Ann Pettifor

QE and the debt-deflationary spiral.

by Ann Pettifor 10 March, 2009

Over dinner at a prominent newspaper the other evening, journalists mused over the threat of inflation.  They were not the first to do so.  Many people, some of them influential,  are warning of the threat of inflation.

Prominent amongs these are commentators and journalists, even economists, that do not understand the nature of bank money. They invariably confuse it with the tangible stuff that appears as notes (printed) and coins (minted).  As a result, they believe that what the Bank of England is doing is printing billions of these notes.   Naturally such a misconception leads them to assume that we are threatened now by the sight of Mervyn King pushing a wheelbarrow stashed with billions of pound notes around the City of London – followed by the spectre of inflation.

If ever you meet up with such a scaremonger, here’s a counter point to put to them.

Money and debt is being destroyed.  Some call it de-leveraging. Others call it debt write-offs. Or debt cancellation. Bankruptcies invariably involve debt destruction – because bankrupts do not pay back their debts, so they get written off. The point is that money/debt is being destroyed in vast uncountable quantities.

Sudden Debt has helpfully provided some examples of truly remarkable debt destruction. The Ford Motor Company is planning to ‘eliminate’ about $10.4 billion of debt. In other words, they are trying to remove the debt from their books.  “Ford will pay 30 cents to 55 cents on each dollar of debt, depending on the type of note. Ford’s debt is trading publicly at about 20 cents on the dollar” according to the New York Times of the 4th March, 2009.

In other words, 45 – 70 cents of every single dollar of debt owed by Ford is to be destroyed, or ‘eliminated’. $10.4 billion of the stuff.  Indeed Ford is being generous.  Creditors would lose 80 cents of every dollar if they dealt directly with the market in Ford debt.

Similarly in Spain, the bank Santander is selling its shares in Compania Espanola de Petroleos SA – a large oil company, for less than half the closing price of CEPSA shares.  The reason for this? Santander desperately needs the cash, and so the bank is destroying half the value of the shares it owns in CEPSA.  (Bloomberg, 25 Feb. 2009)

The destruction of money/debt is best described as deflation.    Deflation of the vast credit bubble that was blown up over the last three decades.

What the Bank of England and other central banks are concerned to do, is to replace the debt being destroyed, with new money.  The trouble is, that the amount of debt being destroyed is so vast, that to replace it would require even vaster injections of new money. Right now, the central banks and Finance Treasuries are just not keeping up with the amount of debt being destroyed. Indeed they do not even know how to count it, or assess the amounts outstanding.

As long as they don’t, for so long will we not have even the remotest threat of inflation.  Instead we will be faced by a far worse fate: a sustained and destructive debt-deflationary spiral.


29 thoughts on “QE and the debt-deflationary spiral.”

  1. Well put.

    There is a difference between normal inflation, which can be beneficial, and hyperinflation, which is destabilizing

    and dangerous. If Koo is right that we are in the midst of a balance-sheet recession and that, consequently, companies will continue to pay down

    debt as long as they can, then the threat of inflation, which has some relation to the size of the debt, would appear to be rather remote. And if

    the level of toxic debt is as astronomical as it seems to be, the threat of inflation, even normal inflation, would seem to be quite remote for the

    reasons you so eloquently set out.

    Many Republicans in Congress have said that they want Obama’s fiscal stimulus package to fail, and

    presumably to do so dramatically. Some of them at least are ignorant of what the possible consequences of such a failure might be. But others are

    not. Can these others be viewed as being even nominally rational? They seem to be prepared to sacrifice even themselves, such is the zealousness

    of their “revolutionary” fervor. Your commentators do not appear to be as out of touch with reality as some far right Republicans, but ignorance

    as well as zealotry can make company with disaster.

    The kind of deflationary spiral you sketch brings with it the specter of bankruptcy,

    even the possibility of sovereign bankruptcy. The degree of toxic debt is so astronomical that even worst case scenarios can not be ruled out a


    Whether dealing with ignorance, zealotry, or simple inability to think “outside the box”, what is to be done?

  2. I perhaps ought to mention that if a comparison of Koo’s theory of recession and Fisher’s theory is wanted, Koo compares his own

    approach to that of Fisher’s in his The Holy Grail of Macroeconomics. As some might expect, they are similar, but differ in the causal accounts

    they provide.

  3. God, if only I could get rid of my own mountain of debt that easily. I am open to all offers of reflation.

  4. “Money and debt is being destroyed. Some call it de-leveraging. Others call it debt write-offs. Or

    debt cancellation. Bankruptcies invariably involve debt destruction – because bankrupts do not pay back their debts, so they get written off. The

    point is that money/debt is being destroyed in vast uncountable quantities.”

    I think you miss the point that these debt write-offs are

    because so much credit was extended to those who could not realistically be expected it to pay it off – the fantasy that we can keep growing on

    cheap credit – but bigger and longer loans fueling rising property prices, etc., etc. What never really existed except as a balance sheet trick,

    cannot be destroyed. AIG. Those that warn of the inflationary threat have some justification, because if there are not more write-downs of these

    unrealistic debts, more and more credit will have to be extended off the back of the taxpayer which ends up hammering the currency. Buying or

    insuring toxic waste is not a smart move – it props up an illusion that the tax is being used to maintain. That “investment” is not, broadly

    speaking, going to increase the productive capacity of the nation. It’s not going to create any jobs, better infrastructure, technology, etc. I’m

    not saying QE is wrong, channeled in the right way it is an incredibly valuable tool. But without dismantling the shadow economy, creating good

    banks, the banks as they are just going to sit on it. So what to do? QE again? For who’s(best)benefit?

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  7. I’m not an economist so be gentle. 🙂

    What would be a proper response to men like Warren Buffett, Bill Pimco and Jim Rogers

    who are predicting inflation in the US, possibly as early as 2010?

    I believe the actual amount of physical currency in the US is around

    $1T. With all the printing of treasuries, that amount has risen to $2T. Should this not have an inflationary effect?


  8. David, Thanks for your comment….and for your question. I think the point that I would make is that a) the money is not

    being printed – but that’s complicated and will not go into it here…you will find more in one of my Huff Post blogs on bank money…

    Second, while an additional $1 trillion may be injected into the economy by the Fed, this has to be substitute for much larger sums of money or

    debt being destroyed…as in the post above…If you judge that there will be more new money than the amount of debt being destroyed, then there

    may well be inflation ()i.e. too much money chasing too few goods). However, if you judge that the new money is no substitute for the vast sums

    being destroyed/de-leveraged etc…then there is still too little money/credit chasing goods and services…in fact there is a ‘credit crunch’.

    Does this help? Please say if not…this is what this blog is for…its not for the high priests of economics that speak in strange



  9. The current economy is a mess everybody knows it. What is amazing is how some people continue their daily life as if nothing changed

    and one such behavior is their attitude to their credit score. Foreclosures and just not paying laons is not a solution. Until Americans become

    more responsible for their debts we can not get out of the current mess. It is about time Americans educate themselves about finances and debt.

    Just taking debts on credit cards and home loans is not the way to go unless you understand what you are doing and face it most of us just do not.

    Here is a good resource to read about credit Education is key after all you would not try to fix your television

    set without studying how to do it first but you take a mortgage without understanding the basics behind debt.

  10. Comment by Philip on 12March 2009

    But debt is credit not cash. Thus equating the two is surely like comparing apples with guavas

  11. It is possible (in fact I think it is likely) that we would end up having the worst combination –

    inflation and deflation.

    Inflation would be on consumer price, which would primarily be driven by commodity price rises. Deflation would

    continue on real estates and equities, therefore bank loan books and pension funds would not get better financial positions.

    Before consumer

    price inflation, however, there can be inflation in precious metals led by gold (my hypothesis of “hyper gold inflation”). Gold will lead the rise

    of oil and agricultural prices. However, when the general public sees the hike in gold price, the confidence to fiat currencies may collapse well

    before consumer price inflation materializes. We will then switch from deflation into hyperinflation, skipping the consumer price inflation.

  12. Maria dos Santos

    Please,please explain to me a mere cleaner,why is it that my shopping at ASDA(WalMart UK)has been increasing dramatically

    since September2008.No debt destruction there!

  13. I have coined the term “Hyperdeflation” to describe this phenomenon in the Financial Times a few years back.

    You can learn more

    about this by searching for “Mr. Fed” at

    Sorry for the plug, but I’m the fellow who coined the term, to my knowledge.

  14. Well said.
    The problem right now is that the monetary authorities and governments are waiting to see if their stimulus works. This is the

    “phony war” period of this crisis. Maybe they think they have some time. The market is not yet grasping how pernicious this deflation is and how

    different from previous crises over the post war era. The difference was that in worshipping at the altar of low inflation, we let inflation and

    interest rates get too low so there is no wriggle room to use rates. Now, basically at zero, they’ve lost their effectiveness.

    As you say,

    more money is being destroyed – going to money heaven – as we speak than they are creating. So, we can’t have inflation if money is going away

    faster than it is being created. Inflation is a red herring.

    The chances of inflation are very low. And if it comes back, is that such a

    bad thing? Better to err on the side of caution. I think at the end of all this people universally will be saying, “What’s wrong with a little

    inflation?” The alternative is far, far worse.

  15. Comment By David Bahr and your reply.
    I did some economics a while back.

    I think i understand the

    debtcancellation bit, as being deflationary to the real economy.I dont fully get the magnitude,except the banks taking the hits are not in a

    position to lend as freely as before because of capital ratios and hence share supported bailouts, which appear ongoing?

    From UK

    perpsective this new money is apparently being used to purchase Gilts/ good assets?. This may reduce some of the deflation on some asset classes.

    Also lowering interest and the exchange rates.

    But for the normal person all i can see is imported inflation in the UK. Increasing

    taxes,food costs.Compounded by lower wages & job lossses and consequent loss of savings.
    Those that remain in work with debt should

    benefit,but are paying down debt.

    I rather agree with UShalfway and would prefer to nationalize the uk banks that are insolvent and setup

    new banks from the remains.Leaving onerous liabilities like unfunded pensions for Fred et al.Uusing QE money for Green infrastructure/products that

    good banks can get in on too.

    Maybe Route 1, giving cash to banks is thought to be quickest(we have an uk election soon)but is it best or

    just politically expedient.
    I suspect that setting up new banks sets a better precedent even if a slower harder path.

    Im not sure hence,

    my instinct is dont reward bad behavior, but we have been captured and i things are just been swept as discreetly away as possible.


    can they honestly know what is best after failing to regulate & govern.

    Meanwhile the little guy gets it good and proper and doesnt

    understand but has a feeling its a closed club between the banks,regulators,treasury and our Great Leader.

    Fingers crossed.

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  17. I only know some rudiments of economics and may be wrong.

    A liquidation of a failed company generally causes debt destruction

    but may not destroy money i.e, reduce the money supply.

    A company normally fails when it is in negative equity with an assets/debtors

    shortfall compared to creditors – this will be the debt destroyed in liquidation (everything simplified). Assuming this is owed to just a single

    company, then it causes a single write-off as loss. There is no money destroyed but only it’s capital account is weakened. No changes in the

    quantity of money in the economy. It is not certain QE, which generally increases the the money supply, is the best way to face this prospect of

    debt destruction spiral downwards.

    The first world government’s “urgent” economic response to the current global economic crisis seems

    to be a linear one-track approach. Fiscal stimulus/bailout to prevent insolvencies, job loss, consumption cutbacks. Replace demands, consumer or

    otherwise, as there is a need to maintain “demand” – thus a deficit spending budget. Is the way to deal with the current global economic crisis

    something these obvious? Just as people asked “Why no one sees it coming” – when everything passed us by, we may ask “Why no one got it right”.The

    reason may be much, much deeper.

    Free market economics have been vindicated by the recent failure of soviet socialist central planning

    economics – and maybe even by history throughout the centuries.

    No one knows the “correct” price of flour, potato, TV sets, hotel room

    rates, oil, hoe and sickle – and this is the beauty and the core of the triumph of free market economics. Infinitely many players on both sides of

    supply and demand tell us the price to make a deal – and no single player must be able to have significant influence over this “signal” which keeps

    the economic machineries running optimally.

    I read somewhere, probably some Austrian economics, that we don’t practice free market

    capitalism “rigorously enough”. The very lifeblood of the economic body, quantity of money and its circulation, is under socialist style central

    planning. The cost of funds, interest rate, is not “capitalistic free market”. We don’t have just “many sellers of funds” facing “many buyers of

    fund” – there are also some exceptionally influential players that can easily “move the market” with resulting undue advantage that harms


    Is this not the real reason that we need to have interest rate policy, volatile currency markets, global resources and savings

    mis-allocation. These may be the real reasons for the cycles of high growths (not necessarily all in proper sectors) with sharp recession-


    Mencius says: “As a rule of thumb, man only learns from mistakes”. It seems that, as a rule of thumb, governments only see

    a yard ahead and respond correspondingly. Also, as a rule of thumb, governments don’t change directions unless their hands are forced.

  18. Not only has trillions of dollars of money and wealth been destroyed, a whole system of economics based on leverage has also been

    destroyed. In addition, confidence and trust have been shockingly eroded.

    It would take full destablization of the currency to cause any

    significant inflation at this time. Is any sensible government really willing to go this far?

    It seems to me that sensible nations will

    come to realize that they will not be able to maintain proper trade with other nations and proper law and order at home if they spend their

    currencies into ruin.

    Already some countries with relatively weak currencies are starting to have second thoughts about further deficit

    spending. And the cordial relationship that so far has existed within and between nations is already starting to unravel.

    We are already

    reaching the limits of the present stimulus-approach in dealing with this crisis and still there is no sign whatsoever of any real worldwide

    economic turnaround.

    And when enough people realize that this stimulus-approach will fail, panic will set in.

  19. ViktorCapitalist, I really don’t get you? Of course I know what is happening to gold, but where oh where are

    signs of inflationary commodity prices? Me thinks you are finding scares where they presently don’t exist.

    Robin Day: ‘debt is credit,

    not cash’. Its true that cash is tangible and credit/debt is not. The latter is bank money and not tangible…but their source is the same. They

    are created by banks, but only created when we apply to the banks for a loan….For more on the relationship between credit and cash see my book

    ‘the coming first world debt crisis’…I have a whole chapter on it.

  20. UShalfway: “What never really existed except as a balance sheet trick, cannot be destroyed.”


    me. Do you think that that stuff on the balance sheet was not used? For buying assets? Like pass the parcel, it was moved on….including on to the

    balance sheets of pension funds whose managers thought they were buying assets with which to pay future pensioners….Now those ‘assets’ ain’t

    there any more…its looking pretty ugly for pensions, e.g…so don’t tell me that it did not exist!

  21. Ann Pettifor is a valuable thinker whose views offer a corrective to prevailing opinions.

    As an old guy I do worry about

    inflation which destroys the value of actual money saved (ie, actual money earned & then converted into savings & investments or, in a

    word, “credit.”)

    But the actual money once earned has, to my mind, a different personal & moral value than the “credit” which banks

    & governments may create — & which is not based on earned or achieved economic values.

    So Ann, isn’t it misleading to keep

    speaking about creating “money” when you are speaking of credit all the while? And am I wrong to distinguish saved money from the credit you speak


    The horror of inflation is that it destroys the value of our work & past achievements. It breaks the government’s own promise to

    “honor as legal tender, etc” mere paper trash.

  22. Ernest, thank you for your comment. This from my book:

    Bank money does not exist as a result of economic

    activity. Instead, bank money creates economic activity.

    As long as fifty years ago, the economist Joseph Schumpeter noted that

    proved extraordinarily difficult for economists to recognise that bank loans and bank investments do create deposits……And even in 1930, when the

    large majority had been converted and accepted the doctrine as a matter of course, Keynes rightly felt it necessary to re-expound and to defend the

    doctrine at some length…and some of the most important aspects cannot be said to be fully understood even now.
    Schumpeter, 1954


    of us still assume that bank loans represent a gift from someone who, unlike ourselves, has taken the trouble to deny themselves a portion of their

    income and to deposit this in a piggy-bank or savings account. Most mainstream economists still believe that banks have “savings” – either theirs,

    or those of others – and extend these savings to others as credit – charging interest. This is not the case. The money for a bank loan does not

    exist until we, the customers, apply for credit.
    In other words, far from the bank starting with a deposit, and then lending out money, the

    bank starts with our application for a loan, the asset against which we guarantee repayment, such as our house, and the promise we make to repay

    with interest. A clerk then enters the number into a ledger. Having agreed the loan, the commercial bank then applies to the central bank which

    provides – on demand – the necessary cash element of the loan. This cash element (notes and coins) is the small proportion of the loan that will be

    tangible to the borrower. The rest is bank money, which is intangible. Once the commercial bank has obtained the cash from the central bank we

    the borrowers, then obligingly re-deposit both the bank money (the undrawn part of the loan) and the cash, which together make up the sum of the

    loan, in either our own, or in other banks – creating deposits. Even if we spend the cash, the recipient of our cash will deposit it.


    Central Bank in issuing the cash, charges a rate of interest to the commercial bank. The commercial bank pays this in due course, adds its own

    interest, and passes both charges on to the borrower.

    ..banks have to hold a ratio of deposits in the bank, as cash. This is known as the

    cash ratio or ‘reserve requirement’. This tends to be a small fraction of total deposits. In any case, as noted above, any cash issued and spent

    (mostly in retail transactions) very quickly returns to the banking system as deposits.

  23. “Excuse me. Do you think that that stuff on the balance sheet was not used? For buying assets? Like

    pass the parcel, it was moved on….including on to the balance sheets of pension funds whose managers thought they were buying assets with which to

    pay future pensioners….Now those ‘assets’ ain’t there any more…its looking pretty ugly for pensions, e.g…so don’t tell me that it did not


    Ann I am essentially agreeing with Michael Hudson about the unsustainable level of bad debt and that debt

    needs to be “destroyed” and not propped up with QE. I use quotes because it’s a fantasy that all these debts could be paid-off so. This is not an

    argument against QE, but how it ought to be used.

    “Thought they were buying assets.” “Now those ‘assets’ ain’t there any more.” I think you

    just made the point I was making. To say they did exist because they were used to “buy” something else is the creation of an illusion. If you

    insist, an illusion is “real” in the sense that people are subject to them, but so are hallucinations, sticks looking bent half submerge in water,

    however they are misrepresentations of how the world is or could be – the idea that the shadow economy could grow exponentially on the back of the

    real economy is surely an idea that collapses under its own logic. So do we QE and give it to the pensioners, build better infrastructure, find

    greener, more sustainable energy production, or do we use it to buy up these “worthless” assets? I say again AIG – how much QE “money” to keep this

    game of pass the parcel going? That’s the inflationary game, but one that has to be mopped up later. If we are to QE, I’d like to think we did

    more than just re-inflate, but used it to build a sustainable economy, so the mop up won’t end up killing us off. Back to those pensioners, unlike

    Fred the “Shred” I bet most of those those people scrimped and saved their wages to put some of it away for the future in those funds, stayed away

    from debt burdens they were unable repay (failing serious injury, etc), added value to the economy. I didn’t say illusions can’t be dangerous,

    used to fool people; make others rich – that’s all too real. I’m saying it is time to remove the power of these illusions. Thanks.

  24. The

    paper wealth disappeared, but it also never existed. It was just an illusion created by fractional banking and investors over leveraging. The Fed

    is now creating the money that didn’t exist and paying it to all those who overleveraged, and the taxpayer is on the hook for the debt.


    Fed has also injected billions of dollars into foreign banks, China is holding billions of US dollars, Japan is holding billions of US dollars.

    In addition, the Fed is creating more money to buy U.S. Treasuries (government debt). More money injected into the economy. Again the

    taxpayer is on the hook to repay the debt. We are now going into debt to buy our debt..crazy.

    Nobody has a clue as to how much U.S. currency

    is floating around the world. The Fed doesn’t release the information.

    When all of this new money is further multiplied by fractional

    banking and leveraging, won’t we just have a new illusion of wealth? Even more money coursing through the economy? Won’t the malinvestment just

    start all over again. I’m sure Wall Street can come up with a new ponzi-scheme to replace derivatives.

    Logic dictates that by the time this

    new money trickles down to the average consumer it will be worth less, and also devalue any money they already have in savings, pensions… I don

    ‘t see how we can avoid severe inflation within the next two years. It’s already started, prices are rising.

    Doesn’t the Fed need an exit

    stragegy to prevent hyper-inflation? If they have one, what is it?

  25. Dear Ann,
    I taught A level Economics from 1975 to 1982, and then switched to Business Studies. As I recall the 1971 Competition and

    Credit Control rules meant banks could lend up to eight times their deposits, so there was a control on bank lending, either by limiting their

    deposits or by raising interest rates to make borrowers unwilling to approach banks for loans.
    What I don’t understand about the present is the

    huge sums of money involved. What happened to the 1971 rules to allow banks to lend so much?

  26. Frank, the 1971 Act was just the beginning of the 30-year de-regulation process…In the end, British banks were required

    only to declare the collateral on a loan – their ‘deposits’ or ‘reserves’ were no longer a factor…They were not relevant. Fractional reserve

    banking became a thing of the past…. gradually whittled away with the approval of the BoE, so that all that was required when say, you applied

    for a £300,000 loan was that the bank could guarantee an asset against that of say, £400,000…As asset (property) prices were rising so

    dramatically, so lending could rise too..Lending was in fact inflating property prices….and the BoE set no limit on how much could be lent….

    In Germany that was not possible: the asset could not be valued at current prices – its value had to be averaged out over a period of 20

    years…that made it harder for German banks to generate debt against rising property values…

    Hope this helps. Ann

  27. Dear Ann,
    Many thanks. Very helpful. What a terrible system.
    It’s astonishing that the experts, like the BOE, allowed it.


  28. Dear Ann, It was really a useful piece of information u provided . It is simply explained and can be undestood by laymen. U clearly pointed about inflation and BOE.

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