Why can't a government print money to pay its debt?

Question

I have written an explanation to one of the famous questions "why can't government print money to pay its debt".

1. Is my explanation correct?

2. Is this the similar situation which happens in real life?

3. Is there really a foreign exchange bank?

4. Do companies like Verizon really buy other countries' currencies?

In Country X, President thinks we have too much debt to be paid to USA. Let us print money and will pay the debt off. Country X uses currency Y.

After printing money, since X has to pay to USA in dollars, X goes to foreign exchange bank and try to catch some "fool". Suppose a telecom operator in USA say Verizon wants to expand business in X, wanted to buy Y since X may need that money to construct office, hire people, bribe politicians etc. So Verizon buys it from X in return for USD. Now X pays its debt off to USA in USD and sleeps happily.

Now Verizon expands business in X, effectively returns the money they got it from X to the people of X, by paying for construction, employees, etc.

So people of X have more money but the production of X remained same. This is a classic case of inflation. So countries tend not to print money to pay off debt!

Answer 1

Your get the basic intuition, but real-life situation is a bit different.

First, I didn't really understand what you meant by "try to catch some 'fool'", but what you are calling foreign exchange bank is actually called the Foreign Exchange (market), and consist of buyers and sellers that are basically ready to buy and sell any currencies (almost all currencies in fact) provided that the price aligns with their expectations. Classic laws of market apply to this market, and if X's government (its central bank to be more precise) prints a lot of money, money supply increases. The result is a decrease in the price of money relative to other money, which is the exchange rate.

Money may be hard to understand, but it is actually a right to future cash flow of a given country. It is a sort of perpetual debt with zero coupon issued by a given country. So, if the country issues more money, it means that it issues more debt, so as a dilution mechanism it yields less cash flow to each unit of money, and since the price of money (as the price of any debt) is the expectation of future cash flow, the price will decrease.

Then, this will indeed result in more inflation. I expose two ways of seeing that. First, you can think about the price of goods as the price of goods relative to the price of money. Indeed, you're going to pay $x$ for a particular good because the seller knows that it will receive $x$ and that $x$ will give him the right to a certain amount of GDP (cash flow of country). But if the amount of GDP that the money represents is lower, he will ask for a higher price. Second, traditional monetary research has derived, a long time ago, the following formula which represents what I explained in my first point, but more formally. The following is always true, it is an accounting relation : \begin{equation} M\cdot V = P\cdot Q \end{equation}

$M$ is the amount of money, $V$ is the speed of money, $P$ is the price level and $Q$ is the output or quantity of goods exchanged.

Without entering into too much details on this equation (there are extended information on Internet), you can see that increasing $M$, holding $V$ and $Q$ constant, results in inflation.

To come back to your question, countries don't (only) print money to repay their debt, because they are afraid of inflation. There is a big debate on inflation (You can read it on Internet), but loosely speaking inflation seems hard to contain. So to avoid hyper-inflation situation, they try to maintain inflation (in general below 2%).

Your story does not need another company investing in X because, as you said, people will end-up with more money, but X's production will effectively increase. But it is true that companies buy currencies for investment purposes in their own country. Even local company may end-up buying their own currency, if for instance they sell product in USA (exportations), and sell the USD they receive against buying their own currency. This is why import and export (worldwide) are good indicators of exchange rate fluctuations.

Printing money to pay debt is a complicated question, and I only tried to sketch some insight here. For more information, read more on money creation and inflation (either in the academic literature or in economic textbook for instance).

Answer 2

It probably could. But it would not be popular with savers. Printing money means all the currency is worth less. So it is essentially like a universal tax on people who have money (usually the middle class and rich).

How would you like it if your thousand pounds saving was suddenly worth half as much as the government had devalued it to pay off the debt.

And those people who are in debt are now more well off since their debt is worth less. Is that fair too?

So all in all, it's not a very good idea unless you really want to annoy your voters.

Answer 3

Actually a country can feasibly create money to buy off debts. But first some clarifications.

There is foreign denominated debt and locally denominated debt.

Let's start with local debt (say the Fed creating dollars to reduce our debt). This happens all the time indirectly as the Fed is constantly created the monetary base to buy treasury securities. They key to this avoiding inflation is to make sure bank deposits are not multiplied off of this new money. If a central bank can control the multiplier, then inflation will not be a problem. This is important because most monetary inflation comes from private banks and not central banks.

Then there is foreign debt. If not anticipated by the market a central bank can make a tidy profit by buying foreign currency with newly created domestic currency. Say there is an exchange ratio of 1000 dollars to 100 pesos. The market assumes this price based on the current quantity of pesos and other factors. If a central banks say doubles the quantity of pesos and uses them to buy dollars before the market can react, they can make some good profit. They key though is that the market will react and punish the Peso as it is now an unpredictable currency. When the exchange rate for the Peso drops, this means foreigners can buy more domestic goods (like say farmland). Say because of the drop in the Peso, a country has to sell off half of its farmland...which now just sends its produce to another country. Less goods for consumption is another form of inflation. This is why exchange rates are important. On top of this, the banking system will multiply (if not controlled) the new base money many fold creating a fine mess. If serious this can cause a banking crisis. As scared foreigners use Peso denominated bank accounts to buy dollars, they will stop lending short term to Peso banks which will create a liquidity crisis.

Answer 4

The easier you explain shows your skills and intelligence. I'll give you a very short and strong example:

India wants a lot of jet fighters from America. There's no way Indian Rupees will be accepted by US without a very very good reason. But let's assume there is a good reason for instance, and India printed money. Just for the price of the jet fighters, they have print a lot of money.

Now, the problems have just begun, what would America do with the Indian rupees? Of course they are of no use unless they buy a products from India or invest in India with the INR. Hence India will soon face inflation due to the increasing supply of money in the country. Hence, the purchasing power of money will decrease in India. That means money devaluation and the international exchange rate will be much more in terms of INR.

Hope you got what I'm saying. I try to avoid economic terms in case you are from a different subject or different streams or maybe just a random guy with no economic knowledge.