Month: March 2023

In Part 35, we got deep into the two types of inflation and showed how any government that institutes a 0% backed fiat currency has the ability to soak up all purchasing power increases from that point on, which is why Americans haven’t experienced much financial progress for the last few generations.

This far into writing anything about money, the writer tends to start getting lazy and skipping some of the micro-steps that are required for the reader to understand the new information being presented. This has happened in every book I’ve read about money. I am trying to avoid doing that. So let’s start this post by clarifying a few different topics that I’ve referenced but haven’t fully explained yet.

First, if a society is using gold coins as money, who should be stamping those into set weights with beautiful and difficult-to-counterfeit and difficult-to-clip shapes?

Government is one option, although that runs the risk of the government slowly making them smaller while still printing the same weight on them. Governments have done that in the past and ruined the society’s commodity money.

So I would prefer the private market to fill that job instead. It would probably lead to a few different companies establishing themselves by being honest and exact in their weights and designing the most convenient and aesthetically desirable stamped shapes. The different companies would be competing, so they would keep each other honest by monitoring the product and prices of the others. For example, if they find that one of the companies is skimping on the gold or something else shady, that would be the death of that company. The competition would also force them to work hard to provide this service for a reasonable cost for anyone who brings in some gold that they want coined. And standardization around certain weights would probably naturally emerge according to the demand in the market. I believe this scenario would lead to a long-term stable currency.

Second, is there any benefit to having the government (or anyone else) define a standard weight of gold for the purpose of naming their currency? For example, the Coinage Act of 1792 defined one U.S. dollar as 24.75 grains of pure gold.

I don’t think so. It just adds one more conversion to the mix. It would be easier to refer to the price of things directly according to their weight in gold. (And how about we use the metric system for weights, eh?)

The other benefit to not establishing a separate name for the currency is that the lack of a currency name lowers the risk of people starting to think of money as some nebulous named thing rather than thinking of it as the commodity itself. So even receipt money would be best if it simply states how much gold it entitles the bearer to and the bank that guarantees the exchange.

Third, I’ve never fully explained token coins.

Most modern societies still use metal as money, but the stated value on the metal coins is much higher than the intrinsic value of the metal by weight. So, they’re not real coins that have full intrinsic value like the gold coins of early Avaria. That’s why they’re called token coins instead. They are a token that represents a certain amount of money. Basically they’re just a metal version of receipt money.

Fourth, I’d like to review the three main ways the government and First Bank can manipulate the money supply.

1. It can change the required reserve ratio, which of course alters the money multiplier.
2. It can change the discount rate. Increasing the discount rate makes banks more conservative in how much money they lend out because it will be more expensive for them to go below their required reserve, so increasing the discount rate decreases the amount of money. And you see the opposite effect when the discount rate is increased.
3. It can create new money for lending to the government.

I could add a bonus fourth one in as well: Adding a new intangible asset to the list of things that can be used as reserves (like we talked about in Part 33). But this is uncommon enough that it’s not usually lumped in with the other three during discussions about how governments and central banks create more money.

Depending on how tasks are delegated, First Bank may be directly in control of setting the reserve requirement and discount rate. But generally the money creation mechanism is only used to facilitate government deficit spending, which First Bank has no direct control over.

So, if First Bank wants to manipulate the money supply, it has to rely on the first two. Probably it would only change the reserve ratio in more extreme circumstances, but it would use the discount rate as a sort of cushion for the economy.

What I mean by that is this: Whenever the economy is struggling, injecting some additional money into it by lowering the discount rate could help the economy bounce back. And whenever the economy is doing well, the central bank wants to increase the discount rate so that it has room to lower it again when another economic rough patch comes. It would also have to balance those changes with the impact on the aggregate money supply that changes in the amount of government debt incurs.

When I talk about manipulating the money supply in that way, doesn’t it seem like a great idea? Doesn’t it seem like the kind of thing that economists could get PhDs in by creating all sorts of sophisticated models to take every factor into account and set the discount rate just right to optimize economic growth? Doesn’t it seem like we should be so grateful for the Federal Reserve’s efforts to help our economy?

Yes, it does seem that way. But I would liken that positive sentiment to seeing a guy rushing to put out a raging house fire by throwing buckets of water on it. We’re watching him doing that and thinking he’s doing the best he can in a tough situation, and then later we find out that he’s the one who lit the house on fire in the first place.

And if that analogy isn’t enough to quell that positive sentiment toward the central bank manipulating the money supply in ways that ostensibly help the economy, I’ll refer you to (1) Parts 1-35 (especially Part 35) of this series and (2) this post I wrote more recently about how administratively setting the price of anything–including money–is unbelievably worse than letting the market set the price instead.

Fifth, I’ve already talked about various effects of monetary expansions and contractions earlier in this series (like way back in Part 21), but I haven’t ever summarized those effects all in one place. So let’s briefly review all of the main effects, looking at them from a monetary expansion point of view:

1. It causes wealth redistribution as the benefits of the change in money supply accrue primarily to the groups of people who are earlier in the chain of effects. For example, the first person to spend newly created money (usually government) gets to do it at pre-inflation prices, so there’s a wealth transfer to them and the other early recipients of that newly circulating money.
2. It induces inefficiencies in the market due to pricing uncertainty.
3. It causes wealth to be lost due to the investment failures induced by the pricing uncertainty and general market uncertainty.
4. It distorts purchasing decisions as people perceive they have more wealth than they really do because prices have not adjusted yet to the new supply of money. This can lead to significant hardship because people have purchased things that they realize after the fact they cannot afford. It can also lead to defaulting on loans, which puts the financial security of banks at risk too.

I want to expand a little bit on the second one listed there.

I’ve talked a lot on this blog about how deliberately changing prices (“administrative pricing”) interferes with a market working efficiently (here and here) because without having the market price anymore, all the information contained in it has been lost. Usually when I’m talking about that topic, I’m talking about administratively setting prices for specific goods or services. What about when the government deliberately changes the price of everything in one fell swoop by changing the value of money?

If the price of everything were to generally rise or fall at the same time, then maybe the relative price of things remains constant enough that it’s not so bad, and we only deal with the short-term generally-too-low or generally-too-high prices.

But prices do not rise and fall at the same time, so relative prices are going to be out of whack to some extent as well.

I currently don’t have any means of quantifying the degree of destructive inefficiencies these pricing inaccuracies cause, but I suspect they are not trivial.

So, when taking all these effects of a monetary contraction or expansion into account, I’m convinced that the costs far outweigh any benefits.

To conclude this post, I’d like to illustrate the effects of a monetary expansion with an example.

Let’s say there’s a pandemic. Global supply chains are disrupted, companies are closing down, and lots of people are getting laid off. People are not buying as much stuff (except for toilet paper and sanitizer and masks), so there’s a general slump falling on the whole economy.

The government sees this, and they think, “You know what can stimulate an economy? A big infusion of cash! Sure, it will induce all those negative effects that Christensen’s Theory of Money blog posts describe, but, until prices adjust, people will behave as if they have more money and will therefore start spending money again, which will help the economy. And a healthy economy helps everyone!”

So the government sends everyone below a certain income threshold a big fat stimulus cheque funded by newly created money. And the recipients of these cheques think they are wealthier, so they start spending money accordingly.

Little do they know that inflation will hit them hard enough down the road that it will more than compensate for the extra money they got in that cheque.

So what the government has essentially done is manipulated people into spending money that they otherwise wouldn’t have spent by convincing them in the short term that they’re richer than they are and then taking that wealth away again (through inflation) later on.

And the people have no idea. In fact, when they get the cheque with the President’s name on it, they think he’s such an amazing guy. And then, when inflation hits them later on, they blame the businesses for greedily raising prices so much.

It’s a perfect PR move by the government. They manipulate the people into doing what they want, get thanked for it (and are now seen as proactive and good politicians), and get none of the blame later on when the people realize they have less wealth than they thought and have been spending irresponsibly.

This sounds pretty critical of government, and I guess it is. But how clearly do politicians supporting these policies know that this is what they’re doing? Maybe some or all of them can claim ignorance. But regardless of their intentions, the effect of their policies is the same: they harm us financially. In fact, they do more harm than just leaving the economy alone. So, this is one more example of how a 0% backed fiat currency hurts us, in this case by facilitating the government manipulating us into spending money we don’t really have and convincing us they’re good politicians in the process.

Part 37 here.

The last few posts, we’ve been processing more about the change to a 0% backed fiat money. And then, in Part 34, we looked specifically at the state of the U.S. debt in the three main categories: bank, government, and individual.

In this post, I’d like to show you how our inflation is terrifyingly worse than what the simple annual inflation numbers suggest.

To start, let’s talk about the two specific factors that make simple measures of inflation completely misleading:

First, the value of money is determined by its supply and also by its demand. As an economy grows, the demand for money increases. Therefore, if we had a fixed supply of our 0% backed fiat currency that we call the U.S. dollar (USD), the purchasing power of each USD would increase each year that there is positive economic growth. We’ll assume foreign demand for the USD stays constant, although a healthy economy increases foreign demand as well, which would further strengthen the USD. Thus, money prices should be going down every year, and it should generally track economic growth; 3% average annual economic growth would equal a 3% increase in the purchasing power of money (assuming stable money velocity). So thinking that stable prices during a period of positive economic growth means the Federal Reserve has not induced any inflation is false. [Sidenote: Continually increasing value of money is not optimal. It would be better if the value of money (i.e., the Wealth Unit:money exchange rate) stayed constant, like when you have a commodity money subject to supply and demand, as I explained early on in this series.]

Second, remember how we made a distinction between the money price and the wealth price of something? Let’s think about wealth prices for a second. Each year, new innovations decrease the cost of things, so we should expect ongoing wealth price reductions in most goods and services. Thus, if money prices aren’t falling along with wealth prices, that means the Wealth Unit:money exchange rate is getting worse, which is inflation. So this is a second reason why thinking that stable prices means the Federal Reserve has not induced any inflation is false.

If you were paying attention earlier in this series, you know that those are the only two ways for the money price of something to fall: (1) the Wealth Unit:money exchange rate improves and (2) the wealth price falls. What I’m arguing here is that both factors should be independently lowering prices nearly every year.

And any time the money prices of things decrease–whether it’s because the WU:money exchange rate has improved or because the wealth price has decreased–that translates into greater purchasing power (i.e., the ability to buy more stuff with the money we have), which ultimately is what matters.

Can you imagine a world where the purchasing power of money regularly increases and, along with that, the wealth price of things decreases? It would mean that each year that my pay from my employer stays the same, I’m actually getting more wealth per dollar and that wealth goes further when I use it to buy things. It’s kind of unfathomable to me. Instead, I worry about if I can continue to afford my lifestyle as my pay stays the same and the prices of everything I buy keep going up.

Here’s the summary statement of what I’m explaining here: When the inflation rate is calculated by comparing the price of a basket of goods from one year to the next, it’s falsely assuming that stable prices means there has been no inflation.

Really, there are two types of inflation. There’s “measured inflation,” which is based upon how much prices have increased (according to the Consumer Price Index, or CPI), and then there’s “unmeasured inflation,” which is how much prices would have decreased had there been no new money creation that year. And since nobody really talks about unmeasured inflation, the government gets away with not being held accountable for it.

How much should we expect prices to decrease each year? In other words, how much “unmeasured inflation” has the government been getting away with? We have to look at the two factors separately and then add them together.

Economic growth: Real GDP growth averages 2.7% since 1971 (in spite of an overly complex regulatory environment and a bad monetary system that definitely slows it down!). So economic growth should bring prices down by an average of 2.7% per year.

Innovation-induced productivity increases: As for estimating how much innovation would bring the wealth price of things down each year, we can use something called the Total Factor Productivity (TFP) growth, which is a measure of “efficiency and technological progress.” Since 1971, average annual TFP growth has been about 0.75% per year.

2.7 + 0.75 = 3.45%. But since some of the economic growth and some of the TFP growth overlap, we can round down to 3%. Thus, prices should decrease by about 3% per year.

Therefore, if the Federal Reserve stays consistent with its 4% or so average inflation per year since 1971, that means they realistically probably have caused around 7% inflation each year (4% of measured inflation and 3% of unmeasured inflation).

Seven percent. Every year (on average). That also doesn’t even count all of the money our government takes from us in the form of income taxes, capital gains taxes, sales taxes, property taxes, licensing fees, . . .

It’s a wonder we’re not all broke. Many of us are, and it’s not just from lifestyle creep (although that’s a factor too). And it should no longer be surprising why. The endemic financial challenges in this country should all but be eradicated by now, but the government’s 0% backed fiat currency has prevented that . . . plus persistent tax increases, but that’s not our topic today.

So . . . yeah. Even though technology enables a worker to generate more wealth per hour of labor today compared to any other time in history, and even though the wealth prices of things have been decreasing consistently for decades, poverty is not decreasing.

Let’s now bring everything back to how our 0% backed fiat monetary system allows that to happen and keep happening.

When a country is at least on the gold standard, the amount of new money that can be created is limited by how low the central bank thinks it can push the reserve ratio. Once it’s pushed it as low as it can go, it can’t create any more money without risking a currency collapse, so inflation has been maxed out. And when inflation/new money creation has been maxed out, measured inflation and unmeasured inflation both grind to a halt, and prices start falling every year.

But when a country is no longer on the gold standard, there is no long-term limit to the amount of inflation a government (with the help of its central bank) can cause. Inflation can never be maxed out. The only limit is the short-term limit of needing to minimize measured inflation to prevent prices from rising so fast that people lose confidence in the currency. But there’s no limit to the amount of unmeasured inflation the government can cause, even in the short term. This means that the government has the capacity to soak up all purchasing power increases that can ever arise from economic growth and innovation-induced productivity gains, and it can continue doing that for forever.

As another means of calculating the innovation/productivity aspect of unmeasured inflation, take a look at this graph:

Do you see how, even though worker productivity has persistently increased, real wages (note: real wages refers to the buying power of the money paid to workers) have stagnated? Normally, they should be closely linked because a worker who can generate more wealth for his company is worth more to the company and, consequently, will be compensated with more wealth. But the link between increasing productivity and increasing real wages broke around 1970.

Can you think of anything that happened around 1970? More specifically, 1971? If you said that the U.S. went off the gold standard, you would be correct.

Why did that link between productivity and real wage growth get broken by going off the gold standard? Let’s look at it step by step:

1. Innovation allows workers to enhance their productivity (i.e., generate more wealth per hour of work), so they get paid more per hour
2. From a real prices perspective, that means prices have just gone down
3. Any time prices go down, it creates an opportunity for the government to create more money to negate that effect without anyone noticing
4. No gold standard means it can create that new money without any limit or even any repercussions, and it usually does

Interestingly, check out what happens when we use the numbers that the above graph was created from to estimate the innovation/productivity aspect of unmeasured inflation.

Worker productivity has increased about 90% since 1971, but real wages have only increased by about 25%. That’s a loss of 65% of buying power over 50ish years and, when you do the math to compound the percent loss by year, it works out to about 0.9% unmeasured inflation per year. That’s very close to the 0.75% we calculated for the same factor above using TFP. Some nice corroboration there.

And what happens when we have a huge burst of wealth price-lowering innovation, such as from the impending AI revoluion? If AI is able to replace a large minority of workers–and every reputable source predicts it will–then the cost of making things will go way down. The average annual innovation-led decrease in prices will be much more substantial, maybe even up to 3-4% while the AI revolution is transforming the economy. And it is likely to fuel more rapid economic growth as well, which could be up to 4-5%. So that means prices should start dropping by a wild guess of 7-9% per year.

But what will actually happen? Yes, the government will leverage the opportunity to induce unmeasured inflation and spend like crazy without inducing any measured inflation. People will believe that the government has somehow finally found some fiscal prudence and cheer the few years of 0% inflation. Then, when that AI-fueled revolution driving such rapid economic growth and wealth price reductions dies down, the government will have a hard time cutting back its spending, and measured inflation will soar.

Meanwhile, Americans will continue to struggle financially because they won’t receive any major purchasing power increases from all that innovation and economic growth. Add to that the unemployment spike while the economy retools, and there’s a good chance people will see AI as the worst thing that ever happened to the economy. That’s in spite of AI likely being the greatest wealth-increasing opportunity in generations.

Catch the vision of what I’m explaining here: When a government has no limit to how much money it can create, it has the ability to soak up all worker productivity gains and economic growth gains for the rest of forever. In other words, it has the ability to divert all purchasing power gains to itself and to banks as long as the 0% backed fiat currency remains.

And in case you try to look at how central bank debt has increased to estimate how much new money has been created, don’t forget that that’s only part of the story. New money is also created from allowing new intangible assets to count as reserves, lowering reserve ratios, and lowering the discount rate, the benefits of which accrue to the banks rather than the government.

Before I end this post, I want to make one more important point:

Up to this point in this series, I’ve always confined inflation to affecting our cash wealth. For example, I wrote in earlier parts that the price of our non-cash assets will rise with inflation, so focus on holding non-cash wealth if you want to become “immune to inflation.”

But now it’s time to revise that in the world of a 0% backed fiat currency. Now that you know there are two forms of inflation, I can clarify what I wrote before and say that that “immune to inflation” comment only applies to measured inflation. Unmeasured inflation, however, is completely different . . .

When we perform labor, that labor is generally compensated in the form of cash. And only after we’ve received that cash can we turn around and buy non-cash assets with it. But when the government has the ability to absorb for itself (and banks) every bit of purchasing power increase that cash would accrue over the years, that means the government has the ability to restrict the flow of wealth into our personal net worth. We end up not being able to buy nearly as many non-cash assets as we otherwise could have because the increases in purchasing power have essentially been capped (and instead diverted to government and banks) since 1971.

There is no immunity to that. Unmeasured inflation has been devastating Americans’ struggle for financial progress for over 50 years, and it will continue to affect all of us as long as our 0% backed fiat USD stands. And it does all of that without most of us even knowing about it.

So when people talk about how the Federal Reserve has decreased the value of our money by 97% since its establishment in 1913, now you know that that isn’t even the half of it; the impact the Federal Reserve has had, especially since 1971, is way worse than they realize.

How do you feel about a 0% backed fiat currency now?

Part 36 here.

In Part 33, we got even angrier about 0% backed fiat currencies because of the hidden transfer of wealth to bankers and governments that they induce, all facilitated by using intangible assets as reserves.

This week, let’s talk about the U.S. government debt!

Now that we understand that any government with a central bank at its disposal has three primary ways to get money (tax, borrow, create) and that the usual method of creating money involves the government giving the central bank an IOU in return, we now have all the tools we need to understand modern government debt.

So, how much of our U.S. government debt is owned by actual people who lent money that already existed, and how much is owned by the Federal Reserve (which means it was created for the purpose of lending to the government)?

According to fiscaldata.treasury.gov, the U.S. government’s debt is currently at approximately $31,460,000,000,000. For simplicity, let’s round down to a cool $31 trillion. [Update: That was originally written in March 2023. Now, in July 2025, just over 2 years later, the debt has increased to $37 trillion.]

The way the debt breakdown is reported, there are two categories: “intragovernmental holdings” (20%) and “the public” (80%).

Intragovernmental holdings is kind of weird. This explanation will be slightly oversimplified, but it will be accurate overall. When an agency takes in more revenue than it needs to immediately spend that year–such as social security, which collects taxes that it won’t need to pay back out in benefits until years later–the money immediately gets sent to the Treasury in exchange for an IOU that says, “You sent money to the Treasury. Thanks! But since that money still belongs to your department, we’ll pay you X% per year on that money while we borrow it from you. And when you need that money back, we’ll give it to you back and destroy this friendly IOU.” And what does the Treasury do with that money that was immediately sent to it? Yep, it spends it on other things almost immediately. So the intragovernmental holdings portion of the debt will have to be paid back (plus interest) with future taxation. It’s money the government shouldn’t have spent yet but did.

Now getting to the portion of the debt owned by “the public,” my first question is, Why are the Federal Reserve’s loan holdings lumped into that category? Because the Federal Reserve is not owned by the government. It’s owned by private regional banks. The implications of this will be made clear later. So let’s ignore that for now and be astounded at the fact that if the Fed holds around 20% of the total debt, that means that (in 2025 numbers) about $7.5 trillion was created by the Fed for the government to spend. How does an organization go through that much more money than it’s earning in taxation? It’s crazy.

Anyway, the majority of the rest of the “the public” category is owned by foreign investors (like foreign governments) and private individuals (especially through mutual funds). Commercial banks own about 5% of the total debt.

I can’t help but share one other detail from this fiscaldata website. Remember when I talked about societal defaults, and the big contributors to that were bank leverage, government leverage, and individual leverage? Let’s see how we’re doing with each of those categories: the current required reserve ratio is 0% as of 2020 (which means banks will be around 100% leveraged), the federal government’s percent of revenue that goes to servicing its debt is 19%, and our average household percent of income that goes to debt is 11%. Does all of this put us at particularly high risk of a societal default (i.e., another great depression)?

The reserve ratio is certainly scary, but the percent of income going to debt for the federal government and for households isn’t quite as scary. Although, regarding the federal government finances, when you consider that 60% of its spending is mandatory spending, that means debt payments are already eating up 35% of discretionary spending (and that number is rising quickly), it’s worrisome that debt payments will soon eat up all of the government’s discretionary spending.

Overall, looking at a snapshot of the current state of things, I don’t think the United States overall is at an alarmingly high risk of a societal default. But when you look at the trends, the outlook gets worse. At the rate the U.S. federal government is accumulating debt, it’s like a locomotive speeding faster and faster downhill toward a chasm with a broken bridge. And that, combined with the bank debt, does make me worried about our future. If things continue to go the same direction, I think the risk of a societal default is incredibly high in the next 20-30 years.

Part 35 here.

When I started this series, I never expected to get up to this many parts! Apparently I had more thoughts on money than I expected. But we are nearing the end of the series. There are still some more things to process with the change to 0% backed fiat money. And, of course, I will have a few things to say about crypto before the series ends. And then at the end I want to take a look back at how far we’ve come and discuss possibilities for improving our monetary policy. But diagnosis first, then treatment.

In Part 32, we got rid of the pyramided reserve structure and discussed how reserve pooling would work in the age of digital banking.

Let’s spend a little more time processing the change that allowed banks to use First Bank Notes as reserves.

Throughout this series, we’ve seen many expansions of what banks are allowed to use as reserves. It started out with cash assets (specie) only, and then it expanded to include non-cash assets, and then it expanded again to include using the fiat money itself (i.e., First Bank Notes) as reserves.

What’s the difference between real assets, like specie or cars or any other form of physical property, and First Bank Notes?

First Bank Notes are an intangible asset. Sure, technically the paper and ink that First Bank Notes are made from can be considered a real asset, but we don’t assign a value to a First Bank Note according to its paper and ink. Instead, we assign its value based upon the words written on it, which means we’re valuing First Bank Notes according to their intangible value as a unit of money. The thing about intangible assets is we can have as much of them as we want. Nothing stops First Bank from printing a note that says, “This note represents a bazillion First Bank Notes.” Easy–we instantly have a bazillion First Bank Notes. Doing this in a computer by simply changing the value in the government’s bank account would be even easier.

When Avaria first allowed banks to use First Bank Notes as reserves, that was still indirectly based on the foundation of real assets because the gold in the First Bank vaults was limiting the amount of new money that could be created. But then, when the backing to gold was broken (i.e., when they went completely off the gold standard, which happened in the U.S. in 1971) and Avaria’s money truly became a 0% backed fiat currency, the cap that gold placed on how much money could be made was removed.

So my point is this: When you start using intangible assets as reserves, there is no longer a cap on how much reserves you can create.

Think about it this way. There are two things that form a hard limit on the amount of money you can create when you are only using real assets as reserves: (1) the value of the real assets you have and (2) the reserve ratio you can get away with before you start triggering bank failures, especially from bank runs, and risk collapsing the currency.

But everything changes when you switch to using intangible assets, such as First Bank Notes, because you now have an unlimited value of reserves.

That doesn’t mean the central bank can just print an infinite amount of money without consequence. Induce too much inflation in a short period of time and the monetary system will collapse when people discover that the money they have been using isn’t holding its value, and then people revert back to barter and using real assets as money. But as long as the central bank keeps inflation to a reasonable level, the central bank can continue printing new money for the government to spend, forever. The government can keep taking small chunks of our cash wealth every year (without our consent) in perpetuity. This removes a lot of the sorely needed accountability on government spending.

What is a reasonable level of inflation? It’s the highest amount of inflation you think you can get away with inducing year after year in perpetuity without triggering a loss of public confidence in the monetary system.

So when you hear that the Federal Reserve targets an average annual inflation rate of 2%, I suspect that’s where that number comes from, although they’ll be quick to tell you that it’s actually the number they think will strike the right balance of stable prices and maximum employment.

But wait, there’s more. There’s another intangible asset that is often used as reserves these days: government debt. If you own debt, you own an intangible asset. And an infinite amount of government debt can be created with a 0% backed fiat currency.

For example, consider the case of a commercial bank buying a government bond. Remember that when anyone issues a bond, it’s basically a request for a loan from whoever will buy it. So the person who bought the bond now owns debt, which entitles them to annual interest payments and receiving their principal back when the bond expires. If a commercial bank finds itself with some excess reserves and wants to push their reserve ratio back down to the minimum required reserve ratio (still set at 0.2), it could make a loan to the government by purchasing a government bond, which usually would just entitle the bank to the interest every year and the principal back when the bond expires. But when government debt is allowed to be used as reserves, this means that the government bond now counts as reserves as well, which allows the bank to lend out an additional 5,000 First Bank Notes just (according to the money multiplier of 5) by owning that bond! So the bank gets the interest from the bond and it gets interest from 5 times the bond’s value in additional loans that it can make.

Wait, what? The bank, simply by loaning money to the government, gets interest on the loan and gets 5,000 more First Bank Notes to lend out?

Yes. And it creates an infinite appetite on the part of banks to buy government bonds.

Who would make such a policy? The answer is . . . (1) any government that is desperate to increase non-central bank buyers of its bonds (probably for PR reasons) or (2) any government that is strongly influenced by commercial banks. I guess a third possible option is that the banking system just got too confusing for all of the lawmakers to fully understand and they were hoodwinked by the bankers into adding such a policy to some giant and confusing piece of legislation. But I’m not sure a claim of ignorance is an adequate excuse.

This shouldn’t be too surprising. The owners of banks (i.e., bankers) are some of the wealthiest members of society. And that means bankers have lots of money to use to influence politics–through campaign contributions, lobbying, and even through threats of doing financial harm to the nation (which no politician wants to happen during their tenure because of how it will reflect on them). So of course governments make policies like this!

Therefore, allowing intangible assets–such as the fiat money itself and also government debt–to be used as reserves is great for banks and spendthrift governments, but it’s terrible for citizens, who are ultimately the source of all the wealth that is being taken.

Let’s end this post by looking at the implications of this on government finances.

Previously, President was stuck only getting money in two ways: taxes and borrowing. He didn’t like increasing taxes because it made him unpopular, and he didn’t like borrowing money either because ultimately he would have to increase taxes or cut spending to pay back the loans plus interest. So he invested in a bank, which has been generating some income for him. That helped a little bit, and then he finally gained the ultimate unlimited source of money when his bank turned into a central bank. Now, any time the government needs to borrow money, it can put some bonds on the market and be assured that they will be bought. And it can keep reissuing bonds to replace expiring ones as long as it wants until it’s ready to pay back the money.

This means there are four different ways for a government to earn money:

1. Taxation
2. Borrowing (i.e., future taxation)
3. Printing money (i.e., taxation through inflation)
4. Owning a profitable investment

I believe taxation is necessary for a government to function. Borrowing should not be necessary except in extreme and rare cases (most of which would be absent if the banking system would stop tampering with the value of money). Printing money has many issues, which I’ll summarize in the next paragraph. And owning a profitable investment could be acceptable, although if it’s an investment that the government is running, then I have serious concerns about its lack of being subject to market forces and, therefore, about the value it’s delivering to customers.

Here are my problems with inflation, in addition to the wealth-destroying and wealth-transferring effects it causes by inducing booms and busts, which I covered thoroughly earlier in this series:

Problem #1: People whose cash wealth is being taken from them through inflation usually don’t even know why it’s happening, so that’s why inflation is sometimes called “the hidden tax of inflation.” This means that the government isn’t being held accountable to the people for the money that it’s taking from them.

Problem #2: Since people with less wealth generally have a higher percentage of their wealth stored in the form of cash assets (e.g., they lack large investment accounts, don’t own their homes, etc.), that means that inflation hurts the poor even more than the rich from a percentage-of-wealth-taxed standpoint. For example, if I am poor and 30% of my wealth is stored in cash sitting in my bank account, and inflation is 100% one year, I lost 15% of my wealth. If my rich neighbour only has 1% of his wealth stored in cash (and the rest is in non-cash assets like a large investment portfolio, the value of which rises with inflation), then he only lost 0.5% of his wealth. So inflation isn’t just a hidden tax–it’s a regressive hidden tax.

Problem #3: When a government subsidizes its spending through indirect taxes–especially the most hidden one of inflation–citizens are blind to the full extent that taxation is costing them, which also skews their opinions about how much the government should do. For example, if citizens hear that their country’s entry into an ongoing foreign war will cost each family about $20,000/year in additional taxes, they may still support that policy. But if they hear that this war will cost them $20,000/year in additional taxes PLUS another $20,000/year through the hidden tax of inflation, suddenly many of them will be much more critical of the decision to enter that war because they will be questioning whether it’s really worth $40,000/year to them. I suspect we end up supporting many government policies out of sheer ignorance of their full cost.

Sooo, how do you feel about the government having a 0% backed fiat currency now that we’ve reviewed how it enriches government and banks at the cost of us, and how we can’t do anything about it, and how terrible permanent inflation is?

I hope this post has helped piece together many of principles we’ve discussed up to this point so that it can drive home just how much governments with their central banks and 0% backed fiat currencies are screwing us over. People back in the early 1900s knew some of this, and it’s probably why the Federal Reserve Act of 1913 didn’t say anything about a “central bank” in it, even though that’s exactly what the Federal Reserve is. Worse, the Federal Reserve is not owned by the government, so all that interest the government is paying to the Federal Reserve isn’t even flowing back to the government. Instead, it’s just enriching bankers.

It took us 33 posts to get here, so don’t be surprised if nobody you talk to has even an inkling of how bad modern monetary systems are, even though 0% backed fiat currencies are probably the biggest wealth-destroying and wealth-redistributing (to bankers and government) scam that has ever been orchestrated. Part 34 here.