When the Government Really Prints Money

March 20, 2009 by  
Filed under Economics

printing_moneyThe 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”?

Compared to regular folks, the Fed seems disinclined to use the “we’re printing money” phrase even when it should be out there for all of us to see. 

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.

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13 Responses to “When the Government Really Prints Money”
  1. PW says:

    Thank you for an easy to understand explanation of government talk. You are really good at that, keep it up.

  2. Rick Beagle says:

    Anyone out there know what our current level of inflation is? While I appreciate the lesson, but isn’t there a bigger picture here? Are there any benefits to some inflation (I remember Carter)? There are experts out there that seem to suggest that we need to increase our level of inflation a bit to help liquefy the markets, and that inflation is a byproduct that the Feds are old hands at controlling. The general lack of inflation has the Feds scratching their heads, so I guess someone said, “let there be money”. Are the Feds just trying to get into their comfort zone?

    Ugh, who knows….

    Rick Beagle

  3. kitty says:

    Thank you for this excellent explanation. It turns out I misunderstood it.

    Rick, I don’t remember the exact numbers, but it is lower than normal. Last month was a tiny bit higher because of raise in energy prices. In January (or was it December?), the numbers showed deflation. There are two things that control inflation – money supply and velocity of money (i.e. how fast money change hands). We have money supply, but since banks are hoarding money and nobody is buying, the velocity is near zero.

    As I understand it – good economy needs certain small level of inflation e.g. 2-3% a year, but I don’t know the exact number. Very low inflation is bad as economy doesn’t grow; high inflation like during Carter times is bad as well since the salaries don’t grow as fast and we lose our purchasing power and savings. But deflation is an even bigger problem – this was a problem in the 30s and also in Japan – because the economy is contracting. It can cause a vicious cycle: initially you are fine – as long as you work – but then people say “why would I buy it if it’ll be cheaper in 3 months?”. So people don’t buy, businesses can’t sell, manufacturers don’t need to produce, they cut jobs. More unemployed people, even less buying, lower prices, etc.. This was what was happening during the Great Depression.

    The fed is trying to do its utmost to prevent deflation. Will its action cause high inflation in future or will they manage to raise the rates in time to take out extra money from circulation – your guess is as good as mine. Personally, I wish I knew whether I should invest for inflation or deflation…

  4. TAP says:

    But there is a much bigger issue that has barely been touched upon by Congress: the way tens of billions of dollars of taxpayers’ money has been funneled to A.I.G.’s counterparties — at 100 cents on the dollar. How can it possibly make sense that Goldman Sachs, Bank of America, Citigroup and every other company that bought credit-default swaps from A.I.G. should be made whole by the government? Why isn’t it forcing them to take a haircut?

    What’s worse, some of those companies are foreign banks that used credit-default swaps to exploit a regulatory loophole. Should the United States taxpayer really be responsible for ensuring the safety of European banks that were taking advantage of European regulations?

  5. MasterPo says:

    The inflation figures are false. Misleading at best, an outright lie at the most.

    That’s because the gov doesn’t include energy, medical, food and housing in the inflation figures. They claim those numbers are too “volitile” so they just toss them out of the equation – how lovely!!!

    I don’t know about you people but I *still* have to pay for energy (gasoline, electric, heating oil etc), food, medicine, and shelter expenses regardless of what the gov includes or not.

    Does ANYONE out there think prices of just about everything haven’t gone up a lot in the last year??

  6. Rick Beagle says:


    Thank you for: 1)reading my post and 2) understanding that mush enough to provide a thoughtful answer. You could have a career as a psychic! :-)

  7. kitty says:

    Master Po – I watch CNBC when they report CPI and PPI numbers. They normally give two numbers – one that includes food and energy and the other that excludes it. It’s no secret. Additionally, last month when the report showed inflation, they actually broke it up by groups – health, education, energy, food, clothing. They might not use food and energy for their I bonds or TIPs, but you can still see the numbers. If you google you could find the PPI and CPI numbers for the past few months that are broken by each of these categories. Last night I tried to post the link, but either I didn’t hit enter or my post got lost. One of the main reasons this month showed inflation is indeed the increase in energy prices e.g. oil going up from 30-something to 50. A part of deflation in December was the drop in energy prices.

    Rick – you are welcome.

    TAP – I thought the whole idea of bailing out AIG was to prevent its bankruptcy that would’ve caused problems in all of its customers. So why is everyone surprised now? Should they have negotiated all these CDS contracts back then – probably. But they didn’t. Now they own AIG and they are responsible for its contracts. If they start canceling the contracts they agree to honor, who would want to deal with them? Because of the whole madness in congress, the Chinese who don’t have credit default swaps but who have normal life insurance policies with AIG are lining up to take their money before the US government takes it. That’s a lot of money AIG will lose – insurance company’s equivalent of “run on banks”. Not to mention that with the way congress is behaving now would make all the private capital they need for their private-public partnership scared to have anything to do with the government. Would you deal with someone who broke a legal contract in the past? I sure wouldn’t. Their idea for taxing bonuses is just so ridiculous. Every time the congress grandstands my net worth drops…

  8. Robert says:

    Unfortunately, even factoring in the government’s inflation numbers for so-called volatile products, the figures are questionable. The government has been modifying the formulas used to calculate inflation for over 2 decades. The claim is that the new formulas were created to make the numbers more accurate, but it’s a very convenient coincidence that the new formulas result in inflation values well below (perhaps by half or more) what the original formulas would have calculated. When you consider that many “entitlement” payments such as Social Security benefits are indexed to the official inflation rate one has to wonder if the new formulas are truly intended to be accurate or to save money?

    I happen to suspect that almost all of the steps the government has taken to react to the financial crisis revolve around one simple thing: The US Federal Government is in a panic over it’s own debt.

    When the credit problems first started to emerge, the government was reluctant to take any big steps until they realised that the problem was quickly growing so large that the world’s largest borrower/debtor (the US Treasury Department) was at risk of finding that it too might no longer be able to borrow money. At that point, Congress enacted a very badly crafted and hastily thrown together program (TARP) in a record time. Our government can’t agree on the day of the week without at least a 6 month study to define what the word day means, but they suddenly manage within a couple days to agree to spend more money than we had ever put into a single spending bill, with almost no controls on how it was to be spent? Not very likely…

    The AIG bailout is yet another “cover your hiney” move by the government. AIG provides backing on an incredible number of government debts, mostly at the state and local level. If AIG collapses, most of the state and local governments in the country could face immediate demands for repayment of anywhere from tens to hundreds of millions dollars due to clauses in those debt contracts. They would not be able to borrow the money to pay off those defaults because their credit ratings would drop faster than a lead balloon. Who would they turn to to demand assistance? Oh, yeah, the government and the US Treasury.

    Last week the head of the government of China (one of the the US Government’s largest lenders) was publicly questioning the US Government’s ability to repay it’s debts and whether it was in China’s interests to continue to buy US Treasury notes. If that sentiment takes hold, the government will have no way to raise money BUT to print new money like there is no tomorrow… And there is no inflation formula tweak that will prevent people from realising it when inflation spirals upwards uncontrollably as a result.

  9. MasterPo says:

    Robert brings up a good point:

    Sooooooo MANY government programs are tied to inflation figures. Even if the budget for a given year was flat (zero increase from the prior year) gov spending would STILL go up because so many programs are automatically increased based on inflation numbers.

    Therefore, if the gov artificially (i.e. deliberately!) under reports inflation those automatic increases are smaller. Therefore the pols can take a cheap and easy path to *claim* they are reducing spending!!

    I know so many people who, this time last year were living very comfortably, and now are scrapping by to pay the monthly bills. (take my word on it they aren’t living the life style of the rich&famous)

  10. Prince Hall says:

    How are freddie Mac and Fanniemae affected the Fed buys Treasury bonds or mortgage bonds from them.

    Does this increase their stock value any time soon? If so, what is the general lag time between that purchase, and the improvement in Fannie and Freddie’s stock ans asset value?

  11. Robert says:

    You are wrong. The US government does not print money, the Federal Reserve does and the Federal Reserve is NOT PART OF THE GOVERNMENT. The Federal Reserve is an independent group which is owned by the banks, not the government. There is nothing federal about the Federal Reserve.

  12. Belle Starr says:

    Thank you so very much for the explaination about the Federal Reserve not being a part of the Federal Government. Would it be possible to inform Rush Limbaugh of that? He has people hating Obama because ‘Obama is printing all the money’ and it is so very dangerous.

  13. Jack Hora says:

    The federal reserve, the u.s. treasury, congress, the administration are all tied at the waist. Whenever the president talks about “investment” he has to depend on the federal reserve to buy bonds i.e., federal reserve request to the u.s. treasury to print paper money for deposit into the FR bank account to cover tax revenue shortfall thus allowing the u,s. treasury to sell bonds to the FR for the needed cash. True the federal reserve is not a u.s. government agency. Of course it depends on what the meaning of the word is is. For that reason I think you might be little too hard on Rush, love or hate him!

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