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Debt monetization and risk for economy

Started by Kalliste, December 17, 2018, 07:25:15 AM

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Kalliste

I'm still struggling with the idea that debt monetization or "printing money" is always risky  as it creates inflation...If US govt prints money to pay off its debt, the money doesn't go into the economy but is purely a financial transaction to pays off bond, etc...And often they are foreign holders (35% of total debt) so not even sure they would want to invest in the US with that cash they get back? so why would that create inflation ? why can't the govt prints money and reduce its debt burden? I see examples of hyperinflation but also some good examples such as US in 2009 (no inflation) or other countries (japan did this in 1990 till now and still no inflation). Any economist out there that could explain the flaws in the reasoning and potentially what are the conditions for "debt monetization" to go well...


swbluedevil

I found Ray Dalio's latest book called "Big Debt Crises" helpful in thinking through this topic. I'll try to answer your questions based on what I have read in the book:

[Question] If US govt prints money to pay off its debt, the money doesn't go into the economy but is purely a financial transaction to pays off bond, etc...And often they are foreign holders (35% of total debt) so not even sure they would want to invest in the US with that cash they get back? so why would that create inflation ?

Actually it does go into the economy. Let's say I own $100 worth of USG bonds. If the fed expands it balance sheet (i.e. prints money) and gives me cash by buying my bond, I now have $100 to either save, invest, or spend in the economy. If the economy is in such a state that the fed is printing money, then it's reasonable to assume that short-term rates are also low (or even at zero). That means my more likely courses of action are to invest (in equities, real estate, other bonds, etc) or spend (this is not an exhaustive list). If 35% of total debt holders are foreign, this implies that 65% are domestic (still a rather large number). Even for the foreign debt holders, they may continue to invest in the U.S. if they view it as a safe haven / believe they will get better risk-adjusted returns than their home market / elsewhere in the world. Printing money won't necessarily lead to inflation if the contraction in credit (because lenders no longer feel comfortable making loans) is more severe than the injection of additional money into the economy.


[Question] why can't the govt prints money and reduce its debt burden? I see examples of hyperinflation but also some good examples such as US in 2009 (no inflation) or other countries (japan did this in 1990 till now and still no inflation). Any economist out there that could explain the flaws in the reasoning and potentially what are the conditions for "debt monetization" to go well...

Ray Dalio answers this question quite well in his book. In some cases, the government can simply print money to reduce its debt burden (by spreading out the pain of a debt crisis). This can happen when a country's debt is denominated in its own currency (i.e. as in the case of the U.S. where the USD is the world's reserve currency). The cases of hyperinflation tend to occur when a country's debt isn't denominated in its own currency, so as it prints money, its currency gets devalued, which increases its debt burden and debt servicing costs. Dalio presents the classic deflationary debt cycle (i.e. US Depression in the 1930s, Great Financial Crisis in the 2008) and the classic inflationary debt cycle along with fiscal / monetary policy recommendations for managing both.