please explain to me why we can't "just print more money" to pay off the national debt

Factual Questions
141

There are various costs to high inflation, including things like menu costs, so called because if prices are constantly changing, then things such as menus will need to be continually revised. Seems like a little thing, but we’ve only got so much mental attention to spare, and if we’re constantly thinking about prices, then we have less attention for other things.

Even more important, though, is the fact that high inflation tends to be highly volatile inflation.

If everyone knew that inflation would be precisely 20% next year, not a single basis point more or less, then that wouldn’t be much of a problem for investment. We’d just tack a 20% inflation premium on top of all loans, and that would be that. A hassle, but not an insurmountable one. But what if we expect inflation to be 20%, with an error of plus or minus 5%? What if we’re looking at a window of 15-25% for expected inflation next year?

If inflation is at 2%, then that window of expectations is extraordinarily narrow. Our expectations might be wrong, but they won’t be wrong by much. Inflation could be a little higher than expected, but probably not much higher. If inflation is running 20%, though, that confidence runs right out the window. High inflation is volatile inflation, and that volatility can cause concern for both borrowers and lenders. If I’m borrowing money at 20%, and inflation only turns out to be 15%, then I’m screwed. What I thought would be eaten away by an inflation premium turns out to be a higher real debt burden. And if actual inflation is 25%, then the bank is screwed. They didn’t charge enough for the loan. Bad juju, all around.

A lot of people say this.

I don’t really like it when people say this. It’s not especially precise.

If the price of a gallon of milk is four dollars, then the price of a dollar is 1/4 a gallon of milk. The “price” of money is how much stuff that the money buys. After all, I can potentially lend and borrow in gallons of milk. I can write a contract borrowing 100 gallons of milk today, with the obligation to pay back 105 gallons of milk next year. But that doesn’t mean that the price of milk is 5%. The price of milk is still four dollars. The price of a dollar is still 1/4 a gallon of milk.

The interest rate is not the price of money, in this sense. It is the price of credit. Different thing. That price of credit could potentially apply to any commodity that is borrowed and paid back, not just money. It’s simply normal to borrow money, since it’s the most liquid instrument available.

And I really, really, really want to emphasize here that interest rates can be highly misleading. Interest rates were extraordinarily high in the 70s, based on high expected inflation because money was way too loose (and the oil shocks didn’t help with that, of course). That’s a key point: money was too loose. An extended period of time with high interest rates is a sign that money is too loose. And Volcker stepped in by doing what? Exactly what deltasigma said: he raised interest rates.

Interest rates can be highly, highly misleading. To borrow an analogy from Nick Rowe: It’s like balancing a tall pole on your open palm. If you want to walk backward, then first, you push your palm forward. Volcker lowered interest rates, by first increasing interest rates. Inflation finally came down, and interest rates were much lower than before. But the lower interest rates after Volcker were not a sign of looser money. Money was much tighter under Volcker, which is exactly why inflation came down.

In the same sense, an extended period of very low interest rates is not a sign that money is easy. We’ve got this pole balanced on the palm of our hands, but we’re up against the wall. That doesn’t mean money is easy. If we look at broader macro aggregates, not just misleading interest rates, we should conclude that money is still tight. We need to focus on nominal aggregates the economy, like the inflation rate or nominal spending. Interest rates are important, of course, but they still tend to confuse people.

142

If you want to rent money, the price you pay is the interest rate, so in a very real sense, it is in fact the price of money. Is it as simple as that though? Of course not. I never said it was.

Interest rates are the product of a) the risk free rate or what people believe they are entitled to for the use of their money with no risk of principal loss, b) the rate of inflation expected over the period of the loan and c) the credit risk or risk of default. But I didn’t see an explanation of all of that being relevant to jt’s question.

143

And if you want to rent milk, the price you pay is the interest rate. So in a very real sense, the interest rate is the price of milk.

You can call it what you want. I didn’t say your terminology was wrong. I said simply that I didn’t like it, and I laid out the reason for my dislike.

144

As is often the case, Hellestal’s post contains much wisdom. But one point may deserve clarification:

I think one should distinguish between nominal interest rate and “real” interest rate (i.e. interest minus inflation). A high real interest rate may be a sign of a very healthy economy: it means people have useful things to do with money!

145

Great post. But how would the Fed stepping in solve this uncertainty in times of high inflation? How does the federal funds rate or any other steps the Fed takes to control interest rates make the calculus of next year’s inflation of 15-25% be anymore certain?

146

That, or it could also be a sign of a deflationary environment. That’s another way that the money supply can contract and it was what the fed was scared to death of near the beginning of the crisis in 2008.

That deleveraging we went through is the flip side of a fractional reserve system and it can be devastating. We were lucky to have a chairman who understood that and flooded the markets with liquidity. And although even such extraordinary measures only had limited success, it did at least prevent our falling into a deflationary epoch.

147

The Fed stepping in wouldn’t make next year’s inflation of 15-25% any more certain.

But the Fed stepping in to jack up interest rates to painful levels will eventually bring the inflation rate back to lower and more predictable levels. After the major recession.

This is exactly what Uncle Volcker did in the 80s when he quite deliberately plunged the US into a major recession, as already described by deltasigma. (More like 13% inflation than your example of 20%, but similar idea.) That was a deliberately engineered decision, forcing the country to take its medicine. Not a pleasant thing, but the recession was temporary while the benefits from lower inflation were permanent. It’s reasonable to believe in strong action to rein things in when money is too loose, as in the early 80s, and strong action to heat things up when money is too tight, as in right now. In my view, the best traffic signal for looseness/tightness of money is the growth of nominal spending, with the ideal being stable growth of around 5% a year. The world of central banking seems to be slowly coming around to this sort of idea.

148

Sorry for being dense, but doesn’t that bring it back full circle? If I know inflation will be between 15 and 25% next year, why does Volcker or anyone else need to raise interest rates? Anyone with excess cash will demand high interest rates or else not loan any money.

Suppose prior to Volcker taking his bold move, the Fed sets it’s target rate at 6%. Why would I loan money at that rate, no matter what the Fed says? Why would any bank? Why would anyone when the data shows that you will lose real value by loaning at that rate?

149

Because you’ll lose money faster by not loaning it. You can demand whatever you want, but you can only get what the market will pay.

150

Something i have always wondered about? If the Unitied States did some kind of massive inventory of all their assets, including intellectual assets and they determined their net worth was considerably higher than the dollars they had floating, could they print more without causing undo inflation?

151

Money is a consensual hallucination, just like cyberspace was in Neuromancer. It’s worth exactly what the consensus sets it to be. What you’re suggesting is a variation of the notion that things have an intrinsic value. They don’t. It’s like perpetual motion: you can create a million variants on the theme that superficially look different but they all have the same flaw in the end.

152

They will do something with the money. They will always do something.

No one sits on 0% cash in a time of 20% inflation. In real terms, people doing nothing with that cash are choosing an “investment” with a 20% loss of purchasing power annually. Nah. They will find something to do with that money. Maybe they’ll purchase securities instead of making loans, but they’ll be in desperate search of something. This relates to another of those costs of high inflation, shoeleather costs, so called because people metaphorically wear out their footwear trying to find a safe place as a store of value to protect against higher future prices.

What they generally do when rates spike is to choose safe harbors of 20% securities over riskier 24% loans in the economy that would probably never be paid back. Basically.

We have to remember that there’s not just one “interest rate”. There’s a whole yield curve out there of different interest rates for different times. Banks are intermediaries. They are both borrowers and lenders. What the central bank most directly controls is the rate at which banks borrow money from each other, not the rate at which they want to lend money out in the general economy for profit. And we have to keep in mind that this is a market. There is supply, there is demand, there is a market price. The interbank rate is not under their fingertips, it’s not quite like a gear shift in a car. The Fed has amazing influence because it’s the 800 pound gorilla in the room, but it is not fully omnipotent.

So the question is: how exactly could the Fed push the interbank rate to 6% in a time of expected 20% inflation? I don’t even think this is possible.

Again, we’re talking market interaction here, not a stick-shift transmission. They don’t just reach out their hands and shift the interest rate down. Rather, they use their power to create monetary base to buy stuff, and their very purchases of stuff stabilize rates at their preferred level.

If they want the interbank rate at 6%, then they would (ordinarily) buy and sell the shortest-term Treasuries until short-term government debt was selling at 6%. Interbank lending is such a closely related market that it will go to 6% as well. Ordinarily, they could do this. But your hypothetical is a world of 20% inflation. If they were willing to step into the Treasury market to bid up prices until Treasuries bills were selling at 6% – which is to say a negative 14% rate in inflation-adjusted terms – then the Fed should be the only real player in that market. Nobody else is that dumb.

Which means they are just pumping monetary base into the system like there’s no tomorrow. They would be the only player supporting prices. Everyone else would walk away.

Which means the world is not, in fact, looking at expected 20% inflation next year. The world is looking at expected 50% inflation, or 100% inflation, or even more. A monetary authority has extraordinary god-like influence in some respects… but only some respects. There are still limits. Once again, I go back to the analogy of balancing a tall pole on the palm of your head. I don’t see how the top of the pole can be positioned at 20%, while you move your hand sharply left to 6%. The balancing act would end and we would drop the pole.

Even if they were simply to maintain rates permanently at 19%, when the top of the pole is at 20%, that is still not stable. Eventually, they have to move their hand or they drop it.

It’s really really bad if they drop it.

153

These threads show that many people have major misconceptions about money and government debt. Let me try to clarify. :cool:

:confused:

I’d state this differently. Silver does have value. Even if you ignore its utilities, the fact that people enjoy it as a status symbol, gives it value. When older civilizations used peppercorn as “money”, the peppercorn did have value; indeed a dozen loaves of bread and the amount of peppercorn you’d have to trade for it had the same perceived value as edibles(*).

Gold has intrinsic value. Unfortunately, the fact that it was used as money within recent memory causes much confusion. A piece of paper promising to pay an ounce of gold has just as much value as ounce of gold if the promissor is sufficiently trusted.

But paper doesn’t have intrinsic value!(*) Here’s a scenario to make this clear. King Bugu of Bogovania has a million dollars worth of gold, entrusts it to Bogo Bank who gives him a million-dollar banknote in return. Now there’s two million dollars! The million of gold in the vault, and the million-dollar banknote. King Bugu spends the whole sum on hookers and blow, but can’t break the big banknote so pays with his own smaller-denomination banknotes. The King and the Bank each have zero net worth now (million of assets, million of liabilities), and there’s three million of money total!

Attila the Hun shows up and conquers the entire country. Everything belongs to him. How much money does he get? 3 Million? No. He has the million of gold, and may as well just burn the now-worthless paper money.

Paper money is just for accounting. The money stock rises and falls based on arbitrary transactions among banks. So many times in these threads, people seem to think paper money is some facsimile of gold. It isn’t. HoneyBadgerDC’s confusion is so huge, one hardly knows where to start an explanation.

(* - obviously paper has some small value for writing and toiletry, etc., and peppercorn had added utility as money. This discussion is simplified for clarity.)

While I’m here, let me clarify government debt. :cool: Many misconceptions would go away if one breaks down the debt by type of debt holder:
[ul]
[li] 1. U.S. gov’t debt owned by American citizens or American companies[/li][li] 2. U.S. gov’t debt owned by foreign countries or companies[/li][li] 3. U.S. gov’t debt owned by the Federal Reserve Bank[/li][li] 4. U.S. gov’t debt owned by other Federal agencies, e.g. Social Security[/li][/ul]

Debt type #1 is less risky than many think. When principal and interest are eventually repaid, the repayment can be thought of as just another transfer payment from taxpayers to some group, like food stamps or farmer subsidies. The transfer will be to the rich (bondholders) rather than to the poor, but that’s irrelevant for this discussion. To understand that this debt is not too malignant, note that the taxpayer of last resort – the rich! – is the same group as the beneficiary of these transfers! (Watch someone misconstrue this explication as Marxist. :smack: )

Debt type #2 is much more of a problem (as Warren Buffett implied in a recent thread :wink: ). Foreign ownership of U.S. Treasury bonds is part of a larger problem: foreign owners are acquiring U.S. factories, etc. Since foreigners need dollars to buy dollar-based assets, the underlying problem is trade imbalance; at present the U.S. imports $400 billion from China annually but exports only $100 billion to them. This trade deficit is not compensated via other countries; indeed the total net U.S. trade deficit is about $800 billion annually.
To understand that debt type #2 is fundamentally different from type #1, note that U.S. can tax rich American bondholders, but not foreigners!
(Many cite Japan as a counterexample to the claim that U.S. debt is a threat. This claim ignores that Japan’s trade deficit is much smaller than that of U.S.)

In debt type #3, since the Federal Reserve is just part of the U.S. government, the Federal debt is just owed to itself! (The reason for borrowing and the reason for buying the bonds are different, but the net effect is a loan to itself. Much of the recent addition to debt takes this form.)

The self-loan can be considered an accounting device to “create paper money,” but recall (above) paper money is itself just an accounting abstraction. That is why Gasps of “Oh no” are misplaced when the platinum coin is discussed – it’s just a different accounting abstraction to create paper money.

I’m not sure what to say about debt type #4. I think it can be considered a mix of types #1 and #3, mostly #1.

Donning asbestos suit. :wink: Over.

154

I snipped the second part to keep it simple. Imagine a world where the Fed and Volcker don’t exist and interest rates are simply set by the market. In a world of 20% inflation, I’m definitely not going to sit on cash. I will buy gold, silver, cattle, chickens, securities or other things that have a store of value.

But there will be a demand for loans. There always is. People want to buy homes and cars. People need money now and not in the future. So who will satisfy that demand? People with money. And people with money in times of 20% inflation will demand an interest rate of at least 20% plus risk plus profit. Or else go buy chickens.

The same way with banks. If they want me to keep my money in their bank, they had better offer me 20% interest plus or else chickens it is.

I’m confused by your earlier statement that Volcker stepped in and jacked up interest rates to control inflation. It seems that in times of inflation, interest rates would naturally rise with no need for Fed intervention.

155

Let’s start with this part:

deltasigma has already explained it but it bears repeating.

The inflation premium is only one part of interest rates. Other considerations are the ‘risk-free’ rate and the risk premium. 20% inflation would lead to an inflation premium of 20%, automatically. That is obvious, and because it’s obvious, it’s the least interesting aspect of interest rates. The other pieces are much more relevant. It is the other pieces that the Fed is directly influencing. If the real rate is 2% and the inflation premium is 20%, then nominal rates will be 22%. What the Fed will do to jack up rates is to increase real rates, increasing nominal rates from 22% to 25%. (Or whatever.)

Increasing real rates will slow down the economy, regardless of what the inflation premium is.

A slower economy will throw people out of work and slow down the circulation of money.

Slower circulation of money will lower the inflation rate (automatically lowering the inflation premium, but that’s not the part they’re directly influencing).

When the committee decides people have suffered enough, the Fed will loosen its grip on real rates, and the economy will recover. Real rates will return to, say, 2% but the inflation rate will be lower. Or in our present situation? Fed influence has pushed real rates negative.

No Fed? That’s getting into even stranger territory.

There are basically two different kinds of money. Monetary base comes from the central bank. It’s basically like central bank gold, created by central bank computers. A fraction of it is paper and coins that are passed around, but most exists on the computers.

The other kind of money is bank-account-money, deposit balances at banks. This kind of money is a promise, an IOU, a liability, specifically a promise by a private bank to pay monetary base on demand. In ye olde daies of banking, the monetary base included real gold and silver. So if you’re asking for a world without a Fed – or without any monetary authority at all – then you’re stating that the monetary base is essentially constant. No one can make any more without digging it out of dark caves under the earth.

Simply put: A world without a monetary authority expanding the supply of the monetary base is a world without persistent 20% yearly inflation. In the short term, there is no necessary direct relationship between monetary base and inflation, but in the long term, the only way to get persistent inflation over extended time periods is to have persistent increases in the monetary base.

(For this reason, some people intensely dislike central banking and would like to abolish central banks, which have the power to create new base money. The problem with that is what they would implement in its place. Eliminating central banks does not eliminate currency manipulations, and in fact, even in ancient history, governments have never needed central banks to debase the money supply. The very word ‘debase’ denotes earlier times when governments would add base metals to their coins, reducing the precious metal content. Governments have been manipulating the currency for as long as currency has existed. And times without central banks? They have been notably volatile. The endless series of booms, panics, and crashes led people to believe there should be a stabilizing influence with the power of an ‘elastic’ currency, which is to say, the ability to create more or less for the sake of the system. )

So if we go back to the early 1980s and tell the Fed that they are, from that point forward, to butt out of the business of banking. They are to keep the monetary base constant, with no more interest rate tinkering. What happens?

Real interest rates spike to stupefyingly high levels.

The Fed uses its control over the monetary base to influence real rates. What Volcker did in order to jack up rates was to slow the expected increase the stock of money. (In fact, the monetary base continued to grow at a steady clip past Volcker, but his influence brought M2 money supply growth significantly down.) For the Fed to stop monetary base growth entirely, that is significantly more extreme than what he did. It is to permanently stop the increase in monetary base. It’s like returning to the old gold standard, with no possibility of ever digging more out of the ground. This is amazingly deflationary. Real rates would spike incredibly high, the financial sector would collapse, and the US would enter another depression.

People don’t really want to buy homes if real rates are at 10%. That’s true regardless of what the inflation premium is. They will make do without.

If the Fed stopped supplying monetary base, the engine would seize. Chickens it is.

Fear of this is what led to the creation of the Fed.

156

Sri Sai Ram Power Controls -Our dry type transformers are widely used across various industries to automatically control the timing of the electrical appliances.

157

Even in the absence of a central bank though you would have a fractional reserve system creating M1 which could just as easily take the place of MB. In fact I think you could argue that the shadow banking system we have now composed of hedge funds and other bank-like entities to a great extent does something of an end-run around the central bank paradigm. That’s what I’ve heard at least. As to the exact mechanics . . . IDK.

158

Gold and silver do not have intrinsic value!!!111:) If anything had intrinsic value, it’d be something that people need - say air, or water. But what is the intrinsic value of air? Is it zero? Or is it infinite? The value of a thing is no more or less than what someone somewhere is willing to give up for it. A thing has value because someone values it - it originates within the person, not from the thing itself. If people wore dung beetles as decorations, or quetzal feathers, it’d give them no more intrinsic value than they’d had in the first place.

Modern money is different from commodity money, but not because it’s less valuable. It’s different because a country that’s in control of its own money has a powerful tool it can use - should it choose to - to prevent the pointless waste of real economic resources, such as the talents and skills of its citizens (unemployment).

The dollars we owe to China are not a problem for the US. It’s not a problem for China, either. But if anybody should be worried about it, it should be them, not us. Because those dollars represent nothing more than an opportunity for them to buy stuff from us in the future. And while we know what we’re getting from them right now (all that crap at ToysRUs) they don’t know what they’ll be able to get from us in the future. Now chances are they’ll be able to get perfectly good stuff from us - cars, or movies, or BigMacs, or whatever. But maybe Americans will get ever fatter and lazier, and in the future we won’t make anything they want to buy. And then they’ll be fucked. And that will be sad for them. But again, the risk is on them, not us.

The idea of China buying up US assets is a problem, sort of. I mean really, if what we were doing is selling off real assets for plastic toys, that would be a problem. Theoretically, the Chinese could buy up all our corporations, and then live off the dividends. We’d be indentured servants, and our Chinese bosses could live work-free. But there’s lots of problems with that scenario. One is the US can easily restrict foreign ownership of US companies. Another is we could tax dividends paid to foreigners at whatever rate we want. Finally, China buying up the US stock market depends on Americans selling all their shares in the market. That’s not likely to happen.

159

I don’t understand.

In a fractional-reserve system, the M1 can’t take the place of the M0, because the M1 is a promise to pay M0 on demand.

As is the M2, M3, Shadow M, etc. The broader money supplies, all of them, are promises to pay base on demand. There’s not any reason for anyone to accept as payment private bank liabilities, numbers entered in ledgers, that are backed by nothing. A government can legislate that its own central bank’s ledger entries are legal tender, payable for all debts and accepted for taxation. A private institution doesn’t have that sort of legal firepower. Private banks convince people to use their version of M1 based on the promise that their M1 is backed by something. Without the credibility established by possession of something more fundamental to offer on demand, no one would rely on the bank’s promises. That credibility is essential. Even today, when bank creditors fear that the bank is no longer solvent, they demand payment in monetary base. That’s a bank run, and it still happens. It’s what happened in 2008.

You can have a fractional reserve system in the absence of central-bank-issued base, but you can’t have the M1 take the place of the M0. The difference between the two is precisely what the “fraction” of fractional reserves refers to: the fraction of base money (“reserves”) compared to broader monetary obligations of the bank, like the M1. The fraction is meaningless without both a numerator and a denominator. The numerator is base money.

In his tract “Denationalisation of Money”, Hayek put forth the theoretical idea of private banks issuing their own currencies backed by nothing. This has never happened in history, but hell, maybe it would work. Obviously, such a system wouldn’t be fractional-reserve banking any longer after the conversion was complete. It would be zero-reserve banking, where private banks issued their own fiat currencies just as central banks do now, and even Hayek believed that in the beginning of the process, those private currencies would have to be backed by something like a basket of commodities in order for them to be initially accepted. The original backing would act as the temporary fractional base, which would later be dropped. After the base was dropped, there would no longer be a fractional reserve system. Maybe that’s the sort of thing you have in mind here.

The shadow banking system was an end-run around traditional banking regulation, and in that sense, I guess people might say it was a way to avoid the central bank paradigm since the central bank is responsible for some aspects of financial regulation. But shadow banking was not an end-run around the necessity of some monetary base. We could use gold instead of central-bank money, but even in the absence of a central bank, Shadow M would still be a promise to pay M0 on demand. Any bank suffering a bank run, with insufficient M0 to pay Shadow M “depositors” when they start demanding their money, will go bankrupt. This was the story of Lehman Brothers.

160

Hellestal: I’m not sure what you’re on about. M0 is a component of M1. In addition, M2 and M3 have components which are NOT demand-type deposits. In fact they are explicitly listed as such things as time deposits.

edit: even MZM contains savings deposits which are not traditionally regarded as ‘demand’ deposits.