Fragile world (especially now)
I copy here a conversation with a friend without Economics background. Although it’s a very high-level and non-sophisticated description of the economic/financial paradigm we live in, I still think it’s pretty accurate in essence, for introducing to general public, without unnecessary complications. It shows how fragile is the world we live in today, and, moreover, how fragile are our hopes for prosperity (if we don’t understand the big picture).
D.: Ham jan, we were wondering with H., where stimulus package $2T is coming from, do you know by any chance?
Me: Hey D. jan,
Short answer: it’s a debt. They borrow it.
Long but still not very accurate answer (but hopefully comprehensive): There are usually 3 ways of “printing” money by countries: bills, bonds and special certificates/notes. This is done whether by Ministry of Finance or Central Bank.
US Treasury Department (analogue of the Ministry of Finance) is the one in charge of “printing” money in US. They do it through bonds. Technically, they issue bonds (debt certificates) that others buy.
When FRS/Fed (analogue of the Central Bank in US) buys it, they “print cash” backed by bonds (it’s our retail dollars) — both paper and in digital form. However, printing leads to inflation, that’s why everyone avoids it.
Besides printing cash, another (and most common) way to print money is issuing bonds to be bought by others — other countries, funds, commercial banks etc. Other countries buy them and hold as reserve for backing their own monetary policies (eg. Central Bank of Armenia holds around $2B of reserves (most of it should be in US bonds — CBA holds them on its account at FRS). This crisis is so harsh for US that first time ever it allowed other countries to swap US bonds to cash instantly in their FRS accounts. They do it in order to bring more liquidity into US markets and not to loose the status of the “Central Banker of the world” to Chinese Yuan. And it seems they’re succeeding with this so far.
In case of $2T, I haven’t dived deeper but I assume it’s mostly bonds which US will try hard to sell to other countries first of all. This brings more liquidity into US markets…
Does it makes sense? I tried to make it very simple.
D.: thanks for the insights, overall makes sense. The only part that is not clear for me, is how swapping US bonds into cash adds liquidity in US, I thought it should lessen it since FRS somehow need to bring in cash, do they print dollars instantly?
Me: Swapping adds liquidity to US bonds. It’s a sort of “withdraw” for US. Others become more willing to buy/hold them. It’s sort of a mean for holding US hegemony over “global currency”.
D.: Another question I had which might not make sense: Can US Treasury issue bonds, if not sold, they are bought by FRS with naively printed cash?
So essentially US takes debt from future. Could this help with inflation problem in short term as long as US gov pays back the money on time in future?
Me: Good question. Actually, your thought is pretty accurate. I provided very simplified description not to overwhelm from very beginning. In reality, FRS prints “digital dollar credits”.
With this we come to the main delusion that most of the people have about the essence of today’s money. They think it’s a fairly backed asset in essence, however it’s only a tool for transactions. In its essence, today’s money is just an unending debt that backs itself by new debt… that’s one of the main reasons that we have financial crises happening regularly (and it’s norm). Over time bad assets (non-backed debts) are being collected into a group that disappears causing wave effects which harm the overall economy (and it’s norm too). Few such defaults increase the overall debt of US (as the world central banker), because it buys the debt eventually. For the household it’s uncomfortable to be in such debt cycle for dozens of years but it is totally fine for the country with N1 economy in case if its economy grows faster than the debt. The person who invented this got Nobel Prize and so far it’s the best framework for making people move. If you add to this also dominating ambitions of China, revanchist mood of Russia, desire to keep high standards of living of Europe, we will have what we have in the world now.
Here’s a great article about comparing current economic situation in US with WW2 and Civil War in US. It’s the first article from a series dedicated to understanding what’s happening now and what may follow (including another/ new world order). We live in very interesting times.
