Crypto thrives on memes and one of the most popular is the message of governments spending their way out of economic problems, with the ‘money printer go brrrr’. Though the message is broadly accurate, and governments are massively expanding the money supply, they don’t actually print more money to achieve this, so where does new money come from and why is it such a problem?
One of the biggest criticisms against our existing money system is that there is no restraint on the supply of money managed by central banks on behalf of government.
You might think that is a good thing, given all the crucial things the government has to pay for. Why even pay taxes, couldn’t the government just print enough money to cover those too?
You can boil down the problems that a rapidly expanding money supply creates:
If the level of production of goods remains the same, but the supply of money chasing those goods is steadily increasing, then prices of those goods will go up.
That is really economics 101. More money chasing the same amount of goods - supply and demand. The result is called inflation. A decline in the purchasing power of the money in your pocket. Managing a national economy is way more complex in reality, but the basic logic applies.
Michael Saylor, one of Bitcoin biggest advocates, uses the metaphor of a melting ice cube to describe the decline in fiat money purchasing power. We’ve created an animated gif to demonstrate how the US Dollar has lost 96% of its purchasing power since 1913.
When inflation gets out of control, it becomes hyperinflation - generally defined by monthly increase in prices of 50%. So every two months prices would double.
Right now about 1.2 billion people live under crippling inflation, which is particularly acute in Venezuela, and history has some terrifying examples of what happens when it gets out of control, such as in Germany between the wars where money printing reached insane levels and inflation so out of control new ways of measuring it had to be introduced. The exchange rate of the German Mark to the Pound was at one point equal to the number of yards to the Sun.
German Mark to Pound exchange rate - 1923
Looking at this, any reasonable person might simply ask why, if generating more money might lead to inflation, does the government keeps doing it?
Entire libraries have been filled with answers to that question, but the most simple response is ‘because they can’.
Up until the beginning of the 20th century there was a constraint on money supply, known as the Gold Standard. Every pound or dollar in circulation was backed by an equivalent amount of gold. That system was, however, relaxed to finance World War I and completely ditched by the US in 1971.
The Gold Standard came to be seen as a historic relic, with no place in modern economies and money markets, which have changed beyond recognition through the digital age.
The modern approach to managing the money supply, without the restraint of something backing it, like gold, is described as fiat money - which literally means money by decree.
The money we use today has no intrinsic value, the coins are all cheap alloys, the note just worthless paper, and the majority is just entries on a central database. Modern money has value because the government say it does, and society accepts that, so long as the government - and the financial markets - trust it.
To generate more revenue, you have to raise taxes, which is politically difficult. Equally cutting expenditure on things like defence, health, education or core infrastructure will always be opposed by a section of voters.
On top of the commitments the government has to the general running of the country, they have to finance responses to disasters and emergencies, from wars to pandemics. And in recent decades, acting as a backstop to a banking industry that has grown in complexity and systematic risk.
It would be a brave government that was willing to upset that status quo, so when faced with trying to balance expenditure and revenue and the political consequences of all the decisions that involves, the easiest solution is to just create more money, and kick the problem down the road.
There are other levers the government can pull to stimulate or restrain economic activity, the most obvious is the interest rate - the cost of borrowing money. If you want to generate activity you can reduce that to encourage businesses to invest. The problem right now is that interest rates have been close to zero for almost a decade, and are actually negative in some cases.
So many governments have little option but to bite the bullet and create more money just to keep the lights on, but what does that mean in reality?
The printer go brr meme suggests that more money rolls off the press at the mint, the factory that the government licenses to produce legal tender - pound, dollars, euros, yen etc.
The reality is that physical cash only represents about 3% of the money in circulation, what is known as the narrow money supply. So where the hell is the other 97%?
Narrow money is the total of physical money - cash and notes in circulation - and the reserve balances of the Central Bank - the government’s bank. Those reserves are lodged by Commercial Banks.
So 97% of the money supply is just entries on the digital databases of commercial banks. There is no physical version of that money. Commercial banks are allowed to lend money to business and consumers by the central bank (the government).
The proportion of the money supply that physical money accounts for
Commercial banks are required by law to hold a certain level of reserves with the central bank, and so long as those are maintained, they are allowed to issue loans to their customers, which are proportionally higher. This is what the term fractional banking means.
Whoever is issued that loan - a business or retail customer - will then create a deposit of that money with the bank which they use to buy a house, car or finance a business. Money has been created out of thin air, no printer required, just an entry on a screen.
So the really simple answer to how governments, and the central banks that serve them, create money, is that they don’t. They simply allow commercial banks to do it for them by expanding the terms by which those banks can operate, generally defined by the reserves they hold.
Money is in fact issued into circulation as a social relation of credit and debt between the state, its citizens and its banks
The 2008 financial crisis created a crisis of confidence and unfathomable amounts of bad debts that governments have had to assume. They’ve tried to stimulate economic activity by reducing interest rates, but they’ve been reduced so much that negative is the only place they can go. That literally means that depositors pay the bank to hold their money.
Governments could just let things take their natural course, but the consequences are too stark, especially in the context of the Covid19 pandemic where lockdowns have decimated so many industries. So central banks - acting on behalf of government - expand the money supply by freeing up bank reserves.
The most common way they do this is actually buying back the existing government debt that commercial banks already hold - known as Quantitative Easing.
This means the amount of available reserves held by commercial banks increases so they can - in theory - go and create more money by lending to generate productive activity. Unfortunately that isn’t necessarily what happens in practice.
A lot of that new money - often just called liquidity - actually ends up fuelling non-productive activities - financial speculation - which is why stock markets have hit record highs, house prices are accelerating along with other stores of value .
If the way governments create money is starting to sound like a monumental version of robbing Peter to pay Paul...well it is. Unfortunately, history tells us that no matter how much financial alchemy a central government might conjure up, there are some underlying fundamental laws - as in the physical world - that suggest that eventually the whole thing will come crashing down.
The warning light for government borrowing generally starts flashing red when the ratio of debt to Gross Domestic Product (the net value of things created) hits 100%.
The US debt to GDP hit that level in 2012 and has been climbing ever since, which is crucial given it is the world’s most powerful economy and issuer of the global reserve currency - adopted as the de facto national currency of money other countries.
If you look back through history, that position seems to be hard to maintain. Though this summary only skims the surface of the problems of fiat money, it should be enough to understand the context within which cryptocurrency exists.
Bitcoin has no one in charge - that is what decentralised means - and a set of rules that fixes the maximum supply of bitcoin at 21 million, which cannot be changed. This is what makes it such a popular alternative to the kind of money that is constantly being inflated.
Ironically, the biggest threat to Bitcoin, and other cryptocurrencies, could be governments ripping up their current economic manuals and starting again with approaches that impose restraint (some kind of gold standard), adopting crypto or some as-yet untested approach.
So far, what we have seen suggests that governments are looking to adopt some elements of crypto, but only those features that increase control and surveillance, though CBDCs (Central Bank Digital Currencies) - the ability to create infinite money remains.
So when you now see the ‘money printer go brrr’ meme you’ll now know what it really means. Commercial banks create money, because central banks allow them that privilege. We, the citizens, implicitly approve that arrangement by putting governments in charge, though the results tend to be very unfavourable to the average person, through declining purchasing power
This is why Chamath Palihapitiya famously called Bitcoin ‘schmuck insurance’ in an investment thesis he wrote in 2013. It’s insurance against government stupidity, and given the choices that most now face, it's not hard to see why they take the path of least resistance and keep the money printer going brrr. What every individual has to decide is whether to take the insurance something like Bitcoin represents, or hope that governments can somehow pull an increasingly unlikely rabbit out of their economic hat.