Milton Fails In The End

Scary Bernanke

We recently came across a news item and an editorial, both of which discuss the merits of monetary pumping by central banks. The news item was posted at Zerohedge and reported on a recent meeting between hedge fund manager David Einhorn’s and Ben Bernanke. Einhorn afterward averred that he found the former Fed chairman’s views ‘scary’ and we can only agree. One item stood out specifically:

“EINHORN: I asked several things. He started out by explaining that he was 100 percent sure that there’s not going to be hyperinflation. And not that I think that there’s going to be hyperinflation, but it’s like how do you get to 100 percent certainty of anything? Like why can’t you be 99 percent certain and like how do you manage that risk in the last 1 percent? And he says, well, hyperinflations generally occur after wars and that’s not here. And there’s no sign of inflation now and Japan’s done a lot more quantitative easing than we’ve done, and they don’t have it. So if there is a big inflation, the Fed will know what to do. That was kind of the answer.”

There are several things that are problematic about Bernanke’s answer, even though we would agree that hyperinflation is unlikely to be an imminent problem for the US at this point in time. First of all, hyperinflation does not require war, and it is also not the ‘result of war’. Was Zimbabwe at war? Is Venezuela at war? The only way in which war can possibly play into it is by causing the monetary authority to inflate in order to fund the war. If war expenditures were funded entirely by taxation, no inflation would occur. A secondary influence on prices may be the possible destruction of production capacity (when fewer goods are produced, their prices will rise, ceteris paribus), but primarily it is the monetary authority’s decision to inflate that creates the conditions that can lead to hyperinflation. Bernanke is only correct insofar as fiat money, central banks and fractional reserve banking were all introduced, respectively tolerated, because politicians realized that funding wars by printing money is not as unpopular as funding them by taxation.

No-one ever embarked on hyperinflation intentionally. It was either not properly understood by the perpetrators that printing a lot of money could lead to a breakdown of the currency system, or they believed that they could keep things under control – until control was lost anyway (i.e., just like Bernanke, they were “100% certain”).

As to Japan, either Bernanke is deliberately obfuscating, or he really doesn’t know that ‘QE’ in Japan works slightly differently than in the US. Neither possibility is very comforting. The difference in brief: when the Fed engages in ‘QE’, it creates almost dollar for dollar as much deposit money as bank reserves. This is not the case in Japan, where the BoJ creates only reserves when it buys securities directly from banks, while concurrent deposit money creation is confined to its purchases from non-banks. The reason why it is different in the US is that the primary dealers are legally non-banks, even though most of them belong to banks. Hence, ‘QE’ by the Fed has created a lot more money supply growth than ‘QE’ by the BoJ, in spite of the fact that the BoJ’s ‘QE’ program is nominally much larger (currently, the year-on-year growth rate of Japan’s money TMS is 5%, which is fairly high for Japan, but still well below both US and euro area money supply growth).