The government printing money

[SmallCap]

I am putting this question out there so that people much smarter then I can explain it to me. This may seem like a simple question but it is something I have never fully understood.

 

There are so many references to the government printing their way out of deficit spending and excessive amounts of debt but how does that actually work? How does the government actually print money in a way that makes any difference?

 

If the treasury ran their presses for a few extra hours some day, how does that impact the money supply? How do those bills end up in the money supply?

 

Now I know that it may be that the term "printing money is figurative but if that is the case then what does the term actually mean and how does it work?

 

does the government actually have the ability to actively cause inflation if they wanted to? say the government wanted to pay off a trillion in debt could they just do so and then the world would be flooded with extra dollars? does that actually actively cause inflation?

 

SmallCap

 

 

[beerbaron]

The process of printing money is some simple that it is mind boggling.

 

Let's say you have a house that is worth 100k and mr government wants to buy it. They wire the money from the Federal Reserve to your bank account and voila you have 100K in your bank account even tough there was no money in the FED's account. As simples as that. (Note that the FED has a balance sheet tough but it's "unlimited to leverage")

 

They don't open the printing press anymore, they buy back assets like the examples I gave you.

 

Yes they can pay their debt trough inflation, it's the oldest trick in the world. If you pay 5% interest on a 30 year bond but that you set-up the inflation at 10% then your are earning a net 5%. Inflation is the ultimate tax on all assets and it's very hard to avoid it when it happens.

 

It's kinda weird to understand but instead of running the printing press they just change the digits on the Federal Reserves's balance sheet. It's much more efficient then printing paper.

 

Regards

BeerBaron

[biaggio]

"Yes they can pay their debt trough inflation, it's the oldest trick in the world"

 

I have heard that the gov't also fudges their CPI. ie underestimate CPI. This would accelerate the repayment/reflation process.

 

How do folks here think of this? I feel that their some truth in it. My personal expenses seem to be increasing faster than stated inflation rate.

[rkbabang]

If the treasury ran their presses for a few extra hours some day, how does that impact the money supply? How do those bills end up in the money supply?

 

Now I know that it may be that the term "printing money is figurative but if that is the case then what does the term actually mean and how does it work?

 

does the government actually have the ability to actively cause inflation if they wanted to? say the government wanted to pay off a trillion in debt could they just do so and then the world would be flooded with extra dollars? does that actually actively cause inflation?

 

"Printing money" is absolutely a figurative statement. The government only actually prints a tiny fraction of the money that is in circulation.   Money is like anything else, the greater the supply, the less it is worth. When government spends money that it has created out of thin air it spends it at current value. It is the rest of us that sees our money inflated as the new money works its way into circulation.

 

Some good reading if your interested:

 

What You Should Know About Inflation - PDF

 

The Case Against the Fed - PDF, EPUB

 

The Creature from Jekyll Island : A Second Look at the Federal Reserve - Amazon.com

 

 

--Eric

 

[valuecfa]

The printing presses are more of metaphor. It is typically done through an extension of credit, as opposed to physically printing money. Though there are other ways to create inflation (using the definition of inflation as a rise in prices). The most common monetary policy to manipulate inflation being lowering or raising interest rates. Some define inflation differently though. For example, the Austrian school of thought defines it as an increase in the money supply, whereas a rise in prices is a side effect.

 

On the topic of the US govt. fudging inflation statistics....Absolutely. All governments fudge their statistics (be it CPI, GDP, unemployment, etc) including the US. Fudging CPI, in particular, saves on entitlement costs like social security, as well as other floating payments like index linked treasury debt.

[scorpioncapital]

When the government extinguishes its debt by "paying it off", it does so by taking a small % of everybody's wealth to do so. When you see the debt calculator say something like $100,000 for every family in America, that means that every family in America is "giving" $100,000 to the government, if in theory, it were to pay off the debt. However, this doesn't actually solve any deficits because if your income is less than your expenses, the very next year you will be in the red again.

 

In practice, the probability the government will pay off 100% of the debt is very close to zero. However, it might pay off enough to fund its deficits year in and year out and over time it could impact our savings quite a bit.

 

There is no free lunch - the citizens of the country pay for it all , the question is if the government needs to go into a mode of asking its citizens to fund the debt more aggresively than in the past and that is not entirely within its control as may become apparent in future years.

[Carvel46]

Personally, I don't buy the inflation meme that is going around.

If I were a regulator today, I would be desperate to encourage this meme.

PragCap has an interesting article responding to Einhorn's NYT article.

http://pragcap.com/talking-ourselves-off-the-edge-of-the-cliff

 

 

[EricSchleien]

Watch the movie Zeitgeist.  There's TONS on the Federal Reserve on here.

[ERICOPOLY]

There were several periods of high inflation when on the gold standard.  One of them was Mexican silver coming to the US around the 1830s and another was a flight of European gold deposits to America during WWI.

 

Fractional reserve banking can multiply such deposits in such a way that the money supply goes way up -- believe the term is "credit creation multiplier".

 

To the misconception(tossed around by Jim Rogers etc...) that recessions are necessarily short if there is no FED, take a look at the depression of 1837-1844.  There was no federal bank at the time.  It had been abolished.  End the Fed... what a dream to a world where depressions/recessions are short... it's a nice dream but it's not supported by history.

[twacowfca]

There were several periods of high inflation when on the gold standard.  One of them was Mexican silver coming to the US around the 1830s and another was a flight of European gold deposits to America during WWI.

 

Fractional reserve banking can multiply such deposits in such a way that the money supply goes way up -- believe the term is "credit creation multiplier".

 

To the misconception(tossed around by Jim Rogers etc...) that recessions are necessarily short if there is no FED, take a look at the depression of 1837-1844.  There was no federal bank at the time.  It had been abolished.  End the Fed... what a dream to a world where depressions/recessions are short... it's a nice dream but it's not supported by history.

 

 

The 1837- 1844 recession was almost certainly prolonged because it was triggered by the closing of the Second Bank Of The United States, the equivalent back then of today's Fed.  After that bad depression, the economy

bounced back relatively quickly after most of the banking panics during the remainder of the 19th century.  The reason for that resilience is probably Keynes view that depressions typically end when people run out of  cash  at the subsistence level and stop saving.  If you gotta eat, people will then pull money or gold or silver out of the mattress and put this back into circulation.  Or they will borrow or barter or steal or whatever it takes.  Then the multiplier kicks in if there is still a banking system left, and the economy takes off again.  Andrew Carnegie's biography describes a good example of how this process of sharp price deflation and recovery often moved rapidly when most of the economy wasn't very dependent on a banking system.  

 

However, doing away with the Fed now in our credit supported economy certainly would cause a depression that would "curl your hair".

[ERICOPOLY]

I read the Carnegie biography a couple of months ago followed by Chernow's biography of Rockefeller.  However I do not remember the example that you are alluding to.

 

Anyways, I think it's possible that the money printing to date this time around will merely support the prior levels of inflation provoked by the collateralized lending against artificial values with silly LTVs.  That type of lending ought to have been inflationary and it won't come back.

 

I worry about inflation quite a bit but I increasingly wonder about where the price level would be today without the quantitative easing -- perhaps by merely supporting prior price levels it is heavy inflation right there already.  We don't feel it though because we were slowly cooked over more than a decade.  This is a case where the hard money people would be correct even though the printing happened after the inflation.  That's why I brought up the topic of credit booms sparking inflation (the examples of rising gold and silver deposits). 

[twacowfca]

I read the Carnegie biography a couple of months ago followed by Chernow's biography of Rockefeller.  However I do not remember the example that you are alluding to.

 

Anyways, I think it's possible that the money printing to date this time around will merely support the prior levels of inflation provoked by the collateralized lending against artificial values with silly LTVs.  That type of lending ought to have been inflationary and it won't come back.

 

I worry about inflation quite a bit but I increasingly wonder about where the price level would be today without the quantitative easing -- perhaps by merely supporting prior price levels it is heavy inflation right there already.  We don't feel it though because we were slowly cooked over more than a decade.  This is a case where the hard money people would be correct even though the printing happened after the inflation.  That's why I brought up the topic of credit booms sparking inflation (the examples of rising gold and silver deposits).  

 

 

The Carnegie bio published not long ago describes how the Carnegie family were scrambling to rise out of poverty in Pittsburg when Andrew was a young teenager.  The panic and recession hit, and money and employment for monetary gain mostly disappeared in their social strata.  However, that didn't stop them and the other energetic people around them from working for bartered goods and services.  They dipped into their meager personal possessions and found things of value they could use for exchange.  The Carnegies and most of their neighbors made out surprisingly well.  There is no account of mortgages being called; so whatever financing arrangements were in place evidently were, I guess, less demanding if they existed, possibly like rent to own agreements for sub sub prime credit is today.  Food prices dropped quickly to dirt cheap levels, purchased with bartered goods or labor, and then the economy bottomed out and made a quick recovery.

[rkbabang]

There were several periods of high inflation when on the gold standard. 

 

Indeed, you are correct. I don't support a government "gold standard" any more than a government run fiat debt created currency like the dollar.  This article is pretty much in line with my thinking:

 

The Money of Your Choice

 

Some pertinent quotes from the above article:

 

"any attempt, well-meaning or otherwise, to create an official gold "standard" - imposed or administered by government or by anybody else - should be resisted just as vigorously as the present system, if we are truly interested in preserving freedom of individual choice, and building a genuinely free market for money and for everything else."

 

"In the 16th century, the economy of Spain was more or less destroyed when conquistadors brought home tons of gold they'd looted from the New World. The value of gold, relative to other things, plummeted because the more there is of anything, the less any of it is worth, a phenomenon economists refer to as the "Law of Marginal Utility". Spain ceased to be a world power and became, instead, the first "sick man of Europe". In many ways, it has never recovered."

 

"The future of monetary standards based on precious metals lies in the stars, or, more accurately, in the Asteroid Belt, where roughly a third of the millions of rocks circling the Sun between Mars and Jupiter are composed of metals, mostly iron and nickel. Other metals are present in lesser amounts: it has been said that a single metallic asteroid a mile in diameter contains more gold than has ever been mined on Earth, lying within relatively easy reach of the asteroid's surface."

 

"Thanks to the Law of Marginal Utility, importing that much gold would halve the perceived value of the gold we already possess. Given a future that offers relatively easy and inexpensive means of importing gold and other metals from space - current proposals for "space elevators" present just such an opportunity - within this century, the entire future global economy could be affected in exactly the same way that Spain's was 500 years ago, if America (and humanity) relies on gold and gold alone as a monetary standard. On the other hand, allowing the market to decide, and to constantly re-decide, what is money - and what is not - would prevent such a catastrophe."

 

"The lesson, in all of this, is that money needs to be based on something of real value, and that the market must be open and flexible enough that it can adjust to changes"

 

 

--Eric

 

[Mark Jr.]

Ok, since others have mentioned Zeitgeist and The Creature from Jekyll Island in this thread without being shouted down, I feel safe enough to point out that the original poster has opened the proverbial "can of worms".

 

Because, the Federal Reserve is not really "federal", it's privately owned. And they don't simply "print the money into existence" to buy things, they print it into existence, lend it to the government who then has to pay interest on it back to the Federal Reserve. The same year the Federal Reserve was created was also the same year income tax was introduced  (in the US).

 

Which is simply boggling. The obvious question being Why doesn't the government just print it into existence itself and not have to pay interest on it?

 

It's been tried. In addition to the Creature from Jekyll Island, you should read Web of Debt by Ellen Brown.

 

I just recently started researching this and I get more perplexed the more I learn about it. Problem is the more you delve into this, the further you get into capital-C "conspiracy theory" and tin-foil-hat land (no, I'm not wearing one at the moment).

 

But once you look at it, it just doesn't make sense.

 

[Myth465]

I dont buy alot of the conspiracy theories relating to the fed.

 

I highly recommend Crisis Economics by Roubini if you want to get an understand of why and how the Fed did what it did.

[SmallCap]

BeerBaron,

 

It seems like you are saying that the government has total and unaccountable control over the creation of money and the dilution of the dollar and that the government can do this without any negative impact to the government besides possibly a lose of the AAA rating on it's debt. of course we all suffer because our money is worth less but that isn't directly a negative to the government.

 

Maybe I misunderstood what you were saying but that seems to be the outcome of what you are saying.

 

So, if that is the case and the government can actually cause inflation then some interesting opportunities arise.

 

If the government can cause inflation then wouldn't the easy solution to deal with the housing crisis and the credit constipation crisis be to give us a jolt of say 20% inflation? It might be painful for a little while but all of the sudden a lot fewer houses are underwater and people are finding it easier to pay back the excessive amount of debt that they incurred.

 

Also if it is so "easy" to pay back the government debt with the only consequence being some inflation then why are we really concerned about the government debt. Right now it looks like the country could use some inflation and it would also take care of the debt at the same time.

 

I know i am greatly simplifying the situation and the various outcomes of these actions but it really seems to me that there is more to the concept of the government "printing money" then your explanation allows.

[beerbaron]

Inflation is tricky, once it is set in motion it will weaken the confidence in a currency. If the confidence in a currency decreases then it decreases in value. If it decreases in value then the confidence declines...

 

Therefore, advanced economies understand it is their well being to keep their currency at a certain level.

 

You don't even want to know the havoc it would cause on the global economy if the dollar would depreciate in a spiral.

 

Can you imagine all the write-downs around the world?

The other countries debasing their currency to keep they currency at an acceptable ratio?

International trade stopping because nobody would accept foreign or local currency?

 

It seems to me the pill would be worse then the disease.

 

P.S. The Federal Reserve did use quantitative easing (AKA money printing) in the credit crisys. Paulson argued that he was merely re-creating money that was destroyed. That leaves me skeptic. If the 10% of the country's wealth disappeared and that you print 10% more money it won't make the wealth come back.

 

BeerBaron

 

[SmallCap]

I agree with you about the long term negative impact of Inflation, I just took a look at the situation through the short term next election cycle eyes of our politicians and it seems to me that they would want some amount of inflation NOW to alleviate the obvious problems out there. And if they had such an apparent magic wand that in the short term would ease their troubles I have a hard time understanding them not wanting to use it.

 

I really don't want to see the problem of inflation but I never leave out of the equation the short term self interest of our politicians and what they would want to do.

 

SmallCap

[twacowfca]

The US gov can print or otherwise craate money but they can't instantaneously print inflation in most circumstances because there is normally a lag of several months between the creation of money and its effect on the economy.  This lag becomes longer in a deflationary environment until the saving, hoarding and reluctance to extend credit turns around.  After the economy turns, inflation still won't be a big problem most of the time until the slack in the economy tightens up.  When that happens, an inflated money supply and nonproductive restrictions on enterprise will usually result in price lnflation.

[biaggio]

http://seekingalpha.com/article/208588-interview-jim-rogers-on-currencies-and-inflation