Government borrowing / printing money - Please explain - for dummies 101

I'm curious about what happens with all the money that the governments are spending at the moment and was wondering if someone can explain .

So every government's spending money . When does it come from ?

I'm assuming they're not borrowing it ( or are they ) , but essentially printing it . Is this effectively quantitative easing . I've heard the term but never bothered trying to understand what is actually happening .

I'm not sure how much the Oz government has " spent yet " but assume it's over 200 Billion . I've heard a number of 50 % of GNP banded around as a likely total spend .

So , if they're not borrowing it , but printing it , what happens if all the governments decide , " hey guys , lets just wipe it off and pretend it doesn't exist " It's a different matter if it's only italy and greece who've stuffed . The others can't let them " get away with it " , but if everyone's in the same boat , why can't they just agree to wipe it off and start with a fresh slate .

As I said , for dummies

Cliff

 

There are two ways to finance government spending. Borrow it (issue bonds). That means someone has to buy these bonds. Doesnt have to be domestic buyers. This is creating assets and selling them for money.

or print money directly. This is QE. Basically the government can create money. If it controls its own currency (and greece, italy and ireland did not) then there is no limit. However too much money printing usually lowers the currency and increases inflation. Except when it doesnt.

Its unlikely that A owes B and B owes A and they can forgive each others debt. The lender nations dont have incentive to forgive debt.

if you are saying why dont governments just ‘cancel’ this created money, there is no point. Because you are forgiving debt to yourself that doesnt need to be repaid anyway. It doesnt change anything.

 

Think about this scenario.

the government prints a $100 note. Throws it onto the street. Someone picks it up, spends it, etc. its real money.

thats QE.

 

Government spending is funded through the issuing of government bonds. They can either be purchased on the open market or from money "created" by the RBA.

The RBA can also create money to buy private debt, eg corporate bonds or mortgage backed securities from the banks. From what I understand, and I may be wrong, is that it is as simple as the RBA typing in the dollar amount they need into their ledger.

 

Ok , so do we know if the Government is issuing bonds , or printing money or both ?

Cliff

 

it probably wont be this particular government spend is to be funded specifically by qe.

More likely that the government will issue bonds, but if the bonds are purchased by the rba, that becomes qe.

the question is, whats the difference? You could say that qe is safer than government bonds, especially if they are purchased by foreign entities or governments.

Obviously the risk with qe is that its too easy to use and printing money leads to a devalued currency. However recent (this generation) qe by the US and Japan suggest that qe doesnt automatically mean hyperinflation.

 

Seechange, what you are getting at is what does it mean to fund massive stimulus with printed money

no one knows. Textbook answer is inflation. But it seems when used in a recession environment it doesnt cause inflation. As the economy recovers the money probably pushes the price of shares and property up. Inflation of goods and services has been held down by cheap manufacturing.

throw in the cratering oil price, and inflation seems unlikely in the short term.

so it may be that the government can put massive stimulus in with no negative consequences in the short term.

so why doesnt every government just do massive qe all the time? Independent central banks, and some government restraint amongst the large countries.

not that countries need qe to get into financial trouble. Cue ireland italy greece.

 

Sorry this begun lamens term, then blew out into a full blown explanation!***

The federal government is borrowing money to fund these expenditures. It's on the national credit card (at a very very very low interest rate).

They will need to issue primary government bonds to actually raise this money (how do they get a credit card? they issue bonds). Financial markets will purchase these bonds issued by Australian authorities (AOFM). This then gives the government money to spend. This is debt funded expenditure.

Taxpayers will eventually pay for this via higher taxes, lower spending (or a devaluation process, but unlikely).

The above is Fiscal Policy at work.

Quantitative easing (QE), is an entirely separate policy and largely independent to the above. QE is a monetary response that is about credit supply.

Unpacking QE in Australia (I've highlighted in bold where the money is moving):

The RBA, is effectively 'making money out of thin air ('printing')' to purchase government bonds from the secondary market. They aren't dropping the money they're making into the street for the average Joe to spend. This begs the questions, where exactly does the money that the RBA are creating go?

• The RBA is using the money that they've created to buy government bonds from the secondary market. That is, they are buying up bonds from existing owners of Australian government bonds. The bonds being purchased go onto the RBA's balance sheet (temporarily hopefully). These bonds are real assets. The RBA have transferred the money they created out of thin air to something real, 'government bonds'.
• Financial market participants are the owners of these secondary government bonds (banks, institutional funds, super funds, etc).
• Therefore, the made up money is actually going into the hands of the owners of these secondary bonds. This means, that existing owners of government bonds are selling their asset to the RBA, in return for cash (the money that's been created!).
• I.e. it is being pumped into the financial market.
• This means there's a lot more money floating around the financial market now, as the existing owners now hold onto this money.

The impact of this is:

• Given the RBA have chosen medium term government bonds to purchase, they have added a LOT of demand for this product.
• This drives the price of the bond up (more demand, price rises!). Given the price of the bond has increased, the yield of the bond has fallen.
• This 'yield' is the 'interest rate' on the governments debt (back to that credit card up top!). That is, the governments interest rate on its debts has come drastically down. This makes the ongoing cost of the governments debt lower.
• This has further consequences to wider interest rate settings too. The government yield curve impacts all sorts of interest rates in the market, mortgage, consumer and business lending rates too.
• Therefore, interest rates across the economy are coming down (particularly interest rates that are tied to longer time periods of the yield curve).
• Owners of these bonds have just made a lot of money. The biggest baddest buyer in the country has walked in and demanded that they buy it, the price of their asset has risen.

Eventually, the RBA will seek to take these bonds of their balance sheet, and 'sell them' back into the market. This will take 'money' out of the financial markets, and increase the cost of borrowing. This is similar to increasing interest rates.

 

Would this mean in a years time we will have hyper inflation?

What is the difference between what we are doing and what Zimbabwe did?

 

This is where the laypersons explanation is impossible. Laypeople are too A will result in B. The system is too complicated.

Its possible we might have hyperinflation, but recent QE done by US, Japan etc have not resulted in hyperinflation of day to day goods. But you could view the increase in property and share prices as a form of inflation.

Weak economies and low oil prices lowers inflation as well. Giving someone who has lost a lot of blood a blood transfusion doesnt always result in high blood pressure.

In nature there is no difference between what we are doing and what Zimbabwe did. Though think of it has giving a patient a controlled, limited dose (with careful observation) of narcotics to ease pain, with a plan on withdrawing it later, compared to just abusing it continuously for the high. Can one take narcotics carefully?

Also note that the hyperinflation cases (Zimbabwe, Venezuela, etc) tend to have a political aspect. Governments do it to keep themselves in power and have little accountability.

 

Thanks it makes sense. Maybe will get some inflation due to a lower dollar from printing but will be offset from less spending and lower income. I'm thinking the government will love inflation to wipe away some of their debt.

 

Maybe. But lower oil offsets the lower dollar for example.

Higher inflation will result in higher interest rates by the independent RBA, which angers borrowers. The government really doesnt care how much debt it has IF it can QE without other consequences. But thats really playing with a 'safe' level of narcotics.

 

I dont believe that Aust prints that much $$$( i reckon 700B or more) into the economy and China or Korea or USA continue to sell their goods at a same price as at before look at toll costs, health, car & home insurance for example, it's not getting cheaper even at this difficult period

If you have seen price on goods now have been dropping substantially that's because it was over-priced in the first place

So the more $$$ pump in from stimulus/printing/borrowing then not quite a good thing for the average or vulnerable people with limited income. On the other hand the $$$ pumping in to invest and create new and future jobs for the people is a different beast

Ask yourself the question why the Govt double the Newstart Allowance while for years they did not bother to do so with any little extra like $50pw?

 

As described above there is always a political aspect of it as well. Politicians do not take economical decisions all the time (well mostly)

 

Because if they dont the huge rise in unemployment will make the recession worse. Its a political calculation but also a practical one. Theyre not doing it out of the goodness of their hearts. So what?

 

The Govt already knew that current goods prices are going to be more expensive that's why they have to provide more to cover for that

They cant really control the unemployment at this time can they?

 

They doubled newstart because they know all that money will end up being spent in the economy.
Same as the cash splash for pensioners.

Most of Rudd's GFC cash splash went into offset and savings accounts.

 

In the US, previous QEs were used to prop up or bail out financial markets by directing QE money
into certain financial assets purchases.

The way QE was paid back was that when economy recovered, business & investors sentiment
improved, those same bailed out assets were then sold to investors on the open markets,
never mind where their money came from. That way, Fed can slowly reduced the QE injected
liquidity from the economy and paid back the future money. It's just like a huge no limit LOC the
way I look at it.

 

What if the government said no taxes on income on the condition you spend all your income ?
It's almost the same without the middleman the govt.
If you don't spend all your money you have to throw it in the street .
Is that QE ?
Then you would not need the ATO or accountants

 

It's not Zimbabewe. But whoever said US and Japan, those are also not comparable.

US holds the reserve currency. Apart from gold, it's probably one of the best things to print because people will buy it, because in this generation I know I can use it probably anywhere. More importantly, it is backed by productivity, and the rest of the world wants to buy American productivity and therefore they need USD.

Japan is similar, because the Chinese and Americans (their primary export markets) actually want their things. What Japan, and countries like China, also do is they hold significant amounts of US dollar reserves. If you checked it up, you'll see Japan holding over 30x Australia's foreign exchange reserves, and China holding around 60 times. Even though their economies (at least in nominal terms) are not 30 or 60x Australia's respectively. Therefore the US, China and Japan are in very interesting positions - significant aggregate productivity, the US controls the reserve currency and the other 2 hold significant amounts of it.

Another way to think of it simply, if we all went to an island and formed our own country, it doesn't matter how much paper currency we print, because no one wants it, since they don't want to buy anything from us.