Chapter 4 - From Where Does Our Government Get Money?

The government of the nation has the authority to create the money of the nation. One might assume that the government would create the money of the nation in the treasury. In Australia, the treasury only creates the coin component of the Money Supply. The central bank creates the cash currency notes in circulation. The 2015 figures from the Reserve Bank of Australia show that the Reserve Bank has created a total of $67 billion. [3] This is the sum total of all the cash currency notes that it has created. This is only 3.5% of the Money Supply of the nation. The Money Supply, listed as M3, equals $1760 billion. [2015] [3] The government, itself does not use cash currency in any of its transactions. The Reserve Bank creates cash currency which is trucked to bank agencies around the country to fill ATMs and teller drawers. The government uses bank accounts to pay its bills and receive taxation. Thus the government operates in the virtual world of bank credit. Before the government can start its spending, it has to top up its bank accounts with virtual bank credit. It could create a few one billion dollar coins and take them to their bank branch, but it does not do so. Some might call this the ‘trillion dollar coin solution’. It could get the central bank to create a few billion dollar notes, but it does not do so. To obtain credit in its bank accounts, the government treasury issues something very similar to a banknote. These are called bonds (securities or gilts). I drew this picture to represent a government bond. The image represents a bond for one million dollars. This bond is printed paper and is purchased by a buyer who credits a government bank account with one million dollars of bank credit. One million dollars of bank credit is transferred from the purchaser’s account to a government account. The purchaser’s bank account falls by one million dollars and the government account rises by one million dollars. The coupons at the foot of the bond certificate represent the periodic interest payments. By this means, the government obtains bank credit that it uses to finance its operations. Gone are the days when the government creates the money needed to operate the nation. The government borrows bank created bank credit by issuing IOUs called bonds. The government borrows pre-existing bank credit. Government borrowing though bond issue does not increase the Money Supply.

One Treasury Bond. Creative Commons Attribute - Andy Chalkley.

The difference to a bank note is that the bond carries interest and is bought by people with ‘more money than they can spend’. The government takes an expensive route to obtain bank credit, it creates notes similar to bank notes but pays interest on them. These bonds have a limited lifespan. Citizens and organisations transfer bank credit to a government bank account and receive the bonds in paper or digital form. The government is then obligated to pay back more than it received for the bonds. The government is thus not only in debt for that which it could create itself, but also pays interest. Simple logic will suggest that this is a recipe for a government to get into ever increasing debt. The government reaches a point, after selling off all public assets, of being unable to pay the debt to the creditors. There is a second issue with the debt. These bonds have an end date when the principal is to be repaid to the holder in — guess what — bank credit. The government needs to issue more bonds to cover the repayments to the previous bondholders. This puts the government is the position of being susceptible to what I call: ‘bond blackmail’. If the bondholders, as a group, refuse to ‘roll over’ the government bonds unless the government agrees to various conditions, the government has been subjected to ‘bond bribery’. This is real and a big problem, and I illustrate with two quotes:

On September 26, 1921, The Financial Times wrote, “Half a dozen men at the top of the Big Five Banks could upset the whole fabric of government finance by refraining from renewing Treasury Bills.”

In 1924 Sir Drummond Fraser, vice-president of the Institute of Bankers, stated, “The Governor of the Bank of England must be the autocrat who dictates the terms upon which alone the Government can obtain borrowed money.”

The government borrows bank credit from organisations with excess bank credit in their accounts. The government creates bonds at the treasury and offers for them to be purchased. The purchaser pays by moving some of their Bank Credit from their bank account into a government bank account. By this means the government obtains Bank Credit to operate as a government. To operate as a government the government is relying on those with excess wealth to lend them the Bank Credit in return for the bond. The bond promises to repay the purchaser with the same quantity of Bank Credit at a fixed date in the future and periodic interest payments in the meantime. The government is also relying on the bank’s good grace to allow them to operate within the bank clearing system. The government is relying entirely on the good grace of those with excess quantities of wealth for its day to day operation in the business of government. If those with excess quantities of wealth cease to extend credit, it is all over for the government. It cannot operate. If the wealthy act together and put conditions on the purchase of bonds, the government, staffed by those that ‘do not understand’, will capitulate to the demands. Bond blackmail has occurred.

The major source of revenue for the government is taxation. The government collects taxation. The government collects this as bank credit deposited into bank accounts. It does not collect tax as cash currency. The government spends money from its bank accounts. Because the government does not create its own money and because the Money Supply needs to increase slightly each year, there is a tendency for the government debt to increase rather than fall.

So the government collects tax and spends approximately the same amount back into society. Thus the government has no ability to adjust the Money Supply. Whatever the government collects as tax, it spends back into society.

The government has no ability to adjust the Money Supply.

The government creates less than about 5% of the money in use in the nation. [UK 3%, Australia 3.5%, USA 7%.]

The government does not use the cash currency that it creates.

The government borrows money that it could create itself through a process involving the issue of IOU’s called Bonds (Securities or Gilts)

The issue of Bonds places the government in a position to be blackmailed.

Here are some quotes pertinent to the chapter so far:

Thomas Edison 1921: “It is absurd to say that our country can issue $30,000,000 in bonds and not $30,000,000 in currency. Both are promises to pay; but one promise fattens the usurer, and the other helps the people. If the currency issued by the Government were no good, then the bonds issued would be no good either. It is a terrible situation when the Government, to increase the national wealth, must go into debt and submit to ruinous interest charges at the hands of men who control the fictitious values of gold.”

Thomas Jefferson: “And to preserve their independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude. If we run into such debts, as that we must be taxed in our meat and in our drink, in our necessaries and our comforts, in our labors and our amusements, for our callings and our creeds, as the people of England are, our people, like them, must come to labor sixteen hours in the twenty-four, give the earnings of fifteen of these to the government for their debts and daily expenses; and the sixteenth being insufficient to afford us bread, we must live, as they now do, on oatmeal and potatoes; have no time to think, no means of calling the mismanagers to account; but be glad to obtain subsistence by hiring ourselves to rivet their chains on the necks of our fellow-sufferers.” [2]

Frederick Soddy 1921: “There is nothing left now for us but to get ever deeper and deeper into debt to the banking system in order to provide the increasing amounts of money the nation requires for its expansion and growth. An honest money system is the only alternative.” [1]

Abraham Lincoln 1843: “The system of loans is but temporary in its nature, and must soon explode. It is a system not only ruinous while it lasts, but one that must soon fail and leave us destitute. [Whig circular 1843]

Thomas Edison (1847 – 1931), American inventor: “It is a terrible situation when the Government, to insure the National Wealth, must go in debt and submit to ruinous interest charges, at the hands of men, who control the fictitious value of gold. Interest is the invention of Satan.”

There is a fairly crude solution that works exceedingly well. The issue so far is that the government is borrowing credit from private institutions and is having to collect tax to pay interest on money that it could have created itself. The crude solution is to run its own government-owned bank which is commonly called a ‘Public Bank’. In this situation, the ‘Public Bank’ lends money to the government. Thus, the government owes money to the government. This makes the debt somewhat irrelevant. Australia did this in 1911 very successfully. China currently follows this practice. China has used its ‘China National Bank’ To successfully propel itself into the modern era in very short timespan. Here is a graph for China:

Graph of China Money Supply and Debt. Creative Commons Attribute - Andy Chalkley.

In this graph for China, much of the government debt is owed to the government and is somewhat irrelevant.

My graphs do not have the misleading x-axis shift found in many finance graphs. I correct the date figures so that I can use data from different series. Lists with annual dates give figures appropriate for the thirty-first of December. I record this as 2015.99. This allows me to use data from different sources. January data goes against dates such as 2015.083 and February as 2015.167. Besides allowing me to mix data sources, it allows me to use regular graphing programs as it is difficult to trust software that graphs with date formats. Economic data is often displayed as a date of 2015, where I display it as 2015.99. This avoids an eleven-month shift on the x-axis between a graph in monthly increments compared to a graph in annual increments. Many graphs drawn by finance people have a misleading displacement on the x-axis and occasionally inconsistent intervals. I have also had problems with incorrect dates on official data. Occasionally I find data listed as Dec 2015 when it actually applied to June 2015. This shows up as a ‘frizz’ in the graph. Very occasionally, data has been listed as one currency, but is clearly in a different currency. I can usually spot this by checking figures elsewhere. One of the biggest problems dealing with the graph data was with obfuscation. National figures can be quoted in comparison to GDP, but the GDP figures are not available. GDP figures are then presented in statistically altered form. It has been a battle to get quality data. With the incredible amount of data available, is has been strange that I struggled to find the data I needed. Australia has very good data for current times, but nothing on the Australian Great Depression. The USA has good figures for the Great Depression but only from 1929. Some GDP figures are available in Euro or $US but not national units. I have compiled lists of exchange rates, but often weekends are missing, which makes date matching impossible without manual intervention.

The reason the government uses bank credit held in bank accounts for the payment of its expenses is that the bank payments system is so fabulously efficient. Cash currency payments require a physical meeting of the respective parties and the physical movement, storage, and protection of physical cash currency. It is a miracle of the modern age that I can sit in this café next to the Golden Temple in Amritsar, and pay by card and the balance in my account half a globe away is instantly debited. The convenience of modern private banking is not lost on governments. The problem to government and citizens is not the payments system, nor the minor transaction payments, but the unpayable debt that the system creates. A simple solution for a government is to create a public bank. This is a bank owned and operated by the government. They come in various forms all of which become undermined by privately owned banks. The government can borrow from its own National Public Bank with the effect that the government owes money to itself. Various restrictive measures are put on the bank to stop government profligacy. The public bank is also able to compensate for the erratic lending practices of private banks that create recessions in a process called counter-cyclical financing. Australia became the most prosperous nation in the world after it created a public bank called the ‘Commonwealth Bank’. It was soon throttled on the advice of the City of London banks. It was given new life to finance WW2 and slowly and given a slow death until it was full sold off to private interests. Australia now languishes in debt to private organisations all blamed on whichever flavour government is in at the time.

A more comprehensive solution is for the government to create all money. The world has moved towards digital money. I have identified two forms of digital money. One is in the form of discrete, numbered and identifiable units.

Governments have always created money in discrete unit quantities. You cannot get half a dollar note and certainly not 0.666666 of a dollar note from a government. Government notes can also be numbered although the same dignity is not generally given to coins.

This may require the government to create ‘Digital Money’ of the same, or a similar, nature to that created by the banks. There are two forms of Digital Money that I have identified and they are quite different. The banks use a system of balances. They simply list how much money they owe you. One relies on their computers being correct. Fractional units are possible. One can have one-half of a cent in a balance even though a half-cent does not exist. One must reference the central computer to know the balance in an account. Balances can be negative. Negative is not possible with government cash currency. One either has cash or one has none. When the government creates money it does so by coining or printing. Government money only exists in discrete units and multiples thereof. Each unit can be numbered and tracked, if necessary, but one can only own multiples of single units. Negative units cannot exist except as account entries whence they are no longer government currency. The second form of digital money is a digital form of government currency. Digital money units are created with a digital signature and a unique identifying number. I liken this to government printing presses creating numbered $1000 notes and storing the physical notes in a vault and issuing photos of the note as a jpeg along with a digital signature and unique id. To claim ownership, an individual only needs to provide the numbered, unique image file and its transaction history. To demonstrate ownership is to show the number and its history so that it can be verified, if necessary, on any of numerous record keeping computers in much the same way as domain names are kept on the internet. This type of digital currency does not rely on a single central computer. The digital units can be carried around on any digital device including a phone, computer or magnetic card. I originally thought of the system as an extension of the current government cash currency system with the modification that the notes produced were photographed as a jpeg. The image file is unique and has an accompanying number. The government could keep the note in a vault and for an individual to claim ownership, the individual would give the digital number with the accompanying jpeg file and the transaction record for the digital unit. A whole string of computers would keep track of ownership in much the way the internet keeps the domain name records. Land title records are kept in a similar manner. The updating of records occurs at some time after the transaction has occurred. After working through my concept, like a few of my other inventions, I realised I had invented a government equivalent to Bitcoin and other digital currencies. My house heating system using mirrors may be my only unique invention. I have strategically placed large mirrors to bring winter sun into my lounge. I think I get one-half kilowatt from my mirrors. As usual, the government will follow a while later with a true numbered digital dollar rather than the virtual digital dollars of the private banks. The serious advantage of numbered digital dollars is that all money would have a digital signature and the money lenders would only lend money that actually existed. They would no longer be able to lend non-existent money in certificate, IOU or balance form. When one borrowed a million dollars, one would be issued with the digital signatures of the digital dollars that were received. This does require that government ensure that adequate Digi-dollars are available for lending. The banks would no longer create the money they lend by account entries. They would lend out existing money. To ensure that adequate money was available for business, the government would lend money at a peppercorn interest to the banks for the banks to on-lend to business, thereby ensuring adequate funding of entrepreneurial activity. There are more advantages to this scheme that I will discuss in further chapters. This acts as an introduction to the topic of government digital money. The government would allocate a billion or ten to small medium business, but none for the purposes of speculation and asset speculation.