The counterintuitive reason why the American government is incapable of having hyperinflation, unlike Zimbabwe or Venezuela

My last post about hyperinflation generated a ton of interest, so I decided to write this as a follow-up. It concerns reasons *why* most developed countries cannot have hyperinflation no matter how much the government spends. This will concern central banks and monetary policy, which is a subject not everyone will be familiar with. I will be describing the situation in the United States, but all other developed countries have similar systems. I will try to describe this system which is complex and counterintuitive, but also describe why this system has resulted in a situation where the US central bank now has to fund hyper-spending by the government, and what this means for the economy. **What is money?** Money is whatever is used as a socially accepted medium of exchange in an economy. For example, in the US people accept US dollars because they are legally obligated to. I’m sure everyone has heard the phrase “fiat currency” - fiat meaning that the US has decreed US dollars to be legal tender, and everyone in the US accepts them out of habit/societal contract. **How is money created in the US?** In the US, the money supply system works as follows: the government spends or lends money into the economy, but the money supply also shrinks as the government taxes/tariffs the economy. Money is also destroyed when the government borbes (sells) bonds. In the US, the central bank is the Federal Reserve (the “Fed”). The Fed is not technically part of the government, but is rather a collection of 12 banks. It is called the “banker’s bank,” because it loans money to commercial banks, and the commercial banks then lend to the consumer. The Fed is a central authority that makes sure commercial banks don’t run out of money and go bankrupt. It does this by regulating a system called fractional reserve banking. *Fractional reserve banking* Fractional reserve banking is a system where commercial banks are only required to keep a fraction of money that is deposited into them. It works as follows: let’s say you deposit $100 into a commercial bank. The commercial bank can only hold 10% of that money and count it towards its reserve. This is called a reserve requirement. In other words, commercial banks are only allowed to hold a fraction of the money that is deposited into them. The commercial bank then loans out 90% of the money and counts it as an asset. You still technically have $100 in your account, but the bank has also loaned out your money to someone else. The money is now effectively doubled. You both have $100. The commercial bank only needs to worry about keeping enough cash on hand in case you withdraw your money. This is where the Fed comes in. If you withdraw your money and the bank doesn’t have enough cash, it borrows from the Fed. In this way, the Fed regulates the money supply in the US. Every dollar that is deposited into a commercial bank is effectively doubled. However, the Fed has ways of taking money out of circulation to prevent inflation. While it can require commercial banks to keep a certain percentage of money in reserve, that percentage can also be changed. Traditionally, the Fed did not create money in the same way as the government. Instead, it created credit. The main way it did this was by buying and selling government bonds. For example, when the Fed buys bonds, it gives money to the bond seller, increasing the money supply. When it sells bonds, it takes money out of the economy, decreasing the money supply. It also has the power to set interest rates. By lowering interest rates, it makes borrowing money easier, which increases the money supply. By raising interest rates, it decreases borrowing, which decreases the money supply. Creating credit and printing money are two different things, but both increase the money supply. Printing money (like Venezuela) decreases the value of money, which is called inflation. The US Fed traditionally only created credit by setting interest rates/buying bonds, and this is why it has historically not printed money or created inflation. Recently, however, the US has had a crisis that has caused the Fed to begin printing money, which I will explain. **How does the government fund its spending?** The US government funds its spending by printing/creating money electronically, selling bonds, and taxing/tariffing. In the US, the government has the power to create money electronically, which is what it does when it spends. So the government naturally has the power to print money, which is what it does when it spends. However, the US government also taxes/tariffs, which takes money out of the economy. So the money supply also naturally shrinks when the government takes money out of the economy. Because the government controls the money supply, it has traditionally been the entity that creates money (not the Fed). This, combined with the system of fractional reserve banking, is how money is naturally created and destroyed in the US. **How does the system of government spending and bond issuing work?** Even though the US government has the power to create money, the government is legally required to issue bonds to pay for some of its spending. In other words, the government prints money to fund its spending, but it borrows some of that money it printed back from itself by issuing bonds, and then spends it again. In general, the government does not have the legal power to run a budget deficit, or spend more than it takes in through taxes. This is why it has to borrow the money it prints back from itself. You might be wondering what the point of this is. Traditionally, the point of issuing bonds was to prevent the government from printing too much money and causing inflation. Traditionally, it was up to the Fed to control the money supply by buying/selling bonds, and to use monetary policy (regulating interest rates/required reserves) to prevent inflation. In other words, in times of economic stress, the government could print money to stimulate the economy, but the Fed would then remove some of that money from the economy by selling bonds. When the Fed sells bonds, it takes money out of the economy, removing the inflationary stimulation. When the Fed buys bonds, it increases the money supply, which stimulates the economy. In this way, the Fed has traditionally controlled the money supply. The government can increase the money supply by printing money, but the money supply also shrinks when the government taxes or borrows. The Fed has traditionally made up for these imbalances by creating credit, buying/selling bonds, and regulating monetary policy. **How does this system prevent hyperinflation?** There are several reasons why the US is not Zimbabwe, and one of the main reasons is that the central bank has traditionally controlled the money supply, not the government. Because the government is required to issue bonds, the US automatically has built-in checks that prevent the government from printing unlimited amounts of money. The Fed then removes some of the printed money from the economy by selling bonds, which regulates the money supply. So why don’t other countries do this? The US dollar is considered a stable currency, which is why the rest of the world accepts it as a global reserve currency. This is a privilege the US has abused. In other words, the US is effectively able to borrow money from other countries by issuing debt denominated in dollars (which it prints). Most other countries do not have currencies that are considered stable, and so they cannot abuse this privilege. In other words, most countries cannot issue debt in their own currency because other countries will not accept it. This is why most countries have to borrow money in other currencies, and this is what gets them into trouble. Because their currencies are not considered stable, they cannot print their way out of debt. They have to pay their debts back in another currency, and if they cannot afford it, they have to default. This is why the government/US has never defaulted on its debt, even when it has borrowed mind-boggling sums during wars. The US has traditionally had a stable currency because the US central bank has traditionally controlled the money supply, not the government. Other countries that have a central bank controlled by politicians have not been so lucky, and have had hyperinflation. **The recent crisis and how it has caused the Fed to begin printing money** In 2008, there was a crisis in the US financial system. This crisis was caused by a speculative bubble in US mortgages. The bubble popped and it destroyed trillions of dollars in assets. The crisis was so bad that 9 million people lost their houses, and the entire US economy was on the verge of collapse. The US government then bailed out the financial system by passing trillions of dollars in stimulus. However, because the crisis was so bad, the US government/central bank decided to give the economy an extra kick-start by doing something called quantitative easing (QE) at the same time. Quantitative easing/monetary policy Quantitative easing is when the Fed prints money electronically and buys financial assets (like bonds) with that money. In other words, the US government spends money into the economy, and then the Fed prints more money electronically and buys financial assets, giving the economy a double stimulus. Who do you think the Fed buys these financial assets from? That’s right, it’s the rich people who own them. So QE is just how the US central bank prints money and gives it to the wealthy. To control inflation, the Fed traditionally buys/sells government bonds. So the Fed buys bonds from wealthy investors, which gives the investors money. The difference is that QE is buying assets other than government bonds. But the principle is the same - the Fed prints money electronically and gives it to wealthy investors, who are supposed to then invest that money into the economy. Except they don’t. They usually just speculate with the money or keep it in the bank. And this is why quantitative easing doesn

The counterintuitive reason why the American government is incapable of having hyperinflation, unlike Zimbabwe or Venezuela

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