How might the world look like without central banks?
A Credit-Cue Presentation. Authored by: Mohit Arora and Devesh Srivastava
What is Money?
Unit of account, a medium of exchange & storage of value?
Or Unlimited fuel for asset inflation and a hidden tax?
Why is money printing done? How is money printing done?
What harm is money printing causing? How grave is money printing? and How not to make it worse?
The value of anything we create can be preserved only by linking it to something else. A few countries link their currencies to foreign assets, or other currencies (historically, gold). However, most countries simply finance their budgets through simple money printing, which gets its value from two sources:
Difference(s) between the actual cost of printing money & its accepted face value (seigniorage)
Why is money printing done?
Why simply print money…? The alternative would be for the country and its people to work hard to accumulate hard assets to issue their currency against it and also pay taxes honestly.
However, asset accumulation through hard work is naturally a long-drawn process, and asking people to pay a true level of taxes is never an easy political option.
So who manages or prints the money for a country…? Countries that link their currencies to foreign assets often had currency boards such as Singapore, Hong Kong, and Estonia… as opposed to countries that primarily finance themselves through currency printing that have a central bank.
So if currency boards earn their assets and then issue currency against it…
how do central banks make money or sustain themselves and in turn sustain the economy?
One would imagine they earn well on their reserves/capital or get new capital from governments when needed.
This would also provide cover against the volatility of the assets they carry for the country.
This may not be the case… as 15% of central banks globally are negative net-worth at any time… additionally, the bulk of central bank reserves are just accounting adjustments - which refer to the higher value of their foreign assets as calculated in domestic currency terms (revaluation reserves).
Adjusting for this most may have capital equal to only 6-7% of their assets, which is barely adequate to cover volatility, leave alone sustained earnings.
So how do central banks make money…?
Central banks have a monopoly over currency printing.
We all can relate to the revenue they create from the difference between the actual cost of printing money and its accepted face value (seigniorage).
However, their primary source of earnings is the inflation tax. This tax is often misunderstood… as it is more than a simple reduction in the value of issued money you hold.
Let’s say 1 hour of wages buys you an apple… now if the central bank doubles money printed, that decreases the value of the currency by 100% to an apple… you would pay 2x for an apple… which is equal to 2 hours of wages as opposed to the previous 1 hour.
So who eventually collected the benefit of an extra 1 hour you were forced into?
The issuer of the currency… which is the central bank or its owner the government.
This is the inflation tax that is imposed by the governments on all, with very few realizing it.
Inflation tax erodes a country's wealth over a period of time as it diminishes the value of your hard work or labor.
Capital being no more than the difference between fair wage and forced wage.
This is an easy option to tax people & a quicker way to finance the country.
Thus, this sets the foundation for why the currency is simply printed.
What made currency printing widespread?
Currency printing to grow the economy gained rapid acceptance during the World Wars due to high unemployment.
This was advocated by economists, such as Keynes, who saw the economy not recovering without government spending.
The governments of the day, especially the UK, were just recovering from the war and barely had resources. They resorted to currency printing in addition to taking out loans.
How is money printing done?
The government issues the central bank a bond/bill promising to pay later.
The central bank accepts that as a security/collateral & issues currency against this security under its power to print.
The former is the asset on the central bank's balance sheet & the latter the liability.
Once the governments spend this money it lands at commercial banks. Commercial banks further offer it as a credit to their clients.
When clients pay back it creates a deposit… which is further lent.
The bank’s borrowers themselves may be financing other clients.
Thus the central bank money is multiplied many times over.
The government services the debt to the central bank with revenue collected from taxes on commercial activities but also through the inflation tax derived from a higher share of labor.
So a common man ends up working harder (a hidden tax) & also paying direct & indirect taxes.
Additionally, commercial bank loans, mortgages, corporate bonds, and even ETFs, are now being accepted as collateral against which the central banks can issue currency.
This, along with the recent purchase of government bonds by central banks has been recently called Quantitative Easing (QE).
What harm is money printing causing?
As argued, capital is no more than the difference between fair wages due and forced wages paid. The value of this differential can only be preserved against other assets.
Since inflation becomes the earnings for the government… sustenance of this earning creates an inflation spiral where people have to work even harder and face ever diminishing purchasing power.
Eventually, goods and services that become expensive at home are cheaper to import.
The country then imports (to consume) more than it exports (to earn foreign exchange).
The country subsequently runs out of foreign exchange causing the “balance of payments” issue and needs rescue by other countries or World-Bank, leading to the sale of a country’s assets or further debt that comes with austerity.
Further, when private assets and excessive government bonds are financed by central banks… the monies often go into stocks and real estate.
Such assets increase in price. This price increase is now paid by people who do not have assets as they have to work even harder and share more of their income.
The excessive money supply also keeps the price of money (interest rates) artificially low. This erodes savings with wages falling behind the cost of living due to inflation… eventually, people are reduced to paying just bills, and worse may fall into poverty.
In Britain, trouble took the form of balance of payment, which led to the devaluation of the pound in 1967.
With an increase in inflationary pressure in the US, the gold convertibility of the US dollar was suspended in 1971.
Both countries took decades to recover and still face higher growth volatilities and homelessness.
Separately, countries such as Singapore, Hong Kong, and Estonia that based their currencies on external assets through a currency board or equivalent, did not face such challenges historically. And experienced consistent stability and poverty reduction.
How grave is money printing?
While there are legal limitations on budget deficits and indebtedness of a country,
currency printing flies under the radar… with no statutory limits in place or even under discussion.
Most economists suggest that currency printing in small measures is fine, but they never define what is not small.
Regardless of its size, the moral hazard remains.
Often QE assets are measured against the GDP which is incorrect… as that is measuring debt like obligations against estimated production, not cash flows. Ways to measure the gravity of QE may include:
Measure whether combined commercial banks equity in a country is positive after netting it off against banks assets purchased by the central bank of the country, Or
On consolidating central bank assets with the sovereign debt obligations, is the leverage lower than, say 10 times tax revenue? Or
Combine central banks’ equity or negative equity with the surplus/deficit of the country to measure if the equity gap can be recapitalized from the budget surplus of the country?
Thus the extent of QE assets is significantly higher, what might be remedial options going further?
Raising taxes further, especially on those who can pay, may not be a politically feasible option given the concentration of capital.
Markets were unsupportive in the best of the times and expected to be further unwelcoming on these assets. Printing more money to service these obligations will only add to inflation, dragging people into poverty with rising asset prices, low wages, and rising unemployment.
Over 100 million people live in poverty combined in the US, the EU, and the UK which is between 10% to 20% of their respective population.
Given the aforesaid, the options may be rather narrow and traditional:
Statutory dollar size limits on the quantum of currency printing.
Central Bank’s exact equity status and market value of QE assets.
Borrow through traditional bonds instead of print currency.
Terming out the debt obligations with creditors as opposed to paying with additional printing.
Take equity instead of giving loans to corporates and banks to retain upside for taxpayers.
Encourage investments and trade with sovereign lenders.
Savings enhancement to re-build competitiveness:
Lower taxes on energy which is a cascading tax people pay.
Reducing expenses on non-essentials such as defense and encouraging frugality.
Support the younger generation with affordable, quality education & free healthcare.
The alternative of currency printing will only push more people down the poverty line, diminishing the nations, as countries are no more than a collection of families. Wage is the elementary building block of poverty alleviation and people's savings. Debt, costs, and all obligations are eventually carried by people not by countries or corporates.
Focus on people by helping them save. Bringing the cost of living down is the best way to regain the economic-footing of the country.
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