Money Printing Misconceptions

And the Magicians of the Fed

Dear Readers,

This week, we’re diving into the timely topic of printing money and its misconceptions. I’m embarrassed to admit that until recently, I thought “printing money” was the act of physically printing money.

Woops. I can’t imagine how many tractor trailers it would take to move around $2 trillion dollars, let alone how long it would take to print, for our last stimulus bill. That’s the equivalent of 20 billion, one hundred dollar bills. 

After doing a bit of research to understand the convoluted process to increase America’s money supply, I realized that it likely wasn’t just me who was operating within this misconception. 

Jargon

This discussion will remain obscure without our agreement on the definition of several terms. The financial industry has a bad habit of using disparate words to refer to the same institution and using similar words to refer to entirely different entities. 

Hence, some slightly generalized terms to make sure we’re all on the same page:

  • Capital: Money, credit, and other types of funds used to spend/invest.

  • Money Supply: Total amount of capital in existence.

  • Money Creation: When the Central Bank of a country (in this case the United States’ Federal Reserve, or Fed) increases the money supply.

  • Commercial Bank: Bank that provides services such as accepting deposits, making business loans, offering investment products, etc. Mostly deals with large corporations and businesses rather than individuals. 

How Money Gets “Printed”

When the term “printing money” is used, it refers to one of three processes by which the Central Bank increases the money supply. The majority of the capital that comprises the money supply is in the form of credit. 

Fun Fact: In the United States economy, there’s approximately $55 trillion in credit, but only ~$3 trillion in hard cash. 

In the most recent stimulus, the Federal Bank “printed” $2 trillion, which was credited to its member bank’s account balances, similar to how your employer deposits a paycheck to your bank account. 

This process is completed in one of three ways.

The Federal Funds Rate

To increase liquidity and lending in the money supply, the Central Bank, or Fed, will lower the federal funds rate. Federal funds are reserves held in a bank’s Federal Reserve account

Participating banks that have a Federal Reserve account are required to keep a minimum amount of reserves on hand at the end of each day. Since these reserves are borrowed from the Fed, that minimum balance has an attached interest rate, called the federal funds rate.

When the Fed wants to increase the money supply, they will lower the federal funds rate. This measure decreases the cost of the bank’s Federal Reserve account, leaving them with more money to lend to businesses and corporations, effectively increasing the money supply. 

Banks in this situation are incentivized to lend any money they don’t have to keep in reserves because they can collect interest, rather than paying it. As soon as federal funds rates are decreased, banks start throwing stacks. 

Open Market Operations

Another process by which the Fed can increase the money supply is through open market operations. In short, the Fed buys massive financial assets and securities from banks, and replaces them with credit on their balance sheets. 

Where does the Fed get this credit?

It casts a spell, snaps its fingers, and shazam! A trillion dollars. 

The Chair of the Fed, Jerome Powell, is actually a magician.

Similar to lowering the federal funds rates, replacing financial assets with credit injects liquidity into the balance sheets of commercial banks, who are then able to lend more. This again adds to the overall money supply. 

This practice is commonly referred to as Quantitative Easing, and is implemented when inflation is low or the economy is in a deflationary cycle. 

Debt Monetization

The third trick up Jerome Powell’s sleeve is debt monetization. In this practice, the U.S. Government auctions off its own debt in the form of bonds and Treasury Bills. 

The Central Bank purchases this debt and collects interest, but in doing so gives the U.S. government liquidity to go and increase the money supply. The government will have to pay the Central Bank back at some point, but in the meantime, a large chunk of the bonds and Treasury bills that were in existence are now out of circulation, and on the Central Bank’s balance sheet. 

This also increases the value of existing, circulating bonds and Treasury bills, which can net the government more spending power in the event that they decide to monetize more debt.

“Unprinting” Money

Although this expansive monetary policy and its penchant for increasing inflation keeps the middle-aged dad inside all of us up at night, the Fed also has tools to decrease the money supply. These tools are all deflationary measures for the economy. 

  1. Contractionary Monetary Policies

Known as contractionary monetary policies, these efforts by the Fed center around raising interest rates. This is done through the reversal of the federal funds rate manipulation that was enacted to increase the money supply. 

With federal funds rates higher and the cost of federal reserves being more expensive, banks have less money to distribute to businesses, corporations, and individuals. The money supply subsequently contracts.

These actions make it more expensive to borrow for business expansion, cars, and homes. Economic growth slows, drying up the demand that drives inflation. 

Unfortunately, the Fed has already stated that they won’t do this in the current economy. With a new policy to keep average interest rates at 2%, there’s little room to move rates higher and decrease inflation.

That being said, contractionary monetary policy is used to slow economic growth. Given the current recession and sickly pallor of our economy, contractionary policies would likely plunge us into deflation. 

By keeping interest rates low, borrowing becomes less expensive and this facilitates economic growth. I’ve written about this topic and the fact that inflation has risen by a petty amount in a previous newsletter.

The Fed is constantly walking the thin line between plunging deflation and meteoric inflation. Jerome Powell is not only snapping trillions of dollars into existence and levitating the stock market, but also riding a bike across a tightrope.

Poor guy. That makes him sound more like a circus act than a magician. I don’t think he would disagree.

  1. “Quantitative Dis-Easing”

The Fed also has the power to reverse Quantitative Easing. This is done through selling massive bonds and Treasury bills back to the banks that originally owned them. 

Banks don’t get a say in this. The Fed removes credit from their balance sheets and plops the securities back where they found them in the ultimate flex of fiscal superiority. 

What happens to the trillions of dollars removed from the bank’s balance sheets? 

Another magic trick. With a wiggle of his fingers and some clever sleight-of-hand, Powell makes them disappear in a flash of smoke. 

Who Actually Prints Money?

Physical money printing is handled by The Bureau of Engraving and Printing. Unlike most paper currencies, U.S. currency is made of 75% cotton. $5 notes and above are woven with security threads and watermarks to discourage counterfeiting.

Upon final inspection, the money is sent to the Central Bank, where they decide how much goes into circulation. This means that printed money is just pretty paper until value is assigned to it and it’s brought into circulation. 

Apparently, the Fed pays nearly $700 million per year managing the currency. That feels ironic. 

Costs include printing, transportation, and destruction of mutilated currency. I tried to find how they destroy mutilated currency, but came up dry. There’s probably a crematorium for retired Federal Reserve notes out there somewhere.


That’s all for this week!

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As always, thanks for reading :)