Back in the old day, when I was about 8 or 9 years old, I was curious about one thing, among many others, in particular, money. Why do people work so hard for it? Why don’t we use leaves as money? Why cannot the government just print more money if it is so valuable and “printable”? After all, this would solve the world economic crisis which happened every now and then. I thought I had made a major breakthrough in modern economic thinking. Well, I was not very thrilled when reality struck. That, to be honest, was the inception of my unwavering love for economics, way before I even realized what it really is.
It turns out money is just a medium of exchange, and that, the whole economy is anchored on products and services it produces. So to explain this economic phenomenon, let’s just forget about money. The wealth of a nation is not the amount of money it has, but the amount of total outputs it generates and accumulates. After all, you would not survive with a million bucks if you were in the middle of Sahara desert. True, don’t you think? Because the amount of goods and services Sahara desert has to offer is virtually ZERO. Thus, I guess (and I am pretty sure) that you would be willing to pay a truckload of cash (Benjamins), let alone a million dollars, for just a bottle of water. How can it be so expensive? Because it is so scarce, so rare to be found, in Sahara that a bottle of water is worth any amount of money you can possibly imagine. This means that its price is merely a signal of the scarcity and the demand for water. If you think of it this way, I guess it will help you to better grasp the concept of economics, especially money.
If a nation prints 10 millions more of
*** QuickLaTeX cannot compile formula: 100 bill, it does not necessarily mean that its people are now any better off than how they used to be. Look at it this way, if a poor country suddenly prints more money, but it still produces the same amount of outputs with no increase in employment or natural resources, that country, technically, is still poor in real economic sense. So what are the outcomes of having more money but same level of goods and services within an economy? Imagine living in a small village with no apple tree, no apple import (i.e. a closed economy). While walking, you kick a genie, woke him up, and the genie now grants you 1 wish. Where are the other 2 wishes? Well, I wouldn't grant you 3 wishes, let alone 1, if you kicked me. He is just too kind. Anyway, now you ask him to bestow upon you, 2 apples (who needs a billion bucks, or even better a huge mansion with unlimited wealth inside, when you can have free apples?). You now have become the only person in the entire village to own 2 apples. Now everyone, especially the rich, would be willing to pay you high price, say *** Error message: Missing $ inserted.
1000 just for a bite. I meant they have never tasted apple before. Until, someone else kicks the genie again, and ask for a billion apples (That is why maths is important because by studying maths, you can count more than 2). All of a sudden, your 2 apples are now worthless because the village now has tons of apples on its hand that it does not even know what to do with them.
This specific scenario, as described above, should be quite similar in nature, and thus, comparable to reality. Money and apple are two different things, but the law of supply and demand are applicable to both items. When apple supply spikes, its value depreciates/declines. When money supply increases (while the output produced remains unchanged), its value will simply fall. In other words, as people get more money in hands, they feel richer, and as a result, they start to demand and consume (buy) more. The demand for goods and services rise, but since the quantity of output is the same as before (remember, we only print more money, NOT produce more), then high demand will turn into a competition, thus bid up the price of each good and service. Simply put, people, who are now richer as a result of having more money within circulation, are not afraid to spend. They compete to get what they want, and in doing so, they either directly or indirectly raise price in the economy. The golden rule is when something is strongly desired by everyone, its value appreciates/rises.
I will give you another example just for fun. You bake a pie, and you hand out 2 tickets to people, each worth half a pie. Now suppose, instead of handing out 2 tickets, you hand out a thousand tickets. Each ticket is now almost worthless because each can only be exchanged for a really really thin slice of pie (1/1000 pie). This is what printing more money does to you when your production has not been improved first (i.e. same amount of goods and services in the economy).
This is what we call “inflation”. It is the deterioration of money value while goods and services become less and less affordable due to rising price. Let’s assume you have 10. So before, 1 = 0.5 pen. So the real economic value of your money is decreasing by half. ouch!
So printing more money can lead to inflation, a “demand-pull inflation” to be precise. That means the higher price is caused by the rapid increase in demand within an economy (while the supply level does not change).
In short, you cannot eat and drink money, but it is, without doubt, one of the foundations of a strong and vibrant modern economy. Its importance is undeniable. However, printing more money is not going to make you any richer in real term because like I said, money is just a medium of exchange. If you are crossing a river, having more boats is not going to speed things up for you, is it? But it will, it will if and only if you have lots of friends and stuffs to be transported.
I will provide further explanation including the negative impacts of printing money within an economy in PART 2.
Image source: http://devilsexcrement.com/2009/10/25/pdvsa-bonds-and-central-bank-law-changes-political-solutions-to-tough-problems/