UNDERSTANDING MODERN MONEY Michael Merrill The Harry Van Arsdale Jr. Center for Labor Studies
Many of us believe that living-wage job guarantees, publicly-provided benefits and services, and well-funded, stronger enforcement of the laws and regulations already on the books, is pie-in-the-sky. We have been taught to think that such guarantees cost too much money and that we can’t afford them, even if we agree that they would be good things to do if we could. We have been taught wrong. We can afford such programs. And we can afford them without imposing an unfair tax burden on anyone. The reason we can is that a legitimate, well-run government like the United States does not depend on the money it gets from others. On the contrary, it issues the money it needs, as it requires.
Here’s how it works. When the national government wants to pay for something, it does so with a check or money order, a thing of value, drawn on the US Treasury and payable by the Federal Reserve. The recipient of this check, in turn, either cashes or deposits the check at their own financial institution. Where does this money come from? It does not come from taxes. Or at least not in the way we usually think it does. The government has money to spend even before it receives any taxes. It does not spend money that other people make. It spends money that it makes itself—which it can do not just because it wants to, but because of everything else it also does. The government can create money because people want the products and services that governments provide, and they are willing to pay for them.
To help them pay governments have learned to issue currencies, which they promise to accept at tax time as legal tender for the payment of the amount due. This money has value, is worth something, because, like anything of value, it is useful to people. In the first place, citizens can use it to pay their taxes, which the government ensures by declaring its money to be the only form in which taxes can be paid. Second, other citizens also accept the government’s money in payment for goods and services because they too need it to pay taxes, and because other people will accept it in turn, etc. Finally, the government’s money is worth something, even to non-citizens, because they can use it to purchase goods and services from citizens, who will use it, etc., etc. In this way, the money created by the national government can be used to meet each and every one of the government’s obligations, whatever they might be.
It works because we accept the government’s legitimacy and agree to pay taxes to it. And, in return, the government agrees to let us use the money it has issued to us as the means to pay our taxes. The result is a virtuous circle of value given and received. The notion that government makes the money it spends is a bit hard to get one’s head around at first. It seems like magic. How is it possible?
I find the following analogy helpful: think of the United States (or any sovereign country, for that matter) as an elaborate extravaganza—a great big show; and think of each unit of a government’s money as a ticket that can be used to gain admission to the show. Each such ticket, each unit of money, has value, is worth something, because every so often the ticket collector—i.e., the tax man—comes around and collects the number of tickets, in proportion to our position or place, we each must have to remain in the show.
To the extent, then, that the government provides the goods and services everyone needs or desires, and to the extent that everyone agrees to pay their taxes, which they generally do, the government’s money has value. It is worth something because people want a government. It is in demand. And they are willing to pay for it. We need to be very clear about all this because one of the most important implications of the government’s money power is that its budget is not strictly limited to the sum it can raise from taxes or by borrowing.
The government has the power to create money of value whenever it needs to do so. That the government can issue all the money it needs, however, does not mean that there are no limits to the amount it can spend. It cannot, for example, simply give money away for free. If it did, its money would be worthless. Rather the government must use its money to good purpose, or lose the ability to issue it. It has to put on a show that people want to see or be part of. Otherwise they will not want to pay the price of admission.
The same holds for taxes. If the government’s money is going to be worth anything, it must tax its citizens enough to preserve the value of its currency. But it does not need to do so to an amount exactly equal to what it spends. Indeed, if the money it issues has other uses than just to pay taxes—for example, if people use the money provided by the government to conduct their own individual business with one another, as we all certainly do—then the amount of money the government spends MUST BE larger than what it collects in taxes. Nor does it have to borrow whatever it can’t raise in taxes. The government does not need to borrow money. It makes money. The only reason the government borrows is so that it can affect the interest rate.
Depending upon how much it borrows, it can drive the interest rate up or down. It is also very important to note that ONLY the national government has this kind of fiscal flexibility. Only the national government has the sovereign authority to issue currency. State, county and municipal governments must live on their revenue or their borrowing, just like households and businesses must. But just like households, businesses and federal agencies, state, county and municipal governments also can and do receive direct money payments (transfers or entitlements) from the national government. There is nothing but politics preventing the national government from funding the essential services of state and local governments.
The conclusion is clear: there is no fiscal constraint on spending to good purpose for the government as a whole, certainly none that the immediate ability of people to pay taxes imposes. There may not be a free lunch. But there can be a good lunch. We must spend responsibly. But we can spend. In the third and final section, I will explore the implications of this perspective for municipal workers and their unions, and for our understanding of what the government is and does. What can we do, what should we do, to ensure that the general public can learn to see the government as an asset to be treasured rather than as a liability to be shunned.