Editorial Note
The greatest risk in arbitrarily printing large sums of money is inflation if the amount of goods and services in a country doesn’t increase proportionately to the money supply.
Inconvertible paper currency is the fiat money worldwide, which is recognized by governments as the legal tender. It is universally accepted as the foundation of the global monetary system since the abolition of the Gold Standard when the value of currencies was fixed based on the gold reserves possessed by individual countries. Laymen often ask a very innocuous question: if governments across the world are not legally prohibited to print any amount of money, why can’t the social issues of poverty, inequality, public debt, demand depression and recession be resolved by printing more money? The greatest risk in arbitrarily printing large sums of money is inflation if the amount of goods and services in a country doesn’t increase proportionately to the money supply. In economic parlance, it pertains to heightened commercial activity and economic growth.
This can be illustrated by an example.
- Suppose an economy produces only wheat at 1 dollar for 1 kilo and all citizens have 100 dollars a month for consumption.
- The value of 1 dollar is 1 kilo of wheat and the total consumption is 100 kilos a month.
- If the government credits every citizen with an additional 100 dollars in their bank account, the demand for wheat increases from 100 kilos a month per capita.
- An increase in aggregate demand pushes the price of wheat to 1.50 dollars per Kilo and therefore for the additional 100 dollars the total quantity consumed is only 66 kilos instead of 100 kilos. If the price goes up to 2 dollars a kilo, then the quantity consumed will only be 50 kilos.
- Therefore, the real value gets eroded with inflation or price rise for goods and services in the country if the production remains the same.
- Suppose, wheat producers decide to hire more labourers in the fields to meet additional demand, then the demand for workers increases and they bargain for higher wages according to the theory of demand, supply and price. Here demand outstrips supply.
- Higher wages translate to an increase in overhead costs of company income statements, which affects profits.
- Every goods and service in a country have its own production possibility frontiers, which means only a certain amount of inputs could be utilized for the production of a particular good in relation to another.
- In the case of wheat production, the labour, land and skillsets are limited in a country (not everybody can be a farmer) and therefore, even if you have more capital, since the other available inputs and necessary resources are constrained, and production cannot be increased by the law of diminishing returns.
- Therefore, if the money in circulation is increasing disproportionately to production and supply of goods and services, the resulting economic phenomenon is inflation and sometimes devastatingly hyper-inflation- an ocean of money chasing too few goods.
In the 1920’s Weimar Republic, which was the erstwhile state of Germany from 1918-1933 and in recent history Venezuela, Argentina and Zimbabwe were subjected to the perils of hyperinflation. Zimbabwe was affected by hyperinflation in 2008, due to the authoritarian ruler Robert Mugabe, and his lopsided economic policies, when prices rose as much as 231,000,000% in a single year. To put things into perspective, a pencil that cost 1 Zimbabwean Dollar in 2008, was worth 23 million in 2009. At that rate, buying a pencil probably require 3 truckloads full of currency. Hyperinflation renders national currencies worth less than the paper it used for printing as savers and investors will abandon it for more stable currencies.
Quantitative Easing (QE) or Asset Purchase is an unconventional monetary policy measure taken by the Central Banks, which is tantamount to printing money, albeit in digital form, from thin air. This was first introduced by the Bank of Japan (BOJ), post-East Asian financial crisis in 1997, primarily to revive the economy from deflation. Quantitative Easing happens during recessions, when central banks like the US Federal Reserve and the Bank of England, engage in open market operations and buy government bonds like US Treasury Bills, Mortgage Backed Securities (MBS) and other gilt-edge securities that are safe havens for investors.
This facilitates cash injections into the books of open market sellers like banks, pension funds and insurance companies. For e.g. if the Federal Reserve buys government bonds worth 1 million from a US pension fund, the fund could use that cash to invest in equities in the stock market that offer a higher rate of return than the government bonds. If the central bank buys bonds from banks or other financial intermediaries, the banks in turn can create new private credit to individuals and corporations, using the fresh liquidity from the sale. As a general rule, when demand for bonds rises, their Yield to Maturity (YTM) declines and the market interest rates are reduced, resulting in a low cost of capital. As a consequence, banks can lower the commercial lending rates, especially mortgage interest rates to bolster borrowings and investments; thereby stimulating domestic demand and reviving economic growth. The US Federal Reserve balance sheet shows a staggering outlay of 8.77 trillion dollars in the Quantitative Easing program to backstop the US economy, against the coronavirus pandemic since 2020.
John Maynard Keynes, regarded as the founder of macroeconomics and Milton Friedman, Nobel laureate and a neoclassical economist of the Chicago School, have argued favourably for printing money and stashing in coal mines and owning it through retrieving by employing labour or dropping from helicopters, which in the current context would be to print money digitally and electronically depositing it to individual bank account holders. This process is known as money financing, in the event of stagnation or recession to stimulate consumption and demand. Neo-Keynesian economist and Nobel laureate, Joseph Stiglitz, and Ben Bernanke, the former Federal Reserve Chairman have also broached on experimenting with money financing, as an alternative to Keynesian debt-financing global debt has grown at alarming proportions. Jeremy Corbyn, the leader of the UK Labor Party has suggested printing money to finance infrastructure projects since the private debt to GDP ratio is at a staggering 219% in the United Kingdom!
The 2008 financial crash is a classic case of imprudent sub-prime lending, in the mortgage market, that had created an environment of inflated asset prices, causing asset bubbles, loan defaults, volatility, interconnections and stock market crashes, leading to the Great Recession. Excessive debt and insolvency have resulted in the economies of Portugal, Ireland, Italy, Greece and Spain, (known by acronym PIIGS), defaulting on coupon payments to bondholders and sovereign debt repayment obligations to the European Central Bank, sending ripples of economic crisis throughout the Eurozone.
In a greedy world buffeted by extreme events every few years, whether wars or insurgencies, terrorism, financial downturns, stock markets crashing or global pandemic are destabilizing economies, eroding wealth and wiping off the livelihoods of millions. Economists, political and financial analysts, public intellectuals and think tanks of the world are baffled at creating viable models, that provides a relatively risk-free economic system, which, addresses income inequality, resource allocation and financial security. The New Monetary Theory that proposes printing electronic money and disbursing to the masses could be a worthwhile experiment to fight the boom and bust cycles of the over debt-financed world. Perhaps, this could become the new leverage and new normal.