When the Government Really Prints Money
The cry that “the government is just printing money” is one of those phrases that is overused and misunderstood by some Americans who are concerned about massive government spending. This phrase is actually a truism, as the government must regularly print money to replace currency that is old and must be destroyed.
That’s not what most people mean when they complain about money being printed. So let’s try to clarify things.
Why Won’t the Fed Announce that “Money is Being Printed”?
The big financial headline this week was from the Fed, which announced that it would be buying $300 billion in Treasury Bonds.
To a lot of people, that headline means little or nothing.
To others, the fanfare surrounding the announcement makes it sound like a really good thing. Maybe it is. Maybe it isn’t. Time will tell if this strategy will benefit the economy.
Why won’t the Fed just come out and say what is really happening when it buys up Treasury debt?
Monetizing the Debt
The technical term for what the Fed will be doing by purchasing billions in Treasury bonds is “monetizing the debt.” The theory is this: The Fed wants to increase the supply of money in the open market to unclog the credit system. Lots of cash moving around is like a laxative for a stuck economy.
At the same time, the Treasury needs to borrow money to use on the spendulus plan, the omnibus spending bill, and all of the other stuff Congress is funding. If the Treasury borrows all of that money by selling bonds to taxpayers and institutional investors in the open market, that takes money out of the private sector of the economy, interfering with the Fed’s money laxative plan.
So the Fed says “We will buy the Treasury bonds” and leave that cash in the private sector. How does the Fed buy Treasury bonds? Technically, it does it by expanding its balance sheet and creating bank deposits out of nothing. More specifically and less technically speaking, the Fed causes the money to be printed and gives it to the government in exchange for the bonds. Now the government can spend the cash without taking it out of the hands of other spenders.
The Dollars and Sense of Printing Money
Let’s look at what the Fed can do to monetize the debt in a series of simple dollars and cents transactions:
1. Our government operates at a deficit, a well developed skill. Let’s say that the government needs to spend $100,000 in cash this week but can only collect $90,000 in taxes. This creates a $10,000 cash deficit. Therefore, the government must find another $10,000 in cash to buy the stuff it needs. (It may not actually need the stuff but Congress wants to spend it anyway.)
2. To raise the needed $10,000 in cash, the government decides to sell Treasury bonds in the open market to U.S. citizens who have some extra money to invest. They get the bonds and the government gets the $10,000 in cash that it needs. The problem is that now there is $10,000 less cash in the money supply that can be used to spend, invest, lend, create jobs, etc. That can be a bad thing in an economy that is contracting like ours. We would prefer that the government be able to spend that $100,000 without taking $10,000 of it away from the rest of the spending economy.
3. To solve the cash crunch problem, the Fed can step in with a monetization step. The slow and indirect way to do this is for the Fed to buy the Treasury Bonds from the individual investors who purchased them from the Treasury. It does this by conducting what is called a $10,000 open market operation to increase the money supply. It grabs a brand new series of $1,000 bills and uses them to buy the bonds from the public. This increases the supply of money circulating in the banking system, etc.
4. The faster method of monetizing the debt is to do what the Fed announced this week. It will buy the bonds directly from the Treasury, leaving the private sector out of it. The result is the same. When all of the paper has finished changing hands, the $100,000 in goods that the government needs is paid for by the collection of $90,000 in taxes and by releasing $10,000 in new currency. The government debt is simply transferred from the Treasury to the Fed.
So now you understand my question: Why doesn’t the Fed just say that it will be releasing $300 billion in new currency into the money supply?
I suppose that the Fed doesn’t want to speak in such raw terms. That would be waving the big red flag of inflation. But there is no question that when the Fed is buying Treasury bonds, inflation is a concern. This is particularly the case now because the Fed is also working hard to keep interest rates low.
So next time you see a headline that the Fed is buying Treasury bonds or mortgage bonds from Freddie or Fannie, now you know what is really going on.