–Why the federal debt is not the total of federal deficits

Federal debt is not the total of federal deficits

I’ve mentioned this before, as part of other posts, but this seems like an appropriate time to give it its own post, especially since the media and the politicians discuss reducing the federal deficit and reducing the federal debt as though this were the same thing. It isn’t. There is no functional relationship between federal deficits and federal debt.

Money is not physical

The story begins with the end of the gold standard in 1971. At that moment, money not only became not physical in itself, but had no physical surrogate. When I say money is not physical, I mean you can’t see it, touch it, send it, hold it or store it. Money is nothing more than an accounting notation.

That dollar bill you have in your wallet is not money. It is a receipt from the federal government, saying the government owes the holder a dollar. In that sense it is similar to a check you might write, which tells your bank to credit the recipient’s account. Think of that dollar as like the title to your house. The title is not the house. The title merely states that you own the house. A dollar bill is just a “title” to an invisible, non-physical dollar.

What is the federal deficit?

The federal government is said to run a “deficit” when it receives less tax money than it spends. Right? Well, yes and no. The word “receives” implies that money moves from Point A to Point B. But because money has no physical existence, it cannot move. What happens is that an account at Point A is debited and an account at Point B is credited. There is no movement.

When you pay taxes, your bank account (Call it “Point A”) is debited, and the Treasury’s account (Call it “Point B”) is credited. There never is a time when money moves between Point A and Point B. That tax check you mail is just a set of instructions telling the federal government to debit your checking account and to credit it own account — which it just as well could do without your instructions.

Similarly, when the federal government spends, it does not send money anywhere. It merely instructs banks to credit certain checking accounts, while it debits its own accounts. Simplified, the federal deficit is the difference between the credits to the “Taxes” account and the debits to the “Spending” account.

And none of this adds to the federal debt.

The end of the gold standard

Before 1971, the federal government needed to obtain money from outside sources, because it did not have the unlimited ability to create money. It’s ability to create money (actually, to credit accounts), was limited by its supply of gold. In August, 1971, the federal government gave itself the unlimited ability to credit accounts. It became Monetarily Sovereign.

This meant, from a fiscal sense, it no longer needed to “borrow” nor did it need to tax. It could credit accounts at will. Borrowing and taxing have no effect on the federal government’s ability to credit accounts. If borrowing fell to $0 or rose to $100 trillion, neither act would affect by even one dollar, the federal government’s ability to credit accounts. The same is true for federal taxes. If taxes fell to $0 or rose to $100 trillion, the federal government’s ability to credit checking accounts would remain infinite.

Borrowing is a relic of the gold standard days, and while taxing does have anti-inflationary purposes, it no longer funds federal spending. Thus, taxpayers do not pay for federal spending. The federal government credits accounts ad hoc, regardless of taxes.

How does the federal government borrow?

The federal government borrows by creating T-securities out of thin air, then exchanging them for dollars it previously created out of thin air, then destroying the dollars. More specifically, if you buy a T-bill, the government will credit your T-bill account and debit your checking account. During this so called “borrowing” process, the federal government receives nothing. It merely debits and credits accounts, according to your instructions.

You may think you have sent dollars to the federal government, but in reality, you have sent nothing. The government has debited your account and credited its own account, which it could have done without debiting your account. Your checking account balance was reduced, and your T-bill account was increased, without benefitting the federal government in any way. Your checking account dollars were destroyed. It’s simply an asset swap.

Why does the federal government borrow?

The answer lies in history. Borrowing is necessary for a monetarily non-sovereign government (states, counties cities, Italy, France et al), because such governments are unable to credit accounts at will. So, the U.S. has a pre-1971 law requiring the Treasury to borrow an amount equal to the federal deficit. The U.S. is Monetarily Sovereign, meaning it can credit accounts at will. Borrowing no longer is necessary. But, the law still is on the books.

What is the relationship between federal deficits and federal debt?

Functionally, none. Federal crediting of checking accounts could exceed federal taxes (aka “deficit) by many trillions of dollars, yet the government never would have to create a single T-bill. Similarly, the federal government could credit T-bill accounts by many trillions of dollars, and never have to credit a single checking account. The only relationship between federal deficits and federal debt is a legal one. Either can exist without the other.

So the next time you hear a politician say he wants to reduce federal deficits because the debt is too high, realize he has no idea what he’s talking about. And the next time you hear him say the deficits or debt are unsustainable, realize he’s claiming that somehow the federal government has lost the ability to credit checking accounts.

What about inflation?

There are two fundamental questions in economics:
1. How many dollars can the federal government create?
2. How many dollars should the federal government create?

Debt hawks confuse the two questions. The federal government can create dollars (i.e. credit checking accounts) endlessly. There is no limit. The federal government has the power to credit checking accounts by a trillion trillion trillion dollars, tomorrow. So all federal deficits and debt are sustainable. The federal government never can run short of money. Never. (Unless a mindless Congress tells the government not to credit checking accounts beyond a certain point known as the “debt ceiling.”)

But if the federal government credited checking accounts too much, this could cause inflation. While the Fed has done a good job controlling inflation via interest rate control, I feel confident there is some point at which checking accounts could be credited so much that even interest rate control could not prevent inflation.

Not only are we nowhere near that point, but we never have been near that point. Since that magical year 1971, inflation has been caused by oil prices, never by federal crediting of checking accounts (spending), and with very few exceptions, inflation has been close to the Fed’s target level.

What’s the bottom line?

The federal government neither needs nor uses borrowed dollars or tax dollars. It can credit checking accounts at will At current or even foreseeably higher levels of federal spending, there is no danger of uncontrollable inflation. Reducing the federal government’s ability to credit checking accounts will hurt taxpayers by reducing the benefits of federal spending. There is no functional connection between federal deficits and federal debt.

In short, budget cutters – the people who unnecessarily raise taxes and/or cut spending – will punish us today and punish our children, tomorrow. And all with no good purpose.

Congress is engaged in a meaningless debate about the budget ceiling. A good analogy would be if Congress were to limit the number of stars the Hubble telescope is allowed to access. In Congress’s view, accessing too many stars would cause a star deficit.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

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No nation can tax itself into prosperity, nor grow without money growth. It’s been 40 years since the U.S. became Monetarily Sovereign, and neither Congress, nor the President, nor the Fed, nor the vast majority of economists and economics bloggers, nor the preponderance of the media, nor the most famous educational institutions, nor the Nobel committee, nor the International Monetary Fund have yet acquired even the slightest notion of what that means.

Remember that the next time you’re tempted to ask a dopey teenager, “What were you thinking?” He’s liable to respond, “Pretty much what your generation was thinking when it screwed up the economy.”