Introducing… hyperstagflation!

Wondering what the implications are of QE2 (as in Quantiative Easing mark II, not Her Majesty) in the US – whereby the Fed will buy up long-dated government bonds of maybe up to a trillion dollars or so?

Well, Marty Feldstein at Harvard University reckons that it’s “a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles that could destabilise the global economy”. He notes that expectation of the policy has already lowered long-term interest rates, depressed the dollar and upped equity and commodity prices – and that these consequences create real risks:

Like all bubbles, these exaggerated increases can rapidly reverse when interest rates return to normal levels. The greatest danger will then be to leveraged investors, including individuals who bought these assets with borrowed money and banks that hold long-term securities. These risks should be clear after the recent crisis driven by the bursting of asset price bubbles. Although the specific asset prices that are now rising are different from last time, the possibility of damaging declines when bubbles burst is worryingly similar.

But John Michael Greer has a different concern about the US “printing money to pay its bills”:

There may be an example somewhere in the long history of finance when a country has done this without facing catastrophic economic consequences in the fairly near term, but I don’t happen to know of one. Once a country starts covering its debts by way of the printing press, the collapse of its currency and its economy is pretty much a foregone conclusion. The exact way in which the consequences come due varies from case to case; the hyperinflation made famous by Weimar Germany and, more recently, Zimbabwe is only one of the options, and there are good reasons to think that this isn’t the most likely outcome just at the moment.

My own guess, for what it’s worth, is that we’re headed into a state of affairs that might as well be called hyperstagflation: the economy and money supply both contract, but the demand for dollars drops faster than the supply as holders of dollar-denominated assets scramble to cash in their dollars for anything that might preserve a fraction of their paper value. As in the stagflation of the Seventies, but much more drastically, prices go up while employment goes down until the economy shudders to a halt.

Q.v. the excellent When Money Dies: The Nightmare of the Weimar Hyper-Inflation.