Ottawa reducing value of money and spending billions

I may be a billionaire, but I feel short-changed. With better timing, I would have been a trillionaire. A few years back, I attended a talk by a Zimbabwean economist. He finished by passing out $10 billion Zimbabwean bank notes, and I got one. That was then. Zimbabwe went on to print $100 trillion notes—that is $100,000,000,000,000 dollar notes, and I missed out.

Across the globe, policymakers, including in Canada, are more or less doing what created Zimbabwe’s calamity—massive moneymaking, reducing the value of money and funding huge government expenditures.

Hyperinflation has led to some of the world’s greatest tragedies, from Argentina to Zimbabwe to Venezuela to Weimar Germany in 1920s, paving the way for the economic disaster that brought the Nazis to power. In Germany, a loaf of bread that cost 163 marks in 1922 soared to 200,000,000,000 marks in November 1923.

Normal economic life becomes impossible. Prices change daily, often several times. Bank accounts are worthless. A full day’s wages on Wednesday won’t buy a potato on Thursday. Uncertainty devastates investment.

Canada and many other countries are engaged in massive money creation, known as quantitative easing (QE). Central banks make money electronically and use it to buy government bonds, which fund government spending. The Bank of Canada has undertaken “large-scale asset purchases of at least $5 billion per week of Government of Canada bonds.” The European Central Bank aims for €1.35 trillion of QE, the Bank of England for £745 billion and the U.S. Federal Reserve for US$700 billion.

With more money circulating, interest rates (effectively the price of money) fall. Governments boost spending with the money central banks create and then spend more again by borrowing since interest rates for government are often near zero, and sometimes below. Canada, the United States and the Euro zone are recording huge deficits, with Canadian governments gearing for even more.

Moreover, QE creates unfairness. With interest rates low, people who have been diligently saving see returns on their savings collapse. On the other hand, again because of low interest rates, money floods into assets, like the stock market, boosting prices. Those with big portfolios benefit. People depending on savings for retirement suffer.

The seeds of hyperinflation can be planted innocently enough. Many, but not all economists, argue in a crisis that pumping out money helps stabilize the economy. However, that sets a trap. When to end?

Inflation sneaks up and policy-makers may respond badly. Adam Ferguson, in “When Money Dies,” wrote that Weimar authorities understood the unfolding hyperinflation disaster but feared shutting down the money spigot. “Day by day through 1920, 1921 and 1922 the reckoning was postponed… as the consequences of inflation became more frightening.”

Still, hyper-inflation in advanced countries is unlikely as central bankers understand the dangers. However, today’s print-borrow-and-spend strategy may lead to another debilitating disease; let’s call it “that 70s show.” Governments across advanced economies in the 1970s were spending wildly and racking up huge deficits under an accommodating monetary policy—similar to now.

Policymakers at the time liked inflation. The extra dollars made people feel richer and boosted demand and economic growth, or so it was thought. But instead, it led to “stagflation.” Big spending and easy money meant the number of dollars chasing goods grew faster than the economy’s productive capacity. Inflation soared to a peak of 14 per cent in Canada and the U.S. But it no longer spurred growth. People didn’t feel richer with a 10 per cent raise when inflation was 14 per cent.

Monetary magic failed but negative effects intensified. Economic uncertainty grew, discouraging the investment. Growth declined. Demand faltered. Unemployment rose.

The cure was horrible. To restrain inflation, in the late 1970s, central banks shut the money spigot and interest rates soared to over 20 per cent in Canada and the U.S. The economy slumped and unemployment worsened. Yet, this painful medicine stabilized money and set the stage for the recovery of the 1980s.

QE has been used before, to combat the 2008 financial crisis in particular, and was wound down more or less successfully. But this time QE has gone hand in hand with an unprecedented, peace-time increase in government spending, well beyond spending in response to the financial crisis. This creates a double hazard.

Unless QE is wrapped up in time, inflation will threaten the economy. But when it is ended, government spending cannot be financed by the central bank. With the economy no longer flooded with newly created money, interest rates will rise and government borrowing costs will skyrocket, perhaps repeating the vicious cycle of the past requiring more borrowing just to pay the interest on past borrowing.

Canadian governments, like other governments where QE is fashionable, are walking a risky path too enthusiastically. They must get a grip before things spiral out of control—and should restrain spending as soon as possible rather than planning for more.