The consequences of printing money

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25 May 2009
Nicolas Michellod
When reading recent financial analysts' comments and listening to politicians' opinions around the world, it seems that the worst of the financial crisis and the economic downturn is behind us. Of course, nobody forgets that the international financial system was about to collapse in October last year but according to the most powerful US policymakers, the world economy will be probably growing again at some point between Q4 2009 and Q2 2010. Some indicators tend to confirm this statement, the first one being the impressive rebound of equity markets around the world. For instance, the S&P 500 has gained a bit less than 30% since it reached its lowest level back in the beginning of March 2009. In other words, most economists, finance professionals and politicians are confident that the urgent measures implemented last year in order to tackle the financial crisis were just the perfect ones. The constant injection of new liquidity into the financial system during the past 18 months, the multiple bail-out plans as well as the low interest rate policy were the necessary ingredients of a miraculous cocktail to save the financial industry and help the economy recover fast. At least, it is what policymakers are now claiming. After a difficult period in all fronts, it seems that the period of self-congratulations has come and that the last 18 months period was just a bad dream we must forget as quickly as possible. Personally, I am not so optimistic and I think there is still plenty to worry about. In a report published in December 2008 called "Flawed Assumptions about the Credit Crisis: A Critical Examination of US Policymakers", Celent reviewed the credit market in the light of figures provided by the Fed and other central banks in Europe and Japan. More than questioning if there is really a credit crisis, what appears to me to be an issue of high importance for the future is the money aggregate in circulation in the economy (click to enlarge): Economies worldwide are struggling and have been experiencing an important slow down in terms of GDP recently. In Europe for instance, certain countries have double-digit GDP decrease rates resulting in higher unemployement and lower investments. On the other hand, beside this tough and cruel reality, there is a huge amount of money available to spend and to invest. What a strange and unsound equilibrium! As a result, we might end up with a period of high inflation, which will require specific actions in the short term on interest rates by central bankers. Taking into consideration the sudden and drastic slow down of GDPs around the world coupled with the equally sudden and unprecedented increase of money supply (as depicted in the figure above), the financial crisis might have been the earthquake, whose tsunami could be a certain form of hyper-inflation. In the long run, the world leaders will have to address the real cause of the problem: the definition of a new international monetary system. But by now, I really believe it is not the right time for self-congratulations!


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