A Blog of the Global Justice Movement

Tuesday, April 26, 2011

In the Blink of an Eye, Part II: What Do You Mean by "Cash"?

Yesterday we started looking at a proposal to convert interest-bearing government obligations, to non-interest-bearing government obligations. As the question was phrased, it was whether it would be feasible to change government securities ("Treasuries") to "cash." Our quick answer was that it wouldn't make any difference. The obligation would remain the same. Whether the obligation is in the form of a Federal Reserve Note, a government demand deposit, or a T-Bill, the government still has to "make good" on the promise it conveyed when issuing the obligation.

As things are now, of course, the government has been satisfying (not exactly the right word) its old obligations with new obligations. Would it, then, make any difference whether the outward form of the obligation changed, or whether or not interest was paid? Let's look at those questions.

At one time (and depending on which country you were in), the "Ms" — the definition of money — went up to M7 and possibly beyond. The 1964 (6th) edition of Paul Samuelson's economics textbook mentions government securities as "near-money" (p. 275-277), a meaningless distinction outside the Currency School. This writer vaguely recalls a professor in college far too many years ago saying something about "M14," but the professor may have been joking — we were using a later edition of Samuelson's economics text, but the professor may have been Chicago School.

At present in Great Britain, "M5" represents the total money supply, which includes all debt instruments, such as government securities ("Treasuries"). In the United States, the Federal Reserve has been eliminating various Ms for decades. The latest round got rid of "M3." This restricted the definition of money to the point of absurdity in an effort to impose more State control on the financial system to attain desired results, such as low inflation and full employment. (This may be analogous to the way the Bureau of Labor Statistics keeps changing the definition of "unemployment" so that the level of unemployment doesn't scare people too badly, or how the definition of inflation is tailored to exclude food and oil prices.)

The fact that government securities are already money was noted in the original question . . . which we haven't posted yet, so let's look at the original proposal, numbering the paragraphs for convenience:

1. Why don't we pay off the national debt by "monetizing the debt," that is, by declaring that all Treasury bonds and bills are now non-interest-bearing cash accounts? This would stop the drain on national resources of on-going interest payments, and relieve concerns that the debt will destroy our economic vitality, or impose an undue burden on our grandchildren.

2. Some would object that it would be grossly inflationary, because it creates such a huge amount of new money. But, in fact, the Treasury bills and bonds are already "money" (M3) for all practical purposes, so it's just converting interest-bearing money to non-interest bearing money. Those who wish to may use that cash to start buying other interest bearing bonds, probably from Blue Chip corporations and states and municipalities, thus driving down the interest that state and municipalities and corporations have to pay for such bonds, because of increased demand for them.

3. Paying off the national debt does not produce more natural resources. But it may result in a more equitable distribution of claims against products and services, and mobilize national resources to provide more goods and services, stimulating job-creation.

4. It is a feature of sovereign governments that they can create money. Since our Federal Reserve System operates to allow most creation of money by private banks, we need to restructure the Reserve System to make it a truly national bank. Private banks create money to advantage bankers. The money that a government-owned central bank creates can and should benefit all Americans, and not just the rich.

Let's deal with the "easy" questions first. We agree that government securities — and all private securities that take the general form of mortgages and bills of exchange (both real and fictitious) — are "money" as that term is understood in the Banking School of finance. The Federal Reserve no longer uses M3, for the reasons above, but that's just "word games" being played to try and fool people into thinking an unworkable system can be made to work, even when based on bad or false assumptions.

It's the issue of interest that interests us here. First, there is no effective interest rate on government securities held by the Federal Reserve. After subtracting administrative fees to offset costs of running the system, all Federal Reserve profits are turned over to the federal government . . . that paid the interest in the first place, not to the member banks that are the ostensible "owners" of the Federal Reserve, and that receive no benefit, and cannot even vote their shares. (The shares are actually an interest-bearing membership deposit, and do not represent real ownership.)

As for converting interest-bearing government obligations held by members of the public (including foreign countries and individuals) into non-interest-bearing obligations, that might violate the Fifth Amendment: "No person shall be . . . deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation."

It might be argued that the proposal is simply to convert the face value of an interest-bearing security into a non-interest-bearing obligation, but consider the possibility that you would thereby deprive the holder of that security of the anticipated future stream of interest payments, in expectation of which the security was purchased in the first place, often by a retiree who needs that income to meet living expenses, or a pension plan or mutual fund with the same goal. You would, in short, be depriving someone of the present value of the future stream of income, and not compensating him or her for it. The holder in due course of any obligation is entitled to both the principal and the interest, and the proposal deprives the holder in due course of the interest, to say nothing of making it more difficult to locate an affordable alternative with the same degree of security as a government bond.

Inflation is another issue, but we'll look at that tomorrow.

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