This is the first in a series of articles about money and monetary system designs. The series focuses on the United States' system.
IOUs and Money
Suppose you need $100 more than you have to pay your federal income tax. You offer your IOU for $100 to the IRS. The IRS refuses to accept your IOU. They tell you to pay up. So you borrow $100 from your mother and hand a $100 bill to the IRS agent in addition to your bank check for the remainder. Of course, that settles your tax debt.
But wait a minute. That $100 bill is really the US government's IOU. The government has promised to accept that bill in payment of your taxes or anybody else's taxes who presents it in payment. In addition, the government has printed on the bill, "This note is legal tender for all debts, public and private." And that means anyone who receives the bill can use it to pay his income tax. Because of this US government decree that bill is worth $100 to anyone anywhere in the United States even though it is only an IOU, a piece of paper backed only by the issuer's promise to accept is as a tax payment. This kind of currency is called "fiat" money because its value is not tied to the value of a commodity such as gold. You can buy gold with it, but the quantity of gold you get for a dollar depends on its market value at the moment.
Another way to value a currency is to tie the unit value to a specified quantity of precious metal. Such a currency is called "hard" money. Back in the day when the US was on the gold standard, regardless of the price of a dozen eggs, you could buy an ounce of gold for $32. And Fort Knox was said to contain an ounce of gold for every $32 of paper currency in circulation. So, what did the US use to pay for all that gold? Where did that money come from? Hmmm? Did the US borrow from the oligarchs of the day to pay for it? And think of the interest on that debt!!! But I digress.
Today the dollar is fiat currency issued with keystrokes at near zero cost by the Federal Reserve Bank at the command of the US Treasury (we are told).
So, when we pay our taxes with this fiat money (which is actually just US government IOUs) what does the Treasury do with those IOUs? It credits our tax payment account using keystrokes and then what? It extinguishes the IOUs. Every government outlay is new fiat money created from nothing. Every incoming payment is extinguished.
Taxes and Government Expenses
Everyone pretends that there is reality in a double entry balance sheet of the government's budget--and that income must be balanced by expense. It is useful fiction because it permits politicians to seem responsible when they insist yearly that the budget must be balanced. They use this fiction to impose austerity on social spending. In actuality, there is no real limit to the expense side of the sheet. Expenses are all created ex nihilo. Only income is limited. There is no necessary connection between income and expense. The government can spend whatever it needs to spend to keep the economy healthy. If spending is not judiciously controlled, inflation and even hyperinflation will result. But Modern Monetary Economics has discovered how much to spend to optimize the real economy.
Continued in Article 2 of this series