Why don’t we just print more money?
My friend’s daughter, Jen, is in junior high. She accompanied her dad, my friend Jimbob, one day when he dropped by to lend Narik a book. You remember Narik, my alien friend from Centurion?
Quite naturally, they started talking about the recession that was, at that time, well under way in the US.
Jimbob, like most people who are not trained economists, held deep opinions about the economy. These opinions, needless to say, were charmingly disconnected from reality. It seems to be a truism of human psychology, as Narik once observed, that the less a person knows, the stronger are his opinions.
(Actually, Narik once told me that most economists too held deep opinions that were disconnected from reality.)
Jen’s iPhone battery ran out of power right after they arrived – and no one had a power cord. So, she was forced to listen to the conversation. After a few minutes, she interjected:
Jen: Why don’t they just print more money? That would solve all problems, wouldn’t it?
(She rolled her eyes theatrically, as if to say, ‘Duh, these adults! Why can’t they think of the obvious solution?’)
Jimbob: That would just cause more inflation because more dollars will be chasing fewer goods.
Narik: It’s true that printing more money will cause more inflation, which is defined as more dollars competing for fewer goods. But that’s the definition of ‘inflation,’ not its explanation.
Jimbob and Jen: Huh?
Narik: Let’s say we were speaking about a war, and I told you that one side lost the war because they were outnumbered by the other side. You ask me why the losing side were outnumbered. I reply that it’s because the other side had more soldiers. Have I given you a real explanation or have I just given you the definition of ‘outnumbered?’
Jimbob: Oh, I see.
Jen: But why does printing money cause inflation? And why is it bad?
Jimbob: It’s bad because things get more and more expensive.
Jen: But why do they?
Jimbob: Eh, it’s because there’s more money chasing fewer goods and services – there are more buyers than sellers, and…uh…
Narik: There is a fundamental reason why printing more money is bad. But before you understand that, Jen, you must understand what money is. Do you know what money is?
Jen: Sure. It’s the dollar bills and coins and credit cards.
Narik: All those things represent money. They are convenient forms of money, not what money stands for.
Jen: Same diff, right?
Narik: If you got an ‘A’ grade on a test, what does the ‘A’ grade mean?
Jen: It means I worked hard, studied well, and did good on my test.
Narik: So, the ‘A’ grade is simply a shorthand way of saying all that, right?
Jen: I guess so.
Narik: Similarly, a dollar bill is a shorthand way of saying something else. What might that be?
Jen: Eh, I think it’s a way of saying ‘so much of pizza,’ ‘so much of a movie,’ ‘this many iTunes songs.’ Something like that?
Narik: Excellent. Money is a standard, store, medium, and measure of value. It represents things that you or someone else values, like pizza, movies, and songs.
Jen: That makes sense. So, why can’t the government print more money? We’d all get more things of value, right?
Narik: Excellent question. The key thing to understand in the definition of money is that it is a standard, store, medium, and measure of value; it is not a creator of value. You see, value must first be created. Then, money is used to measure that value, store it, allow people a way to talk about the valuable things they created – this is what standard means – and then allow people to exchange one value for another – this is what medium means.
Jen: I’m not sure what the diff is?
Narik: Let me give you an example. You get an ‘A’ grade only after you study well, do good on a test, and get graded, right?
Narik: What if your teacher simply handed out ‘A’ grades to you? Does that automatically make you proficient in the subject? Has the grade created the understanding?
Jen: That’d be dumb. Getting a grade won’t get knowledge into my head. I’d have to study for it.
Narik: So, you have to create something of value first, right?
Jen: Like knowledge and understanding?
Narik: You got it.
Jen: I understand that part. What does this have to do with inflation and why printing money is bad?
Narik: Good question. Let’s take this a step further. Let’s say there are two high schools in town. In your school – let’s call it School A – you only get good grades if you really earn them. In the other school – let’s call it School B – the teachers just hand out ‘A’ grades to every student without checking to see if the kids studied and know the material or not.
Jen: Gee, I’d like to be in School B!
Jen (abashed): Just kidding, not really.
Narik: Why not?
Jen: Because, because, everyone would know that the grades they give out in School B are worthless. It’d be a joke. Kids from other schools would laugh at me.
Narik (smiling): You mean, the grades from School B have no value?
Narik: Just giving out grades without the students earning them is like printing money. School B is just printing grades and handing them out. That’s why the grades from School B are worthless.
Jen: I get that. But does it matter? A grade is a grade, right?
Narik: Fortunately, or unfortunately for students in School B, that’s not so. If you were an employer, if you had a choice of hiring a kid from School A or School B, which one would you hire?
Jen: The one from School A, duh!
Narik: So, School B’s practice of ‘printing grades’ cheapened them, because they represent no value. Do you see that?
Jen: Yes, it kinda makes sense.
Narik: Money is just like those grades. You have to first create something of value. Only then will your money have any value. Money is simply a convenience, remember. Society can get along very well without money as we know it – it’ll just be harder. We’d have to barter our way through life.
Narik: Let’s say you and your friend have no money. You have two Barbie dolls and your friend has two CDs. You exchange one of your Barbie dolls for one of her CDs. Both end up getting what you each wanted without using any money. That’s barter.
Jen: We don’t play with Barbie dolls anymore and we don’t do CDs, it’s all iTunes. But I get what you mean.
Narik: You got the idea. Now do you see why printing more money is bad?
Jen (doubtfully): Let’s see. If the government prints more money just like that without checking to see if someone worked hard and actually created stuff, that money is just a bunch of paper that represents no value. It kinda cheapens the value of our dollars – I mean the dollars of those of us who worked hard to create value. Right?
Narik: I wish economists who have Nobel-prizes had your intelligence. When your dollars become cheaper, it takes more dollars to buy the same thing that you could buy last month with fewer dollars.
Jen: You lost me there. I kinda understand the part about printed money, like printed grades, having no value. How does that make the cost of things go up?
Narik: Again, an excellent question. Let’s continue with the school grades analogy. Let’s say you went to School A, where you get a high GPA of 4.0 only if you really worked your tail off. You are only one of two kids to get a perfect 4.0 GPA in your school.
Jen (sitting up straight, with a big grin): Yeah, I like that!
Narik (continuing): Let’s say you want to get a part-time job at a fancy clothing store. When you get to the store for an interview, you see ten other kids there, all waiting to get that same job. Guess what? They are all from School B. They all have a perfect 4.0 GPA. You know that their GPAs are junk. But perhaps the store manager doesn’t know the reputation of your two schools yet. What do you do?
Jen: Gee, I don’t know. It’s kinda tough to convince the manager that I am the best and that the other kids are just losers.
Narik: So, the job you want – something of value – just became harder for you to get because you have to do something extra to convince the store manager that you are indeed the best. Just showing the manager your report card won’t do the trick, right? In other words, it just became more costly for you, in terms of time and effort, to ‘buy’ your job.
Jen: Wow, that makes perfect sense. All those cheap, junk GPAs are driving out my good GPA.
Narik: Bingo – you got it! That’s why junk GPAs make it harder for those who have real honest GPAs. They make it harder for the store managers and employers because they have to work harder to find out who has the real GPA. They also, ironically, make it harder for the kids from School B because those kids don’t learn how to create value; even though they breezed through high school by taking it easy, they’ll suffer in the future when employers, college enrollment officers, and others figure out that their GPAs are useless.
Jen: Gee, Mr. Allemirag, thanks for explaining that to me. I can see how that relates to money and why printing money is bad.