Where Does That Money Come From?
Thoughts on a sovereign currency
“Money is a human created concept. Humans have literally infinite control over human created concepts. Real resources are outside of human control. Money is essentially representations of our decisions of what to do (and not do) with those resources.”
“When it comes to federal spending , saying “how are you going to pay for it?” is either profound ignorance or a false shield behind which to hide immoral decisions.”
President Biden and Vice-President Harris have been touring the country this month to build public support for the massive infrastructure plan the administration proposed. As expected, Congressional Republicans, walking in lock-step down the path of obstruction, have been flogging their alarmist talking points about the cost of the plan. This week they unveiled their own plan which at $568 billion is roughly a quarter of the cost of the Democratic proposal. As usual, it’s all about the money so, before we start tilting at the windmills of government spending, we should first explore the subject of money itself.
What is money and where does it come from? Is it the paper bills in my wallet or the balance in my bank account? There are the economist’s traditional definitions of money: it is a medium of exchange, a method of storing value, or a uniform method of comparing the values of things. Since this discussion generally is about the United States government’s expenditures and revenues, money is defined as what the government accepts as payment for taxes.
Humans have created many ways to investigate and describe the world we inhabit. Language, mathematics, philosophy, religion- these are some examples of how we’ve ordered our thinking about our existence. Money is another such creation. Like most measurements, it is an abstraction used to describe a thing or an event; we use inches to describe length or parade to describe a type of event. In a similar fashion, money is a quantitative way to describe economic activity. It has no intrinsic value. It represents a value created by other human activities, namely the production of goods and services using labor and materials.
There was a time not too far in the past when we measured the value of economic activity in gold, in effect creating an artificial quantifier since there was no direct correlation between the amount of gold humans had accumulated and the economic activities that produced good and services. The gold standard was a blunt tool for maintaining stable marketplaces- the amount of gold did not increase in proportion to the growth of modern economies. Attempting to quantify the economy with a precious metal that is scarce was problematic.
We had the quantification of the economy backward.
In the 20th Century, the United States moved away from the gold standard. President Richard Nixon finally took the US off of it 50 years ago. What we call money today is a sovereign currency- money issued by the government. It is also a fiat currency- it is money because the government says it is money. In the United States, the nation’s central bank, the Federal Reserve, issue the currency to effect government spending.
The Federal Reserve System
The Fed, as it is commonly known, was created by the Federal Reserve Act in 1913, and given several different duties: it is the government’s bank; it regulates the nation’s banks and it provides financial services to the banking industry such as check-clearing. Congress also gave the Fed responsibility for monetary policy, with the three objectives of maximizing employment, stabilizing prices, and moderating long-term interest rates.
It is the Fed’s role as the government’s banker that allows us to peek behind the curtain and witness the wizardry of money creation. We might be surprised to find a computer keyboard as the only artifact of magic. The United States Treasury has a checking account at the Fed, much as you or I have at a bank. When the government spends money it has appropriated- to pay government employees or buy weapons systems or to send Social Security payments- the Fed simply adds those amounts to the government checking account with a few keystrokes. That is all that is necessary for the government to meet it financial obligations.
(A question to ponder: If this is all there is to the process of money creation, why does the government need to borrow and levy taxes at all?)
Back in January, I described how government spending actually injects money into the economy. Conversely, taxation removes money from the economy. The real peril facing monetary policymakers is inflation- too many dollars chasing too few resources for goods and services. In a perfect world where politicians served the public good, fiscal policy would alleviate the Fed of some of the burden of managing the nation’s money supply. Spending less and employing some form of taxation when the economy heats up are potential ways in which the government might act. The goal is to match the money supply to the size of the economy. Of course, especially in the current political climate, allowing Congress a greater hand in fiscal policy is a fraught idea at best. The parochial concerns of party ideologues would likely hinder effective technocratic actions by lawmakers.
In a period where inflation has been at a historic low for a decade, there is an opportunity for the government to simultaneously go big and bold: Spend the money and don’t raise taxes. Forget the idea of only spending the money you have already extracted from the economy, a hangover from a different era. There appears to be ample room for economic growth in dealing with the challenges of the near future, room enough to absorb the trillions which would be spent over the next 10 years.
After all, it’s only money.