When I was a child, I always found it fascinating to watch the cartoon where the cartoon character would be riding a horse while holding a stick with a carrot on the end. The horse would see that carrot and instinctively move toward it. But every time the horse moved, so did the carrot! The most important thing to that horse was the carrot right in front of him, so much so that he didn't even notice the person riding on him.
I was amazed to find out that our country is very similar to that horse. Whether Democrat, Republican, or Independent, all instinctively would agree that we need to balance the budget and pay down the debt. However, every time our country has run a surplus and began to pay down the debt, a recession was sure to follow and we were unable to continue paying it down..
So where is the problem? Why can't we just pay down the federal debt and have no drastic consequences like when your family pays down your personal debts?
First, we will need to understand a little about how money comes into existence.
Every dollar note comes into existence through one of the twelve Federal Reserve Banks loaning out money at a particular rate. Only those notes can be used to pay off the debt with a particular Federal Reserve Bank. So essentially this “money” is created out of thin air, and then loaned out into society.
Then that “money” is further expanded in private banks through a practice called “fractional reserve banking”. According to the New York Federal Reserve Bank,
“If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+…=$1,000).”
According to private sector calculations(since M3 is no longer released by the Federal Reserve) there is estimated to be 14.6 trillion dollars(electronic and dollar bills) in circulation today(a significant amount of that is being held by foreign countries so in reality, there is even less being circulated in the U.S. economy).
Every time the money supply increases, it pushes prices up. Let's say you grow corn. If you produce 100,000 bushels a year at $2.12 per bushel, you make $212,000 in gross sales in which you then deduct costs to determine your income. However, there is a limited amount of corn you produce. You cannot just decide one year that you will produce 200,000 bushels with the same amount of land and labor put into it. So each bushel has a real value as land is limited and your labor and time is limited. So if the government borrows one trillion dollars from the Federal Reserve and they then spend 100 billion on corn, there is now less corn that year and the usual purchasers, such as cereal factories, etc, now have to pay a higher amount to buy the same amount of corn as they would have before since the supply has been decreased. So the price rises and we see inflation. Then as the private banks expand that one trillion dollars to ten trillion dollars, the price of corn and other commodities will continue to rise(or one could say that the value of the dollar has declined).
So if the money supply is expanded through debt creation, which results in inflation, then when you try to pay off debt, the money supply will in return contract, which will result in deflation. So when any significant amount of debt is paid off that is more then being created at a given time, this will cause there to be up to ten times less the amount of money that is paid off. So if the United States Government paid down all of it's debt today, which is 9.3 trillion, this would cause the money supply to contract by upwards of 93 trillion dollars. That would mean a 64% decrease in the money supply. So the price of everything would then need to decrease to 1/3rd their current value(payroll included). During that adjusting period, very few things would be exchanged back and forth which would translate into many people losing their jobs and taking very large pay cuts and also not being able to purchase the basic amenities as they are priced 64% too high. People would feel like they just don't have enough money. Companies wouldn't have enough money to pay their employees and many jobs that are currently paid below 17$/hour would need to be adjusted below the minimum wage rate.
This would translate into a recession the equivalent of the Great Depression. Likewise any amount of paying down the federal debt will cause this deflation to occur proportional to the amount being paid off.
So what is the solution? Unfortunately there is no easy answer. One proposal has been that of allowing the private sector to produce competing currencies. This way if the U.S. dollar spins into an inflation free-fall, Americans have an alternative they can fall back on.
For instance, suppose I owned a business. There is a very attractive private currency called the “Liberty Dollar”. This is a currency backed 100% by silver. So I could set my prices to also accept “Liberty Dollars”. Then if the U.S. dollar inflates or deflates, depending on the Federal Reserve policies, my customers would still have a currency that they could pay with. I would still have a currency I could pay my workers with. I would still have a currency that I could purchase my products with. I could set my prices once and never need to worry about needing to raise them. As I find more efficient ways to produce and deliver my product over time, I would then be able to continually decrease my prices. Likewise, as my employees become more productive, I can measurably determine what increase in pay that they are worth. Productive exchanges would still thrive even though the U.S. Dollar is in no way included in these exchanges. Now if a whole community was completely on a silver or gold or commodity backed currency, then the Federal Reserve's decisions, whether ill or good, would have little bearing on that community.Tweet