Should the people of Middle Earth have done Quantitative Easing to mitigate against Smaug’s tight monetary policy?

Any blog that begins with the words “Smaug the dragon is typically viewed as a fiscal phenomenon…” has immediately got my attention. Please read The Macroeconomics of Middle Earth by Frances Woolley. Woolley compares the size of the dragon’s hoard with a picture of the gold reserves at the Bank of England – although it is likely that Smaug is the beneficial owner of his gold, rather than a custodian of gold for richer dragons elsewhere in Middle Earth. He concludes by suggesting that the peoples of Middle Earth should have abandoned the gold specie standard and adopted paper currency to reduce the deflationary drag that Smaug’s monetary tightness produced. Unfortunately though “the lack of a central bank, or indeed any but the most rudimentary monetary institutions, was a major obstacle to currency reform”. The comments are worth reading too – was Middle Earth an Optimal Currency Area? Before Smaug arrived, were the the Dwarves running Middle Earth like a petro-state?

*SPOILER ALERT* So Smaug dies in the end, and the gold was released into Middle Earth’s money supply. Was there hyper-inflation as a result? Or did Nominal GDP return to trend (i.e. the “catching up” theory that has been talked about by Central Bankers like Mark Carney lately) without longer term inflation problems? If there was hyper-inflation perhaps the political instability that resulted allowed the rise of Sauron as a leader, and the subsequent world war between Men and Elves, and Orcs?

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Discuss Article

  1. Gary Robert Jones says:

    There is also no organised religion, priests etc, (presumably everyone was a believer?) so the gold etc could not go there. Also Elves are eternal (unless killed in battle,natural causes) so how would they plan for retirement?

    Posted on: 02/01/13 | 1:54 pm
    • Gary Robert Jones says:

      I think the Dwarves were the most likely to act as a Travelling Bank, much like the Drovers did in Wales.

      Posted on: 02/01/13 | 1:59 pm
  2. Justin Pugsley says:

    The people of middle earth obviously didn’t have the benefit of the advice of John Maynard Keynes to wean them off the barbaric relic. Talking of gold, I believe there were occasions in history where it did cause inflation such as when the Spanish brought loads of it back from the new world in the 16th century & tried to spend it. I believe something similar happened in 19th or early 20th century California following the gold rush there. Obviously with the gold supply increasing faster than the capacity of other goods to be produced, inflation inevitably followed.

    The problem we have today with quantitative easing is that money either ends up back at the central bank via commercial banks or on their balance sheets, in part probably to meet Basel 3 requirements. Also, private enterprises are failing to spot compelling investment opportunities and with the world so uncertain, prefer not to make big multi-year investment commitments. And can you blame them?

    Meanwhile, some of the money displaced by QE programmes hoovering up bonds ends up in risk assets, such as commodities and / or depreciates the currency of the central bank engaged in such activities – think of the UK & the relatively weak pound. In the UK QE is causing some inflation, but very mild considering the ‘heroic’ scale of UK’s QE efforts. The BoE’s balance has literally exploded.

    So in a sense that inflation is making already hard pressed UK consumers poorer. It’s an incredibly difficult balancing act. What if the UK stopped doing QE? The pound would very likely rise as would probably gilt yields (costing the government more money to service debt) to a certain extent and consumer inflation would probably weaken (more disposal income? But would that go on higher mortgage payments effected by rising gild yields?). Also, it wouldn’t do the UK’s already dismal export performance much good either and there’s the risk that we’d end up like Japan where a strong Yen has helped steadily eroded a fantastic industrial base (we already only have a small one), but delivered deflation making pensioners there better off.

    My suspicion that the next stage of QE programmes will focus more on qualitative easing – that is buying riskier assets such as corporate bonds or more aggressively supporting small business loans to push cheaper money directly into the economy in the hope of stimulating activity. But in a country with miles to go in terms of de-leveraging & with an ageing population I’m not too optimistic on the outcome.

    Posted on: 02/01/13 | 5:23 pm
  3. Sophia says:

    He concludes by suggesting that the peoples of Middle Earth….


    Posted on: 03/01/13 | 1:40 pm

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