Since 2007 the Federal Reserve has expanded its balance sheet by US$2.5 trillion since 2007. To put this in context, it took almost 100 years for the Fed to build its balance sheet to US$0.9 trillion and it then almost tripled this in the last four years.
Like the Fed, many of the world’s central banks have employed the unorthodox (yet now very conventional) monetary policy known as quantitative easing. It is impossible to know what the effects might have been if no intervention had taken place – and policymakers do at least deserve some credit for attempting to tackle the enormity of the credit crisis – but nothing hides the fact that QE is one enormous experiment that could undermine the trust in the perceived value of paper money.
Most cases of hyperinflation occur when governments abuse their trust and monopoly over currency issuance. As pointed out by Reinhart & Rogoff in their excellent book, “This time is different”, a systematic analysis of the data set show that inflation crises and exchange rate crises have travelled hand in hand in the overwhelming majority of episodes across time and countries. Combine this with the fact that most crises are associated to excessive levels of debt (the US national debt now stands at $16.5 trillion, a very excessive 103% of GDP) and we are left with a nasty combination of factors that could have severe consequences for the US dollar.
The economy encompasses such a huge set of variables that determining its precise direction is clearly impossible. Many economists and analysts actually predict deflation as a result of consumers saving more and spending less to reduce the record levels of leverage that has been built since the 1970’s. Others use Japan as the example of a nation that attempted QE and is still mired in inflation.
True Japan attempted QE (although it dwarfs in comparison to the Fed’s QE) and yes consumers will save more. But the crucial and vital point is that the value of a $100 note will only persist for as long as consumers believe its value will hold. No central banker in history has ever attempted to produce hyperinflation. They have all attempted to print money as a short term measure to help fund wars, reparations and… to debts. They all believed they could end it as easily as they started it.
Unfortunately 800 years of financial crises tell us otherwise.