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Money printing and currency depreciation: A correlation analysis

11 Jul 2021

In the wake of the Sri Lankan Government printing a colossal sum of money few days ago, a couple of months old news item surfaced on social media surface in the past week, in which a State Minister was quoted saying that there is no relationship between money printing by the Central Bank of Sri Lanka (CBSL) and the depreciation of the Sri Lankan rupee. Money printing plainly means the printing of money by an authority approved by the government. When the printed money is pumped into an economy to increase the money supply of a particular region or country, it is known as money creation or money issuance. The money printing authority in our country is the Central Bank, under the Monetary Law Act No. 58 of 1949, giving CBSL the authority to do so since its establishment. The Central Bank prints notes at a British company named De La Rue Lanka located in Biyagama. Before the establishment of the Central Bank, however, a currency board system undertook money printing in Sri Lanka. On 28 June, the Central Bank printed the highest amount of money in history in a single day, amounting to Rs. 208.45 billion, and this was reportedly to settle provisional advances taken by the annual budget. Now, when the printed money is pumped into the economy, it leads to inflation, but the possibility of the formation of inflation is ruled out under Modern Monetary Theory (MMT). The theory argues that money printing is indeed a useful economic tool and, as many mainstream economists claim, does not devalue the currency, result in inflation, or disrupt the economy, even though the economics we know dictates that money printing is catastrophic for a nation’s economy. MMT argues that a government can create its own money it needs as much as it wants, in a manner that does not generate inflation. So basically, MMT states that printing money cannot alone be the cause of inflation. In addition to this, ABC Australia noted that MMT says (promoted famously by former British Prime Minister Margaret Thatcher) that national governments must tax or borrow before they can spend is wrong. It further added that MMT economists say that inflation would only be a problem (in a country like Australia) if the federal government spent too much money into an economy that was already running at, or close to, full capacity. But the theory has its own regulations. MMT strongly says investments made in the sectors of health, knowledge and skills, and transport by further widening the budget deficit of the respective country are completely fine, as they would pay off eventually. The next point MMT assumes is that countries have their own rate of unemployment. Unless these are not met, it is quite possible for money printing to show its effects in the form of inflation. If more money is printed, households will have more money to spend on goods, and as a result, prices of products will increase. Inflation in the US Confederacy is a perfect example of inflation led by the oversupply of money. During the Civil War in 1861, the US Confederacy printed $ 20 million notes in May that year and they kept printing money throughout the year, which resulted in $ 105 million printed money by the end of 1861. As a result, paper dollars depreciated immediately, prices of commodities rose, and needless to say, it undermined the cause of the Confederacy for the next three years. The inflation in the Confederacy ended in a complete loss of value of Confederate issues and exacerbated the burdens of the war. Germany is another famous example of hyperinflation led by increased money printing. Following World War I, Germany suffered economic issues. The Treaty of Versailles was the most important of the peace treaties that brought World War I to an end. The treaty required the payment of reparations by the Germans, but the reparations made it impossible for Germany to meet the obligations as they were not allowed to make the payment in their own currency. They had to opt for an acceptable hard currency and printed more and more of it, which worsened rates and shot up hyperinflation. At its height, hyperinflation in Weimar Germany reached rates of more than 30,000% per month, causing prices to double every few days. Some historic photos depict Germans burning cash to keep warm because it was less expensive than using the cash to buy wood. In 1920, the price of one loaf of bread in Germany was one mark and it went up to four billion. Similar to Germany, reparation payments led to hyperinflation in Hungary too. Following World War II in 1946, the inflation rate in Hungary exceeded by 200%, which equates to an annual inflation rate of more than 13 quadrillion percent. It was so out of control that a new currency system was introduced to mitigate this issue. When Zimbabwe was hit by hyperinflation in 2008, prices rose as much as 231,000,000% in a single year. Venezuela too faced a currency instability issue five years ago. In 2015, the inflation rate was 181%, again the highest in the world and the highest in the country’s history at the time. The rate reached 800% in 2016, over 4,000% in 2017, and about 1,700,000% in 2018. Several economic controls were lifted by the Maduro administration in 2019, which helped to partially tame inflation until May 2020. Hyperinflation certainly is not good for an economy. To avoid paying too much in the short term, people will hoard goods at home, but stockpiling will result in shortages of goods in the market. Savings of people will begin to diminish and cash will become worthless. Higher inflation makes a country less competitive, leading to relatively lower demand for their exports and hence currency, according to economists. Inflation in turn devalues the currency. Increasing the money supply enables the Central Bank to buy more foreign currency, which drives down the value of the domestic currency. MMT aside, evidently there is a correlation between money printing and devalued domestic currency.


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