The Strange Reality of Fiat Money

By J. D. Alt

It is time to come to terms with the fact that U.S. dollars are what economists call “fiat money”. Having acknowledged this—and it’s difficult not to accept it as true since the U.S. abandoned the gold-standard over forty years ago—it might be worthwhile to give some consideration to what “fiat money” actually is and the peculiarities of how it works.

A brief history

It may be useful to start with a short (and simplified) historical perspective. In his latest book, The Social Conquest of Earth, the Pulitzer-prize winning naturalist Edward O. Wilson goes to exquisite lengths to describe the unique evolution of human society—as compared to other eusocial species such as ants, termites and bees—which includes on the human side, above all else, the unprecedented specialization and division of labor homo-sapiens developed. This apparently was in response to the fact that early human groups had overlapping territories and were, as a result, constantly interacting, competing and cooperating with each other. Whatever the actual dynamics, it seems self-evident that what made this highly specialized division of labor really take off (to heights never imagined by Nature herself) was not just the invention of money and commerce, but specifically the invention of fiat money—exactly the kind of money discussed by the Modern Monetary economists of today. What is unique about fiat money is that, unlike gold or silver or some other easily carried “trade” commodity that has value in itself (and can, therefore, be traded for other things) printed fiat dollars, in themselves, are completely worthless. They attain their value only through a social contract.

It also seems self-evident that, from the beginning, fiat money required a large social group organized around a sovereign power.  This is because, as an invention, “small-group” fiat money doesn’t work. If every family-clan, for example, printed its own fiat dollars, each family-clan would have no incentive to accept any other family’s currency in exchange for specialized labor/resources—unless it planned ONLY to purchase something back from that one family-clan. So the “invention” of fiat money, as something which can be used in exchange for labor/resources from a large diversity of specialized producers, is not accomplished by small groups. In order for fiat money to work, it has to be shared by a very large group—like, for example, a nation.

The reason the very large group has to be organized around a sovereign power is suggested by Mancur Olson in his book The Logic of Collective Action. To summarize Olson’s argument (without going into details) it is fairly easy for small groups—say the size of an extended family—to work cooperatively together to produce something that benefits them all. In medium sized groups—large enough to prevent every individual from personally knowing every other individual— this becomes more difficult because no one person, by logic, has the incentive to make a personal sacrifice to a cooperative effort since it is clear that whatever personal effort or sacrifice they make will not be a deciding factor in whether or not the cooperative effort is achieved—while, at the same time, they realize that if the cooperative effort is achieved, they will benefit from its result whether they had personally sacrificed or not. Even though this “free-rider” logic make a cooperative goal difficult to achieve with medium sized groups, Olson explains several circumstances under which it can nevertheless be accomplished.

When you get to a very large group, however, Olson demonstrates that the logic of collective action makes it virtually impossible for cooperative goals to be voluntarily achieved—even though every single person in the group fully acknowledges the benefits that would ensue. The only way the collective goals of very large groups can be realized is through some form of coercion: the members of the group must be required to participate in the cooperative effort.

If we consider the widespread use of fiat money as being the result of a cooperative effort in a very large group, then, according to Olson, this can only have happened if the members of the group were somehow compelled to use the fiat money. And, indeed, this has been one of the mantras of Modern Monetary economists (especially L. Randall Wray): fiat money “works” because—and only because—a sovereign power declares (1) that it shall issue a sovereign fiat currency, (2) that a tax must be paid to the sovereign power, on a regular basis, by every member of the group (on pain of imprisonment), and (3) the only thing the sovereign will accept in payment of taxes is the fiat money which it issues. Voila! Modern fiat money comes into existence through a coerced cooperative effort—and the reality is it could not have come into existence in any other way.

Fiat money operations

The next step crucial to consider is HOW the sovereign power proceeds to transfer the fiat currency it creates into the hands of the “citizens” who will need to have it in order to pay taxes. The sovereign could accomplish this with direct hand-outs—and in some cases that may actually be necessary to prevent having to put lots of people in jail for not being able to pay taxes (a necessity that would cost the sovereign a lot of effort to build and run the jails!) A more obviously useful approach is for the sovereign power to SPEND the fiat currency it issues by purchasing goods and services from the “citizens” who need to get the currency to pay taxes. “Sovereign spending”, then, accomplishes the goal of transferring the fiat money into the hands of the “citizens”—but it also has the benefit of creating goods and services the sovereign might find useful.  Once they are paid in the fiat currency, the “citizens” logically begin to use it to trade amongst themselves, being willing to take it as payment for goods or services because they know that every other “citizen-who-needs-to-pay-taxes” will be willing to take it as payment as well.

There are at least two perspectives from which it is interesting to consider the unique dynamics of fiat money. The first is: What is the character of the “sovereign power” that issues it? Is it a monarchy (or military dictatorship)—or is it a democracy? The second perspective is whether or not the fiat money is “convertible-on-demand” to gold.

Fiat Money and a sovereign monarchy

Considering the first perspective, the question arises: what is the sovereign’s motivation to spend its fiat money? If the sovereign is a selfish king, he might want simply to keep the “citizens” employed to his benefit, with just enough benefit to themselves to stay strong and healthy enough to service the monarchy. In this case, the king may decide to levy taxes equal to his planned fiat spending, and then implement his royal plans by hiring the “citizens” to build his grand castles and estates, and to prepare and serve elaborate banquets. The “citizens”, after they are paid, use the fiat money to trade amongst themselves—but at the end of the year, when tax-time comes, all the fiat money earned is paid back to the sovereign king. The “citizens” become momentarily moneyless, but the sovereign commences the process again, issuing new fiat money, and hiring the “citizens” once more to build new rooms and additions on the castles and to prepare and serve even more lavish feasts, repeating the cycle. The king continually gets what he wants (bigger and bigger castles) while the “citizens” are able to continually sustain themselves—but without getting the uppity attitude they might develop if they weren’t rendered moneyless each year at tax-time.

In the course of human social development, some variation of the above model seems to have operated for many centuries and, in not a few cases, continues to operate today.

Fiat money and a sovereign democracy

What if, on the other hand, the sovereign power becomes a DEMOCRACY? (We do not need to imagine the arduous and painful process by which this might occur.) If such a transformation occurred, the model described above will only make partial sense. If a sovereign democracy pays the “citizens” fiat dollars to provide goods and services to the democracy—well, the democracy can vote to have things built and services provided that will benefit the “citizens” themselves. Instead of building royal castles, they can build roads and bridges and schools and hospitals. Instead of preparing royal banquets, they can provide police and fire protection services, and launch weather and GPS satellites.

That part makes sense. But the “citizens” might also ask: Why should the sovereign democracy only spend the same amount of sovereign currency as it plans to collect back in taxes? Why should the “citizens” vote to make themselves moneyless once a year at tax-time? Why shouldn’t they vote instead to have the sovereign democracy issue MORE fiat currency than it is planning to collect in taxes? If that happened, the “citizens” would be able to save some fiat currency each year, build up a reserve of it, and expand economic trade amongst themselves. It is logical, therefore, to imagine that a sovereign democracy will operate with a substantial sovereign “deficit”—the amount of fiat currency it spends over and above what it collects back in taxes being exactly equal to the private wealth remaining in the hands of the “citizens.”

Fiat money and gold

This brings us to the second consideration of fiat money: Whether or not the sovereign currency is “convertible-on-demand” to gold. This is important whether the sovereign is a monarchy or a democracy, but it is ultimately crucial to what appears to be America’s present “fiscal dillema”, so let’s continue with the “citizens” democracy just described. Let’s imagine that—for reasons we don’t want to get bogged down in at the moment—the sovereign democracy decided to make each of its fiat dollars “convertible” to a certain amount of gold. If a “citizen” wanted to, they could present a fiat dollar to one of the sovereign’s banks and receive, in exchange, the specified chunk of bullion. (L. Randall Wray, in his recent book Modern Money Theory, provides an excellent account of why, historically, sovereign powers may have been motivated to make their fiat currencies “convertible” to gold.)

Having fiat money that is “convertible-on-demand” to gold clearly changes the formula. First, and most obvious, the sovereign government is required to have a large supply of gold on hand with which to make the conversions. Even if it calculated that only a certain percentage of the “citizens” were likely to actually demand the converted gold at any given time—and, therefore, it only had to actually back up a certain percentage of the fiat dollars it issued—the sovereign government’s spending nevertheless would be constrained by the amount of gold it had in its vault. Furthermore, and perhaps most important, when the sovereign government spent fiat dollars to purchase goods and services from the “citizens”, it was in effect actually spending the gold bullion it had in its possession. Even though it kept that gold in its vault, it was “promised” to the holders of the fiat currency. At some point then, to continue spending, the sovereign had to either obtain more gold (by digging it out of the ground, for example) or it had to collect the “gold promises” back from the “citizens” BEFORE it could continue spending its fiat currency. In other words, it had to collect taxes in order to “pay” for spending.

Indeed, this sounds logical and very familiar to us right now. Furthermore, to protect the sovereign gold supply from the over-issuing of fiat currency, the next logical step the democracy might take would be to ensure that whenfor whatever reason—the sovereign government decides to spend more fiat dollars than it collects in taxes, then it shall do this by BORROWING the extra fiat dollars needed from the “citizen’s” savings, rather than by issuing additional “new” fiat dollars which might exceed the back-up gold supply. When you think about it, this is quite an ingenious trick: It means that (1) the sovereign government is (apparently) prevented from issuing more fiat dollars than it has gold to back up, (2) the “citizens” get to exchange their saved fiat dollars for sovereign Treasury bonds that pay them interest, and (3) the “citizens” STILL get to benefit from the sovereign government spending MORE fiat dollars each year than it intends to collect back in taxes—enabling the “citizens” to continue to build up their wealth of fiat dollars and expand their private economy.

The limits of gold

The only problem with the set up described above is that, if you do the math, over time the sovereign government will have “borrowed” a great—and continuously growing—amount of fiat dollars from the “citizens”. This, in turn, will have enabled it, year after year, to spend many more fiat dollars than it collected in taxes, adding more and more fiat dollars to the “citizens” savings and private economy—but eventually and inevitably, it will have surpassed the amount of gold in its vault to back up those fiat dollars.

This is essentially the problem the U.S. confronted in 1971. The solution was quite simple, and President Richard Nixon implemented it in that year: the U.S. abandoned the gold standard and declared the U.S. dollar would no longer be “convertible” to anything other than itself. The U.S. dollar returned to the original “pure” fiat money with which we began this discussion.

What DID NOT change, however, was the system that had been set up to protect the back-up gold supply: By law, the U.S. sovereign government continued to sell Treasury bonds to “citizens” in order to “get” the fiat dollars it “needed” in order to spend MORE each year than it collected in taxes. And the “citizens” continued to benefit from this ingenious bargain: they continued to exchange their saved fiat dollars for sovereign Treasury bonds that paid interest. And they continued to add to their savings—and build their private economy—as the sovereign government continued to spend MORE each year than it collected in taxes.

The dangers of fiat money and democracy

The fact that the democracy did not vote to change the law when the gold-standard was abandoned has created today the confused perception that a great problem exists for which there is no reasonable solution. The problem is this: As the sovereign government continues to sell Treasury bonds to “get” the fiat dollars it “needs” to spend MORE than it collects in taxes, the interest it will be paying the “citizens” holding the bonds will become a larger and larger component of annual sovereign spending—requiring the sovereign government to sell even more Treasury bonds to make up the difference. The “citizens” (or at least those who are successfully operating in the expanding private economy, and those who own the Treasury bonds) will have become fabulously wealthy—but the sovereign government itself will appear to have fallen hopelessly into debt.

Debt, deficits and the cry for austerity

It is possible under these circumstances that a group of well-meaning “citizens” could arise declaring that the nation’s debt and deficits are unsustainable and that the only solution is to dramatically REDUCE sovereign spending. But if this discussion accurately depicts the way fiat money functions, this cry for austerity is an irrational solution to a false problem.

First of all, it is clear that what is called the nation’s “deficit” is, in actuality, a balance-sheet account of the fiat money the sovereign has spent into the private economy but not collected back in taxes—it is, in other words, the savings the “citizens” have managed to keep and use to grow their own business and commerce. Reducing the sovereign “deficit” will do nothing more that shrink the private wealth of the “citizens.”

Second, it is clear that the nation’s “debt” was originally created as a strategy to prevent the sovereign from issuing more fiat currency that it could back-up with gold. If the sovereign currency is no longer convertible to gold, this strategy is no longer needed, and the only reason a sovereign democracy would keep it “in place” is because the “citizens”, in fact, want to continue exchanging their saved fiat dollars for Treasury bonds that pay interest. To be more specific, it is unlikely that the bonds will be owned “equally” amongst the “citizens”, but rather will be held by an elite group of financiers. While the sovereign government, in fact, has the power to “pay off” all the “national debt”at any time (by converting the bonds back into non-interest bearing fiat dollars) the financiers might well achieve the power to take effective control of the democracy to prevent this from happening.

Finally, it is clear that constricting sovereign spending—in a confused effort to reduce the sovereign “deficit”—would be the height of irrational behavior on the part of a democracy. As long as there is work that can be done to improve the lives and well-being of the “citizens,” and as long as the labor and sustainable resources are available to accomplish that work in exchange for sovereign fiat dollars, it is a perverse logic that argues the sovereign cannot afford to have the work accomplished.

A sovereign nation with its own fiat currency CAN afford to accomplish that work! The strange reality of fiat money tells us the only limitations we actually have are the physical resources available, our ability to cooperate, and our willingness to confront and constrain any elite group that seeks to take control of, and manipulate, sovereign spending and taxing for the purpose of self-enrichment and power.

52 responses to “The Strange Reality of Fiat Money

  1. “Olson demonstrates that the logic of collective action makes it virtually impossible for cooperative goals to be voluntarily achieved—even though every single person in the group fully acknowledges the benefits that would ensue.”

    And yet Linux and the rest of Free Software exists, which knocks that theory into a cocked hat.

    • This is a valid point that’s worthy of serious exploration! I’m one of the believers that the digital communications of the internet change, potentially, the dynamics of democracy. If you plug that into the essay, it is arguably a very optimistic spin on the future of all this….

  2. Why is it necessary for the US Treasury to borrow money from the privately owned Federal Reserve bank ?

    A sovereign nation has no need to borrow money in order to create it. Critics of this notion scream “inflation and Somalia”, but inflation of a currency is dependent upon how much new money is created, not by whom it is created.
    In essence, the US money supply was privatized in 1913, when the Federal Reserve was foisted on the public. Few people seem to realize that it is not owned by the US government.

    If the US Treasury owned the Federal Reserve it would have no need to borrow. The only function of taxation would be to regulate the money supply and help reduce the predations of capitalism, which has a strong tendency to concentrate wealth and income to the already wealthy.

    • the privately owned Federal Reserve bank ?”

      They take issue with this notion.

      Who owns the Federal Reserve?

      The Federal Reserve System fulfills its public mission as an independent entity within government. It is not “owned” by anyone and is not a private, profit-making institution.

      As the nation’s central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.

      However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve’s activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as “independent within the government” rather than “independent of government.”

      The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation’s central banking system, are organized similarly to private corporations–possibly leading to some confusion about “ownership.” For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.

      Dunno. I am more interested in what arguable value-adding function they serve (if any).

      • Stephanie Kelton

        It’s not about ownership (and, by the way, how many private firms allow Congress to pick their Boards of Governors and also turn over virtually all profits to the US Treasury)? It’s about who’s the boss. Congress is the boss of the Fed. Don’t take my word for it…..

        • First, it is about ownership.
          The Monetary Control Act of 1934 was the first attempt to repatriate the stock of the Federal Reserve Banks. It had already failed its mission by then.
          Second, The banks that create the money, and profits FROM creating the money, are not the entity that Congress votes on. The Board of Governors are overall systemic policy makers, and not privateers.
          It might seem like a big deal to some that the Congress is allowed to confirm the Board members.
          But is this statement true, or isn’t it?
          Durbin: “The banks own this town”.
          Translate: Approve, or move on.
          Third, no corporation would give the Treasury back its profits, unless maybe its profits came from the Treasury and taxpayers. So no big deal there.
          If the banks didn’t ‘own this town’ (country, world) , then they would be borrowing from us, rather than us from them.
          Fourth, the claim was made that the Fed system is privately owned and that the Federal Reserve Banks are private corporations directed by their own independent, profit-seeking, corporate Boards.
          Is any of that not true?

      • The fact remains that the money supply of the US was privatized in 1913.

        The legislation was rushed through Congress On Sunday, December 23, 1913, two days before Christmas, while most of Congress was on vacation, President Woodrow Wilson signed the Federal Reserve Act into law.

        Wilson would later express profound regret over his tragic decision, stating:
        “I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world – no longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men.”

        • There’s always this certain irony at play when the discussion of MMT actually bumps up against the monetary system.
          Dr. Hudson has best opined on the achievement of a state of debt-peonage for the masses by the privileged purveyors of the ‘liquidity’ poison. And he takes the important step of pointing out clearly the mechanism by which the debt-purveyors achieve their ends – it’s called compounding interest in case people don’t follow the math.
          Finally, he grasps completely the public outcomes of the sovereigns who fall prey to the ‘foreign-investment’ (a.k.a. sovereign debt) hook. Those outcomes are privatizations of the commons.
          Of lands.
          Of public utilities and infrastructure.
          Of public employee benefits and wages.

          Yet, perhaps in a forest-for-the-trees perspective, neither he nor any of the progressive economists who associate themselves with MMT, and otherwise, seem to have a clue of a problem, not a smidgeon here, of the privatization of the people’s most beneficial tool for economic democracy, that of the Money System Common.
          Abraham Lincoln, in seeing the benefits of issuing debt-free Greenbacks by the government, called the people’s money-creation power: “the supreme prerogative of the sovereign government”.

          The old aristocratic elite have privatized this nation’s money system, destroying the supreme prerogative of government, and taken to issuing all of the nation”s money as a debt, and thereby simply indebted us all to hell.
          Dept-peonage achieved using the power that belongs to the people.
          So, the questions naturally arises to the fore – if what MMT is advancing is a theory of a sovereign fiat money system, one of governmental monopoly issuance of the currency, in the face of a completely private, debt-dealing monopoly, then why are we talking about anything else?

          FOR the Money System Common.

    • Here are the Federal Reserve shareholders. 54 pages:

    • Frank,

      The 2011 Federal Reserve Budget review;

      “The Reserve Banks’ current income in 2010 was $79.3 billion.2 The major
      sources of income were interest earnings from the portfolio of U.S.
      government securities ($29.9 billion) and federal agency mortgage-backed
      securities ($44.8 billion) in the System OpenMarket Account. Earnings in
      excess of expenses, dividends, and surplus are transferred to the U.S.
      Treasury—in 2010, a total of $79.3 billion. (These net earnings are treated
      as receipts in the U.S. budget accounting system when received and as
      anticipated earnings projected by the Office of Management and Budget in
      the U.S. budget.)”

      The 2010 Federal Reserve Annual Report:
      Page 130 of the Report, or page 138 of the PDF.

      Comprehensive income before distributions to Treasury: $81,735,000,000
      Distributions to U.S. Treasury: $79,268,000,000
      Dividends paid to shareholders: $1,583,000,000

      • Thank you for the link. Over the next few days I shall read it all 😉

        The Federal Reserve has never been independently audited as far as I am aware. The interest made by the bank is transferred to the US Treasury, but what about the principal, which it creates out of thin air ? The 6% returned to the shareholders on loans they make at say 3% means they are taking a loss ? 6% guaranteed return is a nice business these days, especially when it is compounded.

        Of course the Federal Reserve is just one bank of many, who also make loans as a multiple of their equity and/or assets with money they essentially create as debt out of nowhere. I also notice that big banks have been gobbling up smaller banks with government assistance, so that they become even bigger and too big to fail.

  3. Sunflowerbio

    Now that wasn’t so hard was it? I don’t know why our congress critters, some of whom can read and craft complex legislation, can’t understand the contents of the above post. Could it be that they don’t want to understand? Hmm.

    • Robert Bostick

      Congress critters don’t and can’t author complex legislation. That’s why they harvest K St lobbying firms.

  4. To say that fiat money attains its value through social contracts is absolutely correct and this is the true meaning of the expression that money is a “medium of exchange.” However, what most individuals fail to to do is think through in any kind of insightful way what this expression really means. For example, check out Wikipedia’s article on “Medium of Exchange” where the writer/s concern themselves almost entirely with “value.” It is in fact the inter-relationship, or interaction, of two things “Instruction” ( which is the social contract part ) and “Value.” Accordingly money, a “medium,” is used, or “exchanged”, as a way to “instruct” others (labour) to interact with resources to produce the goods and services we want, or indeed to buy from the marketplace those goods already produced by this process of “instruction.”

    So how does “instruction” relate to “value?” Consider, for example, a basic tenet of market capitalism. The more money that’s competitively invested in the production of goods or services, or the more “instructions” that can be issued using the medium of money, the more likely it is that prices will decline and the “value” of money will rise. So if money is doing “instructing” doesn’t it make sense to optimize the amount of money in active circulation in an economy subject to minimizing inflation because inflation reduces the “value” of money? As MMTer’s I’m sure you can think through the rest that all this entails!

  5. Recently acquired 14 volumes of 24 comprising John Maynard Keynes’ complete writings (published 1972). The first ten pages of Keynes’ first book, “Indian Currency and Finance” (1913) has all the seed concepts to grow a MMT, but then, Keynes was looking at a mixed fiat and commodity money system being established in India. Keynes’ writing clarifies many of the issues that elicit comments here at NEP and builds into a comprehensive view of fiat economics, its strengths and limitations in a mixed money system as regards the development of the Indian example. Curiously, Keynes’ observations coincide with the failure of Adam Smith to analyze the relationship between money and price, confounding a value of a commodity (sterling) with cost in his final book in “Wealth of Nations”, and (Smith) goes off on a moral (and mortally flawed) tangent at that point. Karl Marx also found a flaw in Smith’s “Wealth …” in the treatment of value which was the basis of his (Marx’s) observations that essentially defined value and the economic source of value in his labour theories. Failure to coherently define looks to be a possibly fatal flaw in MMT. An example the term wealth is flung about with great abandon, presumption and empty authority. The most concise definition of wealth is: unconsumed economic income (an accumulation of). Economic income is consumed to satisfy economic needs, wants and desires. Economic income comes from economic sources: Land, Labour, Capital and Entrepreneurship (assembling Land, Labour and Capital for production of economic Goods). Economic Goods are those that satisfy economic needs, wants or desires. Economic income accruing to Land is rent; to labour is wages, to capital is interest and to entrepreneurship is profit. These are present when a market is free. Monopoly or monopolistic occur in the absence of free markets, essentially controlling the market for their own interests, marked by economic power over markets. Other than noting political power having a direct relationship with economics, that essentially is what economics itself is about.

  6. Nicholas wade’s book “The Faith Instinct: How Religion Evolved & Why It Endures” is an extension of the arguments found in Edward O. Wilson’s book “The Social Conquest of Earth” in that the development of eusociality or “nesting” in human societies was reinforced by the development of religion. The argument runs that the predators ( including other human bands ) and adverse changes in the environment were labelled as the work of malevolent gods whereas success in defeating or keeping at bay these elements would be achieved by the band, tribe or nation uniting to believe in “good” gods or a “Good” god and following moral precepts believed to be demanded from such gods or god. This had the effect of achieving social cohesion that would help defeat threatening negative forces. The implication of this for MMT is that religions are a form of explanation both direct and indirect of why moral cohesion is important for human societies and acceptance of MMT’s understanding of money is the same and also hinges on a clearly understood explanation of the morally cohesive necessity for coercive taxation in the form of increases and decreases together with the same clear understanding of the morally responsible requirements for private bank creation of money since asset inflation bubbles are also a form of coercive tax increase.

  7. A serious question for the author and others like Stephanie Kelton: what part of this description in this article would serious mainstream monetary economists find controversial? I’m trying to evaluate whether mmt is new economics or merely an attempt to change popular narratives of public debt.

    Respectfully Yours


    • Jacob, I am not an economist—I’m an architect who wants to build things that mainstream economists (and the Congress they advise and influence) apparently believe we cannot build because they must be “paid for with tax dollars” and, of course, there aren’t enough tax dollars to pay for the things we’ve already agreed to pay for, so how could we possibly consider building anything new? For me, the basic misunderstanding is that “tax dollars pay for sovereign government spending.” MMT is saying that statement is fundamentally untrue: Instead, it is sovereign government spending that “creates” the fiat dollars which are subsequently collected back (to one degree or another) in taxes. It is that point, I believe, that mainstream policy makers simply cannot fathom.

      • That’s because that statement isn’t true.
        Have you ever seen the government create ‘dollars’ by spending?
        Like, as if the government spent dollars into existence that it did not already have have in its account?
        Just saying.

    • Mainstream economists think that govt. spending without issuing debt would result in hyperinflation, because it would build up excess reserves and they think banks lend out reserves, in fact they think banks lend out multiples of reserves.

      MMT says: banks don’t lend out reserves, nor do they do anything as fancy as calculate multiples of reserves.

  8. JD, good post. Is your ultimate point that when we abandoned the gold standard, we left in the debt standard? And that maybe it’s time to abandon the debt standard. Because the debt standard is holding us back much like the gold standard did?

    you make a great point in the paragraph titled “The dangers of fiat money and democracy”. what is the solution?


    • Ceteris paribus, fiat money creation by debt always increases the money supply exponentially, since more money must continually be created as debt in order to pay the compound interest ( sounds like a Ponzi scheme, doesn’t it ?)
      Since the creation of the Federal Reserve in 1913, the US dollar has lost 97% of its purchasing power.

      If the US government created money debt free to itself, the usual argument against it is that high inflation would result.
      However, the degree of inflation is caused by the amount of money created , not by whom it is created. If this policy were adopted, then the only need for taxation would be to regulate the money supply and spread the wealth and income more equitably. The problem with extreme wealth concentration is that is gives rise to almost unlimited political power and it also effectively reduces the money in circulation in the real nuts and bolts economy.

      • 97% loss of value over 100 years corresponds to about 3.5% average annual inflation. Not terribly bad, is it? In particular, it isn’t enough to substantiate any scary exponential growth story such as a Ponzi scheme.

        Another thing is, it is fundamentally wrong to appeal to Ponzi analogies in a fiat currency context. Ponzi schemes are those that require exponential growth against a finite population or supply. Depending on the base (1.04 as in paying 4% interest, or 3 as in having to find three suckers to pay participation fee to you to be distributed towards the top of the pyramid), the finite population or supply is bound to be exhausted sooner or later. Convertible currency –e.g., gold standard– contexts might afford the analogy, but fiat currency doesn’t. For it is available in unlimited, undetermined quantities to the sovereign issuer.

    • Jack, as I understand it, the “solution” is to acknowledge that the sovereign government doesn’t need to sell Treasury bonds in order to “finance” sovereign spending. The “danger” is that the democracy may well come to be controlled by an elite group of financiers who WANT to hold the sovereign in debt. I was influenced here by Michael Hudson’s recent posts: “America’s Deceptive 2012 Fiscal Cliff”. (Don’t know how to make a link, sorry.)

      • JD: BINGO!!! I’m tired of being told the govt “needs” to borrow and it’s terribly indebted when it owns the money in the first place. The structure needs to change!

        The curtain is going to be pulled back on the wizard of oz here soon. I hope it can be done before the banksters have too much of our money to screw us in the commodities market, as that’s where i guess they’ll head after we implement PCS. I loved mhudsons post u ref as well.

      • “The “danger” is that the democracy may well come to be controlled by an elite group of financiers who WANT to hold the sovereign in debt.”

        I think that is already the case, isn’t it ? This is because right now all money is created as debt as a zero sum game.
        No debts = no money. Therefore the more debt that is created, the richer it enables some people to become, necessarily at the expense of the many, who are in debt.

        For a very short time I was employed by a large US consumer durables retailer. It seemed to me the basic idea was to suck customers into credit card debt at 23% interest and the product was merely a device to attain this end.

        • Zero-sum game is what you’d have if government never deficit spent and there were only bank loans available to the private sector.

          • Nihat,

            As things stand, all money is created as debt. Even the US government goes into debt in order to create money, by selling US Treasury bonds to the Federal Reserve. At maturity the Treasury has to buy back these bonds with more money it borrows from the Federal Reserve, which is a privately owned by a consortium of private banks.

            This is why we have the Federal deficit each year, which in total becomes accumulated total Federal debt of $16 trillion. Other entities both foreign and domestic, buy these Treasury bonds, since they are a safe investment with a guaranteed rate of return. At maturity they are paid back in Federal Reserve notes or their electronic equivalent.

            • Frank, no, that’s not why we have a federal deficit each year. Even when no government securities were issued ever, fiscal deficits would still be needed to overcome trade deficits and the private sector’s savings desire (in private savings instruments necessarily since govt papers are no more), and keep employment up and prices stable vis-a-vis population and productivity growth (we kinda need more money to go around for more product/bigger pie, don’t we? ).

              That said, I’m fine with decoupling deficit spending and issuance of government securities. I just believe the latter serves a legitimate purpose, too.

          • Nihat

            You have probably noticed that all American dollar bills are headed ” Federal Reserve Note” They are not “US Treasury Notes” although they are deemed legal tender for all debts.

            For good measure is added the motto ” In God We Trust.”

      • Yes, this is the point driven home by the Kucinich Bill.
        A sovereign fiat money system does not require that government borrow its own currency to spend.
        But, given the existence today of an endogenous, private, debt-based system of money, the government has abdicated its rights of money creation to the private bankers, resulting in the requirement that the government that has the money-creation power borrow its ‘deficit’ expenditures.
        The solution really is to first stop pretending that the government is the monopoly issuer of the currency. The bankers are the monopoly issuers of the currency.
        And MMT does not acknowledge this reality and is thus incapable of offering a workable solution.
        The Kucinich proposal ends private money creation and government borrowing.
        It does so by restoring the sovereign money-creation exclusively to the government.
        That is what is needed to restore economic democracy.
        Given that today my browser can no longer find “”, I offer AMI’s version of the Bill.

        • Joe, after reading HR2990 from kuc. i cant believe he is the only sponsor. it fixes the problem the govt needs to stop being the borrower of its own money and start being the issuer. i must say it took a lot to find it, but just like the TDC/PCS option is starting to buz, maybe this one will too.

          i also agree with you mmt does a spot on job of explaining the current monetary operation, but it doesnt seem to address the fundamental structural flaw. how ever i can see from posts here the mmt has provided the base to jump to the next level of sovereign ownership of currency.

          • To Frank.
            Thanks for taking the look.
            Kucinich’s only HR 2990 co-sponsor was Conyers of Michigan and we hope that he will re-introduce in the 113th.
            The main problem has been that Kucinich wants to work on peace, the environment, worker rights, safe food, healthcare (he had the only single-payer proposal and at first had VERY few co-sponsors), poverty, international relations and fixing the money system.
            So did I til my Dad convinced me that we’ll never fix the other stuff unless we fix the money system first.
            While I have high hopes for a Kucinich presence in our evolving debate about monetary reform,
            he has already performed an essential yeoman’s task in putting together the legislation of an intelligent design for public money.
            The macro-economic modeling of Yamaguchi, and more recently that of IMF researchers Benes and Kumhof, fully confirm the workability and positive results of a move to the Kucinich proposal.

            • hey joe, i’m still re-reading HR2990 to help it sink in. again i’m no economic expert but it appears to me to be an almost ingenious piece of legislation. The very last section….lend to local/state governments at 0% interest. how powerful would that be? I know the main discussion here is federal, but the states/local don’t have the power to create money which given current leverage levels is a major underlying problem.

              • Thanks, Jack.
                Someday, very soon I hope, the revolutionary elegance of the Kucinich Bill is going to catch on in a big way – like a prairie fire.
                It solves all of the problems that remain with MMT’s view of a sovereign fiat currency.
                But, in truth, even Mosler’s proposals include a per-capita grant to all at the statewide level.
                Her is what the Kucinich perspective avails to the states.
                The Colonies became the United States and the ‘states’ previously held money-creation powers.
                The great money power is what enabled the Colonies to thrive.
                In joining a union, promises were made that the federal government WOULD handle the money system so that the states would see an equal, if not greater, benefit.
                Rather, the Feds gave the money power to the private banks and their quasi-legal machinations are responsible for the great loss of stability and the real economic suffering at the state level.
                Had the states maintained monetary power, they would not have any of the problems they have today.
                The Kucinich Bill is a true sharing of the money power with the states.
                The states determine their priorities for the use of the new monies.
                This would provide great State budget ‘policy space’ as MMTers are wont to think of on these matters.
                I promise, the more time you spend trying to comprehend the Kucinich Bill, the greater its profile becomes among the solutions being proposed.
                For the Money System Common.

  9. Thanks for a great article – I understand ‘Fiat Money’ now.

  10. Here’s how reality now stands in Western economies:-

    “Private banks don’t have to pre-fund economic expansion only the government but when the private banks make lousy bets forget the pre-funding.”

    Here’s how reality now stands in Communist run China:-

    “State owned banks don’t have to pre-fund economic expansion or the government but when these banks make lousy bets the Central Bank rolls-over or cancels their non-performing debt portfolios.” [edited by admin per poster’s request]

    In 2016 economic analysts are predicting China’s GDP will overtake that of the United States.

  11. If that happened, the “citizens” would be able to save some fiat currency each year, build up a reserve of it, and expand economic trade amongst themselves. It is logical, therefore, to imagine that a sovereign democracy will operate with a substantial sovereign “deficit”—the amount of fiat currency it spends over and above what it collects back in taxes being exactly equal to the private wealth remaining in the hands of the “citizens.”

    Why does that imply that there needs to be a deficit every year ? This is where you muddled thinking begins.

    It is quite possible to have a one (or few) times budget deficit that injects more money into the system. It does not have to be continuos.

    Secondly, you don’t need a budget deficit AT ALL to inject money into the system, that can independently happen through loans/credit, both at central bank level and individual bank level.

    • In a growing economy (growing population and productivity), budget deficits have got to be the rule not the exception. Perhaps not so in an export economy with continuous current account surpluses, in which case you are producing real stuff (call it “wealth” if you will) and shipping it abroad in exchange for “nominal monetary tokens.”

      • You are confused. In a perpetually growing economy, budget deficits can be exactly zero (in fact taxes can be exactly zero).

        Money is created through credit, not budget deficits.

        • There is no perpetually growing economy fueled only by bank loans/credit, or equivalently, by private debt!

          But yeah, when the business is booming, economy is hot, fiscal deficits can be lower or even be negative (but not for long, because no net aggregate savings can be made out of bank loans, and budget surpluses erase private sector financial assets).

          • There is no perpetually growing economy fueled only by bank loans/credit, or equivalently, by private debt!

            You are confused. I said: budget deficits can be exactly zero (in fact taxes can be exactly zero). In practice, obviously, all govts do spend and taxes are never zero. That’s not the point.

            You can have zero govt. spending and zero taxes, and a perpetually growing economy, simply via new money creation via bank credits. Not only that, you don’t theoretically even need new money creation is the velocity of money increases.

            • I am not confused. I am making a choice. I don’t believe in perpetual motion machines. I don’t want to live in a loan/credit racket.

              Thank you for the exchange; it’s been instructive for me.

        • “Money is created through credit, not budget deficits.”

          In our monetary system, every credit has a debit and every debit has a credit. All money is created as debt.

          As I stated before, one man’s savings is another man’s debt.

          No debts = no money

    • The reason for the state-funded-by-fiat-money-issuance deficit is to provide the new money needed for economic growth.
      It stands to reason.
      In a fiat money system, the sovereign does not need to borrow.
      If the sovereign believes, by econometric analysis, that growth in the economy is ‘potential’, then money is created to fund that potential growth and viola, we have growth without debt.
      It stands to reason.

  12. Reducing the sovereign “deficit” will do nothing more that shrink the private wealth of the “citizens.

    You are conflating wealth (which is real) to nominal monetary tokens.

    • There is now much excess money floating around the world it has become another commodity. The quantity is far beyond that needed as a medium of exchange to sustain trade. It is now being used to speculate in the stock, bond and commodity markets.

      You differentiate wealth from money, but there is no clear distinction. Money can buy assets such as real estate, gold etc which presumably you deem to be wealth. They are interchangeable.

  13. Very good.
    But wrong in that Nixon did not abandon the gold standard in 1971.
    FDR abandoned the gold standard, which said that every ‘paper’ dollar was directly convertible to a certain quantity weight, fineness of gold.
    We were totally off the gold standard by 1935.
    As part of the Bretton Woods agreement, certain countries agreed amongst themselves that their currencies would hold certain value for international trade “amongst themselves”, and that the inter-relation of everyone to the US dollar was based on a certain exchangeable dollar gold value.
    The claim and settlement of claim was only for national current account balances.
    And, only involving international goods commerce.
    But this had NOTHING to do with domestic commerce.
    It had NOTHING to do with domestic economic ‘policy space’ as the term du jour.
    After 1934, NOBODY who was holding a paper dollar had the ability to convert that dollar to gold, because we had no gold standard.
    The profile that the gold-exchange standard has to understanding fiat monetary operations is completely misplaced.
    We have had all the domestic economic policy space w needed since FDR.
    In fact, we had it before FDR, but that’s another story.

  14. (I’m no expert but) the US and the world has been on a 100% fiat economy for 40 years. Less than 2% of US money is cash and half of that 2% is outside the USA. 90% is electronic transfer and the rest is checks, money orders, and other kinds of private paper.

    The national debt is in circulation in the form of Treasury bonds/bills and, I suppose, foreign profits from international corporations exporting natural resources, US jobs and the machine tools that foreign companies use to steal US jobs. Because all of this national debt is a form of US fiat money, ultimately it must be spent in the USA for something else it will have no effect on the US economy. What might it be spent for? Could be spent by tourists, for buy goods and services inside the US, buying US businesses, land, or infrastructure. Unfortunately, thanks to the Roberts Court, returned US money can be used to buy Congress.

    In the last 3 years the US government has invented 3 trillion or more in “extra” US money. Why has it not caused a runaway inflation? Or any inflation? Because none of it was spent into the US consumer economy? We can’t have money inflation if it is not spent into the retail economy. Where is it? In Swiss banks? Used to export more US jobs?

    I think that fiat money functions as a government countersigned IOU for goods and services. I could give my grocer an IOU but my grocer could not pass it to his milk guy who has never heard of me. Having the government issue the IOUs simplifies the book keeping.

    Consider grocery store discount coupons, a form of fiat money. Many store accept computer copies. 100 billion people could print $100 worth of Safeway coupons for $1 off on a box of Safeway corn flakes. These will have no effect on anything except the computer paper business until the coupons are “cashed in.”

    Right wingers claim that the US dollar is no longer worth anything at the same time they are complaining about the national debt. How can the government produce an excess of nothing of value? Doesn’t compute.

    Further, I suspect half the US economy is under the table. If consumer prices are inflated much faster than the consumer’s income, more of the economy will go underground. As US food stocks are converted to auto fuel, more people will dig up their lawns and grow food.

    If I am wrong, please explain why.

  15. thanks for a great article. I understand Benjamin Franklin now.