I was reading on sovereign bonds, then I got wondering, that if the reason countries borrow is to finance projects, why can’t they just print the money and use it for what they want, and have it in an account somewhere, the amount of money they printed for the project, rather than borrowing internationally not to talk of locally.
If they just print money the exchange rates on their currency will decrease (their currency will depreciate) and it won’t be able to buy whatever it is that they need.
Well, borrowing locally versus printing money is pretty easy to explain. Increasing the money supply will create inflation, all else equal. It devalues the worth of each dollar. Take a look at Zimbabwe if you want to see a case study (or Germany post WWI).
The downside of borrowing locally is that it potentially crowds out others in the debt (or even equity) markets. Someone investing in government bonds isn’t investing in corporate bonds and therefore the cost of raising corporate debt increases. This can be a drag on an economy. Borrowing internationally can help overcome this, as you’re bringing new dollars into a country. Borrowing internationally brings with it its own set of risks and economic issues though.
Thanks a lot you two. I think I’ve gained a lot more from you two. Hey Magician, how is the write-up on Convexity coming along? Or you could just explain it to me here. Thanks for your usual assistance.