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There's been a lot of talk about the fiscal cliff, a "deficit crisis," and what Obama should do for the economy given the impossibility of working with the Republican House.   I think that it's important in times like this to think about how government finance really works.

1 – The government creates money by spending it.  Every time the Treasury writes a check to a government supplier or employee, it is creating money.

2 – The government destroys money by taxation.  Every dollar that is collected by the IRS and the other various tax-collecting agencies of the United States of America is destroyed.  It simply disappears.

3 – The government subsidizes savers by creating interest-bearing Treasury Bonds.  These bonds give private savers a safe place to put their money, and the interest rate paid on these bonds makes them more or less attractive to savers.  Higher interest rates means a higher rate of government subsidy to lazy investors.  By doing this, the government can encourage them to take their private money out of the economy, and thus discourage inflation by destroying demand.  Or, by lowering interest rates, it can encourage them to find other, better-paying investments, and thus hopefully encourage economic activity by stimulating demand.

4 – There is no direct connection between these three activities.  Tax revenues do not fund spending any more than Treasury Bonds fund government spending, because the Treasury of the United States is infinitely solvent in US Dollars and can create as many of them as it wants, at any time, for any reason.  

5 – The real purpose of taxation is to give value to the US Dollar.  People need dollars to pay their tax liabilities.  A secondary purpose of taxation is to destroy money in the hands of private persons, thereby destroying demand and discouraging a variety of activities.

6 – A common argument against deficit spending is that it will cause inflation.  But what is inflation, anyway?  Current measures of inflation almost exclusively define it in terms of wages and prices - that is, the evil and bad inflation is almost exclusively defined as a rise in wages. Asset price inflation - that is, the rise in stock prices, investment values, and real estate value - somehow is not included in the common measures of inflation.  Strangely enough, those are the kinds of things the 1% happen to own.

7 - Government spending (that is, monetary creation) creates wage/price inflation if those government dollars are being used to buy things that are in short supply. If it's being used to buy up things that are sitting around idle, such as the labor of teachers, then it's not going to be inflationary.

8 - The destruction of money via taxation should never be thought of as "funding" the government in any way, but rather as a way to reduce inflationary pressures and to manage economic actions. Taxation should really be targeted at those areas of the economy where too much money has built up, and thus which might be able to create inflationary economic distortions. For example, massive inherited incomes and ridiculous CEO pay that, in the search for easy returns, fuels the Wall Street casinos and thus creates asset price inflation.

9 – The National Debt, that is, the total of all outstanding Treasury Bonds, is a tool to manage the behaviors of savers and investors.  As the Treasury is infinitely solvent, all decisions about the size of the National Debt should be made with particular economic and behavioral goals in mind.  There is no reason at all to connect the rate at which Treasury Bonds are created to either tax rates or spending levels, except in terms of the larger economic goals of the government as a whole.

The upshot of all this is that all this talk of government deficits and a ballooning national debt is pure delusion.  Too many people think of money as if we were still on the Gold Standard, and it was possible in some way to "run out" of money.  The only real limit on government spending is the capacity of the American economy and American workers to produce the goods and services the government and the private sector wish to consume.  So long as there is mass unemployment, we are nowhere close to reaching the limit of that capacity.

Given all that, what would the best possible solution to another standoff over the debt ceiling?  Honor it, stop issuing Treasury Bonds, but keep on spending just like before.  

Think about it another way – if the government really ran a budget surplus, that would mean that the government is draining money out of the private economy every year, and destroying it.  What possible purpose could that serve?  How would a vampire state such as this be desirable in any way, shape or form?  It is much better to think of the government as the life-giving sun, providing an endless supply of energy for human activity.

If all this is true, then why are so many people so committed to the false and destructive idea of a balanced budget?  Part of it, of course, is pure ignorance.  Many people simply don't realize the difference between a government with a sovereign currency and a household on a fixed income.  However, in my opinion, at least a few people out there don't want the government to add money to the system unless it's going to them.  They want to have all the money, and to maximize their relative position in comparison to the ordinary citizen.  It's not enough to be rich – they want to be a new class of feudal lords, and to use their total monopoly over private money and private credit to make everyone else grovel before them.  But they can't do that if the government is out there, creating money and giving it to the people who need it, and thereby stimulating economic independence.  They don't want an independent and healthy private economy – they want their own bank account to be the sum total of the economy, and the people to be a mass of indentured servants.

These are not my ideas, but rather my understanding of a new and exciting branch of economics, called Modern Monetary Theory.  Instead of creating abstract models based on assumptions of human behavior that are obviously false, the leading scholars of Modern Monetary Theory have studied what banks and the government actually do.  Look it up on Google for yourself if you're interested.  I learned by reading and participating in years of discussion at one of the smartest places on the internet, the European Tribune.

Originally posted to Zwackus on Fri Nov 09, 2012 at 11:05 PM PST.

Also republished by Money and Public Purpose, The Royal Manticoran Rangers, and Keynesian Kossacks.

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