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Money Flowing Like Water – Quantitative Easing & Inflation

If the new money created by QE escapes in an unintended way, then new chaos will reign, with a period of out-of-control inflation, argues Clem Chambers, CEO of leading market information site ADVFN.com, and author of ‘101 Ways to Pick Stock Market Winners’.

Economists are adamant that all the Quantitative Easing, bank liquidity underwriting, fiscal deficit and interest manipulation can be controlled and will not cause inflation. Apparently, this is because the speed at which money circulates will not be accelerated from its already low levels. Creating monetary velocity is, apparently, like pushing a piece of string.

Funnily enough, I’ve never had any trouble ‘pushing string’. It would appear nor did Robert Mugabe in Zimbabwe. Yet, even so, this is the justification for hurling such massive sums into the world’s money flow in the attempt to preserve the economic and political status quo of Europe and America.

Money flows like water. When government tries to manipulate capital, the consequences are usually disastrous. The slightest flaw in logic means money leaks away; pools in the wrong place; or refuses to flow in the necessary direction.

The best ‘plumbing’ for money is created by the market – because small actors (e.g market investors) can’t afford to hold out against losses from false assumptions. Those smaller actors are, therefore, better at finding efficient economic systems by way of fast rounds of trial and error.

Giant actors like governments on the other hand, hold out against market logic, creating continental-sized problems by backing false assumptions with titanic monetary bets. This is why politics always trumps economics in the short run – but why economics always wins out in the long term.

Currently, governments of the developed world believe they are fighting deflation. Many of their citizens however, believe inflation is being created with much to come soon.  This is why gold is so high. Whereas down in the real economy of the US and Europe, price shocks come thick and fast at the petrol pump or the hair-dresser. An older generation has seen this all before.

When there is money to be made in the markets, it is because there is a polarity of opinion. One side believes the opposite of the other group and they both back that position with considerable funds. Both sides can’t be right and when the bet is settled one side makes a lot of money and the other loses heavily.

The key polarity now is inflation; will the future be deflationary or inflationary. The inflationary camp sees life in a simple way: if you magic money out of thin air by the manipulation of paper whether it is currency or bonds, then inflation follows. They see that inflation everywhere.

The other side maintains life is so much more complicated than that – and that technically gifted staff of institutions of various countries will avoid deflation and shortly reinstate stability. Lots of objects like computers and TV’s have fallen in price, so what if the price of cabbages has gone up, they say.

Inflation-believers think history is simply repeating itself. Governments desiring to cover deficits are printing money to make up the gap and perhaps are doing this on purpose to dilute their unsustainable debt mountains.

Statists consider governments are merely cleaning up the mess of a free enterprise gone feral. What they are doing is necessary, benign and cannot fail.

Inflation-deniers blame increases in commodity prices on the developing world. They do not see that that this commodity price inflation is due to fiscal and trade deficits in the developed world, which have exported capital to the emerging markets. This is devaluing developed world currencies in terms of commodities.

Somehow, it is still imagined in the West that while globalisation is driving inflation, local, developed world policies can and will control international inflation at home. This seems a stretch.

The prophets of inflation meanwhile see the process of inflation as already far advanced and furthermore, that a sudden increase is due.

If money does indeed flow like water, then the first signs of inflation should be an unexpected and sudden rise in a kind of asset closely connected with the means of monetary reflation.
This reflation is going on via bonds, QE and other bond centric programmes. The guaranteeing of questionable bonds; the underwriting of them; their defence against default; the use of bonds in circular transactions to bail out institutions; their increasing issuance; the manipulation of their yield curve etc. –  all are part of the mechanism set out to solve the credit crunch and the ‘double dip’ of the euro-crisis.

If the new money created by these programmes escapes in an unintended way, then new chaos will reign.

So now, in 2012 we sit on the wave of a giant equity rally, a renaissance most consider surprising. Why is this happening? How does this global rally make sense? The reason is that in market terms the nearest jump from bonds is to equities. In modern markets all financial instruments are bound together by the constant trading of global markets. Equities, bonds,  currencies, options and futures tick together like a giant clock.

If the new money created by the gross manipulation of bonds and interest rates has begun to escape into the real economy, reflation/inflation will be felt quickly in equity prices. This need not be bad. It’s desirable to a certain extent. The cure to the credit crunch/euro crisis is meant to come from these huge interventions. Their transmission must come through some financial mechanism or other. It is logical that it might be via equities. If so, the endgame of five years of bailout is on its way and it will be a start of an economic revival. Whether that revival will be controllable is yet to be seen.

The technocrats of the statist need to be on their toes or the free marketers will be proven right and we will suffer a round of privations, this time from rampant inflation. In any event 2012 will prove a pivotal year.

About Clem Chambers

Clem Chambers
Clem Chambers is the CEO of financial website ADVFN.com and author of “101 Ways To Pick Stock Market Winners".

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