You hear the media play on this term all the time.  ”The government is just printing money to….”  Every time Faux News, NBS, or CenileNN even mentions the word ‘economy’ they go to the tried and true b-roll of actual money being printed.  This has lead to the perception that the government literally prints money when we need it.  Let’s clear that up now.  NO, the government is not simply printing actual dollars when they need it.

It’s the government, they have to hide the practice under layers of bureaucracy and false legitimacy.  Ah dammit, see I even I did it.  Another mistake of the media is to allude to the practice as if it is against the law or some hidden back office practice that no one talks about directly to the public.  Okay, forget everything from the above and wipe your mind of every misconception you have of how the government prints money.

How The Government Prints Money
Since that title made you think about the b-roll again I have to give it a new name.  Government printing money will now be referred to as capital creation.  By now you should know the government raises money selling bonds to investors.  This is simply taking out a loan.  The government must pay that loan back.  But what if another government agency bought those bonds?  Well that doesn’t necessarily inject new capital into the economy.  But what if we put in a middle man?  That middle man might could do just that.

Let’s look at the players:
Treasury – Sells the bonds
Investor – Buys the Bonds
Federal Reserve – Buys bonds from Investor

We already know the investor’s role.  They might be a mutual fund, pension company, or someone else.  After the investor buys the bond (looking for a safe investment) the Fed will come in and buy the bond from the investor.  The investor now has some free cash to spend on a new investment.  That free cash is new cash injected into the economy.  The Fed gets the money they wanted to borrow and the Fed will collect the interest on the payments.

Wait what?  How’d that happen?

Like a magic trick you missed something there.  The transaction between the Fed and the investor is the key event.  The transaction is electronic.  So the Fed transfers in the money to the investor’s account, which means it must come from another account.  If the Fed were a normal bank that is perhaps true.  Instead the Fed just increases the numbers in the investor’s bank account.

Grab your pitchforks and colostomy bags (what just me?) let’s go take down the Fed!  Dernit, I got excited again.  Don’t get your Chinese made American Idol panties in a wad just yet.  This transaction is completely legitimate and necessary for the economy to function as it does (no recession jokes!).  The Fed is forbidden from directly buying bonds from the Treasury.  This seems like a formality, but it isn’t.  By having the investor as a middle-man the government is successfully able to directly inject capital into the economy.

And just to make sure you put that pitchfork up and pick out that wedgie I’ll tell you that just as easily as the government can “print” money it can burn it too.  It’s simply a matter of reversing the transaction.  Remember the Fed is holding the bond.  The Fed can simply sell the bond to an investor.  The investor gives the Fed the cash (in a digital transaction) and the money disappears into the æther of the Federal Reserve.  The Fed will either create capital or remove capital depending on the needs of the economy.  This gives our economy a bit more flexing room which adds stability to the system.  Imagine our economy as a balloon instead of a wooden block.

Now briefly I’ll let you know that this practice does carry risks.  By injecting too much money into the system we risk creating an environment of inflation.  With more money supply for the same demand of products and services, you could see an increase in the prices of the goods.  Too much inflation means you’ll be taking a wheelbarrow of cash to the store to buy a loaf of bread, not that that has happened before *cough*.

Finally I’ll point out that this isn’t the only way the government can “print” money.  This post is meant to introduce you to the concept so you no longer associate “printing money” with those annoying cutaways to mint factories printing actual cash.

Photo: Archie McPhee Seattle

categories: economics, government