Not so long ago, central bankers would’ve given their right arm for a bit of inflation. Now they risk losing their jobs for having caused too much of it…
Well, they should face that risk. But I don’t know of any central bankers who have been fired, or even threatened with dismissal, despite abysmal performance relative to the objectives of their organisations. But, then again, there has been no shortage of spectacular blunders in the financial world since the South Sea Bubble of 1720.
It’s not that central bankers are admitting they caused inflation to spike. They now seem to deny that the very policies they used for years to try and trigger inflation cause inflation at all. However, some are at least having a debate about the issue.
To be honest, their arguments have been getting a bit odd of late. The Bank of England’s chief economist helpfully explained, “We’re not meant to be inflation nutters.” That clarifies everything, I’m sure you’ll agree.
But we’re not here to make snarky comments, armed with the benefit of hindsight. It’s not as if you or I could do a better job as head of the Bank of England.
In fact – and this is what really matters – nobody could. That is because price controls are an inherently bad idea. It doesn’t matter who is doing it, price controls are impossible to get right. People shouldn’t be setting interest rates in the first place. There should be no monetary policy. It should be a free market.
We accept this argument for almost all prices in our economy. We understand how much of a disaster it would be if the government set the price of coal, food or, God forbid, energy…
We’d end up with the most expensive energy prices in the world if the government controlled our energy prices… and even then, there’d be the threat of blackouts…
But, for some reason, people believe we need a group of economists to set the price of money via an official interest rate or two. That begs the question, why? Why, if we’ve abolished almost all other forms of price control in the economy, do we need a centrally planned interest rate?
It’s because high inflation rates are not a mistake at all. They are a deliberate policy tool by central banks for the benefit of government.
It’s all about robbing you as efficiently and sneakily as possible. The sneakiness matters because, if you happen to realise what’s going on, then the gig is up.
Here’s how it works…
Inflation may look and feel like rising prices. But it’s really the falling value of money.
The distinction is surprisingly important, even if the symptoms of the two are identical. It’s a bit like a similar situation often faced in the medical sphere. Identical symptoms might be caused by very different illnesses, requiring entirely different treatments. An illness caused by a virus versus bacteria might be a good example of this, but don’t quote me on that – as I haven’t been to medical school.
Anyway, rising prices can be caused by supply and demand, or they can be caused by the falling value of money. Those are two very different things, caused by very different causes, but they both present the same symptom – inflation as we measure it today.
The falling value of money can occur without shifts in supply and demand. Or shifts in supply and demand can make prices rise without the value of money falling.
So, when prices rise, it’s tough to tease apart the cause which applies. We don’t know whether to blame Russia’s Vladimir Putin or the Bank of England’s Andrew Bailey, or both of them. The world is a dynamic place.
So let’s focus a bit more closely on inflation – the devaluation of money.
By reducing the value of money, you make debt easier to repay. That’s because debt is denominated in money.
Do you recall your first mortgage, or that of your parents? It might’ve been in the tens of thousands of pounds. At the time, it would’ve been a lot of money and quite a burden. Today, it’d be easy for a gig economy worker to repay. That shows the power of inflation to devalue debt.
The biggest debtor of all is of course the government. And so the government benefits most from inflation. Inflation makes their debts payable, allowing them to borrow and spend more.
But there are two “buts” to this theory.
The first “but” is that some people are being dispossessed by this inflation. Principally, they are the bond investors – the lenders to the government. The value of their investment is being inflated away. That makes inflation a transfer of wealth, not a clear-cut solution to too much debt.
This transfer closely resembles a tax paid by bond holders, by the way. But we’ve dug into that before.
The second “but” is that the policy only works if people think it’s not happening. That is one reason why the Bank of England governor Andrew Bailey hasn’t been out there declaring the impressive success of the Bank of England’s financial repression policy so far.
That’s what it’s called, by the way: financial repression. Keeping inflation above bond market interest rates, thereby reducing the burden of debt.
And, admittedly, it has been a great success. Engineering double-digit inflation while keeping bond interest rates below 5% is one of the Bank of England’s impressive achievements, even for an institution with a limitless budget.
However, if bond investors realised all this is a deliberate policy, they’d sell out. This would drive up the interest rate that governments must pay on bonds. And that would in turn negate the impact of the financial repression. The higher interest paid on the bonds would compensate investors for the inflation, but add to the government’s bills.
That’s a big part of the reason why the Bank of England had to step in to save the UK’s bond market recently – following the adverse reaction to the mini-budget of 23 September. And it’s also why central banks around the world have been so slow to reverse their quantitative easing (QE – the creation of money out of thin air to buy bonds) policies with quantitative tightening (QT – the reverse). They don’t want the bond market to have a fair price – a price that’d compensate investors for inflation. This would undermine the policy of financial repression.
Does all this sound a bit nefarious to you? Well, it’s a well-established playbook which governments tend to resort to after wartime.
Wars are expensive and repaying the debt can be a tough task. But a bout of inflation makes all that go away. That explains the inflationary spurts after WWII and the Vietnam War. Governments, and the central banks that serve them, make the debts worth less by making the money they’re denominated in worth less.
The alternative, by the way, of honouring both your debts as well as maintaining the value of your money was a policy that Winston Churchill applied after WWI. And it’s considered a disastrous mistake because a depression followed. The debt was just too much to honour.
For a more contemporary example, take a peek at a recent Telegraph article, which makes the matter plain:
“The problem for the UK’s public finances has been grossly exaggerated,” said Prof. Peter Spencer from York University and the Item Club. The one-off inflation spike of the pandemic – or more accurately from money created by the Bank of England during Covid – has whittled down the real burden of the debt. That adjustment in the price level automatically boosts tax revenues via bracket creep.
“There are all sorts of magical effects. Inflation has lowered the debt ratio through the denominator effect, and tax revenues are highly-geared to the rise in money GDP. People have got the wrong end of the stick,” he said.
There you have it. A debt-to-GDP ratio above 100% doesn’t matter. We can just inflate it away and call the results “magical effects”.
Just don’t forget who’s really paying for them (you), whether you’re aware of it or not.
That is, unless, you change your investment mix and habits to try and protect yourself, or even profit from the new inflationary environment. I wonder how…
Editor, Fortune & Freedom