Government prints money to pay debts - why bad

Factual Questions
21

Maybe this will help. I actually tried this out on a class once and they got it eventually. Suppose suddenly, every dollar in every pocket and bank account in the land suddenly became 10. What would happen? Well, there are no more goods than there were before, so merchants will raise all prices by a factor of 10 and we would be in exactly the same position as before. The reverse actually happened in France in 1960 or so when they knocked two decimal places off all currency and 100 Fr notes became 1 Fr notes and so on. No real difference except that had to reintroduce centimes for old francs.

Now let me vary my experiment by dividing the population in half and leaving the money in the pockets of one half unchanged and multiplying by 20 all the money in the pockets of the other half. The total money supply under the two scenarios is approximately the same and the prices would willy-nilly rise by a factor of ten, but suddenly half the people would see their material wealth rise by a factor of 2 and the other half would be impoverished. (Actually, my numbers don’t quite add up, but the principle is valid.) What has really happened is that nearly all the true wealth of half the population has been transferred to the other half. And this, with somewhat different numbers, is what happened in Spain. The people who acquired all that gold became wealth, but everyone else, along with the Spanish economy, was impoverished.

Now you may argue, with certain validity, that if the government simply printed a trillion dollars and paid off all its debt, the money would effectively be transferred from the people who owed the money to those to whom it was owed. I cannot refute that and I suspect it might be true. Trouble is, it would still make the economy tank, most likely. Just think back to the eariy 1980s when I got a CD that paid 20% interest for 5 years (not, however, reinvested at that rate). Of course, with taxes and inflation I was actually getting negative interest.

22

When I took economics courses I always heard the same thing that has been pointed out here, if the amount of money doubles the price will double because there is still the same amount of goods and services. However I also learned that when prices rise companies produce more products. Therefore I would expect that the number of goods and services would double prices would come down to their original level and we would have twice as much stuff. Someone please explain why this isn’t true.

23

Unless a company is producing goods at below full capacity, it can’t simply ramp up production. When you build a plant, you build near expected full capacity since building too much unused production capacity wastes money. If I am producing at 95% capacity and my demand doubles, I can either refuse to fill the additional demand which leads to higher prices since demand is greater than supply or I can spend money to meet the demand which leads to higher prices to cover my additional expenses.

Services are similar in that you hire the minimum number of people who can perform the services with no one sitting around waiting for work. Those extra people waste money. If tomorrow your business doubles, you need to go out and hire more people, buy more supplies and possibly expand your operating space. All of that increases your expenses which is passed along to the customer.

Employees want raises every year(bastards!!), supplies tend to increase in price, rent increases, taxes almost always increase, the list goes on. Now of course if there is money to be made, someone is going to jump into the business and drive prices down but they need to recover their investment plus make some osrt of proffit so prices won’t go back down to their original level…it gets very painful from here trying to determining the market equilibrium.

As for the OP, since you are not happy with any answer put forth, it is great debates material.

24

I might be completely off here, but I’ve heard that a bank does not have to have the full amount of money that they lend. They only need to have something like 10% of the cash that they’re loaning out to people, businesses, govt…

Is this true? And wouldn’t this have the same effect as printing these large amounts of money? The bank would be essentially “creating” money and making interest on it. If it is true, it’s happening every day.

25

Yes, banks create money every day, but the Federal Reserve indirectly “controls” it through changes in the discount rate, reserve requirements, or participating in open market operations.

26

The primary reason why this isn’t true from a classical, intro to macro-econ standpoint is this: companies produce more products when prices rise in real terms (which is to say, after adjusting for inflation) as opposed to nominal terms (the face price, before correcting for inflation).

Here’s the intuition: companies increase production not just because the number of dollars they get is increasing, but because the reward they get is increasing. Dollars, in and of themselves, are of no use. What the CEO really wants is a new HDTV or a yacht or a new vacation home. If the company makes twice as much profit, but prices for everything double, then the reward hasn’t changed, has it? It all becomes a wash and we’re right where we were before, except maybe there’s an extra zero stamped on all our currency (which, if you think about it, is a loss to the economy since it would cost money to alter the design of our currency, for no tangible benefit).

This is fundamentally why we can’t (or, at least, shouldn’t) print our way out of debt. Our creditors don’t care about currency. They lent us currency (through bonds and such) that represented a certain amount of goods and services, and they want that amount, plus more goods in services in the form of interest, back. If we increase the money supply by a significant amount, we devalue our currency, because we have lots more currency chasing around the same amount of goods (since new production will not increase commensurate with new money supply). If currency is worth less, the return to the creditors decreases, and unhappy creditors is bad news for any future borrowing on the part of the government (to put it extremely mildly, think in terms of Germany’s hyperinflation after the First World War).

In the end, dollars only represent real goods and services like televisions and staplers. We borrowed money that represented real stuff, and we’re going to have to pay it back with money that represents real stuff. There aren’t really any clever schemes that will get around it, at least not without causing severe economic turmoil.

27

(I’m having a long, crappy day, so I humbly apologize if I am repeating somebody else’s remarks. I did my bets to read the thread, but my brain is not functioning today.)

It is backed, in a sense, since a refusal to accept payment of a debt in the form of cash will render the debt void. You don’t have to accept cash for goods and services, but you do if there is a debt. But I don’t think that’s what you’re getting at.

First off, you could build a career examining this question and any answer we could offer in this setting will ultimately fail to capture reality as best we understand it.

A strict monetarist concludes that there is an equation that holds. Suppose that there is some given amount of money out there and that people spend it. Then the total amount of spending is going to be equal to the number of dollars in circulation multiplied by the how many times the dollars get spent. This is from the buyers’ perspective.

From the sellers’ perspective, there is a whole bunch of stuff being purchased. The total amount of selling going on is going to be the price of the stuff being sold multiplied by the the number of sales there are.

Now, if there are no buyers for a thing, then it won’t get sold, and if there are no sellers of a thing, then it won’t get bought. Therefore, the selling and the buying have to equal out. The amount of money times the number of times it is spent equals the price of stuff times the number of sales made. This is the big equation for the quantity theory: MV=PT, where M is money stock, V is the turnover rate of money (maybe not a rate in a technical sense), P is the price level, T is the number of transactions.

Now, justified or not, if we assume that the rate of turnover of money and the amount of stuff there is to sell hold constant, then it is obvious that the stock of money and the price level are linked. To hold the equality, increasing M means that P has to increase as well.

This is the most simple was that I know of to look at it. It works experimentally. For example, I was a grad. ass. for a prof who did a classroom experiment testing this. When there was more money available, prices went up. (I don’t recall the specifics. You should be able to find an example here: http://www.marietta.edu/~delemeeg/expernom.html )

As far as I know, there is still quite a bit of debate on this. Strictly speaking, the quantity theory holds that money isn’t real. But it may have effects on output, in which case you could increase money supply and increase output without a matching increase in prices. That’s why the Fed can buy Treasury bonds without necessarily increasing price levels. I doubt that you could find an economist who doesn’t think that there is a quantity-theory element to the money supply, etc. (Tell an economist that congress should control the money supply…) I also doubt that there are many strict monetarists around either.

If that doesn’t help, then say so and I’ll try to do a little better over the weekend.

28

Which is not to say that I’m any better, I just like to be helpful if I can and I will try harder if I do a poor job. There are plenty of people here who are qualified to answer better than I can. I hope I didn’t imply otherwise.

29

Okay, I have a question.

Let’s say that inflation is so bad in the year 2004, that $100 is worth a dollar in today’s currency.

I stash away a few hundred (worth a few dollars) for a few years. In the year 2010 the inflation has gone to down to 2003 levels. Will my few hundred dollars a few hundred dollars or a few bucks?

30

Inflation is a measure of the rate at which the value of money decreases. The money will not regain it’s value relative to today’s currency if inflation eventually decreases. While the rate of inflation may eventually decrease back to the current level, the devaluation of the currency has already taken place. Unless you end up in deflation, money loses value over time.

31

That depends. Did you bury it along Weedpatch, so that it got buried under a pile of used, discarded tires? Then it’s unretrievable, and worth nothing.

32

This is not to argue, but to help me understand better …

When the government prints the trillion dollars and pays off the debt with it, how does that sum actually get into circulation (which I assume is what’s required for it to increase purchases and/or lead to rising prices)? Isn’t the governement simply paying itself back (to at least some extent).

33

Howdy all,

So I asked a question of an Econ Prof one time about the opposite thing and didn’t get a very satisfactory answer. (He looked dang tired and frazzled because of a newborn, so I wasn’t gonna push it.)

But what monitarily would happen if the US defaulted on debts. Gimme the whole scenario if you can please.

Thanks.

34

Inflation is a rise in general price level, so your money would be worthless since you’d have nine or ten years of rising price levels to contend with. Inflation is just a measure of how fast the general price level is rising. Which is what The Long Road said.

Suppose instead that you put $1 away in your mattress and price levels went up and then back down, i.e. there is inflation then deflation, then your dollar would have the same value.

Gauss:

The gov’t can circulate the money however it pleases. Most likely, I suppose, it would just pay off bonds and working deficits (wages, purchases, etc.) with the new money.

It wouldn’t be paying itself back since it doesn’t borrow from itself. Of course some whiney baby-boomer will say that it borrows from soc. sec., but our $7 trillion debt (or whatever it is) is all borrowed from private individuals, firms, and other governments. If the gov’t printed enough money to pay it off, then it would be paying off those people.

Bytopian:

Monitarily?? If the gov’t defaulted on some of its debt, it would go from being a risk-free borrower to a risky borrower. You would see the interest rate on new gov’t debt rise. Since it would be more expensive to borrow, either taxes would go up, or spending would go down, or both. The private markets for borrowing would lose its risk-free benchmark, so private borrowing would be affected as pricing becomes more difficult.

I suppose that if it was more expensive to borrow so that the gov’t borrowed less, that would put more money into the private sector. But since the risk-free benchmark has disappeared, private sector investment might drop as well. I don’t know.

I think this is one of those questions we’d have to build a model for and crank through the math, because the outcome seems ambigious. E.g., gov’t is riskier, so foreign investment flees; but higher interest rates entices it back. Which is bigger? Hell if I know.

35

Money supply link:

36

I’m not sure if I can explain it any better than has already been explained, but I’ll try anyway.

You are familiar with the laws of supply and demand, right? Basically, you want to sell products as much as you can get for them and people want to buy them for as little as they can. The actual price being where you can sell about as much of a product as people are willing to buy.

Well think of money as just another product. It’s just one that people accept in exchange for any other product. If all of a sudden, the government dumps another trillion dollars into the economy, people now have more of it to exchange for goods and service. Well, as a seller of goods, I can now increase the price because people are able to pay more than they could.

You are talking about reserve requirements. A bank only has to maintain a percentage (let’s say 10%) of it’s loans in the form of deposits. ie a bank with $1,000 in deposits can loan out $10,000.

Now this does have the effect of creating more money. But this is a good thing. This money isn’t simply being dumped into the economy, it is being used to finance businesses or homes or othe assets. It’s not free money either. The bank expects to be paid interest (essentially a charge for using their money). The Fed adjusts the prime rate to either encourage or discourage lending which has the effect of stimulating or retarding economic growth.

Example - If the economy is growing too quickly, that can lead to inflation. More people have more money to spend and drive the price up. The Fed can increase the interest rate, essentially taxing new money, discouraging loans and slowing growth.

37

[nitpick] The Fed can raise an interest rate. The other just go up in response to it. [/nitpick]

38

From Merriam-Webster Online Dictionary

I don’t see how money could not be considered a commodity.

39

So would doing the opposite lead to what I suspect? For example, if the government somehow “destroyed” or eliminated a trillion dollars from the money supply, would prices drop across the board for goods and services? Is this how deflation starts? What actually would be the effects of doing something like this?

40

I think so. That would be one way to get deflation. IIRC, deflation is bad because firms can’t recoup the cost of production. I’m a little sketchy on that question without looking it up.

Far from a direct answer, the following article is still relevant to the falling money supply question, IMO: www.econlib.org/library/Enc/GreatDepression.html