Why printing money & zero interest rates are the new normal

First of all, I want to make clear that I share my observations based on the things I know, even though that's not much relative to what I need to know. Therefore, I do the best I can to gather believable information from knowledgeable people who enable me to have a better understanding of this topic.

In this post, I will describe what money and credit entail from a higher-level perspective. However, I will first explain how "the system" works, taking the US as an example. Furthermore, I will explain how governments fund their activities and why this causes printing money and zero interest rates to be crucial for the system as we know it to survive.

How "the system" works

Most governments get their funding from taxing activity within their borders. In the U.S., taxes on imports, exports, business profits, and personal income make up most of its tax receipts. Together, the economic activity happening within a country’s borders makes up its GDP (i.e. the total value of all goods and services produced in the country).

On average, the U.S. collects 16-18% of GDP in total tax revenue. Regardless of the GDP in absolute numbers, the collected share is rarely less or more than 16-18%. However, important to know is that when the GDP grows, the total pie gets bigger. Therefore, so does the government’s slice in absolute terms.

Even though their slice gets bigger, governments, in general, tend to overspend. Between 2005 and 2020, the outstanding US Treasury debt tripled. It is estimated that the US budget deficit has hit a record $3.1 trillion in the recently concluded 2020 budget year, equivalent to 15.2% of its GDP (Marketwatch, 2020). This is the largest deficit, relative to the size of GDP, since 1945. Furthermore, 2020 was the fifth consecutive year in which the deficit increased as a percentage of GDP. That's what happens when overspending becomes the norm. The US treasury finances its overspending by selling bonds, bills, and notes with different maturity dates which can range from 4 weeks to 30 years. When they come due, they repeat this all over again which makes the US debt pile never shrink.

Today, it’s never been cheaper to borrow money than ever before as the interest rates are +/- 0%. When the money has to be paid back, new money can be borrowed (for free) to pay off old debt. Therefore, it's tempting for governments to pay back old debt with new debt, even though it causes the debt pile to grow. In a normal situation or, a free market, this is undesirable as it would increase the pressure of interest costs which are recurring costs until the debt is due. However, as we can not speak of the US as being a free market, shown by the fact that interest rates are near zero and potentially go negative in the (near) future, there are hardly any interest costs. Hence, growing the debt pile by paying off old debt with new debt has become very tempting, and has led to the biggest debt pile in history. If the interest rates would rise it would increase the US government’s interest costs such that it would be soon insolvent, so they cannot and will not rise.

Money and credit

All entities (i.e. companies, people, or governments) deal with the same basic financial realities and always have. There is money that comes in (i.e. revenue), and there’s money that goes out (i.e. expenses). Remember, for governments the income is its ‘slice’ of the GDP (tax income).

The income and expenses together, when netted, make up a net income. When the net income is positive, it causes one’s savings to go up which adds to one’s assets. When the net income is negative, or a net loss, one is required to make up for the difference by either taking money from one’s savings or taking it from another entity by borrowing. Taking money from another entity makes the borrowed amount an asset for the lender, whereas it’s a liability for the borrower. The US government's income (the slice of GDP) is always lower than its expenses which requires them to borrow money from another entity. The US government does so by selling US Treasury bonds, bills, and notes to the FED. Consequently, the US government’s debt is an asset for the FED and appears on the FED’s balance sheet, while it's a liability for the US government, and increases the debt pile.

What one’s savings look like will show up on one’s balance sheet in the form of either assets or liabilities. When one doesn’t have sufficient assets in relation to one’s liabilities and one’s income falls, one is required to cut one’s expenses which will then hurt those that depend on that spending to earn income.

Similarly, since one’s debts are another’s assets, defaulting on debts reduces other entities’ assets, which requires them to cut their spending. This causes a self-reinforcing cycle which eventually will become a political issue as there is a need for help in order to improve the situation (i.e. monetary & fiscal policy; in other words, influencing interest rates and printing money).

To fix the issue, entities need money (i.e. credit) in order to increase their spending on goods, services, and investments which then allows one to live above one’s means. Often, this is liked because everything tends to go up in price. However, as aforementioned, borrowing money is a liability on the balance sheet of the borrower which requires the borrower to eventually pay this back; this is painful, as it requires one to live below one’s means. Even though this is the reality, the US government won't live below its means by paying back old debt with its (potentially increased) income, so they just borrow new money to pay back the debt that’s due which increases the debt pile.

The new normal

Today, the problem that we collectively face is that incomes tend to fall as the world economies are suffering. Therefore, the GDP shrinks and so does the ‘slice’ of it that makes up the income of the US government. Consequently, it leads to incomes becoming negative (i.e. costs > income) which requires many entities to make up for the difference by either taking money from their savings or taking it from another entity by borrowing. As most entities don't have sufficient savings to make up for the loss of income, they require financing which, in 2020, has come from the US government in terms of stimulus. Consequently, most businesses were able to stay alive, and individuals have been able to keep spending money.

Therefore, this requires the US government to finance its increasing deficits. Remember, it does so by selling US Treasury bonds, bills, and notes to the FED and then buying them with money they create out of thin air. Eventually, this needs to be paid back by the US government which requires the GDP to grow as the 16-18% slice makes up the US government's income. However, many entities' incomes have fallen to a point at which they might go out of business without stimulus which requires these entities to cut their expenses. Consequently, cutting one's expenses will then hurt those that depend on that spending to earn income. This causes the self-reinforcing cycle I previously mentioned which, eventually, weighs down on the GDP.

As a result of all this, the US government would need increasingly more money to make up for the loss of income. In the meantime, it cannot allow interest rates to rise as it would (significantly) increase its expenses and, consequently, its deficit.

Printing money and zero interest rates are the new normal.

References

Dalio, R. The Changing World Order (2020).

Nicholson, J. (2020, October 8). Federal budget deficit hit a record $3.1 trillion in just-ended fiscal 2020, CBO says. MarketWatch. https://www.marketwatch.com/story/federal-budget-deficit-hit-record-3-1-trillion-in-just-ended-fiscal-2020-cbo-says-11602184460

Tucker, E.B. Why Gold? Why Now? (2020).