Aug 23, 2019
Re-thinking the Economy’s ‘Fuel System’ to Avert the Collapse of Civilization
“Money makes the world go ‘round.” That is a once-common line that I haven’t heard in a long time. Money definitely makes the economy “go ‘round.”
Money is the fuel of the economy. Without it, the economy will not function. (Even in a barter economy each participant in a trade is in effect producing one’s own money, trade by trade.) So the monetary system can be thought of as an economy’s fuel system.
Today, every nation has money that is its ‘legal tender’. That means only it can be used to pay taxes and only it can be required by banks for repayment of loans. [Nations in the EU have decided to have a legal tender, the Euro, common to all member nations.]
The most important feature of the monetary system is how money originates/enters the economy. That is the functional basis of the whole economy.
In other words, the most important question concerning the economy is, where does money come from? Today, it comes from debt.
Every nation’s monetary system is debt-based. That means that every country’s economy is functionally debt-based.
Time for an upgrade?
The history of the contemporary, debt-based monetary system goes back to 1668, when Sweden created the first Modern central bank. Before the central-bank monetary system was invented coinage was a prerogative of monarchs. That system is the bulwark of the Modern economy.
The central-bank monetary system has of course evolved over its history, but the basic structure was there at the beginning. It makes the central government and the central bank the institutional pillars of the nation. The Modern nation-state rests upon them and their interrelationship.
Capitalism did not begin to develop before the central-bank monetary system was invented. It developed in nations with that system in place.
So capitalism is embedded in the Modern economy. It has no existence independent of the central-bank monetary system that is the bulwark of the Modern economy. That system is more economically important than capitalism is. Capitalism is dependent on that system and subordinate to it. The central-bank monetary system can exist — did exist — without capitalism; the reverse is not true.
For present purposes, then, capitalism, as such, is irrelevant. That is to say, the monetary system is of such overweening importance to society that its structure and functioning must be analysed and proposals for its improvement must be evaluated without regard for possible effects on capitalism, as a particular paradigm for supplying goods and services within the economy that is defined by the monetary system.
It is a fact that, after the Civil War, when capitalism triumphed in this nation, the U.S. had no central bank. Even though that institution’s functions were being carried out via other means, one can understand how capitalists and their ‘running dogs’ feel like capitalism exceeds the monetary system in economic importance in this nation.
It does not. It is those functions, above all (but not limited to) the function of supplying legal tender for the economy, on which capitalism is dependent, which make its existence possible.
In 1913, with a single Act of Congress, we established our current central bank (the third one in our nation’s history), the Federal Reserve System (the ‘Fed’), (re)consolidating those functions in one institution. Even that was done more than one — hugely eventful — century ago.
Might it be time for a monetary upgrade?
Avoiding the cataclysm to which the debt-based economy is bringing us
At the end of this essay I’ll present a way to change from the debt-based monetary system/economy to an income-based monetary system/economy. In the U.S. we could make that transition with a single Act of Congress. It would not require tearing down any of the existing institutional structure. Even the central bank would still exist.
[For the record, I do have an M.A. in economics; I have been developing this idea, working out the details and addressing the various issues such a big, new idea necessarily entails, over a considerable period of time.]
The U.S., as the world’s most important economy, should lead the way in establishing an income-based economy. If we do not, sooner or later our economy will completely collapse (if collapse hadn’t already been initiated from some other source) and take the entire global economy down with it.
This time, complete economic collapse will be the end of civilization as we know it (as the rule of law). The other time the Modern economy collapsed completely, which is called the “Great Depression,” government was available to act as a life-support system for the economy. Now government is already fully involved in supporting the economy — with the central bank fully involved in supporting government. So there is no institution available to come to the rescue.
That means the collapse of the economy will mean the collapse of the nation-state system — i.e., civilization as we know it. Most likely (if a nuclear war did not result), following a period of unprecedented suffering the world would be divided among local warlords, with almost all survivors as their slaves. The rule of law would be replaced with rule by individuals’ whims. [Silver lining (if nuclear annihilation were avoided): that would mean an abrupt end to too much human activity producing greenhouse gases, thus putting the brakes on global warming.]
Making income the functional basis of the economy would make the Modern economy stable and self-regulating. It would provide the means to eliminate unemployment (at no cost to anyone) and poverty (without having to redistribute anything) for all citizens, whatever the GDP, the total output of goods and services, might be. The process could be used to fund government (all government, forever, at the current per capita rate of total government spending), eliminating the need for any taxes/public debt at all levels of government. Sustainability would be increased (even without any other measures).
Those outcomes are not hopes, or dreams, or visions, or suppositions, or even probabilities; they are absolutely, positively guaranteed. Moreover, none of that would require anyone to change any of one’s behavior one bit. Rather, those outcomes are built into the structure of the income-based monetary system (which I happened to stumble upon wondering how a really just economy might be possible — but this is a strictly economic proposal, with no reference to justice). This monetary paradigm could be adopted by any nation or group of nations (without compromising national sovereignty).
As much as I hate it, capitalism would also still exist. This change to the monetary system would not require any changes to the current paradigm for supplying goods and services within the economy. Still, having civilization (as the rule of law) with capitalism is better than not having civilization would be.
Where money comes from in the debt-based economy
In the debt-based economy money is created by debt in two different ways. One occurs when banks lend. The other occurs when the central government borrows money.
When banks lend they do not actually hand over money. They keep their money in their vaults. In ‘lending’ banks actually ‘extend credit’. That credit is used to make a purchase. The credit is thereby transferred from the debtor to the seller. The seller can then use that credit to make purchases, and those sellers can use it to make purchases, ad infinitum.
[A long time ago lending was done with actual pieces of paper, ‘bank notes’. The borrower presented the note to the seller. The seller could take that note to the bank to get the money it promised (redeem it). Alternatively, the note could be used by the seller to make a purchase, just like actual currency, and that seller could choose to redeem it or to make a purchase with it, ad infinitum. Banks could also sell their own ‘notes’, a promissory note that the bank would give a specified amount of (usually) gold to whoever presented the note to the bank. So back then banks had — or claimed to have — (usually) gold in their vaults (as well as money). [The notes were sold at a discount to agents who would resell them for the bank; the agent could sell a note at a price that would represent a profit for both him and the person who bought it and took it to the bank for redemption.] The idea, for the banks, was for those notes to get used as currency; even honest bankers were banking on some notes never being redeemed, but circulating forever — or being permanently lost or destroyed. Notice that a piece of paper currency in the U.S. today is designated as a “Federal Reserve Note,” the Federal Reserve System’s Notes being our legal tender. There was a time when Federal Reserve currency was in the form of “Certificates” that could be exchanged at a bank for gold or silver, but those days are long gone (though I am old enough to have received and spent old paper currency with “Silver Certificate” written on it, not “Federal Reserve Note”). Now its Notes can only be exchanged at a bank for other Federal Reserve Notes.]
So, when banks extend credit they create something that can be used indefinitely for making purchases. That is one of the three standard functions of money. In the lending process that extension of credit takes on another function of money: being used as a unit of account. When that credit changes hands it gets counted as income that can be retained rather than spent, thus taking on the third function of money: it can be used as a store of value. So when banks lend they are effectively creating money, though they are not producing actual money.
Debt is also used to produce actual money. That occurs when the central government borrows money. It does that by selling promissory notes, promising to pay back the amount loaned to it plus some specified amount of interest. (Notice the slight changes from the way banks used to do their notes.) The central bank handles that for the central government. The central bank is required by law to be the ‘lender of last resort’ — to see to it that every promissory note of the central government is purchased. In the process the central bank has the authority to direct the treasury of the central government to create actual money to be handed to the central bank for it to purchase some of those promissory notes. [Assets are transferred to ‘balance the books’, but since those assets can be the government’s own promissory notes, and can at all events be used by the treasury to conduct other transactions, that transfer of assets is effectively nothing more than an accounting fig leaf.] How much, if any, actual money the central bank chooses to have created depends on many factors, but the decision is its and its alone. (Those transactions have never involved physical currency getting hauled back and forth — what used to be done ‘on paper’ is now done through digits on computers — but actual money is created nonetheless.)
With debt as the basis of the economy it was perhaps inevitable that our economy would end up where it is today. Where is that?
The mess we have gotten ourselves into, and how
As can be seen in any graph comparing debt and GDP from, say, 1929 to the present (such as this one), the U.S. underwent a dramatic change in 1980. We went from ‘tax-and-spend’ to ‘borrow-and-spend’. The institutional structure of the system did not change, but that change in flows of money that started with the central government has engulfed businesses, households, and individuals. We have now had ample time to see what that change has meant for the economy as a whole.
For one thing, we can see that debt has grown way, way faster than the GDP has. That graph shows a gap between the GDP and total debt that is growing like the distance between the ground and a fighter jet upon takeoff. Changing from tax-and-spend to borrow-and-spend was like hitting the afterburners.
We have seen through experience that debt makes the economy more precarious. Notice I did not use the word “unstable.” Instability refers to the ‘natural’ ups and downs, expansions and contractions (recessions) that have always been a part of the Modern economy. (That used to be routinely referred to as ‘the business cycle’, but for whatever reason that is a term one seldom encounters these days.)
“Stability” can be thought of as the length of expansions, the periods of time between recessions. Debt can actually make the economy more ‘stable’ by making those periods longer. We are currently experiencing the longest economic expansion in our history in the U.S.
Why would debt make periods of economic expansions longer?
We must first note that when we say “longer” we are making comparison between 1980 to the present, the era of borrow-and-spend, and the time between WWII and 1980, the era of ‘tax-and-spend’. The economy before that was a different animal — one that perished with the Great Depression. WWII ended the Depression and facilitated a transition to what has been, functionally, a different economy than the one that existed when the Depression occurred (though not structurally different: the central-bank, debt-based monetary system has been in place, recall, since we re-instituted a central bank in 1913).
Taxing and spending by the central government can be used to ‘manage’ the economy, i.e. support expansions and end — perhaps even avoid — recessions. To end/avoid a recession requires ‘stimulus’. Such “stimulus” has always meant ‘deficit spending’.
That is, the central government has borrowed the money to increase its spending. It could raise taxes to get the money to spend, but of course the idea of raising taxes will always be opposed by some ‘on principle’. Most importantly in economic terms, though, raising taxes would be anti-stimulating because it would take money from people and businesses that could have been spent on goods and services and plant and equipment — the stuff of the GDP, the very thing stimulus is supposed to be increasing.
So even in the tax-and-spend regime government used borrowing to stimulate the economy. In that mode of economic management, though, the idea is that the increase in debt is temporary and will be repaid by higher tax revenues (without higher tax rates) when the economy expands, which increases total income and therefore total taxes collected.
That did not exactly happen. The debt of the central government increased rather steadily up to 1980. (Right after WWII ended it did decrease for a few years because we were no longer funding a World War.) It went from a post-war low of $252 billion in 1948 to $908 billion in 1980 [numbers from here].
We should also note, however, that the central government’s total debt went from being 92% as large as the output of the entire economy to 32% of the GDP over that period [same source]. So the ratio of the debt of the national government to national income, which is one measure of solvency, improved dramatically under the tax-and spend regime.
At any rate, once stimulus makes the economy start to expand, inflation becomes a potential problem. To keep inflation in check using the central government to manage the economy has meant raising taxes — again, something many people always oppose ‘on principle’.
By the middle of the 1970’s the idea of raising taxes for any reason had become all but politically impossible. That is when the phrase ‘tax-and-spend Democrats’ was invented. As a result, even though inflation was rapidly increasing, no meaningful action was taken to dampen it. By the end of the 1970’s it got really bad. (Major inflation was one reason the nominal ratio of debt to income got as small as it did as of 1980, but that ratio was pretty steadily decreasing over that whole period of time.)
[The Democratic Party had control of Congress from the middle of the 1950’s to 1980 — and beyond (for another 1½ decades). In the ‘70’s there were still lots of ‘conservatives’ in the Democratic Party who opposed raising taxes ‘on principle’. (Many of them also opposed the desegregation of society ‘on principle’, which is why they left the Democratic Party, the Party that stood for integration, for the Republican Party, which had invited them in — President Nixon’s (R) “southern strategy.” That is all historical fact, not opinion; it explains why ‘tax-and-spend Democrats’, who held the presidency and both houses of the Congress in the second half of the 1970’s, did not raise taxes even though inflation was getting almost completely out of hand.)]
It must be noted that unemployment was also high in the second half of the 1970's, which militated against raising taxes, but inflation was becoming an existential threat. In 1979 President Carter (D) nominated Paul Volcker to be the Chairman of the Board of Governors of the Federal Reserve System with the understanding that he would raise interest rates to stop inflation by inducing a recession. He was approved by the Senate and he did raise interest rates very sharply in 1980.
A very steep but very brief recession ensued; the Carter/Volcker plan of action succeeded — to the benefit of President Reagan (R), elected in 1980. That, however, represented the beginning of the borrow-and-spend regime.
The borrow-and-spend regime uses debt to fund increases in spending by the central government as a routine matter. It even uses new debt to pay off old debts that come due. As of 2018, the debt of the national government of this country was 105% of GDP [same source] (so 92% to 32% to 105%). (Note also that, just as unusually high inflation made the ratio look better than it really was, lower inflation means it is relatively even worse than it appears.)
In the borrow-and-spend regime it has become the responsibility of the Fed to ‘manage’ the economy. It does that primarily by adjusting interest rates. Lower interest rates stimulate the economy by encouraging borrowing for spending and investing (as well as speculating), and also mean cheaper costs of borrowing for the national government. Higher interest rates have the opposite effect.
So the Fed has sought to keep rates as low as possible, which has encouraged borrowing. With incomes for most individuals and households being stagnant since 1980, even moderate rates of inflation have meant that they have had to increase their borrowing to maintain a middle class lifestyle. Businesses, especially large ones, have taken advantage of low rates to borrow rather than spend cash on hand.
The traditional form of stimulus, purposeful deficit spending by the central government, is still sometimes used, though it now adds but a tiny fraction each time to the total debt of the central government. Tax cuts have also been used to stimulate the economy, with the resultant drop in tax revenue covered by yet more borrowing.
As we’ve seen, in the tax-and-spend regime stimulus tended to lead to inflation. Measures taken to stop inflation (when they were used) invariably contributed a recession. In the borrow-and-spend regime inflation has not been such a problem. For that reason, the Fed as manager of the economy has been able to allow expansions to continue for longer periods of time.
One reason for less inflation is that when households and individuals are repaying loans they have less income available for purchasing goods and services, so there is less demand than there would otherwise be, which dampens prices compared to what they would be. Moreover, because wages and salaries for most positions in the economy have been stagnant during the borrow-and-spend era, while individuals’ and households’ average indebtedness has hugely increased, that debt is being repaid out of effectively the same personal incomes.
For all that, major inflation is actually still with us. In the tax-and spend regime inflation has mostly occurred in assets — real estate, stocks, bonds — the stuff of the wealth of the ‘investor class’. Far from being a problem that should be stamped out, the Fed has seen that kind of inflation as a good thing (despite one Chairman’s famous reference to “irrational exuberance”). The Fed is, after all, the pinnacle of the private banking system, and bankers do love wealth.
To be sure, other things have been going on in the economy, but the big picture is accurately portrayed by the transition from a tax-and-spend regime to a borrow-and-spend regime. Now that regime is teetering.
The inevitable end of the path we are on
Remember “precarious?” We’ve seen that, in the nature of the borrow-and-spend regime, economic expansions have lasted longer. Yet with debt as the source of the economic fuel that allows that to happen, that does create an economy that will suffer much greater damage when the end of an expansion does come. The ‘Great Recession’ of 2008 is an example.
In economic terms debt is ‘leverage’. Physically, a lever is a means of increasing the power of a given amount of force. In the economy debt is used as leverage to increase the immediate purchasing power of a given amount of income. Whether debt is used to purchase food, clothes, cars, houses, stocks, bonds, or anything else, the principle is the same. (It is technically illegal to use debt to buy stocks or bonds, other than buying stocks ‘on margin’, but that bar is easily skirted. I’ve done it myself.)
If a person is physically using a lever to increase the power of whatever amount of force that person is able to generate, the potential for serious injury is compounded, should the lever break. The same is even more certainly true of using leverage in the economy. The more debt an economy has in it, the more damage will occur when the inevitable economic contraction occurs.
With the debt of the national government alone, much less all other debt, now greater than the size of the total income of the entire economy, it is safe to say that the economy of this country is in an extremely precarious state. Modern monetary theory (MMT) maintains that the debt of the national government is all but irrelevant, but that is only because actual money can be created ad infinitum to keep it from defaulting on its debts. Even if such a course did not represent a dangerous economic path in itself, that says nothing about all the other debt that has accumulated in the borrow-and-spend regime.
Of course, there is always ‘quantitative easing’ (QE). With it actual money can be created ad infinitum to keep banks and other ‘significant financial entities’ from going broke.
If, however, with our current monetary system, we got to the point of expressly creating actual money both to fund the central government outright and to keep the ‘significant financial entities’ financially solvent indefinitely, that would truly be the other side of the economic looking glass. Nothing would make economic sense. It would be the end for this economic system. Most likely, hyperinflation such has never been seen would eventually precede total economic disintegration.
I do not mean to suggest that collapse is (necessarily) imminent. The emergence of the use of negative interest rates to spur spending (which negative rates encourage by discouraging saving), which inevitably means more borrowing, and the unlimited capacity to create actual money probably provide the means to stave off economic collapse until some exogenous shock, probably due to war (especially cyber warfare) or global warming, occurs. When the economic collapse comes, however, whether from within or without, it will be the end for civilization as we know it.
An alternative
Why not consider an alternative? Make no mistake, the alternative I am proposing is a new idea. It is similar in some ways to some ideas that have been proposed or implemented, but it is not a variation on any other theme any reader has ever encountered. Given its guaranteed outcomes, it is something we should do regardless of the ultimate fate of the debt-based economy.
In encountering this idea it is of the utmost importance to set aside all ideology. This idea was not formulated with any ideology in mind. It is not intended to please or displease people on either side of the ideological divide. If looked at through the lens of any ideology, it will be totally distorted and impossible to understand.
My idea is to make income, not debt, the basis of the economy. That would be accomplished by instituting an “allotted income.” Links for further reading will be provided for those whose curiosity exceeds their cynicism, but here I’ll give the briefest possible sketch of the basic idea.
· The amount of the allotted income would be based on the current median income — say, in the U.S., $15/hr.; $600/wk.
· The money for that income would be created as needed, so it would be available for an unlimited number of people.
· The allotted income would be paid to eligible citizens: though it would not be paid to all citizens, any citizen could become eligible for it.
· It would thus be an absolutely, positively guaranteed (potential) minimum income available for all (adult) citizens.
The total of that income would form the supply of money for the economy. To prevent inflation money would have to be returned to its point of origin, which could be either the central bank or a newly created Monetary Agency. People and businesses would, however, retain plenty of money (determined by the amount of income) and, unlike taxes, no money would be collected from any person or business before it could be used for purchases, to include investing (and even speculation).
To some readers this idea might look very similar to the situation I described previously as being “on the other side of the economic looking glass.” Here, though, the amount of money being created, though vast, has a definite limit. Also, the allotted income goes directly to individuals, not to government or financial entities. It involves no debt. Finally, there is a mechanism in place for returning money to its point of origin, which our current monetary system does not have.
Those differences make all the difference. The banking system, including the central bank, would still exist. Banks would still extend credit. Debt would not, however, be the sole, or even the major source of fuel for the economy.
Further reading
If interested, a ’5 min read’ summarizing the idea is available here in Medium. It has links to more detailed explications of the paradigm.
A plea
This idea needs advocates.
