Why We Cannot Pay Off The National Debt

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.


Comments

  1. says

    You’re a bunch of dweebs.  The federal reserve is a private cartel of bankers.  Their money is not real because it is printed from nothing and creates nothing except debt.  More money more debt more slavery.  The debt is not real…this follows.  End the criminal fed print true government notes and you will end debt, period.

    • Stanley Mulaik says

      As I’ve shown it does not create debt. That it does is a myth held-over from the time the dollar was backed by gold. It no longer applies.

  2. lechatelierite says

    Silver isn’t real either. What’s the intrinsic price of silver? Nothing, it’s only what people are willing to pay for it. Same as fiat money.

  3. Stanley Mulaik says

    Many treatments of the national debt fail to take into account that the United States has a fiat money system. Our fiat money is money created out of thin air (or just “created”) and backed by nothing but full faith and credit of the United States.
    The Federal Reserve Bank (the Fed) is an agency of government that serves as the nation’s central bank. It has powers to create money out of thin air delegated to it by Congress, which derives this power from the Constitution as the power to “coin money and regulate the value thereof”. Subsequent Supreme Court decisions have determined that “coin” means broadly to “create” money.
    Now when the Congress deficit spends, the Treasury issues Treasury securities to cover the deficit. These are IOU’s to pay the bearer a certain number of dollars plus interest. For deficits these are lots of dollars. They are sold at public auction to banks. Treasury gets its money from the banks. The banks get the securities. At this point the government has a debt to the banks. But before the government pays back the debt, the Fed purchases the securities from the banks. It pays for these with fiat money it makes out of thin air. The fact that the Fed is an agency of government and creates the money for this purchase out of thin air (Congressional power) means it redeems the debt for the government in the securities. There is no debt. The Treasury’s money from the banks has been turned into debt-free money by the Fed’s debt-free money.
    This analysis suggests that the usual practice of rolling over the debt is not necessary but illegal. Once acquired by the Fed, the debt obligation of the Treasury’s security is redeemed automatically and implicitly. There is no need to continue the debt after acquisition. There can be no payment or replacement of securities, because these are not authorized by the original debt which has been redeemed. The Fed gets 6% of the interest on the security as a transaction fee to help pay for the Fed’s banking operations. The continued payment of this interest year after year for a given security may be illegal too. The Fed gets its 6% of the interest each time. But once a security’s debt obligation has been redeemed, and the transaction fee paid, there is nothing more to collect on it.
    There being no debt now at the Fed means debt ceilings are meaningless. The Treasury can also use the same debt-free procedure to redeem the securities left at the Soc. Security Trust Fund by Congress. Treasury issues securities to buy back the securities at the SSTF. Banks buy them at public auction. Treasury gets money for buy-back and banks get securities. Fed then comes and buys the securities from the banks, using money created out of thin air, redeeming the debt. Treasury goes to SSTF and acquires the securities and in return replaces them with Federal Reserve Dollars it got from the banks. This should not be inflationary since dollars will only be drawn out in relatively small amounts to supplement FICA tax revenues to pay benefits. And some of this in the distant future.

  4. Stanley Mulaik says

    The article is correct in asserting that if we attempted to pay off the debt with taxpayer money, or money already in existence, this would take a large segment of the money supply out of circulation causing not just a recession but a severe depression. But there is no need to do this because since 1971, at least, the Fed has been redeeming the debt of Treasury bonds by purchasing them, and it does this with debt free dollars.

  5. merkin says

    The main article is close but still slightly confused.

    The main creator of money in the economy are the banks. They create money any time that they make a loan. Fractional reserve banking presented here is a wonderful theory but it is not what happens in practice. Banks make loans and in turn make money whenever they can, subject to their underwriting standards. If they don’t have the deposits needed to cover the amount of the loan they are allowed to borrow the money needed to cover the loan they have made. If required the Fed will loan the bank the money at the discount window using money it creates out of thin air. This means that the day to day money creation is a function of the demand for loans in the economy, not a function of the reserve ratio set by the Fed. In fact for most of the loans that a bank makes there has been no reserve requirement for a decade or so. The only control that the Fed has over this process is by trying to maintain a target interest rate to try to control inflation.

    If you think about it this more desirable than the Fed or anyone else deciding how much money the economy needs. The economy creates the amount of money that it needs. But this money is destroyed when the loans are paid off. Paying off debt destroys money. This leads to a big problem when you have a recession and an even bigger problem when you have a recession caused by a financial crisis that calls the banks underwriting standards into question like the Great Recession of 2008. Then you suffer a double shock. People stop borrowing money and start to pay down their existing debt in a recession. This destroys money in the economy and always happens in a recession. It makes the recession worse and is called debt deflation. But in a recession triggered by a financial crisis the banks stop loaning money to people who still want to borrow making matters even worse. Not only are there very few new loans being made the existing debt is not rolled over, existing loans are not renewed under the stricter underwriting standards. This results in defaults on loans and the deflation spiraling out of control.

  6. merkin says

    Inflation is not caused any time that the Fed creates money. Inflation is caused when there is too much money money chasing too few products or services. Widespread inflation can only happen when the economy is running close to capacity. (You can have prices climb for isolated products or services if they become more in demand than can be supplied. This means that you can have inflation in certain things even while you have deflation overall in the economy.) If this widespread inflation happens the Fed must step in to try to control it by reducing the money supply. Its big weapon in this is control of the interest rate. Raising the interest rates reduces the demand for loans and the creation of money. The Fed can also sell bonds to dry up money. But this is less effective for many different reasons I won’t go into.

    Interest rates are something of a crude way to try to control inflation. They do it by acting on a few interest rate sensitive industries like construction, automobile manufacturing and white goods, large appliances, for example. A far better and more even way to control inflation would be with an inflation tax that would go up or down depending on the rate of inflation. It would have to be a simple payroll tax with monthly withholding. The withholding amount would go up and down depending on the amount of inflation in the economy. The tax would take a small amount of money from everyone to fight inflation rather than as it is now, throwing a few people out of work.

  7. says

    You may be interested to know that the combined amount of public and private sector debt in the USA is now $37 trillon, a number that is 3.55 times the entire money supply as defined by M2, namley, $10.4 trillion. It follows that there is a a huge gap of some $26.5 trillion dollars. Without that money, it really is impossible to ever get out of debt. The only real solution would be for the US Treasury to create $26.5 trillion in debt free money and allow the government to spend it into the system. That’s $84,000 for every man, woman and child in the USA.

    At the same time, it would have to remove the ability of commercial banks to create any more interest bearing loans.

    It’s a workable solution. But don’t expect Wall Street and the Federal Reserve to roll over. Citizens will have to march for it…

Leave a Reply

Your email address will not be published. Required fields are marked *