Some new figures out from Japan show that nation's debt is approaching 1 quadrillion yen. I remember Alan Simpson of Simpson/Bowles fame making all these goofy analogies about what a trillion was -- a stack of dollars stretching all the way to Mars and back or something like that. Imagine the field day Simpson would have with a quadrillion.
I bring this up because there's always such an outcry whenever people start talking about government money-printing. The inflationistas go crazy, their predictions of hyperinflation and currency debasement and depression flying everywhere. Yet, even with the mindboggling quantity of debt in Japan, the highest as a percent of gross domestic product anywhere in the world, there are still no bond vigilantes in sight. Moreover, the interest rate on a Japanese 10-year government bond is a paltry 0.75%. Who would have thought?
That's not to mention the fact that we've seen decades of 0% interest rates, massive quantitative easing and, in general, the Bank of Japan trying as hard as it can to inflate. Maybe, after all, it's not that easy for a central bank and government to cause inflation.
The fact of the matter is that the quantity of money is only one variable in what can cause price inflation. The other factors are the quantity of stuff produced and the rate at which we spend the money. The whole thing can be written as an equation that looks like this:
MV = PQ
What this says is that, for any given some quantity of money (M) and given a rate at which it's turned over in the economy (V), you get some quantity of stuff produced (Q) at some price level (P). For example, if I make five trips to the store with $10, $50 worth of stuff was purchased. Not very illuminating.
But the important thing to understand here is that M, V, P and Q are all variables. Even if M goes up, the others can change and offset whatever the effect is from a rising money supply.
To help you understand this, if we rearrange the equation and solve for P, we get P = MV / Q. That means the general price level is equal to the supply of money, times the velocity of money, divided by the quantity of goods and services. So if the supply of money goes up, but the velocity at which it is spent goes down, or the quantity of stuff produced goes up, then the money supply can rise and prices can actually go down. Now you can see where the inflationistas' problem lies. They assume that V and Q are constant, and they are not.
This is why you can have massive money creation in a country like Japan, for example, and still have no inflation. Velocity is low. People just aren't spending that much, and Japan is a modern, highly productive society. Its economic output grows as more money is created. Because of the slow velocity and a growing output, the large supply of money does not lead to price increases. The same can be said for the U.S., where the debt is much lower than it is in Japan, but where irrational fears of inflation are ever-present.
It is very rare to see modern, sophisticated and highly productive economies experience inflation from a rise in the money supply. That's because the rise in the money supply is almost always concomitant with a rising output. Recently, it's also been accompanied by slower velocity of money.
Until the velocity of money goes up and the quantity of goods and services produced cannot go higher, there is no need to fear high monetary growth.