Can’t we just print more money? Part 1.

Sometimes when in a discussion about politics or economics, someone will ask “But why don’t we just print more money?”.

Most people instinctively know that doing this won’t work, basically because if it could…wouldn’t people just do it? However, many people don’t understand WHY it wouldn’t/can’t work.

To fully understand WHY simply printing money wouldn’t work, we must first understand what money actually is.

This is another concept that seems obvious, but most people don’t truly understand the fundamental basis of currency. We use it every day, but don’t think about what it is, how it derives value etc.

Money as we know it today, has no intrinsic value. This means that the currency itself does not actually have value in of itself. This is obvious when one thinks about it. The paper and bits of shiny metal that you hand over to a cashier are just that….bits of paper and shiny (cheap) metal.

The value of money comes from your BELIEF in its value. A piece of paper with a certain water mark, the Queens face and a number “20” on it has 20 pounds of value. The whole system exists because we choose to believe it exists. This is referred to as the “Tinkerbell effect“.

Money was not always so.

Originally, we had what is referred to as “Commodity money”. This was when we exchanged certain commodities as a form of currency. Some cultures used salt, some used seashells. Historically gold and silver have been used as a means of currency as well.

We then evolved to “Representative money”. Since carrying around all your gold (for example) is cumbersome, people created a system whereby you would hand over your gold to a bank, who would record the amount and keep it safe for you. They would then hand you a certificate stating how much gold you had, and these certificates could be broken down into smaller amounts. This was the beginning of paper money.

This is the origin of “pounds” a term still used today in many nations such as the UK. The “pound” referred to a pound of gold.

Theoretically you could retrieve the gold at any time with your certificate, but this was unnecessary as the paper notes were deemed sufficient within the economy.

While the currency you were exchanging was simply paper notes, they DID have intrinsic value as they were backed up by a physical commodity.

When the entire financial system was backed by gold, this was referred to as “The Gold standard”. All the money printed within the economy had to be backed by the actual commodity. Since, historically, the price of gold has remained largely stable, there wouldn’t be massive fluctuations in the price of the currency.

It was also a useful way of calculating international exchange rates. If gold cost X in America and Y in France, then the Dollar/Franc exchange rate was X divided by Y.

The next stage in the money evolutionary scale is what most countries have today. This is “Fiat money”.

The Gold Standard was abolished largely due to the fact that it tied governments hands on monetary policy. In a recession, governments and central banks often like to keep interest rates low to incentivise borrowing and disincentivise saving, which means more is spent in the economy, thereby stimulating it.

In a Gold Standard type economy, interest rates tended to be kept high to incentivise people keeping their gold in their bank and not cashing in their deposits which would, of course, deplete the gold supply.

Fiat money is not backed by any currency. It is only backed by belief in the economy and the government. If your country’s economy is strong, its government stable, and its monetary policy sound, people from around the world will seek to purchase your currency as it is seen as a safe haven, and even as a sound investment if the buyer believes the price will increase in the future. When people do this, it drives the price of the currency up, and obviously in the reverse, it drives the price down as people lose faith in it.

With all that in mind, the next part will deal with WHY printing out more money not only won’t fix an economic problem, it can make economic problems much…MUCH worse.