State Currencies and Modern Monetary Economies: Part 1

State Currencies and Modern Monetary Economies

Part 1

Introduction: Ass + U + Me = Assume

A brief word about orthodox economics. Mainstream alchemists – I’m sorry, ‘economists’ – start with just an assumption – not fact, but assumption mind you, about the history of ‘money’, which then leads them to another assumption concerning how a monetary economy works, and then they say, “Let’s all assume that this is how it works. So, if one does this, then clearly that will happen”. In other words, if Gandalf the Grey shouts, “You shall not pass!” and slams the butt of his magic staff on the ground, then thunder will roll, the earth will shake, and the ground will collapse to the amazement of any hobbits, elves, dwarves, and human-like persons whose life spans total 250 years or more that might be in the immediate vicinity. They need a bit of complex math to describe their nutty ideas.

So, they employ their s00per d00per, Cap’n Crunch decoder ring math skillz, pretend to be scientists like Werner Heisenberg, Richard Feynman, et al., and they create equations that describe what will happen, assuming that they are correct in their initial assumption, which, in reality, they are not. In order to cover up the fact that their entire view of the economy is an assumption, they point to their position of academic authority and declare to the public that it is not an assumption, but an insurmountable fact; that their fantasy view is how the economy actually works in the real world.

“My God, man! I’m a professor at Oxford! Do you really think that Oxford would allow me to teach this stuff if it were all the product of mere assumption and delusion? That’s crazy talk.”

See that? And with a little help from your favourite politicians whom you idolise, and whose donors reap great benefit from the promotion of this totally errant view of economics, you then believe that mainstream economists are high authorities; scientists of great knowledge and insight, and you also believe in their bullshit. They can appeal to authority all they wish, it’s still assumption and delusion. The debt to GDP ratio is an example of this bullshit.

In the real world, examining debt to GDP to determine when the public debt of national governments like the US, Canada, UK, Australia and Japan will result in everyone’s hair catching fire and fiscal collapse is an utterly useless endeavour because these nations cannot experience fiscal collapse. No amount of public debt is unsustainable for these nations. They have monetary economies established by their national governments and they operate on a state currency.

To summarise this introduction, ignore mainstream economists. The US/UK governments both issue the currency, and regulate their markets through their currency-issuance, taxation, and legislative authority. These economies are all 100% dependent upon their national governments to spend and tax – yes, tax. As we will learn, tax is what causes the demand for the state’s currency so that the economy, which operates based on the state’s currency, can continue to exist. In part 2 of this series we will examine the gold standard, we will learn that in the modern era, treasury bonds/gilts issued by these governments are an anachronism.

a·nach·ro·nism (noun) a thing belonging or appropriate to a period other than that in which it exists, especially a thing that is conspicuously old-fashioned.

Treasury bonds are holdovers from the gold standard days of long ago when the government had to defend its supply of gold by taxing and borrowing. But, no fear: I will explain all of this in a way that the public can easily understand it, and by the end of this series, the reason why things like debt to GDP are meaningless and the difference between gold standard spending operations and today’s will be made quite clear.

So, let us begin with a look at state currencies and modern monetary economies. In other words, we will examine how things really work, not how mainstream economists tell you that things work.

Monetary Instruments

On the one hand, you have gold which is a commodity, and on the other hand, you have the government’s currency which is not a commodity. US dollars/British pounds were not commodities back in the days of the gold standard, and they are not commodities today. The US dollar/British pound are man-made things that we call ‘monetary instruments’. The term ‘money’ is vague, but for the sake of familiarity, I will briefly use it here. ‘Money’ is always infinite. As Minsky said, “Anyone can create money. The problem is getting it accepted.” You could create your own ‘money’ if you wanted. As the creator of your own monetary instrument, you are the only person authorised to issue it. Therefore, do not need someone else to finance you in terms of your own ‘money’, and so you simply cannot run out of your ‘money’. As Eric Tymoigne points out, for something to be a monetary instrument, it will require at least three ingredients:

1.) It must have an issuer.

2.) The issuer must declare a face value on the instrument. In other words, when the US government strikes a quarter, it says, “This here coin is worth one quarter of a dollar, or 25 cents.” 25 cents is the quarter’s face value. The same applies to dollars/pounds in paper notes and treasury bonds/gilts.

When the UK government produces a ten pound paper note, it says, “This piece of paper is worth exactly ten pounds.” That is the note’s face value. When the US government produces a one dollar bill, it says, “This here paper thingy is worth exactly one dollar.” That is its face value.

As a side note for all of you printing money enthusiasts and true believers, it is very important that you understand that the US/UK governments do not rely on paper cash to fund their spending today. Today, these governments spend with keyboards and type dollars/pounds into existence. They do not print paper cash to fund their spending.

So, at this point, if you are an analytical person who’s not given over to political nonsense or conspiracy, you might ask yourself, “For a $100 paper note to be worth exactly one hundred dollars, that would imply the paper note is but a representation of the actual $100. So, where are the actual one hundred dollars?”

Very good question, and the answer is that the paper note represents the government’s unit of account – the US dollar – and in this case, it represents exactly one hundred dollars that the US government issued when it keystroked them into existence, creating deposits in reserve accounts at the Federal Reserve. At some point, a bank needed more cash on hand to meet customer demand for cash, so the Federal Reserve deleted $100 from the bank’s reserve account and sent the bank a $100 paper note.

Put simply, all US dollars begin as numbers on a computer screen when their respective governments type them into existence, just like when you open up Microsoft Word and type words into existence.

So why cash?

Well, people like you and I enjoy having cash in our pockets from time to time, especially around the holidays. So, banks will ask the Federal Reserve to convert some of their reserve balances into paper cash. It is only after the US government has already spent, that dollars in reserve accounts are now available to be converted into physical cash. The Federal Reserve then contacts the US Treasury’s Bureau of Engraving and Printing and lets it know how much paper cash it needs to meet bank customer demand for cash. Paper notes are then printed by the US Treasury’s Bureau of Engraving and Printing and sent directly to the 12 regional Federal Reserve banks for distribution to commercial banks within those 12 regions. Thus, when bank customers like you and I wander into our banks and ask for a $20 bill, the banks then have them on hand to give to us. But in order for these banks to have the cash on hand, they had to ask the Federal Reserve to convert some of their reserve balances into physical notes. The Federal Reserve deletes dollars from a bank’s reserve account and then ships that exact number of paper notes to the bank. For example, if the bank ordered $1 million in cash, the Fed deletes $1 million from the reserve account and ships exactly $1 million in paper cash to the bank. The bank now holds its reserves in the form of cash within its vaults. None of this activity has anything to do with funding federal spending.

The $100 paper note is the physical manifestation of exactly one hundred dollars in US government spending. It is the face value declared by the US government. The paper note is not the thing that was spent by the government, but rather, it stands as physical evidence that at some point in time the US government spent one hundred dollars into existence and that those one hundred dollars still exist.

And lastly,

3.) The issuer must promise to accept the monetary instrument back as payment for something, or else the monetary instrument is utterly useless.

In the case of a state currency like the US dollar or the British pound, this means taxes. It also means fines and fees as well. The government promises to accept its monetary instrument back as payment for taxes, fines, and fees. Because you must pay the tax or suffer the consequences, you and everyone else in the nation will be desperate to obtain the government’s US dollar/British pound. Let’s look at why this is.

How a State Currency Works

As mentioned in the previous section, US dollars/British pounds are state currencies; they are not private monetary instruments. They are issued only by their respective national governments. Mainstream economists like to view the economy as a barter economy that just happens to have money in it. Their precious barter economy has been contaminated with ‘money’, and that contamination only cocks things up, complicating everything and making it really hard for them to predict outcomes.

Nice story and all, but it is completely wrong; false to the core. I think that for the sake of clarity, so that there can be no misunderstanding amongst the widest number of people, the word we are looking for here is ‘bullshit’ – it is complete bullshit.

The barter view is totally unsupported by historical evidence, and when I say that, I do mean that even the tiniest bit of evidence cannot be found for an entire macroeconomy operating on the barter system. This is because the barter view is completely irrational on the macro level. Since our goal here is to actually understand how things work, we will actually pay attention to what we can find in the historical record, rather than blatantly ignoring it and making up bedtime stories as mainstream economists do.

We do have historical evidence that kings and their governments issued monetary instruments – everything from tally sticks to metal coins, and they also imposed taxes which then caused monetary economies to come into existence that functioned based upon those monetary instruments. In other words, long, long, long, long, long ago, authorities realised that by issuing a single item which they chose to refer to as ‘money’, they had an efficient means to acquire various goods and services, and that also meant that these money thingies were an efficient and powerful means for the authorities to command and control their populations, which is precisely what a national government is supposed to do. That is its purpose. Whether a king, dictator, or a free nation with a government of, by, and for the people, the national government is the supreme power that dictates the nation’s laws, regulates, and governs everything within the nation accordingly.

The National Government is the Supreme Authority Over the Nation

The reason why the US/UK governments issue the US dollar/British pound respectively is because these governments are the supreme authority of these nations. They represent the nation as a whole. Without them, there is no United States and there is no United Kingdom. They were instituted with the idea that they would endure throughout the ages. Businesses will come and go, people will be born and they will die, but the national government itself must live on if the nation is to endure.

Governments, like any other institution, need supplies in order to function as government. They need pens, ink, chairs, computers, paper, wood, furniture, carpet, bullets, bombs, hair jelly in case Ronald Reagan shows up again, phones, coffee and coffee makers, cars, biscuits and tea, flags, hammers, cups, plates, forks, knives, spoons, saucers, tins of canned peaches in heavy syrup and other food products, bland and nasty putty-coloured filing cabinets, faucets, sinks, glass, picture frames, airplanes, routers, light switches, light bulbs, outlets, wiring, on and on. The US/UK governments do not produce these things, they just need these things. Members of the population, which we refer to as “the private sector”, produce these things using the nation’s real resources (land, labour, raw materials, etc.) to do it. Just like you and I must acquire these goods and services to survive, the US/UK governments must also acquire these goods and services from the people in their respective nations. So, there are two ways the US/UK governments could go about obtaining the goods and services that they need: The uncivilised way, or the more civilised approach.

In the uncivilised approach, the US/UK governments recognise that they are the embodiment of their two nations, and that they are the supreme authorities over their nations respectively. So, since the nation consists of all of the land, people and materials within its boundaries, and the nation’s real resources are commanded by the national government, then the US/UK governments could easily supply themselves with whatever goods and services they require by using the military to force the population to hand over the goods, and by impressing labour into service through a few good knocks on the head like the British Navy used to do back in the day when it was in want for sailors.

In the civilised approach, the US/UK governments decide that it is probably best if they didn’t go around confiscating goods and cracking people on the head with blunt instruments, and instead, simply purchased from the people whatever goods and services they needed to function as government. Force will still be necessary, but it is more of a gentle force. So, the more civilised approach is for the US/UK governments to purchase the goods and services that they require to fulfil their mandates by using their supreme authority to issue their own monetary instruments and then impose taxation on the population.

The Primary Purpose of US/UK Government Taxation

To tax means to impose a burden. There are two separate parts to taxation:

1.) First, there is a demand for payment. The burden is placed upon the heads of persons by the government.

2.) Then second, the tax payment is collected by the national government.

These are two separate events. In a state currency system, something occurs in between these two events which makes it possible for the population to pay the tax, and that something is called government spending.

When the tax is imposed, the US/UK governments also clearly outline a severe punishment that will be exacted upon any person or entity that is subject to the tax but doesn’t pay it. In other words, “Pay up, or you will lose your property or go to prison.” The burden of tax is the force mechanism that causes the population to suddenly need the US/UK government’s US dollar/British pound because the population knows that the US/UK government can easily carry out their threats, and so, the population wants out from under that burden. And the burden of tax is the mechanism that then enables the US/UK governments to generate their own ‘money’ to buy what they need from the population. The US/UK governments promise to accept back their US dollars/British pounds as payment for taxes, and the population then demands the US dollars/British pounds. The force of taxation fulfils the acceptance requirement that Minksy mentioned: “Anyone can create money. The problem is getting it accepted.”

Problem solved.

A National Government Generates its Own ‘Money’

The US/UK governments offer to buy goods and services from the population. These governments will first determine the price of the goods and services that they want to buy, because they are the only supplier of US dollars/British pounds, and then these governments will generate their own ‘money’ to make the purchase. In doing so, the population then has possession of the US dollars/British pounds that it needs to pay the tax. From this point onward, as long as the US/UK governments continue to impose taxes payable only in US dollars/British pounds, and can enforce their tax collections, their respective populations will demand and use US dollars/British pounds. The end result is that the US/UK governments can always buy what they need to function as government in perpetuity without fear of going broke, thus fulfilling their founding purpose as a national government: To endure throughout the ages.

By issuing the US dollar/British pound, the US/UK governments are able to ensure that they can easily acquire any goods and services that they will need to function as government without fear of going broke and being unable to purchase what they need at some future point.

So, how a modern monetary economy that operates on a state currency actually works can be summarised like so:

1.) The private sector does not fund the US/UK government with US dollars/British pounds to spend.

2.) The private sector supplies the US/UK government with goods and services.

3.) In return, the US/UK government supplies the private sector with US dollars/British pounds.

This concludes part one of the series. In part 2, we will examine the gold standard. That is all I have for today. I thank you for listening.