What happens when your country owes more than it can ever pay back –
perhaps more than the entire planet can pay back?
This morning the Federal Reserve announced it was going to embark on a third round of “quantitative easing,” a financial maneuver that already has its own nickname: QE3.
But what exactly is “quantitative easing”? Well, as The Washington Post helpfully explains,
Since the Federal Reserve can just create dollars out of thin air, it can buy up assets like long-term Treasuries or mortgage-backed securities from commercial banks and other institutions. This pumps money into the U.S. economy and reduces long-term interest rates further.
“Create dollars out of thin air” is another way of saying, “Print money.” Since the U.S. dollar is no longer backed by gold or any other commodity other than people’s faith in the government, the Federal Reserve can just print up billions of dollars and hand them out. (“Print” in this situation is entirely metaphorical, of course: the government isn’t actually printing paper bills, but rather just arbitrarily increasing the amount of “money” it has.)
Now, the average person might wonder: If creating money is that easy, then why don’t we just print up $16 trillion and get ourselves out of debt? The answer is interesting: Although the government can increase the amount of cash floating around, it can’t conjure actual value or worth. All it can do is put more money into circulation in an economic system whose underlying net worth remains the same. The end result is that, although the total amount of dollars in circulation increases, the cumulative value of things to buy remains the same — so the intrinsic worth of each dollar is diminished. Another word for this is inflation.
…Travel back with me to Germany in 1923 and let’s look at what can happen when a government starts printing money with no basis behind it.
The root causes of the hyperinflation in Weimar Germany are complicated and still debated: the wikipedia article on the topic is a good starting point if you’re interested. Germany at the time (just as the U.S. does now) had a crushing national debt, and many other nations felt that Germany intentionally ignited inflation of the German Mark as a way to “inflate its way out of debt” — a strategy some have suggested for the U.S. now, in fact.
But as the citizens of Germany discovered in 1923, once inflation starts heating up, it can quickly reach a level of explosive combustion that even the government can’t control. In the early ’20s, the other nations of Europe, distrusting the stability of the German Mark, began demanding payment in either gold or foreign denominations. So the German government frantically began buying up other nations’ currencies. But those other nations didn’t trust that the Marks they were getting would keep their value, so they demanded a higher and higher exchange rate. So Germany simply starting printing up bills to pay the higher rates, but that only increased the doubts over the Mark’s solvency, and exchange rates rose, and more money was printed, and it spiraled out of control. In early 1923 trust in the value of the German Mark completely collapsed, and it quickly descended toward worthlessness. With every passing month, week, day, hour, the Mark became worth less and less, and the government had to print more and more bills of higher and higher denomination. This lasted until late November 1923, when the Mark was discarded as a currency entirely, and a new national currency — the “Rentenmark” — was introduced, with 12 zeros being lopped off the old prices.
By chance I recently came into possession of a fascinating collection of these now worthless “inflation Marks” from the Weimar Republic. (So many are still floating around that you can pick them up fairly easily at flea markets and collectibles stores.) I scanned the bills and present them below for your edification as to what can happen when “quantitative easing” is overused…
Why Zimbabwe no longer has a currency:
Hyperinflation in Zimbabwe began shortly after destruction of productive capacity in Zimbabwe’s civil war and confiscation of white-owned farmland. Food output capacity fell 45%, manufacturing output 29% in 2005, 26% in 2006 and 28% in 2007, and unemployment rose to 80%. During the height of inflation from 2008–09, it was difficult to accurately account and monitor for Zimbabwe’s hyperinflation because the government of Zimbabwe stopped filing official inflation statistics. This cessation in filing made it difficult to accurately observe how severe inflation was in the country. However, Zimbabwe’s peak month of inflation is estimated at 6.5 sextillion percent in mid-November 2008. In 2009 Zimbabwe abandoned its currency; at present in 2012 a new currency has yet to be introduced, so currencies from other countries are used.
It gets worse…
1946 Hungarian banknote, 100 million bilpengő (1020 pengő)
The pengő (sometimes written as pengo or pengoe in English) was the currency of Hungary between 1 January 1927, when it replaced the korona, and 31 July 1946, when it was replaced by the forint. The pengő was subdivided into 100 fillér. Although the introduction of the pengő was part of a post-World War I stabilisation program, the currency survived only for 20 years and experienced the most serious hyperinflation ever recorded.
The pengő lost value after World War II, suffering the highest rate of hyperinflation ever recorded. There were several attempts to break down inflation, such as a 75% capital levy in December 1945. However, this did not stop the hyperinflation and prices continued spiralling out of control, with ever higher denominations introduced. The denominations milpengő (1,000,000 pengő) and b.-pengő (pronunciation: bilpengő) (1,000,000 milpengő, 1,000,000,000,000 pengő or one billion pengő (long scale)) were used to alleviate calculations, cut down the number of zeros and enable the reuse of banknote designs with only the colour and denomination name changed.
The Hungarian economy could only be stabilized by the introduction of a new currency, and therefore, on 1 August 1946, the forint was reintroduced at a rate of 400 000 000 000 000 000 000 000 000 000 (400 octillion) = 4×1029 pengő, therefore the total amount of circulating pengő notes had a value of less than 0.1 fillér…
Coming soon to a location near YOU
Stephen Green a/k/a “Vodkapundit” has an excellent explanation of how this will play out in the US Federal Reserve system.
Much more information:
- Wikipedia: Paper money of the Hungarian pengő
- Dallas Fed: Hyperinflation in Zimbabwe
- Cato Institute: Zimbabwe
- Kevin Wilson: Hyperinflation (many examples)
- PJM: Interview: Mark Steyn on After America, One Year Later
- Swift Economics: So Many Dollars
- PJM: Math Is Coming