Your Stimulus Check Is Not Free Money

Because of the Covid-19 pandemic, governments around the world have injected trillions of dollars into their economies. When the pandemic began only a few months ago, the global economy slowed to a crawl, causing officials to fear a total economic collapse. As a response, they sent obscene amounts of money to businesses and individuals.

As of this writing, almost 40 million people filed for unemployment benefits in the US over the last 9 weeks, and the government has injected $2.2 trillion into the economy, with many individuals getting $1200.

This sounds like free money, but the hidden cost is inflation. Over time, inflation makes not just that check but all money less valuable. The purchasing power of a dollar gets whittled away, leaving your savings less valuable. If inflation gets out of control, the economy might collapse, such as the case of Zimbabwe, where it took $35 million to purchase one loaf of bread. 

Money From Nothing And Debt For Free

Your check came from two places, each of which leads to inflation.

Some of the stimulus money came from the central bank–in the US it’s the Federal Reserve Bank–simply adding money to the reserve accounts owned by commercial banks. Just like you have an account with your bank, commercial banks have accounts at the central bank, who created new money by hitting a few keys. In other words, the central bank “printed” new currency by adding it to the accounts of commercial banks. In exchange, the central bank gets Treasury securities or agency securities, which are backed by home mortgages bundled together.

In an unprecedented move, the Federal Reserve is also buying corporate bonds. The chief researcher at ETF Funds said “It is unprecedented for the government of the United States to own the corporate debt obligations of the private enterprises in this country. That is new territory.”

On the other hand, the majority of the stimulus money comes from issuing treasury bonds. The Treasury Department has the power to create debt obligations, which it sells to just about anyone that is willing to buy them. The sale of these bonds funds the US yearly deficit, as the government routinely spends more than it brings in. As of now, the US has a total debt of nearly $25 trillion. Because of the pandemic, the Treasury sent this money directly into people’s bank accounts via the IRS.

The idea behind doing the above is to inject money into the economy, which encourages spending and lending, thus keeping the economy moving. If not, the movement of money will slow down, causing the economy to shrink, very possibly leading to a global recession or depression.

However, these solutions are just kicking the can down the road.

The Danger of Hyperinflation

In 2015, the government of Zimbabwe formerly abandoned their own currency in favor of more stable currencies, such as the US dollar, the Euro, and the Chinese yuan. The transition involved exchanging quadrillions of Zimbabwean dollars per US dollar. You read that correctly. The government printed so much currency that it was virtually worthless. They even printed a trillion dollar note. This is why people had to use wheelbarrows full of cash to purchase basic items.

This is similar to what happened in the US during the Civil War, Germany during the 1920s, Hungary after World War 2, and Yugoslavia in the 1990s. In all of these cases, the governments had to create more currency to keep their economies moving due to an unexpected shock, thus devaluing their currency. They also needed to sell treasury bonds to finance the government, obligating them to pay interest on their debts, which, in turn would be paid with more printed currency.

Hyperinflation occurred in the US during the 1860s because the Confederates printed their own money to pay for the Civil War. In Germany, it was the rebuilding needed to recover from World War 1. In Hungary, it was due to the cost of World War 2. In Yugoslavia, it was due to political strife and mismanagement. Hungary holds the record for the worst case of hyperinflation. Some put the inflation rate at 195% per day, with prices doubling every 15 hours.

The Covid-19 Pandemic

Are we at risk of hyperinflation? It’s hard to say. At the moment, probably not, but, if governments around the world continue to pump money into the economy and increase their national debts, it might happen. The national debt for the US is near $25 trillion, meaning over $500 billion is spent on paying the interest each year. Before the pandemic, roughly a trillion dollars were added to the debt each year, but, because of the pandemic, trillions more have been added.

The US may pass another round of relief worth $3 trillion.

While the US will have no problem continuing financing its debt for the time being, things may turn sour if investor confidence is shaken. That is, if the US debt gets so large and debt payments continue to grow, investors may hesitate to buy US debt, fearing the government will not be able to pay the interest. If this happens, the economy could spiral downward, similar to what happened to Greece in the 2000s.

Furthermore, inflation puts pressure on the economy by increasing unemployment, discouraging spending, causing trade imbalances, hurting foreign exchange rates, among others.

Therefore, your stimulus check is necessary to keep the economy moving and to help you and your family make it through the pandemic. However, on the other side of the pandemic, consequences might be waiting for us.

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