Lessons from Japan: why quantitative easing won't lead to inflation

The received wisdom is that quantitative easing inevitably leads to inflation. Not necessarily, says James Ferguson.

You don't need to have taken Economics 101 to be familiar with the demand curve. Everyone knows that if the supply of a product rises then, all other things being equal, the price will fall. The same goes for money. If there is growth in the stock of money (the money supply), then the value of money falls and you get inflation. So on that basis, quantitative easing (QE), which is nothing less than a substantial increase in the money supply, should mean inflation, right? Especially if the QE is likely to continue for as long as it takes to revive the economy. How could a rational person come to any other conclusion?

On a recent trip to New York, I was informed that the most crowded hedge-fund trade of all is to sell long-dated Treasuries short in anticipation of just such an inflationary outcome. This is in a country where QE has not even started yet. Here in Britain, where there are £53.25bn of notes and coins in circulation, the planned £150bn of new money creation (£75bn now and £75bn later if needed) is equal to nearly three times the monetary base. Inflation, even hyper-inflation, can be the only outcome. Or can it? There are many measures of money supply. The monetary base (M0) is by far the smallest. M1 is a wider measure, which includes demand deposits (such as the money in your bank accounts) as well as notes and coins in circulation. M1 far exceeds M0, at £1,060bn. But even this isn't the true, wide money measure, for which we might look at all sterling bank deposits, which total £2.6trn. That £75bn doesn't look so impressive now, at a mere 2.9% of this wider measure of money supply.

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James Ferguson qualified with an MA (Hons) in economics from Edinburgh University in 1985. For the last 21 years he has had a high-powered career in institutional stock broking, specialising in equities, working for Nomura, Robert Fleming, SBC Warburg, Dresdner Kleinwort Wasserstein and Mitsubishi Securities.