I don't really understand, can you explain in more detail? Taking a loan is a risk-free savings vehicle? Can you explain exactly what you mean please
Ah, I wasn't clear, sorry about that, government bonds are a risk-free savings vehicle for citizens that invest in them, which is why they are generally a few percentage points lower in interest than even the highest grade corporate bonds. (For why that is good, see the example in response to your third question below)
That I do understand - if we do "need" to borrow money then we'll have established relationships with lenders so it won't be a problem, that makes sense to me. BUT, how is our internal capacity determined or calculated?
This is where it gets a bit complicated, obviously the government is printing money all the time, and it's impossible to keep things perfectly balanced all the time, which is why they don't bother, they have an inflation target of 2% that they try and shoot for. So if everything were easy in a perfect world, they would print just enough money that $1.00's worth of goods today would cost $1.02 next year, there are so many variables... births/deaths/retirements/productivity improvements/international trade flows/supply and demand of goods...
I guess what I'm getting at here is, how does borrowing money create less inflation? If you borrow $100b there's still $100b more in circulation, except now you have to pay it back plus interest - where does the money to pay the interest come from? And what about all the electronic transactions that get put into the economy every time a transaction is made online; does this not inflate the supply as well?
Ok, now you're getting so in depth I need to bring the scale down to explain it. Let's imagine a small world where the only people in it are you, your four brothers who spend money as fast as they get it, and your grandmother, who is a saver from way back and wants a risk free nest egg for the remainder of her years. You are the family's government, and you print the currency, Byron Bucks. When you first printed them years ago you divided them equally amongst everyone, but as of January 1st of this year, each of your brothers had $25 and your grandmother has $300. You have $0.
Now, you decide you want to buy something from another country that is worth $100. You have two ways to pay for that, you could print another $100 Byron Bucks, or you can borrow it from your grandmother and pay a small interest rate, say 2%. If you borrow it from your grandmother, the money supply has not truly increased, because while you now have +100 Byron Bucks, your grandmother has 100 less, and she has an IOU from you. While technically there are measurements of the money supply that don't count such debts, for inflationary purposes the actual sum total of the purchasing power is what matters. You then either spend the next year working, and sell the product of your labour to a brother or a grandmother, and use those profits to pay the interest, or, since you're the government, you just tax them all and use the money they give you to pay the interest. Either way it's a palty additional price for you since you're such a good credit risk, your grandmother is happy, your purchaser is happy, and your brothers are off doing whatever it is they do.
If you instead decide to PRINT the $100, you go from 400 outstanding byron bucks (300 + 25 + 25 + 25 + 25) to 500. The laws of supply and demand would then indicate that while demand for goods and services is still the same as it was, the supply of money has increased by 25%, and therefore, prices will rise by 25%, so what used to cost 1 Byron Buck now costs 1.25 Byron Bucks. The person who sold you the item is ticked (think China selling to the states) because he can no longer get fair value for his item, if he'd known you would crank up the press he would have insisted on 125 Byron Bucks. Your grandmother isn't happy... her 300 now only has the purchasing power that 240 did before you printed. And your brothers aren't happy, because their $25 each has the purchasing power of $20. The only person who is really happy is you, because you still have the thing you bought and you didn't have to work for it, borrow money, or do anything productive.
So as you can see, the person paying the interest either earns it by providing goods or services to people that currently have money, or if they are a government, they simply tax it from who they want... everyone, the rich, property owners, consumers... depending on their tax scheme. As for electronic payments, they don't actually increase the money supply for inflationary purchases, what they do is speed up the flow of money. And for that, I need to give you another long example....
Let's take three people, a lumberjack, a millman, and a carpenter. They each have $100 in Canadian money, and they are so far out in the woods that they are a closed system, noone else ever comes and gos, there are no banks, etc. At the beginning of year one their net worths are all that $100.
In the first third of the year, the lumberjack cuts down a ton of trees and now has $100 and a bunch of logs. He sells the logs to the millman for $50. He now has $150, but the total money supply is $300, and the total net worth is $350. The millman then spends the next few months cutting those logs into perfect planks. He sells those planks to the carpenter for $100, and now both the lumberjack and the millman have $150 each, and the carpenter has no cash, but $100 worth of logs. Our total net worth is now $400.
In the next three months, the carpenter builds three ice fishing shacks that can be pushed out to the lake when it freezes, and sells one to the lumberjack and one to the millman for $100 each. They then spend the next three months fishing so their year end numbers are as follows:
The lumberjack has $50 cash left and owns a shack worth $100 for a total net worth of $150. The millman also has $50 cash and a $100 shack for a total of $150. The carpenter now has $200 cash and a $100 shack for a total net worth of $300.
Our total money supply is still only $300, but our total net worth is now $600... at least on paper... after all, if the lumberjack wanted to sell his shack, he probably wouldn't get $100 for it since everyone already has one, and it's only use would be scrap lumber for the carpenter for some other project in a future year. But let's just keep using this figure. Now, effectively what we have done is we have created $300 in value over the course of 12 months. But what if each of them could have done the same work in half the time? If all of this were done in six months, that would give the lumberjack more time to cut more lumber, the millman more time to chop it up, and the carpenter more time to build something else... say a henhouse for each of the three people. At the end of the year there would STILL only have been $300 cash in the money supply, but the net worth would have been $900 instead of $300... and that's the same effect electronics transactions have... they speed up the flow through the system.
But what are the restraints? What is stopping them from printing or borrowing (or both)? Is it not the Minister of Finance calling the shots at the Bank of Canada? I know that he's involved but I have no idea to what degree, and I know it's definitely a board of members but ultimately someone has to decide when and how much is going to be created, and it can literally be created with the click of a mouse/touch of a keyboard. Further, where do people find any concrete evidence or proof of such? We're required to be held accountable for just about every financial hair that gets displaced; I have heard of Government audits, but I have yet to find any concrete proof of the exact process and accountability of this.
The restraints are the citizens... if the politicians thought they could get away with it I'm sure they would print whatever they wanted, but the ultimate evidence would be that as the money sloshed through the system, prices would start going up, faster and faster... and seniors on fixed incomes would see they were getting worse off with every trip to the grocery store, and smart economists would see what was happening and alert the media, who love government scandals. But you are right, this is not something that can actually be audited because it is completely fluid, and a lot of it is estimating... after all, the government prints a lot of money that is assumed lost... a cumulative effect of people putting their wallet through the washing machine, the wind blowing away a $20 you didn't hold on to tightly, millions of pennies tossed away because they are worthless.... but how could someone audit to see if the leakage estimate was right? In fact, the only way the government can even guesstimate it's printing is to take a basket of goods (the CPI) and compare it's price from the base year to the current year. If it's up around 2%, great, they're doing fine. If it's up 10%... ohoh, they printed too much money so they have to choke it back. If it's down 5%, unless there's a good reason (like beef during the mad cow scare), then it's time to print up more money since we don't want deflation.