Are We Really Printing Money to Finance Our Debts?
When the Fed wants to raise money for the government it sells government bonds. The more bonds it sells the more money it raises. As long as there are buyers the government can raise as much money as it needs. If the buyers grow skittish the government can raise the yield on the bonds to make them more attractive. Most of the time the Treasury sells bonds either to private investors of governments like China. But it can also sell them to the Federal Reserve. When the Fed buys bonds it can pay for them simply by printing money.
Economist Bill Anderson, Associate Professor of Economics at Frostburg State University, points out that “technically, the government can print money to pay debts, although one has to remember that in our financial system, new money comes through bank loans. In that way, we are different from countries like Argentina, Zimbabwe, or Bolivia, all of which have large numbers of state-run enterprises with people paid directly with cash that comes from the printing press. We don't have that kind of direct printing-press-to-purchase situation.”
Just how much money is the U.S. government printing to meet its debts? Steven Horwitz, professor at St. Lawrence University, and co-author of The Austrian Economists blog, explains that the amount of money printed in the past few months since the October economic crisis, has been absolutely unprecedented in U.S. history. “Since September, the 'monetary base,' which is the measure of currency plus bank reserves, has doubled from about $850 billion to $1.7 trillion, about $600 billion of which is in the form of bank reserves,” he says.
Increasing the money supply should theoretically increase liquidity, one of the goals of the government since the onset of the credit crunch. But the effect of the increase has been less than you might expect, Horwitz observes. Only about $300 billion has gotten into consumers' hands.
While the Fed is selling bonds to raise money to cover government debts, it is also buying bonds to inject liquidity into the system. The more bonds it buys the more cash goes into circulation. Horwitz notes that the week ending January 7th 2009, “the Fed increased its holdings of Treasury bonds by about $10 billion, while since October 1st 2008 “it's been about $215 billion.”
According to both Horwitz and Anderson, there is a great danger of inflation in the coming months due to the Federal Reserve’s massive expansion of the money supply. The most inflationary period in U.S. history, according to Horwitz, was the end of the 1970s when “inflation rates were as high as 14%,” while the least inflationary was in 1929-1933 when massive deflation caused the Great Depression to be so long. Anderson notes that the government of Weimar Germany printed money to meet its post-WWI debts, which led to massive hyperinflation. The Federal Reserve has expanded the monetary base to avert a crisis, as it did in the wake of the stock market crash of 1987, according to Horwitz.
Inflation dangers would be exacerbated if the Chinese stop buying bonds, warns Anderson. "Will the Fed be purchasing bonds directly from Treasury?" he asks. "If that is so, then all bets are off, as there will be no limit to the Fed's ability to inflate.”