Debt, Money And Inflation

Historically, public debt has always been closely associated with inflation. A quick look back in time will suffice to show why. Rather than be saddled with debt, notably at the end of wars, States would often simply monetise it. Debts, most of which were payable in gold, were reduced to almost nothing once they were converted into paper. Paper money could be issued as long as others believed in it. Inflation could exist, since for any given quantity of goods and services, there were more means of payment in circulation. The illusion would last a certain time before evaporating with the first requests for conversion, generally during periods of great turmoil. After 1720 and the bankruptcy of the Law system, notes issued by the Royal Bank were nailed to the doors. In 1796, the plates for printing assignats were burnt in the town centre. Marks were burnt to heat homes in the Weimar Republic during the winter of 1923.

According to Keynes, “there was no subtler, no surer means of overturning the existing basis of society than to debauch the currency” to get rid of debt. Monetisation was deemed dangerous, and little by little it was banned in the western world after the Second World War. Under Article 104 of the Maastricht Treaty, the European Central Bank (ECB) is explicitly banned from monetising debt. The U.S. Federal Reserve (the Fed) and the Bank of England (BoE) have not resorted to it over the past forty years, at least not until the recent crisis. It was only then that the central banks began bending the rules and breaking the ban.

In 2008, all the major central banks, in one manner or another, began providing increasing support to the financing of the economy, notably to state governments.

The monetary base swelled to unprecedented proportions. For those who adhere to the quantitative theory of money, the inflation in central bank liquidity would sooner or later carry over to prices. But rather than seeing this as a threat, a number of officials are actually encouraging it. In an article in February 2010, Olivier Blanchard, head economist at the International Monetary Fund (IMF), asked whether the time had not come to raise the inflation targets set by the monetary authorities. Three years later, the Bank of Japan (BoJ) moved into action, raising its inflation target from 1% to 2%. In the United States and Europe, the same 2% targets seem increasingly less secure as anchors. The Fed has just added a target for the unemployment rate, and the BoE could follow suit fairly soon.

BY Jean-Luc PROUTAT

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