greshams-law.com / By Thomas Gresham / February 5, 2013
If you measure the laxness of a central bank by the magnitude of its balance sheet expansion then there’s been a clear winner in recent years: the Bank of England (which has quadrupled its balance sheet since mid-2008). This leaves the UK at risk of a huge expansion in the broad money supply if the fractional reserve banking machine were to get going again. This, however, could be some time away and is not the only mechanism in play. Here we’ll look at central bank balance sheet expansions in relation to government accounts. By the end of this piece you’ll have a good understanding of how addicted various governments are to the printing press.
As we’ve mentioned recently, the thing that leads a sovereign down the path of aggressive inflation and/or default is when interest expense consumes the entirety of government tax revenue. When this happens, every cent that’s spent has to be printed and/or borrowed. So, the further the government goes down the path of choosing to print, the higher the interest rate charged, and the greater the government’s need to borrow and/or print. Each iteration through this cycle worsens the situation. Eventually there’s no hiding and a meaningful restructuring takes place. This can happen early, or much later (like in Weimar Germany for instance).
We think that the danger of it occurring later is heightened when a government is addicted to the printing press. Meaning, if a government has a long precedent of using the printing press (and having it “work”), they’re more likely to stick with it. So the question is; if nominal central bank balance sheet changes don’t matter in this respect then what does?