How a toaster killed inflation
Low cost Chinese manufacturing and the Internet have played big roles in keeping inflation low.
In the aftermath of the global financial crisis the return of inflation was a real threat. Central banks everywhere were rolling the presses on an unprecedented scale.
In November 2008, the US Federal Reserve unveiled QE1, a quantitative easing program that involved the Fed purchasing about US$1 trillion in mortgage backed securities. The Fed finally ceased purchases in October 2014 having purchased US$4.5 trillion in bank debt.
The money used to make these purchases was not real in the way that you and I understand it. Created with the stroke of a pen, it showed up as a few more zeros on a screen. As long as you're a government with a compliant central bank, money can indeed be created from thin air.
This unconventional monetary policy was co-ordinated. Across the Atlantic The Bank of England was following its own QE program, as was the European Central Bank. In China, another trillion US dollars was injected into the local economy, although its purpose was not to repurchase bad debt but to create more of it.
There was no peacetime precedent for this policy. Interest rates were near zero and the risk of deflation was so great that policy makers had to act, even if it meant running the risk of creating hyper-inflation, a cure potentially worse than the disease.
No sign (yet) of inflation
That threat – one that many Intelligent Investor analysts took very seriously – never happened. As yet, there is no sign of inflation, let alone hyper-inflation.
Much of the US and European money that ended up on banks' balance sheets remains there. It turned out that after a financial crisis, companies and consumers pull their heads in.
Corporations are sitting on huge cash piles and show no sign of being prepared to invest it. A recent Deloitte survey showed that business demanded returns of at least 10% for a new project to proceed. With hurdle rates so high and growth anaemic, no wonder companies keep their capital locked up.
Consumers meanwhile increased their savings rate. As Business Insider put it, 'people weren't supposed to be saving this much money.' So whilst a huge amount of money has been created, not much of it has hit the real economy. At least not yet.
A third reason relates to the humble toaster above. On Tuesday, my grill packed up. The toaster I purchased so the kids could have breakfast without me getting up early on Australia Day cost me $10. That's an incredibly low price for materials, manufacture, packaging and transport from China to my local Woolworths (ASX:WOW).
If there is any inflationary pressure in the system, the constantly falling prices of products like this help reduce its impact. The Internet is having the same effect, lowering the cost of everyday products and services from taxis to groceries.
Central banks around the world like to take credit for safely walking the thin line between heading off deflation and not opening the door to inflation. But the widespread adoption of the Internet and the huge growth of low cost Chinese manufacturing have played a big but under-appreciated role.
In the future we may come to appreciate just how lucky we have been in experiencing this confluence of events right at the time of the biggest financial crisis since the Great Depression.
So tomorrow morning, I shall gently pat my modest but gleaming toaster and give thanks to its larger role in beating inflation.
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