I’ve grown up with news headlines and sound bytes that have painted the government in a mostly negative light.
These headlines existed before me and they will continue to exist long after I’m gone.
But just for a minute, let’s evaluate the question on whether the government oversteps on its role in our lives. In other words: Is the government good or bad?
I think we have to begin with talking about money. More accurately wealth and how it is created.
But to do that we’ll first need to distinguish between “money” and “wealth”? There is a difference.
Money is a medium by which to transfer value.
Wealth is the accumulation of a medium (like money) in order to increase your utility or quality of life.
Now we can begin! 🙂
The Creation of Wealth
If you produce a good or service and someone pays you for it with money you now have created “wealth”. What they once had you now have. So between the two of you, although money was exchanged it was not created. Only wealth was created by seller of the goods or service.
This is the first notion: money is only important (to you and I) to be exchanged as a medium of value for wealth accumulation. Simply put, you and I shouldn’t care how it is created only that its distribution leads to the creation of our own wealth.
This is why I’m confused when I hear statements like: “the government is printing (or creating) too much money” as if this practice impacts the ability to create wealth.
When the government prints money, nothing is really happening to you or me per se. But it is helpful to understand what is being done.
Why does the government print (or create) money?
A better question is actually, what result is trying to be achieved by this action? The resulting act of consumers to use what has been created with the goal of wealth creation should be our focus. In other words, the intended result of these actions.
The government has two jobs to regulate (stimulate or neutralize) economic activity…control inflation and reduce unemployment. Everyone can agree on these to phenomena are bad for an economy. But just in case you don’t, let’s cover the effect of each briefly.
Inflation is when the price of goods rises faster than the amount of money available to purchase those goods. Consider a trip to the grocery store with 100 consumers that all have a $100 budget (each) but only 5 loaves of bread are available on the shelves. Although great for the store owner (in the short term) because he’s able to raise the price per loaf to maximize his profits knowing there is at least $10,000 of purchasing power (i.e. demand) chasing 5 loaves of bread (i.e. supply). This is bad.
In the case of unemployment, wealth creation for the middle and lower classes is hindered when there are too few jobs to provide for a decent living. Rampant unemployment leads to all sorts of social ills like homelessness, theft, etc. As the rate of unemployed people to the overall population increases there will be less purchasing of goods and service, which will eventually lead to failing businesses and still fewer jobs. This is bad.
The true role of government (in finance)
So the government seeks to control inflation by reducing the amount of income available to purchase goods. Remember our bread example. It is a good thing to have fewer dollars chasing a limited amount of goods. The most effective tool of control is taxation, but can only be used in a limited fashion. Most tax law changes have to be approved by voters and this is not a popular political agenda item. But suffice to say, with less disposable income, you will spend less money on goods thus preventing demand to outstrip supply and increase the price of those goods.
The other tool is controlling interest rates. This is typically done when the government-issued bonds. Households (or other entities) then purchase these bonds which acts to reduce their disposable income. This is better than taxation and used more often because it is easier to enact. An ancillary effect is that it allows borrowers to get a safe return on their “investment.” (Buying government bonds has remained one of safest investments throughout time.)
Finally, the collected taxes or the borrowed money is used for things you and I enjoy like roads and clean running water
Here’s the but…
Now the government owes what it borrowed plus interest.
Is this a real problem?
Although you and I can’t borrow endlessly without the lender of those funds eventually wanting payment, is this true for the government?
You be the judge.