Money Doesn't Grow on Trees

 

My mother used to say: “Money doesn’t grow on trees.” It was a common phrase for those who grew up during the Great Depression; they understood the virtue of thrift. They knew the importance of saving and investment. But now, politicians and economists know better. They are much better educated and more sophisticated than my mother ever was. They are disciples of John Maynard Keynes.

 

In the United States, the world’s largest economy, the government revenues from taxes are 18% of GDP and their expenses are 24%. The 6% gap is made up by borrowing. The US Government debt is over US$16 trillion and growing - and that does not include the huge unfunded liability for social security. Unable and unwilling to raise taxes or reduce spending, the US Congress must now increase its level of debt. Fortunately, this is quite easy. The Federal Reserve simply prints more money. So the punters don’t get nervous, the politicians perplex them by calling it quantitative easing (QE).

 

So what is all this fuss about fiscal cliffs? Surely they can continue to print money forever. In fact it is such a good idea that it is catching on elsewhere; Japan and Great Britain are also adherents to QE.

 

Well there is a problem. As you print more money its unit value declines; that is, you have inflation. It may not be immediate but it is inevitable. The burden of inflation is not born equally. It robs the savers and benefits the borrowers. It distorts investment decisions and leads to malinvestment, making everybody poorer. The currencies of the world are all what is called “fiat money”, supported by nothing more than the reputation of the government who printed them. There was a time when they were backed by gold and before that gold was the currency of choice. The US dollar was backed by gold until 1971, when President Nixon reneged.

 

Since then, the world money system has been inherently unstable and could collapse at any time. You do not need a PhD in Economics to understand that printing money cannot create wealth or repay the debts of prior profligacy. I think my mother was right and Dr Bernanke is wrong.