Currency is after all a piece of paper, which is why, during times of crisis, ordinary citizens have wondered why the government cannot simply print its way out of money troubles.
Economists, however, have time and again cautioned against the impulse to create more money. If the government creates too much money, people would end up with more money in their hands. Consumers would demand more and supply in the short run would fail to meet the sudden rise in demand. High demand pushes prices up, which in the worst-case scenario can lead to hyperinflation.
For instance, in 2008, inflation rose to 231,000,000% in a single year in Zimbabwe, because of the government's mistreatment of the currency as its piggy bank. A sweet which previously cost only one Zimbabwean dollar cost 231 million Zimbabwean dollars a year later.
Keep updated, follow The Business Standard's Google news channelSuch rules, however, do not appear to apply to everyone.
The US Federal Reserve released approximately $3 trillion during the pandemic. Over a span of three and a half months (from March 2020 to June 2020), the Fed expanded its balance sheet from $4.16 trillion to $7.17 trillion, which further expanded to around $9 trillion in April 2022 on account of Biden's 'Inflation Reduction Act'. In short, the United States was providing Covid-19 stimulus by printing money.
While many economists blame the government's Covid relief package for the currently ensuing inflation, it is not remotely as severe as those experienced in Zimbabwe. On top of that, anti-war intellectuals have often accused the Fed of funding US misadventures in the Middle East and beyond through the printing of money.
On a similar note, governments usually remain wary of their public debt rising too much and economists have long warned that under no circ*mstances should the debt-to-GDP ratio be allowed to rise beyond the 100% mark.
However, the US debt-to-GDP ratio currently (2021) stands at 124.9% and unsurprisingly, the US economy has shown no signs of implosion, whereas Bangladesh, despite having a debt-GDP ratio of 20.8%, is constantly worried about a Sri Lanka-like catastrophe.
The question then arises, how can the US keep printing money while developing nations get clobbered by inflation for doing the same? How can the US keep raising the debt ceiling but not us?
The answer, evidently, has to do with the somewhat unipolar US hegemony over the global economic and political system and more specifically, the dollar's role as the global currency.
A global US hegemony
As of 2021, approximately 60% of global trade was denominated in dollars. That is, the global demand for the dollar is sufficiently large to absorb a short-run excess supply of the US dollar.
As Dr Ahsan H Mansur, Executive Director of the Policy Research Institute said, "The US dollar is the global currency. Most of the trade around the world is denominated in the US dollar and central banks around the world keep it in their foreign reserves. Hence, they can get away with an excess supply of money."
However, it's also important to consider how the US and its allies came to adopt such a hegemonic position in the first place, and why it is so difficult for developing nations to aspire to reach that level.
In the post WWII landscape, the United States began to rise as an economic powerhouse, as Europe and the rest of the world was reeling from the aftermath of the devastating war.
Owing to its economic and geopolitical significance, the US got to play crucial roles in setting up the Bretton-Woods Institutions like the World Bank, the International Monetary Fund (IMF), and Generalised Agreement on Trade and Tariff or GATT (the predecessor of the World Trade Organisation, WTO).
Given the US dominance in global trade, it would soon trump pound-sterling as the global currency. The process would be further exacerbated by the World Bank and the IMF, which provided development assistance, and more importantly, loans to developing countries denominated in the US dollar.
Around the same time, the GATT was founded and its spiritual successor in the WTO would also continue to do the US' bidding, often coercing members to open up their services sector (example: Nepal), lowering tariff barriers erected to protect domestic industries, while allowing developed countries to maintain large aggregate measure of support (AMS) in agriculture.
Through the Marshall plan, the US also got to reconstruct the economic systems of Germany and Japan, two of the largest economies that to this day remain close allies of the United States. So, it was no surprise that most of the global economy would become over-reliant on the US dollar, giving the US and by extension its Federal Reserve a free pass to behave a bit more recklessly with its currency.
The developing and least developed countries neither have the influence nor the demand for their currencies in the international market, barring a few exceptions like China, Russia, India etc. Even then, most of them occupy such a minute portion of the global reserve, they cannot afford to print money or borrow as they please.
Dr Selim Raihan, Executive Director of the South Asian Network on Economic Modelling (SANEM) agreed.
"The global economy is highly unequal with the US holding disproportionately more influence over global trade and multilateral institutions. Even most of the global debt is denominated in US dollars," said Dr Raihan.
"Starting from such an unequal position, it is difficult for developing and least developed countries to generate enough demand for their currency in the global market to cushion their domestic economies from inflationary pressure," he added.
That is, as long as the US dollar remains the global currency, i.e., global trade, debt and official development assistance remains denominated in the US dollar, the US Federal Reserve should be able to get away with increasing the money supply in times of crisis, given the increase remains within a certain confidence interval.
The curious case of European Union
The European Union (EU), despite boasting the second-most dominant global currency in the Euro, cannot be similarly flexible in money supply given its multilateral nature.
As Dr Raihan said, "Everyone expected the Euro to compete with the dollar as a global reserve currency. However, given the variety in governance structure, economic strength and the over-reliance on Germany's economic might, Euro is not very attractive as a reserve currency."
The Euro is odd in other ways as well. In the twelve months since March 2015, the European Central Bank printed 60 billion euros per month, totalling over 700 billion, as part of its Quantitative Easing programme. The EU was only able to do this because of years of stagnation and low inflation.
But even then it failed spectacularly. Not only did it not raise aggregate demand, the inflation actually decreased by 0.1% as the banks never lent the printed money, nor did the entrepreneurs of small and medium enterprises try to take out loans. Consequently, the hundreds of billions of euros pumped into the European economies remained stashed in the banks.
This particular precedent contradicts the long-held notion that printing money inevitably leads to inflation. Instead, it seems that the rate of inflation only rises if the money supply actually contributes to a spike in aggregate demand.
Can the US keep printing money forever?
Obviously not.
First, regardless of how much economic might the US possesses, it cannot infinitely produce dollars to fund the whims of its leaders as too much reckless monetary policy can indeed have catastrophic economic repercussions.
More importantly, developing countries like China, Russia and India are already looking for viable alternatives to the US dollar given their recent experience during the Russian invasion of Ukraine.
For instance, central banks around the world have been on a gold-buying frenzy, which led to the purchase of around 399.3 tonnes of gold from July to September 2022, an increase of more than 400% compared to last year.
China had caught wind of the risks of holding US treasury bills long before the war, as US treasury bills held by Chinese investors rose by only 0.22% in 2020 while the East Asian superpower's reserve grew by 3.45%.
Dr Ahsan Mansur believes that it was the diversification attempts of the rest of the world which actually led to inflation in the United States as the global market did not sufficiently absorb the US dollar.
And as more economies diversify their reserve portfolio with renminbi, euro, ruble, pound and
other majorly traded currencies, the Fed, in the future might have to be a bit more careful with its monetary policies.
