Washington DC, March 24, 2009 --  

America's decision to print money will prove addictive to the government, and may lead to an inflationary disaster.

The Obama Administration's unprecedented surge in government spending has led to a breakdown of America's borrowing system and forced the country to begin printing money to cover its spending. This unprecedented change came last week, when the Federal Reserve's announced plans to purchase $300 billion¹ in long-term bonds. Because the Federal Reserve will invent money out of thin air to pay the Treasury Department, the measure is no different than the money-printing policies that ruined the economies of Argentina and Zimbabwe.

The decision to print money marks a sea change from recent decades, when foreign countries, particularly those with export-driven economies have financed virtually all of the new public debt accumulated in America. (See graph.)

But two recent changes have led to the breakdown of this funding mechanism: The crash of export markets and a rise in government spending.

First came the crash of world export markets and the price of oil. With China's exports down 26 percent since February of last year ², America's biggest creditor is no longer flush with new cash ready for investment in American bonds. China's assurances that it will continue to buy American debt³ are solely intended at shoring-up investor confidence in the $740 billion⁴ in it already owns. Without growing export income, China's new debt purchases are sure to be meager.

The same goes with OPEC countries. Oil prices have dropped by about half since last spring, so Kuwaitis, Qataris and Saudis won't be buying as many bonds either.

Meanwhile, the U.S. government is increasing spending with such recklessness that it sometimes sounds like it's making up numbers. Numerous financial bailout measures costing hundreds of billions of dollars and a stimulus package of nearly a trillion dollars will add about $2 trillion to the debt this year alone. Going forward, the Obama administrations' proposed budget runs deficits in the high hundreds of billions every single year for the next decade, adding $9.3 trillion in new debt by Congressional Budget Office estimates.⁵

All of this adds up to an unprecedented expansion of government spending -- with no hard money to back it. Who on earth has trillions of spare dollars to pay for America's new deficit spending?

Just in time, the U.S. government has pulled out the last-ditch economic tool of every desperate economy: printing money. The Federal Reserve uses a bit of accounting theater to make this look more respectable: it "buys" long-term Treasury bonds. All this really means is that the Treasury prints an IOU on paper, gives it to the Fed, which then prints (or electronically credits) the same amount of money to give to the Treasury for spending.

Make no mistake, this is no different than what has happens at central banks in Zimbabwe and Argentina. And while the effects have not been felt yet, this should be no comfort -- it takes time for printed money to flow through the economy and affect prices. But when inflation does start, it is extremely painful and difficult to stop.

The day after the announcement, the dollar dropped 2.7 percent against foreign currencies, the biggest daily decline since 1971⁶. And this drop understates the real erosion in the value of the dollar, because other countries including Britain, Canada, Switzerland and Japan have started printing money, too.⁷

Will these policies lead to the same ruinous hyperinflation that wiped out savings accounts in Argentina and eviscerated salaries in Zimbabwe? Will they lead to a lesser crisis like America's double-digit stagflation of the 1970s?

Apologists for the Fed say this won't happen. We are told ad nauseam that one of the biggest dangers of an economic downturn is a deflationary spiral, when consumers delay purchases until prices go down further. Economist Milton Friedman, a hero of Federal Reserve Chairman Ben Bernanke, famously said that deflation could be easily stopped with a "helicopter drop" or printed money.

This sounds good, except for the elephant in the room: there's no evidence that America is experiencing deflation. In fact, American consumer prices rose 0.4 percent in February after a 0.3 percent rise in January.⁸ So how on earth can printing money be justified as fighting deflation?

Funding government spending with printed money is certainly not Bernanke's goal. In public statements he sounds utterly obsessed with avoiding the tight-money policies that he believes caused the disaster of the 1930s, even if it risks creating a new, different and possibly worse inflationary disaster.

By printing money, Bernanke is administering powerful medicine to the American economy -- it's like the morphine of the financial world. But because the patient is already addicted to deficit spending, this is the equivalent of giving morphine to a heroin addict. And since the American government's foreign suppliers are no longer able to keep its spending going, it's hard to imagine how the Federal Reserve will be able to wean the addict from more printed money.

Related Web Columns:

Persistent Problems, Painful Solutions, February 10, 2009

The Rise of the Mutant Beast, January 13, 2009

Circling Sharks and the Magic Hand, September 30, 2008

Stagnation's New Decade, September 16, 2008

Yawning Toward Disaster, September 2, 2008

Aggravating the Hangover, August 5, 2008

House of Cards
The Collapse of Credit-Driven Spending, November 27, 2007

Deficit Nostalgia, June 13, 1999

Notes:

1. Financial Times, Overview: Bold Fed Move Sparks Inflation Fears, March 20, 2009

2. Associated Press, WTO: World Trade to Fall 9 Pct, Worst Since WWII, March 23, 2009

3. China Daily, Purchase of US Treasuries to continue, March 24, 2009

4. U.S. Treasury, Major Foreign Holders of Treasury Securities, March 16, 2009

5. Washington Post, Deficit Projected To Swell Beyond Earlier Estimates, March 21, 2009

6. Bloomberg News, Euro Currency of Choice as Fed Easing Devalues Dollar, March 23, 2009

7. City Wire, Making Money From Quantitative Easing, March 23, 2009

8. Bloomberg News, U.S. Economy: U.S. Consumer Price Gains Accelerate, March 18 , 2009

Chart sources:

1. U.S. Treasury, Major Foreign Holders of Treasury Securities, (2008-2009) March 16, 2009

2. Ibid., Major Foreign Holders of Treasury Securities, (2000-2007), August 15, 2008

3. Ibid, Debt to the Penny (Daily History Search Application), As Queried March 23, 2009