Mitchell’s laws: The more budgets are cut and taxes inceased, the weaker an economy becomes. To survive long term, a monetarily non-sovereign government must have a positive balance of payments. Austerity = poverty and leads to civil disorder. Those, who do not understand the differences between Monetary Sovereignty and monetary non-sovereignty, do not understand economics.
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I’ve almost despaired of teaching economics to adults. Too many fixed minds. Worse than fixed. Actively resistant. Those of us who try to the tell facts often meet not just with doubt, but with hatred. With name calling. Swearing. Sneering.
This isn’t sincere questioning, which I would love. It’s far deeper. Perhaps, it’s fear — the horror some people feel at discovering they’ve been wrong.
The adults may be hopeless. Eyes sewn shut. Ears plastered over. Brains cemented. So I’ve been thinking, maybe there’s hope for the young people. And with that thought, I’m going to write a few posts just for young people, whose minds still are open.
Sometimes, things that are complicated also are simple. Take the weather. Weather is complicated. It’s hard to predict more than a day or two in advance. Each second, millions of individual weather events, in locations around the world, affect weather in all other locations.
Heat in Africa can affect storms in America. Wind in China can cause drought in Kansas. It’s all connected.
Yet, weather also is simple. The sun warms the earth and the air. Cold air holds less moisture than warm air, so cooling air causes clouds, which lead to rain — or snow if the air is cold enough. Summer is warmer than winter, because the tilt of the earth makes seasons. And if you look up into a clear, blue sky, your picnic probably won’t get rained out. Simple.
Economics too, is complicated and hard to predict. Each second, millions of world-wide transactions affect other economies, worldwide. A purchase in America can change a salary in Asia.
Yet economics is simple, and that simplicity can be understood by young people, if not by adults. So here is the first attempt.
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MONETARY SOVEREIGNTY FOR YOUNG PEOPLE– Part 1.
Before August 15, 1971, the United States government was on a gold standard. This meant, the U.S. government needed to own gold before it could pay its bills.
It didn’t pay its bills with gold. No, it paid with dollars. But unless it owned gold, the U.S. was not allowed to create its own dollars. That was the law. No gold, no dollars to pay bills.
And when the government didn’t have enough gold to make dollars to pay its bills, it had to get dollars from someone else. Either it had to borrow dollars, or it to levy taxes.
Not being able to create dollars, whenever you want to, is called being “monetarily non-sovereign.” You and I are monetarily non-sovereign. We can’t just create dollars. We can’t pay our bills unless we obtain dollars from someone else. Our states, counties and cities are monetarily non-sovereign. They have to obtain dollars from taxes or borrowing. They are not allowed to make dollars out of thin air. That is the law.
On August 15, 1971, President Nixon announced that the U.S. would change the law. No longer would we need to have gold. The federal government would simply create dollars without having gold. No gold. No problem. President Nixon made us MONETARILY SOVEREIGN.
And this changed everything.
Today, in America, only the federal government is Monetarily Sovereign. Only the federal government can create dollars out of thin air. The federal government is unique.
Here is how you and I pay our bills:
Personal Income (salary, investments)
+ Personal Borrowing
Personal dollars available to pay our bills
In order to pay our bills, we need to have a source of dollars. We are monetarily non-sovereign
And states, counties and cities pay their bills the same way the same way:
State Income (taxes)
+ State Borrowing
State dollars available to pay state bills
Yes, the states, counties and cities also need a source of dollars, to pay their bills. They too are monetarily non-sovereign.
That’s the way it is, and that’s the way it always has been. So naturally, many people think the federal government works the same way. And once it did, but now it doesn’t. Not after 1971. Here’s what the federal government does with any money it receives:
Federal Borrowing
+ Federal Taxing
Dollars destroyed
What??! The federal government destroys all that tax money you and your parents send it?? And the government even destroys all the money it borrows??
That’s right. All dollars going to the federal government simply disappear, never to be seen again. Amazing, isn’t it? All the taxes you and your parents pay, gone. Borrowed dollars, too. Gone. Useless. If taxes were $0 and borrowing was $0, the government still could pay its bills.
Of course, when you think about it, why would anyone who can create dollars, need to get dollars from someone else? If you had a “dollar-printing press” in your basement, would you ask your friends for dollars? Of course, not.
So, here’s how the federal government pays its bills:
1. A vendor sends the federal government an invoice, let’s say for $1,000.
2. The federal government sends instructions (not dollars) to the vendor’s bank, instructing the bank to increase the number in supplier’s checking account by 1,000.
If the vendor once had $5,000 listed in his checking account, that number now is $6,000. The vendor now has 1,000 more dollars than he had before. Where did that extra $1,000 come from? The vendor’s bank created it out of thin air, because it had received the federal government’s instructions.
And that’s it. Every day, the federal government sends those kind of instructions to banks, and the banks obey those instructions. The banks don’t ask whether the federal government has or doesn’t have and dollars. The banks just do as they are told. That’s the law. That’s how the federal government creates dollars.
What do instructions look like? Sometimes they are government checks. Other times, they just are invisible wired instructions. Dollars are just numbers in a bank account. So, changing the numbers changes the amount of money in the bank account.
So why do we pay federal taxes? Before 1971, the federal government was monetarily non-sovereign, just like you and me and the states, counties and cities. It needed a source of dollars so it could pay its bills. It did not have the unlimited ability to send instructions.
Unfortunately, the politicians in Washington, DC do not yet understand that the federal government became Monetarily Sovereign in 1971. They do not understand the differences between Monetary Sovereignty and monetary non-sovereignty. So they act as though the federal government’s spending still relied on taxes and borrowing, as it did when we were on a gold standard.
So, misleading themselves, they mislead you, the public. But it’s not. The federal government made a law that allows it to destroy tax dollars, and to create more dollars by spending.
When the government spends more dollars than taxpayers send it, that is called a “deficit.” Many people don’t like the idea of a “deficit.” It sounds negative. So they want to reduce the deficit.
But “deficit” merely tells how many dollars the federal government has created from thin air. To reduce the deficit, the government would have to increase taxes or spend less.
Would you or your parents like to pay more taxes? I don’t think so. Paying taxes makes people poorer. And if the government spends less, we’ll have less of things we like. Worse roads. Broken bridges. Less health care. Less Social Security. A weaker army. Poorer schools. The federal government uses “deficits” to pay for millions of things that benefit us.
No, reducing the deficit is the worst thing that could happen, because it takes dollars out of everyone’s pockets. To make our economy grow, and to make our lives better, the government needs to cut taxes and spend more. It needs to increase the deficit.
Some people are afraid that if the deficit increases, we’ll have inflation. Inflation is when everything gets more expensive. The government likes a little bit of inflation, because that makes people buy things today, rather than waiting until later. When people buy things today, rather than waiting for later, the economy grows, there are more jobs, and people lead better lives.
However, it is true that if the deficit goes up too much, we could have too much inflation, so it’s important that if ever we start to have too much inflation, the deficit should stop going up. The deficit should go up enough to make the economy grow, but not enough to cause too much inflation.
Fortunately, though sometimes we have had too much inflation, this never has been caused by deficits. (Actually, inflation has been caused by oil prices.) So far, the U.S. has been free to increase the deficit by cutting taxes and increasing spending, and not cause too much inflation.
Later, we’ll talk about what dollars really are — and are not. Meanwhile, just write any questions into the comments box, and I’ll try to answer them.
And if you’re an adult, please show this to a young person.
Rodger Malcolm Mitchell
http://www.rodgermitchell.com
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No nation can tax itself into prosperity, nor grow without money growth. Monetary Sovereignty: Cutting federal deficits to grow the economy is like applying leeches to cure anemia. Two key equations in economics:
Federal Deficits – Net Imports = Net Private Savings
Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports
#MONETARY SOVEREIGNTY
#Monetary Sovereignty - Mitchell 
States cannot credit a bank account? Can you describe how the process differs if say a state government pays a vendor $1000?
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Hoonose,
Good question. Yes, the states can send instructions to banks to credit bank accounts. Even you can send the same kind of instructions. You do that by writing a check, which is nothing more than instructions to your creditor’s bank.
The difference comes in the clearing. The Federal Reserve tries to clear your check through your bank, and if you don’t have high enough numbers in your checking account, your bank will reject the clearing, the check will bounce, and the whole process will unravel.
By contrast, because the U.S. government is Monetarily Sovereign, all checks clear. None ever bounces. The U.S. has the unlimited ability to raise bank balances.
Actually, there is one limit. It is that illogical, harmful law known as the “debt limit.”
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And, if you are a young person, please show this to an “adult”!
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I recently found your site and enjoy receiving your emails. I am having difficulty agreeing with some of your comments. I understand that the Fed has unlimited authority to create money via instructions to banks. Creating more money in this manner only debases the value of the dollar for everyone. There must be a limit to how much money creation people and other nations will accept. Is it your opinion that the Fed should continue to create money until there is clear evidence that inflation is evident? Once the Fed needs to stop creating money, then what?
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Luther,
Up ’til now, there has been zero relationship between federal money creation (aka “deficits”) and inflation. See:https://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation/
So-called “debasement” is a popular myth, having no basis in fact (and please don’t mention those old, debt-hawk chestnuts, Weimar Republic or Zimbabwe. First research the reasons for their hyperinflations.)
One reason may be that we now are in a world economy, so goods and services are available everywhere. It is difficult to create an inflation in one nation, when people can import from other nations.
In answer to your question, the government should continue running deficits — in fact increasing the size of those deficits — until an uncontrollable inflation is imminent. By “uncontrollable,” I mean an inflation that cannot be controlled by raising interest rates.
Meanwhile, our biggest danger is not from inflation, but from recession, unemployment and poverty.
If, in the distant future, the government needs to slow spending, it simply will have to slow spending. I expect that not to be within our lifetimes.
Rodger Malcolm Mitchell
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RMM,
Thanks for the re-writing on this topic more or less from the beginning. This was a very fine article. I am going to pass this along.
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There is the issue of how banks create bank money, but that can come later.
In the meantime, I’m going to show this to as many adults as I can as well – the still open minded ones, because they’ll likely get it; the closed-minded ones because I like to annoy them as much as I can.
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Excellent article. Your articles are perfect for me to post on various websites (in past only with a link to your website).
So thanks. Its a battle I have been fighting for some time. Although it seems like a lost cause with the misunderstanding and flawed beliefs so strong.
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RMM,
After sharing this with some people I got a request for citations to:
Dollars being destroyed.
How the govt pays its bills
That the banks just change a bank account without drawing from one account to pay a vendor (though I think this one is a bit misleading. correct me if I’m wrong, but the government does spend using Treasury bank accounts that do “use” tax dollars, even if it’s mostly an illusion)
Can you offer any citations to support your claims?
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This was my response to dollars being destroyed.. (maybe you can comment as to whether I sufficiently explained it?)
“I contacted the author requesting citations to the information you mentioned. Waiting for a response. You can visit his website here: https://rodgermmitchell.wordpress.com/
But some of your concerns don’t really need citation. What they need is thoughtful consideration. For example, when you explore what “is” money, the concept of dollars being destroyed makes intuitive sense. Money is usually defined three ways:
1. As a store of value – an item that retains and represents worth over time
2. As a unit of account – the way in which something is valued against other things
3. As a medium of exchange – an item that is widely accepted in place of barter
What’s interesting is that what money “is” … isn’t tangible. Sure, our dollar bills and coins are tangible. But they are only (tangible) representations of the three characteristics listed above. For example, dollars and coins are no more useful than the digital numbers in your bank account that you use for most of your spending. Are the digital numbers in your bank account “real” ? Aren’t they no more than (intangible) representations of the three characteristics listed above?
So, how are dollars “destroyed” when the government taxes us? They are taken away from people who need them in order to make purchases (and who can’t create them)… and given to the federal government, who can and does create them … for what purpose? It’s not to be able to spend. That just doesn’t make any sense. Why would the federal government NEED tax dollars in order to spend when they have the exclusive ability to create them out of thin air?
I believe the author is being a bit misleading: technically, our tax dollars go from our bank accounts into government bank accounts, and the U.S. Treasury debits it’s accounts when it spends money, and credits it’s accounts when it taxes us.
But I think his point is fundamentally correct: money is “destroyed” when the entity that issues the currency takes the currency away from the entities that use the currency. It’s destroyed because the federal government, regardless of whether it takes money from us or not, can always spend money. So by taking money from us BEFORE it spends what it otherwise could have spent without taking money from us, it technically “destroys” our money. Does that make sense?”
(Maybe what is confusing for many people about dollars being destroyed, is that it seems like they are not being destroyed.. rather they are just being redistributed.)
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JK
Ah, looking for a second opinion, eh? 🙂 Always a good idea.
I can’t direct you to specific cites, as I’ve read literally thousands of economics articles in the past 15 years. But I will direct you to people.
Before I do, let’s look at the logic. Do you agree that the federal government is Monetarily Sovereign, and therefore has the unlimited ability to create dollars? If so, your questions are moot.
That is, whether or not a specific tax dollar is destroyed has no meaning, when the government can create unlimited dollars. If the government receives 2 dollars in taxes and spends three dollars, does it matter to a Monetarily Sovereign government whether the 2 tax dollars were destroyed and replaced, or recycled?
In both cases, the deficit is 1 dollar, the taxes are 2 dollars and the spending is three dollars.
I talk about dollars being destroyed to demonstrate the utter uselessness of federal taxes in a Monetarily Sovereign government. But if it’s easier for you to visualize tax dollars as being recycled, no problem.
And you’re right; it’s an illusion.
Anyway, you might like to write to:
Warren Mosler, the creator of Modern Monetary Theory at warren.mosler@gmail.com
and/or
Randall Wray, a professor at UMKC, and one of the leading economists in America, at wrayr@umkc.edu
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Just to be clear, those are not my conerns. I’m a regular reader here at MS and study economics at UMKC. So I’m familair with all of this, but I’m still learning. I added the following to my response to the conerns raised that were raised:
“I’ll expand upon the transfer of our money to the government via taxes…
When you pay taxes, there isn’t a physical item that is taken from you and given to the federal government. What happens is the numbers in your bank account go down, and the numbers in the federal government’s bank account goes up. Nothing physical/tangible was exchanged.
But…
The federal government moves more numbers up in bank accounts every year than it moves down (the budget deficit). Where does this money come from?? The answer is that it comes from nowhere! It’s created out of thin air. Or more precisely, it’s created with keystrokes on a computer.
So…
When you pay taxes, and your numbers are moved down, money is DESTROYED. When the federal government’s numbers move up in it’s account, money is CREATED. The fact that this can or does happen simultaneously creates the illusion that our tax dollars fund the federal government.”
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You’re fortunate. In my opinion, UMKC is the best economics school in the country, maybe the world — for one simple reason. They understand the differences between Monetary Sovereignty and monetary non-sovereignty.
Few schools do.
Say hello to Randy Wray for me.
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Maybe you want to come to UMKC this Fall and give another talk? Or does an invitation need to be initiated by UMKC?
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Thanks JK but,
1. Too old
2. Sick wife
3. UMKC doesn’t need me. Guys like Randy Wray et al know what I know — more than I know, actually. Though we disagree on some details (especially involving inflation), the basics are the same.
But again, thanks.
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Am I accurately explaining the processes? (bare in mind I’m trying to explain this, and justify your positions, to be completely unfamiliar with Monetary Sovereignty and MMT)
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Yes, pretty good.
Bottom line. The U.S. government is sovereign over the dollar. It can create all it wants, and doesn’t need to get dollars from anyone else.
All else is mere description.
Rodger Malcolm Mitchell
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Thanks. But accurate descriptions are important. I think that’s something that shouldn’t be underappreciated. Without accurate descriptions of the processes involved, it all seems like pie in the sky to people who’ve never heard this stuff before… ‘it can’t possibly be true!’
But I think when the processes are accurately described, and combined with the inherent logic, it all becomes very convincing. Hell, that’s how all of you won me over and how I ended up at UMKC 🙂
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JK,
You’re right. It’s just that this particular question — are dollars really destroyed — can devolve to endless Sophistry. There is no absolute answer, though there are plenty of good arguments for both sides.
I just happen to like the visual of tax dollars being destroyed, to emphasize the uselessness of tax dollars. But I like your explanation, too.
Take your pick.
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Mr. Mitchell…you are my sanity in an insane world. While age may limit you physically, your mind is first rate. Please, continue sharing your knowledge, i have learned much from your writings.
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Thank you, Ellen.
Rodger Malcolm Mitchell
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Rodger,
No questions from me today. Just wanted to introduce you to a friend of ours: http://blogs.forbes.com/johntharvey/
Thanks,
Tyler
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He is right on target. So, there now may be as many as one dozen people in the world who understand Monetary Sovereignty.
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We’ll get there, Rodger.
I just learned that six million Americans were unemployed in the year 2000. I had no idea that a national unemployment rate of four percent means millions of Americans are unemployed.
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That’s why they announce it in percentage terms. It’s like a finance deal of ‘only’ $x per week – makes it sound cheap until you do the maths.
But I don’t think six million gives you the scale of the problem.
However if you think of it in terms of cities you get an idea.
Currently there are 12,8 million unemployed, which is a population the size of the cities of New York and Los Angeles combined.
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