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Mainstream Economists, Listen Up: Printing Money Does Not Create Wealth

By: Iván Cachanosky - @ivancachanosky - Jun 5, 2014, 2:35 pm
Edificio del Banco Central de la República Argentina. Fuente: Wikipedia.
Building of the Central Bank of the Argentinean Republic. Source: Wikipedia.

EspañolMany economists believe that printing money is necessary for economic growth. This belief is very dangerous, not only because it is false, but also because it involves the violation of the rights of every citizen in a given country.

If we take a closer look at the belief that it is possible to create wealth by printing money, we’ll find that this understanding is completely false. Money is a medium of exchange for goods and services. That is to say, what people actually demand are goods: paper currency is just the tool that allows them to obtain those goods efficiently.

In other words, wealth emerges from the production of goods, not directly from money. Consider an economy that produces 1,000 goods during a given period of time, and it costs a total of US$5,000 to acquire them all. If we also suppose, for illustrative purposes, that the government is the only potential buyer of these goods, then purchasing all the goods in the economy costs the government a grand total of $5,000.

If the government decides to print another $5,000, the government now has a total of $10,000 to spend, but can it now buy more goods? The answer is a resounding “no,” because in the real economy there are still only 1,000 goods. In this example, the government, despite possessing more dollar bills, has failed to acquire more goods. In short, the government did not increase its wealth.

In the example above, we can clearly see that printing new money is far from a solution to creating new wealth. If a country wants to develop and become wealthier, it must produce more goods. To achieve this goal, it must attract investment. Investments go to countries with high-quality institutions, where the rules of the game are clear. Having quality institutions means respecting contracts and private property, maintaining an open trade policy, and ensuring that public finances are in order so that the government can pay its debts on time. Printing money to pay for the government’s debts does not strengthen institutions; it actually weakens them due to the consequences this brings about.

With respect to the government’s monopoly in the production of money, it’s worthwhile to review the reasons why this particular form of monopoly is necessarily harmful. Monopolies in any economic sector are very much frowned upon today anywhere in the world. It is widely accepted that concentrating too much power in the hands of a given economic agent creates an incentive for that agent to abuse that power.

So is it not then harmful for society to institute a monopoly on the production of money? If one subscribes to the notion that all monopolies are bad, then one should also oppose government’s current role in the issuance of currency. Economists of the Austrian School of Economics pointed out a long time ago that there are different types of monopolies. In particular, they made a distinction between “competitive monopolies” and “legal monopolies.” In a competitive monopoly, despite the fact that there is only one producer in the market, it continues being competitive against the potential threat of other entrants if the barriers to entering and leaving the market are kept low.

Therefore, the monopolistic producer is unable to increase prices, as this would encourage potential competitors to enter the market. In other words, in a competitive monopoly, the producer has no power to abuse his position, since he continues to essentially compete with other potential entrants.

On the other hand, a legal monopoly is a completely different story. The monopolistic agent here enjoys a government-sponsored privilege that ensures the legal exclusivity to produce a good or service. The legal prohibition is an insurmountable barrier to entry, so in this case the monopoly literally has no competition. In this case, the monopolist does possess a power that can be abused.

In short, a competitive monopoly is still beneficial for society as it allows for the production of higher quality goods at the lowest possible price, while a legal monopoly harms society, as it is not subject to any competitive pressure to produce high quality goods and services. From this perspective, the monopoly held by central banks for monetary production falls under the category of a legal monopoly.

So, if the government is irresponsible in managing its finances and has access to a central bank that allows it to print money in order to pay the debts that it cannot service through tax revenues, it punishes all citizens with the loss of purchasing power caused by inflation.

It is worth remembering that the monopoly on money production only came about when central banks were created. Before that, there were competing currencies in many countries, and many strong currencies that maintained their purchasing power emerged spontaneously in the marketplace. In Argentina, the Central Bank was established in 1935. Anyone willing to take the time and effort to calculate the accumulated inflation from 1940 to 2013, would find that it is a staggering 4,835,716,461,499 percent.

Considering that not even 100 years have passed since the creation of the Central Bank in Argentina, that figure is quite alarming indeed. Maybe it’s not a bad idea to pay more attention to academics who have dedicated their careers to developing theories and studying the history of competitive monetary systems, such as Friedrich Hayek, a Nobel laureate in Economics in 1974.

In conclusion, economists who love the supposed virtues of money printing should think twice for two main reasons: first, wealth is never generated by printing money, but by producing physical goods that people demand; and second, printing money has a negative inflationary impact on the purchasing power of the people living in a particular country, and hits the pockets of the poor with a vengeance.

Translated by Alan Furth.

Iván Cachanosky Iván Cachanosky

Iván Cachanosky holds a bachelor's degree in business administration and a master's degree in applied economics. He's currently an instructor at CMT-Group. Follow him on Twitter at @ivancachanosky.