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How many of us have ever got this question in our mind “If a country is indebted, why should it not print currency notes and settle the debt?”  I had this doubt for quite some time and it has been a while since it got clarified.  For people who know the answer, kindly appreciate my understanding if not criticisms are welcome.  For people who don’t know, never feel the answer is quite obvious, as it is more complicated than what you actually think.

 So, lets begin with the fact that currency notes do not form the wealth of a country. It is only a measurement of the wealth, rather wealth consists of human efforts and the country’s productivity.  What really happens when more money is issued? A. The value of money reduces. The cost of making the money bill is actually the cost of the paper and printing, which is insignificant and similar irrespective of the currency’s denomination (producing a 50Rs or 100Rs note costs the same). So what determines the value is the nation’s wealth?  The wealth when fixed at a particular point of time is measured in terms of money (Just like you measure cloth using a scale, the cloth is the subject for valuation and not the scale). Another example: I have a gold bar (wealth) broken into 2 parts (units/money). If I further break both parts into 2, the number of parts (money) is doubled, but the gold (wealth) remains the same.

 If my country has Rs.1000 in circulation in the economy, and assuming the only wealth in the economy is a cell phone, then the phone is worth Rs.1000. Now the country prints more currency, say Rs.1000 more, now the value of the phone is increased to Rs.2000. Thus we can understand that the currency notes do not form the country’s wealth.

Now let us revisit our all important question, which is not about intra-country affairs but inter-country. How does it hit the country if the newly printed money is given outside? Consider the same example where the country’s wealth is Rs.1000 (Assume in lakhs, crores or whatever), the debt is in the form of a debt instrument which is worth Rs.1000.  Assume new rupee notes are printed for Rs.1000. Whether the note is given to a lender from another country or circulated in own economy is immaterial as the note will come back on exchange and moreover it is this particular country’s currency. Now, since you have 2000Rs instead of 1000Rs, the value of the rupee note is reduced to half of the original amount.  Then the creditor ( initially for Rs.1000) will now demand twice the amount (Rs.2000).  Again, you face shortage / debt as you printed only Rs.1000 but the lender is demanding Rs.2000  Puriyalayle? Enakkumthan!!. If you conclude that the only solution is to print more bank notes, then you will reach a point of nowhere.

Thus we understand that printing of currency doesn’t solve debt crisis.  But does that mean it is not practically done? The answer is NO. If you are really interested to know in detail kindly read about German currency inflation crisis during World War II and Zimbabwe inflation crisis, once you are done with this article.

Remember, the example I gave should be considered extremely basic, and one should appreciate that a country has much more wealth than a cell phone and circulating currency enormously above Rs.1000!!  If you had asked our primary question to any knowledgeable person, he would have answered you in simple terms that it will lead to inflation.  A complicated idea has been beautifully fitted into one word called inflation.  

The concept of printing money to get rid of national debt is not impractical to execute. To understand this let us consider a more meaningful example.  A country is indebted for Rs.100crores, it prints money for Rs.100 crores and settles the debt in the short run.  Consequences will be that the rupee value will heavily deteriorate, exchange rate may drop from 1$ = 45Rs to 1$ = 55Rs. over a period of time (i.e. I have to pay more of rupees to buy 1 dollar).  Many people will get affected by the decrease in the rupee value terms.  For instance, consider an importer who initially had to pay Rs.450 for a credit purchase, now should pay Rs.550. He requires more currency and will resort to banks for borrowings, this will in turn require RBI to print more notes (which will now form an inflationary cycle).

Another instance will be where a person who rendered service, agreed to receive Rs.4500 next month.  He desired to pay his monthly house rent of Rs.4500 with the receivable amount.  Due to inflation, the rent increases to Rs.5500, and so he will be forced to borrow Rs.1000 from bank and the cycle starts.  

This will continue and may reach a point where a loaf of bread will cost Rs.1000?! Thus the solution for debt crisis is not printing money but purely increased human efforts, productivity and efficiency. Hence proved, LHS=RHS!!!

Help me improve myself by sending your comments, queries and suggestions at

fahimhaniffa.blogspot.com

fahim.haniffa@yahoo.com

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