The US dollar is a sovereign fiat currency. It is not pegged to a commodity and its exchange rate floats. Everyone seems to agree with this, until the rubber meets the road in real world application in our economy. That’s when it seems no one can agree on what this means and how it impacts our national fiscal policy. We, for all of our business and financial acumen, have lost the simple ability to follow the money in a logical and linear manner, insisting on injecting ideological detours at every step to mold reality to a desired political outcome. Then, when the results of our manipulations don’t match our predictions we immediately dump blame on the lack of “purity” in the system, as if failure can be reversed by doubling down on its root causes.
I love the game of Monopoly, but many of the rules could use some revision, so I like to play the game with the rule book that came with Parcheesi. This makes as much sense as managing an economy with a sovereign fiat currency by the rules of an antiquated gold standard or fixed exchange. Defending a gold reserve by inflicting austerity, and all the misery that comes with, didn’t make much sense when we were restrained by the gold standard, but it’s nothing short of insanity now. As I listen to politicians discussing the proposed tax bill that just passed out of the house I’m struck by the fixation both sides have with the national debt. Since this seems to be the singular driving factor in our economic policies, with the sides only disagreeing on how to reduce it, we should, at least, understand what it is, and isn’t.
The only source of the US dollar is federal spending into the private sector. Only Congress can “create” the dollar, and its authority is not limited in any way in doing so. It could send every household a million dollars tomorrow and be within its constitutional authority, (just to emphasize a point). It incurs no “debt” in that process as it spends dollars into existence to provision itself and to fund programs it approved. Likewise, the private sector incurs no debt when it accepts those dollars in exchange for the goods and services the government requires. So far, that represents a completed contract, not an assumed liability for anyone.
This was no different when we used the gold standard, so it isn’t unique to the fiat. What changed is how we assign value to the dollars Congress spends. With a gold standard the currency “represented” the gold reserve, so its total value, divided by the number of dollars in circulation, equaled the value of each dollar. Increasing the currency supply didn’t actually add any value to the economy if the gold reserve wasn’t increased in proportion. With a sovereign fiat dollar this value is determined only by the ability of the economy to produce goods and services for the dollar to purchase. As long as there is reserve demand (dollars) business will increase output, up to its maximum ability, to attract dollars. Inflation only happens after that maximum is reached and the supply of dollars is increased. Most economists measure the maximum output by equating it to 100% employment, which should be our goal in affecting fiscal policy that serves the public purpose.
With the gold standard we accounted for the currency supply in relation to the gold reserve in the category “debt/surplus” to advise Congress of its policy space to spend or tax. Taxation didn’t enter into this except as a tool that Congress had to draw down the currency supply. The spending had to precede taxation or there would be no currency available to pay the tax. Taxation was never intended to be “revenue” directly and there is still no function of the Fed or Treasury that makes collected taxes available to spend/recycle. Taxes cease to be money/currency the moment they are paid, so recycling them would present an apples to oranges conflict to Treasury. Consequently, all spending by congress is affected by the creation of new currency and taxes are “canceled currency”, not revenue, only useful for accounting purposes.
Within the Federal Reserve Act of 1913 is a mandate that Congress fund all spending that would increase the currency supply in excess of the value of the gold reserve with Treasury bonds. Since the purchase of bonds require existing currency the spending was balanced with removal of currency from circulation, similar to taxation but with interest and temporary. The interest rate/bond price also allowed the Fed to apply monetary policy in the economy via the banking system. The formula applied was simple. Spending-taxation-reserve=deficit. However, when the gold reserve is removed from this the dynamic changed drastically and is now spending-taxation=deficit. In other words, the debt (accumulated deficits) became much more massive without the balance of the reserve and represents all spending in excess of taxation, or all of the currency in circulation in the private sector.
This is hardly so complex that the great minds available to our Congresscritters missed its implication. Still, we appear to be formulating fiscal policy with the intent of removing all currency from circulation and forcing the default of all private bank debt. “THIS” is responsible governance?? The arrangement of the deck chairs on the Titanic comes immediately to mind. Is $20 Trillion sufficient currency to effectively operate our economy? Obviously not, or it is so poorly distributed that it is not available to do so. Otherwise we would surely be in better shape, right? Until the Einsteins in Congress figure out this simple truth and govern accordingly we will be playing Monopoly with the rules of Parcheesi. We don’t “owe” $20 Trillion. We “OWN” $20 Trillion.
