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Q: Why would a country prefer borrowing to printing its own money for development? ( Answered, 12 Comments )

Question

Subject: Why would a country prefer borrowing to printing its own money for development?
Category: Business and Money > Economics
Asked by: bigben1-ga
List Price: $200.00

Posted: 25 Jan 2006 09:18 PST
Expires: 24 Feb 2006 09:18 PST
Question ID: 437511

Why would a country prefer borrowing from outside to printing its own money for development? Why would such loans from abroad, which would have to be transformed into local currency to be of any use, be any better against inflation than increasing the money supply through loans made available by banks (even if the deposits in those banks came from money printed by the government). I want to prove they aren't. NOTE ONE: Assume for the sake of this question that we are talking of money for LOCAL inputs for development, not for imports. NOTE TWO: Any answer that has to do with the inflationary influence of printing money would not be valid (because that is not my question) unless it proves that borrowing money from abroad for LOCAL inputs needed for development, such as labor, etc. would NOT cause that inflation. NOTE THREE: Any answer that has to do with using local money ALREADY printed by the country to exchange the foreign currency coming through a loan would not be valid since my question pertains to LARGE inputs of money for LARGE development not being able to be absorbed by the local money already printed. NOTE FOUR: I'm looking for some quotable economic theory to make my case (and I'll have a tip for that). Even if those quotes will only but clearly show that the true obstacle to fast development is the fear of inflation on the part of governments and NOT lack of money the payment and tip will be due. Even if there's some quotable economic source that clearly REFUTES what I want to prove (showing that borrowing money from abroad and printing local money to convert it and use it is better than simply printing the money) payment and the tip offered through this question will be due.
Request for Question Clarification by pafalafa-ga on 25 Jan 2006 09:28 PST bigben1-ga, While I'm interested in your question, past experience has shown that customers who want a particular outcome (It's better to print money than to borrow) are rarely satisfied with an answer that argues to the contrary. However, I can't imagine a situation where anyone could argue, on sound economic principle, that it is, in fact, better to just print money. Neither economic theory nor experience support this. Ultimately, your question revolves around other questions such as "What is money?", and "Why does anyone assume it has any value whatsoever?" If you'd like some discussion of these, I can perhaps take a crack at it. But I don't think I can demonstrate that printing money is the preferred approach to development. Let me know your thoughts on this, pafalafa-ga
Clarification of Question by bigben1-ga on 25 Jan 2006 09:52 PST I WOULD BE SATISFIED WITH AN ANSWER THAT ARGUES CLEARLY TO THE CONTRARY. "I can't imagine a situation where anyone could argue, on sound economic principle, that it is, in fact, better to just print money." MY QUESTION IS WHY? IF FAST DEVELOPMENT IS DESIRED IT SEEMS TO ME IT WOULD AVOID THE DEBT WHILE PRESENTING THE EXACT SAME PROBLEMS WITH INFLATION? "I don't think I can demonstrate that printing money is the preferred approach to development." EVEN IF YOU CAN DEMONSTRATE WHY IT IS NOT THE PREFERED APPROACH(TO FAST DEVELOPMENT) I'LL BE HAPPY. BUT SAYING THAT INFLATION WILL ENSUE WOULD NOT BE AN APPROPRIATE ANSWER. FINDING QUOTES THAT SAY THAT FAST DEVELOPMENT SHOULD BE AVOIDED DUE TO INFLATIONARY PRESSURES (ESPECIALLY IF THEY SAY THAT IS SO NO MATTER WHERE THE MONEY COMES FROM) WOULD ALSO SATISFY ME. ANOTHER MEANINGFUL ANSWER COULD BE ONE THAT SHOWS WWHHYY IT IS BBEETTTTEERR TO BORROW AND THEN PRINT TO CONVERT THE BORROWED MONEY, THAN STRAIGHT PRINTING. A GENERAL DISCUSSIION ABOUT "What is money?", and "Why does anyone assume it has any value whatsoever?" WOULD NOT BE OF INTEREST TO ME THANKS FOR ANSWERING SO FAST.
Request for Question Clarification by pafalafa-ga on 26 Jan 2006 06:01 PST bigben1-ga, I'm looking into your question, and I'd like to get your feedback on two things: 1. I'm perplexed by your condition that all spending be local. While I can see this happening for a small-scale development, it seems to me that any large-scale project is going to involve imported goods and services... computers, cell-phones, civil engineers, steel, oil, etc. Can you elaborate a bit on what you had in mind with this particular restriction. And maybe give an example of the type of development project to which it would apply. 2. Have a look, please, at this link on hyperinflation: http://www.econlib.org/library/Enc/Hyperinflation.html which discusses, among other things, the classic example of German hyperinflation between the two world wars. The culprit, for the most part, was printing money. Do you have any qualms with the explanations provided here? International loans don't, as far as I know, lead to hyperinflation. Printing money does. That strikes me as an important difference, but I'd like to know your thoughts about it. Thanks, paf
Clarification of Question by bigben1-ga on 30 Jan 2006 11:04 PST "I'm perplexed by your condition that all spending be local. While I can see this happening for a small-scale development, it seems to me that any large-scale project is going to involve imported goods and services... computers, cell-phones, civil engineers, steel, oil, etc. Can you elaborate a bit on what you had in mind with this particular restriction. And maybe give an example of the type of development project to which it would apply." I WANT TO FOCUS ON THE LOCAL COMPONENT OF THE PROJECT. I WANT SOMEONE TO TELL ME WWHHYY A FOREIGN LOAN IS BETTER THAN PRINTING MONEY FOR THE LLOOCCAALL COMPONENT OF THE PROJECT (EVEN IF THE PROJECT WILL ALSO NEED A FOREIGN COMPONENT). BY LOCAL COMPONENT I MEAN LOCAL LABOUR, LOCAL SUPPLIES, ETC. I KNOW THAT THE CONVENTIAL WISDOM IS (as you say): that "International loans don't, as far as I know, lead to hyperinflation." BUT IS IT REALLY SO? AND IN THAT CASE WHY? I WAS ONCE TOLD THAT YEARS AGO THERE WAS INFLATION IN VENEZUELA FROM CONVERTING THEIR OIL DOLLARS INTO LOCAL CURRENCY FOR LOCAL DEVELOPMENT. THEN WWHHYY CONVERT THE DOLLARS IN THE FIRST PLACE? WHETHER EARNED OR BORROWED. WWHHAATT ADVANTAGE DOES THAT GIVE YOU THAT PRINTED MONEY WOULDN'T. THE ARTICLE YOU MENTIONED SHOWS ME WHAT WILL HAPPEN WHEN YOU CIRCULATE ADDITIONAL MONEY WITHOUT PRODUCING MORE--NOT WHY ONE SOURCE OF CIRCULATING MONEY IS BETTER THAN THE OTHER. REGARDS.

Answer

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
Answered By: guillermo-ga on 31 Jan 2006 23:31 PST

Hello Bigben1-ga (Big Beni, maybe?), In order to organize my answer logically, please let me split you question in two interrelated main aspects: One is why would a country prefer borrowing money from abroad, i.e., contracting an external debt than printing local currency. The other issue is whether that is necessarily the only way to finance development, as opposed to doing so by printing local currency. I'll address the former first. We live in the era of "fiat money", as opposed to "commodity money". Commodity money, gold for instance, used to be a good with an inherent value itself. Fiat money (from Latin fiat = trust) implies a reliance from the society in the value "behind" an object (typically paper), represented by that object, which has a negligible inherent value. Now, what is the real value "behind" the note, in which the society trust? It is the totality of the economic production in the country, what economists define as the Global Domestic Product -- GDP. The currency unit in a country can be thought of as a fraction, a portion of the GDP or, more exactly, a representation of that portion. Let's suppose that a person who owns a small business wants to develop it. Maybe she has four part-time employees, and wants it to be more productive by duplicating their time at work, hiring them full-time. (You can see that I'm using it as a simplified analogy of your scenario, leaving aside the needs for external resources, such as feedstock for production). Now, supposing that the workers have no problem with the extension of the working time, they will accept it as long as they increase their payment. So, our entrepreneur will need to invest more capital in order to finance that improvement. There are three possible scenarios: 1. The company has accumulated capital enough to self-finance the projected development -- no external capital is needed. 2. The owner has personal savings and is willing to invest them in her enterprise -- the company receives an external loan from her owner. 3. The owner either doesn't have personal savings or if she does, she's not willing to invest them in her enterprise -- the company takes a loan from a bank. If this was a country instead of a small business, none of these scenarios would be the one in which the state decided to print more money. The first case would be a rare situation in which the nation's development plan could be fulfilled entirely with national resources, such as state investment and domestic banks loans to finance whatever initiative. In your question, this would correspond to the case in which the use of local money already printed. In the second case and third case, an external source is financing the development, if it was a nation, it would be contracting an external debt. If in the small business analogy the lender was the owner itself or a bank, is irrelevant -- in both cases it was an external entity in relation to the company. What would be the analogy in the small business example for the case in which the government decides to finance the development by printing currency? Well, let's suppose that the owner pays the four employees a total amount of $4,000 a month. Now, since they are going to work double time since next month, instead of giving them forty $100 bills -- ten $100 each -- she will double the payment by giving them eighty $50 bills -- twenty $50 bill each. That is approximately what a country does when just prints money. Of course, the four employees will not accept the deal. They will immediately notice that they will work twice as much for the same money. In other words, they will immediately notice that their payment will be depreciated. They will receive the double of papers, but the actual value will be the same, while they will be delivering twice their work. When a country prints money to finance the acquisition of resources such as work, feedstock, machinery, or whatever good is needed, even in the domestic market, the economic players will eventually notice that there are more papers, but not more value behind them, the value remains the same. The difference is that the perceiving the depreciation may take some time, because it's not as obvious as changing one paper of $100 by two of $50, and also because there are billions of the currency unit involved, and tens or hundred millions of people. In that time lapse is when inflation takes place, as the visible part of the economic process in which the society realizes that their currency has no longer the same value. And eventually that may lead to strikes of workers who ask for their wages to regain their real value, and other forms of social uneasiness. Please notice that inflation here is not mentioned as the cause of the inadequacy of printing money as a way to finance development. The cause is that increasing the money supply depreciates the purchasing power of money, being the rise of prices (inflation) what makes it evident. Now, why does it happen? Because the circulating amount of money has got unbalanced with respect to the GDP, which is what gives substance to what the currency -- actually not more than a conventional symbol -- represents. But, what is different if the country borrows money from abroad? The difference is that the country is actually entering more capital to its economy. The currency in which the country receives the loan is as strong or stronger than its own, that is, it's backed by a solid GDP from its country of origin. The fact that the loan was granted implies a reliance in the future capacity of the borrower to repay the loan and its interests. (Theoretically, we all know that the debt crisis are one of the current major problems of world economy). Anyway, assuming both conditions -- strength of the foreign currency and reliability of the local economy to repay the debt -- makes possible to the country to print money backed on the borrowed foreign currency. I'm sorry if the explanation above doesn't contribute to make your point, but is my honest understanding of the phenomenon, as is confirmed by the sources I'll post below. However, up to a certain point development seems to be financed by increasing the money supply, but not relying only on it -- instead, managing a balance includes in the equation external and internal debt, and economic growth. Anyway, particular historic moments -- either desperate or epic, or both -- may require innovation and courage to do the unexpected and succeed. Such as the American Revolution, which was financed practically only by continuous money supply increasing and hyperinflation. However, in the aftermath the American economy was exhausted and did have to resort to external debt. I believe this should satisfactory answer your question. Otherwise, or if some point is not clear enough, please ask me for clarification and I'll be pleased to respond. Sincerely, Guillermo
Clarification of Answer by guillermo-ga on 01 Feb 2006 00:17 PST Rather than a search strategy, I consulted sourced already known. Sources: For a general understanding of money itself see: http://en.wikipedia.org/wiki/Money Quote: "Fiat money is a relatively modern invention. A central authority (government) creates a new money object that has negligible inherent value. The widespread acceptance of fiat money is most frequently enhanced by the central authority mandating the money's acceptance under penalty of law and demanding this money in payment of taxes or tribute." And also: http://en.wikipedia.org/wiki/History_of_money "Fiat money refers to money that is not backed by reserves of another commodity." "Governments through history have often switched to forms of fiat money in times of need such as war, sometimes by suspending the service they provided of exchanging their money for gold, and other times by simply printing the money that they needed. When governments produce money more rapidly than economic growth, the money supply overtakes economic value. Therefore, the excess money eventually dilutes the market value of all money issued. This is called inflation." To explore the concept of public debt: http://en.wikipedia.org/wiki/Government_debt "Governments borrow money in a currency for which the demand is strongest. The advantage of issuing bonds in a currency such as the euro or the US dollar, is that the universe of investors for the bonds is very large. Countries such as the United States, France and Germany have only issued in their domestic currency. Relatively few investors are willing to invest in currencies that do not have a long track-record of stability. The disadvantage for a government issuing bonds in a foreign currency, is that there is a risk that they will not be able to obtain the foreign currency to pay the interest or redeem the bonds. In 1997/1998, during the Asian financial crisis this became a serious problem when many countries were unable to keep their exchange rate fixed due to speculative attacks." Particularly, external debt: http://en.wikipedia.org/wiki/External_debt "Having understood external debt as that part of sovereign (or government debt) of a country which is owed to outsiders (or foreigners), it can be defined as the total outstanding liabilities to the external world on behalf of the host nation. This brings us to a clear proposition that any flow of funds from outside a country inwards, in the form of debt, shall comprise a part of the external debt of the country, provided it is borrowed on government account. A borrowing of an individual or corporate of a nation from outside is not included in this term external debt as it is one specific to or on behalf of the government." Money supply: http://en.wikipedia.org/wiki/Money_supply "Money supply ("monetary aggregates", "money stock"), a macroeconomic concept, is the quantity of money available within the economy to purchase goods, services, and securities." "...if the money supply grows faster than real GDP (unproductive debt expansion), inflation must follow as velocity has been shown to be relatively stable." Gross Domestic Product (GDP): http://en.wikipedia.org/wiki/GDP "GDP is defined as the total value of goods and services produced within a territory during a specified period (...), regardless of ownership." You will notice that, in general, I turned into a more regular language the very much technical explanations from some parts of the articles mentioned above. About the money supply during the American Revolution: Excerpts / synopsis from Davies, Glyn. A history of money from ancient times to the present day, 3rd ed. Cardiff: University of Wales Press, 2002. http://www.ex.ac.uk/~RDavies/arian/northamerica.html "When the war broke out the monetary brakes were released completely and the revolution was financed overwhelmingly with an expansionary flood of paper money and so the American Congress financed its first war with hyperinflation. By the end of the war the Continentals had fallen to one-thousandth of their nominal value. Yet although the phrase not worth a Continental has subsequently symbolized utter worthlessness, in the perspective of economic history such notes should be counted as invaluable as being the only major practical means then available for financing the successful revolution." "The financial chaos of the aftermath of the revolution and outbreaks of violent conflict between debtors and creditors led to the establishment of the dollar as the new national currency replacing those of individual states. However, owing to shortages of gold and silver bullion and the rapid disappearance of coins from circulation legal tender was restored to Spanish dollars in 1797 and it was not until 1857 that the federal government felt able to repeal all former acts authorizing the currency of foreign gold or silver coins, but by then coins were merely the small change of commerce."
Request for Answer Clarification by bigben1-ga on 01 Feb 2006 01:47 PST Hi Guillermo (Guillermo who?), While I appreciate the effort, and your answer comes slightly closer to the topic than those from researchers I've dealt with before through google, your answer does not go to the crux of the matter. Reliability of the local economy to pay the debt is equivalent to my premise that the printed money WILL turn into actual production. I don't see how the fact that the country is actually entering more capital through foreign currency loans that rely on the local economy's ability to pay makes a difference, for local inputs, except perhaps if the money about to be circulated for local inputs DOESN'T turn into production. In that case it might be an insurance against failure, but I can't see how it makes any difference in the case of success. It would seem obvious that increasing the money supply would depreciate the purchasing power of money initially just the same, no matter whether this supply is backed by a foreign currency or not. I find it fascinating that there doesn't seem to be any contradiction to this point but no one would have discussed it or will admit it. Please note that I wouldn't be able to accept as valid your answer yet. Expressing the answer in terms of depreciation of the purchasing power of money is not different from expressing it in terms of inflation, because I'm sure you will appreciate 9no pun intended) they are two sides of the same coin or two ways of looking at one and the same phenomenon. My question therefore was and continues to be how would this one PHENOMENON be any different with borrowed money than with printed money; and if it isn't, has any economic theory or economist or politician in power or after leaving power ever admitted it in a quotable manner. Have they said something like "it's not that they lack the means to fund development--they could print money--(at least insofar to local components) but they aren't sure about success, so they would rather let someone else like a foreign country or bank take the risk and bring in THEIR capital, which if worse comes to worse, could be converted into foreign-goods-and-unpaid-debt instead of no-goods-and-inflation; and if no one will lend them foreign capital, the country is willing to take, as good enough for them, the foreign assesment that they are bound to fail, so why try themselves to do something with their currency; and they can hide behind economic terms to justify doing nothing, instead of admitting that THEY are unwilling to rely on their resources and capacity for success and roll up their sleeves--they would rather say 'everyone knows that printing money is bad, just ask the IMF,' rather than saying 'by that we are actually being told we can't be succesful, so that's fine with us'" If any good quotable source has said something like this it would prove my point and I would be satisfied. If anyone can prove that this is not so, I would also be satisfied. If neither of these two things exist, maybe we're breaking ground here and I'm the quotable source.
Clarification of Answer by guillermo-ga on 01 Feb 2006 07:26 PST Hello Bigben1, Thank you for your appreciation of my work and your recognition that I've gone a bit closer to the point. I'm most willing to go further and satisfy the points you are highlighting, I would just ask you please for a little patience, because right now I'm leaving town for three days to a place where no Internet access is available. I'll be able to address the topic again at my return on Saturday. I count on your understanding. That is mainly for the search of quotable statements. However, I can tell you in advance something about the concept behind. If I take it right, the core of the problem is what difference it makes if the printed money has a foreing reliable currency backing it or not. The difference is that, since the country is needing (or willing) a development beyond the financial capacity it already has acquired -- and which is represented by the currency already printed, or printable according with its accumulated wealth -- it won't make any economic positive effect to print unbacked papers because the players in the economy will see soon that they are not the document for any real wealth. Instead, when a country borrows money in a currency from a country which is already backed by a wealthy economy, it is actually borrowing the corresponding part of wealth (industry, services, machinery, dams, roads, agriculture, etc) of that country (in proportion to the amount of the money the borrower country receives with respect to the total money supply of the lending country). It is similar to when a finantial institution holds shares of a company and issues any kind of finantial paper representing quotas of those shares. If the company is successful enough, people would accept to by them, because they are backed on shares that are backen on assets of a company they already rely. But if the financial institution issued its documents with no backing, it's highly unlikely that they will have any acceptance in the market. What the borrowed foreign currency provides is not only a symbolic reliability, is very materially the additional wealth that the borrower country needs to finance its desired development beyond what its present wealth would allow it. The example I gave about the American Revolution is not just symbolic, it is very related to the issue you point out about "relying on their resources and capacity for success and roll up their sleeves". That is what that first generation of Americans did -- and we're talking about one of the nations that historically has shown the highest capacity for that (you can take my word for it, I'm not an American :) However, while they did manage to finance the war by printing money, in the aftermath their economy was exhausted and they desperately needed to resort to foreign monetary resources. As you can see, I'm most commited to provide you satisfactory explanations to your issue. I ask you please to pospone for a few days your final decision on this answer, so I can find a post supportive quotes on the subject. Also, I commit myself to dig in search for any authorative assertion that could support your case as well, I will not only limit my search to the explanations I've already given you. Thanks for your patience. Best regards, Guillermo (sorry, posting my last name would go against Google Answers' rules)
Clarification of Answer by guillermo-ga on 04 Feb 2006 12:16 PST Just an update. I'm just back and working on it. I'll be in touch. Guillermo
Clarification of Answer by guillermo-ga on 05 Feb 2006 10:47 PST Still working. Thanks for your patience. Guillermo
Clarification of Answer by guillermo-ga on 07 Feb 2006 06:29 PST New update. In order to satisfactorily respond to your clarification request, I'm looking through many, high level sources on economics. This may take a few more days. I thank you for your patience and understanding so far, and ask you please for a little more, thus in the end you can have information to rely on. Thanks in advance. Sincerely, Guillermo
Clarification of Answer by guillermo-ga on 17 Feb 2006 07:39 PST Hello Bigben1, Just to let you know I didn't leave the boat :) I'm getting closer. Please keep the faith -- and patience. Thank you. Guillermo
Clarification of Answer by guillermo-ga on 17 Mar 2006 10:40 PST Dear Bigben1, I am at the end of my research now, and persuaded that you will find the outcome most exciting. It seems that you weren't so much out of the right track after all, and I have collected enough authoritative statements to back it. No need to say that this has been one of the most interesting researches I've ever done. Please let me organize the data -- I'll try to have it ready today, or tomorrow as latest. I think you'll find your patience well rewarded. Best regards, Guillermo
Clarification of Answer by guillermo-ga on 20 Mar 2006 05:32 PST Sorry for the new delay. I'm working on my report -- it's just a matter of hours now. Guillermo
Clarification of Answer by guillermo-ga on 21 Mar 2006 01:28 PST Hello Bigben1-ga, It took me a lot of time, but we're finally there. I am not an economist -- actually, a Social Psychologist, and a GA researcher who likes economics and used to believe that was familiar with its basics and maybe a little more; I mean, the habitude of reading economic literature understanding its concepts -- rather than its mathematical models. Now I realized - thanks to your question - that what I was familiar with is a certain economics' "common sense", meaning by this a type of knowledge generally accepted to be correct, which while often is so, also often is either obsolete or at least being challenged by new scientific research. This is precisely what further research brought out about your subject so, despite what the commenters below and myself have said, there is economic thought in the lines you are thinking over. When I posted a simple update on February 17th, all the new material I had found was confirmatory of my original answer's approach. Thus, my final clarification was to be a reformulation of the answer in order to better explain the point, with more backing, and some corrections. But honestly, I had nearly given up the hope of finding support for your thesis -- which, by the way, I really wanted to prove right, or at least plausible. I had just a few results left to review from my varied keyword combination searches -- and then, when I didn't expect it anymore, there it was the nugget! The keyword combination that did the trick was <"sovereign debt" "money supply"> [://www.google.com/search?num=100&hl=en&lr=&safe=off&rls=GGLG%2CGGLG%3A2006-06%2CGGLG%3Aen&q=%22sovereign+debt%22+%22money+supply%22&btnG=Search ] Among its results there was an article at Safe Haven signed by Henry C. K. Liu, titled "Liberating Sovereign Credit for Domestic Development Part I: The Curse of Dollar Hegemony" - November 27, 2005 (http://www.safehaven.com/article-4176.htm ). In said article, Mr. Liu critics the dominant neo-liberal monetarist thinking, and analyzes the current "dollar hegemony", denouncing -- according to his opinion -- its distorting effect on the world economy, on the ability of sovereign countries other than US to freely use their own fiat currencies to finance their development, and finally warns about the embedded risks to the American economy itself. And more specifically regarding your question, he states that A SOVEREIGN GOVERNMENT IS ENTITLED TO ISSUE FIAT MONEY TO FINANCE NATIONAL DEVELOPMENT WITH NO NEED TO BACK IT THROW BORROWING, because -- according to his standpoint -- all a government needs to back its fiat money is to make it the ultimate means to pay taxes. In the article, there are passages such as: "Government levies taxes not to finance its operations, but to give value to its fiat money as sovereign credit instruments. (...) Technically, a sovereign government needs never borrow. It can issue tax credit in the form of fiat money to meet all its liabilities. And only a sovereign government can issue fiat money as sovereign credit." (...) "The sovereign state, representing the people, owns all assets of a nation not assigned to the private sector. This is true regardless whether the state operates on socialist or capitalist principles. Thus the state's assets is the national wealth less that portion of private sector wealth after tax liabilities, plus all other claims on the private sector by sovereign right. (...) As long as a sovereign state exists, its credit is limited only by the national wealth. If sovereign credit is used to increase national wealth, then sovereign credit is limitless as long as the growth of national wealth keeps pace with the growth of sovereign credit. "When a sovereign state issues money as legal tender, it issues a monetary instrument backed by its sovereign rights, which includes taxation. A sovereign state never owes domestic debts except by design voluntarily. (...) When a sovereign state borrows foreign currency, it forfeits its sovereign credit privilege and reduces itself to an ordinary debtor because no sovereign state can issue foreign currency." It sounds to me pretty much in the lines of your argument. Now, this is particularly interesting: without leaving the line of reasoning that supports your same case -- rather, strengthening it -- this author provides an answer to your specific question "why would a country prefer borrowing...?" The point is that, instead of explaining it as a practice justified as part of a healthy economic policy, Mr. Liu exposes it as a manifestation of a dysfunctional global economic order: "Dollar hegemony is a geopolitical phenomenon in which the US dollar, a fiat currency, assumes the status of primary reserve currency in the international finance architecture. (...) dollar hegemony is objectionable not only because the dollar, as a fiat currency, usurps a role it does not deserve, but also because its effect on the world community is devoid of moral goodness, because it destroys the ability of sovereign governments beside the US to use sovereign credit to finance the development their domestic economies, and forces them to export to earn dollar reserves to maintain the exchange value of their own currencies." (...) "Any government printing its own currency to finance legitimate domestic needs beyond the size of its foreign-exchange reserves will soon find its convertible currency under attack in the foreign-exchange markets, regardless of whether the currency is pegged at a fixed exchanged rate to another currency, or is free-floating. Thus all non-dollar economies are forced to attract foreign capital denominated in dollars even to meet domestic needs. But non-dollar economies must accumulate dollars reserves before they can attract foreign capital. Even with capital control, foreign capital will only invest in the export sector where dollar revenue can be earned. But the dollars that exporting economies accumulate from trade surpluses can only be invested in dollar assets, depriving the non-dollar economies of needed capital in domestic sectors. The only protection from such attacks on domestic currency is to suspend full convertibility, which then will keep foreign investment away. Thus dollar hegemony, the subjugation of all other fiat currencies to the dollar as the key reserve currency, starves non-dollar economies of needed capital by depriving their governments of the power to issue sovereign credit for domestic development." Therefore, under this viewpoint there is a reason why non US countries seem compelled to borrow foreign currency -- namely, US dollars -- to back its own, but due to very different reasons than those provided in my original answers and in several comments, convinced that is was necessary to keep the value of the domestic currency of those countries while increasing the money supply. According to this viewpoint (which, by the way, I find very much worthy of attention), "all non-dollar economies are forced to attract foreign capital denominated in dollars even to meet domestic needs" because otherwise the local currency will be depreciated by the pressure of the dollar hegemony via the currency exchange market -- this would be a inherent to the dollar hegemony. Now, what "viewpoint" is the one this author is speaking from? He mentions a line of thought: "The State Theory of Money (Chartalism) holds that the general acceptance of government-issued fiat currency rests fundamentally on government's authority to tax. Government's willingness to accept the fiat currency it issues for payment of taxes gives such issuance currency within a national economy. That currency is sovereign credit for tax liabilities, which are dischargeable by credit instruments issued by government in the form of fiat money. When issuing fiat money, the government owes no one anything except to make good a promise to accept its money for tax payment." (...) "The Chartalist theory of money claims that government, by virtual of its power to levy taxes payable with government-designated legal tender, does not need external financing." (...) "according to Chartalist theory, an economy can finance with sovereign credit its domestic developmental needs, to achieve full employment and maximize balanced growth with prosperity without any need for sovereign debt or foreign loans or investment, and without the penalty of hyperinflation. But Chartalist theory is operative only in predominantly closed domestic monetary regimes. Countries participating in neo-liberal international "free trade" under the aegis of unregulated global financial and currency markets cannot operate on Chartalist principles because of the foreign-exchange dilemma." "Under principles of Chartalism, foreign capital serves no useful domestic purpose outside of an imperialistic agenda. Dollar hegemony essentially taxes away the ability of the trading partners of the US to finance their own domestic development in their own currencies, and forces them to seek foreign loans and investment denominated in dollars, which the US, and only the US, can print at will with relative immunity." So that is the school of economic thought that Mr. Liu seems to adhere to -- Chartalism (from Latin "charta" - ticket or token). Well go further into it later but, first, I had to solve another problem. I didn't know Henry C. K. Liu, never had heard of him before, so I had to learn enough of him to confirm he was authoritative enough to quote him. According to Wikipedia: "Henry C.K. Liu is an independent commentator on culture, economics and politics. He was born in Hong Kong and educated at Harvard University in architecture and urban design. Liu developed an interest in economics and international relations while working as a professor at UCLA, Harvard and Columbia University on interdisciplinary work on urban and regional development. Liu is currently the chairperson of a New York-based private investment group and a contributor to Asia Times Online. "The term "dollar hegemony" was coined by Liu to describe how he sees the dollar, a fiat currency since 1971 that yet continues to play the role of the major reserve currency distorts global trade and finance. Liu is a critic of the United States and the policies of its government and also a critic of central banking. Liu calls for the use of sovereign credit in lieu of foreign capital for financing domestic development in developing countries." (http://en.wikipedia.org/wiki/Henry_C.K._Liu ) Well, I decided that even though not having a degree in economics, an architect and urbanist from Harvard, teaching in there, and also in Columbia and UCLA, is someone that deserves being taken seriously on economics, especially if is making a living by running an investment group and is a regular columnist for the Asia Times. Now, the next logical step is to find out what is Chartalism about. Briefly, the word chartalism, referring to a token, expresses the notion that money -- coins, paper or whatever -- has no inherent value but, opposing to "metallism", which argues that the money originated in the inherent value of precious metals. Interestingly, the debate goes all the way back to the origin of coinage, and no matter how distant this may seem from the economic problems of our time, it actually makes sense. The metalists argue that the markets, in their evolution, needed to find a commodity that all the players would accept as a medium of exchange and that, eventually, precious metals became the best choice, and thus coins were made of precious metals so that money would be measured by their inherent value according to its weith. Conversely, the chartalists contend that coins originated in the claim by the state -- authority -- of the right to establish the value of the unity of measure -- thus reducing the coin -- regardless the material it was made of -- to just a token. In present times when the gold standard was left aside, virtually all money in the world is somehow "chartalist" money, as much as we can assimilate it to "fiat money". However, there is a deeper issue in the debate. Chartalists insist in the idea that money is not a spontaneous byproduct of the market, but a "creature of the state" as expressed by Abba Lerner, one of the authors of this school of thinking (Money as a Creature of the State - http://f.staff.umkc.edu/fkfc8/Lerner.htm ). Thus, neo-liberal monetarists, while accepting fiat money, are not chartalists. The first thinker who apparently used the word "chartalism" was German economist Georg Friedrich Knapp, in his book The State Theory of Money (1924) (http://socserv.mcmaster.ca/econ/ugcm/3ll3/knapp/StateTheoryMoney.pdf ). Now, before Knapp, in an article for "The Banking Law Journal", Vol. 31 (1914), Pages 151-168 by Mitchell Innes called "The Credit Theory of Money" (http://www.warrenmosler.com/docs/credit_theory_of_money.htm ), in which exposes how the money is created by an authority as a credit for the payment of taxes, being this precisely the only backing that money needs to be accepted and, thus, have value. John Maynard Keynes embraced both authors, recognizing their influence in his thought. To learn about the contemporary view of chartalism, through its history and digging back to the very origin of money on ancient Greece, you can read the article by L. Randall Wray "The Neo-Chartalist Approach to Money" (2000) (http://www.cfeps.org/pubs/wp-pdf/WP10-Wray.pdf ), from which I extracted the following excerpts: "As Kurke argues, the 'mystification' of the origins of money that ties it to markets (rather than to the polis or state) is ideological?as it remains today?a purposeful rejection of the legitimacy of democratic government." "Money is, and always has been, a ?creature of the state? (in Lerner?s felicitous phrase), and currency has always been a state token." "The value of a Chartal money (that is, its value in terms of what it can buy) depends on the difficulty of obtaining it. If the state simply handed out HPM [high powered money] on request, its value would be close to zero, as anyone could meet her tax liability simply by requesting HPM. On the other hand, if the state required an hour of hard labor to obtain a unit of HPM, then that unit would be ?worth? an hour of hard labor. As the monopoly issuer, the state can determine what must be done to obtain its HPM, thus, can set the value of HPM far above the value of the material from which it is manufactured. This is why precious metal coins issued by the state normally carried a nominal value far above the value of the embodied precious metal." Also, the article by Pavlina R. Tcherneva "Money: A Comparison of the Post Keynesian and Orthodox Approaches" (2001) (http://cas.umkc.edu/econ/Oeconomicus/VolumeIV/Winter2001/Tcherneva.pdf ) is illustrative of the current debate. Both Randal Wray and Pavlina Tcherneva make part of the Center for Full Employment and Price Stability, "a non-partisan, non-profit policy institute at the University of Missouri - Kansas City" (http://www.cfeps.org/ ) Now, I do think I have fulfilled your requirement, I hope you will agree, and that the reading and research behind the report compensates the long waiting. One last clarification. In my original answer I referred the word "fiat" (from "fiat money") to an alleged Latin origin meaning "trust". Later I realized that it was a mistake -- with an explanation, though. An equivalent expression for "fiat money" is "fiduciary money", being the word "fiduciary" the one that comes from Latin "fiducia" meaning "trust". I was mixed up by the coincident first syllable "fi", but actually fiat means in Latin "let it be done" (alluding to the government authority) (http://en.wikipedia.org/wiki/Fiat_money ) (http://en.wiktionary.org/wiki/fiat ) It's been a most enlightening research for me. I hope you share my enthusiasm. Please ask for clarification if you need so. Best regards, Guillermo

Comments

Subject: Re: Why would a country prefer borrowing to printing its own money for developme
From: siliconsamurai-ga on 25 Jan 2006 10:01 PST

For the reason pafalafa cited I would be more likely to answer this
sort of question if the four points were broken into seperate $50
questions.

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
From: bill22-ga on 02 Feb 2006 05:34 PST

I have a comment (I did not take the time to read thru the complete
answer)and I am not an economist. The simpler the answer the better.
The main reason a country will borrow instead of print is the
perception of INFLATION and the rate of INFLATION. Examples of the
extreme help people see the point easier. Lets say a country of ten
people borrows money from abroad to build a theme park. The associated
liability and the revenue generation from the theme park will pay off
the liability with the printed dollars and keep the net total dollars
in circulation the same over time. IF the ten person country prints
dollars there is no liabilty the dollars are constantly in
circulation. This is an implied perception ( you can see it in the
macro currency markets)

ONe thing I think you are headed to is that over time the inflation
rate must equal the long term average interest rate in that country or
else the debt could be never paid back. IE I borrow all the money in
the ten person country at a rate of 5%. If there is not 5% etxra money
(notes) around I cant pay back the debt. This is what I mean by rate
of inflation in the above example the rate of inflation is much lower
than printing because of the associated LIABILITY.

If you start thinking along these lines I think you can see why
governments prefer borrowing.

Subject: Re: Why would a country prefer borrowing to printing its own money for developme
From: siliconsamurai-ga on 02 Feb 2006 11:49 PST

Bill22 is close with the inflation angle.

The truth is that all countries are currently printing money as fast
as possible (that was what the past few years of low interest rates
actually translated to) in an effort to devalue their fiat currencies
and thus make thier goods cheaper - the same thing was tried before
(Smoot Hawley Act) where tarrifs were used.

If you doubt that this has happened, just look at the value of gold.
Gold is REAL money and when gold goes up in price that actually means
the local currency is, in fact, falling.

That is why you don't want to print more money, as with Germany after
WWI, you eventually end up with a major depression.

Subject: Re: Why would a country prefer borrowing to printing its own money for developme
From: elids-ga on 02 Feb 2006 14:14 PST

Yup they are right. I think that your question boils down to this one statement

?It would seem obvious that increasing the money supply would
depreciate the purchasing power of money initially just the same, no
matter whether this supply is backed by a foreign currency or not.?

The difference is that the borrowed money wont depreciate the value of
the existing monetary unit because you pay for it in ?interest? that
will be paid with the production of future goods. You are borrowing
foreign funds to pay them back with the production you would otherwise
not have, so only after you?ve increase your production will the
interest play a part on your economy. If you fail to increase your GDP
then your rationale would apply, but still it will be sometime in the
future, when the debt payments are due.

You can?t lift yourself off of the ground, regardless of how strong
may be. If on the other hand you have a partner (regardless of how
weak) give you a helping hand, you can use him as a stepping stone.

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
From: bill22-ga on 02 Feb 2006 15:39 PST

I think people are seeing the point the Borrow versus print is a
perception and a rate thing. Money borrowed over the long term does
not increase money supply but it general it has to since how could you
pay the interest without increasing the money supply (small country
example above). Printing money is an immediate and quick devaluation.
SO the answer to the question is the government wants to control the
rate and perception of inflation that is why they borrow instead of
print money!!

PS the government prints money all the time one branch gets the fed
reserve notes and one branch gets the bond. the reserves notes go into
cerculation and future genreations get the debt!!!!!

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
From: bigben1-ga on 05 Feb 2006 18:43 PST

Thank you for your comments Bill22, Siliconsamurai and Elids.

I'm also not an economist, but I appreciate your comments to my
question. Let me introduce another element. Suppose the project was
not a theme park as in Bill's example, but an orange grove with
exportable oranges. And the money printed to grow them was (call it)
Pesetas (or some local currency). In case of success of the project
the hard currency revenues from these exports would be used to buy
back the extra local curency printed so that the additional currency
issued to get the project going would not be in constant (permanent)
circulation.

Would this not be like paying back the debt? What would the real
advantage (as opposed to a perceived one) of borrowing outside be in
this case? Notice that my assumption is that all inputs for the
project can be obtained locally with local currency that would have to
be printed (because there isn't enough) whether you borrow first or
you just issue.

Subject: Re: Why would a country prefer borrowing to printing its own money for developme
From: elids-ga on 07 Feb 2006 21:24 PST

Ok lets use a real example it might be easier to follow. The the world
has in US currency  around 600 billion dollars in circulation as shown
in the table below, source
http://www.frbatlanta.org/invoke_brochure.cfm?objectid=83FD41E6-9AF0-11D5-898400508BB89A83&method=display_body


Date                  Amount of
                        Cash in                         Amount of Cash
                        Circulation                  per Capita*
June 30, 1910     $   3,148,700,000     $    34.07
June 30, 1920     $   5,698,214,612     $    53.18
June 30, 1930     $   4,521,987,962     $    36.74
June 30, 1940     $   7,847,501,324     $    59.40
June 30, 1950     $  27,156,290,042     $   179.03
June 30, 1960     $  32,064,619,064     $   177.47
June 30, 1970     $  54,350,971,661     $   265.39
June 30, 1980     $ 127,097,192,148     $   570.51
June 30, 1990     $ 266,902,367,798     $ 1,062.86
June 30, 2000     $ 571,121,194,344     $ 2,075.63
*In the United States


assuming that we were to do what you suggest would result in more or
less this scenario:

Today the US has about 8.2 TRILLION dollars of EXTERNAL (external debt
only, if you count internal debt it is closer to 28 Trillion) debt if
we were to convert all of our debt into US currency and attempt to pay
it off, our dollar would be almost worthless because of the incredible
mountains of us currency circulating in the world. Which goes back to
Guillermo-ga's original explanation of

"We live in the era of "fiat money", as opposed to "commodity money".
Commodity money, gold for instance, used to be a good with an inherent
value itself. Fiat money (from Latin fiat = trust) implies a reliance
from the society in the value "behind" an object (typically paper),
represented by that object, which has a negligible inherent value."

You are attempting to print money without adding value in an
environment were neither inflation nor devaluation is accounted for.
You need Reagonomics to achieve that.

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
From: bill22-ga on 17 Feb 2006 19:21 PST

Bigben1
   Good example. The debt is estinguished by growth and the perception
of inflation is lower as is the rate. Printing money is defacto
inflationary. Some of the comments are gettign political instead of
focusing on the issue rasied by the question.

Subject: Re: Why would a country prefer borrowing to printing its own money for developme
From: myoarin-ga on 18 Feb 2006 03:07 PST

Good point, Bill.

Bigben,
In your last comment, you suggested that the government would later
buy back the paper currency issued from the population with its newly
earned dollars.  Maybe, but then at a market price, no doubt, and if
perchance the momentary exchange rate  does show a decline in the
value of the local currency, and the population preferred to hold
dollars, we are describing the situation in countries that have
inflation.  More likely is that the government  - regardless of prior
promises -  would hoard the dollars.
Gresham's Law has a bearing:  Bad money drives good money out of circulation.
The latter gets hoarded.

(I know, folks, Gresham's Law referred to commodity currencies, but
the principle still has applications.)

Regards, Myoarin

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
From: pafalafa-ga on 21 Mar 2006 04:57 PST

<>

It's always the US's fault!

But very nice work, Guillermo.


paf

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
From: guillermo-ga on 21 Mar 2006 06:33 PST

Thanks, Paf :)

Guillermo

Subject: Re: Why would a country prefer borrowing to printing its own money for development?
From: bapu1-ga on 30 Mar 2006 23:18 PST

Government printing money to finance its expenses / Devlopment:

 

Olden times money was not there so government can not print money, now
government can create money. So do we need current tax system.

 

Positive:

1.        No need of government official for collecting tax.
Government expenses will reduce directly.

2.        No need for people to worry about the VAT, sales tax, income
tax, wealth tax, and any other tax, etc etc etc

3.        Low level of corruption in devloping country

4.        Less interference by government in the business.

5.        Market determined interest rate, as government will not have
any interest manipulating it. LIKE USA and JAPAN

6.        Full white economy.NO tax so no black economy

7.        More efficient allocation of capital as businessman will
take more economically efficient decision as there is no other
consideration involved.

8.        Future generation will not suffer for the money borrowed
earlier and no need to service the debt.( currently India pays 26 % of
its budget receipt in Interest and same is very high in Japan with
declining population).

9.        Direct control over government expenditure as any increase
will result in the inflation and same generation will face the problem
so will pressure government to behave properly.

 

 

Negative:

 

1.        High inflation in the country 

2.        Poor people will have more burden of tax as inflation
normally has large impact on them.

3.        Will people trust government for doing such thing? ? Money
may loose its value? I am not sure.

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