On May 11, 2016, CNN ran an article by Heather Long with the headline, “How can Trump ‘print the money’?”, filled with misinformation that only neoliberalism can conjure up, finishing strong with warnings about the U.S. becoming just like a small African nation called, you guessed it – Zimbabwe. Let’s debunk the article.
From the start, allow me to point out that I am not a Trump supporter. People who know me, know that this is true. In the article, Ms. Long asks, “So how exactly do you print money?” The actual answer is, you don’t.
“Printing money” is a gold standard operation and does not apply to a free-floating, non-convertible fiat currency like today’s US dollar. Nixon ended the dollar standard Bretton-Woods in 1971 and though the gold standard has been defunct now for years, the ‘printing money” nonsense continues unabated. During the gold standard, gold backed the US dollar and so, the US Government had gold reserves to defend. Any person or nation possessing US dollars could bring them to the US Government and demand gold in exchange for their dollars. This posed a potential problem for the government in that if it weren’t careful, it could run out of gold and so, run out of “money”. Therefore, there were three ways that the US Government could fund spending during the gold standard:
3. Printing money
The first two, taxation and borrowing, allowed the government to spend while defending its gold reserves. The third, “printing money” was what the government did when it wished to spend above and beyond what it taxed or borrowed. With today’s fiat US dollar, “printing money” to fund spending doesn’t occur, because all federal spending is merely the crediting of bank accounts with IOUs, which we will get to in a moment. The US Government does, in fact, print paper cash, however cash is based on consumer demand and has absolutely nothing to do with funding federal spending. Allow me to quickly explain what cash is before I continue.
What Is Cash?
A federal reserve note (cash) in a free-flaoting, non-convertible fiat system is nothing more than a paper bank statement. It’s a piece of paper that has a number on it. When you head down to your bank and withdraw a twenty dollar bill, the numbers in your bank account drop by twenty, the dollars in the bank’s vault drops by twenty and now, you are carrying around a paper bank statement that says, “Look everyone! I have twenty dollars” and everyone believes you. In fact, their belief in you is so strong that they are willing to give you goods in exchange for the paper bank statement.
So, you head to Walmart, grab twenty dollars worth of goods and Walmart takes your cash in exchange. When Walmart deposits that twenty dollars in cash in its bank, the numbers in Walmart’s bank account rise by twenty and the dollars in Walmart’s bank’s vault rise by twenty. So, by withdrawing and spending the twenty dollars in cash, all you have done is shifted twenty dollars from one bank to another. So, why then is there cash?
Because you demand it.
Some people prefer to carry around cash in addition to swiping debit cards and writing checks.
Such is life. But, let us continue, shall we? Ms. Long goes on to say,
“But when Trump or anyone else talks about “printing money,” they usually don’t mean manufacturing new bills and coins. Physical dollars and coins are only a small part — about 10% — of the “money supply” in the economy. The other 90% is in electronic form in checking and savings accounts at banks.”
No, no, no, no, no, NO! The “money supply” which Ms. Long refers to is not comprised of US dollars created by the federal government and then lent out, allowed to float around in the economy, ready to cause hyperinflation. Today, the “money supply” is determined endogenously by the level of GDP. In other words, the ‘money supply” is demand determined, which is outside of the control of the Federal Reserve.
The mainstream insists that the Federal Reserve controls the money supply, but this is false. The Federal Reserve, being a government agency, can control the price of money, but it has no control over the money supply. True, the Federal Reserve emits HPM (US dollars) however, banks do not lend out reserves; banks issue IOUs denominated in US dollars, so the “money supply” is determined by demand for bank credit. As banks issue loans, the money supply expands. As consumers and businesses pay off their loans, the money supply shrinks. In layman’s terms, when bank IOUs are paid back, the “money” that was created is then destroyed. Bank transactions such as these are what we refer to as horizontal transactions.
At this point, when discussing banking operations, it is important to understand that only the US Government can add or destroy US dollars, which occurs through interactions between the government and non-government sectors and which we refer to as vertical transactions. Banks can shift reserves from one bank’s reserve account to the next, but they cannot add or reduce US dollars. Influencing the supply of actual US dollars requires action to be taken by the US Treasury or the Federal Reserve.
So, in summary, bank lending is the process of leveraging HPM (US dollars) created by vertical transactions in order to profit. Banks issue IOUs which are pegged to the US dollar and the money supply expands or shrinks based on demand for these bank IOUs (bank credit).
Ms. Long continues with her article,
“Instead of printing more physical dollars, it’s quicker for the Fed to get money into the economy by purchasing assets such as bonds from a bank. The Fed pays the banks dollars in exchange for the assets.”
The Fed injects US dollars, created out of thin air from a keyboard, into the reserve accounts of banks and those reserves are never lent out – period. Reserves allow the payments system to operate correctly. Banks are not intermediaries, as we have discussed. Ms. Long demonstrates a thorough lack of knowledge concerning federal spending and the purpose of US Treasury bonds. Let’s address these two subjects.
In a free-floating, non-convertible fiat system, the US Government’s supply of US dollars is always equal to infinity, because nothing backs the US dollar. This also means that federal taxes do not fund federal spending. All federal spending occurs prior to taxation. Federal taxes regulate the economy, controlling spending power, but they are not a source of revenue. As the federal government is the currency issuing authority, it does not need a source of revenue. It can afford to buy whatever is for sale in US dollars.
The federal government spends by crediting bank accounts with its IOU, the US dollar, and it accomplishes that spending by going into a bank account, typing a number and that number becomes a US dollar. Let us assume that the US Government wishes to buy $1 million worth of coffee from Starbucks. The government goes into Starbucks’ account and types the number “1,000,000” and suddenly one million dollars exists. That’s it, that’s fiat – end of discussion.
As to US Treasury bonds; bonds do not serve any necessary financing function. They are not actual “borrowing”. Again, the US Government needs no revenue to spend and certainly it doesn’t need to borrow its own currency to spend. Today, Treasury bonds basically do two things:
1. Act as risk-free interest-bearing savings accounts
2. Drain excess reserves
Let’s start with number two.
One task that the Federal Reserve performs is setting an interest rate target and then defending that target if that target is set above zero – In other words, making sure that the target stays “on target”. Interbank lending of reserves on the Federal Funds Market has the effect of driving the overnight rate (FFR) towards the floor. If the Federal Reserve does nothing when it has set a target interest rate above zero, then it will lose control of its target interest rate. In other words, it’ll lose control of monetary policy. So what can the Federal Reserve do?
Use bonds to drain off the excess reserves.
Simply put, the Federal Reserve will exchange a treasury bond for the excess reserves, thus halting the overnight rate fall to the floor and maintaining control of its target interest rate. That is one of two uses the US government has for issuing bonds: To drain excess reserves from the banking system. The second use is the one you always hear about on TV. You know, the one where China is loaning the US government money. A treasury bond is a US dollar that pays interest. The sale of bonds to non-government entities doesn’t fund federal spending. What happens is very simple.
You buy a treasury bond from the US government. The Federal Reserve then shifts your numbers (dollars) from a reserve account to a securities account. This is absolutely no different than your checking and savings account at your bank. When you move $100 from checking to savings, are you $100 in debt to someone? No. Similarly, the Federal Reserve moves numbers from reserve accounts (checking) to securities accounts (savings). Bond purchases/sales are nothing more than the shifting of numbers around between savings and checking accounts, all held at the Federal Reserve. You buy a bond and the dollars shift to savings. At maturity, the dollars then shift back to a checking account. $100 was here, now it is there. Then, $100 that was there, moves back over here again. All of the time that those dollars sit in the savings account, they are earning interest. It’s what we call an interest-bearing savings account.
Unlike the US government, China does not issue US dollars. Therefore, like you and I, China must find a way to earn US dollars if it wishes to net save in US dollars. How does it do this? Well, drive to a Walmart, head down the Asian food isle and check the shelves for Chinese goods. Next, wander over to the toys, electronics, housewares and various other departments, check the shelves and look for the label “Made in China”.
A stunning revelation for all politicians: China sells stuff to the United States in exchange for US dollars. Well now, that certainly is frightening, isn’t it? When US companies sell stuff to US consumers, it is called business. When China or Japan do it, it’s called financial armageddon looming on the horizon. Get real. And it gets even more interesting, making these “loaning money to the broke US government” claims absolutely ridiculous.
Next, China sticks its money in a bank account at the Federal Reserve. China then buys some treasury bonds and earns some interest on its hard earned US dollars. So does the UK. So does Canada. So does any nation that sells its goods to the United States. China, the UK, Japan, Germany, et al., simply wish to exchange their production for US dollars and we happily accommodate them. Why? Because it raises our standard of living.
You like BMWs? Great. There are a bunch here to choose from. You prefer Honda? No problem. In fact, with all those US dollars that Japan earned, it went and opened factories here providing Americans with decent jobs. The US market is awash in goods from all over the globe, from clothes to cars, furniture, housewares, tools, food, spices, toys, electronics – on and on. US consumers have many choices on what to buy. The standard of living just goes up, up and up. And what do these nations get in return for selling us their production that they could be consuming themselves?
A paper bank statement.
An all-around bad deal for them and a really good deal for the United States. That paper bank statement isn’t even denominated in a currency that most of these nations can spend in their own country. They have to either spend those dollars here in the US, thus creating jobs in the US, or where someone will accept US dollars as payment for something, leave those earned US dollars in savings, or they can convert their earned US dollars into another currency at their own expense on the market. But then, the next question on everyone’s mind is “how on Earth does the US government pay the interest on these bonds”?
When the time comes, the Federal Reserve will move their hard earned US numbers (dollars) from their savings account back to checking. Then, it will simply go into that checking account, raise up the number a bit and the interest is paid out of thin air. The US government will declare, “Behold! Let the right amount of dollars appear in China’s account to reflect the interest owed.” The Federal Reserve says, “Ok”, types the correct number and China’s interest is paid. You earn interest on your hard earned savings from Chase and that’s just awesome. China does it and we’re all going to die.
Spare me the drama, ok?
And so, the US National Debt is not a real debt at all. For those of you willing to accept reality, here is what the US National Debt actually is:
The National Debt of the United States Government is all US dollars ever issued by the US government, from the founding of the United States until this moment, that have never been taxed away by the US government.
In other words, it is the National Savings. From around the 1790’s until today, 2016, the US government has issued, after taxes, $18 trillion dollars for everyone in the non-government sector to use. In fact, the national debt has been around for over 170 years now, so at some point, we’re going to have to start understanding that it’s not an actual problem. This so-called “debt” is nothing more than an accounting record that lets us know how many US dollars US government has so far issued.
Further on down the article, Ms. Long states,
“The idea was to get more money into the bank vaults and grease the financial system. In 2008 and 2009, the financial crisis was exacerbated by the fact that many big banks didn’t have enough cash on hand to make good on what they owed others. To get money flowing, the Fed had to step in. The hope was the extra money would make banks healthier and then they would start lending more to Main Street. That second part of the equation didn’t happen as much as policymakers desired. It’s one of the reasons there hasn’t been much inflation, the usual demon that comes along with printing money.”
There is nothing in the above quote that is true. Correctly put, it is a total fantasy. Firstly, QE is an asset swap for liquidity. The idea of QE being not to fill bank vaults, because that would involve filling them with cash (a major eyebrow scruncher moment there), but swapping assets and then injecting HPM into bank reserve accounts in the hopes that banks will begin lending out those reserves. Sadly, as we’ve already discussed, no such thing ever occurs, which is the reason why QE hasn’t been inflationary. I will say it again to be clear:
Injecting bank reserves with US dollars isn’t inflationary, because banks cannot and do not lend out reserves.
Finally, let us turn our attention to the most ridiculous part of the article. Ms. Long states,
“In economics classes, professors teach students that printing money is a bad idea. Why?”
Because mainstream “economists” do not know what they’re talking about, for starters. But let’s continue,
“Because when a government prints more money, it usually makes the money already in existence worth less. Think about it like a pizza being divided up into even more slices. It won’t take long for people to realize that they need more of the new, smaller slices to equal one old slice. Stores soon start charging more goods. A gallon of milk may jump from $3 to $5. It’s what economists call inflation.”
It might be what so-called “mainstream economists’ call inflation, but a gallon of milk jumping from $3 to $5 isn’t inflation. Now I do get what she’s trying to say, that the price level rises, but the milk example just irks me. This kind of nonsense; picking out one particular item like milk and jacking the price up on it just to provide an example of inflation is what confuses the general public.
Inflation is not just “inflation”. Now, what do I mean by that? There are different types of inflation and different causes. People see the price of eggs rise and think, “Inflation!”. People talk about the cost of living and think, “Government spending is killing the value of the dollar!”. People will see what is a stable increase in inflation and think, “Armageddon is coming! We’re all gonna die!”. Also, for the most part, thanks to politicians and mainstream “economists”, people are trained to view all inflation as a government spending problem; our greatest fear and we must be eternally vigilant. It’s a subject that simply isn’t cut and dry. When it comes to inflation, we have to first know what we are talking about.
First, let’s outline what inflation is not and then provide the actual definition. Inflation isn’t:
1. When the price of bread goes from $2 to $2.10.
2. When Walmart gives workers a pay raise.
Inflation is defined as a “continuous” rise in the price level of goods and services over a period of time that the price rise is observed. In simple terms, a price increase is necessary, but not necessarily inflation. We need more information to declare that an inflationary episode exists and further, to define exactly what type of episode is occurring. Let’s briefly review different inflationary episodes.
Stable inflation occurs when the price level rises steadily over a period of time. For example:
Jan – 5%
Feb – 5%
Mar – 5%
Apr – 5%
is what we call “stable inflation” Politicians and the media never seem to mention this type of inflation.
Accelerating Inflation (A.K.A. “Inflation”)
Accelerating inflation occurs when the price level rises increasingly over a period of time. For example:
Jan – 5%
Feb – 6%
Mar – 7%
Apr – 8%
is what we call “accelerating inflation”. The price level rises faster with each period observed. It therefore, accelerates. This is the type of inflation that politicians and the media associate with government spending, which they label as simply “inflation”. As we will soon see, it is based on several false assumptions.
Decelerating inflation occurs when the price level drops over a period of time. For example:
Jan – 5%
Feb – 4%
Mar – 3%
Apr – 2%
is what we call “decelerating inflation”. Politicians and the media do not know what decelerating inflation is and so, they never mention it.
Cost-Push or Demand-Pull?
Just as there are different types of inflationary episodes, there are also different causes. The two main causes of inflation are defined as either:
1. Cost-Push: A supply-side issue.
2. Demand-Pull: A spending issue.
I will ignore Cost-Push since our concern in this article is to address the public’s fear of “too much government spending”. However, before we begin delving into what Demand-Pull inflation is, we need to address the reasons why you believe government spending will always result in inflation.
What you’ve heard on TV about government spending and inflation is that any increase in the “money supply” is inflationary and we will all die. However, the truth is that it’s all a sham. Literally. There’s absolutely no truth to the assertion whatsoever. Let’s briefly debunk the sham and then get on with the truth.
One Reason Why You Fear Government Spending and Inflation
The “economist” Milton Friedman and his jolly band of monetarists in the 1970’s devised a clever way to steal from the poor and give to the rich and also, to make you fear government spending. Milton takes an innocent equation and makes it do scary things with a little magic trick. First, Friedman asks us to make assumptions, which we all know usually make asses out of you and me, then proceeds to construct a ridiculous argument that simply doesn’t hold water, unless, of course, you’re a politician. We begin with the innocent equation:
M(V) = P(Q)
Where (M) is the money supply, (V) is the velocity of money, (P) is the price level and (Q) is output. There is not a thing wrong whatsoever with this equation. It is perfectly legitimate.
The first false assumption Friedman asks us to consider as a fact, is that the Federal Reserve controls the money supply, which we define as (M). The problem, is that the Federal Reserve doesn’t control the money supply. It can control the price of money, but not the supply. The money supply, in economist-speak, is endogenously determined by the level of GDP. In layman’s terms: The money supply is determined by demand for commercial bank credit money.
The second false assumption Friedman asks us to consider as a fact, is that the velocity of money (V) is constant. However, the velocity of money is not constant. It varies.
The third, most ridiculous false assumption that Friedman asks us to consider as a fact, is that we are always at full employment and so, always at maximum output. Any person without a hint of education in economics can simply look out the window and see that we aren’t always at full employment. Now, let’s put Uncle Milty’s magic trick together.
Since (V) and (Q) cannot rise, because if they did Milton’s argument would fall apart, then the only things that can rise now are (M) and (P). So, if the US Government increases the money supply, then the only thing else that can increase is the price level. Therefore, federal spending will result in accelerating inflation and we will all die. But here’s the important point: Note that Milton says that it will result in “accelerating” inflation, not stable inflation. Yet, politicians and the media simply blanket the condition as “inflation”. Just plain old inflation. However, we now know that accelerating inflation is not stable inflation. Accelerating inflation is a serious condition. So, what politicians and the media do is simply leave the horrifying images of accelerating inflation in place and drop the term “accelerating”, referring to it as “inflation”. Thus, in the mind of the general public, when they hear the word inflation, they think:
“A condition caused by government spending that will kill every man, woman and child on the face of the Earth. Remember the great inflation of the 1970’s? We don’t want to go there again!”
And that’s one reason why you fear government spending and inflation. Now then, let’s get to the truth of the matter.
Demand-Pull occurs when spending exceeds the real capacity of the economy to produce. Now, what do we mean by that? Let’s consider the US economy. The US economy is vast, capable of some serious output (production of goods and services). It’s not the size of a third world nation. To generate output, one very important component is labor. So, we ask, are there enough idle (unemployed or underemployed) workers available to increase output? If there are enough workers to employ and the infrastructure is in place and functioning, then as long as any increase in government spending results in output, all is well. So, quite simply, if we are not near or at actual true full employment where there are no more workers that can be hired, then government has room to spend. But let us assume that we have a true situation of full employment, where there are no more available workers to employ to increase production.
When we approach a level of true full employment, bottlenecks in supply chains can occur. If, in fact, we are at a situation of full employment, any further spending will exceeded the real ability of the economy to produce and inflation will occur. However, to alleviate this condition, the US Government can simply do one of two things:
1. Reduce spending
2. Increase taxes
Federal taxation has many functions, but one major function is to reduce spending power. When the US Government increases taxes, US dollars are withdrawn from the economy And destroyed. As long as the US Government does not withdraw too many US dollars, full employment can be maintained. However, if the US Government taxes too high, unemployment could result. It is a balancing act, to be sure, which is why pump priming the economy isn’t such a good idea. Initiating a federal Job Guarantee is a far better solution to achieving and maintaining a situation of full employment. However, discussion of a Job Guarantee is for another article entirely.
So, with actual unemployment figures today at around 9.7%, the United States has plenty of room for increased output. As long as government spending results in output, you can safely ignore any inflation fear-mongering from mainstream economists, politicians and the media.
Moving on towards the end of the article, we read,
“Zimbabwe is the prime example of how bad things can get,” says Wellesley College professor Dan Sichel, an economist who used to work at the Federal Reserve and U.S. Treasury. Zimbabwe printed so much money that prices shot up almost exponentially in the country (e.g. bread suddenly cost over a trillion Zimbabwe dollars). The currency basically became worthless in 2009 and the economy tanked.”
That is not what happened at all. The entire statement is complete nonsense.
Hyperinflation (A.K.A. “Anti-Government Ron Paul Scare Tactic” Inflation)
Libertarians and anti-government fiscal conservative elements love to scare the public with hyperinflation. They will point at Zimbabwe and say, “That there’s what happens when the government prints money to hand out welfare checks and hire people!” Puerile nonsense. Hyperinflation is not the result of government “printing too much money”. Hyperinflation occurs when the real capacity of the economy to produce is severely damaged or destroyed, which might be because of war, or political unrest and then high levels of spending continues. Also, hyperinflation can occur when a currency peg has been released. This is a grand episode of inflation and it is very rare. Here’s what actually happened in Zimbabwe.
Mugabe came to power in Zimbabwe and one of the first things he did was to evict farmers from their land. Next, he handed over the land to his friends who didn’t know the first thing about farming. So, the food supply was destroyed. Next, Mugabe proceeded to damage his infrastructure and railways to the point that transport of raw goods and other goods became impossible. More and more people were thrown into unemployment. Imports of food and other goods became essential. High tariffs caused importers to abandon goods at the border.
A major supply shortage existed. With unemployment above 80% and no real way to provide jobs for the unemployed, Mugabe ordered the government to keep spending. And spend it did, far in excess of the economy’s real ability, ending in hyperinflation.
So, it wasn’t just “government printing too much money”. Serious damage was done to the economy and “then” excess spending pressure was applied to the decimated output ability. Conservatives and Libertarians who insist that US government spending for the public purpose will result in hyperinflation, are, quite simply, advocates of pure nonsense and purveyors of anti-government fear mongering. If you want to create a hyperinflation episode in the United States, you will first need to either:
1. Decimate America’s output infrastructure, so that the majority of the population cannot be employed.
2. Destroy most of the nation with a volcanic eruption or nuclear strike.
then afterwards have the US Government spend and spend and spend.
So, with that, I think we’re all done here.