Tuesday, March 31, 2015

Can America run out of money? No.

Can Americans run out of money? Yes.

Let's examine these two seemingly contradictory assertions.

First, America, that is, the United States government, cannot run out of money because it actually creates money by spending. You see, US dollars are essentially federal government IOUs. Dollars are created when the federal government issues checks or makes electronic payments and the recipient's bank increases the balance in the recipient's account by the amount of the payment. At that point of balance increase, and not before, money is created in the US economy. If nothing else, the US government is authorized by the Constitution to spend. Of course, Congress could theoretically put an end to federal spending through legislation. That legislation might end government spending, but, it technically would not end the government's ability to spend. Thus, the federal government, which does not need to have money in order to spend money, can never run out of money.

What about the federal "debt" you say? Well, decades ago Congress enacted an arbitrary law that requires the US Treasury to sell Treasury securities in an amount equal to the difference between federal spending and federal tax collections. Get that? Spending does not follow Treasury security sales. Rather, Treasury security sales follow the amount of federal spending and tax collections. The federal "debt" that everyone complains about is the amount of outstanding Treasury securities, not some amount of money the federal government had to borrow to pay for its spending. The "debt ceiling" is a limit on Treasury sales, not a limit on federal spending per se.

Now, on to the second assertion - Americans can run out of money.  

Money is created in two ways: 1) through bank lending, and 2) federal spending. In both cases, the private sector, of which the American people, households, businesses, and local and State governments are a part, are the recipients of this newly created money. With bank lending, however, the borrower incurs a responsibility to pay the money back. When he borrows $1000 from the bank he must pay it back, with interest. Consequently, if money came only from bank lending there would be no net money in play except for loan defaults. A growing money supply would necessarily be only the flip side of a growing private sector debt load. In aggregation, the private sector cannot, has not, and will never be able to create a positive net amount of money. If it had to depend on itself, the private sector would always stay in the hole to the tune of interest amounts.

On the other hand, when the federal government spends into the private sector (all its spending goes into the private sector by definition) there is no requirement that that money be repaid to the federal government. However, there is a little thing called federal taxes. The money paid to the federal government in the form of taxes simply reduces the net amount of money the federal government has injected into the private sector via its spending. If the federal government were to tax back exactly as much as it spends, then there would be no net money flowing to the private sector and the private sector would eventually run out of money, and be unable to save a dime or pay interest on any private borrowing. Oh, by the way, that situation where the federal government taxes back every dollar it spends, thus depriving the private sector of any net money flow, is known as "The Balanced Budget". Good thing we don't have a Constitutional requirement to balance the budget, huh? Hear me Oh Tea Party, Libertarian Party, Republican Party, and even Democrat Party!!!

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