Friday, March 4, 2016

If the Federal Government Creates Dollars, Why Borrow?

If you believe that the federal government truly must borrow and tax to be able to spend, then quit reading and move on because you won't accept what I'm about to tell you anyway. But if you acknowledge that the federal government creates US dollars and wonder why, with that ability, it taxes and borrows as well as spends, then listen up.

But first, let me acknowledge that there is some truth to the common assertion that "printing" too much money could, under conditions of full production, cause inflation. So for you folks who like to talk about the US turning into the Weimar Republic or Zimbabwe, this is for you.

Now, as I have said many times, federal spending creates US dollars while federal taxing destroys US dollars. The federal government's ability to create dollars gives it the ability to spend however much Congress wants to spend, even if there were no such thing as taxes. The purpose of taxing, then, is not to respend those dollars. Taxes do not produce revenue. There is no operational need for revenue. There are a few reasons for having taxes, all pure policy, but the main purpose for having federal taxes is a policy decision to reduce the supply of US dollars in order to prevent inflation. Taking dollars out of circulation helps prevent there being too much money and theoretically helps thwart inflation. It may not really be necessary to tax in order to check inflation, but policy is policy.

Okay. But why does the federal government borrow?

The same reason - to prevent inflation.
Each year the government spends about $4 trillion and taxes back about $3+ trillion. That leaves about $1 trillion or so more spent than destroyed. That $1 trillion or so is called the federal deficit and could be inflationary, or so Congress thinks. In order to remove that $1 trillion deficit from circulation and keep it from being inflationary, Congress has mandated that the Treasury offer the public very safe savings accounts in which to hold those extra dollars. Thus, the Treasury "sells" Treasury securities which means the Treasury accepts and holds onto peoples' current dollars in exchange for a promise to give those dollars back later with interest. And each year they do it in the amount of the deficit. Over the years those Treasury security savings accounts add up and now have reached $19 trillion, otherwise known as the federal debt. Imagine that. The combined private sector savings at the Treasury is called the federal debt and considered by many to be a big problem of some kind. I'm still trying to figure out why savings is a problem.

So with all the newly created and spent US dollars taken out of circulation by taxes and "borrowing", we can safely say that federal spending is not inflationary.

Yet, we still have inflation to varying degrees. Why? Not from federal spending. Taxes and "borrowing" have seen to that. But the federal government does not control all spending. The private sector creates "money" (although not US dollars) by bank lending and credit creation. All the debt money created by the private sector amounts to about $12 trillion a year compared to the $4 trillion actual dollars created by the federal government, it's easy to see that any inflation pressure (which hasn't been much in recent years) comes from the private financial sector, not federal spending.

So there you have it. The federal government has reasons for taxing and borrowing, but those reasons have nothing to do with its ability to spend. That makes any accusations of the government taking money from some people in order to give it to some other people inherently false.

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