Is Hyperinflation Just Around The Corner?
By Laurence Kotlikoff in
Forbes Magazine
In his
parting act, Federal Reserve Chairman Ben Bernanke has decided to continue
printing some $85 billion per month (6 percent of GDP per year) and spend those
dollars on government bonds and, in the process, keep interest rates low,
stimulate investment, and reduce unemployment.
Trouble
is, interest rates have generally been rising, investment remains very low, and
unemployment remains very high.
Bernanke’s
dangerous policy hasn’t worked and should be ended. Since 2007 the Fed
has increased the economy’s basic supply of money (the monetary base) by
a factor of four! That’s enough to sustain, over a relatively
short period of time, a four-fold increase in prices. Having prices rise
that much over even three years would spell hyperinflation.
And
while Bernanke says this is all to keep down interest rates, there is a darker
subtext here. When the Treasury prints bonds and sells them to the public
for cash and the Fed prints cash and uses it to buy the newly printed bonds
back from the public, the Treasury ends up with the extra cash, the public ends
up with the same cash it had initially, and the Fed ends up with the new bonds.
Yes,
the Treasury pays interest and principal to the Fed on the bonds, but the Fed
hands that interest and principal back to the Treasury as profits earned by a
government corporation, namely the Fed. So, the outcome of this shell game
is no different from having the Treasury simply print money and spend it as it
likes.
The
fact that the Fed and Treasury dance this financial pas de deux shows how much
they want to keep the public in the dark about what they are
doing. And what they are doing, these days, is printing, out of thin
air, 29 cents of every $1 being spent by the federal government.
I have
heard one financial guru after another discuss Quantitative Easing and its
impact on interest rates and the stock market, but I’ve heard no one make clear
that close to 30 percent of federal spending is now being financed via the
printing press.
That’s
an unsustainable practice. It will come to an end once Wall Street
starts to understand exactly how much money is being printed and that it’s not
being printed simply to stimulate the economy, but rather to pay for the
spending of a government that is completely broke — with long-term expenditures
obligations that exceed its long-term tax revenues by $205 trillion!
This
present value fiscal gap is based on the Congressional Budget Office’s just-released
long-term Alternative Fiscal Scenario projection. Closing this fiscal gap
would require a 57 percent immediate and permanent hike in all federal taxes —
starting today!
When
Wall Street wises up to our true fiscal condition (and, some, like Bill Gross
already have), it will dump long-term bonds like hot potatoes. This will
lead interest rates to jump and make people and banks very reluctant to hold
money earning no return. In trying to swap their money for goods and
services, the public will drive up prices.
As
prices start to rise and fingers start pointing at the Fed for fueling the
inflation, QE will be brought to an abrupt halt. At that point,
Congress will have to come up with an extra 6 percent of GDP on a
permanent basis either via huge tax hikes or huge spending cuts.
Another option is simply to borrow the 6 percent. But this
would raise the deficit, defined as the increase in Treasury bonds held by the
public, from 4 to 10 percent of annual GDP if we take 2013 as the example.
A 10 percent of GDP deficit would raise even more eyebrows on Wall
Street and put further upward pressure on interest rates.
But why
haven’t prices started rising already if there is so much money floating
around? This year’s inflation rate is running at just 1.5
percent. There are three answers.
First,
three quarters of the newly created money hasn’t made its way into the blood
stream of the economy – into M1 – the money supply held by the
public. Instead, the Fed is paying the banks interest not to
lend out the money, but to hold it within the Fed in what are called excess
reserves.
Since
2007, the Monetary Base – the amount of money the Fed’s printed – has risen by
$2.7 trillion and excess reserves have risen by $2.1
trillion. Normally excess reserves would be close to
zero. Hence, the banks are sitting on $2.1 trillion they can lend to the
private sector at a moment’s notice. I.e., we’re looking
at an gi-normous reservoir filling up with trillions of dollars whose dam can
break at any time. Once interest rates rise, these excess reserves will
be lent out.
The fed says they can keep the excess reserves from getting lose
by paying higher interest on reserves. But this entails poring yet more
money into the reservoir. And if interest rates go sufficiently high, the
Fed will call this practice quits.
As
excess reserves are released to the economic wild, we’ll see M1, which was $1.4
trillion in 2007 rise from its current value of $2.6 trillion to $5.7
trillion. Since prices, other things equal, are supposed to be
proportional to M1, having M1 rise by 219 percent means that prices will rise
by 219 percent.
But,
and this is point two, other things aren’t equal. As interest rates
and prices take off, money will become a hot potato. I.e., its velocity will
rise. Having money move more rapidly through the economy – having
faster money – is like having more money. Today, money has the
slows; its velocity – the ratio GDP to M1 — is 6.6. Everybody’s
happy to hold it because they aren’t losing much or any interest. But
back in 2007, M1 was a warm potato with a velocity of 10.4.
If
banks fully lend out their reserves and the velocity of money returns to 10.4,
we’ll have enough M1, measured in effective units (adjusted for speed of
circulation), to support a nominal GDP that’s 3.5 times larger than is now the
case. I.e., we’ll have the wherewithal for almost a quadrupling of
prices. But were prices to start moving rapidly higher, M1 would
switch from being a warm to a hot potato. I.e., velocity would rise
above 10.4, leading to yet faster money and higher inflation.
I hope
you’re getting the point. Having addicted Congress and the
Administration to the printing press, there is no easy exit strategy.
Continuing on the current QE path spells even great risk of
hyperinflation. But calling it quits requires much higher taxes,
much lower spending, or much more net borrowing (with requisite future
repayment) from the public. Yet weaning Uncle Sam from the printing press
now is critical before his real need for a fix – paying for the Baby Boomers’
retirement benefits – kicks in.
The one
caveat to this doom and gloom scenario is point three – increased domestic and
global demand for dollars. The Great Recession put the fear of God
into savers worldwide. And the fact that U.S. price level has risen
since 2007 by only 15 percent whereas M1 has risen by 88 percent reflects a
massive expansion of domestic and foreign demand for “safe”
dollars. This is evidenced by the velocity of money falling from
10.4 to 6.6. People are now much more eager to hold and hold onto
dollars than they were six years ago.
If this
increased demand for dollars persists, let alone grows, inflation may remain
low for quite a while. But our ability to get Americans and
foreigners to hand over real goods and services in exchange for very few green
pieces of paper is hardly guaranteed once everyone starts to understand the
incredible rate at which Uncle Sam is printing and spending this
paper. Once everyone gets it into their heads that prices
are taking off, individual beliefs will become collective reality. This
brings me to my bottom line: The more money the Fed prints, the more it
risks everyone starting to expect and, consequently produce, hyperinflation.
Laurence
Kotlikoff is a professor of economics at Boston University, a Fellow
of the American Academy of Arts and Sciences, a Research Associate of the
National Bureau of Economic Research, a contributor to Bloomberg, the FT, the
Economist, Forbes, and other media and President of Economic Security Planning,
Inc. -- a company that markets personal financial planning at
www.esplanner.com, www.esplanner.com/basic, and
www.maximizemysocialsecurity.com. Recent books: The Economic Consequences of
the Vickers Commission, The Clash of Generations (with Scott Burns), Jimmy
Stewart Is Dead, and Spend 'Til the End.
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