posted on 03 January 2016
Written by John Hemington
In explaining how fiat money works in Modern Monetary Theory it is typical to have government (fiat) money defined as debt of the government. And, while this may be technically correct in some ways, it is not totally correct and is confusing to many.
In a True Fiat System the Government is Not a Debtor
In actuality the government in a fiat system effectively has an infinite capability to cover any debt it might incur by simply creating more money. What the government actually assumes is an obligation to accept the money it issues back as payment for taxes the government later assesses. This is what ascribes value to the money issued. So rather than describing the relationship as the government as debtor, the relationship is one of obligor and obligee not debtor and creditor. Thus the government is not indebted when it creates money and distributes it into the economy - whether that distribution is by direct spending or by directly injecting it into social programs for those in need - and, ergo, no creation of government debt.
Obligor - Obligee Relationship
This is not simply a semantic issue the terms debtor and creditor do not mean exactly the same thing as obligor and obligee. A debtor is one that owes something to another. An obligee is somebody to whom another person is legally or morally bound to do something. The government does not owe something to those holding its money; but it is legally obligated to accept that money from the holders in payment of taxes just as non-government creditors are legally obligated to accept government money in payment of debts, goods and services.
These legal obligations are created by the government. Since the obligation is to accept government money in payment of taxes, it is always possible and likely that the government will issue more money than it collects in taxes. In which case there would be an accounting deficiency which would equate with the additional amount of government money actually circulating within the economy. The remainder of circulating money would be that created by banks out of thin air by making loans to borrowers. Unlike government created money, which does not have to be completely reabsorbed by taxation, bank created money does have to be completely repaid (assuming no failure of the debtors). The government does not need taxes for any purpose other than giving its issued money value - Congress' foolish laws and restrictions notwithstanding.
No National Debt
In this scenario there would never be anything called a "national debt". Instead there would be an accounting entry showing money issued on one side of the balance sheet and taxes collected on the other side. For the economy to prosper the money issued side would always have to be greater than the taxes collected side of the ledger; otherwise there would be reductions of money in circulation to fund economic activity, excepting increases in bank credit issuance.
(Note: Of course, there may be extraordinary circumstances of increasing inflation where fiscal surpluses - more taxes received than money spent - may be needed.)
Even bank lending is implicitly creating new government money out of thin air when making loans to borrowers. While such money may be entirely virtual in nature it is still denominated in dollars and only has validity as long as the government money retains its value - thus the necessity of taxation.
How Does the U.S. Have $18 Trillion Debt?
So why is it that there is currently $18 trillion dollars in national debt? This is a complicated question with a relatively simple answer - Congress did it! And what Congress did Congress can undo if it has the will. But it will only have the will if the public at large demands that it do so; and the public will only demand that it do so if the public can develop an understanding of how fiat money works and what it can and should do to maintain a vibrant and fair economy.
The Unstable Gold Standard
There were periods in U.S. history when the country was on what is known as a "gold standard", in other words the government had to maintain a store of actual gold to support any money it needed to issue. If it was necessary to issue more money value than it had on hand in gold, the government would have to borrow additional gold to do so and thus incur debt. If it issued money without gold to back it the value of its money would devalue, i.e. inflation would result. The periods on the gold standard were always sporadic and temporary and inevitably ended in major recessions, depressions or wars.
Bretton Woods System
Following World War II no agreement could be reached among the Allied powers about how to return to the pre-Great Depression gold standard. So a convoluted system was agreed to at Bretton Woods where only the Dollar would be backed directly with gold priced at $35 per ounce and all other major currencies would float relative to the Dollar. This worked until the early 1970s when inflation due to energy shortages impacted the Dollar and other nations, particularly France, began demanding that their Dollar holdings be redeemed in gold from the U.S. gold supplies. Faced with losing all of its gold to redemption, President Nixon declared the faux gold standard of Bretton Woods null and void and initiated what is known as a fiat money standard.
However, even under the Bretton Woods treaty, the United States could effectively operate as a fiat standard domestically since it did not have to borrow gold from other nations if it ran a deficit - it owned the gold the world was using as a standard and redemption was only possible for foreign governments, not U.S. citizens.
The U.S. Does Not Have a Fiat Currency
But the U.S. didn't have a fiat currency under Bretton Woods and it still doesn't. The question all Americans should be asking is: "Why not?" And the reason is, as they say, complicated. But it's not as complicated as most economists and financial commentators would have everyone believe. The biggest and simplest reason is that our leaders and financial rulers don't want the public to understand how money works in general and, more importantly, how fiat money works in particular.
If people really understood just how fiat money could and should work in an economy there would be an almost immediate revolt against the leadership of both major political parties as well as against the financial lords whose purpose it is to keep us enslaved to the system as it has been falsely sold. The reason that the public is kept in ignorance about money is largely that the current system benefits those whose money controls its leaders; and the leaders benefit from serving those who control them. So it is that the American public (and much of the rest of the world) is schooled on a mostly mythical concept of how money works in this society.
It Is a Myth That the U.S. Government "Borrows Money Into Existence"
The myth is that the government must borrow its money into existence; and the corollary, that taxes are necessary before the government can spend money into the economy. The simple fact is that the government must inject money into the economy before there is anything for taxes to be paid with. The incorrect ideas harken back to the days of the gold standard when it was true that there were times when the government did have to borrow to spend, but it was never true that it needed tax revenues to spend. When the Federal Reserve was established in 1913, as a creature of Congress, the creation of government money was delegated to the Fed. At the time the nation was on the gold standard. But even then there was no money paid to the Fed for the creation of money beyond the actual cost of printing the currency.
The Banking Act of 1935
However, likely at the behest of Wall Street banking interests, Congress later passed the Banking Act of 1935 in which a new requirement was added to the Federal Reserve Act, that being that the Fed could no longer transfer created money directly to the Treasury without interest. It was this Act which effectively created the ongoing growth of the national debt once Nixon revoked the faux gold standard in 1971. The Banking Act of 1935 (when the nation was not on a gold standard) required that when the Treasury required additional money for government operations it must first issue treasury bonds to the public through Wall Street bond brokers, at interest, and the Fed could then purchase these bonds on the open market, create the required money to replace the money in the private sector which had been transferred to the Treasury upon issuance of bonds. This increases the money in the private sector by the amount of Treasury securities issued.* This process leads some to state that government deficits create money - but it is actually the Federal Reserve system that creates the money. This was and is a wholly unnecessary and wasteful subsidy benefitting only Wall Street banks.
* There are, of course, some Treasuries which remain in private hands as private sector savings, such as in pension funds, as well as individually and corporate owned assets. Such transactions do not directly increase the money in circulation and can actually reduce it if "operating capital" that was in "cash" was removed from operations to fund the Treasury securities purchase. In the private sector this can be thought of as moving money from "checking accounts" to "savings accounts".
The Debt Limit Law Scam
But even with this there was still no reason why the United States as a sovereign issuer of its own money could not pay any debt incurred no matter how it was incurred. Once again, Congress came riding to the rescue of banking interests and passed an ongoing series of laws limiting how much debt the government could incur without having to stop spending.
The stated intent of these laws was to control the possibility of "run-away inflation"; but, in reality, they primarily served as an effective block against government spending for social needs and services. It is clear that they have never, ever been used to control expenditure for military, defense or intelligence operations.
Nor, as was demonstrated following the Great Financial Crisis, did they have any limiting effect on the Treasury and Fed's bailout of the Wall Street financial interests as somewhere between $21 and $29 trillion dollars in direct subsidies, loans, guarantees and repurchases were provided with nary a whimper from Congress or the President.
The Budget Offset Scam
In addition, Congress created an even more draconian limitation a few years ago when it determined that any new expenditures which exceeded a designated budget amount would have to be off-set by cuts in other programs somewhere else in the budget - this usually means cuts to existing social programs since the war and security apparati and their corporate suppliers are sacrosanct and untouchable as are most subsidies to mega-corporations generally. This follows the neoliberal policy agenda which asserts that all activities for individuals should be serviced through private providers, but mega-corporations and multinational financial institutions are fully deserving of government assistance and financial support anytime they deem it necessary.
The Abomination of Our Time
This then is the abomination of our time and it will persist unless the U.S. citizenry can come to grips with the concept of money and debt and just how they are being manipulated and used against their better interests.
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