Why Does the U.S. Government Borrow Money Instead of Just Printing More?

BY Paul Solman  August 24, 2010 at 5:37 PM EDT

Question: Why does The U.S. government borrow money and thereby create debt when it has the sovereign and Constitutional right to create whatever money we NEED? $1,000 of debt and $1,000 of created money are both the same claim on our wealth — but the debt adds interest and is thus more costly to us. Creating debt is simply dumb — it creates no more inflation than creating money.

Paul Solman: Interesting question (or “comment”). But don’t you see the difference? Debt is a transfer of accumulated wealth from someone to someone else. New money is wealth created from scratch. New money makes old money worth less. As people rush to get rid of the old money before it loses too much value, those words can fuse into WORTHLESS.

Suppose we could do as you suggest, and simply take the $8 to $9 trillion that the US owes to anyone besides its own trust funds and pay back all the bondholders, here at home and abroad. Hey, we save the interest payments, which amounted to nearly $400 billion last year! Sounds good, right? And that’s your point.

Unfortunately, for every actual dollar currently out in the world at the moment, there would suddenly be about four. Now I don’t know about you, but here’s my fear the minute I hear that’s going to happen: that any given dollar would be worth 1/4 of what it had been before the debt-to-currency transformation. In other words, inflation: everything suddenly quadrupled in price. And what would I do the next minute? Figure out how to cash in any dollars I had in exchange for other currencies or assets (houses, cars, foreign stocks) that weren’t poised to plummet in value because the supply of them had suddenly soared, as with U.S. dollars.

If you heard that I — and millions like me — were about to do this, Mr. Carbone, would you not be tempted to do the same? If you did, you would be part of the “run on the dollar” that people ALREADY fear today. That’s because of the several trillion dollars that have been created by the Fed during and after the Crash of ’08.

Thus far, those several trillion have NOT caused runaway inflation and a run on the dollar, because – and this is a crucial point that most people simply don’t realize – the newly created money has stayed inside the U.S. banking system.

In essence, the several trillion has been deposited in U.S. banks, which have REdeposited the new money back with the Fed. The Fed is paying a small — .25 percent — interest rate to induce the banks to keep the money out of circulation, as we’ve tried to explain both on the air and on this page.

You can argue with this strategy: it may be keeping the banks from lending and fueling a recovery. But if the purpose is to keep a lid on inflation, well, that sure seems to be working.

I guess there IS a twist on your idea. The Fed can’t actually quadruple the money supply by eliminating (“retiring”) the debt right away. Most of the debt doesn’t come due for years. But since no bonds are of longer than 30 years duration (“maturity”), let’s imagine a gradual, 30-year process.

In that case, the Fed could simply refrain from borrowing the new amount it needs every year to cover the annual deficit between spending and revenues, and also refrain from borrowing to pay for any debt that has to be redeemed as it comes due. In 2010, my wild guesstimate of those two numbers, totaled, is about $2 trillion.

So: Under the Carbone scheme, as modified by me, the Fed creates $2 trillion new dollars, almost doubling the money supply, while of course keeping paying banks to hold onto the new money to prevent inflation. It might have to hike the interest rate it’s paying, just to be safe. Let’s say, however, that it can get away with keeping the rate it pays at .25 percent.

But wait just a cotton-pickin’ second. (This is how they used to talk in the cowboy TV shows of my formative youth.) You want to stop the Treasury from BORROWING. But right now, if the Treasury borrows the money for one year by selling a one-year “Treasury note,” it pays a measly .25 percent. Yes, you read right: .25 percent! You could look it up. But that’s exactly the same amount it’s paying the banks to redeposit money with the Fed!

So retiring the debt by issuing more dollars — in today’s environment — wouldn’t save any interest payments at all!

One last objection to be dispensed with. The Treasury isn’t borrowing only in short-term increments. When it borrows for ten years, for example — “10-year Treasury notes” — it’s paying more than 2.5 percent. But of course that’s the equivalent of taking out a super low-cost mortgage these days. If inflation DOES rise and exceeds 2.5 percent, the Treasury will actually be MAKING money on its debt, since it’ll be paying back with dollars decreasing in value by more than the interest rate. In that case, it SHOULD borrow, right?