Thursday, April 28, 2011

In the Blink of an Eye, Part IV: Word Games

This will (we hope) be the final posting in this series about repaying the national debt by changing one form of money into another. To recap, the idea was put forth to convert all interest-bearing government obligations of the United States, currently totaling somewhere in the rather exclusive neighborhood of $14.3 trillion, to non-interest-bearing "cash."

Also to recap, this would in no way reduce the national debt. It would simply change it from an obligation on which interest is paid, and thus presumably attractive to investors, to an obligation on which interest is not paid, and thus presumably unattractive to investors. The instruments would remain obligations, and the national debt would remain the same — that $14.3 trillion, after all, includes Federal Reserve Notes and government demand deposits at the Federal Reserve.

What seems to be behind the proposal is the fixed idea that government somehow "creates money," and that money "created" by the government does not have to be repaid or redeemed. As monetary theorist Gertrude Coogan claimed — erroneously — money is an unrepayable debt owed by the nation to itself.

On the contrary. "Money" is anything that can be used to settle a debt. That being the case, the issuer of money has to have some kind of property or other right in whatever backs the money so that the issuer can make good on the promise conveyed by the money. When private individuals and companies create money by drawing bills of exchange, they have to own the present value of whatever will be used to redeem the bill. When a government creates money by emitting bills of credit (the "constitutional version" of private sector bills of exchange), it must back the bills with its power to collect taxes and redeem the money in the future. Neither private individuals nor a government can draw bills of exchange or credit that are unredeemable, or there is no basis for accepting the money in exchange; the "faith and credit" of the issuer has been compromised, and the money is worthless.

The idea that a fiat currency is unredeemable by anything is called in logic a "fallacy of equivocation." True, a fiat currency is unredeemable in specie, that is, gold and silver. If issued by a private sector individual or business (including a bank), however, the original issuer of the money — the drawer of the bill of exchange — must deliver either the goods or services promised on the maturity date, or the value thereof in other goods or services, or other negotiable instruments, depending on the specific terms of the contract (bill), thereby redeeming the original promise. If a government emits a bill of credit, the government must eventually collect sufficient taxes to redeem the bill, or go bankrupt when people realize that the money is worthless and refuse to accept it as something that cannot be exchanged for what ultimately backs it. No one, whether private individual, business, or the State, has the power to make a promise he doesn't have to keep. Thus, we can see the weakness in the proposal as explained in the final posting in the discussion:

When the Fed creates money by fiat, they call it "quantitative easing" or "money market operations" and the journalists call it "printing money." Printing money is the better metaphor, although hardly a precise description. "Quantitative easing" is obfuscation, pure and simple. What they are doing is creating money with key strokes on a computer. I am perfectly happy for a sovereign government to have that ability. Somebody has to do it. But since we know they can do it, why don't they do it on a scale sufficient to eliminate the national debt? They bailed out banks, insurance companies, hedge funds, government sponsored entities, such as Freddie Mac and Fannie Mae. Why don't they just bail out the United States Government?

If we accept the explanations in this brief blog series, we can see that the Federal Reserve (according to Harold Moulton under the direct control of the federal government; the "independence" of the Federal Reserve is a transparent fiction, Moulton, Financial Organization and the Economic System. Washington, DC: The Brookings Institution, 1938, 416-417) doesn't create money at all, whether by printing or "with key strokes on a computer." Nor does "a sovereign government . . . have that ability."

What happens when the Federal Reserve (or the federal government) manufactures some form of negotiable instrument backed by future tax collections instead of existing savings is to transfer wealth from the private sector to the State via the "hidden tax" of inflation. The only acceptable means to retire the national debt is not to repudiate it by transforming it into unredeemable fiat currency with no backing of any kind, but to rebuild the tax base, increase tax revenues, and pay down the debt with money created by the private sector. This can be done by drawing bills on the present value of existing and future marketable goods and services. These bills are discounted and rediscounted with individuals, enterprises, or banking institutions. They can then be rediscounted at the Federal Reserve (or purchased through open market operations) to provide an asset-backed currency with which to carry out day-to-day transactions, such as making consumer purchases and paying taxes.

Rebuilding the tax base and restoring a sound money supply, while critical, is not the focus of this series. Suffice to say that implementing the monetary and tax reforms embodied in Capital Homesteading would, we believe, fix the problems and put things back on a solid footing.

We do not think that repudiating the national debt (whatever the means or sleight-of-hand), printing more money, or "going back to gold" is the answer. The currency was never 100% gold and silver, anyway. Congressman George Tucker gave statistics in 1839 that estimated that gold and silver were less than 5% of the money supply at that time. In 1912, the year before the enactment of the Federal Reserve Act, U.S. GDP was $37.4 billion — and total estimated WORLD production of gold and silver from 1492 to 1912 was $29.1 billion. (Harold Moulton, Principles of Money and Banking. Chicago, Illinois: University of Chicago Press, 1916, 74.)

Capital Homesteading is the only answer.

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