Last Saturday morning it was going pretty much to script. Sky News on in the background. Different day. Same bad news stories. COVID-19 update. Latest on Beirut blast. Sports results (really bad news if you’re a Broncos supporter).
Then there was an interview with someone from a small business seeking additional government support.
It was the standard industry lobbying…‘we need more money’.
Where does the money come from? Get the RBA to print some more dollars. Then use those newly-minted dollars to buy an almost zero-yielding government bond. The proceeds from the bond finance the government’s deficit spending.
The host, channelling popular thinking, asked the lobbyist ‘what about the potential for this money printing to create hyper-inflation?’.
Here we go again. Money printing = Weimar Republic = barrow loads of money to buy a loaf of bread.
Everyone is on alert for high to hyperinflation.
But what about the Land of the Rising Sun?
Japan’s money creation exploits are the stuff of economic legend.
The Bank of Japan has printed gazillions of yen to finance an endless number of government stimulus schemes.
If money printing alone is responsible for hyperinflation, then why has Japan been mired in low inflation/deflation for three decades?
Source: Trading Economics
Can you see even the hint of hyperinflation or high inflation or even some moderate inflation in that chart?
Nope. Japan is in a constant battle with deflation.
The reason why money printing alone does not create high to hyperinflation can be found in this extract from Treasury & Risk (emphasis added):
‘It is hard to overstate the degree to which psychology drives an economy’s shift to deflation. When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers all change their primary orientation from expansion to conservation. Creditors become more conservative, and slow their lending. Potential debtors become more conservative, and borrow less or not at all.’
Japan’s mood change is evident in this next chart.
Private sector debt momentum continued for a few years beyond the bursting of Japan’s in 1990. However, as a more conservative/cautious mood took hold, private sector debt contracted.
Public (national) debt then expanded to fill the void created by the private sector’s newfound conservatism.
Source: Wolf Street
Try as they might, successive Japanese governments have been largely unsuccessful in moving the inflation needle or rekindling the private sector’s desire for debt.
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The shift in social mood starts an economic chain reaction that becomes hard to arrest.
Falling asset prices and rising unemployment tend to make consumers a little debt-shy…
Source: Trading Economics
The game between the ears changes.
Will I have a job to pay my existing loans, let alone take on more debt?
If the value of what I borrowed to invest in has fallen, do I really want to risk borrowing more?
Lenders also ask different questions…do we really want to lend in this environment and if so, to whom and to what level?
A once vibrant credit-infused economy suddenly looks a little lethargic.
Does the lacklustre economy have what it takes to produce the growth needed to justify further private sector debt?
The feedback loop becomes self-reinforcing.
Which is why, in Japan’s case, the private sector voted with their wallets.
From the Federal Reserve Bank of San Francisco on March 2019 (emphasis added):
‘Japanese households are well known for their preference for cash, which represents the majority of their financial assets. On the surface, this seems like a rational choice in an economy experiencing persistent deflation. Moreover, an aversion to risk similarly appears rational in the wake of Japan’s traumatic equity and real estate market collapse in the late 1980s, from which the country still has not recovered.’
Japan is caught in a liquidity trap…as defined by Wikipedia (emphasis added):
‘A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. According to mainstream theory, among the characteristics of a liquidity trap are interest rates that are close to zero and changes in the money supply that fail to translate into changes in the price level.’
In addition to hoarding cash, the private sector is channelling surplus income into accelerated debt repayment.
Whether the money is in the bank or being repaid to the bank, either way it is not circulating in the economy…which means there is little to no pricing pressure in the marketplace.
Central bank friend is now its foe
For decades the lazy policy settings of central banks produce economic growth. Lower rates. Higher immigration intake. More debt.
A little tweak of the dials here and there was all it took to make this economic fraud look genius.
But debt, once the ally of central bankers, could now become their foe.
The following is an extract from Treasury & Risk.
In a 1957, A Hamilton Bolton, an expert in bank credit, wrote (emphasis mine):
‘In reading a history of major depressions in the U.S. from 1830 on, I was impressed with the following:
- All were set off by a deflation of excess credit. This was the one factor in common.
- Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
- Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
- None was ever quite like the last, so that the public was always fooled thereby.
- Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
- Credit is credit, whether non–self-liquidating or self-liquidating.
- Deflation of non-self-liquidating credit usually produces the greater slumps.’
What’s the difference between self-liquidating and non-self-liquidating debt?
Self-liquidating debt is a loan used for productive purposes. Generating an income return that aids in the rapid repayment of the debt.
A non-self-liquidating debt is money to buy a home, car, travel, boats, clothes and other nice things to have.
These purchases all add to a nation’s GDP. But there comes a point when these debts have to be repaid or defaulted on.
If COVID-19 proves to be the catalyst for a shift in social mood to conservatism and low inflation and high unemployment set in, then households will begin trimming budgets.
Just like they did in Japan.
Printing money by itself does not create hyperinflation. Psychology and private sector debt loads exert significant influence over the pricing mechanisms within an economy.
The longer the economic disruption continues, the greater the deflationary forces.
Which means we can expect to see our public (national) debt go way beyond the $1 trillion mark in the coming years.
Editor, The Rum Rebellion