The Short View

December 2, 2010 8:42 pm

QE: Replacement not debasement

Printing money may be off the agenda of the ECB – for now

Silver denarii were often debased by mixing in lesser metals when the Roman emperor needed more money to raise an army. Inflation followed, as people typically demanded more of them for the same amount of goods. The process is electronic today, but the principle is widely believed to be the same: when central banks create more money, their currencies should fall.


The European Central Bank has, for now at least, taken quantitative easing – the modern equivalent of printing money – off the agenda. It hopes to stop contagion to Italy and Spain with limited purchases of peripheral country bonds. If it fails, the idea of creating money to solve Europe’s problems may return.

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This is a vital issue for traders of the euro. But how much does it really matter?

The expansion over the past two years of the US monetary base (physical greenbacks and coins plus cash on deposit at the Federal Reserve) suggests some link between creating money and the weakness of the currency. The dollar fell when the Fed conjured up money to fix the banks, and rose again when it stopped intervening. But the link is far from perfect.

More importantly, in the long run there appears to be no link. Barclays Capital compared the US monetary base, adjusted for the size of the economy, with the monetary bases of major trading partners, to see if printing money affected the currency. It found that over the past half-century the dollar has moved independently of the monetary base.

This sounds counter-intuitive, but modern money is not like denarii. Commercial banks create money when they lend; if they create less, then the central bank magicking up more may have little effect on the broad supply of money.

With banks in Europe’s periphery in crisis, and euro-area broad money growth still lower than any period from 1971 up to last year, perhaps the ECB should drop its visceral opposition to QE.

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