QE Forever and Banana Republic Monetary Policy
What’s the difference between “polished” Western nations applying Quantitative Easing (QE) and a Banana Republic printing endless, worthless money? Credibility, it seems, that stems from GDP and reserves too, also differentiate nations in numbers. Yet defining the difference is an interesting and often alarming pursuit, so similar are aspects of QE and junk money.
Why shouldn’t the US or the UK go into terminal hyperinflation by enacting what are ostensibly collapsed state money printing measures? Led by the Federal Reserve, central banks worldwide have seemingly repeated what most would consider a recipe for disaster, were it applied to emerging markets. Of course, economists have long lists of differences between QE and the junk money induced by hyperinflation. Money engineering can be very similar to money printing, however, and there is only so much financial engineering that even giants like America can get away with before the veneer starts to thin.
The similarity in approach between QE and a classic worthless currency story presents as far more disconcerting than the lengthy technical details usually mustered to explain the differences. Unlike dated historical hyperinflation episodes, much has also changed politically (and commercially) over the last two decades. China has become the manufacturing arm of the globe, with a growing economy that dwarfs almost all others. There is an ongoing commitment to dismantle existing petrodollar arrangements and allegiances, confirmed during a recent meeting of the Russian and Chinese heads of state. The old, clear lines between weak and strong (and their currencies) have forever blurred.
There are also shifting and solidifying political alliances from the Middle East to Asia, that present the first real challenge to Western hegemony since the First World War. These modern realities serve to accentuate the need for answers to the simple question: how can the QE nations get away with so blithely ensuring money supply as a response to financial woes? Historically, any country that abused its printing press paid dearly in currency value, ultimately resulting in a wholly collapsed economy.
MONEY PRINTING HYPERINFLATION: A CASE STUDY
Arguably the most analysed hyperinflation episode to date occurred in Germany early in the 20th century. The victor nations of WWI decided to assess Germany for their costs in waging war against the belligerent German nation. With no means of paying in gold, or currency backed by reserves, Germany ran the presses, causing the value of the mark to collapse. The Weimar Republic printed the papiermark in volume to address the post war debt, as its only means of payment. Very quickly, between 1921 and 1923, hyperinflation consumed the German republic’s currency, making the papiermark essentially worthless.
The social fallout included unheard of hardships in the country for the general populace, as well as considerable internal political instability. It led to the occupation of the Ruhr region by France and Belgium, as well as the overall loss of any kind of fair-trade options for the bruised nation. At the end of 1923, it took 1 trillion papiermarks to buy a single goldmark. Between 1914 and the end of 1923, the German papiermark’s rate of exchange against the US dollar plummeted from 4.2 mark/dollar to 4.2 trillion mark/dollar.
The price of one gold mark (0.35842g gold weight) in German paper currency at the end of 1918 was two paper marks, but by the end of 1919, a gold mark already cost 10 paper marks. This inflation worsened between 1920 and 1922, as it rapidly degenerated into hyperinflation. The cost of a goldmark (or conversely, the devaluation of the papiermark) rose from 15 to 1,282 papiermark. In 1923, the value of the papiermark had its worst decline. By July, the cost of a goldmark had risen to 101,112 papiermark, and by September the rate sat at a whopping 13 million papiermark
For a single goldmark. In just another two months, on 30th November 1923, it cost 1 trillion papiermark to buy a single goldmark. To go from one hundred thousand to one trillion units in two months, Germany experienced a 29,500 percent hyperinflation during October 1923. This extrapolates into roughly 21 percent interest per day. Bizarre scenarios of buying bread in the morning and being unable to afford it in the afternoon were commonplace in German households.
The repercussions of this bottomless free-fall of commercial conventions were virtually identical to later snapshots of hyperinflation. Historically, this extreme one-month inflation rate has since only been exceeded three times: in Hungary, at 41.9 quadrillion percent (207 percent per day) in July 1946; Yugoslavia at 313 million percent (64.6 percent per day) in January 1994; and Zimbabwe, at 79.6 billion percent (98 percent per day) in November 2008. Previously Argentina, and modern Venezuela, have also depicted the insane ravages of hyperinflation.
MODERN REENACTMENTS OF HYPERINFLATION
The Germany that became the bedevilled Weimar Republic had been bombed into hyperinflation. It lost the war and its credibility, its ability to dictate its affairs conventionally. It is not only military conflict that cultivates the right conditions for hyperinflation, however. Failed political cohesion and/or internal policies have since in practice far exceeded the tragedy of the Weimar Republic’s war-induced hyperinflation. The need for a national currency and blunt attempts to ensure circulation of viable money, for example, led to 1940s Hungary being the worst case of hyperinflation on record.
To be fair, external aggressors of WW2 had decimated Hungary’s economy. But as per the modern QE notion of ensuring money supply, the Hungarian government of the time subsequently turned the country’s economy to ashes by copiously printing money. On the cusp of hyperinflation, in June 1944, the Hungarian pengo had dipped to 33 units against the US dollar. By June 1946, one US dollar cost 460 trillion, trillion pengo. At the time, the regime quite literally ran out of decent quality paper with which to print bank notes.
Even more recently, Venezuela’s economy is still battling the ravages of hyperinflation. Again, the inevitable comeuppance for turning to the mint, millions of Venezuelans currently cannot afford basic necessities such as food and toiletries. Prices are effectively doubling with each passing month, and the IMF is on record as predicting an inflation rate in the millions of percent for Venezuela in 2019.
YET MONEY SUPPLY IS STILL BEING ENGINEERED
With a further round of QE currently on the agenda, why has QE not simply tumbled the playing economies into hyperinflation? Firstly, some of the essential differences between QE and Banana Republic knee-jerk currency printing are valid. Indeed, some economists point out the although pushing liquidity into the markets, the Fed, for one, is actually not printing money per se, but simply enacting a “fiscal transfer.” The Fed pays interest on owned money; money it has a monopoly to issue. In this closed circle, hyperinflation is theoretically stymied.
Secondly, with QE, the Fed can be said to be simply altering the composition of public financial assets, and/or their duration. In this economic exercise, no “new” money is printed as a final solution to cash flow and economic stability. While this is all good and well, the one thing central banks can never truly control is market sentiment. Should the integrity of bonds and currencies become suspect, perhaps due to the unavoidable dilemma around raising interest rates beyond nominal terms, for example, public confidence and participation in the machinations could fail, sparking an economic implosion.
Accounting is a two-tier system with a precarious balance. In the eventual reshuffle to return to a “normal” market economy, sentiment may sour and serious corrections could occur, bringing the prospects of hyperinflation dangerously closer. Modern Monetary Theory (MMT) predicted the avoidance of hyperinflation under QE, dealing as it does with the subtleties of a fiat economy. Interest rate and term adjustments as well as other fiddling to maintain an economy, leave out the vagaries of what many consider the principal driver of a currency’s value, however, namely sentiment.
QE has largely been a smooth if sometimes obnoxious exercise, largely because of the authoritative stance of the US Reserve and the measured pace of application. Very importantly, too, a prime reason for QE not having induced ghastly inflation to date is that economies were already deflationary as QE was initially enacted. No matter how sophisticated, the fact remains that central bank interference in remedying commercial woes is fundamentally dangerous. As soon as a currency’s value is freed of determination by a free market system and engineered by the authorities, it becomes something else.
No matter the euphemisms for ‘Quantitative Easing,’ money printing is money printing, and history has proven these policies to lead to desperate economic turmoil. Nothing builds genuine economic prosperity like confidence. And nothing builds national confidence (positive sentiment) like a free, operationally strong currency. The “emergency measure” of QE contaminates all of that. The proof will come in its ending, when in theory QE must die, as the emergency has passed. That is when the true nature of the romance between QE and hyperinflation will be seen.
