There has been a great deal of anger, even rage, directed against our "interest-bearing, debt-backed money supply." There is a measure of truth in the assertion that the medium of exchange throughout the world is burdened with debt, and that the holders of that debt receive interest on it — but only a measure. Discovering that the U.S. dollar (and every other currency on the face of the earth) is backed primarily by debt is, however, a little like discovering — and revealing as something shocking — the fact that the earth is round and revolves around the sun. As for interest, the greater part of the U.S. money supply is not even today, in strict point of fact, backed by interest-paying government securities. It consists of discounted and rediscounted private sector bills of exchange that pass at a value reflecting the present value of the instrument and a "risk premium."
The fact is, in yesterday's posting we discovered that all money is "debt-backed," that is, is a promise, a contract to deliver the present value of marketable goods and services when the issuer redeems the money, that is, makes good on the promise conveyed by the contract. To some people, this means that all money is inherently evil, the "root of all evil," as some have distorted St. Paul's dictum in his letter to Timothy.
That being the case, it's a little like asking if someone is a good witch, or a bad witch. The fact of witchery is, evidently, not a matter for question. The only concern is whether actual good or evil is being done, regardless of the presumably inherent evil already established. Thus, the real issue is whether the promise — the debt — that stands behind the money is a good promise, supported by the present value of existing or future marketable goods and services in which the issuer has a property right or the ability to take what belongs to others to satisfy the debt when presented for redemption (as the state has with its power to tax), or a bad promise, supported by nothing that has a defined present value.
Today, most currency (only a part of the total money supply — and usually the smallest part) is backed by government debt. If the government's power to tax remains effective, the currency is usually sound. If the government's power to tax is ineffective or there is nothing to tax, the currency is usually unsound. Still, this raises the question as to how the State got involved in the business at all. Confined to its proper role, the State doesn't produce marketable goods and services. How did it get into having anything to do with the medium whereby people exchange marketable goods and services?
The State got into the money business by default. When coins began to circulate outside the area in which a private issuer's name was recognized and trusted, it made sense that the certifying authority be the political authority, backing the promise conveyed by the coin with the full faith and credit of the State instead of a private individual, and that had the judicial power to enforce the contract.
Of course, as the body charged with adjudicating contracts in the event of a dispute, the State has had, from the beginning, the responsibility of regulating money. If two private individuals are fighting over whether or not the terms of a contract have been met, some presumably neutral third party had to step in and pass judgment — and keep the peace so that the disgruntled party didn't "settle" the dispute by killing the other party.
Of course, putting the State in the place of the adjudicator and regulator assumes that the State can be trusted. That means that the State has to be accountable to its citizens in some fashion. To make certain that the State would keep its word in the ancient world, many early coins were stamped with the image of the State's patron deity. This made the promise conveyed by the coin into a sacred oath, with the god or goddess as a witness, ready to punish with eternal damnation the blasphemous ruler who cheated the citizens by shorting the amount of metal in the coin, and made counterfeiting or clipping (removing metal from the coin) sacrilege.
Unfortunately, governments early on found that, with respect to coinage as in other things, they could say one thing and do another, and the gods wouldn't take (immediate) revenge. Typically, a government would put less metal into its coins than was stated on the face. Usually this was justified on the grounds that in this way the government could cover the cost of minting the coins. The government would otherwise have to raise taxes or user fees — never a popular move, even in an absolutist State or under a tyranny. It's much easier to protect power, even absolute power, by controlling money and credit (two sides of the same coin, so to speak), thereby hiding the true state of affairs from the public, as Henry C. Adams pointed out in Public Debts: An Essay in the Science of Finance (1898).
In theory, of course, regardless of the actual weight of metal in each coin, the government bound itself to deliver the full weight of metal or the value thereof when presented with one of its coins. It didn't work out that way in practice, however. While originally the same, weights used in commerce, and weights used in coins soon became different. A pennyweight (dwt) of 24 grains, for example, has been, through most of history, much heavier than the penny purportedly containing a pennyweight of silver.
Seniorage or agio — the difference between the face value and the value of the medium out of which the money is made — is thus a liability of the issuer. In the accounting equation, Assets = Liabilities plus Equity (with Equity divided into Owners Equity and Retained Earnings), seniorage goes on the right side of the equation, Liabilities and Equity.
Unfortunately, profit also goes on the right side of the accounting equation, where, if it isn't paid out as dividends to the shareholders, it is accumulated as retained earnings. Almost inevitably, governments confused the liability that they owed the public that accepted their coins, with a profit made from issuing coins with less metal than was stated on the face. It's as if a business made a journal entry shifting a bill from an outside vendor from Accounts Payable to Income, and then proclaimed that profits had increased by that amount — and simply refused to redeem their promise when the holder in due course of the bill presented it for payment.
This sounds dishonest — and it is. It is also common practice among governments. In the old days, when the currency was predominantly gold and silver coin, the temptation was often too much to resist for a government in financial trouble. Instead of making things better by fostering agriculture, commerce and industry, however, thereby increasing the tax base, it has often been thought much easier (and more profitable) simply to put less metal in the coin than is stated on the face. This shifts value from those who accept the coin, to those who issue it, as well as from consumers who pay more for fewer goods and services, to producers who make a greater profit on sales.
That being the case, where did we ever get the idea that having the State go into debt by "printing money" — making promises it can't possibly keep — is somehow a good thing?
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