UK and US printing money 'out of thin air' to fight credit crunch

UK and US printing money 'out of thin air' to fight credit crunch
New worry is hyper-inflation
By Zhen Ming
March 20, 2009

BACK in 1991, when a group of us launched Money Mind (a TV programme still telecast on Channel NewsAsia), I was allowed to film De La Rue Currency's ultra-secretive banknote manufacturing facilities in Singapore.

De La Rue Currency - the world's largest commercial currency printer, involved in the production of more than 150 currencies - closed its Singapore factory in 2002 after finding it difficult to cope with rising costs.

During my visit, I saw the firm's banknote design and production facilities.

A line of 300 Singaporeans were inspecting sheet after sheet of freshly printed $2 banknotes to spot errors (none on that day).

These days, however, most of the money that flows around an economy is created electronically rather than printed physically.

Quantitative easing

And as the world's ailing financial systems continue to remain immobile, central banks everywhere are introducing what's known as 'quantitative easing' (QE) - the modern equivalent of printing more money - as a desperate measure of last resort.

Under QE, a central bank creates new money literally 'out of thin air', which it then uses to buy what are essentially IOUs from ordinary banks.

The banks, in turn, use this money to create even more new money in a process known as deposit multiplication, where the amount of money (or loans) in circulation is further increased to stimulate additional spending.

The impact of QE is not very different from dropping paper money from a helicopter - as Mr Ben Bernanke himself once described this policy before he became chairman of the US Federal Reserve (Fed).

This idea (first mooted by US economist Milton Friedman) won Mr Bernanke the nickname 'helicopter Ben'.

The Fed is effectively practising QE - except, for ideological reasons, the Fed prefers to call it 'credit easing' instead.

To date, total QE assets held by the Fed stand at US$1.9 trillion ($2.9 trillion) - 2.4 times the size of the stimulus package sponsored by US President Barack Obama.

The US, not unlike the UK, has just signalled that it will continue to print more new money (that is, embark on further QE) in order to re-inflate its flagging (or deflating) economy. The Fed is scheduled to issue its statement on QE later today.

Mr Bernanke's view is that if the Fed provides liquidity, credit will flow and lower the price of loans, feeding pent-up demand for homes, cars, credit-card borrowing and capital expenditures by business in the depths of the worst recession in living memory.

Will QE work?

But will QE work? Or will triple-A sovereign borrowers like the US and the UK risk destroying their solvency, as they use QE to rescue over-indebted private sectors?

This possibility of a botched-up QE programme could be nightmarish for surplus countries like China, Japan and Singapore.

These countries currently hoard mountains of foreign reserves denominated in Western currencies like the US dollar and the British pound.

These hard-earned reserves actually stand the risk of dramatically losing their value in real terms because QE, if mismanaged, could trigger runaway inflation or hyper-inflation.

In some extreme examples of old-fashioned money printing, the results were disastrous. Think of the Reichsmarks in Germany after World War I, Japanese banana money in colonial Malaya during World War II, Russian roubles after the fall of communism, and the current hyper-inflation in Zimbabwe.

That's why Chinese Premier Wen Jiabao is 'worried' about the safety of China's US$1 trillion investment in US government IOUs.

Singapore should be too.

# Zhen Ming, a Harvard-trained economist based in Singapore, is a freelance contributor.

http://forums.delphiforums.com/sunkopitiam/messages?msg=24631.1