In Part 38, we discussed how bad central bank digital currencies could be, and then we talked about the potential for cryptocurrencies to come into common use through market mechanisms.
I did my homework and, as I promised at the end of Part 38, read through my notes to see if any additional cleanup of scattered topics is necessary before moving on to discussing different ways to fix our monetary system.
One claim I hear people sometimes make and that is worth addressing is this: “All of our money is created through government debt, so if our government pays off its entire debt, then all of our money would disappear.” When smart and knowledgeable people make this claim, it feels pretty persuasive. But are they right? Will the federal government getting out of debt make all of our money disappear? This has important implications on whether it would even be fiscally safe for the government to pay off its debt!
To answer that question, let’s very briefly trace the origins of all the money we have.
First, people were using various commodities to facilitate trade. Ultimately, they landed on using gold because it was the most convenient commodity (again, check out Part 9 for details on the optimal form of money). Eventually, gold was being stamped into coins that were a standardized weight and were difficult to counterfeit. As individuals got wealthier, they were able to store any newly acquired wealth by buying more gold and having it stamped into coins. Let’s say there were a total of 5,000 gold coins at this time. And even when people started using receipt money instead of the coins themselves, the receipt money was 100% backed by gold coins, so the only difference was one of convenience by switching to receipt money. At this time, if all of the gold coins were in the bank vault, then there would be 5,000 Goldnotes in circulation.
Then along came fractional reserve money, which, if the reserve ratio went down to 0.2, caused the amount of money to expand 5x, so then there were 25,000 Goldnotes circulating. But still there were only 5,000 actual gold coins in the bank vault.
Then, skipping a few steps that aren’t relevant to this example, the government decided to centralize the money into First Bank Notes, so now we have 25,000 First Bank Notes instead of Goldnotes. And, not long after, the government liberated all that money from its gold backing, which then allowed it to take the 5,000 gold coins and give it to foreign companies as compensation for war supplies.
Next, with the newfound freedom to print as many First Bank Notes as it wants, the government started printing more and more First Bank Notes using that accounting trick where an equal amount of government debt is created at the same time. Let’s say it printed 75,000 new First Bank Notes, so now there are a total of 100,000 First Bank Notes, and the government debt is worth 75,000 First Bank Notes.
We could now divide all of the country’s money into three categories according to how they were originally created: the commodity-created money (5,000 First Bank Notes), the fractional reserve-created money (20,000 First Bank Notes), and the fiat-created money (75,000 First Bank Notes).
So, if the government suddenly pays off all its debt, would all of the money disappear? Of course not. Only the fiat-created money would disappear.
The only way all of the money would disappear is if there was no commodity-created money or fractional reserve-created money in the society prior to the government starting to add fiat-created money to the money supply. But since no society ever jumps from no money (i.e., the barter system) straight to fiat money, that would never happen.
In the United States, we have a ton of fiat-created money, especially relative to the commodity-created money and fractional reserve-created money. But, regardless of how much more fiat-created money we have than the other two types, there will still be money if the U.S. federal government pays off all of its debt. True, not very much money would be left, but there’s no such thing as not having enough money for a society to function, as I explained in Part 5. The only challenge would be that the Wealth Unit:money exchange rate would change drastically, and that would make prices unreliable and hard to interpret until everything settles.
Obviously the pricing uncertainty would, in the short term at least, be a huge downside to the government paying off its debt (specifically, the debt owned by the Federal Reserve). But would there be a benefit to it as well?
Of course. I don’t like this intergenerational pyramid scheme the government is running, and I know my posterity will like it even less than me. I call it a pyramid scheme because government debt is future taxation (plus interest). So future generations are going to pay heavily for the deficit spending that the government is doing now. And the other benefit to paying off this debt is that it will free up a huge chunk of the government’s budget again so it doesn’t have to send 19+% of its revenue every year to creditors, most of whom are foreign.
To summarize: Yes, let’s pay off the entire U.S. federal debt!
Part 40 here.
Clear Thinking on Healthcare 