QE Quite Logically Didn't Cause 'Hyperinflation'

In the aftermath of the Fed's horrid imposition of Quantitative Easing (QE) on the U.S. economy, many are asking why this adolescent approach to monetary policy didn't result in hyperinflation. The easy - but incomplete - answer is that QE is anti-money growth. The latter is true despite what you hear, but again the answer is incomplete.

Still, it's a good place to start.

In his brilliant Principles of Political Economy John Stuart Mill made the basic point that production amounts to money demand. About Mill's observation, readers shouldn't be fooled. He understood well that money itself isn't wealth. Indeed, Mill mocked the notion embraced by mystics then and now (think Ben Bernanke, Paul Krugman, and Janet Yellen to name but three) "that money is synonymous with wealth." As Mill went on to write about such a juvenile presumption,

"The conceit seems too preposterous to be thought of as a serious opinion. It looks like one of the crude fancies of childhood, instantly corrected by a word from any grown person."

What fun Mill would have with mainstream central bankers and economists of today. Comically convinced that money is wealth, economists like Bernanke, Krugman and Yellen are the modern equivalent of the adults from the 19th century whom Mill described as children. For a return to reality, read on.

As Mill so eloquently put it, "Money, as money, satisfies no want; its worth to any one, consists in its being a convenient shape in which to receive his incomings of all sorts." Mill was merely stating the obvious, that while our production represents demand for money, what we're really doing when we produce is expressing our demand for what we don't have. I produce bread for "tickets" that we call money that you'll accept in exchange for your wine.

Money's use in the above-mentioned transaction is as a measure. The baker sells his bread for money, but in reality he's selling his bread for wine; money merely the store of value accepted by producers with differing wants. Indeed, if the vintner actually wants the butcher's meat rather than the baker's bread, he can still trade with the baker thanks to money's role as a facilitator of exchange between producers. We trade products for products, and money makes transactions much easier and quicker than traditional barter.

Back to QE, most who felt it would be inflationary felt that way on the assumption that such "easing" would push money into the system. Put more simply, QE would increase the supply of dollars on the way to inflation. The very presumption fails basic Classical economic logic promoted by Mill, among many others.

What people think of as "money supply" is in fact demand driven. That's why money supply tends to rise during booming economic periods. Economic thinkers from both the Austrian and Monetarist schools have taken to presuming that an increase in "money supply" is what drives the boom, but in suggesting this they put the proverbial cart before the horse.

Once again, money supply is demand driven; meaning it goes up when production increases. As explained previously, while we produce products with an eye on getting products we don't have, we express our production through our demand for money. The more we produce of market value, logically the more money we can command.

Thinking of this in terms of QE, the Fed didn't "print money" as much as it paid banks 25 basis points in return for a portion of their reserves. The Fed borrowed $4 trillion from the banks, but then it went and bought Treasuries and mortgage securities with an eye on propping up the housing market.

Basically the Fed stimulated consumption of a good that has nothing to do with production. If you buy a house, your purchase of it won't make you more productive, it won't open up foreign markets for you, it won't lead to cancer cures that elongate lives, software innovations that make us more efficient, nor will it lead to increased production of tractors, cars or refrigerators. Housing is once again an item of consumption as opposed to a capital good meant to ramp up production. Described in the most basic terms, a house is not a factory.

In that case it should be no surprise that "money supply" didn't surge in response to QE. The latter amounted to Ben Bernanke and members of the FOMC not just usurping the market's proper role as allocator of always limited capital, but arguably worse, it amounted to the Fed stimulating consumption over production. When we produce we're demanding money, but the Fed was stimulating no such thing. Naturally money supply didn't surge.

Of course, all of the above is as previously mentioned an incomplete summation of the flawed hyperinflation argument. Those who were making it regularly added variations of "once banks start lending out the $4 trillion created by the Fed, there will be a massive inflationary breakout." This too was backwards.

Missed by those possessing Austrian and Monetarist points of view is that money supply is once again a function of demand for same. If money is cheap or unstable, it's not heavily demanded. No one wants to produce in exchange for a ticket (money) that is unreliable. That's why the German Mark amid the post-WWI hyperinflation was eventually scarce as explained by Adam Fergusson's wonderful book on the tragedy, When Money Dies. With the Mark near worthless, it was also worthless as a ticket meant to foster real exchanges of wealth. Conversely, the gold-defined dollar could open all manner of doors in Germany.

Thinking about the $4 trillion that has so many money-supply types shaking, the lending of it will be the surest sign not of an inflationary dollar, but the exact opposite. It's when money is stable in value that it's not just more in demand (who wants to exchange their wealth for money that lacks credibility?), but it also means there's more investment in capital advances that lead to more production and money demand.

As much as the money-supply focused want to believe otherwise, and this includes members of the Fed who childishly think money is wealth, the Fed cannot increase the supply of money. The latter is once again a function of demand for money, and so long as the U.S. Treasury pays little mind to the dollar's stability, the investment and production that drive dollar demand upward will be limp.

In short, we'll know the dollar is truly sound (meaning non-inflationary, or better yet stable in terms of gold) when lending and the supply of dollars surges. It's when money is credible that investment soars, production soon after, and with both up, demand for and supply of money that will facilitate exchange of all the newly created wealth.