The Truth About Inflation by Paul Donovan

Author:Paul Donovan
Language: eng
Format: epub
ISBN: 9781317690030
Publisher: Routledge

Printing money and investing

Printing money does not create inflation – if nothing else that is the one message investors should take from this chapter. Roosevelt’s printing of money in 1933 did not create inflation, because it was absorbed by a demand for narrow money on the part of the American public of the day. Japan’s prolific production of cash over the past quarter century has not created any meaningful inflation, as much of the cash that has been printed has been tucked away under the metaphorical futon. Similarly, six years after central banks embarked on a significant increase in narrow money supply across the industrialised world, an increase in money that aimed to avoid repeating the depression-inducing errors of the 1930s, inflation has yet to appear because that liquidity has been absorbed by demand. As long as the increased money supply is gathering dust under the mattress, or sitting idle on corporate balance sheets, the increase in money supply presents no significant inflation threat.

Investors need to have two concerns when it comes to money printing. The first is largely unconnected to inflation, and it is that the action of printing money will generally create some distortion in financial markets as the central bank purchases assets in a liquefaction process. This will generally mean that more risk has to be taken by investors if they wish to achieve a specific rate of return.

The second concern is inflation related. Investors need not worry about the inflationary consequences of printing narrow money, but they do need to be aware of the inflationary consequences of printing narrow money relative to the fluctuating levels of narrow money demand. Money demand is not simply identified, and the difficulty of pinpointing the level of money demand is one reason why central banks may periodically make mistakes and allow inflation or deflation episodes to arise.

The final point to make when considering money printing and inflation is around the independence of central banks. Political interference in the conduct of central banks is almost a necessary requirement for too much money to be printed. From medieval China via Weimar Germany to Zimbabwe, political addiction to the ease of printing money means that political interference all too often equates to too much money being printed. An independent central bank can make mistakes in its estimation of the levels of narrow money demand, and that may cause a temporary inflation surprise, but an independent central bank has measures it can take to reverse the excess money problem (either by reducing narrow money supply or artificially increasing narrow money demand).

Perhaps the best rule of thumb for investors is that printing money with a politically compromised central bank is likely to lead to inflation. If the central bank is politically independent, run by economists, then investors can afford to relax a little about the inflation consequences of any money printing that is undertaken.

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