A Treatise on Unsound Money: Part 5
Written by Derryl Hermanutz
The current structure of our money systems isn't written into the immutable laws of nature. It is a flawed, some say perverse system, thought up by men. If they were trying to design a money system that served the needs of the economy, they failed. The system seems more designed to make the real economy serve the needs of money and money creators. People need to be able to save their money without sabotaging the economy in the process. Debtors need to be able to have at least an arithmetic chance of earning their money back to repay their bank loans plus interest, which means that some party has to create additional money and spend it into the economy where debtors can earn it, equal to the amount of money savers removed from circulation plus the amount of bank interest charged.
As we saw earlier, keeping the quantity of circulating spending money constant does not cause inflation: too rapid creation and spending of new credit money causes inflation. It is the "change" in the direction and volume of newly created spending money that causes economic prosperity or recession, a dynamic that Steve Keen is currently systematizing for academic and policy making macro economics. And non-monetary factors like supply disruptions also cause inflation (or deflation, in the case of technological productivity improvements).
Once the new credit money is spent in the first place, the economy has to keep spending that amount to maintain prices at their new level and to keep the economy functioning at that level so debtors have a chance to earn their money back. Saving removes money from circulation, so somebody has to add new spending into the equation to keep it working. Paying interest to banks takes money out of the hands of people who are inclined to spend it and puts it in the hands of people who are inclined to save it, so that source of savings (or "capital formation") has to be offset with additional new non-debt money too.
Governments can perform this arithmetically necessary money-adding function by spending more than they tax. But under the current system governments have to "borrow" this deficit-spending money from their banking systems (who create new credit money out of thin air to purchase interest bearing government debt) and from their savers. If it is assumed that governments eventually have to increase taxes in order to get their money back to repay their debts, then this method of funding deficit spending is not feasible. The governments would have to tax the money from the people who have the money, the savers, which is not much different than private debtors robbing savers for the money to repay their private debts. So if government (and private) debt reduction is desired (which it is and should be), then some method other than taxation will need to be employed to achieve it. Steve Keen and Michael Hudson advocate debt forgiveness, for e.g.
Canada's central bank directly funded government deficits from 1939 until 1974, effectively interest free, and Canada grew prosperously with low inflation and manageable government debt. It is compound interest, after all, not bare loan principal, that transforms million to billions to trillions of government (and private sector) debt. In a 1995 set of discussion papers released prior to his revolutionary budget balancing act, Canada's Liberal finance minister Paul Martin showed how about $80 billion of deficit spending had grown with compound interest to nearly $600 billion of government debt by 1995 (including the Volcker 20% interest years, where debt was DOUBLING in each 3 ½ years simply due to compounding interest added to the loan principal).
Note: "Doubling time" is calculated as 72 divided by the rate of interest, so 72 divided by 20% = about 3 ½ years. The "money" to pay this interest was never created and does not exist, like two kids betting a thousand bucks on some silly game of chance. Neither of them actually "has" the $1000, but one ends up "owing" it to the other. Good luck collecting, ever.
With Quantitative Easing (QE) the Fed and the Bank of Japan are indirectly funding US and Japanese deficits. The eurozone has its own methods of forestalling debt-plagued monetary collapse. China adds money into its system by capturing other nations' spending via trade surpluses, the mercantile way of old. But "borrowing" from your central bank still irreversibly increases total public debt, even if there is no interest cost, and the public rightly fears ever increasing debt. So a better way is for governments to simply exercise their sovereign constitutional responsibility to "coin money, and regulate the value thereof".
Joe Firestone, among others, is prominent in advocating that the US Treasury coin a multitrillion dollar platinum coin (which is legal, as the government can arbitrarily regulate the face "value" of the coin to any amount it chooses regardless of the market price of the bit of platinum in the coin), deposit it in Treasury's bank account at the Fed, and use the new deposit money to buy back some or all of its Treasury debt. Or the government could simply use its new bank deposit money to fund its deficit spending. The first action reduces total debt far below the debt ceiling and opens up new borrowing room; the second action bypasses the debt ceiling by using non-debt money to fund spending in excess of taxes. Congress authorizes the deficit budgets, after all, and it is the Executive's job to do what it must to implement the will of Congress, of "the people". And it is the government's constitutional obligation to pay its debts without question, so if the government has the power to pay its debts, which it does, then it should use them.
Banks hold a lot of Treasury debt as assets on their balance sheets, which they paid for by creating bank deposits in the government's accounts at those banks, so if the government bought back its Treasury debt from the banks then the banks would just use the money to reduce their assets and reduce their liabilities by an equal amount, as in any other loan principal repayment, and the money would be extinguished along with the debt. There would be no "money" added into the system in this way, just a reduction of bank balance sheets and of government debt. So there could be no possibility of causing inflation because no money is being added into the system.
But Treasury securities have become a core foundation of the US and global financial system, so I don't think it's advisable for the US government to buy back its debt too quickly, if at all. The US dollar is still the global reserve currency, and countries need to get dollars by exporting stuff to the US in exchange for dollars (what de Gaulle saw as America's "exorbitant privilege": getting real stuff in exchange for printed pieces of paper). Cash is a non-performing asset: dollars sitting on a pallet in a vault earn no interest. So countries want to hold performing assets denominated in US dollars in order to earn some return on their holdings of the reserve currency. So they buy US Treasury securities that pay interest. Low interest is better than no interest, especially on nation-size holdings of US dollar reserves. For nations to acquire and hold dollars, the US must run trade deficits with the world, importing real stuff in exchange for dollars. The "Triffin dilemma" explores some of these implications of using one nation's currency as the global reserve currency.
But one implication is that as long as the world holds US dollars as reserves, the world wants and needs US Treasury debt. Which is why so many of the 21 big banks (plus China) who have "primary dealer" status to bid on new issues of Treasury debt are non-US banks. These banks buy and distribute Treasury debt to the world, by selling Treasuries into the secondary markets. Treasury debt is caused by US government deficit spending financed by new debt. So US trade deficits and US budget deficits are mechanisms that enable the global monetary system to hold an interest bearing form of US$ reserves. I don't think it's a good idea to mess with this global mechanism in order to solve a domestic monetary problem. Global finance is fragile enough without fiddling with its core pillar.
In the last monetary Depression Irving Fisher justified his 100% reserves monetary reform proposal, which involved taking away the money issuing power from the banks and letting the government issue all the money and lend it to the banks at zero interest, by observing that pretty much everybody thinks the government is ALREADY creating the nation's money. In fact the banks were creating the money in the 1930s as they still are now, so Fisher said his reform would simply make the money system perform in fact as people mistakenly think it performs already. IMF research authors Kumhof and Benes are advocating the same thing today with, "The Chicago Plan Revisited".
Personally I think Joe Firestone has the more modest and more workable proposal, as the Congressional legislation authorizing Proof Platinum Coin Seigniorage (PPCS) is already in place and the Executive can do it any time it likes. Adrian Ash and the sound money guys already blame the government for causing monetary inflation as if the government, not the banks, is creating the money. So if the government gets the blame anyway, then the taxpayer might as well get the benefit of having the government issue its own money and save taxpayers half a trillion a year interest, plus the threat of hyperinflated taxes if the government ever tries to get the money back to repay its debts to the bankers.
Most banks most of the time are very prudent about their lending, and we need bankers managing the creation and allocation of financial credit (and the collection of debt payments) to finance our real economies and to operate the payments system. I hardly think governments would do a better job of "banking" (credit creation, allocation and management) than bankers do already, though revoking Glass-Steagall which opened depository banks to casino capitalism should be reversed because we need a "sound" focused banking system. You don't need to take the money issuing power away from the banks in order to make the system keep working. All you have to do is add some non-debt money into the equation. And the platinum coin is a simple and immediately available way of doing that.
The Five Parts of the Treatise on Unsound Money