Why Paying Off the National Debt Will Result in an Economic Downturn

Seven times in US history, the US government has run a budget surplus and tried to either pay down or eliminate the US national debt. All seven attempts resulted in an economic downturn shortly thereafter. Let’s look at the data.

1.) 1817-1821: 29% of national debt eliminated.
Depression occurred in 1819.

2.) 1823-1836: 100% of national debt eliminated.
Depression occurred in 1837.

3.) 1852-1857: 59% of national debt eliminated.
Depression occurred in 1857.

4.) 1867-1873: 27% of national debt eliminated.
Depression occurred in 1873.

5.) 1880-1893: 50% of national debt eliminated.
Depression occurred in 1893.

6.) 1920-1930: 33% of national debt eliminated.
Depression occurred in 1929.

7.) 1998-2001: 14% of national debt eliminated.
Recession occurred in 2002.

Why then would a budget surplus and “paying down” the US national debt result in economic downturns? There are two reasons. The first involves what the national debt actually is and the second involves how politicians attempt to pay down or off the debt. The truth is that you can easily eliminate the so-called US national debt today without doing any harm to the US economy. The harm comes from the “how” it is done. What I wish to focus your attention on is, first, what the US national debt really is.

The US national debt, you will notice, is currently 20 trillion US Dollars; not 20 trillion Canadian Dollars, 20 trillion Australian Dollars, or 20 trillion British Pounds. Again, it is US Dollars. This is highly significant if we wish to label it as a “debt”. Because the ‘debt” is in US Dollars and not Canadian Dollars, Australian Dollars, British Pounds, or any another currency in the world, the US national debt is not an actual debt of any kind, in any sense of the word “debt”. The reason for this is because without the US federal government, there would be no US Dollars. The US national debt is actually the sum total of all cumulative budget deficits ran by the federal government. In layperson’s terms:

The US national debt is all US Dollars that have ever been manufactured and then spent by the federal government that have not been taxed away by the federal government.

The US government is the exclusive constitutionally-authorized manufacturer of every single US Dollar in existence (Article 1, Section 8). To understand the national debt, you have to see the United States without a single US Dollar in existence. At this point, there are no US Dollars, and also, there are no US Treasury bonds denominated in US Dollars to purchase in order to create a “national debt” with either. There is, however, a declared tax payable only in US Dollars that is about to be placed upon the US private sector by the US government. At this point, there is only a tax declared. No tax collections are possible yet, not because trade isn’t occurring, but because there are no US Dollars in existence yet, thus no goods are priced in US Dollars. Both US Treasury bonds and the tax collections do not come before US Dollars are first issued. Nobody can pay a tax in US Dollars or buy US Treasury bonds without first having US Dollars in their possession.

It is important that you understand this critical point: Trade can be going on, and in another currency, let’s say Mexican Pesos as an example. But through the new tax, it is the Mexican Pesos which the US government seeks to eliminate by introducing US Dollars. The US government does not want to tax the Mexican Pesos, so at this point, no amount of current trade will result in anyone being able to pay this new tax. The idea then, will be to make trade transition (switch over) from Mexican Pesos to US Dollars.

So, the US government has informed the US private sector that a tax burden payable only in US Dollars is now demanded of it and there will be a severe punishment if it is not paid. How, then, can the US private sector pay this tax and avoid the severe punishment if it doesn’t have any US Dollars? The US private sector must offer goods and services to the US government in exchange for the US government’s new US Dollars.

At this point, the offer is made to the US government, but no price can be asked for the goods and services, because since US Dollars do not yet exist, nobody knows what the price of the goods and services could possibly be in US Dollars. It is the US government that will have to decide how much it is willing to pay in US Dollars for the goods and services, and the US private sector has no choice but to accept that price, since it must pay the tax and it doesn’t yet have US Dollars to pay the tax with.

The US government declares a price for the goods and services and then manufactures US Dollars out of thin air and exchanges them for the goods and services. Now, the US government has the paper, pencils, pens, ink, wood, carpet and the workers that it needs to properly function, and the US private sector has the US Dollars that it needs to pay the new tax. Any amount of US Dollars left over after paying the tax can now be used by the US private sector to conduct trade in US Dollars, because US Dollars now exist and a price can now be known. Why, though, would the market decide to drop Mexican Pesos and conduct trade only in US Dollars?

Because, firstly, the tax was not a one-time-only tax. The tax is persistent, on-going and only payable in US Dollars. Secondly, other taxes, fines and fees are also imposed, payable only in US Dollars. Thirdly, the US government can demonstrate that it can enforce its tax collections. As long as the US private sector knows that the US government can easily enforce its tax collections, then the majority of the US private sector knows that it cannot escape any federal taxation, nor can it escape the punishment prescribed for not paying the tax. Some will try to escape it and either fail or succeed. The point is that a majority cannot and will not. Therefore, a persistent, on-going demand for US government’s US Dollars is created by the tax. As the years go by, the US government strengthens its tax collection infrastructure. By 2016, its power to enforce federal tax collections is not in dispute.

What must be clearly understood, then, is that without the US government first manufacturing and then spending US Dollars, it is literally impossible for any US private sector business or citizen, or foreign entity to buy US Treasury bonds. Thus, without US Dollars manufactured and spent beforehand by the US government, it is impossible to create a US national debt that is denominated in US Dollars. To clarify the concept, let’s entertain a hypothetical example using Canadian Dollars.

One Example of a Way to Create an Actual US National Debt

Now, instead of issuing US Dollars, the US government could have decided that the US private sector should conduct trade in Canadian Dollars. If it had, then the US government could have perhaps gone to the Canadian government and asked for a large loan of Canadian Dollars and the Canadian government could have lent the US government Canadian Dollars. Understand though, that the US government cannot issue Canadian Dollars; only the Canadian government can do that. So, the US government would, in effect, become a user of currency. In order for it to spend at all, the US government would have to lay a tax payable in Canadian Dollars. The US private sector would then offer goods and services to the US government in exchange for the Canadian Dollars it needs to pay the tax. The US government then would take the Canadian Dollars lent to it by the government of Canada and pay for the goods and services. A market would now be set in motion in the US based on Canadian Dollars.

For the US government to spend, it must now persistently collect Canadian Dollars through taxation and then spend Canadian Dollars. If it then wanted to continuously spend more than its income, it would issue US Treasury bonds for sale in Canadian Dollars to fund its deficit spending. If it did so, then the US government would be incurring an actual national debt which would grow at the end of each fiscal year. Through persistent deficit spending, the national debt would quickly grow to the point of unsustainability. The US government does not want a recessionary bias to occur from persistent tax increases to pay the debt, nor does it want to default either. So it would either have to borrow more from the Canadian government to increase the amount of currency in circulation, or convince Canada to come and invest in the US in order to keep spending and grow the US economy. And that’s assuming that the US government could enforce its tax collections.

But we do not have to worry about all of that, because the so-called “debt” is in US Dollars that only the US government issues. The US economy is a powerhouse and the more US Dollars that the US government manufactures and spends, the more powerful the US economy can grows – as long as the US has the real resources available and that spending is targeted at full employment (maximum production), the public purpose. On its current course in 2016, much of that production power is left idle, much of its manufacturing and spending of US Dollars is for military might and the rich, its tax policy is designed to stifle consumer spending, and the US government actively encourages consumers to save through IRAs and other vehicles; an act which is nothing less that the US government encouraging demand leakages when, on aggregate, consumers need to be spending. In such conditions, only high unemployment, poverty and persistent recessions are possible. Let’s briefly cover demand leakages since I mentioned them. What are they?

A demand leakage is when US Dollars are being saved somewhere, and therefore, not being spent. The US government must meet the demand leakage with an equivalent injection of newly manufactured US Dollars. If it does not, then consumer spending will slow. The greater the leakage, the greater the fall in consumer spending. So, in the case of IRAs, through its tax policy, the US government is encouraging people to save during times of deficient consumer spending. The tax penalty for early withdrawal encourages people to leave their dollars locked away. Thus, if the US government causes $500 million to be locked away, then the economy will be $500 million short in consumer spending, and so, the US government must add $500 million more to the economy to maintain consumer spending levels. The US private sector is one, big saving community. It wishes to net save in the US government’s currency. So, through deficit spending, the US government must meet the savings desire of the US private sector or else cause stagnation or a recession. If the US government runs a budget surplus, it will then be stripping the US private sector of its savings. How then is it possible that Bill Clinton ran a surplus in 1999 and the economy was booming? Private debt expansion, that’s how.

Bank lending is not the lending of US Dollars. It is the lending of a bank IOU that is denominated in US Dollars, which makes it acceptable to clear tax liabilities to the US government. In other words, it is bank created money that can be exchanged on demand for US Dollars. The loan must be paid back with interest. So, as Bill Clinton reduced the deficit, reducing the number of US Dollars added into circulation, he also encouraged private debt to increase to fill the gap in consumer spending. When Bill Clinton achieved the surplus he began destroying private sector savings. As US Dollars were taken from the private sector through taxation and destroyed, Clinton encouraged bank credit (loans, credit cards, etc) to escalate, and greater private debt was added to the private sector, which allowed people to keep on spending.

Again, since a bank IOU is acceptable to clear tax liabilities owed to the US government, a bank IOU is spendable on goods and services, or are you willing to deny that you can buy something with a credit card? These bank IOUs will be accepted by everyone as payment. Remember the purpose of the initial tax we discussed at the beginning? Everyone will accept a bank IOU, because everyone can settle their taxes owed with them. How then can the US government accept a tax payment in bank IOUs when I said that payment can only be made in US Dollars? Easy. The US government doesn’t take the bank’s IOU. It takes back its own IOU – The US Dollar.

Let us assume that you owe $5,000 in income tax to the US government and you go to Chase and obtain a $5,000 loan to pay the tax. Chase creates a deposit containing 5,000 Chase Bucks that are denominated in US Dollars, so $5,000. Now, here’s what happens:

Chase maintains a reserve account at the Federal Reserve that contains US Dollars. It also maintains a record of your loan totaling $5,000. When you pay the US government the $5,000 tax you owe using the loan to do so, the US government removes the actual $5,000 from Chase’s reserve account, causing Chase’s reserves to drop. Your deposit then drops by 5,000, reflecting that you demanded US Dollars in exchange for the bank IOUs. Now you owe Chase $5,000 plus interest.

Unlike a normal transaction where reserves would shift between banks, here the US government is removing reserves completely from the banking system when it taxes. Since Bill Clinton was running a surplus, the US government was not replacing the US Dollars that it removed through taxation, which means that Bill Clinton was persistently destroying US Dollars in circulation. Or in other words, Bill Clinton strangled the US economy.

Bank IOUs act like US Dollars, so they are indistinguishable from US Dollars. Thus, as private debt increases, spending increases, and so, unemployment drops creating the illusion that the surplus is driving a booming economy. Eventually, though, under these circumstances something has to give, and it did in 2002. Consumers cannot endlessly take on ever increasing amounts of private debt. In 2002, consumers contracted their spending, business lost income, laid off workers, unemployment rose, and a recession occurred. As the unemployed sought relief from welfare and unemployment insurance assistance, the surplus automatically became a deficit again. Just like his six predecessors, by running a surplus to “pay down” the US national debt, Bill Clinton caused an economic downturn. But, even if he had not tried to “pay down” the debt, and instead, decided not to add a penny to the national debt, Bill Clinton would have still caused a recession.

If you add up all US Dollars currently in existence, which is: US Dollars in cash and coin, US Dollars in reserve accounts and US Dollars in securities accounts, the total equals the US national debt to the last penny. Again, the US national debt is the total of every US Dollar in existence today that only the US government manufactured and spent into the economy, right down to the penny. The so-called “national debt” is actually the national savings.

So, the real question to ask when it comes to the US national debt is not how to pay the national debt off, but rather, “Is every, single American citizen adequately benefiting from the $20 trillion that currently exists?”

The answer is, no.

Look at the goods and services for sale today, and those that will be in the future. Look at how much food goes unpurchased and thrown out. Look at how many computers go unsold. Look at how many houses are left vacant and unsold. Look at how many apartments are left vacant. Look at how many new cars sit on a car dealer’s lot. This is because of two things:

1.) Because of the US government’s incorrect fiscal policy stance, there is a poor distribution of US Dollars between the majority of the population which would spend them if they had them, and a minority of the population which is amassing US Dollars in savings.

2.) The US government is not deficit spending enough in any fiscal year to fill the spending gap by targeting the savings desires of the entire population.

In other words, in an environment of high involuntary unemployment, low wages, rampant underemployment and high private debt levels, consumers on aggregate do not have enough US Dollars to do anything meaningful for the US economy. Each year, the federal deficit is entirely too small to bring about full employment and prosperity for every, single citizen. Cutting the deficit when the US imports more than it exports, plus relying on private debt to fill the spending gap only means stagnation, then unemployment, and then recession.

So, are you absolutely certain that Hillary Clinton should not add a single penny over the next four years to the “national debt”? Hillary Clinton is totally unfit to be President of the United States.

Finally, we come to how the US national “debt” is paid off without destroying the US economy. It can easily be done, but we must remember that the US government is the currency-issuer, and so, there is no unsustainable level of public debt in terms of US Dollars for the United States. If you really feel the need to “pay off” the non-existent debt without “printing money” (Which in a fiat system is impossible. There is no such thing as “printing money” to fund federal spending any more) and without raising federal taxes, here’s how it’s done.

A US Treasury bond is nothing more than a savings account that pays interest. Once you have enough US Dollars you can then buy a treasury bond. Let us assume that you buy a $10,000 US Treasury bond. When you do, $10,000 in your bank’s reserve account held at the Federal Reserve will shift to a securities account also held at the Federal Reserve where the $10,000 will sit, earning interest. What all of this actually is, is two spreadsheets with numbers on them. Not actual cash in vaults. Just numbers on a spreadsheet. Over here is a spreadsheet called “Reserve Accounts” and over there is a spreadsheet called “Securities Accounts”. When you buy the treasury bond for $10,000, the number 10,000 is deleted from the reserve accounts spreadsheet and then added to the securities account spreadsheet. If you have a checking and savings account, print off a copy of both and then look at the numbers. That is basically what we are talking about here. Reserves are like checking accounts and securities accounts are savings accounts. The numbers are a record. The national debt is a record of dollars held in savings accounts at the Federal Reserve.

When the bond matures, the US government deletes the number 10,000 from the securities account spreadsheet and adds the number 10,000 back to the reserve account spreadsheet. In other words, the government shifts $10,000 from a savings account back to a reserve account. From there, you need to collect your interest payment. Like the US government does when it spends for anything else, it goes into your account, and, through keystrokes, simply manufactures new US Dollars by typing them into existence. You are now “paid back” plus interest. So, let’s pay off this non-existence US national debt.

The US government moves $20 trillion from securities accounts to reserve accounts then types US Dollars into existence to add the interest. The national debt is “paid”. No tax dollars involved to pay the interest, which isn’t possible in a fiat system, no “printing money” which isn’t possible either, and no damage to the US economy. As we’ve discussed, the reason why politicians will damage the US economy in the future should they try paying down or paying off the debt, is because prior to doing a simple shift of numbers on spreadsheets, politicians feel the need to first raise taxes, reducing the number of US Dollars in circulation, and run a surplus which then wipes out the economy. Then afterwards, the US government will move US Dollars from securities accounts to reserve accounts.

Such a thing is akin to you deciding that you need to move $100 from your savings account to your checking account. But, before you move the $100, you burn your house down, throw out all of your food and take a sledge hammer to your car. Afterwards, you then move $100 from savings to checking. Make sense?

Apparently, it makes perfect sense to Hillary Clinton. Hence, #ImNotWithHer