“I enjoyed your paid seminar at the World Money Show on Saturday. You showed how central banks took a consistent view with regards to money supply and velocity by massively increasing money supply when the velocity dropped. I wondered how easy you think it will be for governments to withdraw the money supply once velocity picks up. Is there a risk here that they are unable to sufficiently to prevent inflation?”

Eoin Treacy's view Thank you for your kind words and participation at my talk at the World Money Show in London last weekend. Central banks from the Fed to the Bank of England, ECB and Bank of Japan have stated explicitly that they are courting inflation. They will continue on that policy route until they have declared victory over deflation, however long it takes. The Bank of England in particular has demonstrated it is willing to accept a higher than anticipated rate of inflation for as long as deflationary pressures are perceived to threaten the wider economy.

They would have us believe that they are totally in control of the situation. Centrals banks explain that they have taken extraordinary measures to ensure money can be withdrawn from the system at will when growth returns to a more sustainable footing. However since many of the measures employed have never been tried before and because there is no empirical evidence to suggest they can quickly be reversed I prefer to maintain what I consider a healthy scepticism.

There is little argument that short dated paper can quickly be sanitised. Reverse repos will also be used to sanitise somewhat longer dated issues. However, the Fed told us more than a year ago that it plans to hold a substantial portion of its Treasuries to maturity. Surely this raises questions both about its inclination and ability to withdraw liquidity. Over the last year, the Fed has also been increasing its holdings of agency backed mortgage debt. Since these are both illiquid and the Fed is becoming a dominant holder of these securities, it is questionable that it will ever find a buyer. This will probably to impinge on its ability to shrink its balance sheet when needed.

Velocity of money has been trending lower across the G7 for more than a decade. When it eventually turns upwards, whenever that may be, the balance of probabilities is that central banks will not be able to withdraw money from the system quick enough and inflation will rise. This will then require higher interest rates.