On Printing Money

Note: This subject is interesting to me, so please bear with any rambling.

Over the last couple of years, the government (through various agencies and programs) has been doing something very interesting. First, though, I'll explain some background which will probably be familiar.

When a government runs a deficit, they typically finance it through borrowing, either from foreign or domestic participants, with the promise to repay the borrowing with interest over long periods of time. This, of course, is the source of the declared portion of the national debt, about half of which is owed to foreign entities (mainly countries such as China), and about half owed to domestic entities (in the form of government bond funds and such). This doesn't count the unrealized obligations such as Social Security and Medicare, but these are somewhat more flexible, as they are promises which can be changed, unlike bonds which are promises which carry the "full faith and credit" of the US (and are thus harder, but not impossible, to modify).

Normally, these debts would be paid by future tax revenue of the government (hence the idea of "pushing" the payment obligations onto future generations, which is what the debt does). However, there is a second mechanism by which the government can reduce its effective debt, provided it controls its own currency, and the debt is denominated in its own currency: it can create more currency. Smaller and less stable countries have been doing this literally for centuries, basically since fiat currency was invested, with various degrees of success (they all collapse eventually, but some stay around longer than others).

For many years, the government has been spending more than they take in, but this has really ramped up under the Obama regime: the government has been increasing the national debt by approximately 10% annually for the last two years. However, during this time the Fed has created approximately the same amount of new currency, under various programs (QE1, QE2, banking support, etc.). The debt is still increasing since the US is still borrowing, but the Fed is buying the bonds with new "money" (US currency is actually Federal Reserve notes), so effectively no additional lending from foreign or domestic sources is needed to sustain the borrowing. In essence, the Fed is printing money to cover whatever additional borrowing/debt the government is creating, and there is no effective limit to their ability to do so.

At first glace, the typical economist theory would say that this is going to be massively inflationary, with the amount of currency increasing by 10% annually; however, this is not proving to be the case. Part of this is due to the official inflation statistics: they have been corrupted and manipulated over the years to the point that they can/do understate actual inflation by a virtually arbitrary amount, so the government can keep official inflation as low as desired. Part is also due to fractional reserve lending and the economy: the fact that since borrowing is still low due to weak demand means that the total effective currency is not increasing nearly as quickly as actual currency. However, even without those two factors, it would be difficult to say that the American people would realize the problem or really object to the root effects, outside of some vague notion that this massive borrowing/printing is somehow "bad": the typical people just don't have the knowledge to correlate it with the eventual effects.

Speaking of that, what will the effects be? Well, contrary to the "gut" thoughts, these actions are probably "good" for the economy, at least in the short term, and considered in isolation from the political manipulation and market disruption which results from such. In essence, inflation is just wealth redistribution from the people who have currency; in the US, that's "rich" people (defined here as anyone trying to save money) and entities which have lent us money, both foreign and domestic. It's essentially a way to tax everyone with money, and spend that money as the government sees fit. As such, in a country where the national debt per person often exceeds the average person's net wealth (especially in a down economy), this can be beneficial to a lot of people, and especially those of the receiving end of the wealth redistribution.

This begs the question: if the effect isn't as bad as the theory would hold, and many people would be in favor of it, should the Fed just buy any excess debt as a regular policy? I would contend that perhaps they have been doing so as a "dry run" to testing such a policy, intentional or not, and have a reasonable gauge of public opinion and reaction to such moves. Wealth redistribution, while exceptionally un-American, might be ethically preferable to generational theft, which appears to be the alternative in an era of uncontrolled government spending. Of course, the "correct" answer would be to fix the root problem, but the voting populace has proven incapable of even not electing socialists, much less encouraging spending reform, so I find that exceedingly unlikely.

Of course, the wealth redistribution through money printing only works for a while, after which the currency and economy collapses entirely, but it might work for longer than traditional theory would dictate. As the saying goes, "in the end we're all dead", and a little more turmoil for future generations (in the form of the fall of the country) might be preferable to trying to fix the systemic spending and obligations problems now. At least that appears to be the approach of the current government in the US, and unless you think the voting populace is going to get a lot smarter really soon, I'd suggest people plan accordingly.