For many years, every few weeks, my dad would call me up with the latest reason why some sort of financial crisis was imminent. And each time I responded, “Central bankers will just print more money.” Is there any crisis which more money printing can’t solve?
Now you might think a pandemic fits the bill. Surely money printing can’t overcome a pandemic and lockdowns?
But, it turns out, even amidst the pandemic, money printing was enough to make stocks and house prices go up, supposedly making us richer than ever before.
Think about how absurd it is that stocks and property went on to boom in the midst of a pandemic. That is the extraordinary power of money printing.
The remarkable success of this policy made people question why we’ve put up with financial crises, unemployment and recessions in the past. Why did it take a pandemic for us to discover the magic money tree and the free lunch that is quantitative easing (QE)?
But this era of money printing solving everything may actually be coming to an end. To understand why, you need to understand the question “Why can’t central bankers just print money and buy all the debt?”
I’ve seen this question asked all over the place. The French economist Thomas Piketty asked it in an opinion piece, the In Gold We Trust Report discussed it, and Liam Halligan was asked the question on GB News by Andrew Neil.
An entire school of economics and ideological movement called Modern Monetary Theory (MMT) has sprung up around this question too. They argue that central bankers can just create money and buy all the debt. And their opponents are up in arms against the MMT crowd’s claims.
But, as far as I’m concerned, I’ve never seen a satisfactory response from anyone as to “Why central bankers can’t just print money and buy all the debt.”
And so I asked the smartest people in the world… the ones who I happen to know, anyway.
And I got a bunch of different answers, none of which really got to the bottom of the question. Over the past few days, we’ve published that series of interviews in Fortune & Freedom. You can review them here:
You’ll notice the same question can be asked in so many ways. If central bankers do print money and buy all the debt, where does the buck stop? What goes wrong?
Before the emergence of inflation in 2021, there didn’t seem to be any obviously bad consequences from central bankers buying up vast amounts of debt in order to lighten the load on overindebted governments and financial systems. After all, politicians and bankers rely on ever more borrowing being possible. But, having reached impossible levels of debt, something had to be done.
Since 2008, central bankers rode in to the rescue by buying vast amounts of government bonds and other assets. This removed debt from the economy, allowing it to return to borrowing more.
Has inflation signalled we’ve reached an endpoint to this policy? I’m not sure, because the inflationary spurt we’ve seen was triggered by events other than plain old money printing, even if past money printing was the fuel those events set alight.
Let’s take a quick look at my own take on the question…
Here are the basics you need to understand.
The central bank sits outside the economy. This simple and vague statement is what unlocks this whole story, so keep it in mind.
The central bank manages the money supply by injecting and removing how much money there is inside the economy.
It does so by buying assets from the economy, usually government bonds, which are a loan to the government. This exchange injects newly created cash into the economy and removes debt, freeing up the economy from its debt burden (ironically, so that it can borrow more again).
So, if there is too much debt in the economy, the central bank can just create money out of nothing, use it to buy debt from the economy, thereby exchanging debt for money and solving the problem of too much debt in the economy.
Of course, the debt ends up on the central bank’s balance sheet instead. But, because the central bank is outside of the economy and not subject to the same rules and constraints, that debt simply doesn’t matter anymore. The economy is freed from its debt burden and cashed up instead.
Now, there is technically no limit to how much money central banks can create. It could buy all the debt, or just some of it.
But there is a different sort of constraint, which we’ll get to.
First, we need to clarify how having a central bank own government debt actually solves the problem of too much debt. In other words, what happens to the debt that central banks buy?
For now, let’s focus on government debt. No doubt you’ve heard all about how our governments are overindebted and we need to raise taxes and cut spending as a result. Well, if the central bank can just buy the debt endlessly, that wouldn’t be true.
But the debt that central banks buy doesn’t just disappear. So how does it solve anything when a central bank buys the debt and sits on it?
Well, if you and I own the government debt, when the government pays interest on its debt to you and I, we can spend it. But if the central bank owns government debt, that interest is simply paid right back to the government. It’s as if the government owns its own debt, by way of a subsidiary that sits outside the economy and off the government’s balance sheet.
Of course, central banks have bills to pay. So some of the money they get paid by the government goes to paying those bills. But most is remitted back to the government.
This monetary merry-go-round means that the debt has in effect been retired. It is still there, but it is not costing governments anything anymore, so it might as well not exist. The problem of too much debt has been solved for the government and the economy.
But over the last few years, central bankers haven’t just been buying government bonds. They’ve bought all sorts of assets like stocks, corporate bonds, high-risk corporate bonds which are known as junk bonds, exchange-traded funds (ETFs) and more.
Again, this has moved debt from the economy to the central bank, and replaced it with money, thereby lightening the debt load on the economy and allowing it to get growing again.
At this point, let’s take a step back. All this seems like a free lunch. As though debt doesn’t matter. But what are the implications?
The issue is that this system is open to abuse. If there are no obvious and immediate consequences from issuing too much debt and having the central bank buy it, why not go for broke?
History goes in cycles of forgetting and remembering what happens when governments are given the power to create money. The disaster that eventually results is fairly obvious – inflation. The question is how long it takes for governments to abuse the system too much – enough for the inflation to emerge.
The cycle begins when we trust the government to issue money. Over time, because of political incentives, they spend too much and become overindebted. Next, they resort to money printing. The value of money falls – what we call inflation.
Then society settles on a monetary system which prevents governments from being able to create money. They must tax or borrow to finance their spending, which puts a constraint. But, over time, that constraint is lost because we forget the lesson we learned. And so the cycle begins again.
In the 70s, we forgot this lesson once again and handed the power back to government by allowing it to go off the last remnants of the gold standard. We assured ourselves that an independent central bank is enough to stop governments from being able to spend as much money as they like. Central bankers would simply refuse to finance government deficits, we presumed.
But we were wrong. When given a choice between causing inflation and letting a government go bust, central bankers always make the same choice. They buy the government’s debt to prevent a sovereign debt crisis. Even making explicit rules against this hasn’t prevented the eurozone countries from going down that path.
So, the answer, as far as I can tell, is that central bankers can create money and buy all the debt, and this would solve our problem of too much debt. But it would simply create a new one. A temptation for politicians to spend so much money and create so much money, that we end up with severe inflation.
How far along we are in this cycle is up for debate. But the point is that it is a cycle and you need to be prepared for its next phase.
Editor, Fortune & Freedom