Here’s a response to the first question from last week’s Q&A. I feel like it’s worthy of its own post because it’s important. The question was:
“How do you respond to someone who is constantly claiming that inflation and therefore interest rates are bound to shoot up with “all of the money the government is printing?”‘
That’s easy. Here is how that conversation will usually go:
Hyperinflationist: “Can you believe how reckless our government is printing all this money every year?”
You: “Well, technically, the government doesn’t ‘print’ most of the money we use. Most of the ‘money’ we use is created by banks and is created when banks issue loans which create deposits. These deposits make up the majority of the money we all use to transact. Banks are the biggest ‘money printers’.”
Hyperinflationist: “Yeah, but can you believe the high government deficits we’re running and all that new money that gets printed when the government spends?”
You: “The government isn’t printing new money when they run a budget deficit. They’re actually ‘printing’ a government bond that is used to raise ‘money’. This results in the redistribution of existing money and the issuance of a new government bond. The amount of ‘money’ in the system doesn’t change, but the quantity of assets is increased.”
Hyperinflationist: “Oh yeah, but Quantitative Easing has been crazy money printing. Have you seen the size of the Fed’s balance sheet? Just wait until those dollars all get out of the banking system and cause crazy high inflation!”
You: “Well, that’s not exactly right. The Fed has created reserve balances through QE’s asset purchases which resulted in the increase in outstanding reserves in the private sector, but the reduction of another asset in the private sector. This isn’t asset printing. It’s asset swapping. Of course, if it’s done in conjunction with a large deficit then that could be called “money printing” and might cause high inflation, but QE alone is just asset swapping cash for bonds.
And more importantly, these reserves are used by banks INSIDE the banking system. That money doesn’t “get out” of the banking system in any meaningful sense. Remember cash is transformed from deposits so even if customers withdraw cash then this doesn’t mean there is necessarily “more money” in the system. It just means the type of money has been exchanged.
Hyperinflationist: “Well, what about when the banks start using all those reserves to multiply the money supply through new loans? Won’t that cause crazy high inflation? ”
You: “That textbook story is cute and all, but it’s not really how banks operate. Banks make loans and find reserves later if they must. They aren’t reserve constrained. The money multiplier is a myth.”
That should help you out. Good luck. It’s an uphill argument every time!
- Stop with the “Money Printing” Madness
- Pragmatic Capitalism: What Every Investor Needs to Know About Money and Finance
- The Biggest Myths in Economics
- Understanding the Modern Monetary System
- Hyperinflation: It’s More Than a Monetary Phenomenon
- The Bank of England Debunks the Money Multiplier
Buy Cullen Roche’s New Book Pragmatic Capitalism – What Every Investor Needs to Know about Money and Finance
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.