Here Comes the Greek Default

Greece will probably default on a roughly €740m payment due to the International Monetary Fund on Feb. 12, judging from the strident positions the new government has taken and a deeply disturbing connection between the ruling coalition’s junior party and the darkest corner of the Putin regime.

Taken together, the news this week dashed whatever hopes there were that Greece’s victorious radical leftists would see sense and cooperate with official creditors. Although the government can almost certainly afford to make the February payment, it can’t afford to pay the more than €16b due to official creditors this year unless they agree to roll it over into new loans. Given how little hope there is of reaching such a deal, the new government will probably stop paying immediately.

Two signals came on Friday. Yanis Varoufakis, the new finance minister, said the new government would refuse to meet with functionaries sent by official creditors to Athens to monitor implementation of Greece’s “adjustment program.” He said the new government would instead insist on high-level talks with European politicians to reach a new and completely different agreement. Varoufakis, a leftist economics professor, has been writing in his personal blog for years that Greece should default and insist on a large write-down of its debts.

Meanwhile Alexis Tsipras, the leader of the victorious Syriza party and the new prime minister, acted on a campaign pledge to end privatizations by sacking the head of the privatization agency. Since the latest version of the adjustment program expected privatization revenues would cover €2.2b of this year’s financing needs (see Table 11), the sacking was a clear message to foreign creditors to expect less repayment than planned.

But it’s the revelations about two ministers in the new Greek government that make a deal with Europe almost impossible. A Russian ultranationalist’s hacked emails, which garnered little attention when they were leaked to the internet in November, show that the new defense minister, Panos Kammenos, traveled to Moscow in October as a guest of Konstantin Malofeyev, a Russian oligarch under US and EU sanctions for his deep involvement in Russia’s war in Ukraine.

Although ostensibly an independent private businessman, Malofeyev has worked closely with Russian covert operations agencies to organize and finance the war. Igor Girkin, the Russian covert operations officer who led the Russian forces in east Ukraine until last August, professed to be a volunteer who recently left a job as head of security for Malofeyev.

Malofeyev and Girkin also worked together behind the scenes of the annexation of Crimea. Malofeyev has been accused of making his fortune by ripping off a big Russian state bank and misallocating French insurer Axa’s investment in his “private equity fund,” Marshall Capital.

Malofeyev also funds a creepy ultranationalist movement led by Alexander Dugin, who calls openly on his Facebook page for a genocide to be carried out in Ukraine. A prominent figure in Syriza, Nikos Kotzias, invited Dugin to speak at a conference in Athens in 2013, where Dugin urged Greeks to form a pro-Russian lobby within the EU. It looks like Dugin got his wish: Kammenos and Kotzias are now defense minister and foreign minister, respectively. Any future attempts by the EU or Nato to try to pressure Russia to stop attacking Ukraine will likely be vetoed by the new Greek government.

The Bulgarian journalist-blogger Christo Grozev has done a great job of tracing Kammenos’ trip by matching references in the leaked emails to a published interview of Malofeyev. Kammenos traveled as part of a big, fat Greek wedding party that Malofeyev brought to Russia because he couldn’t go to Greece. Grozev however misidentified the hotel where the wedding was held: it was Marshall Capital’s Tsargrad resort hotel outside Moscow.

Kammenos was listed among the wedding attendees in an email between two Malofeyev associates, and Kammenos’ trip to Moscow was mentioned in an email to one of them by a minor character in Syriza, Dimitris Konstantakopoulos. A pro-Russian journalist who cooperates closely with Dugin and Malofeyev’s organization, he gave the impression Kammenos stayed a long time in Russia, claiming the now-defense minister “disappeared off the face of the earth in a most impressive way.”

Syriza is a diverse umbrella coalition of many parties and organizations, some of which are practically parties of one man. There’s no evidence that Tsipras or Syriza generally are strongly pro-Russian. But as long as Kammenos and Kotzias are holding their current positions, the rest of Europe has every reason to want the Syriza government to fail. The United States, which has a crucial say over IMF lending, is unlikely to support any relaxation of conditions for this coalition.

The IMF tentatively agreed with the previous Greek government to roll over €7.2b of the €9.8b of its loans that come due this year (including interest), but that’s just not going to happen with the government flouting the loan conditions and the defense and foreign minister playing the role of Russia’s fifth column within Europe. Greece needs another €10b or more on top of that to make all its debt payments this year. It was a pretty safe bet that the EU would have rolled that €10b over if the former government had been re-elected. Now that looks extremely unlikely.

As I wrote previously, Greece’s financial position is not as strong as some have suggested. Greece ran a primary budget surplus of 0.7% of GDP in 2014, but that’s likely to deteriorate this year as Syriza tries to make good on populist campaign pledges and as households and businesses prepare for the worst by hiding money from the tax collector and moving it abroad. The most likely result of Greece’s rebellion against the austerity imposed by creditors will be worse austerity imposed by the absence of creditors.

In July and August, Greece is due to repay nearly €7.5b to the European Central Bank and Euro Area national central banks. As the organization that controls the Greek central bank and facilitates international bank transfers of euros, the ECB has considerable power over Greece. The ECB could use that power to make life so miserable for Greece that it will have to decide between getting back on an adjustment program or quitting the euro.

But I don’t expect to see Greece leave the euro. Polls consistently show strong support among Greeks for staying in the euro and almost no support for quitting. Syriza clearly promised to stay in the euro and would not have won had it been even a little bit shifty on that question. More likely, support for Syriza will quickly erode until it becomes unable to govern.

(UPDATE: For what it’s worth, “Greece will repay its debts to the European Central Bank and the International Monetary Fund and reach a deal ‘soon’ with the euro-area nations that funded most of the country’s financial rescue, Tsipras said in a statement e-mailed to Bloomberg News on Saturday.” Note that this is a paraphrase and the actual statement might have been less categorical. I suppose it shows that Tsipras understood by Saturday that the signals he and Varoufakis sent on Friday could undermine his own state finances. It may mean that Tsipras will go ahead and make the Feb. 12 payment to give time for negotiations. We’ll see.)

(UPDATE #2: For details of Greece’s 2015 debt payment schedule, see my more recent post.)

Greece Is Still Trapped

Paul Krugman has written a widely read blog post that appears to have gotten many people excited about the potential for bounce-back growth in Greece by reversing austerity. I’m here to rain on that parade.

Krugman figures that if Greece could get permission from its creditors to reduce its primary surplus to zero from the 4.5% of GDP that it’s supposed to run, it could boost its GDP by 12% and reduce unemployment by 10 percentage points. The math involves multipliers, which you may or may not agree with, but that’s not the point of this post.

The problem is that Greece doesn't have that 4.5% primary surplus. That's a target that it was supposed to reach in 2016, according to the previous government’s last fiscal agreements with the EU and IMF, published last April and May. The target for this year was a primary surplus of 3% of GDP, and the target for 2014 was 1.5%.

The actual primary surplus in 2014 was a smidgen over 1% of GDP, or €1.87b, according to the Greek finance ministry’s latest budget report. (UPDATE: By the IMF’s count Greece had zero primary surplus. See my more recent post.) In other words, although Greece has implemented quite a lot of austerity since 2010, it’s not generating some big cash surplus that could be spent on fiscal stimulus if the burden of debt service were lifted.

What’s more, that improvement in the primary surplus to 4.5% of GDP by 2016 was supposed to come not from more austerity, but from a recovery of nominal GDP, which the EU and IMF agreed should bounce back from a small 0.1% contraction in 2014 to grow by 3.3% this year and 4.9% in 2016. So far that’s not working out, as a slight rebound of real growth has been overwhelmed by deflation: nominal GDP contracted by 2.3% year-on-year in the first three quarters of 2014.

So let’s map out a couple scenarios, and see how the numbers actually add up.

Scenario 1: No Default, Maximum Creditor Leniency

Imagine that somehow Greece’s NGDP really does bounce back, and roughly matches the optimistic trajectory charted by the EU and IMF. Imagine the EU and IMF agree to refinance all of Greece’s debts that fall due through 2016, European central banks agree to continue reimbursing to Greece the interest payments on the Greek debts they hold, and all they ask of Greece is to finance its own outlays and other interest payments.

According to the April EU report, Greece is due to repay about €11.7b to the IMF in 2015-2016, of which the IMF is already planning to roll over about €9b (using dated exchange rates). So the IMF would have to agree to roll over that other €2.7b.

Greece is due to repay €15.6b of private debts, repos and arrears in 2015-2016, not counting short-term treasury bills and other domestic credit to the government that the EU and IMF assumed will be rolled over. Of that, €5.6b was supposed to be covered by privatization sales and the other €10b was left to be negotiated. Privatization receipts came to €0.4b last year. Never mind, let’s assume the rest of Europe agrees to roll over that whole €15.6b into multi-decade loans with deferred, near-zero interest.

So then Greece would only need to run enough of a primary surplus to cover the interest owed to creditors that aren't deferring or reimbursing it. Those are surprisingly low. Gross interest payments in 2014 came to €5.57b according to the finance ministry budget report. But a large portion of that goes to the ECB and Euro Area national central banks, which have a standing agreement to reimburse it right back to the Greek government. Those reimbursements were expected to come to €2.5b in 2014, as estimated in the EU’s April report (labeled “ANFA & SMP profits” in Table 11).

That works out to €3.07b of net interest costs or just 1.7% of GDP. The EU estimated Greece’s net debt service costs would drop to 1.6% of GDP in 2015 and rise to 1.9% of GDP in 2016.

So if the growth trajectory is enough to generate primary surpluses of 3% and 4.5% in 2015 and 2016, then in this scenario the Tsipras government could instead run primary surpluses of 1.6% and 1.9% and spend 1.4% of GDP in 2015 and 2.6% of GDP in 2016 on fiscal stimulus. That’s a lot of growth optimism and a lot of creditor leniency for not so much stimulus after all. Krugman’s rosy scenario isn’t just extremely rosy, it’s completely impossible.

But what if the growth rebound doesn’t work out, or if real growth happens but continues to be canceled out by deflation? Then there’s no room for any fiscal stimulus, even with the very high degree of creditor leniency I’ve described. If nominal GDP continues to contract, creditors will demand more austerity.

Note that I’m not factoring in any potential write-downs of the principal of Greek debts. Those aren’t actually important to cash flows, as long as creditors keep rolling over and extending the debts.

Scenario 2: Default

With a primary surplus, even a small one of 1% of GDP, it might seem in Greece’s favor to strategically default. But dig into the details and it turns out not to be so.

Greece has basically four creditor groups that it needs to make payments to in 2015-2016. One of the biggest and by far the most prickly is the European Central Bank and Euro Area national central banks, also called the Eurosystem. Because it's the backbone of the euro and any losses it takes fall directly on Euro Area taxpayers, the Eurosystem was exempted from the 2012 restructuring of Greek government bonds, which involved swapping old bonds for less valuable, longer-dated ones. So the Eurosystem holds the vast majority of the bonds that fall due in 2015-2016, which total €9.8b according to the April EU report.

Defaulting on partner central banks within a currency union would be a totally unprecedented step with unpredictable consequences. I figure no small number of lawyers around the EU are deep in the law books right now trying to trace all the possible outcomes. I have no idea. But these are not your ordinary creditors. These are the people who make the currency.

Many writers assume Greece would somehow be expelled from the currency union or from the EU itself, but one thing I do know is that there’s absolutely no legal way to do either of those things. Perhaps the ECB could do something really mean and annoying, such as stop processing interbank transfers into or out of Greece, to try to pressure Greece into either paying up or quitting the euro. The ECB could perhaps issue irritatingly restrictive orders to the Bank of Greece, but given the European system of self-enforcement, that might not be a good idea.

The biggest chunk of repayments in 2015-2016 are due to the IMF, which as I explained above is owed about €11.7b and has already agreed to roll over about €9b. As a rule the IMF never forgives debt, and I don't see it making an exception for one of its wealthiest debtors. IMF loans are like US Federal Student Loans: they never go away, however long you’re in default. International aid organizations stick up for each other, so Greece would be a pariah in that community until it made a deal to get out of default.

The third big group of Greek creditors are Greek institutions, mainly banks and pension funds. Of these the biggest chunk is the €13.3b of short-term treasury bills that were outstanding as of the end of September. Greece wouldn’t gain anything by defaulting on these debts, except big losses for its banks. The EU and IMF appear to be assuming that these debts will be rolled over.

And finally there are the holdouts who refused to participate in the 2012 restructuring. So far they have been getting paid 100%, which must be galling for everybody who took haircuts of 53.5% by face value and about two-thirds by net present value. But the holders of these bonds are largely vulture investors, who know how to cause enough pain in foreign courts to make it not worth the fight. And they bought the best bonds to go to court with. I haven’t got the details on how much of these come due in 2015-2016, but I’m guessing it’s less than €2b since there were only €6.4b of holdouts in total and some have already been paid.

Rebel All You Want, You’re Still Trapped

 Anyway you slice it, there’s very little to be gained by defaulting. Defaulting on debts to domestic banks would be suicidal. Defaulting on debts to European central banks would kick off an unpredictable legal battle with EU institutions, which hardly seems worth it given that the debt is interest-free till maturity and the EU can probably be convinced to roll it over into multi-decade, near-zero-interest loans. Defaulting on the IMF would make a pariah of Greece and seems pointless when the IMF is offering to roll over most of the debts that come due to it over the next two years.

And consider one more thing. Although none of Greece’s EU bailout loans come due anytime soon, if Greece defaults on Eurosystem or IMF loans it would be effectively stiffing the EU. The EU could respond by suspending structural aid, which is worth more than Greece could save in interest costs by defaulting. Greece received €4.65b of EU funds in 2014, while paying €2b as its contribution to the EU budget. That’s a net inflow of 1.5% of Greek GDP, bigger than Greece’s primary surplus.

The harsh truth is, Greece is boxed in. Trapped as trapped can be. So Greeks elected the only people who claimed to know a way out, however radical. But what can the Tsipras government actually do? I suppose it could make a show of throwing itself against the walls that surround it on every side. That might be what Greek voters are expecting.

Everyone hates austerity. Greece doesn’t have enough money to reverse its austerity. Who’s going to give it? You?

Euro QE: Halfway to Clever, or Halfway to Crazy?

The biggest controversy about quantitative easing, which will soon have been tried in all the world’s major advanced economies, is no longer about the policy itself. It’s about where QE might lead.

Quantitative easing has a deservedly mediocre reputation. When it arrived in the United States and Britain in 2008-2009, QE was promoted as a cure for overly low inflation, while the right wing demonized it as a throwback to overly high inflation. It turned to be nothing of either sort. Some people claim that inflation would have been lower without QE, but the evidence is sketchy. What’s clear is that QE came and went and inflation is still low.

In Japan and now Europe it’s a somewhat different story, as QE has made a clear difference: by devaluing the currency. The yen has lost a third of its value against the dollar since the fall of 2012 when Shinzo Abe began signaling he would push for QE. The euro has lost a tenth of its value against the dollar since the December 4 presser where Mario Draghi made clear QE was on the way.

These currency devaluations will somewhat boost Japan's and Europe's reported inflation rates, but that's an empty victory. As Paul Krugman explained back in 2010, QE was meant to encourage borrowing and spending by raising inflation and thus driving down real interest rates. But that logic doesn't apply to devaluation-driven inflation.

In the real world, borrowers don't actually care about real interest rates. They care how the nominal interest rate compares to their estimation of their future nominal income. Real interest rates, combined with real growth rates, are just a shortcut way of estimating how such calculations work out for the average potential borrower. It usually works because one person's higher prices paid are another person's higher income earned.

But with devaluation-driven inflation, the people earning the higher incomes are outside the country, and not actually earning more in their own currency. None of that is good in any way, shape or form for the importing country. Increases in prices of imported goods are a sheer loss. They make people poorer and reduce spending on domestic products.

The benefit from devaluation comes not from lower real rates, but from increased export competitiveness and increased investment in export-oriented industries. I won't get into the debate over how well that works in the long run. What matters here is that Japan and Europe think it will work.

However much European and Japanese officials protest that they don’t mean to be fighting a “currency war,” they appear to know exactly what they’re doing. Both Japan and Europe have long histories of deliberately devaluing their currencies to boost competitiveness. They can hardly claim not to be familiar with how it’s done.

Matteo Renzi, the Italian prime minister, plainly admitted in a recent interview his reason for supporting QE: His “dream is parity” between the euro and dollar, or basically to double the devaluation of the euro versus what we’ve seen in the past eight weeks. Gary Cohn, the chief operating officer of Goldman Sachs and not usually a big fan of hyperbole, said recently at a Davos forum: “We are in currency wars.”

Anyway, it’s hard to argue with a chart of the euro’s value against the yen. Especially with one as tastefully illustrated as this:

QE’s role as a weapon of currency war is the main news story of the week, but it's not my main reason for writing. The 2010s currency war could even turn out to be a minor footnote in the history of 21st century monetary and fiscal policy, if QE leads where it looks like it might be leading.

Increasingly, QE is being promoted as half of a policy that would combine it with fiscal stimulus, or what Oxford professor Simon Wren-Lewis, borrowing a term from Ben Bernanke who borrowed it from Milton Friedman, calls “helicopter money.” Or for another example, here’s Italian and Australian academics Biagio Bossone and Richard Wood arguing that QE is pointless unless combined with fiscal expansion, in what they term “Overt Monetary Financing.”

Mainstream commentators aren’t so explicit, but many of them favor the same thing, albeit probably on a more moderate scale. Gavyn Davies, a British centrist, called European QE “genuine progress” but “no panacea” and concluded: “The politicians now have work to do on the fiscal and structural components” – by which he means a combination of fiscal loosening and market reforms. Paul Krugman’s well-known preferences for fiscal expansion were understood when he concluded his blog on the European QE announcement by writing: “Great work, Mr. Draghi, but it’s going to take a lot more than this to save the day.”

Similar calls for QE to be joined with fiscal stimulus have been made many times before, but they gained no political traction in the United States or Britain and little in Japan. The idea also faces plenty of resistance in Europe, especially from Germany, which would have to participate in fiscal expansion for it to happen on any scale.

Given the heinous extent of unemployment in southern Europe, the Germans just might be cajoled into going along. And if such a policy is implemented and appears to work in Europe, it might well spread across the developed world. Europe’s decision to launch QE could turn out to be a first step in something very important indeed.

The question is, is QE half-way towards an effective cure for advanced economies’ recent growth malaise? Or is QE half-way towards treating malaise with mad malpractice? It’s time to dust off the old controversies around QE, because this time it might get serious.

Why QE Could Be Halfway to Clever

Whether explicit or tacit, a combination of QE and fiscal stimulus amounts to the same thing: printing money to finance a bigger public deficit. This proposal will sound frightening to many people, and I’ll come back to why such fears might be justified.

But for now, let's focus on two points. First, the taboo aganst printing money to fund public spending has actually already been broken. Since long before QE, European countries have funded their deficits largely by selling bonds to banks which then post those bonds as collateral for central bank credit. That's actually how Greece got into so much trouble. The other members of the Euro Area let Greece get away with a whole lot of that for a long time and then suddenly clamped down.

Regardless of whether it's combined with fiscal expansion, QE means printing money to fund public spending. The central bank prints money and lends it to government, simple as that. But QE without fiscal expansion doesn't fund any more public spending than was already happening, so it doesn't cause inflation.

And the second point: why do we need to be paralyzed by the fear of inflation? Inflation in advanced economies is comfortably low. It's substantially lower than Americans and Europeans were accustomed to until 2008, and much lower than the Japanese considered normal until the 1990s.

Personally, I'm not much convinced by the argument that boosting inflation would significantly encourage borrowing and spending. Until investors and consumers see more income growth, marginally cheaper money will not be much of an enticement. I'm also not at all afraid of mild deflation. That's a topic for another day.

But I do agree that boosting spending would help to employ the unemployed. And if it wouldn't cost much in terms of extra inflation, then why not help them?

The drop in inflation rates in recent years owes to a mix of factors, especially slowing population growth, aging populations, growing preference for leisure, a slowdown in the growth rate of productivity and high unemployment. Only the last of those is likely to respond to helicopter money.

Thus, we could afford to create some additional inflation pressure by printing money and making sure it gets spent. And the one way to be sure printed money gets spent is to have the government spend it. If you’re on the political left, you’d probably like to see more public spending on education, health care, infrastructure, research or even industrial policy.

Personally I think a large part of our problem since 2008 is that advanced economies are increasingly slow to adjust and re-absorb large numbers of laid-off people, because their employment process is increasingly about long-term teambuilding and decreasingly about tapping pools of general laborers. I'd like to see sit-at-home long-term safety nets replaced with public retraining and job placement, which wouldn't be cheap.

But helicopter money doesn’t have to be a license to veer left. If you’re on the political right, reducing taxes is presumably one of your top goals. Helicopter money can also do that, by printing money to substitute for reduced tax collection. There’s no firm guarantee that people would spend their resulting bigger net incomes, but it’s an excellent bet that they would.

The point is, how helicopter money is utilized can be decided democratically. The decision to use it wouldn’t limit people from freely determining the appropriate level of public spending relative to GDP, except by ruling out a regime with less public spending than QE. The Euro Area’s QE program is just over 7% of GDP and public spending is somewhere in the 40s, so that limit seems unlikely to matter.

Another technical point worth making is that funding public spending with QE incurs no direct interest costs. Although the government formally pays interest to borrow from the central bank, the central bank turns around and remits that money right back to government. QE does cost the public if the central bank pays interest on cash deposits, but usually such rates are near zero during QE. In the Euro Area they're currently negative 0.2%, which means the public earns a little money by taxing banks that hold cash.

The bottom line is we'll never know if helicopter money would work unless we give it a try. If inflation accelerates quickly, we might end up having wasted a lot of policy-making effort on a flash in the pan. But there shouldn’t be any other damage done, so long as the central bank can be trusted to respond quickly by reducing or canceling QE. Moderate proponents of combining QE with fiscal expansion want QE to be limited to whatever amount keeps inflation near 2%. Radical proponents want to allow inflation to go up as high as 4%.

In the grand scheme of things, is even 4% inflation really a disaster? Would that be such a terrible price to pay if it would help put substantial numbers of people back to work? Is there some reason why we can’t even allow ourselves to try?

Why QE Could Be Halfway to Crazy

The critiques of helicopter money come mainly from the right, and especially from the Austrian school of economics, a libertarian ideology that’s viscerally opposed to the very concept of central banking. The Austrian school enjoyed a resurgence of popularity in the wake of the 2008-2009 crisis due to its focus on credit excesses, which led many Austrian theorists to predict the American subprime disaster. “Austrians” are generally also goldbugs, so it's no surprise they called the post-crisis surge in gold prices.

Since then the Austrians – actually mostly American these days – have lost a lot of credibility by repeatedly making extreme doomsday predictions about QE and inflation, or even hyperinflation. But if one looks past the often nutty types that Austrian theory tends to attract and actually read the Austrian economists, they do make a very important point.

The Austrian school’s aversion to central bank money-printing actually goes back to a 1912 book by Austrian economist Ludwig von Mises, Theorie des Geldes und der Umlaufsmittel, later translated into English as The Theory of Money and Credit.

The book delivered a dire warning about the threat posed specifically by printing money to fund public spending. Few listened, and nine years later, Germany was crushed by hyperinflation. German democracy was mortally wounded.

There have been many more episodes of hyperinflation around the world since the 1920s, and all of them have had one thing in common: money-printing was used to fund ever more fiscal expansion.

I’m not trying to suggest that Europe or any other contemporary advanced economy would be so irresponsible as to print money to the point of hyperinflation. Hyperinflation is a deliberate, desperate policy that usually reflects some very serious underlying problem, such as war or a collapse of the state’s ability to collect taxes. A government that’s adding zeroes to its bills to fund itself is a government that’s not looking much past tomorrow.

My point of going through all this is that, unlike QE alone, QE in combination with fiscal expansion can be extremely powerful. Even devastatingly powerful. It’s not a policy you would want a blithe, happy-go-lucky type to manage on your behalf. There needs to be a very high level of trust between society and the central bank for it to work.

What if, for example, helicopter money is tried and the result is mediocre: unemployment comes down some, but inflation also rises quickly, to say 5%. Would central bankers have the political will to cut off the QE tap, when politicians might well be clamoring for more QE, in order to bring down unemployment more quickly?

There are any number of other possible reasons for caution. QE could make it too easy for governments to raise funds and thus remove the usual disciplining role that bond markets play. In other words QE might be an enabler for bad governance.

There are growing numbers of people who think that QE or low interest rates actually reduce growth. Personally I find the economic models that attempt to explain how that might work to be a bunch of hoo-ha (you can Google John Cochrane and Stephen Williamson and judge for yourself). But perhaps in a few protected industries with stifled competition there could be a similar lack of market discipline that's being exacerbated by overly cheap money.

Another thing that should give everyone pause is that managing the money supply is simply mysterious. Until QE was tried, every mainstream economics school predicted it would spur inflation, as did all but a few mainstream economists (Krugman was one who got it right early – and no, the rest of you guys, he will never let you live that down).

To this day, economics students are learning models in which the money supply and consumer prices are presumed to even out over the long run, even though our experience with QE has disproved that. Economics students are still learning that there is an attribute of money called “velocity,” which supposedly determines the relationship between money supply and spending, even though for the last six years US money supply and spending have moved completely independently of each other.

The concept of “velocity” is so prevalent that even I have used it in my professional writing, because it’s by far the most easily understood way to explain how a developing economy can boost money supply without causing inflation (by simultaneously reducing “velocity”). But the concept of velocity misses the whole point. The crucially important thing that changes over time and differs across countries is the willingness of people to hold their savings in the form of money.

In advanced economies, people turn out to be willing to hold quite a lot of their domestic currencies as savings. The Chinese turn out to be willing to hold even more, albeit with some coercion. Among other emerging markets and developing countries, the situation varies widely from country to country. Some situations are easy to predict, such as Venezuelans' growing aversion to the bolivar. Others come out of the blue, such as Myanmar's escape from chronic double-digit inflation, which began with a lucky pause during the 2009 global collapse in food prices and then all just sort of fell together from there.

The main thing I discern from my experience with various countries is that changes in people’s willingness to hold money savings are self-propelling. When a country with chronic high inflation starts to improve, savings pour into bank deposits, strongly suppressing inflation and building trust in the currency. That draws in more savings into banks, and the process continues.

Or the spiral can go the other way. When people start to expect high inflation, and especially inflation that exceeds interest rates on savings deposits, they pull their savings out of the bank and rush to buy property or a business or gold. Or they just consume more of their income. That leads to higher inflation, and the process continues.

Which, by the way, is exactly how helicopter money is meant to work. And begs the question, will people really understand and react in time before it goes too far?

Again, the simple, almost too simple answer is that the central bank will set an inflation target, and stop QE when that target is surpassed. But would QE be stopped in time before that spiraling change in mentality sets in? Is a 4% inflation target low enough to avoid the spiral? Or, as Ben Bernanke argued back in 2010, would it be crucial to maintain a 2% target, in order to preserve hard-won confidence in central banks?

Those are the trillion-dollar questions. If you can answer them, you can say whether QE is halfway to clever or halfway to crazy. I honestly don’t know.