Central Banks Cannot Create Investment Via the Printing Press

Richard Duncan, a former World Bank employee, has posted an article that discusses his belief that QE is a form of debt cancellation that will allow governments to leverage up and make new growth inducing investments.

http://www.richardduncaneconomics.com/qe-is-debt-cancellation/

The Duncan argument runs as follows:

1) Central banks create money from thin air and buy government debt.

2) As governments owe money now to the central banks, and since central banks return all of their proceeds to the government, governments actually become less leveraged as central banks print.

Conclusion: This means that governments can really lever up now and invest in things that will create growth for the future in combination with central bank money creation from thin air.

The problem with this argument is that the second premise is demonstrably false. When central banks buy government debt, they issue a new form of debt, currency. This currency is also debt. Look at any central bank balance sheet and you will see it show up as a liability, just like every other form of debt.

Currency is slightly different from government debt in that it doesn't have a maturity date or pay interest. It is zero coupon perpetual debt. Nevertheless, it represents the same kind of claim on goods and services as the government bond. That is, $1000 in cash has the same purchasing power as a bond that sells for $1000. Nothing has really changed with the central banks money creation gambit, except for one small wrinkle.

Unfortunately, the small wrinkle completely destroys Duncan's conclusion that central bank printing will allow us to create new investment for future growth.

When central banks print money from thin air and buy bonds, they artificially push interest rates down. That is, to induce the holder of the bond to sell to them, the central bank must bid up the price of the bond above where it would normally trade, driving down the interest rate associated with the bond.

There is a funny thing that happens to the rate of savings when you do this however, it falls. As the central bank shifts the supply curve of money to the right, we see that rates will fall, all else being equal. This means that the interest rate is now below the equilibrium rate for the supply and demand for savings. This induces people to save less and consume more.

We can see now that Duncan's prescription of more central bank printing will bring about the exact opposite outcome of what he believes will happen. There will be less savings and investment available with more central bank printing. Investments require savings as someone somewhere has to defer consumption of their output in order to be able to lend it out so that the workers erecting a plant, or software coders creating an app or actors and technicians filming a movie can be paid and survive until the fruits of their labor are completed and their investment can start to earn a return.

Duncan, like most economists, confuses cash with savings. They are not the same thing. Savings, deferred consumption, is required for actual investment. Cash gives you a claim on that savings, but it not only doesn't create savings, the creation of cash destroys the incentive to save. Cash creation causes less investment, not more as Duncan hopes.

Duncan's argument is the equivalent of saying that central banks can create output, that they can just print up barrels of oil, employee retraining systems and jobs. They, of course, can do no such thing. Their money creation from thin air actually destroys future output (less savings means less growth) and creates malinvestment (malinvestment being a topic for another time).

Think about it like this, if money creation from thin air creates investment opportunities as Duncan proposes, why is the rate of savings and investment so weak? Why don't business invest more with the free money?

The reason that they don't is that they couldn't even if they wanted to as the savings doesn't exist at this level of consumption given the artificially low interest rates. If you want more savings and investment, you need higher rates and, therefore, less central bank printing. Duncan has it all backwards.

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.