Addiction to the Printing Press Visualized
If you measure the laxness of a central bank by the magnitude of its balance sheet expansion then there’s been a clear winner in recent years: the Bank of England (which has quadrupled its balance sheet since mid-2008). This leaves the UK at risk of a huge expansion in the broad money supply if the fractional reserve banking machine were to get going again. This, however, could be some time away and is not the only mechanism in play. Here we’ll look at central bank balance sheet expansions in relation to government accounts. By the end of this piece you’ll have a good understanding of how addicted various governments are to the printing press.
As we’ve mentioned recently, the thing that leads a sovereign down the path of aggressive inflation and/or default is when interest expense consumes the entirety of government tax revenue. When this happens, every cent that’s spent has to be printed and/or borrowed. So, the further the government goes down the path of choosing to print, the higher the interest rate charged, and the greater the government’s need to borrow and/or print. Each iteration through this cycle worsens the situation. Eventually there’s no hiding and a meaningful restructuring takes place. This can happen early, or much later (like in Weimar Germany for instance).
We think that the danger of it occurring later is heightened when a government is addicted to the printing press. Meaning, if a government has a long precedent of using the printing press (and having it “work”), they’re more likely to stick with it. So the question is; if nominal central bank balance sheet changes don’t matter in this respect then what does?
Let’s think about an analogous situation first: Suppose there are two households: A and B. A earns $100’000 a year with expenses of $150’000. B earns $10’000 with expenses of $15’000. Suppose that for the past 5-10 years, household A has borrowed $49’000 per year and printed $1’000 per year and that household B has borrowed $4’000 per year and printed $1’000. Who would you say is more dependent on the printing press? Household B of course. B is printing 10% of its earning capacity whereas A is printing 1%.
If you look at it this way, the addiction can be measured by the degree to which a government is monetizing relative to earning. So on the next chart we look at central bank balance sheet changes over government revenues since mid-2008:
[We're approximating here by assuming that the entirety of central bank balance sheet increases go towards purchasing government securities.]
As you can see, the situation is rather different from the first chart shown above. Whereas the UK was ahead of the rest, with the BoJ towards the bottom (having only 1.5x’ed its balance sheet since mid-2008), we have a situation where the BoJ is printing the highest proportion of its government’s revenues.
Also, there’s a great potential for more. Over this period, Japan had a deficit amounting to 80% of its revenues and it only printed about 30% of it. In a bond crisis you would expect that latter number to rise appreciably (just take a look at the Euro Area on the chart below).
On the chart below, you see revenues in dark turquoise, the deficit that hasn’t been monetized in light turquoise, and the deficit that has been monetized in red. Should the existing pools of capital to purchase JGBs dry up then the red section could expand to dominate the light turquoise section. The US is not far behind, but the difference is that if Japan’s red monetization section were to dominate the light turquoise part, the JGB yield would easily add 2%, thus traversing the Keynesian endpoint and detonating the Japanese government’s accounts.
So although the UK and the US may be at risk of a 1970s-style inflation (if banks were to stop holding excess reserves), it may be Japan that could go down the path of monetizing in an aggressive, spiraling manner.
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