Yesterday’s dire inflation and growth forecast by the Bank of England proves that increasing the money supply does not work. It does not just fail to produce lasting results. It is also harmful and destroys potential growth. Here is why.
Increasing the money supply by way of quantitative easing or artificially low interest rates devalues the existing mass of money. So everybody holding money ends up poorer. Labour never picked up on the fact that QE is in fact a flat tax. Your money can purchase less because the government is printing more of it. This is typically (as now) reflected in an increase in the rate of inflation. Therefore the amount of growth you could produce through spending or investing is less, than if the government had not printed new money. You will for example have to pay more devalued pounds to buy fuel abroad. As a result potential private sector growth is destroyed.
In the very short term QE produces a mirage of growth. The state pumps the fresh money in the sectors of its choosing, creating a sudden boom. This then has a ripple down effect in other sectors of the economy (see Dr. Eamonn Butler’s forthcoming book on Austrian Economics). At the same time the existing capital devalues. But this devaluation of the existing money does not register immediately with the money owning public. For a short time the private sector keeps spending and investing as before. They may for example be working with existing stock, bought at pre-devaluation prices. The double dip is the catching up – a sign that the penny has dropped.
But it is not even like for like – state growth simply replacing private sector growth. The priorities of politicians or their staff (the Bank of England) will dictate where the freshly printed money is allocated. Their priorities may be very different from where the free market would allocate capital to create maximum growth. Politicians’ investments are virtually always less efficient than market investments. Therefore they will destroy more potential private sector growth than they create through the state.
Brown’s decision to print more money was understandable – he wanted to create a short term revival of the economy to win the election in the short term. It did create some optimism in the beginning of the year – there was for example the temporary increase in house prices. Sufficient optimism to prevent complete eradication of the Labour Party and a non-win by the Conservatives. Now the chickens come to roost.
Let’s not do it again.
