With permission from Being Libertarian, I am reposting an important exclusive piece I wrote that lays out some fundamental changes in how I’ve come to understand the functioning of a fiat money economy, and its economic implications on debt, deficits, and other hugely important concepts:
The US national debt was a topic in the other night’s presidential debate, and, according to the Nonpartisan Committee for Responsible Federal Budget, both candidates will raise the debt.
Why The National Debt Doesn’t Matter
If you’ve read my post about Modern Monetary Theory you’ll understand that in a sovereign floating fiat money system (e.g. US dollar, Japanese yen, but not the Euro, by the way), the government always spends by creating bank reserves, and then later on drains some injected bank reserves via taxation.
The bank reserves spent and not taxed out of existence (aka a government budget deficit) remain in private bank accounts, and some people choose to move their bank reserves into interest-bearing claims to future bank reserves, by buying government bonds.
When the Treasury pays interest on the public debt, it does so by asking the Fed (the banks’ bank) to mark up the recipient’s bank’s bank reserves via electronic keystrokes. It doesn’t need to raise taxes anywhere in order to perform this operation.
On that same token, when the Treasury retires a maturing government bond, it asks the Fed to remove said bond from the bondholder’s bank’s securities account and in turn marks up said bank’s bank reserve account accordingly. Once again, no tax money is needed to perform this operation. No future generations, to cite a popular cliche, are being asked to cough up the money to perform this operation.
Not a single government in world history that has operated under a sovereign floating fiat money system has ever been forced to default on its national debt, neither explicitly, nor through hyperinflation. Weimar Germany was under a gold standard and owed lots of gold to foreign governments, and Zimbabwe’s currency was pegged to foreign currencies (not freely floating), just in case you were wondering.
Why The National Debt Does Matter
The national debt, plus bank reserves, essentially represents the cumulative total of all past government budget deficits. How much we want our governments to spend is a political decision that many individuals have many different views on. Some prefer less government spending (such as myself), others more. How much the government spends is certainly an economically-relevant question, since government spending moves resources from the private into the public sector. The size of the annual budget is thus certainly a relevant figure, and the national debt is, by extension, a figure that is indirectly derived from these past decisions. In that regard, of course, the national debt matters.
And finally, the interest payments that go to bondholders every quarter or so certainly matter. When bank reserves are moved towards bondholders to make interest payments, their spending power increases over those without the bonds, effectively a government subsidy. How many bonds are outstanding, at what maturity, and how much interest we wish to pay on them, are both 100% present-day political decisions that the federal government can make independently of the private sector. Theoretically, all outstanding bonds could be replaced by bank reserves that pay zero interest. All that would happen, in that case, is that one type of government obligation (government bonds, the promise to pay future bank reserves) is replaced with another government obligation (bank reserves, the promise to accept them to settle tax liabilities).
Thus, unlike the popular story we’re being told about how poor disenfranchised future generations will be fleeced unless we pay down the national debt, the national debt does matter, only it matters to us in the present right here and now, and not to some obscure future generations down the road.