If Countries Can Print as Much Money as They Need, Why Does Debt Even Matter?
Whenever people start to learn about how the monetary system (i.e. central banks, money printing, etc.), there comes a point when they ask themselves or their teacher "so, wait, if a country can print as much money as it wants, how can it ever go bankrupt? Why default on your debts if you can just print more money to cover them?" The instructor (or Smart Alec at the right sort of boring dinner party) will then smile wryly at this allegedly stupid question and brush it off with something involving "inflation." In fact, this is not a stupid question at all. Not only that, the conclusion is, at its heart, correct. Theoretically, a country that prints its own money (not all countries do) cannot go bust! Yet countries throughout history, even those that printed their own money, have defaulted, in effect declaring bankruptcy and refusing to pay back all or some of their debts. Why?
The brisk answer "inflation" is not incorrect. Usually, when a country starts printing money to cover purchases it starts to cause inflation because it spends beyond its means. "How can you have means if you can have as much money as you want?" you may ask. Another good question. The answer is simple: goods and services are not free. If everyone in the world were millionaires, they couldn't all have luxury yachts, penthouse apartments, and helicopters. There is just not enough oil, labor, or space atop tall buildings. Everyone can't have everything. If everyone had millions of dollars to spend, this would not change the fact that there is a limited supply of everything. Prices would just shoot up to adjust to the new status quo. Billionaire would be the new millionaire. "Poor" would be people living on a salary of just $900,000 per year. All the printing, and no better off. I hope that makes sense, as I know it's a tricky concept to wrap your head around.
Still, the inflation answer is incomplete. This is because printing money does not, in itself, cause inflation. Printing and spending too much money does. In other words, having more money in circulation than there are goods and services to be bought will bid up the price. So the key would be not printing too much money, but rather, enough money.
Much of the rich world currently finds itself in an ongoing economic crisis; a slow one, which just feels like a general uneasiness. The world financial system has not yet, at least, collapsed, but unemployment is still high and growth and spending are sluggish. It's become harder for optimism to prevail, even among optimistic Americans. The main reason for the slow growth and high unemployment is too little "demand." That means that consumers, government, and companies together are not buying enough to push growth forward. The reason for that is mainly that households and banks, who obviously cannot print their own money, are busy paying off debts and have become much more cautious about spending even when they have the money. But what about the government, which can print money?
Theoretically, the government could just borrow from itself, printing money to spend on infrastructure, education, housing, whatever. Since the current problem is not enough demand (i.e. people not buying enough), the government could take up the slack. In theory, as long as it didn't take up too much slack and spark inflation as described above, everything would be all right.
So why don't we do it? The main problem is that we would have to trust the government to cut spending and raise taxes to reduce inflation, and do the opposite to drive things on. At the moment, the US Government can't even get the necessary consensus to do things like maintain bridges so they don't collapse. The (justified) fear is: once you have free money, you can't stop the spending. History has borne this out, too: there are many cases of just that sort of thing happening, going back hundreds of years. And let's face it, if you could print as much money as you wanted, would you stop? Yeah, right, keep telling yourself that.
To stop all this happening, central banks are usually permitted to lend only to other banks. They also do not normally purchase government debt. Instead, they borrow it from other banks, never taking on the risk of government default (both the bank and the government would have to go bust for the central bank to lose money... which it could replace by printing more, anyway, if legally permitted to do so). This wall of separation prevents central banks from financing government profligacy. That prevents the dangers of out of control spending and inflation. If savers are concerned that the government is borrowing too much, they stop lending the government money and the rates it has to pay to borrow rise; that usually results in budget tightening.
So really, everything's true: if central banks were willing to lend governments unlimited cash directly, they could never go bust, but the worry is that massive inflation would come as a result, as it has in the past. At the same time, though, central banks could lend directly to governments in times of crisis when inflation is not a big worry. They could continue to lend in order to keep interest rates reasonable, too, no matter how high the debt. They could then still allow rates to rise to stop inflation. So theoretically (how many times have I used that word now?) the Federal Reserve, Bank of England, the European Central Bank, and the Bank of Japan could lend directly to their respective governments during the current crisis, cutting off the supply if inflation threatens to return.
Central banks work on credibility, though. The expectation that inflation will remain stable is part of the reason that it does, in fact, remain so. Unorthodox operations like this by central banks could damage that credibility. Also, and this cannot be underestimated, there is a lot of political opposition (think most of the Republican party, the Tea Party, and followers of Ron Paul, just to name a few). So it's difficult, but theoretically possible, for a central bank to fund a government to push an economy forward after a crisis without sparking inflation -- regardless of how much debt has accrued, or to bail a government in a debt crisis out by lending it the necessary cash. Tricky, but possible.