Glen Tuan

Apr 19, 2020

9 min read

Why can’t your country simply borrow and print money indefinitely like the United States in times of Crisis? Will the United States ever default on its debts?

Money can do wondrous things. Who doesn’t want free money? However, if you are not an U.S. citizen, your country would not be able to print money indefinitely to finance its debt or support fiscal spendings.

The U.S. government debt continues to rise by more than 16 percent under Trump’s presidency, bringing it to over $24 trillion as of April 2020. The U.S. Debt Clock depicts a shocking yet interesting view of the real-time changes to the U.S. national debt.

During major crises such as the 2008–2009 Global Financial Crisis and the Covid-19 economic crisis, governments around the world implemented fiscal stimulus to stimulate the economy and to provide support for businesses and households. For example, in the Covid-19 crisis, the U.S. planned to implement a USD$2 trillion stimulus package, in Japan, this was a USD$1 trillion stimulus package; in Indonesia, US$9 billion; in Malaysia, S$83.6 billion; in U.K., $37 billion. How do these countries that holds substantial amount of debt and faces persistent fiscal deficits for many years finance such spending? The short answer is to print money and/or borrow money!

What Happens When Your Country Prints Money Excessively?

There are 2 main consequences of excessive printing of money:

  1. Inflation
  2. Depreciation of Currency

Inflation

Excessive printing money can have tremendous consequences. As Economics Nobel Laureate Milton Friedman famously wrote

“Inflation is always and everywhere a monetary phenomenon”,

increasing money supply in the economy can potentially result in higher inflation. This is commonly said to be the case of

too much money chasing too few goods.

Although there is low inflationary pressure during a recession due to weakness in demand for goods and services, the inflationary pressure can come after the economic recovery.

Besides inflation, there is also the possibility of the formation of asset bubbles especially in the stock market where idle cash is often channeled towards.

A good example is Zimbabwe that has experienced hyperinflation with an annual inflation rate of more than 500% and, in 2008, prices rose as much as 231,000,000% in a single year due to excessive printing of money to finance its debts! The people of Zimbabwe have since abandoned the currency and have been using the U.S. dollar and cryptocurrencies.

Depreciation of Currency

The increased supply of currency would also leads to the depreciation of the currency in the foreign exchange (forex) market. Excessive depreciation of currency can lead to imports becoming more expensive. In turn, further imported-inflationary pressure domestically.

The strongest argument against printing money is the higher cost of borrowing when a currency depreciates. Most countries borrow overseas in the form of U.S. denominated debt (the reason is explained in a later part of this article). This means that countries and even companies that are looking to finance their loans often borrow in U.S. dollars through bond issuances or alternative loan instruments denominated in U.S. dollar. This is especially so for poor countries as domestic savings are often insufficient to finance domestic investments and spending. Ultimately, when your country’s currency suffers large depreciation due to excessive printing of money, your country and local companies will find it increasingly difficult to finance their debts that are denominated in U.S. dollar. This has also been the case for Zimbabwe that has defaulted on its debts. A similar problem faced by Indonesia during the 1997 Asian Financial crisis when its currency depreciated more than 30% in nominal value. As companies and a country find it increasingly difficult to service its debts, default risk would rise, causing investors to demand higher interest rates to compensate for the risk. The worst-case scenario is a Balance of Payment (BOP) crisis where countries have to default on their debt repayments!

A sharp depreciation of a currency really shows the danger of printing money. It can quickly spiral out of control and further send the economy into further turmoil.

Therefore, it is evident that your country cannot and should not print excessive amount of money during an economic crisis due to inflation concerns and depreciation of your country’s currency.

If We Can’t Print Money, let’s Borrow Money?

Don’t forget in times of crisis, we really need money to cushion the impacts of an economic fallout. So, if we can’t print money, let’s borrow money instead?

Yes. That is predominately what many countries do in times of a crisis. When debts can no longer be financed by domestic bondholders, countries would have to turn to the foreign market to borrow. Moreover, remember they have to borrow in U.S. dollar or other major currencies such as the Japanese Yen.

The following are the main concerns with regards to excessive and unconstrained foreign borrowing:

  1. Balance of payment crisis that was mentioned above!
  2. Higher interest rates as default risk increase, leading to a higher cost of borrowing.
  3. Borrowings have to be paid eventually. If an economy continues its weak performance in the future, it might find it increasingly difficult to service its debts and eventually default. A good example is the Greek Debt crisis.

Borrowing is still the favourable choice for many countries in times of economic crisis as many countries expect themselves to be able to pay back their debts after a crisis is over.

Why countries have to borrow in U.S. dollar or other major currencies?

Investors are less willing to accept foreign currencies that are not a major part of the global circulation. This is especially so for poor countries that are most likely to face a sharp depreciation of their currencies in times of economic crisis. The purchasing power of a depreciated currency is tremendously undermined! Thus, it reduces the return for investors in terms of their own currency.

IND/USD Trend

This graph that depicts the Indonesian Rupiah against USD, you can observe that the Indonesian Rupiah has depreciated sharply since the onset of the Covid-19 economic crisis.

Imagine yourself as an investor and you can now see why it is important to lend in terms of the U.S. currency, the reserve currency of the world, to preserve the value of your returns!

Therefore, it is difficult for countries to borrow in their own currency as compared to the notable countries that holds major currencies of the world that are the United States, Japan and Germany.

Why is the United States Able to Print and Borrow Money Excessively in Times of Crisis? 🇺🇸

The United States enjoys the exorbitant privilege and seignorage.

Exorbitant Privilege

The exorbitant privilege is a term that describes the U.S.’ immunity to balance of payment crisis due to its currency, the U.S. dollar (USD), being the international reserve currency. In other words, U.S. is always able to avoid a default on its debts by printing money. Therefore, U.S. will never default on its debt!

The mighty U.S. dollar is the international reserve currency as it is the currency held by central banks around the world and it is used for international transactions, investments and all aspects of the global economy. The greenback is deeply rooted in our economies and this can be seen from central banks around the world holding about 61% of their foreign currencies in USD and about 88% of global trade in 2019 involved the USD (at the time of writing in early 2020).

Furthermore, most of the valuable things that countries around the world buy and sell to one another, including gold and oil, are priced in U.S. dollars. So, if the US wants to buy more things, it really can simply print more dollars. Though if it printed too many, the price of those things in dollars would still go up too. Other nations will find it more expensive to consume these valuable goods as their currencies depreciate against the dollar.

Seigniorage

U.S. currency that is held abroad is effectively interest-free loans to the United States as the United States can issue more of its currency to service its debts. Interest savings are on the magnitude of approximately USD$20 billion a year, although a small fraction of the U.S. GDP. This benefit goes as the term “seigniorage” as there is profit when the U.S. currency is printed.

Note: We need to be clear of the distinction that although much international borrowing is denominated in dollars, it does not naturally imply that the Fed is the “world’s central bank”!

The common consensus is that the United States will always be able to service its debts because

  1. The United States can print more money to service its debts as all its debts are denominated in U.S. dollar and
  2. The U.S. government can tax the wealthiest people on Earth whenever it is needed.

Downsides for the United States

The exorbitant privilege, seigniorage and printing money does not come without cost. The United States do face the same issue of inflationary concerns in the long-run. The major downside is that the U.S. dollar exchange rate is overvalued at an estimated 5 to 10 percent than it would otherwise be because of the high demand for U.S. currency for the aforementioned reasons.

The current Federal Reserve Chairman Jerome Powell in 2020

Other Implications

This idea that the United States will never default on its debt has huge implications in the investment and banking world. An example is the treasury bond that is issued by the U.S. federal government is widely considered as the risk-free rate. The common consensus is that the U.S. government can always repay its debt hence the interest rate paid on treasury bonds are interest rates without risk.

Critics

Of course, there are critics. There are three occasions in U.S. history that came close to a default, with the most recent occurring in 1979.

In 1790 and 1933, both involve defaults when creditors were forced to take less money than what they were owed. However, those were periods when the United States was yet the superpower and the U.S. dollar played less of a major role in the global economy.

In recent history, in 1979, the US Treasury inadvertently defaulted on $122 million, because of what it said was a word processing error.

In my opinion, the United States is unlikely to default on its debts but the possibility is always there!

In conclusion, as debts are mounting across nations, we should keep a lookout on the increasing default risk amongst countries and companies. There are serious consequences for printing money and borrowing money recklessly. The United States is able to do so due to the exorbitant privilege and seignories that it enjoys.

Countries Print Money when They Get Richer

Do not misunderstand this article as explaining that any country that is not the United States are not able to print money at all. This is incorrect. Countries can continue to print money as their economy become richer in which more money is needed to facilitate transactions for the consumption of goods and services. Other reasons include a shortage of liquidity and a stronger demand for a nation’s currency will allow printing of more money.

Singapore

I understand that most people may think this is unfair but it is a reality. The United States is the winner of World War II, has the wealthiest people on the planet and the most profitable companies in the world.

There have been sayings of alternatives such as the Chinese RMB and cryptocurrency that will substitute the U.S. dollar as the international reserve currency in the future. However, the prospects for those are still quite dim for now and even so many countries will still face the same aforementioned issues. The best solution that I know is to maintain a strong reserve and a strong currency that can be useful in times of crisis. Only a few countries such as Singapore, Denmark, Qatar and South Korea that either has good governance and/or abundance of oil reserves that are able to do so.

Food for thought: Before reading this article, you would imagine that your country and all other countries are able to print their own currency freely, without constraint. However, if this is true, wouldn’t there be no poor people in this world anymore?

Thank you for reading! I hope this has been helpful for you in understanding the constraints that your country may face in times of crisis, and the role and privileges the United States has in the world.