Preamble: I’ve been thinking a lot about Quantitative Easing again recently. Janet Yellen is preparing to start the slow unwinding process of the Federal Reserve balance sheet in the coming months (that is: the massive balance sheet that QE created). And so I wanted to share an updated version of this 2014 post, written just after (America’s) QE program was finally concluded, about why we didn’t get the ‘inflation’ that so many of us expected.

When Janet Yellen came out and told the world that Quantitative Easing was officially over, the question that I kept asking myself was: “what the hell just happened?”

Where was all the inflation?

Mr Paulson? Mr Gross? Any of the many that threw out dark warnings about the imminent collapse of the US dollar in waves of global calamity?

And I have to include myself in that list. Specifically, this post: America’s Hyperinflation. *looks embarrassed*

Here’s the basic summary of what that post said:

  1. Inflation is one thing. Hyperinflation is…something else.
  2. A line that I’m still proud of: “Inflation is a rise in prices. Hyperinflation is the loss of faith in a particular currency as a medium of exchange – as expressed by excessive rates of inflation.”
  3. My call was that some kind of policy/intervention/fiscal shock would trigger that loss of faith, and then all that created money would funnel itself into a hyperinflationary spiral.

Only it didn’t.

Three possible places to go from here:

  1. “Oh please – it just hasn’t happened yet, but it’s a-comin’. Y’all mark my words now…”
  2. Or: “The inflation happened, because deflation didn’t happen, duh. And also, you don’t understand what Quantitative Easing is – it’s not outright money creation – it lacks a transmission mechanism… <insert technical defence>”
  3. Or, my preference: “I’ve realised something(s) that I didn’t consider at the time.”

The best place to go would be “gloating”. But that’s reserved for the inflation nay-sayers – and Paul Krugman already has that sufficiently covered in Knaves, Fools and Quantitative Easing.

Realisation: We need to redefine inflation

Or, rather, we need to be quite clear about what type of inflation we’re talking about.

When we talk about inflation, we usually mean consumer price inflation, as expressed by movements in the Consumer Price Index (CPI). It’s what gets Central Banks are hot and bothered. And the idea goes something like:

When extra cash goes into the market, you have more money chasing the same amount of goods and services. Therefore, the value of money goes down relative to the value of goods and services. But because those goods and services are denominated in money terms, it means that the price level has to shift upwards in order to reflect that fall in the value of money.

The trouble is: that inflation leaves out the fact that the economy is not just goods and services. An economy is goods and services and financial assets.

In ‘normal’ situations, you can probably get away with ignoring financial assets. Or with quietly assuming that financial assets derive their value from goods and services – because their values are based on current and future earnings that are in turn driven by the provision of current and future goods and services.

But in a society that has entrenched dynastic wealth, my personal feeling is that this assumption starts to fall apart.

Why does ultra-wealth matter?

Because for the really wealthy, the investment in financial assets stops being an alternative to consumption. As someone becomes wealthier, investment takes on a life of its own. You need to put the money somewhere, and you can’t spend it fast enough. I mean, if your wealth grows by $1 billion every year, even if you dash around buying yachts and hosting lavish banquets, your spending becomes a nonsensical blip on your radar. And the pressure to find a home for that unspent cash becomes an imperative.

In short, you don’t just “spend the money” in order to preserve its purchasing power.

So when we look for signs of inflation in today’s world – the world of Piketty and co – we can’t restrict ourselves to goods and services. We have to look at financial assets.

Now bearing in mind that we have had no real good news on the economic front since 2008, I give you…

Almost all the asset classes

The US Corporate Bond market:

Screen Shot 2014-10-30 at 9.09.44 AM

The US Treasury Bond market:

Screen Shot 2014-10-30 at 9.09.30 AM

The High Yield USD-denominated Corporate Bond market:

Screen Shot 2014-10-30 at 9.09.13 AM


The Australian Bond Market (because why not):

Screen Shot 2014-10-30 at 9.08.45 AM


The US stock market:

Screen Shot 2014-10-30 at 9.06.48 AM


The UK stock market:

Screen Shot 2014-10-30 at 9.06.39 AM


The German stock market:

Screen Shot 2014-10-30 at 9.06.22 AM

The Dow Jones Industrial Average:

Screen Shot 2014-10-30 at 9.06.12 AM

Each is doing a fairly glorious job of presenting itself as a boom market.

Except that it’s not really a boom market.

The Asset-Price:Consumer-Price Link

When central banks create money, the first port of call for inflation is financial assets. It starts there, and then it’s meant to converge back into the market for goods and services. That is: people get richer (through higher asset prices), and then they spend more (on consumption).

Meaning that during the course of Quantitative Easing, we didn’t “not have” inflation. We had the first wave of it – in the financial assets market.

So is inflation “always and everywhere a monetary phenomenon”? Of course it is. It’s like economic physics: more liquidity = inflation. We’re just looking for it in the wrong place.

But we also haven’t really seen the second part – where people end up spending more….

The Trillions-of-Dollars Question: Will The Markets Converge?

They could.

Or, conceivably, they may not.

Traditionally, the convergence is driven by:

  1. Falling asset prices, as the wealthy liquidate their assets to crystallise their capital gains and use it to buy lifestyle goods;
  2. Increased liquidity entering the consumer market (through spending by the wealthy trickling down into the lower classes – hence the “trickle-down economics” term).

I’d also add in a third factor: foreign-local good arbitrage. In smaller inflationary scenarios, consumer goods are underpriced relative to financial assets and goods available in neighbouring countries. So you get inflation arising from the hoarding and/or export of cheap consumer goods in the inflating country – and you also get inflation on imported goods, where importers attempt to preserve the real value of their investment in inventories by raising their prices.

Some observations:

  1. If the depression is global, you don’t get quite the same foreign-local good arbitrage. At the very least, the force is not as powerful as it would be in a small inflating country.
  2. I’m not convinced that dynastic wealth would liquidate its assets and spend the proceeds. If there is any liquidation, it would be a reallocation between asset classes, not a reallocation between spending and saving.
  3. In the end, consumer price inflation demands consumption. And we seem to be moving toward a global economy where those with the ability to consume, don’t – and those with the desire to consume, can’t.

Which may mean that the current discrepancy between financial assets and the consumer goods and services markets is actually not a discrepancy, but a new equilibrium.

How’s that for a bombshell?

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at