The difference between organic and inorganic money is that the latter is issued without real backing. This means that the monetary base has increased, but not the quantity of goods and services in the economy.
Organic issuance always comes hand in hand with greater productive activity, that is, it responds to a public need to use more money. Therefore, it does not generate inflation. However, inorganic emission does result in a rise in prices.
This is explained because as the monetary base expands, consumers have more resources to spend. Then, they increase their demand, in general, on all merchandise. As a consequence, if supply remains the same, prices will tend to rise.
Another way to analyze it is that, with inorganic emission, there is more money chasing the same amount of goods. Therefore, more tickets are allocated to each product.
Organic money issuance
Let’s look at an example of organic money issuance. Suppose that the central bank of Brazil buys safe-haven assets internationally such as gold or the dollar. Thus, it increases the level of its reserves.
As a second step, the Rio de Janeiro monetary authority issues cash in its local currency for an amount similar to that of the first operation. In other words, if you acquired US $ 10 million, you will be able to place its equivalent in Brazilian reals.
Inorganic money issuance
The issuance of inorganic money began after the abandonment of the gold standard in the late 1970s. Thus, central banks began to manufacture notes and coins without the need to back them with a part of their reserves.
At this point, it is worth mentioning that inorganic money is also known as fiat money because its value is sustained only by the trust of its users.
Inorganic money is issued in various ways. However, perhaps the most dangerous is the concession of debt to the public sector. In this case, the monetary authority offers liquidity to state entities in exchange for a future payment commitment.
This can be catastrophic if the government abuses inorganic emission to finance state spending. Thus, in the extreme, episodes of hyperinflation are generated, as happened in some Latin American countries at the end of the 20th century.
It should be noted that central banks usually resort to inorganic emission when there is a fiscal deficit and, in turn, it is impossible to raise taxes. In this way, the leaders ‘create money’ to cover their need for disbursements.