Why Even Bad Bailouts are a Good Deal

Why? Because the government gets to pay with monopoly money and get paid back with real money.

Right now, with the T-bill rate at approximately zero, the Fed can effectively create an unlimited amount of money to finance the government. No matter how many T-bills the Fed buys, the rate won’t go much lower than it already is, so such purchases, even on a very large scale, won’t have much economic effect (and if they do have an economic effect, so much the better). So anything the government pays today, it can pay with free money, money that it created out of nowhere (and for some reason, people are all too willing to accept it as payment for all sorts of things).

Eventually (one should at least hope) this crisis will be over and the economy will recover, putting upward pressure on prices, causing the Fed to tighten, raising the government’s borrowing costs. Isn’t it nice that a bunch of folks are going to be owing the government a lot of money at just that time? And many of them will finally be able to pay, which means there is so much less that the government will have to borrow now that it can no longer print money with abandon.

As long as the crisis continues, the deflationary pressure will continue, T-bill rates will stay near zero, aggressively expansionary monetary policy will be warranted, and the government can continue to make payments with monopoly money. If Citicorp’s assets go sour, chances are this situation will be continuing, and the government can pay out those guarantees with monopoly money. And if the crisis continues for 5 years or 10 years, that’s so much longer that the government gets to print worthless pieces of paper (in the usual trope, though most money isn’t literally paper) and make various assetholders happy by allowing them to retrieve these worthless pieces of paper. And if the government takes some losses in the mean time, who cares? Yes, it will have to print up more worthless pieces of paper. So what?

When the recovery finally comes, everyone to whom the government has lent these worthless pieces of paper (all the ones that are still solvent, anyhow), and whose loans it has rolled over and over as the crisis continued, will have to pay up. It’s like a huge, temporary tax increase, just when it’s needed, only without having to actually raise taxes.