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:
Inflationist: “Can you believe how reckless our government is printing all this money every year?”
Monetary Realist: “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”.
Inflationist: “Yeah, but can you believe the high government deficits were’ running and all that new money that gets printed when the government spends?”
Monetary Realist: “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. There actually isn’t any “money printing” going on there.”
Inflationist: Yeah, but what about all those paper dollars floating around. Those have to be inflationary at some point, right?
Monetary Realist: “Not necessarily. Paper money is only accessible to people who have previously had bank accounts. That is, any cash in the monetary system is placed there by someone who withdrew money from a bank account. They essentially transformed their deposits into cash notes. But the “money” still originated with the banks creating deposits even if the US Treasury is the entity that actually prints up the physical notes. They only do that so you can transact in physical currency more conveniently and this money is distributed THROUGH the banking system.
Inflationist: “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!”
Monetary Realist: “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.
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.
Inflationist: “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? ”
Monetary Realist: “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