver of movement than the event itself. That’s why, after a sharp October sell-off, we have seen stock markets largely shrug off confirmation of the two outcomes they had been fearing most – a second wave of coronavirus lockdowns and a disputed US presidential election.

A substantially impotent presidency looms, whichever candidate eventually triumphs. With no majority in Congress, both Biden and Trump will struggle to push through much of their policy agenda. Only last week, such an outcome was being widely described as the worst of all possible worlds. But now it’s been confirmed, investors seem happy to go with the flow.

Personally, I’ve never understood why a gridlocked Congress should be thought such a bad thing. Part of the genius of the US political system of checks and balances is that it prevents the executive from doing stupid things. An ineffectual presidency might reasonably be thought better than a highly active one.

But there is another reason why markets have taken the recent raft of economic and political negatives on the chin – the sound of the cavalry riding to the rescue with another great splurge of monetary policy action. Prospects for Biden’s giant fiscal stimulus may be fading fast, but no matter; the world’s central banks can be relied on to do the heavy lifting instead.

Over the hill here in Britain comes the Bank of England, with an additional £150 billion of “quantitative easing”. Such has been the scale of asset purchases since the financial crisis 10 years ago that once the latest allocation has been fully spent, the Bank will be the proud owner of nearly half the current stock of UK public debt of £1.8 trillion.

For all the Bank’s supposed independence, it is in fact just an arm of the state; in buying up government debt, the Bank behaves like the vendor bidding against himself at an auction. One part of the government machine ends up buying the other’s IOUS. This is handy when so many of them are being issued, and particularly handy right now when the Chancellor is further piling on the debt by extending the jobs furlough scheme until the end of March. It may help save jobs, but like so many other aspects of renewed lockdown, we can only guess at the cost to future generations.

Without the Bank’s support, the markets would be suffering a severe bout of indigestion; renewed lockdown would indeed scarcely be a viable policy option in the first place.

Not that this has been offered as the official justification for more QE. Absolutely not. There is a world of difference, the Bank has always insisted, between primary financing of government deficits, where the central bank simply prints the money the government needs to finance itself, and so-called QE, where it buys up the debt in secondary markets after it has first been bought by investors. If you think the distinction is academic, you’d be right.

In any case, after the experience of hyperinflation in Weimar Germany, Zimbabwe and elsewhere, direct financing of government spending is still regarded as completely taboo by most central bankers.

So please do stick with the official explanation – that of depressing market interest rates so as to encourage households and companies to spend rather than hoard, and thereby bring subdued inflation back in line with the target. That it also helps governments finance their elevated levels of spending is entirely by the by. Believe that if you will.

In truth, the two explanations – the official one and the never-to-beadmitted one – are just two sides of the same coin. If demand is depressed because the private sector isn’t borrowing to spend, the public sector must borrow to support that demand instead. And if in so doing it ends up borrowing from itself, then at least it can’t go bankrupt.

Do not believe, however, that all this monetary financing is somehow costless. It won’t be this year, or next, but the stars seem ever more well aligned for an eventual upsurge in inflation. Domestic savers forced to buy government debt at today’s ruinously expensive levels are taking far bigger risks with their money than they are led to believe. Government debt will always repay in full on maturity; quite how much it will have been devalued in the meantime by the ravages of inflation is another matter.

Yet it is not just the scale of today’s central bank manipulation of the markets that gives cause for concern. It’s also that some of the big disinflationary forces of the past 30 years are starting to go into reverse, particularly cheap goods from low-cost labour markets such as China. Rising incomes in the developing world in combination with the pursuit of economic self sufficiency is almost bound to have significant inflationary consequences almost everywhere.

All such arguments tend for now to be dismissed as faintly eccentric, fringe thinking; the immediate challenge is that of deflationary forces, not inflationary ones. But watch them go mainstream over the years ahead.