Topic: The Death of Inflation despite QE (Read 3645 times)

When evaluating the inflationary impact of QE, its important to consider that QE can occur in two ways.  The impact of each can be different.  In the last few years central banks have been primarily buying bonds from banks, which may not be as inflationary as people expect, in the short to medium term.

1.      The central bank buys government bonds from a commercial bank. This appears to have little impact on the economy and really only effects the accounts of the two entities.  The central bank buys the bonds from the commercial bank and in the process creates deposits, (just like how a bank makes a loan to you or me).  These deposits are treated as reserves by the commercial bank.  For example if the Bank of England purchased £10m of bonds from Barclays the Balance sheet impact would be as follows.
a.       Barclays has swapped one asset for another, it has swapped bonds for reserves, the size of its balance sheet does not change
b.      The Bank of England has expanded its balance sheet, it now has a new asset, the bond and a new liability, the money it owes to Barclays

2.      The central bank buys government bonds from a non-bank institution.  Here the situation is a little more complex.  Let’s say for example the Bank of England buys a £10 government bond from a private individual Mr Smith (in reality it is large insurance companies or asset management institutions).  The Bank of England writes a cheque to Mr Smith in exchange for the bond.  Mr Smith is not going to just keep this cheque and do nothing, therefore Mr Smith immediately goes into his normal commercial bank, say Barclays and deposits the cheque.  Now Barclays has £10 more reserves because the Bank of England owes Barclays this money.  In reality of course, this all happens on instantly computers, there is no cheque.  The accounting treatment is as follows:

a.       Mr Smith has swapped one asset for another, he had a bond and now he has bank deposits.  His balance sheet remains unchanged
b.      The Bank of England has expanded its balance sheet, it now has a new asset, the bond and a new liability, the money it owes to Barclays
c.       Barclays has expanded its balance sheet, it has a higher level of reserves which is an asset and it has increased its liabilities, which is the deposit.

I think it is vital to understand the dynamics of QE as these two mechanisms have different outcomes.  Method 1 merely helps banks out in a major liquidity crises.  Method 2 increases bank deposits, Mr Smith has money which he is likely to spend on something.  This is likely to boost the economy and may be inflationary.

Fair point but I'm just talking about 5,000 Euro of a loan. I could struggle to pay 500 a month back for 10 months. If things get tough I'd lower the amount is all.
It is not 50,000 Euro!

That is what they do (invest in assets), but they have a government guarantee if the market tries to burn them too bad.  You would not be so lucky and would wind up filing bankruptcy if things turned against you.

Thanks for the rates guys. I am an American living in Germany so I guess I don't get the good rates.
I would love to get a 5,000 Euro loan at 2%. I would roll it into Bitcoins at an opportune time.
I mean isn't that what the banks are doing once they get money from the FED? They buy bonds, put money into the stock market, etc. as that is near guaranteed profit with little risk. Risk... ehehhe

I highly recommend Wealth of Nations.  It is required reading for anyone who wants to study economics.  BTW, it isn't the worker who increases productivity (other than the initial ramp up as they learn their job), it is technology that makes each worker more effective.  Ultimately, this leads to less demand for labor and does indeed lead to price and wage deflation in an unmanipulated economy.  The worker can never expect anything other than his wage, which is dependent upon economic conditions, until he takes his productive capacity into his own hands rather than merely offering it to the highest bidder.

Here in the US, I get a steady stream of credit card balance transfer offers for 0% interest for the first 18 months and a 3% transfer fee, so effectively 2% annually for 18 months.  Obviously, when rates rise the ability to roll it over will dry up.  However, I only have a balance because I've chosen to pay down student loans with 6-8% interest instead.  I've got enough assets to cover the balance if necessary.

In Canada I am offered 0-2% with a 1% handling fee for 6 months to 1 year. I would pay 6% on my no frills Credit Card and 18% on my 1% back Credit Card.

Spot on.

Contemporary Author Eckhart Tolle's New Earth sees this happening now and predicts it will happen (an awakening).
I had a hard time reconciling the idea as all the things I enjoy today are a result of forced labour. So I wrote it of as an impractical spiritual Utopia on my first reading.

Now understanding the economic mechanisms behind Monetarism I see a clear vector between where we are and where we need to be to continue human evolution.

Bitcoin is the most effective meme I've found in achieving that goal.

Hawker, over exaggerated, it is not all that bad. Read Adam Smith's Wealth of nations for a clear overview of economics.
My point though is it is going to inflation (aka the bankers)

Oh boy, so where is the incentive for the worker to increase productivity if the fat lazy capitalist should reap all the rewards? Just another capitalist i see.

Article explains why printed money did not cause inflation yet. But this money will be spent eventually. It is very naive to think that this money will never be in actual circulation, and it is naive to think that bank money creation mechanism won't multiply it like 20 times.
And what FED is going to do when inflation kicks in eventually? Sell bonds? This will remove bearly 1/20th of injected money due to what I said above. Not to mention the fact it will make goverment borrowing fuckin expensive.

I'm curious here. What interest rates are you guys being offered on credit cards and loans. I understand better credit history means more.
Anyway, I get these offers in the mail (I'm in Germany) and there are credit offers (loans) for 8.5% - 8.9% over 5 years! I am shocked as I don't have bad credit and am self employed for years now.
And that is cumulatively of course, so 8.5% on 10,000 is way way more than 850 Euros.

It just gets me that these banks get such low interest loans from the ECB and then fractionally loan out magnitudes greater amounts at crazy rates. It really should be illegal. How is this helping us?

Working less is not my goal.  Increasing the entertainment value of work, or the work value of entertainment would be a better goal.  Doing what you love to do and having that provide meaningful value to yourself and others is the way to be.

In other words, consider what you would do if you owned all your time, and do that.

solution = Bitcoin

A while ago I found myself sharing a table during lunch with a Director of the largest local credit union.  
Rather than just blurt out Bitcoin and the need for reform in the environmental and Financial systems, (as Amir Taaki so eloquently addresses the bankers in his interviews) I thought I would talk about the resulting problems caused by the system and see if I could come to a consensus and then introduce Bitcoin.

I never got to discuss Bitcoin, Instead I was pigeon hold as a work less party activist. This was something that court me off grad, as a left leaning anarcho capitalist, and utilitarian environmentalist, I had thought of the local work less party, as a bunch of fundamental hippie urban farmers, devoid of material aspirations.

So the discussion revolved around many of the goals the work less party and addressing there platform, which I was rather clueless about.  

Where I had to conclude my discussion is, our economy needs growth, and reducing the amount of work we need to do, to keep on going is a political reform we will have to enforce through law if the political will exists. (Not my opinion just were we left off)

My take home was if one wanted to achieve the goal of more leisure time (working less) and curb exponential economic growth, you can do it with one single reform, if you can effectively introduce a fixed non adjusting means of exchange (money ) you will achieve that objective.  

The net problem is cause by monetary inflation. So mitigating the inflation form QE, is not a solution, it is a tax on the productive members of the economy (the makers of the actual things we need) and all these high flying economists and critics seem to overestimate the fundamentals in the economy.  

The fundamental being: I pay producers $1.30 an hour to produce the typical things society needs, and I pay my layers $500 an hour to suppress competition, and the net outcome is more money is spent on the layer in the economy than on the goods and services that drive the economy.  And as a business the inflation happens first in the professional services and about 2 years down the line the costs of productive labour increases, I am no economist, but I can see the writing on the wall, something has got to give, and it is not the producers at the bottom who are underperforming.  

This pretty much hits the nail on the head. As we enter the "new normal" economic growth cannot continue at the rates we are used to. It is limited by both natural resources and population growth. We need a paradigm shift away from using increased productivity to make more stuff. Instead increased productivity should-> lower prices and less work. If I work less, and thus make less money, but prices are dropping (due to increased productivity and ideally a lack of central bank intervention) I am essentially channeling that increased productivity into a higher standard of living. Over the long term economic growth shouldn't exceed population growth by much.

Since you mention plain old economics, Adam Smith would disagree with you.  According to him, while the capitalist might see a small short term boost in profits, it is solely the landholder who sees any long term benefit from technological increase in productivity.  This is because, as Mark Twain said (paraphrasing), "buy land, they don't make it anymore".  Liquid capital on the other hand is virtually unlimited, as is labor.

Many interesting points here!

In my opinion, if your efficiency increased but your income did not increase, it means that the money supply is not enough -- more product chase for the same amount of money, so that each product get less paid

But there could be other reasons that your income can not increase by 8x even your efficiency has lifted by 8x

For example, if one business is more than 20% profitable, then capitals will enter this branch and increase the competition and drive down the profitability. Patent/secret process might delay that effect but eventually it will even out

And, the demand could not increase by 8x due to consumers do not have 8x income,  added production capacity will just lower the sale price. Of course various type of consumer loans could increase the sale, but it could never generate 8x more sale than before. Anyway, a big part of people's income in the next decade has already been sucked into housing, you can't expect a dramatic increase in spending for decades (Japan's lost 20 years)

The most possible benefit of an increased efficiency is that you could spend much less time to do the same work. But for employee, since the salary is decided by the amount of worked hours, this just means they have to sit in the office and do nothing. And when their boss see that they are not doing anything, they will fire some of them, and that will further reduce the income and demand for the whole society

Due to the limitation in total demand, reduce the working hours is the best way to benefit from the efficiency increase, but seems only a few governments are supporting this view, most of them still think working 8 full hours a day is necessary

Spot on

Interest rate has already been low (0.25%) for a long time,  but average household still pay a lot for their mortgage interest, so most of those cashs are pumped into banks' pocket

QE3 and QEI money was used to buy debts (agent MBS and government bonds), but these debts will have to be repaid at a later time, it just like borrow some more money to buy some time to avoid the default, it does not improve the income, just increase the debt

Correct. The problem with Monetarism , Milton Friedman's Keynesian / Free Market hybrid (aka a managed economy,) is the free market can't adjust to keep the market balance of supply and demand in equilibrium. There are winners and losers and the manipulators have some control on who they are.

One way for central banks to work the system is keep adjusting how the CPI is calculated to make the model work better, the result is misallocated recourses, they call it risk management, but always the risk is mitigated to benefit the present at the expense of the future, while inflation may be bearable for some it will kill the creativity in the economy and the first quality of life compromise will be accommodation for new home owners and renters alike.   

I don't have a mortgage myself, but don't the lower interest rates lead to higher housing prices? So if you already have a mortgage it's great, but if you're young and are looking to buy your first house you're kinda screwed here. And low interest rates can't be sustained forever, what happens when they rise again? Bubbles go *plop*. Yeah QE is great for some, bad for others and worse for the future.

As in your increased productivity and innovation reduced inflation in your sector.  Fair point.  In the early 90s I had a headhunting firm with 7 staff - the Internet meant firms could get direct applicants and that reduced firms costs.  Of course, it put me out of business.  So I know what you mean - these productivity increases can be very painful for those involved.

You have assumed the capital didn't originate with me; or the risk undertaken in the business was deviating from the status quo was insignificant. None the less, I would agree bad business investments parr for the course.
But you (and monetarists) are overlooking the role increased productivity and innovations have on the economy.  

Replacing workers is more expensive when financing costs are higher, if a business can get a loan for next to nothing it makes sense for them to do so and to invest in capital (robots, automation, advanced software etc). If the cost of capital is high it is significantly cheaper to higher a low wage employee as their are 0 financing costs associated with hiring most workers. granted this assessment assumes that all else is equal, when you have things like massive changes to how much companies pay for healthcare and social security that necessarily drives up the cost of hiring people vs machines.

Also the majority of the 99% would be protected by the FDIC under a default, most of them don't have more than a quarter of a million worth of fiat sitting in their checking account. I believe that 5-10 years from now the legacy of the G8's experiment with sustained QE and by extension ZIRP will be the buildup of an asset bubble of currently unknown proportions. Just like easy money helped fueled the dot com bubble and the housing bubble it is now fueling the risk asset bubble. Anything with yield is being snapped up by professional investors just like high yielding mortgages were before the housing crash.

As to lower mortgage rates, that's a great idea but most people with ARM were for foreclosed on and getting a Refi for anyone without stellar credit is pretty hard where I live. Also the 1% probably makes more in a month of the rise in risk assets (dow and S&P 500 at historic highs) then the 99% saves on paying .5% lower rate on mortgage. Especially when you consider the tax implications negate about 1/3 of any savings. While a 99%er with good credit might be able to get a loan at 3.5% JPM and BoA are paying .5% and turning around and gobbling up yield irrespective of long term valuations. QE benefits the first recipients of money which are the financiers of government debt, not contractors or government employees.

I think that hits on a different issue, the competitiveness within the market.  I was specifically talking about the effects of QE.  When the federal reserve sets interest rate via QE it is overriding the market forces that you reference and thus we get bad investment booms (the tech bubble or housing bubble are examples.)  In the long run it wont even be the Chinese firm with cheaper labor costs that will wipe you out it's the company that goes fully automated, similar to what Foxconn is pushing towards these days. 

My main point was that for all of the talk about the benefits of QE there are potential downsides and they are not included in most analyses of the usefulness of the policy. 

But you are in a market.  If you don't get rid of the unproductive worker, a factory in China will put your entire company out of work.  Surely the higher the interest rate, the faster you have to fire people?

No worries I have no problem with reasonable people disagreeing.

My point about the 5% interest is that in a more normal interest rate environment (I picked 5% as an example, my main point is that 0% is not a normal interest rate) a project that has to meet a 5% return on investment hurdle rate (I'm veering off into finance here) is going to be much harder to find than a project that has a 0% return on investment hurdle rate.

If I buy a machine that replaces human workers for $100 using borrowed money and have 0% interest then that machine needs to earn me at least $101 to justify the investment.  At 5% it has to earn at least $106 which narrows down the investment pool.  Ultimately those workers are still going to lose their jobs if a machine can replace them, but QE(0% interest rates) allows the process to accelerate. 

Surely the worker is more likely to be replaced when finance costs 5% as the business is under that much more pressure?

I take your point about "unreasonable" - your point was perfectly reasonable and I just disagreed.  Sorry

QE effects the timing of their fate.  A project to replace a human worker with an automated machine is less likely to happen at 5% interest rather than 0.

Even with QE there is the risk of default.  Banks still grow broke today, look at Cyprus if you don't believe that.  Also there are plenty of historical examples where inflation inflicts a significant loss not the "tiny loss" you reference, get some facts before you call my point unreasonable.

That's not a reasonable point.  Without QE you have risk of default and that would mean confiscation of savings.  Given the choice, people choose the tiny loss that inflation inflicts.

The workers that can be replaced by outsourced labour or machines are surplus to requirements.  QE is not relevant to their fate - they need to be looking for new jobs.

On the other hand 0% interest rates mean anyone with savings is having money taken directly out of their accounts.  Also 0% interest rates makes it much cheaper to invest in those innovative technologies that replace expensive human workers with less expensive automation.  QE is not a free lunch.

Adrian-x what you are describing is increased productivity.  None of the benefit of that should go to you as a person doing the work - it goes to the provider of capital.  This has nothing to do with QE - its plain old economics.

One fundamental point that is overlooked in these examples is Innovation.

When I started my new company over 10 years ago it was just me. I employed the latest technologies available in the industry, and I was more productive than the previous company I worked for who employed 8 people.  

To my surprise over time my competitive advantage was lost and my income was reduced. What changed is I was now expected to be 8 times more productive for the same salary, those who didn't adapt went out of business and those who did became more productive. Being more productive did not equate to an increase in revenue but rather it masked inflation with a static price, the benefit was absorbed by the printing of money.  

The point being the efficiency innovation employs is lost through the increase in the money supply, and it is disguised as price stability or marginal inflation.  The net benefits of technology don't benefit the manufacturers or the consumers but the fractional reserve banking system.  Obviously there are industries that innovate slower or faster than others - computers would be a good example, but the trend is innovation is lost to inflation.

It doesn't say that at all. 

Add this to the fact that government money goes first to the government employees, and banks and contractors.  They get it before inflation's effect.  Once they spend it into the economy and the rest of us get hands on it, it is post-inflationary.

The onset of inflation is often rapid and changing monetary policy is not fast nor often is it rapid in effect, in the USA:

The OP's linked article basically says no, it hasn't. 

The claim is that the QE has enabled institutions to keep afloat and keep paying huge salaries and bonuses, and made asset prices higher, but has not reached the consumer.  Price inflation shows up when the average consumer suddenly has more cash to spend, so retailers can start jacking the prices.  The current DOW highs and continued large bonuses have apparently not (yet?) affected the average consumer. 

For most consumers, having higher net wealth will affect spending.  However for the first few levels of QE beneficiaries, the extra money isn't going to affect spending at all and therefore won't affect price inflation. 



 

Unless I am mistaken, QE has pushed down interest rates.  Many of the 99% have mortgages so QE is already directly pumping cash into their accounts.  The same pressure on bond rates has kept a large tranche of people in jobs that otherwise would have been lost due to companies being unable to raise cheap finance.

1% of that QE money has reached the 99%

You mean the death of price inflation despite concurrent monetary inflation. 

Conditions, especially velocity of money, will change the exact numbers but in general it probably takes somewhere in the neighborhood of years to a generation for price inflation to emerge after monetary inflation.  Especially if the monetary inflation just goes to the very top of the pyramid and has to go through a narrow funnel to get lower.   

Price inflation will of course arrive immediately if any of that QE money ever makes it to the 99%.  The big question is, will it?       

This clearly shows that currency's valuation has no direct relation to supply and demand, it is decided by consensus

People always use hyperinflations happened during war to prove that oversupply of money will cause inflation, but that is a very bad example of exponentially increased military spending combined with reduced productivity in the society, and a high risk of government being wiped out in the war. During normal days, even a 10x increase in money supply won't impact CPI that much, most of those newly added money can just sit in someone's pocket doing nothing

And this further proved that the current pyramid of central bank managing from the top is not a good structure for organizing the society

Interesting article on how years of money printing has failed to get inflation started.

http://coppolacomment.blogspot.com.au/2013/05/inflation-deflation-and-qe.html

Money quote: