The risks are high on printing money

Feb 25 2009 by Bill Midgley, The Journal

IT would appear that we are all now familiar with the benefits of Quantitative Easing, or at least those of us who do not assume it is the latest diet fad. However, while it would appear that this is the latest ‘fix’ to our economic recession, it is far from being the panacea that politicians would have us believe.

The printing of money to flood into the economy is by no means a new idea and has been used many times in an attempt to solve economic problems, sometimes with devastating results to the countries concerned. In its simplest form, the idea that the creation of more money would stimulate growth by increasing purchasing power is not unsound, but the problem is how far the process should develop, the size of the increase in the money supply, and when such growth should stop. The Japanese were probably the most successful recent example of using this system of rebuilding their economy in the 1980s, when recession and deflation had overtaken them. There is, however, one significant difference between the Japanese economy and our own in that they retain a huge manufacturing base.

An increased money supply chasing too few goods will result in price inflation, perhaps a simple statement of basic economics. The trick, therefore, is to ensure that there is not a shortage of such supply. However, our own economic boom over the past decade or more has been based upon retail spending, but to too large an extent on imported goods and there is a great danger that the Quantitative Easing process will do no more than exacerbate this problem. A further worsening of our already chronic balance of payments deficit which ultimately has to be funded. If inflation can be capped at 2% or 3%, then there is a real possibility that we will see an upturn in the economy in the not to distant future. If, however, that proves not to be the case, then there is a real danger that we will see the return to the high inflation days of the late 1970s and early 1980s. The knock-on effect will inevitably be higher wage demands and a further reduction in the efficiency of what remains of our manufacturing base. In other words, British goods will become increasingly more difficult to sell abroad. High inflation also destroys savings, as money becomes devalued and those sections of the community who have provided for their own pensions or a reasonable lifestyle in old age find that their resources are considerably less than expected and are unable to maintain their anticipated lifestyle. History demonstrates that it is the middle classes that tend to be affected more by high levels of inflation than other sectors of the community, and the destruction of the middle class in any society is also shown to have significant political results. Given that the middle classes are by far the largest section of our community, the risks to politicians and perhaps to democracy are high.

A high inflation rate can soon become hyper-inflation, as witnessed in Germany in the 1920s, but perhaps more significantly in the South American countries in recent decades. The trick, therefore, is to be able to cap the inflation rate.