Christian Concepts Daily
May 20, 2012
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Many policies aimred at stimulating economic growth may result in the unitended consequences of these measures argue economists Dr Alex Mirtchev and Dr Norman Bailey
‘Inflation is always and everywhere a monetary phenomenon.’ — Milton Friedman
For as long as there has been the systematic issuance of currency, there have been governments keen to control that currency. Some policies, of course, have been effective, while others decidedly less so.
Exemplary of the latter category is the attempt of the Roman emperor Diocletian (284-305 AD) to find a solution to the socio-economic turbulences besetting his world. Faced with Barbarian incursions, domestic unrest, declining production and rising prices, the emperor imposed price controls and debased the currency, the silver denarius. These measures resulted in shortages, even more rapidly increasing prices, a barter economy with a growing black market and concomitant social hardship and unrest.
Diocletian’s successor, Emperor Constantine (306-337 AD), famous for his conversion to Christianity and for founding the city of Constantinople, was, in his time, probably at least as famous for his monetary reform.
He introduced a series of bold policies and measures, some comparable with the modern understanding of fiscal discipline, epitomized by the replacement of the debased denarius with a gold coin, which he named the solidus, in a brilliant early example of public-relations spin. This currency remained ‘solid’ for 700 years, a span of time unrivalled by any other currency at any time. Notably, hoards of these coins are still found as far away from Rome as China.
History’s lessons have a tendency to repeat themselves. In response to the 2008 – 2009 financial meltdown and in pursuit of recovery, governments around the world have adopted policies reminiscent more of Diocletian than Constantine’s vision.
Confronted by multiple challenges in the wake of the global financial and economic crisis and having exhausted more traditional central bank levers which left interest rates at near zero, governments adopted a series of policies almost as a matter of course. Whether termed ‘credit easing’, ‘quantitative easing’ or ‘twisting’, these policies all have one thing in common – they increase the money supply to ramp up liquidity, driven by the age-old imperative of financial panics, ‘when every one becomes desirous of possessing himself of the precious metals as the most convenient mode of realising or concealing his property.’
Further complicating the book keeping, some central banks, most significantly the U.S. Federal Reserve, are maintaining the policy of directly monetizing the federal debt. To be clear, debt monetization is not a result of the 2008-2009 crisis; it has been used for a number of years to help finance government deficit spending. By enabling governments to continue to spend beyond their means, it, in effect, is both a cause of and a response to the sovereign debt crises faced by a number of countries today, including the United States. Indeed, ‘mounting public debt will persuade governments to monetize the deficit and cause severe inflation in so doing.’
Traditional debt monetization is a two-step process where the government finances deficits by issuing new bonds and selling them to the public. Central banks in most industrial economies are not allowed to purchase bonds directly. Central banks then purchase the bonds from the public increasing the money supply in the economy.
Post crisis, the U.S. Federal Reserve (Fed), the Bank of England as well as the European Central Bank (ECB) have turned to quantitative easing to manage the debt crisis and add stimulus to the economy — considering it, if not non-inflationary, then as a preferred remedy for the possibility of deflation. However, as noted by Robert Fisher, President of the Federal Reserve Bank of Dallas, the US is now monetizing its federal debt through quantitative easing. In other words, you might call a dog a cat, but in the end, it’s still a dog.
The dog in this case, quantitative easing (QE), is an unconventional lever of monetary policy where central banks, instead of buying or selling government bonds, purchase assets from financial institutions including banks, pension funds and other private sector entities. To do this, the central bank doesn’t actually print new bank notes. Instead, it pays for these assets by creating new electronic money and crediting the seller’s bank account with this new e-money. QE can only be done by central banks that control their own currency, e.g., the U.S. and the UK. For this reason, members of the Eurozone cannot individually employ QE as a policy tool, and instead have to rely on the ECB.