MODERN MONETARY THEORY UNIT II: THE MONETARY SYSTEM OF THE UNITED STATES
The US Government cannot run out of money any more than Lambeau Field can run out of points during a Packer game. Quoting former Chairman of the US Federal Reserve Bank (the Fed), Ben Bernanke, during a 2009 interview with Scott Pelley on CBS 60 Minutes:
(PELLEY): “Is that tax money the Fed is spending?”
(BERNANKE): “It’s not tax money. The banks have accounts with the Fed much the same way that you have an account with a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.”
In 1944 as World War II was coming to an end, Europe and Japan were in economic ruin while the United States had become the undisputed economic and industrial powerhouse of the world. At a historic meeting in Bretton Woods, New Hampshire, forty-four countries agreed to keep their currencies fixed to the U.S. dollar, and the dollar was fixed to gold at $35/ounce. Thereafter known as the Bretton Woods monetary system, countries settled their international balances in dollars, and US dollars were convertible to gold.
Initially, the Bretton Woods agreement operated as planned. Japan and Europe were rebuilding their postwar economies and demand for US goods, services, and dollars was high. Since the United States held about three-quarters of the world’s official gold reserves, all seemed well.
But the years passed and Europe and Japan recovered. By the 1960’s their exports became competitive and, as Americans purchased more and more of their products, these nations soon found themselves in possession of excess dollars. This shifting of U.S. balance of payments eventually resulted in more foreign-held dollars than the United States had gold. There was a loss of confidence in the US government’s ability to meet its obligations.
In 1971, fearing a run on the banks, President Richard Nixon and his advisors closed the gold window. Foreign governments could no longer exchange their dollars for the scarce metal. This prevented a banking collapse, and at this point in history the US dollar became unbacked fiat currency. It had value only because the US Government said it did. And, as Chairman Bernanke indicated above, the government simply created money out of nowhere as needed.
It is critically important that we, the people of America, begin to educate ourselves on the difference between true productive capacity – the actual physical ability to provide the goods and services needed for a decent life – and money. Even though the US Government monetary system has been operating on a fiat basis for 50 years, we – and certainly our political “leaders” – continue to think of money as a thing, mysteriously backed by something like gold.
For a moment, let us consider the chemical element gold. Gold’s symbol on the Periodic Table of Chemical Elements is Au. This comes from the Latin word aurum which translates to “shining dawn.” Gold’s atomic number is 79, meaning it has 79 protons in its nucleus. Gold is what is referred to as a “noble” metal because it is highly resistant to reacting with other chemical elements. This gives gold some of its most useful properties. It doesn’t rust, tarnish, or corrode. This allows gold to be used in the most critical electrical applications. Spacecraft and satellites use gold in their electrical/electronic components because of its reliability. All of our cell phones contain tiny amounts of gold. Dental work commonly uses gold. No matter what we eat or drink, gold doesn’t react. And certainly, gold makes beautiful jewelry and other artforms. But one thing is certain. . .
Gold is of absolutely no value to humanity formed into bullion and locked in a vault supposedly representing “money.”
The suggestion that we return to the “gold standard” would completely cripple the US and other national economies, and factually, all of the known gold on Earth represents not even a fraction of the world’s current gross productive capabilities. Gold needs to be placed wisely into useful circulation like iron, aluminum, copper, and tin.
This brings us back to the critical need for the US citizenry to understand what a fiat monetary system actually is and does. The economic discipline of Modern Monetary Theory (MMT) isn’t a “theory” at all. It is an explanation of the monetary system that has been functioning in America for half a century. Our future prosperity depends on our grasping the concepts. We can begin by defining fiat money:
Fiat money is a currency without intrinsic value established by government regulation. It has an assigned value only because the government uses its power to enforce that value. Parties exchanging goods and services are required to use the currency doing business and in paying all taxes. In economies utilizing fiat currency approximately 97% of money in circulation does not physically exist. It is entries on a computer screen. The U.S. Treasury and Fed create money by clicking keys on a computer.
While there is no limit to the amount of money a sovereign government using a sovereign fiat currency can create, the practical limit on money production is that the circulating money supply must represent the actual physical productive capabilities of the society to avoid devaluing or overvaluing (inflation/deflation) the currency.
The ramifications of fiat money are enormous and they challenge everything we have been taught to believe about how our economy works. These are some of the implications:
- The U.S. Government can never run out of money. It would be the equivalent of a carpenter saying he could not finish building a house because he ran out of feet and inches. If congress chooses to fund a new war, a bank bailout, infrastructure, or Medicare for All, the Treasury creates the money to do so. It is a political decision, not an economic one.
- The U.S. Government never has to default on its “debt.” It can create all the money it needs to pay for all services required by society. In fact, government debt doesn’t actually exist in the traditional sense of the word. Government “debt” is simply a computer record of the money created by the Treasury and injected into the economy to allow the nation to function. Government “debt” is private sector operational funds and savings.
- The U.S. Government never has to borrow money. It is the constitutionally authorized creator of the nation’s money. Within the constraints of productive capability (inflation/deflation) the government can supply itself with all the money it needs.
- The U.S. Government never needs to collect taxes to pay for its own operation. It created the money people and corporations use to pay their taxes in the first place. Taxes don’t fund the government, the government funds taxes. Congress can authorize the Treasury to create any money needed for ongoing operations.
- The government collects taxes to enforce the legitimacy of the dollar as the nation’s currency, to exert a degree of control over inflation/deflation, and to maintain a level of societal equity. In the past, extreme inequality was mitigated by progressive taxation.
It must be understood that none of these operational abilities apply to state and local governments, private business, or households. Only a sovereign nation using sovereign currency can create its own money. However, revenue sharing by the federal government can offset shortages in state and local funds.
Much of the current work being done on the subject of fiat currency and “Modern Monetary Theory” emanates from the Economics Department at University of Missouri – Kansas City and the Levy Economics Institute of Bard College, Their work and the work of other economists and universities around the globe can be found at New Economic Perspectives.
A wonderful source written for laypeople on the functioning of economics in the USA under a fiat currency system is Warren Mosler’s book, THE SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY. It can be read on line at http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf While I do not personally agree with Mosler’s closing statements regarding the US military, his work is an excellent, clear presentation.