“…the Wall Street investor accomplishes what the alchemist could not – creating gold from dross, real wealth from mere paper…”

A clever and insightful quote from William Greider in his book “Secrets of the Temple” but not entirely true. As we have learnt, in the long run money is worth not the number that is printed on it, but what it can be traded for, which gets smaller over time. A printing press has value not because it can print valuable money, but because it can reduce the value of money.

Paradoxical, scary, and true. One of the primary reasons that the Eurozone is in trouble of breaking apart is that each individual economy doesn’t have its own printing press with which to create its own currency. Is gold a good hedge against inflation and The Wonderful Central Bank of Oz highlight how increasing the money supply can stimulate the economy by reducing interest rates. But with some countries booming (like Germany) and others in recession (like Greece) how much money should you print? The Germans are worried about inflation while Greece is worried about deflation. The reason that Germany can’t have high interest rates while Greece has low ones is actually the same reason that China can’t have high interest rates while America has low ones. When Greece uses the same currency as Germany , it is the same as the both of them using different currencies, but having them pegged to each other at a rate of one for one (see What have China’s money supply and America’s money supply got in common).

Vast economies like America have the same problem of booming states and floundering ones, but taxes are just paid to the government and California doesn’t care if their tax dollars are used to help stimulate Ohio. German taxpayers on the other hand are much more apprehensive about their tax dollars being spent to help the Greek economy, particularly when accusations of tax evasion are so rife in Greece.

The printing press has a less well publicised part to play for indebted governments. Part of the reason why the US has thrown the inflation textbook out the car window and printed copious amounts of money is because even if inflation gets out of hand, it will erode the value of the government’s debt. This was illustrated in Can the Federal Reserve “Really”affect interest rates. If the government borrows $50 billion (in debt) then spends it, it has an incentive to induce inflation. Once money is printed, fast forward to all else being as it was, except prices are now higher (see What’sthe scariest thing out there at the moment for a quick look at what we’ve “yada yada’d” here). Sales taxes are now higher because they are based on the actual prices of goods. You might not think of your wage as a price, but they are most certainly the price of your labour to your employer, and wages rise with money printing too (think lobbying labour unions). This means your income is higher so you pay more income taxes. So the government’s income is higher, but the one thing that has not changed is the value of the government’s debt, $50 billion, and its interest payments. This makes it easier to cover the interest payments and the real value of the debt has fallen.

Without a printing press however, Greece is doomed to be accountable for its actions and honour the full value of its debt. Unless of course it just plain defaults.

Don’t worry, we’ve just begun digging around in this tangled forest of politicians and summits for the real economic deal.

Euro-zone
Government debt
Greece
Inflation
Taxes