Just as every asset has a corresponding liability in accounting, the currency issuer's debt is dollar for dollar equal to the currency users' savings. On the surface this may sound implausible but what exactly is going on?
The currency issuer is the monopoly producer of money and, just as every asset has a liability, also results in government liabilities.The issuer's liabilities, or "debt", is a digital account of the currency supply used by the currency users. To a fiat currency issuer, the currency supply is a digital accounting tool, not an asset in and of itself. The currency supply is simply the bookkeeping records corresponding to all the currency users’ savings in banknotes, deposits, and treasuries.
Looking at it from a sector perspective, the issuer's debt is the "savings" of both the private sector and the foreign sector as a matter of accounting. What exactly is "savings"?
Money functions as both a store of value and a medium of exchange. When users acquire dollars they can either trade them, known as spending, for items in the marketplace or choose to "save" them as banknotes, deposits, and treasuries.
The more users choose to save the more "debt" the issuer takes on. A common misconception is that currency issuers "borrow" money. The issuer does not borrow because it is the monopoly producer of the currency - the money that currency users spend or save. China does not lend to the US government. China saves in the currency the US produces. This is not a theory this is simply double entry accounting.
Savings by currency users, domestic or foreign, is a straightforward concept on an individual level but becomes counter intuitive on a macro level.
In fact, economists have created “laws” based upon the very idea of savings at the macro level. For example, Says Law states, supply creates demand, but this presumes a monopolist currency issuer exists and no monopoly suppliers are involved. Let's say a currency user saves a large amount of money in Say’s system, if the issuer fails to replenish the supply then there are no profits for the Say’s “supplier” to take. In other words, without a currency monopolist to replenish the supply of dollars Say’s Law fails. Keynes’ paradox of thrift provides more insight. The paradox of thrift states that the more people save the less overall demand will result. Keynes system assumes a currency monopolist is not replenishing the supply of dollars. Says’ and Keynes’ oversight is that both their models presume an issuer acting within the system and fail to mention how. The currency issuer as the monopoly producer, lender, and price setter of money is without a doubt the least understood participant within the system.
The digital nature of government debt and the impact of currency users decision to save informs the issuer’s of it’s options. For any given level of output, the currency issuer’s must choose between maintaining equilibrium both in terms of price and output or not. In order to do so, the issuer needs to add to the supply of currency. Likewise, if users collectively choose to save less then the issuer needs to spend less (or tax more) in order to maintain equilibrium. Fiscal policy is the mechanism to add to the currency supply by either increasing public spending and/or adjusting taxes depending on one’s politics.
Managing the currency supply provides price stability for a given output but how can the supply be managed to maximize output within a resource constrained marketplace?
Currency optimization requires managing the supply of currency to operate at full capacity as much of time as possible. Changing conditions cause effective capacity to naturally lower but also enables the policy apparatus to focus on what's adaptive and make adjustments accordingly. Excess currency results in spending that overwhelms constraints, like production capacity, causing inflation and price instability.
Government as the currency issuer can grow the currency supply indefinitely because the supply is generated digitally. Government is fully capable of operating those real constraints at full capacity and chooses not to when constraining it's currency supply.
What are the costs of a suboptimal currency policy?
Failing to manage currency within a constrained marketplace leads to excess capacity, reduced goods and services, and poor labor utilization. If your one to view government spending as inefficient, like i do, I would warn that suboptimal policies also come with opportunity costs. Currency optimization should be used, in my mind, for R&D. (my next post will focus on critical importance of the "invisible" government subsidy to R&D). The cost of suboptimal deficits is the missed opportunity to subsidize research that can create next generation technology for the private sector.
What course of action is recommended?
Managing the currency supply is ultimately a political decision that influences the overall output level of the economy. Fiscal policy of a currency issuer is the a tool used to optimize currency within a resource constrained marketplace. Government as the currency issuer can maintain optimal currency levels indefinitely because government debt is a digital resource, a digital account of currency users savings in banknotes, deposits, and treasuries. Government is fully capable of operating those real constraints at full capacity and chooses not to when constraining the deficit.
The modern free market is an invention of the state. It’s rules are not naturally ordained but simply the outcome of political arrangements. Political arrangements defined by law though property rights, the corporation, and the creation of money. Among other reasons, this is why classical economists never spoke of “economics” but always of the “political economy.” The intended purpose of these political arrangements is to benefit of society by reducing risk and driving economic development.
So where does all this leave us?
The US is the reserve currency of the global economy representing 62% of the worlds currency reserves. In 1971 Nixon closed the gold window and moved the US to non-convertible, floating exchange rate, fiat based currency system. For the last 40 years the entire mainstream economic profession has failed to grasp the fundamental nature of our monetary system. The result has lead mainstream economists to give disastrous advice to our policymakers. Their fear of the federal deficit is a testament to their complete misunderstanding of the accounting relationship between the issuer and user. Well-intended policymakers are only as good as their economic advisors. Mainstream economists are using the wrong models, drawing the wrong conclusions, and giving the wrong advice.
And that leads us to my Kickstarter project. The Kansas City school of economists are doing good work but are marginalized by the mainstream profession and fail to influence policymakers. My goal is to bring attention to their work by using my "issuer-user" paradigm to explain their concepts without all the technical jargon of the economists. The sooner the rest of the economic profession grasps these basic concepts the sooner they can give advice policymakers to remove the yoke suffocating our economy, underutilizing our resources, and reducing our global competitiveness. So please consider supporting my Kickstarter project and together let’s both challenge the group think that has caused so much collateral damage to the US economy and the American public