Just a few short years ago, the idea that central banks in the Western world would one day be printing money to buy government bonds from the banks that held them was inconceivable.
But this might only be the first step. The financial press is now alive with mutterings that the next move could be for central banks to pay for government spending directly.
The idea is that the Bank of England (or the Federal Reserve) would just cancel all the government bonds they've bought already. So the government wouldn't owe the money anymore.
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Let's make our position clear just now this way madness lies. We'll explain why in a moment. But that won't stop the world's central bankers from giving it a shot.
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Lord Adair Turner made a speech last week that many saw as being a closet job application for the Bank of England governor's job. He argued that the Bank could take even more unconventional' steps to boost the economy.
Various journalists claimed that he secretly likes the idea of cancelling the government bonds that the Bank already holds. Turner said at the weekend that this isn't what he was thinking of. But that hasn't stopped it from being talked up enthusiastically.
So what's the idea?
Currently, quantitative easing (QE) involves the Bank of England buying gilts (UK government debt) from gilt investors such as banks. The idea is to drive down interest rates and also have banks sitting on more spare cash. In turn, that should encourage people to borrow and banks to lend.
In practice, that's not happening. Or at least, it's not happening quickly enough for growth-obsessed politicians and policy-makers.
One academic explanation is that people know that in the future this government debt will have to be paid back, or sold back to the private sector. This will suck money back out of the economy. The private sector knows this, and so in the long run, QE doesn't make much difference to their overall borrowing and spending decisions.
So why doesn't the Bank of England just cancel the gilts? If it did this, the gilts would never have to be repaid or sold back. In effect, you've permanently increased the money supply. You've also removed this overhang' of bonds waiting to be paid off.
So in theory at least, the private sector would stop worrying about it, and start spending more. Given that the Bank now owns 25% of all outstanding government debt, this could have quite a big impact, notes Gavyn Davies in the FT Money Supply blog.
Inflation is a psychological problem
Anyone living outside the rarefied heights of academia or central bank policy-making can see what the problem is.
Central bankers have been at pains to argue that QE is not actually money-printing. Indeed, they and their supporters sneer at this idea as being a simplistic interpretation of what they're doing.
Trouble is, if they cancel government debt, then it becomes very clear that money-printing is exactly what they've been doing. More importantly, it becomes very clear to everyone that this is exactly what the Bank is doing.
In the absence of a gold standard, the one restraint on government spending is the bond market. If governments get too reckless with their spending, then investors should stop lending to them, for fear of not being repaid. That's what's happened to Greece, for example.
Britain has been able to keep borrowing because we have a good record of repaying our debts. But we also have a government that talks a good game about cutting spending (even if the reality is somewhat less impressive). So QE is tolerated as a temporary measure designed to prevent the financial system from imploding.
But if the Bank of England writes off the debt altogether, that changes the game. If the government knows it can spend what it wants, and the Bank will just print money to fund it, then you are into Weimar Republic territory. And everyone will know it.
As my colleague Merryn Somerset Webb has constantly warned, the velocity of money is ultimately a psychological issue. Everything can look fine one day, but the next, you hit a tipping point where people fear the destruction of the currency more than anything else.
That's when they start to swap the currency for whatever they can lay their hands on. And that's when the currency's value plunges and inflation takes off.
The real danger is that if central banks nakedly print money to fund government spending, then this psychological tipping point will be breached.
Why sterling investors should be especially vigilant
This sort of talk is why you should hold gold in your portfolio, particularly if you're a British investor. After all, it looks as though if anyone is going to try this particular monetary experiment first, it's the UK.
Even that manic money-printer Ben Bernanke might hesitate before blatantly monetising the deficit. I can see him gazing admiringly at the next Bank of England governor and thinking: "Rather you than me, pal."
I don't know about you, but I'm not keen to have all of my savings in a currency whose central bank is thinking of boldly embracing the risk of hyperinflation.
The best way to defend against this sort of monetary catastrophe is to have some money in gold. As John Dizard notes in the Financial Times, as the policy debate moves more towards getting the "velocity of money circulation moving again a hyperbolic, 1979-1980 style blowoff in the gold market is becoming much more likely."
One sign of this change in tone, is that gold mining stocks have already started to outperform the gains in the metal, says Dizard. "In the third quarter, for example, the dollar price of gold rose by 10.9%, while the broad XAU index [that's an index of gold miners] increased by 21.7%."
However, as yet, the "broader public has not really been drawn into any gold mania, as it was in the late 1970s." Nor have we seen "any flood of dubious junior mining stocks based on pieces of moose pasture in Northern Ontario or desert in Nevada." That phase still lies ahead.
So hang on to your gold that goes without saying. But you should also get a position in gold mining stocks if you haven't already. We've just launched a new newsletter on precious metals miners find out more about it direct from our expert, Simon Popple.
This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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