Money is not a Durable Good

Saving money and giving it to your children is something that can be done by an individual that benefits the individual child.  It’s not something that we as an entire nation can do collectively.  If everyone saves a hundred dollars and gives it to their descendants, it does not improve the overall society at all.  This is also true at the government level when the government can create money at will, anyways.  It doesn’t make sense for a government entity to “save” money with the intent of spending it later if it can create money at will.

There’s a lot of caveats to this, but before we get to them, I want to make sure my overall point is clear.  Let’s say you have an island of 1,000 people who use their own currency called “Isles”.  Let’s say someone came by and dropped a big ‘ol pile of Isles onto the population.  They’d all have more money, but would they be better off?  Of course not, they have more money, but no wealth was created.

Now let’s say that one year the people living on the island have a really good year and everyone has lots of food and luxuries.  Always mindful of the future, they decide to plan for years when there won’t be lots of food and luxuries.  To do this, they all decide that everyone in the village is going to put some of their Isles money into a chest, lock it, and bury it for future use.  Now let’s say 5 years later, the villagers have a lousy fishing season and must work extra hard in other areas.  Then, someone remembers the chest they saved and they all rejoice and open the chest and take out the money out and pass it around.  They’d all have more money, but are they better off’?  Of course not, they have more money, but no wealth was created.

None of the two scenarios change at all whether or not there is a government entity involved. One more look at our fictional island nation.  Let’s say that the government wants to save resources a bad fishing season.  Therefore it decides to tax more than it spends for a couple years.  During this time the economy of the island goes into recession because of the extra tax burden, and the island has less wealth and more unemployment.  Now a few years later there really is a bad fishing season.  The islanders are not even worse off than in the last scenario.  Not only does the extra money not help them, but there was already a lack of good from the recession.

The only way the scenario of a generation saving money can help, is if it gets a gluttony of foreign currency from a neighboring island.  This isn’t as easy as it sounds.  First of all, the people would have to agree to only sell goods to the neighboring island and not buy anything from it.  Second, the parent generation will have to hope that the money foreign money is still worth as much when they give it to their kids.  Third, once the kids try to spend it, they must find willing sellers on the neighboring island.  Of course, all of these things could happen, but the parent generation would have to put in a whole lot more work than the child generation would get back – if they get it back.

The point of this is that, as a society, one generation cannot make the next generation better off by saving money.  This only works on the individual or small community scale.  In fact, one generation can’t really make themselves better off by saving money.  Money is not wealth nor is it a durable good.  Some of the things we create as a country will still be around and appreciated by the next generation when they grow up.  Money, is not one of them.

 

The Purpose of Taxes

The story of taxation usually goes like this:  You earn your dollars, then give some portion of it to the government.  The government then takes your money and buys tanks, builds roads, and gives food to the poor.  For local and state governments, that is a true story.  However, for the federal government, which creates the currency, this story remains just that: A story.  Despite what most people in Washington believe, the government doesn’t need your tax dollars to fund it’s activities.  Since the federal government can create money at will, then how does it make sense to say that it needs your taxes to fund all the things that it does?  Obviously, it doesn’t.  So what is the purpose of taxation? The purpose is two-fold:  To control inflation and maintain demand for the currency.

Taxes are needed to regulate inflation.

Since you already know that government spending is constrained by inflation, not revenue, then this should make sense.  If everything else were to remain equal, then taxes would always have to rise with spending to regulate inflation.  If the government kept injecting large amounts of spending without taxation you would eventually see inflation.  However, there are several reasons that inflation and budget deficits don’t always correlate.

There are many reasons that they do not always correlate.  A high savings rate is a good example.  If people are saving dollars instead of buying items it can cause deflation.   Another is fluctuations in foreign exchange markets.  In fact, we are currently living in an age of astronomical budget deficits, and yet we are still seeing very low inflation.

The other reason for federal taxes is to maintain demand for the currency.

Once a currency has already been established, this reason isn’t as obvious.  To understand this concept you we must go back to the launch of a brand new currency.  Let’s say Ireland decided to dump the Euro and create a new currency called ‘quid’.  The Irish government would make a bunch of quid and then try to use it hire someone to sweep the streets of Dublin.  What they would find is that no one was willing to word for quids, no matter how many were offered because everyone would still be using Euros.

Ireland finds that it must artificially create a demand for quid.  They do this by declaring that all taxes must be paid in quid.  Suddenly, people need quid.  People are now willing to work for the government in exchange for quid.  They can make the quid they need to pay their taxes and then sell their excess quid to people who don’t work for the government, but must still pay their taxes in quid.  In exchange for their quid, the workers could get Euro’s(an example of a foreign exchange market) or goods and services(a plain old money transaction).  The amount of Euro’s and goods they get for their quid is negotiated by the market.  After a time the currency will take hold and the Irish government will find it can pay for anything it wants in quid.  As long as people MUST pay their taxes using quid, there will be a demand for quid.

Upon reading this I hope that you come away with a better idea of what taxes are really used for.  Most people believe that the federal government must tax people to fund itself.  When you point out that’s silly because the government can create money at will, many people will start to think you’re suggesting doing away with all taxation(which would be equally silly).  That’s why it’s important to know and to explain to others the purpose of taxes:  Regulate inflation, and maintain the currency.

The Debt Limit is Obsolete

As I discussed yesterday, the debt limit is the congressional limitation on the amount of bonds that the U.S. treasury can have outstanding at a given time.  Two significant things happened in the 1970s that made the debt limit obsolete.  One is the Congressional Budget and Impoundment Control Act of 1974.  It formalized the budget process for the president and congress.  And even though it’s been amending several times, the current budget process still uses the same blueprint.  Also, the United States went completely off the gold standard in 1971.

At the time when it was first created, having a debt ceiling made sense.  It put a check on the executive branch to keep it from spending and borrowing without regard to congress.  It also protected our Gold Reserves from being over leveraged.  Gold Reserves were extremely important because we were (for the most part) on a gold standard so that the dollar could maintain value at home and overseas.  These two reasons for maintaining a debt limit no longer applies.

The Congressional Budget and Impoundment Control Act of 1974 created a new check on executive power.  It laid out a formal budgeting process that must be passed by congress every year.  Otherwise, the government must “shutdown” until congress acts to re-instate it.  Also, by statute, the President could no longer refuse to use or try to shift unused funds from one area of government to another.  Funds allocated by congress to build a road must be used to build that road or the President and executive branch would be committing a crime.  This budget process provides sufficient check on the executive branch from trying to (legally or “semi-legally”) re-allocate congressional funds.

In 1971, the United States went off the Gold Standard and never looked back.  Unlike past times when the U.S. went off the gold standard, it wasn’t temporary.  While there is a group advocating to go back to the gold standard, it’s small and doesn’t have a lot of momentum behind it.  For all points and purposes we are no longer on the gold standard and won’t be going back.  So what this means is that o matter how many dollars are issued by congress, treasury, or the Fed, they cannot be redeemed for anything but more dollars.  While that has several implications, but none of them is the possibility of any bank losing gold reserves.

So what does it all add up to?  The debt limit has lost its usefulness.  The only purpose it serves is one more thing congress has to do when budget deficits increase.  You might say it offers a chance to get the public and congress to face large budget deficits.  However, that already happens every year thanks to the yearly budget process.

Congress should “raise” the debt limit one last time, but instead of raising it just eliminate it.  If removing it does create a problem, congress can always add it back.

What is the U.S. debt ceiling?

The U.S. debt ceiling  is, as this CNN Money article describes it, “The legal cap on how much the government can borrow”.  That’s what it means in layman’s terms, but where does it come from?  Why does it exist?  How can it be changed?

The phrase “debt ceiling” appears to be a media created term.   Technically it’s called the “debt limit” in the U.S. Code of laws.  It can be found in Title 31, Subtitle III, Chapter 31, Subchapter I, subsection 3101, paragraph (b):

The face amount of obligations issued under this chapter and the face amount of obligations whose principal and interest are guaranteed by the United States Government (except guaranteed obligations held by the Secretary of the Treasury) may not be more than $11,315,000,000,000, outstanding at one time, subject to changes periodically made in that amount as provided by law through the congressional budget process described in Rule XLIX of the Rules of the House of Representatives or otherwise.

You’ll note that the amount listed in U.S. code doesn’t match what the current limit actually is.  Modification of U.S. code hasn’t been updated to reflect the last time the debt ceiling was raised.

What’s interesting is that even though the united states has been consistently in debt since it’s inception, the concept of a debt ceiling didn’t come about until 1917 during World War I, but the birth of any overall limit on all public deb didn’t come about until World War II.  A paper prepared by the congressional research service gives a brief history.

The statutory limit on federal debt began with the Second Liberty Bond Act of 1917,10 which helped finance the United States’ entry into World War I.11 By allowing the Treasury to issue long-term Liberty Bonds, which were marketed to the public at large, the federal government held down its interest costs.

Before World War I, Congress authorized specific loans, such as the Panama Canal loan, or allowed the Treasury to issue specific types of debt instruments, such as certificates of indebtedness, bills, notes and bonds. In other cases, Congress provided the Treasury with limited discretion to choose debt instruments. With the passage of the Second Liberty Bond Act, Congress enacted aggregate constraints on certificates of indebtedness and on bonds that allowed the Treasury greater ability to respond to changing conditions and more flexibility in financial management. Debt limit legislation in the following two decades also set separate limits for different categories of  debt, such as bills, certificates, and bonds.

In 1939, Congress eliminated separate limits on bonds and on other types of debt, which created the first aggregate limit that covered nearly all public debt.  This measure gave the Treasury freer rein to manage the federal debt as it saw fit. Thus, the Treasury could issue debt instruments with maturities that would reduce interest costs and minimize financial risks stemming from future interest rate changes.16 On the other hand, although the Treasury was delegated greater independence of action, the debt limit on the eve of World War II was much closer to total federal debt than it had been at the end of World War I. For example, the 1919 Victory Liberty Bond Act (P.L. 65-328) raised the maximum allowable federal debt to $43 billion, far above the $25.5 billion in total federal debt at the end of FY1919.   By contrast, the debt limit in 1939 was $45 billion, only about 10% above the $40.4 billion total federal debt of that time.

Since WWII the debt limit has been raised dozens of times.  Whenever it changes, it has to either temporarily or permanently change the section of U.S. Code that defines the debt limit.  In fact, if you scroll to the bottom of the subsection I link to, you’ll see a list of how many times the code has been amended.  So what is the point of the debt limit?  Originally it was to have some kind of cap on the U.S. treasury department, but also give it the ability to get the lowest possible interest rates using whichever debt instruments it wanted.

So the debt limit was there just to keep the treasury from borrowing, (and the president from spending), whatever it wanted without any congressional say.  It also freed congress from having to approve every single bond sale.  Until the Budget Control Act, it was the only self-imposed limit on federal spending.

The difference between Wealth and Money

Economically speaking, what is the difference between wealth and money?  Here’s how I look at it.  Wealth is all of the valuable goods and resources that you want in the world.  Whether it’s a gallon of gas, or a video game, both are examples of things that people desire andor use.  Money is worthless pieces of paper and even more worthless numbers in a computer.

Looking at an entire economy, wealth is a measure of all the goods and services produced by that economy.  Those include any goods anybody was willing to pay for.  Such as: cars, homes, bread.  It also includes any services anybody was willing to hire.  Such as: Medical, education, and fixing broken goods.  Money, on the other hand, is still worthless pieces of paper and even more worthless numbers in a computer.

Wealth is what we desire: goods and service. Money is a tool we use to exchange those goods and services between each other. The point of this post to acknowledge the difference between the two. Giving everyone more money does not necessarily result in everyone getting more wealth. The wealth is created when people start trading that money with each other in exchange for more goods and services.  So money changing hands can create wealth, but the act of having money doesn’t do it.  Some people hoard money to obtain future wealth.  This is a bad idea because unless it is earning interest, the money will lose value overtime due to inflation.

The biggest thing that I want to emphasize is that money is a tool, and is not a typical commodity.  Granted, it sometimes behaves like a commodity, but it has no intrinsic value.   Creating wealth should always be the goal, and money should be seen as nothing but a tool used to achieve that goal.

Your Dollar Savings is Another’s Debt

The way most modern banking systems are setup, it is impossible for someone to save money without somebody else going into debt.  That’s because, as I described in a previous post, all money is created as a debt.  Therefore, for anyone to get a dollar, they must either have borrowed it, or gotten it from someone (who got it from someone who got it from someone… etc) who borrowed it.

So how does this work in practice?  Let’s say we have in our country 300 million people exactly.  Let’s also say that everyone, but one person, wants to save a dollar.  That is, they want to spend one less dollar than they make.  The only way that is possible is if the remaining person goes an extra 299,999,999 dollars in debt – 1 dollar for every other person who wants to save an extra dollar.

Think about what that means.  It means it is impossible for anyone to have more dollars than they owe, without at least one other person or entity(company, non-profit, government, etc…) owing more dollars than they have.  At first this conclusion may be hard to accept, but once you accept that all money is created as a debt you’ll realize that it has to be true.  Let’s take a look at a few more examples to better illustrate.

If you buy something from the Dollar Store, you are 1$ poorer and the Dollar store is 1$ richer.  No money was created and the Dollar store is richer at your expense.

Dollar Store +1

You – 1

Net = 0

Now let’s say you buy a 25 thousand dollar car from a dealership, but have to borrow the money from Fifth Third bank. Fifth third lends you the money so they’re now 25 thousand less dollar, but have your loan as an asset.  You have a car and a 25 thousand dollar debt.  The car dealership is now 25 thousand dollars richer.

Fifth Third – $25,000 cash

Auto Dealership + $25,000 cash

Fifth Third + $25,000 asset(your loan)

You – $25,000 debt to Fifth Third

Net = 0

As before, let’s say you buy a 25 thousand dollar car from a dealership, but have to borrow the money from Fifth Third bank. This time, however, let’s say that Fifth third doesn’t have the cash on hand and has to borrow it from the federal reserve.  This changes things a little bit, but still no one getting ahead.  Instead of being out $25,000 cash, they take on a $25,000 debt to the federal reserve.  Also, there is extra cash in the system now too.

Federal Reserve + $25,000 asset(Fifth Third Loan)

Federal Reserve – $25,000 cash (which it creates)

Fifth Third -$25,000 debt to federal reserve

Auto Dealership +25,000 cash

Fifth Third + $25,000 asset (your loan)

You – $25,000 debt to Fifth Third

Net = 0

Everything still nets to zero.  The only difference is that the federal reserve had to create 25,000 in cash to fulfill Fifth Third’s requested loan.  The federal reserve didn’t have to borrow that cash since it creates cash at will.

Now let’s take this even further.  The auto dealership isn’t just going to hang on to the cash it just received.  They’re going to take that money and put it in their own bank.  Let’s say Chase Bank.  Chase, is going to then take that money and lend it to somebody else.  Let’s say to your neighbor as a home improvement loan.  Now all that’s happened is that the auto dealership exchanges cash for an asset, and your neighbor gets cash in exchange for a debt to Chase.

Federal Reserve + $25,000 asset(Fifth Third Loan)

Federal Reserve – $25,000 cash (which it creates)

Fifth Third -$25,000 debt to federal reserve

Auto Dealership +25,000 cash (you gave them)

Fifth Third + $25,000 asset (your loan)

You – $25,000 debt to Fifth Third

Auto Dealership – $25,000 cash (deposited to Chase)

Chase + $25,000 cash (from Auto Deposit)

Chase – $25,000 debt to Auto Dealership

Auto Dealership + $25,000 asset (Bank Deposit)

Chase – $25,000 cash (loan to neighbor)

Neighbor + $25,000 cash

Chase + $25,000 asset (loan to neighbor)

Neighbor – $25,000 debt to Chase

Net = 0

I suppose I could keep going by having your neighbor go to home depot to buy supplies, but I think the point is made.  No where was cash or some other dollar asset created without a corresponding debt.  Granted, non-dollar assets (the car) changed hands, which is a good thing and is what actually makes the economy work, but the net amount of savings never changed.

One more case before I leave this topic.  Let’s look at the effect of someone defaulting on their loan.  Let’s say you default on your auto loan before even making your first payment and declare bankruptcy.  In the example where you borrowed from Fifth Third and didn’t involve the federal reserve, what would happen is that Fifth Third would lose their $25,000 asset and you would lose your $25,000 debt.  After your bankruptcy, it would look like this:

Fifth Third – $25,000 cash

Auto Dealership + $25,000 cash

Net = 0

In the case where Fifth Third had to borrow money from the federal reserve, it would look like this after your bankruptcy:

Federal Reserve + $25,000 asset(Fifth Third Loan)

Federal Reserve – $25,000 cash (which it creates)

Fifth Third -$25,000 debt to federal reserve

Auto Dealership +25,000 cash

Net = 0

Fifth Third still owes the federal reserve $25,000 dollars.  That money will have to come from more profitable loans.  So no matter what, no money was created without a debt, and nobody made any money without themselves or someone else going into debt.  As you can see from these examples and the explanations, any dollars you manage to save, must be at the expense of someone else going into debt.

How money is created: As a debt

Not a lot of people sit around and wonder how money is created, but for some reason I did.  I found my answer and thought I would share it with you.  In our economy, money is created by borrowing it.  The story of money creation starts when someone wants to take out a loan.  Say you want to borrow twenty-thousand dollars to buy a car.  You go down to Bank of America (BofA) and take out a loan.  They then put that money into the auto dealer’s bank account and you drive off the lot with a new car.  At this point:

  • You are twenty thousand dollars in debt
  • The auto dealership is twenty thousand dollars richer
  • BofA has twenty thousand less dollars, but have a twenty thousand dollar asset (your loan) which nets to zero(not counting interest).

This is an example of money being created using the Money Multiplier concept.  If you add up all the money spent and borrowed, it equals the amount that was earned and is owed.  However, until that loan is paid off there is now extra money in the economy rather than sitting in a bank account.  Now, let’s say that BofA didn’t have the money to loan you.  That’s no problem, they can just borrow that money from the federal reserve.  Before BofA gives you the money, they go to the federal reserve and borrow twenty-thousand dollars.  The federal reserve goes *poof* and money is deposited into BofA’s account, then they give it to you, and you give it to the auto dealership.   In this case,

  • You are twenty thousand dollars in debt
  • The auto dealership is twenty thousand dollars richer
  • BofA has a twenty thousand dollar asset (your loan).
  • BofA has a twenty thousand dollar debt to the federal reserve.

While all the assets and liabilities equal zero, that 20 thousand dollars that the federal reserve created is now in the economy, and that’s how money is “created”.

The government has to borrow money too.  Any money spent by the federal government that isn’t offset by taxes must be borrowed from the federal reserve.  The federal reserve temporarily loans the government that money and puts it into U.S. treasury’s account at the federal reserve.  The federal reserve then auctions off that borrowed money as U.S. bonds and other securities.

This leads me to make two observations of this system.  I call them “observations” because I’m not sure if they are bugs or intended features of the system.

The first observation is that for our money supply to grow, people must continually borrow money, not just from each other, but from the banks and, eventually, the federal reserve.  Not only that, but each year more money must be borrowed than the previous year just to keep up with interest.  That’s because when I borrow 20 grand, I have to pay that back with interest: Say, 21 grand in total(just to keep the math simple).  That means I have to earn back the 20 thousand I gave the auto dealership plus another thousand dollars.  I could work for the auto dealership and earn back the 20 grand, but where am I going to get the extra thousand dollars?  It’s going to have to be from someone who takes out a new loan (for money that came from the federal reserve) and pays me a thousand dollars for some service like driving them around in my brand new car.

Therefore, what this means for the economy at large, is that if the amount of money being borrowed ever levels off or drops, somebody-somewhere, is going to have to default on their loan.  The reason will be because there won’t be enough money in the economy to pay back all those previous loans with interest.  Again, I don’t know if this is a bug or an intended feature when congress setup the federal reserve system.

My second observation is that if every entity in existence paid off all their debts, there would be no money left in the economy.  Think about it, what money would be left if all money is created as a debt?  There’s no way for someone to save a dollar without another person or entity owing someone a dollar.

These two observations disturb me.  You would think this would cause problems, but I don’t really see or hear many people talk about it.  If you think my two observations are incorrect, or I missed something, please let me know in the comments.

Make Money with your Blog Fiction

For those of us with delusions of someday making money off of our blog fiction writings, there’s a limited number of options for us.

Selling ad space on your blog is probably the most obvious, and easiest option. Just like any other blog or website it’s easy to add Ad Sense or some other ad service. If you have enough readers you can make a few bucks this way.

The other way would be if you use your super duper awesome writing to attract a publisher. With a little luck, you can convince a publisher to swoop in and save you from the penniless internet writing and get you into the “respectable” dead tree publishing business. It worked for Cheeseburger Brown after all.

Another way is to try and sell to your readers. You can try and sell dead-tree versions of your blog. Wilf almost did this. Something else a lot of bloggers do is sell T-Shirts and other paraphernalia to make money. It’s something I’ve yet to see a Blog Fiction writer do, but it’s out there as an option.

For the longest time, I figured those were the only three ways a writer could make money off of a blog fiction. Well, that was until I found The Curly Situation. This enterpising author does something that never really occurred to me to try. He just asks for paypal donations. He even throws in a vague threat about not continuing without some coin.

It’s a blog novel (or “blovel” if must blestroy the blingo). It’s also an experiment. I write, you read, and we all get a laugh along the way. The story centres on Curly Gibson, an Aussie cricketer whose talent for accidental sporting success is surpassed only by his talent for getting shot at. I’ll post twice a week, as long as I get nice comments and a few bucks in the tip jar. Puh-leeese. – JD

Now that I think about it, it seems like an obvious thing to try. I’ll be curious if Jason gets any “tips” this way. I Hope he does.

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