Ad Hoc Commentary – jobs as the true antidote to low inflation in Europe
“…Now that the Buba had ‘given’ green light for European QE, the only thing that we need to wait for is a low European inflation print. The Eurostat will give a flash estimate of European CPI YoY on Mar 31, and the final print will be out on Apr 16. So, if you are finding reason to celebrate in the equity markets and sell EURUSD, this will be one of your main reasons for the coming months…”
We got the low inflation, and now the ECB is moving one step closer to QE:
“…The European Central Bank has given the strongest signal yet that it is prepared to embrace quantitative easing to prevent the eurozone from sliding into deflation or even a prolonged period of low inflation…”
“…The governing council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation,” Mr Draghi said…”
The equation that matters most in QE is Irving Fisher’s MV = PQ. M is the quantity of money, V is the velocity of money, P is the price level and Q is the quantity of goods and services. We note that PQ is the GDP. The notion that printing is inflationary, i.e. printing increases P, implicitly assumes that M increases, and V and Q remain constant. That is far from certain in this global economy.
First, let us look at V, i.e. the velocity of money. Simply put if you gave me 100 dollars and I hoard it under the mattress, then velocity decreases, and inflation is not likely to increase. The degree of hoarding depends on my confidence in the future. If I think you are going to keep printing, like in hyperinflationary Germany of the early 1920s, then of course I will spend the 100 dollars as quickly as possible. Velocity increases and inflation likely increases.
Next, let us look at M. In a closed economy, when the government embark on QE and buy back government bonds, the money will stay in the economy and prices will likely increase. However, in an open economy, the Americans can buy back US government bonds from China and it will never be inflationary for Americans. The new money is exported into China. Effectively America prints, China gets the inflation. So, even the ‘common sense’ notion that printing leads to higher M domestically is not necessarily true.
Moving on to Q, it is generally assumed that Q does not increase. This is true short term, but is not guaranteed medium term. If the newly minted money is invested into productive enterprises instead of being wasted on a good lunch, then Q will increase medium term. The higher productivity could even lead to falling prices medium term.
So the belief that printing is inflationary is filled with caveats. The Americans printed, the Japanese printed, the English printed. Where is the hyperinflation that the inflation-mongers and even gold-bugs were clamoring about? Obviously someone forgot to tell them that Irving Fisher wrote MV = PQ, not M = P. What’s more, it is not even guaranteed that M will increase domestically when China is holding your debt. To make things even more interesting, you need to model human confidence to predict V.
So, if the ECB thinks that Europe QE will fight deflation, they should think again. However, if the European QE is designed to address the public debt that is growing under the carpet like a cancer, then please QE. Jobs are probably the true antidote to deflation. To create jobs, a QE into productive debt is required. Infrastructure debt could work. Infrastructure worked in jobless Roosevelt America, and it should work in jobless Europe. A Europe Works Progress Administration (WPA) funded by Europe QE into a federated European infrastructure debt is perhaps what the ailing union really needs. But in the short term, please feel free to QE to help the Franco-German core, and those of us who are finding reasons to continue celebrating in the equity markets, and selling EURUSD.
Good luck in the market.