In a previous article, we have explained that despite what some economists claim to be a “new paradigm” of central banking, there is a limit as to just how low interest rates can go. Simply put, while savers are willing to tolerate low or even slightly negative interest rates for reasons which range from convenience to complacency, they percentage of those who say that enough is enough goes up with each reduction cycle and eventually, fractional reserve systems cannot help but… well, break.
There is a reason why for example the European Central Bank, which already has interest rates in negative territory, is not rushing toward options that revolve around aggressive future cuts. They understand all too well that no, savers are not willing to tolerate anything the banking system throws at them and as such, we are close to the limit in terms of what central banks can reasonably do in terms of interest rate reductions.
This leaves the second dimension of central banking action as a potential “new paradigm” solution: monetary easing, with the most popular to the term of (in)famous term being the QE one (Quantitative Easing) used in the United States after the Great Recession. In light of the fact that the ChinaFund.com team believes we have established that there are limits in terms of rate cuts, it makes sense to ask ourselves if the same principle is valid with respect to monetary easing or, on the contrary, if we are in El Dorado territory when it comes to the latter.
As a reference point, we have the aftermath of the Great Recession, with many central banks “printing” trillions of currency units, in an attempt to provide adequate liquidity levels and thereby avoid a financial system meltdown. For example, in the case of the United States, as much as $85 billion per month were “printed” by the Federal Reserve at the height of US QE, more in one year than had existed since the year the Federal Reserve was established (1913) and up until the Great Recession. As far as the European Central Bank is concerned, it injected even more liquidity into the system at the height of its monetary easing program and the list could go on and on.
Many economists, in light of these unprecedented monetary easing measures, expected runaway inflation. Fast-forward to 2020 and, with the benefit of hindsight of course, we can safely state that no, monetary easing did not result in runaway inflation and if anything, central banks were still more concerned about deflation than inflation.
Does this mean there are no limits to monetary easing?
Has humanity found the “quick fix” it has been looking for all along, with central banks simply injecting as much liquidity into the proverbial system as necessary after a deflationary shock so as to get things back on track?
In our view… no.
Right off the bat, we need to understand that the data we have with respect to the worldwide monetary easing experiment is limited. As such, it would be premature to state that monetary easing stood the test of time.
Furthermore, we need to also look at the trajectory of the currency that was created. While central banks have controlled the “how much?” dimension by deciding how significant of a monetary easing programs they went with, they had (far) less control over what happened next. To illustrate this, we will resort to an extreme example and assume the Federal Reserve “prints” not one trillion but $999 trillion, yet simply buries the currency in question somewhere. Needless to say, there will be no inflationary effect to speak of, for the simple reason that those $999 trillion have not found their way to the “real” economy.
On a much smaller scale, the same principle was valid after the Great Recession, with a lot of currency simply being used as reserves in the banking system (hoarded, if you will) rather than finding its way to Main Street. As such, the direct effects of QE in the case of the US did not involve consumer price inflation, as it most likely would have if the Federal Reserve would have somehow distributed the $85 billion it created monthly to each US citizen. Instead, that currency found its way to the “hands” of the largest US stake holders and was indirectly used to buy various assets (stock buybacks, for example), with the end result being asset price rather than consumer price inflation.
What about the realities of 2020?
Let’s just say that this time around, from China to the United States and from South America to Europe, citizens have made it clear that they are no longer willing to tolerate a primarily “too big to fail” bailout framework and instead, demand that money ends up in the hands of the average individual as well. This became apparent in the United States, with the first Congress-passed bailout package also involving a sum of $1,200 that is to be distributed on a per-person basis, based on 2018-2019 records. The beginning of something that resembles a Universal Basic Income paradigm, if you will.
The more of the currency that is created ends up being used for consumption (especially if it offsets the deflationary effects of the 2020 crisis to a significant enough degree), the more likely it is that this time around, consumer prices actually go up… economics 101, at the end of the day. Can there be guarantees that inflation would finally become problematic? Of course not, because as always, time will tell and only let’s call them excessively optimistic/confident market participants claim to be able to predict the future. A common sense conclusion would therefore be this: while nobody can know with certainty what happens next, “prudence” is the operative word and it would therefore be wise (in the opinion of the ChinaFund.com team, at least) to exercise restraint before claiming victory for the proverbial “limitless monetary easing” camp.