VDemosthenes Gold Standard question got me thinking. Nixon took us off the gold standard in the middle of the night, at least in part because the Vietnam War was causing America to hemorrhage money, and this policy helped.

Now we are hemorrhaging money, deeply in debt to China and other nations, and we don't have a standard left to take our money off. So...


Questions for debate:


Can we get out from under our foreign debt load?


How will we do it?


What is going to happen if we don't get out from under it? In other words, what will happen if our debt stays at this level or continues to increase?

Ah, ralou, we do have a standard to take our money off of. Our money isn't quite fiat money - it is backed by government paper - promising to pay interest. We'll solve this problem by not backing our money with anything but a promise to accept it as payment for debts TO the United States, namely, taxes.

The United States Constitution
Section 8, clause 5



Currently the Federal Reserve Bank (not a United States Government Institution) creates money, and with it, an associated debt.

Using gold is really just barter with a value dense commodity. When gold coins were given a face value, or even a royal seal, their trading value increases. This difference between face value and production cost is known as seigniorage.

With paper money, seignorage is very near 100%.

Countries have gotten into trouble with using seignorage to raise revenue. As new money is printed, the value of existing money tends to decrease - inflation.

However, if no new money is printed, the value of existing money increases - deflation. If there is not enough money to lubricate transactions, they slow, and the economy falters.

If just the right amount of money is printed, the value of existing money stays the same: overall prices stay the same. This rate has historically been around 3%.

Currently, in addition to new money printed by the Fed (who generally returns the direct profits of seigniorage to the government of the United States), individual banks create check money everytime they take a demand deposit. When I deposit $100 into my checking account, most of it immediately becomes available for a loan. So the next guy gets $90 of my money BUT I still can withdraw $100. So the next guy deposits his $90 into his bank, who then loans out $81....until a total of $1000 are available to various people, $900 of which is collecting interest for the banks, and $100 of which MIGHT be collecting interest for me.

This is all due to the Deposit Creation Multiplier, a component of Fractional-Reserve Banking, where banks are only required to maintain a small fraction of their demand liabilities in cash. This is why we have the FDIC: we cannot all ask for our money at once, because it isn't there.

So, if we outlawed fractional-reserve banking, we'd destroy a huge chunk of money. Currently the money base of the United States is about $780 Billion. Ending fractional reserve banking would remove ~ x9 that, or $7020.

Removing that much money would be severely deflationary, and would probably simply result in a complete economic failure, and people would return to bartering with goods, as there would be too few dollars to effect transactions. However, if we replace the money we destroy with our banking change, the net change is neither deflationary nor inflationary. We replace that money with newly printed United States issued Notes.

So we take that $7 Trillion in new notes and we pay off the outstanding debt: $4.5 Trillion in cash to the public holders of US Gov't Debt, and the remainder in Treasury Deposits for intragovernmental debt.

We then set about printing 3% more money every year, so as to maintain a relatively stable money supply. Three percent of $7.8 Trillion is $224 Billion, which would make up for roughly half of our annual deficit.

I would suggest that while we're cleaning house, we remove, or at least severly hinder, the U.S. Government's ability to borrow money (or print more than the allotted 3%). If we did this, the budgets would tend to be balanced, though they wouldn't be required to be: Treasury holdings could be spent in thin years and stored in thick years.

I got rid of the debt, y'all figure out the deficit. My guess would be to look at the military.

Implicit in this question is that foreign debt is "bad". From how I understand it, foreign debt simply results from other countries investing in our government.


Umm, ask other countries not to invest in the USG?


However, in any situation, having too much debt is unsustainable. Massive debt has the power to destroy any organization rather quickly. Or at a minimum, reduce its credit rating so that only speculators would be willing to invest in it.

BTW, the USD certainly is fiat currency.

http://en.wikipedia.org/wiki/Fiat_currency


http://www.numismedia.com/glossary.htm


http://en.wikipedia.org/wiki/United_States_Notes

I will concede that the US Dollar is debt-backed fiat money. Paper money originated as receipts for stored gold. Goldsmiths quickly figured out that they could issue more receipts than they had gold on hand. This gave us fractional reserve banking. Under the gold standard, issued money could be exchanged for gold, if the paper money suffered too much inflation.

However, backing our money with united states debt is just a convoluted method for transferring money from US taxpayers to holders of US Debt.

A 'pure' fiat money would be simply issued and accepted, with no association with a debt. You could call it credit backed money in that the government would issue it in payment for governement expenses, and the holder would have that much credit with the government. Of coure the recipient of that currency could spend it anywhere it was accepted, and the final holder of that currency could use it to pay taxes.

Okay, I guess I should have phrased the question better!

Economists have been saying our current foreign debt load is unsustainable over time and growing, correct? So that was the debt I spoke of, unsustainable debt.

And when I asked what we can do, since we can't take ourselves off a standard, I assumed that we would not be allowed to perform similar shenanigans with currency, because we owe too many powerful nations who will be powerfully annoyed if suddenly they aren't getting back the money they loaned us valued similarly to the amount it was when they loaned it, plus interest. Not only that, but China, who holds a huge amount of our debt, might prefer we collapse and not pay it, because if we collapse, China gets to move in on more oil reserves. We certainly won't be able to compete for trade!

But this raises new questions, much of which I know little or nothing about. Educate me: Is there a way for the US to sneak out from under its debt by manipulating currency that won't hurt the nations it owes money to?


If so, what way is that?


If not, what can we do to pay off our unsustainable debt?

What I was suggesting was that the debt was paid off with new currency, like paying your car loan early. The inflationary effects of new currency should be counterbalanced by the deflationary effect of increasing reserve requirements. If that's not acceptible to the creditor nations, we could put the currency in the treasury, and continue paying the interest out of that stored currency, while not assuming any new debt.

If we otherwise just increased taxes and reduced spending while using the surplus to pay off debt, we'd wind up with no money whatsoever.

We don't have to do anything to "solve" our debt "problem". Fortunately, the world economy does not pay any attention to our political goals; it just marches on following the dictates of economics. The large amount of debt we are carrying will lead to two results: first, greater ownership of US assets by foreigners, and second, the continuing fall of the value of the dollar. If we do nothing to reverse the trend, eventually foreigners own the entire country. Given the trend towards plutocracy in our government, they would also own the government and could then do anything they want with us.

If we want reverse this trend, then we have to increase our savings rate, which means reversing deficit spending into surplus and paying down the debt. Our current policy is to hit the accelerator as we draw closer to the cliff.

SWM28WDC, your proposal seems to be too good to be true. You seem to be saying that we can solve all our problems by just printing more money. I've always been under the impression that printing more money just inflates the currency.

Now, I realize that your proposal is more subtle than that. You are proposing that we require banks to loan out only as much money as they actually have on deposit. That destroys a good part of the money supply, and you want to make up for that by printing new money. In other words, drastically alter M1 and M2, but keep M5 constant (or whatever the damn numbers are -- I can never keep them straight).

This scheme confuses me. Exactly who gets the money we print? Banks retire loans but then can't make new ones for a while; are you saying that the Fed would pump money into the banking system to permit them to make new loans? If so, then I gather that the Fed could transfer the debts owed by the banks to the Fed to pay off the debts owed by the Treasury. But doesn't this clobber the profitability of the banks? If they can, in effect, loan out $1,000 on my $100 deposit, paying me 5% interest and charging others 5% interest, they make a great profit. But if instead they can only loan out $100 on my $100 deposit, then banking becomes a charitable operation. Yes, they make some fractional profit on the difference between the Fed's rate and their own, but that's a lot less. My God, we'll have bankers on the streets with tin cups! Horrors! Catastrophe!

This statement really boggles my mind. Could you expand on your meaning?

Exactly. I can't keep them straight either, but I don't think there is an M5. I firmly believe in TANSTAAFL- There ain't no such thing as a free lunch.



This is where TANSTAAFL comes in. What passes for Banks would probably no longer give interest on checkable deposits. In fact, they'd probably have to charge you a fee for securely storing your money. My guess is that people wouldn't keep very much of their money in banks. However, mutual funds that invest in mortgages, or consumer loans, would probably become more poplular - but they wouldn't be directly demand, and they wouldn't be FDIC insured.

Who gets the money? Well, the Federal Government spends roughly $2.5 Trillion a year. Under the plan I outlined, $224 Billion of that would be new money, and the remainder would have to be raised from taxes.

Also, there would be no Fed Rate, because there'd be no Fed, and the US Government wouldn't generally borrow funds to pay interest on. That's another part of TANSTAAFL: there'd no longer be a 'Risk Free' interest rate. I thnk the markets would survive - infact I'm sure they'd prosper. Without the US government competing for a $7.7 Trillion dollar share of the world credit market, credit should become significantly cheaper - with lower rates of interest charged for borrowed money.



Because of the way we allow money to be created (the issuance of Treasury Bonds, namely. "High Powered Money"), paying off the debt destroys the high powered money, and thus the money supply. Those Federal Reserve Notes in circulation in currency would remain (a very small fraction of our Money Supply).

Intrestingly, coins (an infinetesimal portion of our Money Supply) are minted directly by the US government, who enjoys revenue from their creation.

Well, that's a pretty radical solution you propose -- dispensing with banks and the Fed. I won't argue against it, because I have not thought through all the implications. My natural conservatism is skeptical, but the case you make here seems plausible enough. Food for thought -- which is why I come to AD. Thanks!

SWM28WDC:

I don't think that is a good idea. I'm not sure how it would reduce debt, in the first place. If we are going to repay our debt, we are going to to have to get the money from somewhere, not nominal money, real money, or else other countries are not going to be to happy with us. Therefore someone has to lose out. I'm not sure who you are suggesting that will be.

Furthermore, if we increase reserve requirements we are going to decrease investment by a great amount. Inflation hasn't been a problem in this country for a long time. We do, however, have a low savings/investment rate. The biggest problems in terms of saving actually have had to do with stock market bubbles, and you want to channel more money into that system.

Furthermore, if you eliminate federal insurance of savings you are going to end up with all sorts of problems. People are not going to want to risk their entire savings in the stock market, but on the other hand they do not want to just put it under their mattresses, because then the value of their money would not keep up with inflation. So a lot of money is going to be in the stock market, and you are going to have stock market panics all of the time. Its pretty simple: there is an economic downturn, some people pull their money out, leading to an even greater downturn, and then more people pull out. Now this doesn't happen as much because people have much of their savings in banks - they still have something even if they lose everything in the stock market. If you cannot make a secure investment which earns at least enough interest to keep up with inflation, there will be problems.

It would reduce debt by buying the bonds etc. back with real, valuable, legal United States tender. It's real money, created by the US Treasury rather than by Chase, Bank of America, Citigroup, or Wachovia. Someone does lose out - those banks get off the gravy train, and the US Treasury gets on it, benefitting America, rather than the bank owners.



I'm not sure what reserve requirements have to do with investment: if bank deposits become less financially attractive, more money goes to capital investment. Inflation is, and has been a problem for the last decade, for anyone trying to buy a house, or a property to start a business. We have a low savings & investment rate, because our wages can barely keep up with the cost of living, namely real estate, healthcare, and education. The biggest problems associated with savings is not earning more than we spend. Taking money creation away from the banks and giving it to the US Treasury reduces taxes against us, and reduces competition for credit, both of which benefit the economy, and jobs.



The FDIC merely shifts the risk from for-profit banks and shifts it to the taxpayer. Risk-averse investors still have the option of buying high-grade bonds, precious metals, low-risk mortgages, cash, etc. One of the main contributors to economic downturns is the Fed's manipulation of interest rates. Limiting money growth to 3% per annum will reduce inflation, which has been averaging 2.6% for the last 5 years.