If you keep creating money out of thin air — which as per my admittedly naive understanding is equivalent to just printing money without giving back anything in return — wouldn't it ultimately lead to a collapse or a hyper inflation? Like it did in Venezuela a few years ago (???).
Why is the US seemingly immune to this kind of thing?
1) taxation destroys money.
2) new money can be absorbed by economic growth. Imagine you have $100 in an economy and 100 apples. $100 is added, so there’s $200/100 apples. Inflation might occur. But if you make 100 more apples, so there’s $200/200 apples, the ratio of money to goods didn’t change, and you wouldn’t get inflation. That’s an extremely contrived example, but it gets the point across.
Considering both of those factors, I hope it’s understandable that printing money doesn’t necessarily cause inflation.
Central banks don't fix the price of apples. They simply make it possible/easier for cultivators of apples to obtain capital to invest in more machines or developing new cultivars of apples. The alternative is that cultivators have to try to find the capital by borrowing more expensively from a fixed supply of stored wealth. From the point of view of people holding the stored wealth, the arms race for better products at lower prices becomes a zero sum game where it's a winning move not to just hold onto the cash and let other people take the risks. Unsurprisingly, this does not benefit consumers, or the productive.
A company wants some money to fund business expansion. So it borrows $1m with a promise to pay $1.06m back, which it can fund because it has customers. The bank in turn can fund this by borrowing $1m and promising to pay back $1.03m (when lending activity increases this money comes from the Fed, albeit normally indirectly via its bond market activity). It's not free money for the business: if they don't sell enough stuff they go bankrupt. It's not free money for the bank: if enough of it's customers don't pay they also get bankrupt. So the money created is based on market participants believing that the additional money will result in additional economic activity
Additionally, you've got the Fed actively intervening on a day-to-day basis to fix that base interest rate for borrowing and on a month-to-month basis to increase it if it thinks people are borrowing too much and prices are going up too fast
See https://en.wikipedia.org/wiki/List_of_countries_by_military_...
Not trying to be a low-effort reply but any Economy 101 textbook will theorize that it's impossible. Practically, the world is too dependent on the USD in one way or another. If they try to break loose, they might get confronted with those military expenditures which is a good enough incentive to keep using USD as a global reserve currency.
The difference between Venezuela and any relatively stable country (the US is one of many, some of which have tiny armies and pacifist foreign policies) isn't military spending or reserve currency status, it's that the money in the country with the stable currency is created as a debt which the borrower and bank has to be repay in future (with the central bank also intervening if it thinks too many borrowers and banks are taking on debts) whereas the money in places like Venezuela is being created to pay off debts.
And when do you expect this debt to be repaid back? If you cycle all the way back, at some point the money is created out of thin air backed by nothing but believe that the US will not default. It's not ignorance but reality that as long as you are the strongest arm in the room nobody is going to challenge you into paying back your debts. Yes, on paper it's all economically sound and "basic accounting" but the reality of the situation is that if America would not be able to defend its position as "stable country", nobody would accept their debt denoted in the currency they create themselves.
According to the terms of the loan or repo or maturity date of the bond. The money isn't "backed by nothing" it's backed by the productive capacity of an economy, and virtually all of it is created by market demand for credit, not the demand of the US government.
> It's not ignorance but reality that as long as you are the strongest arm in the room nobody is going to challenge you into paying back your debts.
It's absolutely ignorance to base your arguments about how a monetary system works on the assumption that the US is the only country in the world with a stable currency and modern central banking. The majority of the developed world is not "the strongest arm in the room" and people happily use those countries' currency and buy up their domestic-currency-denominated sovereign debt without any worries about hyperinflation or their military.
The military is of significance only to the extent that the dollar wouldn't be worth very much if the US was on the verge of being annexed by Mexico, but Venezuela has a military that prevents it from being annexed by Colombia too, and its military spending in excess of its productivity is still a cause of rather than a solution to its problems
This is not to say that hyper inflation isnt a severe risk, it is. it’s to say that the mechanisms through which it’s created or avoided are not well understood nor proven.
Unless you're talking about literal printing press operations, "the fed tries to tweak the money supply to control inflation as one of its dual mandates" seems like an absolute correct, if simple, explanation of why we don't have hyperinflation.
(I know tone is hard to convey. I am serious about learning if I have a misunderstanding)
[1] https://www.stlouisfed.org/on-the-economy/2018/july/federal-...
These are different things.
Printed money is cash (or currency) and it represents a small amount of the total money in use, just under 3% in the UK. I don't have the figure to hand for the US but it's comparable, less than an order of magnitude difference. Printing money isn't a significant driver of the size of the monetary base, currency is (more or less) printed to replace the notes & coins that are guessed to have been lost or damaged. Talk about printing money, especially as a means to expand the monetary base, is usually misguided.
The monetary base consists of currency in circulation + reserve balances.
Reserve balances in the US, since March 2020 (Fed reserve requirements changed to 0%), refers only to the balance recorded in the account at the central bank for a given commerical bank (or other approved user of reserves). Reserves are money but they're a special kind of money that can't be spent in the economy. They're only usable by the central bank and institutions who are licenced to hold reserves at the central bank (predominantly commercial banks). They're not phyiscal (reserves used to include actual cash in the vault back when there were reserve requirements). Reserves, like most money today, just exist as rows in a DB on a computer.
There's an unlimited supply of reserves available to commercial banks (via the discount window), they are created on demand as needed from nothing by the central bank and charged at the discount rate in unlimited supply. A commercial bank today cannot run out of reserves.
>> the fed tries to tweak the money supply
The fed doesn't control much of the money supply, most of our money is created as commercial banks issue new loans. There's a common misunderstanding that commercial banks operate as intermediaries lending deposits, but they don't.
That’s like saying to the police officer: “I didn’t speed, I merely pressed on this pedal that’s connected to a rod that opened a valve providing more fuel to the engine that’s connected to the wheels”.
Customer approaches commercial bank for a loan, bank assesses credit worthiness[1] and choses to make the loan. New money was “printed” into the economy.
What levers did the fed pull?
Also what function does the fed have in the tax part the GP mentioned?
[1] the bank has other depts looking at capitalisation constraints, another dept managing day to day operations of the reserve account, perhaps another dept managing funding sources etc. but the loan making function doesn’t consult them before creating new money to make the loan
The next mechanism is setting the Fed funds rate and discount rate. That will very directly incentivize the bank to loan more or less money.
The third is the ability to buy whatever asset it deems necessary to support the economy. Quantitative easing almost directly impacts money supply.
No that doesn't exist anymore: https://www.federalreserve.gov/monetarypolicy/reservereq.htm
>> The bank isn't going to make the loan if they don't have the reserve
The bank has unlimited reserves since the central bank will issue reserves via the discount window in unlimited quantities.
Loan making is capital constrained, not reserve (or deposit!) constrained.
>> That will very directly incentivize the bank to loan more or less money
No. This is ignoring what's happened over the past 14 years.
>> Quantitative easing almost directly impacts money supply
Again - this is a statement that isn't supported by what we've seen happen since the GFC.
The Fed both controls the rate that commercial banks are charged (via the discount rate, or other rates based on it) to access the discount window and the rules for doing so. Infinite reserves[1] that charge interest when used aren't infinite. They explicitly have to be used to generate more value than the repayment with interest or the banks lose money and go broke.
If I am wrong, please explain how. But I interpreted most of your post a pedantic explanation about how their control of the money supply wasn't direct and instead through controlling other things that then controlled the money supply.
[1] Only, of course, capital requirements limit banks ability to lend.
You can’t really do that and hope to have a handle on how money works. If you don’t have a grasp on the meaning of reserves, you’re sunk.
What are reserves, how are they created, how are they destroyed and why are they exchanged between banks? If you can answer these then you’re a solid third of the way to fully understanding this space.
You’ve talked about controlling the monetary base which makes me think you’ve fallen down the exogenous money hole. While you’re stuck in that alternate reality you won’t be able to accurately describe how banking works. Money, as we experience it today, is endogenous.
>> instead through controlling other things that then controlled the money supply.
They don’t control most of the money supply, commerical banks do. Capital requirements rein in commercial banks desire to “print” more money into the economy.