Tuesday, March 1, 2022

Mo' Problems Mo' Money

First, my heart goes out to all the citizens of Ukraine who are experiencing this horrible tragedy. There simply is no place in the modern world for the tragic death and destruction that Putin has unleashed. I hope and pray for a peaceful resolution and an end to this senseless violence and suffering.

This whole experience had me thinking over the weekend about how inflation has been historically been high during war times. The typical narrative offered by people is that governments "inflate away" the financial debts incurred during the war.

Indeed, most people generally believe that inflation (i.e. rising prices of goods and services) is the effect of governments "printing money."

But what if this is completely backwards? What if higher costs of goods and services (in real resource terms) is actually the cause of money printing?

Money comes from two sources: the government and commercial banks. New commercial bank loans are "funded" with newly created money deposits. Banks have a special government license to create new money on its behalf. Banks are money printers.

When problems arise, that compels entrepreneurs and/or governments to solve them. Doing so requires new money creation.

Let's say a community's hospital is destroyed thanks to an unprovoked invasion by a psychopath (i.e. what is happening in Ukraine right now). That hospital was funded by either the government or a bank creating money to pay for it. The loss of the hospital represents a real economic cost, because hospital buildings generally have multi decades of useful lives, and sick and injured people can no longer be treated there. This represents a real resource deficit. In order to get back to square, in terms of real resources, either a bank or a government must create new money. This will obviously increase the "money supply," as the new money is added to the money that funded the original hospital. So, in order to deal with a real resource problem, we have to first create new money.

That's not to say that printing money in and of itself solves problems. But addressing real resource deficits requires printing new dollars. Real resource deficits represents real costs to people: the hospital that got destroyed by definition creates a deficit for healthcare facilities. This limits people's access to such services and is an increase in real resource "costs." The real resource costs requires money printing to be dealt with.

Likewise with the pandemic, which created a strain on real resources. It made life more difficult for people. The inflation we've been experiencing reflects the problem of real resource deficits. Money printing is the effect, not the cause. Recall that corporations drew down billions of dollars' worth of credit lines in March 2020 in order to preserve cash and liquidity given the uncertainty posed by the pandemic. That represents rapid money printing in a very short period in response to a real economic problem. That new money creation by itself did not cause consumer prices to go up.

And this isn't anything new. An economy can accurately be described as people using real resources to solve problems for other people and create real-world prosperity. If a town lacks a pizza restaurant, an entrepreneur may view that as a problem to be solved. While they may have some money saved to open the restaurant, they usually require a loan from a bank as well, to fund purchases of equipment and working capital to hire people and pay suppliers for ingredients. That bank loan represents new money creation.

More problems leads to more money creation.

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