Riding dead horses
As central banks engage in another round of quantitative easing and money creation the old fears of the years after the financial crisis are peddled once more. Back in the day, people liked to show charts of the balance sheet of a central bank and then theorised that inflation would have to rise. Today, they are no longer showing central bank balance sheets but M4 money aggregates because, well, I guess, historically that has provided a better fit with inflation.
I could show data from all kinds of countries, but I will use UK data here, because we have central bank balance sheet data and monetary aggregates back to the late 17th century. The chart below shows the average annual growth rate of the balance sheet of the Bank of England, the broad monetary base, and consumer price inflation. I have used rolling 10-year averages because monetary policy works slowly, and it takes a while to impact inflation.
Long-term trends in the monetary base and inflation
Source: Bank of England.Â
As you can see, the monetarists who predict that more money in the system will create more inflation and vice versa were on to something. For more than 250 years, there was a relatively close link between the money in circulation and inflation.
However, if we zoom in to the time after the Second World War, the lost link between the monetary base and inflation becomes clearer. Since the mid- to late 1990s there has been no correlation between money creation and inflation anymore. But remember that the chart shows 10-year averages. For a divergence to materialise in these lines, the underlying relationship has to be broken for roughly five years or more. Otherwise, it won’t be visible in the 10-year average. Thus, the link between money creation and inflation has been non-existent for roughly 30 years now. Â
Monetary base and inflation since 1945
Source: Bank of England.Â
To me, monetarists and other pundits who claim that money printing will lead to inflation are trying to ride a horse that has been dead for three decades now, not just since the financial crisis.Â
That is not to say that we might eventually get back to a world where an increase in the monetary base will lead to higher inflation. I am perfectly willing to change my mind if there are good reasons to do so. But to convince me, you have to show me more than a scary chart. You have to explain to me, why a link that has been broken for longer than my entire investing career should suddenly re-appear. And so far, I haven’t met anyone who can do that.
The link is broken because of the rise of another inflation: asset inflation. Due to globalization the CPI hasn't risen since the late nineties. But when you look at the rising prices of assets (not only real estate, but also securities and private markets) there is definitely a correlation between the balance sheets of the central bank and asset inflation. It's not clearly positively correlated. Yields have also dropped because of globalization, demographic developments in the West and Japan and technological innovations. But there is a rise in asset inflation. When you look at social developments in Western societies, you see a division emerge between 70% haves and 30% havenots. I think that's the main social-economic problem for Western societies at the moment....
Ironically, this 30 year period exactly coincides with neoliberal deregulation, wrestling inflation to the ground, the creation of the gigantic wealth gap and the complete disenfranchisement of the working class in terms of any influence (good or bad) on public policy and their own income. Given this chart and your previous discussion of MMT is there perhaps a link between why MMT might actually hold true at least for the forseeable near mid-term future? Maybe it is a good time for fiat currency governments to start reinvesting in all the neglected infrastructure and social programs.