Facebook Debate Requires One More Attempt at Reasoning With Doubters

Here is another shot at what is becoming a tedious subject for me and probably for some of you who may read this blog.

Virtually all of my friends and correspondents cling to the ideological certainty that the federal government spends too much and will soon go broke because of it. They cannot conceive of the idea that the federal government does not need tax money in order to spend. They also are convinced that the government must borrow money in order to spend, thus digging itself into deeper and deeper debt that we, the taxpayers, must eventually cough up the dough to repay.

Why, I ask you, would a nation that has full Constitutional authority and financial wherewithal to "print" (that is, to create and issue) money need to tax and borrow other peoples' US dollars in order to get money to spend? Is it absurd to think that the US government creates money? No, even my doubting Thomas friends and correspondents readily admit that the government can and does "print" money. Still, they cling to the paradigm of the US government having the same financial constraints as a business or household. Why is that?

Okay, there are constraints, two of them, but both are self-imposed by Congressional dictate as a means of, I guess, controlling inflation. I will get to those two constraints in a minute, but first let me tell you how the federal government creates US dollars (and it does not "print" them and scatter them to the wind for people to latch onto).

First, the federal government issues a check or an electronic deposit and voila, someone's bank account balance is increased. Simultaneously, the central bank (the Fed) marks up the receiving bank's reserve balance. The reserve balance is the number of on-account dollars the receiving bank has with the Fed to clear checks. The Fed creates those reserve balance dollars out of thin air when the government spends. That is how banks get the money to cash and clear checks. They do not use depositor dollars for those purposes. By authorizing the Fed to create reserves, the federal government creates money when it spends.   

Now let us look at the two self-imposed and arbitrary artificial constraints on the monetary system. The first is that when the government runs a spending deficit, the Treasury must "borrow" money in an amount equal to that deficit by selling bonds, notes, and other security types to the public. The federal deficit is the amount the government spends in excess of tax collections in a given year. For example, if the government spends $4 trillion in a year and collects $3 trillion in taxes, the deficit equals $1 trillion and the Treasury must sell $1 trillion in securities. On the surface, it would seem that the government "borrows" the money from the sale of securities in order to pay for what it spent in excess of its tax "revenue". This is not really the case because the government had already created the money and paid for what it spent. The Treasury, therefore, does not spend the money it receives from the sale of securities. The securities money really goes into the buyers' (investors) accounts at the Fed as safe and secure investment savings. The Fed returns those savings to the buyers (investors) along with some newly created interest dollars when the securities expire. The purpose of selling Treasury securities is to take dollars out of circulation thus offsetting any inflationary pressure federal spending might have triggered, not to acquire money to spend.

The government defines the federal "debt", currently approaching $19 trillion, as the total dollar amount of outstanding Treasury securities at any one time. This leads us to the second self-imposed and arbitrary artificial constraint on the monetary system - the debt ceiling. Even though Congress requires the Treasury to sell securities equal to the deficit as described above, it also imposes a limit on the total amount of Treasury security dollars in existence at a given time. Thus, if Congress sets the debt ceiling at $20 trillion and the deficit becomes $1.5 trillion, the Treasury must sell securities equal to $1.5 trillion. Selling that amount of securities, however, would cause the outstanding treasury security balance to exceed the $20 trillion debt ceiling. Congress would have has painted itself into a corner (and frequently does) with its two conflicting rules. Congress creates a deficit by spending more than it gets in taxes, but does not tie its spending to the debt ceiling until after it has already spent. That is why Congress must periodically raise its arbitrary debt ceiling. The fact that Congress has spent the money before selling the securities is ample proof that the government does not depend on borrowing in order to spend.

These two arbitrary constraints on the federal monetary system have caused untold waste and rancor in Congressional debate. They have also bamboozled the American public into believing that the US government must borrow money in order to spend, even from competitor nations such as China, which itself invests its extra US dollars from its trade surplus into Treasury securities for safe-keeping and to earn interest. Neither constraint is necessary now that the US monetary system is no longer on a gold standard and no longer runs the risk of insolvency. The whole premise that the federal government accrues "debt" from spending and borrowing is pure fabrication.

The US dollar is itself a debt - that is - it is an IOU of the federal government to pay the holder of that dollar another US dollar, nothing else. It is simply a permanent or temporary accounting liability. The other side of that liability, the asset, belongs to the holder of that US dollar. Those asset holders are we in the private sector.

Do not federal taxes pay for federal spending, you might argue. No. The receipt of federal tax dollars by the Treasury removes those assets from the holder and removes the liabilities from the government. Tax dollars simply go out of existence, even though ledger entries continue to show their amounts.

In summary, the federal government creates US dollars by spending. It destroys US dollars by taxing. It neutralizes US dollars by parking them in Treasury securities. The government does not tax or borrow in order to spend but I will bet that you, the reader, and most of Congress do not believe it.