Have you ever heard anyone asking why can’t governments just print money to pay off the
country’s debt or pay for everyone’s education or end the poverty, or abolish taxes, or distribute
it to make everyone rich? That would be a real example of money growing on trees! right?
By the end of this video, you will think that this question is absurd, which it is,
but the question has been asked so many times by so many people, and there is nothing wrong to ask!
But before you can wish for more money printed, you have to answer WHAT IS MONEY? If your answer
is anything like “Money is something that buys things” then we have to update this definition!
Money is a medium that determines the value of goods and services. This medium could be in the
form of coins, gold, banknotes, or anything that is verify-able and acceptable. The medium itself
does not hold any intrinsic value, instead, it is only considered valuable because it quantifies the
value of goods and services. If you are stuck on an island all by yourself, like Tom Hanks in Cast
Away, and you happen to have your pockets full of money in the form of banknotes, they are good for
nothing! Because you can’t buy anything with it on that island. In short, money is like Tinker Bell,
the fairy from Peter Pan, that only existed because an audience believed it existed.
We have three types of money. Back when there was no proper medium to exchange things of value,
there used to be what's called 1) “Commodity Money” whose value is derived from a commodity
it is made. For example, person A has some barley, and person B has cocoa beans, they can exchange
with each other. This is also called Barter. How much it will be exchanged would depend on
the decided value between them. But, you can’t carry your barley all the time everywhere and
for many other reasons that can’t work. There is also “Intrinsic Value” under commodity money which
could be metals like gold that is desirable and can be used as a medium of exchange as well as a
way to store wealth more easily. Weapons, horses, precious metals, etc. are some of the examples
of money used throughout history. Technically gold and silver have no intrinsic value either
but it has been generally accepted that they have a value due to their scarcity and other factors.
But you can’t keep your valuables in your pockets all the time and can’t carry your
gold either for many obvious reasons. Then comes the second type which is called 2) Representative
Money” which involves something invaluable like a banknote representing your valuables.
It works in a way that you give your gold to the bank and the bank gives you paper
money issued by the government that puts a number on how much gold you have in the bank.
And you can go exchange this money to buy other valuables.
Then comes the third type of money also known as “Fiat money” that is currently in use.
Although fiat money has been tried in different eras in history, its most recent example was
back in 1971, when President Richard Nixon officially abandoned the gold standard and
adopted the Fiat money and announced that the US dollar that used to be a representative for gold,
won’t be backed by the gold anymore. That is also known as Nixon Shock and it made fiat
money to be widely acceptable. A system of national fiat money was implemented
globally with variable exchange rates between major currencies.
Since then your banknotes have no convertibility in gold or any other thing of value. Well,
what is it backed by? Only the government’s trust and word if that's enough for you.
Now that you understand that it’s not backed by anything except for the government’s trust,
does that mean the governments can print as much money as they want?
Before we can get into why governments print money or
why they should or shouldn’t? Let’s first understand what printing money means.
Let’s say the government decides to inject more money into the economy.
Three entities get involved in the process. The government, the treasury department,
and the central bank like Federal Reserve in US, also known as the FEDs.
The government has no power to print the money but it can approve it for a reason like a stimulus.
The Treasury then raises this money by selling treasury bonds to the groups
that are savers that include the public sector, the private sector, and the foreign entities.
The government is responsible for paying back this
money with interest while it can use the borrowed money for stimulus.
The central banks can print money to purchase these treasuries. But,
when someone uses the term ‘Printing Money’ that does not mean they are physically printing and
their printing machines are going all Brrrrrrr! That means the central bank push a few buttons
and credit the Treasury’s account with money. It’s electronic money instead of paper one but
it’s still money and that’s why you can use the term “printing money” for this process.
Let’s suppose an economy produces $10 million worth of goods. Let’s say 1 million chairs at
$10 each. The money circulating in the economy is $10 million. No economy consists only of chairs
with the same price tag but we are just using a simple example for the sake of understanding.
Let’s say for some reasons, the government decides to print another $10 million. The money
circulating in the economy is now $20 million. BUT, the economy still has 1 million chairs!
As we discussed earlier the money just quantifies the value of goods. And in this example,
the number of goods is still the same. But people have more money and they will go out to spend this
money. THIS will make the demand go up! The sellers will see greater demand from people.
This will make the prices go up due to little supply for greater demand. The most likely
outcome would be the economy producing 1 million chairs sold at $20 instead of $10. On paper, the
economy is now worth $20 million but it's just an illusion as people are paying more than earlier.
Printing more money only increases the amount of cash flowing in the economy without
increasing the economic output. The disturbance in
supply and demand depreciate the purchasing power of the currency.
That means the value of the money is decreased OR in other words the same amount of money
buys fewer goods than it was capable of buying earlier. In one word, it’s called "Inflation".
On the other hand, if the money supply stays the same, while the economy is producing more goods
and services, then each banknote would see an increase in value as it buys more than earlier
and that is called "Deflation". That sounds good, BUT, it isn’t.
Too much inflation means your money would be worth less than it is now so you would want to
spend it now than in the future. While this could boost the businesses, but it could also fall under
the category of overconsumption, or hoarding commodities resulting in the increment of its
demand followed by higher prices followed by a shortage of goods and services.
On the other hand, deflation can make people hold onto their money, which means less consumer
spending and fewer business profits, and more unemployment from the shrinkage of the economy.
In short, deflation is bad and so is too much inflation. BUT,
a little bit of inflation is okay. It’s good, so the economy keeps on growing,
and people and companies keep on investing and people stay employed.
That's why FEDs using their sophisticated data try to target a specific amount of inflation.
Economists believe that targeting around 2% inflation is the right way to go.
Countries with good economies usually have an inflation rate somewhere between 0 to 5 percent.
But if the governments prints way too much, and, the demand for goods and services go up
and so are the prices, and, inflation reaches to a crazy high like up to 50%
monthly inflation. That's when we use the term Hyperinflation.
Now, this isn’t just a theory in economics. We have seen examples where printing more
money resulted in the economic decline. A more recent example is Zimbabwe that faced an economic
collapse in 2008. There were a series of events like President Robert Mugabe’s land reforms of
2000-20001 to re-distribute land largely from white farmers to the majority black populace,
involvement in Congo’s civil war and other socialist reforms resulted in increased
government spending for which they printed money like no other. Prices were getting doubled every
24 hours and the government decided to print more and more with higher denominations. By the end
of the whole drama, they were printing trillion-dollar bills. Hyper Inflation
was an obvious outcome and the government decided to force the businesses to not raise
prices and force is not a good idea. Their currency was abandoned later and the country
has no national currency to this day and they have to rely on the US dollar and Euros etc.
From 1945 to 1946, Hungary saw the worst hyperinflation in history.
After World War II after signing a peace treaty, they were ordered to pay massive
reparations to the Soviets. The central banks printed the money to pay for it and
as expected they had to face hyperinflation so worse that prices were rising every 15 hours.
it was at 419 BUT with 14 zeros after that so it can only be expressed in formulas.
The wealth of a nation doesn’t increase by printing more money. The little green pieces
of paper you have are not equal to wealth if it can’t buy anything. Countries do resort
to printing more money using the central banks or what is called Quantitive Easing,
but only to spur economic activity. But they can’t just go on the printing spree because that
disturbs the supply and demand chain system which results in inflation and if that gets out of hands
then it becomes hyperinflation that makes your paper money as good as wallpaper or even worse.
That’s why it’s said that “If money grew on trees, it would be as valuable as leaves!”
Thank you for watching! We will reply to every question in the comment section.