A few weeks back, a listener asked that I address what happens if we just print money to pay off the debt we have created fighting the virus.
Great question. Let’s look at history for the answer.
At the end of WWI England and France were faced with having to pay back the us billions of dollars they had borrowed during the war.
So, the allies now decided that Germany should pay for all damaged caused by the war and this became a key issue in the peace settlement known as the Treaty of Versailles.
France estimated the amount at 200 billion.
Needless to say Germany said no way and said they shouldn’t have to pay anything.
Eventually they did offer to pay 7 billion.
Germany said that until the allies got off their back and let their economy recover, they wouldn’t be able to pay any war debts.
Part of the problem here is that the US was demanding that France and England pay off on their debts. They owed us $10.35 billion.
As such France and England were putting the screws to Germany.
The Treaty of Versailles stipulated that Germany had to pay the allies 5 billion dollars a year for 5 years, then a balloon note to be determined later.
This proved devastating to the German economy.
The Germans now offered to pay 15 billion but again the Allies refused the offer and said it was an insult.
The French now sent troops into the Ruhr valley in 1923 to force the Germans to work and hand over all profits from their businesses.
Germany now resorted to passive resistance and told the workers to simply stay home.
German inflation now went through the roof. The only way the Germans could pay their war debts was to simply print money.
Now here is my concern. We just spent $4 trillion dollars in the Covid 19 bailout. We don’t have that kind of money. So what can we do?
I am afraid we will follow in Germany’s footsteps and simply print more money. This could trigger an economic disaster. Don’t believe me? Let’s look at what happened to Germany.
Printing money following WWI devalued the German Mark and triggered hyper inflation.
In 1922 the German mark was rated at 4.2 to the dollar (like our quarter).
By the end of the year it was at 7000 to the dollar.
When the French occupied the Ruhr in 1923 and the workers went on strike, inflation rose to the rate of one trillion marks to the dollar!
Let me put it in simple terms.
In 1914, before World War I, a loaf of bread in Germany cost 13 cents. Two years later it was 19 cents, and by 1919, after the war, that same loaf was 26 cents – doubling the prewar price in five years.
Now the German government started printing money to pay its war debt. A German loaf of bread now jumped to $1.20. By mid-1922, it was $3.50. Just six months later, a loaf cost $700, and by the spring of 1923 it was $1,200.
As of September, it cost $2 million to buy a loaf of bread. One month later, it cost $670 million, and the month after that $3 billion. Within weeks it was $100 billion, at which point the German mark completely collapsed.
The whole time the German government kept printing more money, so much so that people burned it in their fireplaces because it was cheaper than wood.
The only thing that saved Germany was a program developed by an American banker named Charles Dawes. The US could see that we would never get our money until Germany could recover and start paying back their debts to France and England. So we stepped in, told France and England to back off of Germany, and we then helped rebuild Germany following WWI.
The plan was proposed by the Dawes Committee on April 9, 1924, and accepted by the Allied and German Governments on August 30, 1924.
Knowing what happens when you simply print money to pay your debts, the US had developed a system to control runaway inflation.
The Federal Reserve System.
The Progressives in Congress, under President Woodrow Wilson, passed the Federal Reserve Act on December 23rd, 1913.
1. They set up 12 regional banking districts, each with a federal reserve bank.
2. The federal reserve banks were owned by the member banks of the federal reserve system. (all national banks were required to join)
3. Member banks had to subscribe 6% of their capital to the federal reserve bank in their region.
4. Federal reserve banks would the use this capital to back federal reserve notes (Dollars. Take a look at one, it says “Federal Reserve Note”)
Now this is over simplified, but here is how the system works.
The government prints money. It distributes it thru the federal reserve banks. The government basically loans the money to the federal reserve bank and charges them interest. Let’s say 2%. This is what is referred to as the prime rate.
The federal reserve bank then has cash to loan to the member bank (your local banks. The Federal reserve bank tacks on their percentage. Let say another 2%. We are now at 4%.
So now you want to buy a car. You go to the local back to get a loan. Your local bank needs to make a profit, so they tack on another 2%. So you get a loan and pay 6%.
Now, I am not an economist, and like I said, this is an oversimplification, but it basically shows how the feds control the economy.
If the interest rate is low, more people buy stuff. Cars, appliances, houses, etc. Businesses now raise their prices because people have money to spend. In other words, inflation. This is how the feds can pump money into the economy.
If interest rates are high, people tighten their belts and don’t buy new cars, appliances, and houses. Businesses now have to lower their prices to get people to buy their stuff. Deflation.
Now bear in mind. you took out a loan for that new car when interest rates were low. Now they are high, but you are still paying on that 5 year loan.
Where does that money go? To your local bank who then has to pay back the federal reserve bank. This is how the feds can pull money out of the system.
See how this works? By setting the prime rate, The Federal Reserve can control the economy and basically decide if they want to makes prices for everything you buy, either higher or lower. Money in, money out.
So who runs this mess? The Federal Reserve Board.
The Secretary of the Treasury, and 7 people appointed by the President.
Bet you will pay attention, next time they talk about the prime rate.