Article by Jared Dillian in "Bloomberg":
Doing “whatever it takes” to save the global economy from the coronavirus pandemic is going to cost a lot of money. The U.S. government alone is spending a few trillion dollars, and the Federal Reserve is creating another few trillion dollars to keep the financial system from collapsing. A custom Bloomberg index measuring M2 figures for 12 major economies including the U.S., China, euro zone and Japan shows their aggregate money supply had already more than doubled to $80 trillion from before the 2008-2009 financial crisis.
These
numbers are so large that they no longer have any meaning; they are
simply abstractions. It’s been some time since people thought about the
concept of money and its purpose. The broad idea is that money has
value, but that value is not arbitrary. Former Fed Chairman Paul Volcker
once said in an interview that “it is a governmental responsibility to
maintain the value of the currency they issue. And when they fail to do
that, it is something that undermines an essential trust in government.”
The
dollar has no real intrinsic value, backed only by the full faith and
credit of the U.S. government. Under a fiat currency system, the
government says that a dollar is a dollar. Its value relative to things
such as other currencies and gold is determined on global markets. Gold
is considered to be an objective store of value, and the metal’s rise in
dollar terms can be expressed another way, which is that the dollar
fell in gold terms. That implies the market has rendered a decision on
the value, or rather, the purchasing power of the dollar.
The
three main functions of a currency are as a unit of account, a medium
of exchange and a store of value. It is that last function that is most
important. Ideally, a central bank would want its currency to retain its
value over time. The era of flexible monetary standards, however, allow
central banks to manipulate a currency’s value to help fight recessions
as well as smooth out and lengthen business cycles at the expense of
inflation. But even low inflation, say on the order of 2%, will greatly
erode the purchasing power of a currency over time.
And
if there are too many dollars in circulation, the monetarists would say
that the value of those dollars has diminished, eventually leading to
higher prices for things. That theory hasn’t worked too well in the last
decade, because inflation has been low and stable, but it is too soon
to declare it discredited. The transmission mechanism that results in
inflation is not well understood, even 45 years after the last great
period of inflation.
It
took a while, but it seems as though the U.S. government has decided
that it has no constraints on its spending, as long as the Fed continues
to monetize government borrowing by purchasing the debt issued to
finance expenditures. It’s not crazy to think government spending may
reach $10 trillion – for just one year! And the numbers will go up from
there.
Nobody
really knows how this is going to turn out. In smaller economies,
runaway government spending has resulted in hyperinflation and social
unrest, such as well-documented cases in Venezuela and Zimbabwe. Many
think that wouldn’t be possible in the U.S. given the dollar’s role as
the world’s primary reserve currency. Perhaps, but it’s not one of those
questions we’d really want to experiment with.
If
all this money that’s being created does spark inflation, or at least
boost inflation expectations, it will be difficult - if not impossible -
to reverse. Inflation rates soared in 1979, but that was during a time,
unlike now, when most government officials believed that balanced
budgets and careful spending were important. A blistering series of
interest-rate hikes pummeled inflation expectations, but the result was a
hurricane-force recession. Argentina, which has more or less been
practicing MMT for some time, proves that it’s hard to put the inflation
genie back in the bottle. Argentines have been hoarding dollars—the
only practical store of value, other than gold—for decades. They
probably view recent events in the U.S. with some trepidation.
The
counterexample to all this is Japan, which historically has had the
most debt relative to the size of its economy and the most radical
monetary policy, and yet has a peaceful, productive society with scant
inflation. Demographics explain a lot about inflation and inflation
expectations, and Japan’s steadily declining and aging population has
put downward pressure on prices for years in spite of all the printing.
Economists and central banks generally fear deflation more than
inflation because it can hinder investment. History has shown that
persistently high inflation rips societies apart; in deflation, people
band together.
Throughout
Venezuela’s economic crisis, we saw images of ordinary Venezuelans
tossing their useless bolivars in the streets. That is what happens when
money has lost all meaning; it is in jeopardy of becoming a commodity
when it is supposed to be a scarce resource. There are a million reasons
why the U.S. will never meet the same fate as Venezuela, but you still
don’t want to tamper with people’s perception of the value of money.
After you throw a few trillion dollars around, people start to believe
that it’s all a big joke.