Federal Deficit Spending is “Money” Creation

In addition to closing on a new house and moving over the next two weeks, plus dealing with allergies, I am pre-occupied with writing a series on the Gold Standard and why it was and always will be, a monumental failure. Therefore, I’ll keep today’s discussion brief with another look at how federal spending works. Before I begin, I wish to point out that for the sake of the layperson’s familiarity and understanding, I am going to use the word “money” in reference to federal spending rather than “currency”. We will also skip discussions of private debt and the sectoral balances.

A dollar is not a piece of paper, or a coin. A dollar is just a number. Cash (paper notes and coin) is nothing more than a physical representation of a number. For instance, a $20 bill is a piece of paper that physically represents twenty of something. That something is the government’s chosen unit of account, or “currency”. In this case, dollars. The number twenty alone has little meaning, since we do not know what the number represents. It could be twenty apples, twenty cars, twenty kids, twenty people who think that federal taxes fund federal spending, etc. We need to define the number. So, by placing a symbol in front of that number, we are able to define the number:

$20

Twenty dollars. But what if we did this:

£20

Now, the number twenty represents something else entirely. In this example, the number twenty is twenty British pounds. The difference between the two is the national government that issues the unit of account.

Mathematics tells us that numbers are infinite. Thus, we can type as large of a number on a computer screen as we wish:

100, 1,000, 10,000, 1,000,000,000,000,000,000

Now consider the following:

$100, $1,000, $10,000, $1,000,000,000,000,000,000

Here again, instead of typing numbers, we’ve typed numbers that are clearly defined. The numbers have become dollars. You and I can type dollars of any size on a computer screen, or write them down, or enter them into a spread sheet, but they never become currency. We cannot spend those numbers that we type. This is because, you and I have no authority to issue currency. However, such is not the case for the federal government. When the federal government enters a bank account and types a number on a computer screen, that number appears in the banking system and becomes “money”.

The federal government can type as large of a number that it wishes in a bank account and when it does, the federal government spends. To illustrate this concept, let us assume that there are zero dollars in the Australian economy. Dollars presently do not exist, but the banking system is already set up and waiting to receive dollars from the federal government. The government enters a bank account and types the number 5,000. Now, there are $5,000 in the Australian economy. Next, it enters another bank account and types the number 500. Now, there are $5,500 dollars in the Australian economy. Entering yet another bank account, the federal government types the number 100,000 and now there are $105,500 in the Australian economy.

The insight here is that when the federal government of Australia types a number in a bank account, it is creating “money” and spending at the same time. In short, when the federal government of Australia spends, it is spending money into existence. The further insight is that if the Australian government spends money into existence, then it has no supply of dollars on hand first before it spends. Therefore, we understand that the capacity for the Australian government to spend is, in fact, infinite and so:

The supply of Australian dollars available to the Australian government is always equal to infinity.

Today, there is nothing backing the Australian dollar to run out of. It floats freely on an exchange and the Australian government will not convert your dollars into gold, silver, plastic spoons nor anything else but Australian dollars. If you were to take a $20 bill to the Treasury, the Treasury would give you two tens, four five dollar bills or any combination thereof that equals $20. Since there is no gold attached to the Australian dollar, the dollar is now fiat and the Australian government is free to expand its fiscal space dramatically without fear of depleting its gold stock. Since numbers are infinite and the Australian dollar is a number, the Australian government can always afford to buy anything that is for sale in Australian dollars.

So, all federal spending is the typing of numbers into existence, or put another way, it is the increasing of numbers in bank accounts.

At this point, laymen will ask, “Ok, let’s assume that is true. If it continues to spend money into existence, eventually that spending will cause inflation, won’t it?” Eventually, yes, if that spending exceeds the Australian economy’s real ability to produce goods and services. But, you see, that is where federal taxes come in.

As the Australian government spends money into existence, it can also tax money out of existence. Taxation is the reverse of the spending operation, or more precisely, it is the deletion of numbers. When the Australian government taxes, it enters a bank account as it does when it spends, but this time, it deletes a number, thus removing those dollars from the economy forever. Let us assume there are $5,000 in a bank account and the federal government wishes to tax $1,000. The federal government enters the bank account and types the number 4,000 and $1,000 disappears forever. The federal government merely subtracted the number 1,000 from 5,000 and typed the correct answer to the subtraction problem in the bank account. Where did the $1,000 go?

It’s gone forever.

To better clarify the taxation process, grab a calculator. Using the same example above, enter the number 5,000 on a calculator. You can clearly see the number 5,000 on the screen. Now then, hit the minus key and enter the number 1,000 (which is the amount that the federal government wants to tax). You can clearly see the number 1,000. Now hit enter. You can clearly see the number 4,000 now. But, where did the number 1,000 go?

It’s gone forever. It was there, then it wasn’t. That is federal taxation.

So, spending is the increasing of numbers and taxation is the decreasing of numbers. More precisely, federal spending is the act of depositing dollars into the economy and taxation is the act of withdrawing dollars from the economy. When the federal government adds more dollars to the economy than it withdraws, we call the result for the Australian government a budget “deficit”, but, on the other hand, it is a surplus for the economy. In short, what the federal government spends is deposited into the private sector for us to use. What the federal government taxes is removed from the private sector, thus reducing our spending power.

The insight then is that if the federal government’s deficit is too high (depositing too much money into the economy), inflation can result. And if the federal government’s deficit is too low (depositing too little money into the economy), then spending power is negatively affected and unemployment results. Therefore, federal budget deficits are necessary for job creation and the good health of the economy. But what happens when the federal government runs a surplus?

When the federal government withdraws more money from the economy through taxation than it is depositing through spending, the result is a budget surplus for the federal government, but, on the other hand, it is a deficit for the economy. When the federal deficit reaches zero (when what the federal government spends is exactly equal to what it is taxing), the balanced budget then forces the private sector into spending more than its income which we call a deficit. When the budget passes into surplus, no dollars are being deposited. Dollars are only being withdrawn from the economy. Since consumer spending power is being reduced dramatically, it contracts and a recession occurs. At this point, the budget surplus will then automatically become a budget deficit again.

We understand then that a federal deficit is necessary and a federal surplus is rarely, if ever, appropriate. A government such as the Australian government which spends money into existence cannot save its own money nor does federal taxation fund any federal spending. It simply cannot save for a rainy day. To do so, would require the Australian government to determine how much it wished to save and first spend that amount of money into existence before it could save it. So, the Australian government saving in its own currency is impossible. Only the sectors outside of the Australian government can net save in the government’s money (currency).

If we wish to understand why unemployment is too high and why the economy is stalling, then we must change our errant viewpoint to one reflecting macroeconomic reality. By reducing or eliminating federal deficits, the federal government is causing unemployment and sabotaging the economy.