Why countries don’t print unlimited money? What is inflation?

Have you ever wondered why countries can’t just print more money to off their debts… or feed the homeless or fix unemployment, or any other issue for that matter? Now, this may seem like a rather silly question, but I think it may be one of those questions people might be a bit too embarrassed to ask, but there’s a shortage of people wondering. The short answer can be summed up in just one word… inflation.

Inflation

Inflation is defined as “a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency”. 

But I’ll get to that… first though, we need to establish exactly what money is.

Now, this may seem obvious, but something that’s important to know is that money has absolutely no intrinsic value. What that means is that money in itself has no actual value, it’s only considered valuable because it can buy things, but if you were stranded on a desert island, money would be totally useless. 

The Tinkerbell Effect

Money only has value because we believe it has value. This is called the Tinkerbell Effect, something I learned about from V sauce. The Tinkerbell Effect is used to describe something that only exists because we believe it exists. And this is the case with money.

Hypothetically speaking, if people suddenly started to believe that money had no value… it wouldn’t have any value.

Of course, it wasn’t always this way, money has been around for millennia, and when it was first used it was in the form of commodity money. Things were traded that had actual value and uses, like salt, spices, horses, or weapons. As well as precious metals such as gold and silver, which technically don’t have any intrinsic value either, but due to their rarity they are almost universally as currency. 

Then we have representative money. Since carrying around everything you own can be difficult, representative money makes more sense. Basically, you give your gold to a bank and they keep it safe for you, and in return, they give you a piece of paper acknowledging that you own that gold. These pieces of paper can therefore be used as money as anyone can go and redeem the gold at any time. 

But today, almost every country in the world uses fiat money. Fiat money requires faith and trust in the government that their money will have value. 

Implementing Monetary systems

If we use a relatively young country as an example, the United States has gone through all three monetary systems within 200 years.

In 1792, when the US stopped using European money. The Coinage Act of 1792 brought the inception of the US dollar. The US dollar was originally in the form of commodity money in the form of gold, silver, and copper coins. The coins were actually made from real gold, silver, and copper, and the value of the metal that made the coins were exactly equal to their face value.

The country then moved onto a mixture of commodity and representative money with the 1900 Gold Standard Act. The government issued dollar bills that could be exchanged for gold at any time. Gold Standard is a type of representative money that money countries used at the time. This was an effective way to accurately calculate the exchange rate between countries. 

For example, if one gram of gold costs £1 in Britain and $1.50 in America, then you can easily deduce that £1 equals $1.50.

Gold coins were discontinued and the silver was removed from the other coins, effectively ending commodity money. In 1971, Richard Nixon officially abandoned the Gold Standard, and the US moved onto fiat money. So money today isn’t back by gold or anything else of value for that matter. So back to the question at hand; basic economics tells us that an increase in supply results in a fall in demand and therefore a fall in price. So the more money in the economy, the lower the value of each dollar. Meaning other countries can purchase more dollars in exchange for their currency.

Why this leads to a rise in prices?

More money in the economy causes a shift in the demand curve for goods and services, but since this isn’t matched by an increase in economic output, prices must rise. 

Look at it this way, if the government printed a million dollars and posted it to everyone in the country, causing everyone to go out to buy sports cars… but there’s only a finite number of sports cars in the country. 

If we use an analogy to demonstrate this…

Imagine there are 4 people on a desert island, they each have 10 pieces of fruit each. All fruits are considered equal in value. Now imagine they discover a whole forest of apple trees. The nominal value of apples has increased because there’s more of them, but the actual value of an apple has gone down due to an increase in supply. Therefore it now costs 10 apples for 1 banana since the demand for apples is low but high for bananas. Just to clarify, in this analogy, the people represent different countries, the fruits their respective currency, and the apple tree is the printed money.

But it’s not only because of economic theory that we know printing too much money is a bad idea, there are several examples throughout recent history. The most recent example is Zimbabwe.

Inflation in Zimbabwe

In 2008, Zimbabwe suffered extremely high inflation due to printing money. This was the result of some awful decisions by President Robert Mugabe. When the economy took a turn for the worse, Mugabe printed more money to pay government expenditure. This caused inflation to skyrocket, and, in mid-November 2008, Zimbabwe’s inflation peaked at…

First I need to provide some context.

  • Inflation in the United States is around 2%. In India around 5%. And China 0.2%.
  • Economists generally agree that inflation levels around 1-3% are optimum.
  • First-world countries’ inflation rates today range from 0-5%.
  • A country is said to have enter hyperinflation when its inflation levels exceed 50%.

So… with that in mind, Zimbabwe’s inflation, at its peak, reached 6.5 Sextillion percent. Or to put it another way… that number has 22 digits. Can you imagine it? It got so bad that prices doubled every 24 hours.

One Hundred Trillion Dollar Banknote of Zimbabwe

The government tried to solve the problem by printing more and more money with higher and higher denominations. They also kept knocking zeroes off the end by re-valuing the Zimbabwean dollar 3 times, going through 4 different types of currency with 4 different ISO codes. Before the final re-denomination, they were printing 100 trillion dollar bills. People were literally using wheelbarrows full of cash to buy a loaf of bread. The government even made inflation illegal at one point and people were actually arrested for raising prices.

In 2009, the Zimbabwean dollar was abandoned and to this day they still have no national currency, their people use currencies such as the US dollar, the Pound Sterling, and the Euro. Before the hyperinflation, the first Zimbabwean dollar was worth about 1.25 US dollars. If that 100 trillion dollar bill was worth that exchange rate, that single bill would be worth more money than there is in the entire world… twice.

Inflation in Hungary

But as ridiculous as this was, this is only considered to be the second-worst inflation in history, after Hungary in 1946. Although Zimbabwe’s inflation peaked in Mid-November of 2008, their overall highest monthly inflation was 79.6 billion %, whereas Hungary’s highest monthly inflation which took place in July 1946 was 41.9 quadrillion %. With prices doubling every 15 hours.

To put that into perspective, in a country with a healthy inflation level of around 3%, prices double every 23 years. Their currency was called the pengo, and as inflation rose, the bil-pengo: short for billion pengo. Which is actually one trillion pengo on the short-scale. As well as the record for the highest monthly inflation, Hungary also holds the record for the highest denomination banknote ever issued- the 100 million bil-pengo note. (i.e – 100 million billion, or 100 quintillion). Which is 100 quintillion pengo on the short-scale. 1 milliard bil-pengo were printed but never issued.

  • In 1941, the exchange rate was about 5 pengo to 1 US dollar.
  • In 1946, when the currency was discontinued. Things had gotten so out of hand, that if you took every single banknote in the entire county, they would have a total value of one-tenth of a US penny.
  • Hungary then switched to the forint, where 1 forint equaled 400 Octillion pengo. Well, that number has 29 zeroes.

So that’s why the government can’t just print money to pay off their debts, it does not end well. It’s also important to understand exactly what national debt is. The national debt is much more complicated than personal debt. It isn’t simply a case of ‘you owe people money.

Paying debt of the country

Take the country with the highest National Debt- the United States, which currently has around 17 trillion dollars of debt. And you’re probably aware which country holds the most US debt is… China.

Although that is true, it’s somewhat misleading. Of the total debt, China only has about 8%. Most of the debt is actually owned by the United States government itself, but organizations such as Social Security or the Federal Reserve. On top of this, a further 30% is owned by US citizens. And even though 8% of 17 trillion is still a lot, China can’t just knock on the door of the White House and demand 1.2 trillion dollars. It doesn’t work like that.

Basically, the US Department of the Treasury issues treasury bonds. You can buy these bonds and the government will pay you interest on that bond every year. Then, once the bonds have matured, they’ll buy the treasury bonds back from you. Now, if a country gets into financial trouble, it may have to default on its debt. It basically means you won’t get your money back. But the US is generally considered an extremely risk-free investment because the US dollar is the most widely used and most trust-worthy currency in the world. It’s even written into the Constitution that the United States cannot default on its debt. 

 

I’ll leave you with a final thought. This is possibly the best way, to sum up why governments can’t just print off unlimited amounts of money…

If money grew on trees, it would be as valuable as leaves

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