10/08/2012
The Inflation MonsterHow Monetary Policy Threatens Savings
By Ferdinand Dyck, Martin Hesse and Alexander Jung
DPA
Germany's central bank, the Bundesbank, has established a museum devoted to money next to its headquarters in Frankfurt. It includes displays of Brutus coins from the Roman era to commemorate the murder of Julius Caesar, as well as a 14th-century Chinese kuan banknote. There is one central message that the country's monetary watchdogs seek to convey with the exhibit: Only stable money is good money. And confidence is needed in order to create that good money.
The confidence of visitors, however, is seriously shaken in the museum shop, just before the exit, where, for €8.95 ($11.65) they can buy a quarter of a million euros, shredded into tiny pieces and sealed into plastic. It's meant as a gag gift, but the sight of this stack of colorful bits of currency could lead some to arrive at a simple and disturbing conclusion: A banknote is essentially nothing more than a piece of printed paper.
It has been years since Germans harbored the kind of substantial doubts about the value of their currency that they have today in the midst of the debt crisis. A poll conducted in September by Faktenkontor, a consulting company, and the market research firm Toluna, found that one in four Germans is already trying to protect his or her assets from the threat of inflation by investing in material assets, for example.
Germans Fear Assets at Risk
The German economy may be doing relatively well, with low unemployment and better economic performance than in many other industrialized countries. But Germans sense that they will end up paying for the current debt crisis, one in which politicians and monetary watchdogs are playing for time, through inflation that will gradually reduce the value of their savings.
It's a silent but insidious and cold form of expropriation that has now begun.
Andrew Bosomworth can offer some insights into how this form of indirect theft of assets is taking place. When Bosomworth, the head of portfolio management in Germany for PIMCO, the world's largest investment management firm, talks about the calamity that the debt crisis will bring upon mankind, he sounds like a concerned doctor. "The industrialized world is stuck in a severe debt and growth crisis," he warns. "The central banks are fighting the disease with monetary infusions of previously unknown proportions, and the side effect is a slow but dangerous devaluation of money."
Bosomworth argues that a gigantic redistribution from the bottom to the top has begun. "Gradual inflation has a numbing effect. It impoverishes the lower and middle class, but they don't notice," says Bosomworth. He believes that the Germans' fear of inflation is more than justified.
For the past five years, governments from Berlin to London and from Brussels to Washington have been in crisis mode. They rescued the banks in 2007 and 2008, then they stimulated the economy and, since 2010, have threatened to drown in their own debts. The burdens are being pushed up the line, from private investors to central banks and government bailout funds. But this doesn't make the debts any smaller. In fact, the opposite is true, as the example of Greece and other countries shows.
Governments Accepting Higher Inflation
Since September, when the central banks of the United States, the euro zone, Great Britain and Japan jointly announced their intention to pump even more cheap money into the financial markets, the people have become increasingly aware of the growing influence of highly indebted governments on central banks. They also recognize that governments seem to be willing to accept higher inflation if it facilitates debt reduction.
The official inflation rates are still moderate. According to recent figures, consumer prices rose by 1.7 percent in the United States, 2.2 percent in Germany and 2.6 percent in the euro zone as a whole, compared with the goal of about 2 percent inflation set by the European Central Bank (ECB). Nevertheless, economists, like American Nobel laureate Paul Krugman and Peter Bofinger, a member of Germany's Council of Economic Experts, which advises the government in Berlin, believe that fears of a new era of inflation are nothing but hysteria. They argue that unemployment is too high and demand is too weak for companies to be able to achieve higher prices in the long term.
But perhaps the public does have a good nose for what is really happening, because consumer prices don't tell the whole story. "The inflation debate is being conducted in an extremely abbreviated way," says Thomas Mayer, a former chief economist at Deutsche Bank who still serves as an advisor to the company.
"The consumer price index does not reflect major purchases, like real estate, so that perceived inflation is higher than official inflation. Real consumer buying power is consistently declining." And didn't Anshu Jain, the new co-CEO of Deutsche Bank -- who as a man born in India is less likely to be burdened by thoughts of hyperinflation that worry many average Germans -- recently declare, with great conviction, that inflation will come?
The truth is that inflation isn't some specter. It's already here -- still halting, but unmistakable and insidious.
It is evident at gas pumps in Germany, where the price of gasoline reached a new record high in September of €1.70 per liter (about $8.35 a gallon). It's evident in real estate ads, which reveal considerable price increases in major cities like Munich, Hamburg and Berlin. And it's also reached the precious metal markets, where gold is currently being traded at the record price of $1,775 per ounce.
Inflation, in the form of inflation of asset values, is already taking place in the financial markets.
The new price bubbles are being fed with cheap money from central banks, as well as by investors and savers fleeing into supposedly safe material assets. And there is something else people have figured out: If they are earning minimal interest or no interest at all on their savings, a hint of inflation is already chipping away at reserves.
The Flood of Money from Central Banks
One word from Italian economist Mario Draghi on Sept. 6 was enough to trigger jubilation in the financial markets. "Unlimited," the head of the European Central Bank (ECB) said, along with his trademark crooked smile. What he meant was that the ECB would buy unlimited quantities of government bonds from euro-zone countries if they requested aid from the European Stability Mechanism (ESM), the permanent euro bailout fund that went into operation this week, and accepted the conditions of their euro partners -- a statement Draghi reiterated last Thursday.
The ECB has already spent more than €200 billion on government bonds, and now the central bank's balance sheet could continue to swell. The mood in the markets was further improved when the central banks in London and Tokyo also announced their intention to continue their bond purchase programs and, above all, when "Helicopter Ben" Bernanke, chairman of the US Federal Reserve, lifted off for another rescue flight.
In a speech in 2002, Bernanke cited economist Milton Friedman, who had once recommended throwing money out of a helicopter to avert deflation, which is when prices decline throughout the economy.
Bernanke certainly earned his nickname with his announcement, on Sept. 13, that the Fed would buy up $40 billion in mortgage loans every month to bolster the housing market and stimulate demand. It's the third load of money that "Helicopter Ben" is tossing out over America since 2008. The Fed's balance sheet already contains close to $3 trillion in government bonds, mortgages and other securities.
But that isn't everything. The prime rate has been at zero since the end of 2008, and now Bernanke has announced that banks will likely be able to continue borrowing money for free from the Fed until at least mid-2015. "Helicopter Ben" is promising not to land before the American economy takes off and there is a significant drop in unemployment.
That may all sound good and well, but it no longer has very much to do with monetary policy.
In the eyes of PIMCO executive Bosomworth, Bernanke's approach marks a departure from the Fed's independence. "We are experiencing a 'reverse Volcker moment' in the United States," he says. What he's referring to is this: After the oil crises of the 1970s had driven up inflation in the United States, former Fed Chairman Paul Volcker rigorously combatted inflation with high interest rates. During that period, the Fed emancipated itself from the government's influence. "Today the Fed is increasingly becoming subservient to fiscal policy," Bosomworth says critically.
The US government debt has just exceeded the $16 trillion threshold. Inflation could help reduce this enormous mountain of debt. "The alternative is to reform and save -- and to accept higher unemployment as a short-term consequence," says Bosomworth. "But that isn't as attractive politically."
Instead, the US government is behaving the way governments have always behaved when their debts have gotten out of hand. The history of money is a history of almost constant devaluations.
It has been years since Germans harbored the kind of substantial doubts about the value of their currency that they have today in the midst of the debt crisis. A poll conducted in September by Faktenkontor, a consulting company, and the market research firm Toluna, found that one in four Germans is already trying to protect his or her assets from the threat of inflation by investing in material assets, for example.
Germans Fear Assets at Risk
The German economy may be doing relatively well, with low unemployment and better economic performance than in many other industrialized countries. But Germans sense that they will end up paying for the current debt crisis, one in which politicians and monetary watchdogs are playing for time, through inflation that will gradually reduce the value of their savings.
It's a silent but insidious and cold form of expropriation that has now begun.
Andrew Bosomworth can offer some insights into how this form of indirect theft of assets is taking place. When Bosomworth, the head of portfolio management in Germany for PIMCO, the world's largest investment management firm, talks about the calamity that the debt crisis will bring upon mankind, he sounds like a concerned doctor. "The industrialized world is stuck in a severe debt and growth crisis," he warns. "The central banks are fighting the disease with monetary infusions of previously unknown proportions, and the side effect is a slow but dangerous devaluation of money."
Bosomworth argues that a gigantic redistribution from the bottom to the top has begun. "Gradual inflation has a numbing effect. It impoverishes the lower and middle class, but they don't notice," says Bosomworth. He believes that the Germans' fear of inflation is more than justified.
For the past five years, governments from Berlin to London and from Brussels to Washington have been in crisis mode. They rescued the banks in 2007 and 2008, then they stimulated the economy and, since 2010, have threatened to drown in their own debts. The burdens are being pushed up the line, from private investors to central banks and government bailout funds. But this doesn't make the debts any smaller. In fact, the opposite is true, as the example of Greece and other countries shows.
Governments Accepting Higher Inflation
Since September, when the central banks of the United States, the euro zone, Great Britain and Japan jointly announced their intention to pump even more cheap money into the financial markets, the people have become increasingly aware of the growing influence of highly indebted governments on central banks. They also recognize that governments seem to be willing to accept higher inflation if it facilitates debt reduction.
The official inflation rates are still moderate. According to recent figures, consumer prices rose by 1.7 percent in the United States, 2.2 percent in Germany and 2.6 percent in the euro zone as a whole, compared with the goal of about 2 percent inflation set by the European Central Bank (ECB). Nevertheless, economists, like American Nobel laureate Paul Krugman and Peter Bofinger, a member of Germany's Council of Economic Experts, which advises the government in Berlin, believe that fears of a new era of inflation are nothing but hysteria. They argue that unemployment is too high and demand is too weak for companies to be able to achieve higher prices in the long term.
But perhaps the public does have a good nose for what is really happening, because consumer prices don't tell the whole story. "The inflation debate is being conducted in an extremely abbreviated way," says Thomas Mayer, a former chief economist at Deutsche Bank who still serves as an advisor to the company.
"The consumer price index does not reflect major purchases, like real estate, so that perceived inflation is higher than official inflation. Real consumer buying power is consistently declining." And didn't Anshu Jain, the new co-CEO of Deutsche Bank -- who as a man born in India is less likely to be burdened by thoughts of hyperinflation that worry many average Germans -- recently declare, with great conviction, that inflation will come?
The truth is that inflation isn't some specter. It's already here -- still halting, but unmistakable and insidious.
It is evident at gas pumps in Germany, where the price of gasoline reached a new record high in September of €1.70 per liter (about $8.35 a gallon). It's evident in real estate ads, which reveal considerable price increases in major cities like Munich, Hamburg and Berlin. And it's also reached the precious metal markets, where gold is currently being traded at the record price of $1,775 per ounce.
Inflation, in the form of inflation of asset values, is already taking place in the financial markets.
The new price bubbles are being fed with cheap money from central banks, as well as by investors and savers fleeing into supposedly safe material assets. And there is something else people have figured out: If they are earning minimal interest or no interest at all on their savings, a hint of inflation is already chipping away at reserves.
The Flood of Money from Central Banks
One word from Italian economist Mario Draghi on Sept. 6 was enough to trigger jubilation in the financial markets. "Unlimited," the head of the European Central Bank (ECB) said, along with his trademark crooked smile. What he meant was that the ECB would buy unlimited quantities of government bonds from euro-zone countries if they requested aid from the European Stability Mechanism (ESM), the permanent euro bailout fund that went into operation this week, and accepted the conditions of their euro partners -- a statement Draghi reiterated last Thursday.
The ECB has already spent more than €200 billion on government bonds, and now the central bank's balance sheet could continue to swell. The mood in the markets was further improved when the central banks in London and Tokyo also announced their intention to continue their bond purchase programs and, above all, when "Helicopter Ben" Bernanke, chairman of the US Federal Reserve, lifted off for another rescue flight.
In a speech in 2002, Bernanke cited economist Milton Friedman, who had once recommended throwing money out of a helicopter to avert deflation, which is when prices decline throughout the economy.
Bernanke certainly earned his nickname with his announcement, on Sept. 13, that the Fed would buy up $40 billion in mortgage loans every month to bolster the housing market and stimulate demand. It's the third load of money that "Helicopter Ben" is tossing out over America since 2008. The Fed's balance sheet already contains close to $3 trillion in government bonds, mortgages and other securities.
But that isn't everything. The prime rate has been at zero since the end of 2008, and now Bernanke has announced that banks will likely be able to continue borrowing money for free from the Fed until at least mid-2015. "Helicopter Ben" is promising not to land before the American economy takes off and there is a significant drop in unemployment.
That may all sound good and well, but it no longer has very much to do with monetary policy.
The US government debt has just exceeded the $16 trillion threshold. Inflation could help reduce this enormous mountain of debt. "The alternative is to reform and save -- and to accept higher unemployment as a short-term consequence," says Bosomworth. "But that isn't as attractive politically."
Instead, the US government is behaving the way governments have always behaved when their debts have gotten out of hand. The history of money is a history of almost constant devaluations.
- Part 1: How Monetary Policy Threatens Savings
- Part 2: The Return of Inflation
- Part 3: Financial Repression
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