Have you ever wondered why countries can’t just print more money to pay off their debts, to feed the homeless, to fix unemployment or for any other issue for that matter? This may seem like a rather silly question but I think it’s one of those questions that people may always wonder about but never ask. The answer can be summed up in just one word - inflation.
Inflation is defined as a persistent and substantial increase in the general level of prices related to an increase in the volume of money resulting in a loss of value of the currency, but I’ll get to that later. First, we need to establish what exactly money is. Now, this may seem obvious to many but we still need to clarify that money has absolutely no intrinsic value. This means money in itself is only considered valuable because it can buy things. But if you were stranded on an island, money would be totally useless. Money only has value because we believe it has value. It is called the ‘Tinkerbell Effect’. 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 we suddenly start believing that money has no value, it wouldn’t have any value. Of course, it wasn’t always this way. Money as a concept has been around for thousands of years, and was first used in the form of commodity money, i.e things that had actual value and uses like salt, wheat, horses and weapons as well as precious metals such as gold and silver, which technically don’t have any intrinsic value either but due to the rarity they were almost universally accepted as currency. Then we have representative money, which makes more sense since carrying around everything you own can be difficult. Basically, you deposit your gold into 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. Anyone can go and redeem the gold at any time.
However, today almost every country in the world uses fiat money. Fiat money requires faith and trust in the government by the people. The people will have to value their money enough to use it for transactions. If we use a young country as an example, the United States has gone through all three monetary systems within 200 years. In 1790, when the United States stopped using European money as the Coinage Act of 1792 brought the inception of the US Dollar. USD 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 was used to make the coins was exactly equal to their face value. The country then moved on to a mixture of commodities and representative money with the Gold Standard Act of 1900. The government issued dollar bills that could be exchanged for gold anytime. The gold standard is a type of representative money that many countries used at the time. This was an effective way to accurately calculate the exchange rates 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= $1.5. Later, gold coins were discontinued and silver was removed from other coins, effectively ending commodity money.
In 1971, Richard Nixon officially abandoned the gold standard, and the US moved on to fiat money. So, money today isn’t backed by gold or anything else of value. Now, back to the question at hand: basic economics tells us that an increase in supply results in a fall in price. So, the more the money in the economy, the lower the value of each dollar. This means other countries can purchase more dollars in exchange for their currencies. A second supply and demand analysis shows 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. If we use an analogy to demonstrate this, imagine there are 4 people on a desert island, they have 10 pieces of fruit each. All fruits are considered equal in value. Now, imagine they discover a whole forest of apple trees. The total nominal value of the apples have 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 compared to its supply but the same is high for bananas. Just to make it clear, in this analogy, people represent different countries, the fruits their respective currency and the apple trees are the printed money.
But it’s not just because of economic theory that we know printing too much money is a bad idea, there are several examples throughout history. The most recent one is that of Zimbabwe, which in 2008 suffered extremely high inflation due to printing excess money. This was a result of some awful decisions by President Mugabe. When the economy took a turn for the worse, Mugabe printed more money to pay for government expenditure. This caused inflation to skyrocket and in mid-November 2008, Zimbabwe’s inflation peaked at 6.5 sextillion percent! To put that in perspective actually, first I need to provide some context. The inflation rate in the United States is around 1.5%. Economists generally agree that inflation levels around 1-3% are optimum. First world countries’ inflation rates range from 0 to 5%. A country is said to have entered hyperinflation when its inflation level exceeds 50%. So, with this in mind, Zimbabwe’s inflation at its peak got so bad that prices doubled every 24 hours. 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 revaluing the Zimbabwean dollar 3 times, going through 4 different currencies with 4 different ISO codes. Before the final re-denomination, they were printing 100 trillion ZWR 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 till this day they still have no national currency, their people use currencies such as the US Dollar, the Pound sterling, or the Euro. Before the hyperinflation, the first Zimbabwean dollar was worth about $1.25. If the 100 trillion-dollar bill was worth that exchange rate, that single bill would be worth more money than there is in the entire world! 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 mid-November as of 2008, their overall highest monthly inflation was 79.6 billion percent which means prices doubled every 24.7 hours. Whereas Hungary’s highest monthly inflation took place in July 1946 which was 41.9 quadrillion percent with prices doubling every 15 hours. To put that in perspective, a country with a healthy inflation rate of around 3%, prices double every 23 years. In 1941, the exchange rate was about 5 Pengo to $1. In 1946, when the currency was discontinued, things had gotten so out of hand, that if you took every single banknote in the entire country, they would have a total value of one-tenth of a US Penny. Hungary then switched to the Fornit, where 1 Forint equaled 400 octillion Pengos. That number has 29 zeros!!! So, that’s why the government can’t just print money to pay off their debts, it does not end well. I’ll leave you with this final thought and what I think is possibly the best way to sum up why governments can’t just print unlimited amounts of money is “If money grew on trees, wouldn’t it be as valuable as leaves?”
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