Finding Cuts to Pay For Federal Spending is Obsolete

The federal government does not “pay for” any federal spending by making cuts to other programs such as NASA, SNAP, or the military. The statement “finding cuts to pay for” errantly implies that the US Government can run out of money, which is a completely impossible condition, because the US Government is the exclusive issuer of US Dollars.

Now, I’ve discussed the gold standard at length over the years, but let’s very briefly review concepts and then relate the “finding cuts to pay for” mythology to our review.

The US Government is always the exclusive issuer of US Dollars. The gold standard didn’t change that reality. What it did do, was restrict federal spending to the supply of gold available. The US Government pegged its US Dollar to gold and agreed to exchange its dollars on demand for gold at the fixed exchange rate. The US Government had to agree to convert its dollars to gold, otherwise the system wouldn’t work. This necessitated keeping a supply of gold on hand in order for the US Government to conduct the exchange.

Because the US Government had to exchange dollars for gold at the fixed exchange rate, this meant that the US Government could run out of gold if there were more US Dollars in circulation that the gold supply could handle. In other words, if there were $500 billion in circulation, but only enough gold on hand to exchange $200 billion, then the US Government faced a very real possibility of running out of gold. In order to avoid such a situation, which would collapse the gold standard, the US Government was forced to conduct its spending in a way that would keep the amount of US Dollars in circulation consistent to the gold supply. There were two ways to do this: Federal taxation and borrowing.

Federal Taxation:

We will assume a gold standard and that there is $500 billion in circulation. The US Government taxes $50 billion out of the economy. That leaves $450 billion in circulation. Good so far? Ok.

Next, the US Government then spends the $50 billion in tax dollars that it collected, thus, injecting them back into circulation. Now, once more, $500 billion is in circulation, because:

$450 billion + $50 billion = $500 billion.

No increase in the amount of currency circulating, and so, the gold reserves are defended.

But what if the US Government wanted to deficit spend; that is, spend more than taxed?

Borrowing:

Again, let us assume a gold standard and that there is $500 billion in circulation. First, the US Government taxes $50 billion out of the economy. That leaves $450 billion in circulation. But, the US Government wants to do some infrastructure work and $50 billion isn’t enough. It must deficit spend while at the same time, defending the gold reserves.

The US Government offers US Treasury bonds for sale and collects another $100 billion. So, the US Government has removed a total of $150 billion, which leaves $350 billion in circulation. The US Government spends the $150 billion in both tax dollars and borrowed dollars back into circulation. Now, once more, $500 billion is in circulation, because:

$350 billion + $150 billion = $500 billion.

No increase in the amount of currency circulating, and so, the gold reserves are defended.

As you can hopefully understand, during the gold standard it was “tax and borrow to defend”. The US Government could always spend, with or without taxation and borrowing, because it was then and still is today the exclusive issuer of US Dollars. But how it did so during the gold standard was called “printing money”.

The concept of printing money to fund federal spending does not exist in a fiat currency regime. It is a gold standard federal spending operation. If the US Government wanted to increase the amount of US Dollars in circulation, it would print dollars and spend them into the economy. Doing so could threaten the gold supply as well as to devalue the dollar.

In the fiat currency regime that we have today, all federal spending is the manufacturing and disbursement of new US Dollars. The federal government spends by crediting bank accounts with its IOU (US Dollars). What this means in layperson’s terms is that the US Government enters a bank account somewhere and types numbers into that account, thus raising the numbers up:

The Checking Account of Bob Behunia:

Current Balance: $1,000

(Now the federal government deposits $500 in Bob’s account by typing the number 500.)

Current Balance: $1,500

End of transaction. No tax dollars are involved in that transaction, because the US Treasury is merely disbursing 500 new US Dollars from the total amount that Congress authorized to be manufactured in that fiscal year.

In today’s fiat system, the currency manufacturing process is both initiated and completed when Congress decides on a budget. Let us assume that Congress authorizes $4 trillion in spending and $2 trillion in taxes this fiscal year. When the President signs off on this budget, the US Dollar manufacturing process is complete. The US Government has now authorized $4 trillion new US Dollars in total to be created and spent, and it has authorized $2 trillion dollars to be destroyed during the fiscal year. Hence, the US Government will run a deficit of $2 trillion, or in other words, of the $4 trillion new US Dollars that it authorized to be created and spend, the US Government will leave exactly $2 trillion of those new dollars in the US economy, thus, increasing the amount of US Dollars in circulation by $2 trillion. The new dollars exist because Congress declared them into existence. The US Treasury is handed instructions to begin disbursing the $4 trillion.

If there is to be deficit spending, Congress demands that the US Treasury issue bonds. That demand does not, in any way, mean that the US Government is “strapped for cash”. There are two operational purposes to treasury bonds in a fiat system:

1.) To conduct monetary policy – Congress will not allow the US Treasury to supply the central bank with bonds directly, so the US Treasury auctions off the bonds to the private sector, and then the Federal Reserve can get ahold of them. This activity is what makes the public think that the US Government is borrowing from the private sector in order to deficit spend. The Federal Reserve obtains the bonds through Open Market Operations and uses them to drain off excess reserves in the banking system when interbank competition for those excess reserves threatens the Fed’s target rate. If the Fed’s target rate is above zero, the target rate must be defended. By replacing liquid reserves with treasury bonds, the Fed halts the competition and maintains control over monetary policy. This is why the Federal Reserve sets the target rate at or near zero prior to conducting QE operations. Since it will be building reserves to excess, by first setting the target rate at or near zero, interbank competition for excess reserves will not threaten the target rate, and the Fed will not need to intervene with treasury bonds.

2.) Interest-bearing savings accounts – US Treasury bonds in a fiat system act as savings accounts, which are maintained at the Federal Reserve. When you purchase a US Treasury bond, the Federal Reserve moves the dollars that you used to purchase them from your bank’s reserve account at the Fed to a securities account at the Fed. Those dollars then sit there, unspent earning interest. At maturity, the Fed simply shifts those dollars in the securities account back to your bank’s reserve account. Interest is paid to you exactly the same way as in our Bob Behunia example. Let us say that you are owed $300 in interest. The US Government enters your bank account, and simply raises the balance in your checking account upward by 300. Interest paid. No federal tax dollars involved. But, why does Congress demand that the US Treasury issue bonds when the government deficit spends?

Because bond markets and corporations demand them. Business entities use US Treasury bonds for risk management. In layperson’s terms, US Treasury bonds are a form of corporate welfare. Bonds do not fund federal spending of any kind, because there is no gold peg that would necessitate bonds to keep the currency in circulation consistent with the gold supply should the US Government want to deficit spend. In other words, US Treasury bonds do not conduct fiscal policy. By simply ordering the Federal Reserve to maintain a zero interest rate policy, the US Government could stop issuing bonds altogether and still deficit spend without inflation or any ill side effects. In a fiat system, the inflation barrier is the real production ability of the economy. The US Government can easily and safely deficit spend, increasing the amount of US Dollars in circulation up to the point of actual full employment (less than 2% unemployment, no hidden unemployment or involuntary underemployment). At maximum output, tax payments will automatically increase and, thus, the federal deficit will automatically decrease. Should the US Government deliberately and persistently increase its deficit spending when a condition of actual full employment exists, then it will be persistently spending beyond the real ability of the US economy to produce goods and services, and inflation will occur.

So, when someone says,

“You tax the rich AND cut the wasteful, bloated, military budget by 50% to pay for those things… There is no need to deficit spend, simply taxing the pig rich and cutting the military budget by 50% will put the budget in the black… When the federal government deficit spends it prints money AND treasury bonds in the same amount. Then we have to pay interest too.”

that person is talking about the gold standard and how federal spending worked in the 1920’s. That person is discussing a by-gone era of flappers, the Brooklyn Dodgers, and a gold standard – none of which exist today. That person claiming that federal taxes fund federal spending and the federal government prints money to fund spending, is akin to that person claiming that Abraham Lincoln is the current President of the United States and that General Lee’s Army of Northern Virginia is preparing to invade Maryland by January 2017.

Simply put, that person is discussing US history.