In the previous posting in this series we defined money as anything that can be accepted in settlement of a debt. All money is thus a contract, just as (in a sense) all contracts are money. What happens, however, when we change the definition of money by removing or changing one of the elements of a contract?
Clearly, a contract is not really a contract if any one of the three essential elements (offer, acceptance, consideration) is missing. If the maker of a contract or drawer of a bill does not own that which he or she promises to deliver on maturity of the bill, the promised item has no present value, or bills are drawn with a face value greater than that of the consideration at the time the bill is drawn, the bill is fraudulent or "fictitious."
Right away we can see problems with backing the money supply with government debt, that is, with public sector bills of credit instead of private sector bills of exchange. Every one of the elements of a valid contract — a real bill — is missing.
This is because the State does not own the future taxes it hopes to collect to redeem its bills. Taxation is a grant from the citizens. It is not the exercise of a right of property. The present value of future tax collections is thus backed not by existing marketable goods and services in the economy as many believe, thereby making State-issued money a general claim on the wealth of society. Rather, State-issued bills of credit are backed by the ability of the government to collect taxes.
Taxes are in turn collected out of future private sector production that may or may not take place if the government has undermined the capacity of the economy to produce marketable goods and services. Bills of credit are therefore backed indirectly (and at two removes) by the general wealth of the economy, which the State may or may not be able to tax in order to make good on its promises.
When emitting bills of credit, then, the State is not making a genuine offer, for it does not yet own that which it is offering, the present value of future tax collections. Nor is there actual acceptance, for no one can truly accept an offer that is not really made or which conveys something that the offerer does not own. Finally, instead of the present value of a specific good or service being conveyed by the bill of credit, there is only a vague promise that the bill will be redeemed — there is no actual consideration.
This is why the "currency principle" — that money consists exclusively of State-issued or authorized coin, banknotes, demand deposits, and some time deposits — always requires that the State have the power to force acceptance of its bills of credit on the economy. Lacking the essential elements of a valid contract, such "money" can only be accepted on compulsion. It is, to all intents and purposes, a legal form of counterfeiting, as Keynesian economist and Nobel Laureate Paul Samuelson admitted.
Under the currency principle, all money that is not issued directly by the State is, paradoxically, considered fraudulent, for private issuers of bills of exchange do not have the legal power to force people to accept their bills, and can thus create money without the permission of the State. A private sector bill of exchange represents dangerous competition to the presumed State monopoly over money creation. Having real value behind them instead of vague promises, bills of exchange endanger State control of the economy and the ability of the government to manipulate the money supply for political ends.
The problem with State control of the economy for political purposes is painfully evident. As governments emit increasing numbers of bills of credit to finance deficits and redistribute existing wealth, the chance that there will be sufficient marketable goods and services produced by the private sector both to generate enough wealth to provide for the material needs of those who are productive and meet increasing demands for taxes decreases dramatically. Obviously, we are here construing the inflation induced by emitting bills of credit as a "hidden tax" that transfers wealth to government and wealthy producers through "forced savings." (General Theory, II.7.iv, IV.14.i, V.21.i, VI.22.vi.)