Hello Ppl, I have a question related to economics. Is there any basis on which government of a country would decide to print its currency. Here are few scenarios i am looking an answer for 1) If a country was hit with a natural disaster, many other countries would offer unrequited aid as a relief, what difference will it make if you mint the required money rather than accepting the relief. Would it make the economic system unstable if you mint? 2) What incentive does a country have if it loans from a world bank or any other country rather than printing the money which is required for its spending? Thanks
Dax21b, You raise an interesting question, does accepting economic relief in the form of currency make a country better off? The short answer is no, and it doesn’t matter whether the money is minted in the country or given by another country. The reason is that money is only worth what goods and services it can be exchanged for. It has no intrinsic value. In the case you mentioned, the country is devastated by a natural disaster, where are the construction companies that you would hire to rebuild? where are the markets where you buy groceries? where is the infrastructure? the cars? the gas station? law enforcement to enforce property rights? any semblance of organization? You see, in such a state money isn’t worth the paper its printed on because there is 1) No one ready, willing, and able to exchange it. 2) No system in place to protect the rights of property holders. Thats why organizations like the world bank have been so ineffective at alleviating poverty in its 50+ years of existence. Most of the time a corrupt politician will take the aid and put it in offshore accounts to enrich himself. If you really want to help a country devastated by a natural disaster, donate food, water, clothing, construction equipment, farm equipment, building materials, technology etc. Thats the ‘real stuff’ that makes life good.
FinanceMBA2011 Wrote: ------------------------------------------------------- > Dax21b, > > You raise an interesting question, does accepting > economic relief in the form of currency make a > country better off? > > The short answer is no, and it doesn’t matter > whether the money is minted in the country or > given by another country. Completely disagree with this. Giving somebody money, while not creating new wealth, does in fact make the recipient better off (provided you are not giving them a worthless currency of course). There is a huge difference between printing new money and accepting donations as relief. In the first case no new wealth is created, you are simply adding more pieces of paper to the economy. Accepting donations, while not creating new wealth, does in fact transfer wealth to the country in need. With that new wealth (cash!) the country can pay construction workers build, plant food, provide medical care, etc. FinanceMBA, you do make a valid point about the failures of the World Bank just giving money to corrupt politicians, however, that does not negate the value of the money given. As you note, the corrupt politicians take that money and by their 7th Mercedes or whatever, which they couldn’t do if it had no value. Your critique is with the distribution method, not the value of the money. As Milton Friedman loved to remind us, “inflation is always and everywhere a monetary phenomenon” so printing money devalues currency, which is why sovereign debt with payments denominated in local currency is worth less than those in USD. So, to answer your second question, simply printing money causes inflation and can devastate an economy. Borrowing money, in and of itself, has no such effect.
Chi Paul, Let me ask you this, in a developing third world nation that lacks the human capital (no universities/training centers), physical capital (buildings, equipment, hi-tech goods i.e. computers), effective governance and a strong stable currency to sustain a market economy, how is currency going to help it? In theory, said developing country could purchase American goods with American $ and make itself better off. In practice, this isn’t done. The money goes into the national bank reserves and is exchanged for currency X. What can currency X be exchanged for in country X? If the country lacks the aforementioned qualities, the currency will not buy much. I repeat, money is only worth what goods and services it can be exchanged for. The whole point of the world bank bringing a country out of poverty is to get the country to develop to the point where it can sustain its own development. Money will not do the trick. And borrowing money does increase inflation. In order to meet the exchange of the gift or borrowing, country X either will have to print currency or reach into its own reserves. In answer to your 2nd question Dax, it makes no difference whether they borrow or print money.
Well, if you make the assumption of a developing 3rd world country with no human capital, physical capital, government or property rights - essentially nothing but poor uneducated people, then yes, throwing money at that country would probably not help it all that much, especially in the short term. But I don’t see where Dax made that assumption in his question. FinanceMBA2011 Wrote: > And borrowing money does increase inflation. In > order to meet the exchange of the gift or > borrowing, country X either will have to print > currency or reach into its own reserves. In answer > to your 2nd question Dax, it makes no difference > whether they borrow or print money. Borrowing money, in and of itself, does not neccessarily increase inflation. If you resort to printing money to pay it back, then yes, you’ll have inflation. But lets assume that the money borrowed is actually used in a wise investment that generates a return greater than the interest rate (which is what every company on the planet issues debt for), how does that translate to inflation? If there is truly no difference between borrowing money and printing money, then why on earth would any country ever borrow for that matter?
I thought that assumption was implicit in his question. Well developed countries can lift themselves up by their bootstraps. The principal recepients of gift aid in a natural disaster situation would be third world countries. Did the rest of the world pitch in to help us during Katrina, what about 9/11, Pearl harbor? No sir. Why would a country receiving gift aid put the money to work in the stock market? That sounds like a blatantly egregious misuse of what the money was intended for. You’re better off secretly stealing the money. I think the reason countries borrow instead of print their own money is to protect their currency in the long run. By borrowing there is an implicit promise of being repaid, but because countries like companies are ‘going-concerns’, a lending country has no need to demand immediate repayment. As long as a country is growing, the debt serves like collateral that doesn’t deteriorate. I’m speaking in terms of rich countries however. Example: Rich country A lends to rich country B a$. Country B puts a$ in reserves at central bank and gives Country A the equivalent amount of b$ which it puts in its central bank. Country A continues to grow, its growth financed by Country B. As long as country A continues to grow, there is no reason for Country B to demand its currency back since a$ maintain their value. No new money in circulation, no inflation, everybody’s happy. With a poor country all the debt does is increase inflation since they aren’t growing. All they can do is print money and invest it ‘nowhere’.
Have to agree with Chi Paul here: borrowing in itself won’t increase inflation or devalue the currency, but printing money certainly will. I do agree with FinanceMBA2011 that money is only as good as what it can buy, but all your examples are pretty extreme. There really isn’t a country out there with no human capital at all, no physical capital, or no governance or legal system. If there were, they’d be a bunch of people who wake up every day, sit around all day, and then go to sleep. They’d either be taken over by another country or would die off in a few days due to no food. Even in the most third world country, there is productivity. If nothing, people will wake up and farm or hunt so they can eat (this productivity was known to cave men). Once that happens, trade is just around the corner - having a bunch of grain and no meat won’t get too far - a barter system may be put in place. Finally, given where the world is now and that fact that all countries own printing presses, they’ll print money and use that as a medium of exchange to swap whatever they want - meat, grains, or otherwise. FinanceMBA2011 - your point is valid but the example is so theoretical it can’t be found in the real world. Given that money is then worthwhile for all countries (I don’t think anyone is still on the barter system, or trading precious metals exclusively), there is certainly a difference in borrowing vs printing. Printing increases the money supply, thus deflating the currency (in the simplest form, think of a closed economy with a fixed number of people and fixed resources - if the amount of paper doubles then the “price” of everything will double too). Since the currency is printed at will and basically has no value, it can’t be used to trade with other countries either, so the people aren’t any better off. Borrowing from another country, on the other hand, doesn’t increase the money supply and so in itself doesn’t cause inflation. Some of the borrowed currency will likely be used to buy goods and service from other countries (if a poor nation borrowed dollars, they’ll likely use some of those dollars to buy foreign goods), which will benefit the population. You are indeed correct that a country will only lend to another if there’s reasonable chance of a return. So, a country with no growth and productivity is unlikely to get a loan since they have no way of paying it off. Finally, in the case of the original question, when a natural disaster strikes. There is likely to be more gifting of money than lending - larger countries are likely to donate money without the expectation of repayment, which is always better than printing your own currency. So, I think that you almost never want to print cash as an alternative to borrowing or a national disaster. That would devalue your currency locally and internationally resulting in your inability to trade with other countries.
I don’t think being a 3rd world country was implicit in original question as plenty of emerging nations do take foreign aid. Also, the US did in fact receive foreign aid after those disasters you mention (well not sure about Pearl Harbor). That aside, I am not sure where you got the idea that I said that aid should be put into the stock market…??? Back to the crux of the discussion: > With a poor country all the debt does is increase > inflation since they aren’t growing. All they can > do is print money and invest it ‘nowhere’. Right, they print money and that leads to inflation. However, I still don’t see how having debt, by itself, causes inflation, which was the original question. I’m open to being pursuaded, can you elaborate on how, ceteris paribus, a country taking a loan leads to inflation?
Thanks for the insights guys, @FinanceMBA2011: My assumption was this. When i said a country is hit by a natural disaster, i meant that its a tiny region of the country that’s effected but of a huge magnitude. It doesn’t mean that the country doesn’t have construction company, markets, infrastructure, property rights etc in the rest of the country. In such a situation what difference does it make if the country wishes to use its unrequited aid to use the services of the companies within it’s country to rebuild the devastated place or do the same by printing its own money. In both these instances the country would be using its home currency as it has to buy its home currency by converting the financial aid, which in turn leads to increase in supply of money and inflation…
Receiving foreign aid is probably inflationary at the margin up to a point, but it’s not going to lead to hyperinflation like printing money is. Google the word seigniorage and you should be able to find out more on this. I remember having to study this in college. Some economists developed scenarios whereby 3rd world countries could benefit from printing money to pay off their foreign debt under certain circumstances. The details are a hazy blur at this stage unfortunately. Aside from that one special case, seigniorage was not well liked amongst economists from what I can remember.
Dax, >In both these instances the country would be using its home currency as it has to buy >its home currency by converting the financial aid Agreed. >which in turn leads to increase in supply of money and inflation… Disagree. Lets say your hypothetical country receives $1 million USD. They need to convert it to the local currency, so they go to the forex market and make the exchange. There is no increase in money supply here, they simply purchase existing Local with USD. If you want to read more on this, check out Milton Friedman. Probably his greatest contribution to economics (and he had a lot of great contributions!) was his research and insight on inflation and its causes.
Maybe my example was extreme and perhaps i didn’t understand some of Dax’s assumptions. I thought we were talking about a country so devastated by natural disaster there was nothing left. But I do think borrowing money will lead to inflation in developing countries. Here is the reason; Borrowed money to developing nations has the objective of increasing the money supply. The central bank borrows the money and exchanges it for its own. This money is lent out at low interest rates but with few investment opportunities inflation increases. Borrowed money to developed nations is different since the money is used to finance profitable investments. Real interest rate increases more than inflation and currency maintains its value or even appreciates.