QE or not to QE? - A Lesson From History
QE or not to QE? - A Lesson From History
Quantitative easing (QE) – when a country's central bank buys financial assets from banks and other private sector businesses with new, electonically created money in order to inject a predetermined sum of money into the domestic economy with a view to stimulating activity – is used when conventional stimulative monetary policy, such as lowering interest rates, is not feasible.
Such is the case in the UK (and elsewhere) now, the Bank of England’s Bank Rate lingers at 0.5%, its lowest level since the Bank was founded in 1694. There being no historical precedent, QE is considered untested. This article reflects on a period of history that bore witness to money creation on a comparable scale and considers whether there are implications of this experience in the context of the current efforts by western governments to solve their debt and economic crises.
The most powerful country in the world – the United States – and the most powerful economy in Europe – Germany – find themselves grappling with similar economic problems from diametrically opposed historical contexts, resulting in varying degrees of political support for particular monetary solutions. Just as an individual’s greatest fears may manifest in former experience, so each nation’s vision of the economic solution to its crisis is tainted by history. Thus, the primary objective of the US Federal Reserve is to avoid a repeat of the deflationary experience suffered during the Great Depression of the 1930s, hence its willingness to propagate QE, while the Bundesbank maintains acute sensitivity to inflation and is therefore a more reluctant participant in QE. It is easy to consider the German stance as excessively conservative, unhelpful even, however a cursory glance at German history illustrates why Bundesbank conservatism may be in all our interests.
Germany suffered hyperinflation – when the price of a set of goods and services rises in excess of 1% every day, rather than by a few percent each year, due to a domestic currency’s loss of value at an accelerating rate – during what are termed the years of crisis (1919 – 1923). To prosecute war requires vast amounts of money and the First World War was extreme in that respect, the Kaiser’s government funding large parts of its effort with vast amounts of promissory debt. The British Embassy in Berlin noted at the time that result of ‘printing’ on this scale was that by October 1923, the number of marks to the pound equalled the number of yards to the sun. The majority of Germans have good reason to be chilled by this spectre of repeat inflation.
Stamps and letters are important enough now; at that time they were a staple of civilised life. A devaluation of one trillion to one resulted in the new Reich Mark in August 1924. With some energetic financial engineering in the preceding 12 months, the German economy briefly entered a ‘golden era’ in the mid 1920s.
Much of this new found stability was based on financial support from the US banks via the 1924 Dawes Plan. Under this scheme, German national treasures such as railways were used as collateral for financial support. However the crash of 1929 swiftly eradicated the new age of American prosperity and with it US bank support for Germany’s nascent recovery. The Great Depression descended on Germany with particular severity. In 1927 German manufacturing had been at a post war high and some 22% above its level of 1913, yet by 1930 it had fallen dramatically and unemployment had rocketed from a few hundred thousand to in excess of three million people. Arguably this second blow to fragile German society left the door open for National Socialism, the vast unemployment of the early 1930s giving Hitler the votes he needed to wrestle power from the Social Democrats. This is not to say that inflation caused the Third Reich, for that would be too simplistic an interpretation, but that the socially debilitating effects of hyperinflation contributed towards a political environment that facilitated the creation of a totalitarian state is a contributory reason not readily refuted.
Fiat* currency is simply a medium of exchange. When it is no longer recognised as such, its use changes from facilitating economic activity to papering walls and keeping fires burning to keep warm: absent purchasing power, necessity becomes the sole criterion of value, air and water being most prized, closely followed by shelter, food and clothing. Whilst history may never repeat itself, it does sometimes rhyme, and over the last two years the US monetary base has increased by twenty eight percent whilst US debt to GDP is now in excess of 380%, having screeched passed the 1933 peak of 300% in 2003. If the German economic experience of eighty years ago is in any way relevant to today, it surely is as a warning against the debauchery of currency in the interests of short-term political expediency.
*Fiat money – money that is not backed by anthing other than a government trust. It has no intrinsic value; it only has value at all because all participants in an economy agree to trust the government issuing the currency.
By James Maltin & Kevin Custis