Printing Money: The wrong band-aid all along?

Have you ever wondered why governments do not just print money every time they have a large debt? After all, if there is a need for funds, and if the governments have the means to create more money, then why do not they do it?

In fact, in the United States, the president Joe Biden has been actively printing money to overcome the pandemic crisis. Such measure has been concerning most of the American population, as the inflation rates are increasing by the minute and a hyperinflation crisis is in the mind of many.

A question imposes, should we be concerned? What can history tell us about using these mechanisms to overcome major depressions? The answer to this lies in the balance between rising inflation and the reduction of debt. In this article, we will analyse this equilibrium, and explain the consequences of rising inflation throughout history.

The Mechanics used in overcoming a Crisis

First and foremost, we must observe the mechanisms used to overcome an economy which is deleveraging. During economic hardships, the amount of debt increases to a point where the debt repayment grows at a much faster pace than levels of income, thus decreasing spending. As one’s spending is another’s income, we have an ongoing stream of less borrowing (since people become less creditworthy), while the debt repayment still prevails.

In such extreme situations, lowering interest is not enough to overcome these crises (as the Central Banks would do when faced with a short-term recession). Thus, to decrease debt burdens, there are usually four ways to do so: Cut Spending, Reduce Debt, Redistribute Wealth and Print Money.

While the first three are deflationary forces, still resulting in income decreasing at a higher rate than debt, printing money is an inflationary and stimulative force controlled by the Central Bank and used to buy financial assets and government bonds, increasing their value. As the Central Bank is only capable of buying financial assets and the Central Government (not able to print money) of spending on goods and services, giving the money directly to households, these two institutions must combine forces to stimulate the economy. This reinforces the importance of policy makers, who need to balance the mix between deflationary and inflationary forces to maintain stability, ensuring a debt decline relative to income, positive economic growth and a controlled inflation.

However, there have been many times when this did not happen. The Central Bank needs to print money in such a way that the rate of income growth is higher than the rate of interest on accumulated debt. Since this method is quite preferable to the other alternatives and easy to undertake, it is no surprise that it has been abused a lot throughout history, leading to disastrous outcomes as hyperinflation.

Examples of Hyperinflation throughout time

Most of us recall hearing that post World War I Weimar Germany was one of the worst cases of hyperinflation. In fact, during the war, Germany financed most of its army and resources through money printing, portraying it as an investment since they believed they would win the conflict. Consequently, the German government not only used propaganda to appeal to patriotism, as to disguise the immanent inflation that was on the horizon, but also censored a lot of information regarding the stock exchange market and foreign exchange rates.

After the war came to an end, the major debt in Germany’s economy culminated with the well-known Versailles Treaty. The Germans were left to pay an astronomical and unrealistic debt after a miserable conflict. By September 1920, prices were 12 times higher than the ones before the war, and France was starting to put pressure on Germany to reimburse its repairment payments, going as far as, in March 1921, surrounding and occupying German ports.

While instability spread across the country, Germany tried to start implementing the mentioned above mechanism, mainly through deflationary forces, such as wealth redistribution. However, due to the abnormal high taxation, it is said that the rich started to spend all their money in whatever they could, to avoid giving it to the government. Simultaneously, Germany kept printing money, trying to stay afloat, perpetuating the vicious cycle of inflation and uncertainty which would lead to the rise of the extremist and far-right party.

This is a very good example of how dangerous it can get when the two main forces mentioned are not managed correctly.

Furthermore, another known and current example is Venezuela. Throughout the last decades, Venezuela’s currency, the Bolívar, and its overall economy had been highly dependent on oil exports. However, due to the global price drop, the foreign demand for the Venezuelan currency to buy oil crashed, and with it the Venezuelan economy. In 2013, after the presidency of Hugo Chavez, his new successor, Nicolas Maduro, decided to start printing money as a solution, because of its intrinsic inflationary force.

However, as the price of oil kept falling and Venezuelan oil output decreased, even more investors decided to look elsewhere, which deepened even further the devaluation of the bolívar. As prices began to rise, the government kept printing more money to pay its bills and debt, entering into a hyperinflation cycle.

Faced with the tremendous devaluation of the currency and to deter the population of adopting the US Dollar, the government decided to issue currency controls, namely a fixed exchange rate that would stop currency transactions. The government also made many attempts at valuing the currencies by creating new ones tied to the oil price but never succeeded. Moreover, this led to many cases of unofficial currency trading, fomented by the uncertainty and distrust of the Venezuelan population towards the country’s political and economic instability, which only worsened the situation.

Regarding this case, we may note that, faced with a crisis, the Venezuelan government emphasized inflationary mechanisms, failing to establish a sustainable balance.

A look in the present

One of the most discussed policies nowadays is Biden’s. After Fed’s injection of 2.3 trillion dollars in the economy, with a total amount of stimulus checks to households of 391 billion dollars, we have seen rising inflation in the US, with the consumer price index reaching 5,4% in September 2021 (Graph 1).

In order to explain this value, there are several matters to consider. Firstly, some external shocks to monetary policies have an impact, such as the energy shock, as the prices of energy and fuel have been rising (consequence of lack of resources). Besides that, some supply chains that were disrupted have not returned to normal, leading to price increase in imported goods. On the demand side, with the economy returning to ordinary again, the demand escalates in some sectors, such as services, and this disturbance can lead to the rise of prices, as families attempt to return to their previous consumption habits and companies seek to compensate the losses. Another important aspect is related to long-term expectations. The inflationary forecast can lead to an even higher inflation rate in the long run.

Will the United States repeat the past?

All in all, USA’s inflation is dependent on many consequences that came out of the pandemic crises other than Biden’s stimulus policies, unlike the mentioned examples. However, all of them share a similar imminent problem regarding the excess amount of debt they are supporting, despite the United States currently being able to attenuate it.

We are living uncertain times and as long as policy makers are aware of the need to find an equilibrium between inflationary and deflationary waves, this current deleveraging may occur in a stable way.

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Sources: Business Insider, Caixa Bank Research, CNBC, Financial Times, Forbes, The Conversation, The Economist, The Guardian, The New York Times, The Washington Post, The White House, Trading Economics, VOX.