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There is no deficit. The national debt is mostly money that one part of the government owes to another, that's all. It is, of course, very useful for demagogues to frighten the masses. But why would an entity that can create money with a printing press even need to tax, let alone fret about debt, unless it was to reward some citizens and punish others?

The federal government issues our currency, and since it is not backed by precious metals, is fiat currency. Government IOUs are always accepted in payment all around the world.  The government spends by crediting bank deposits and crediting the reserves of those banks.  Theoretically, the government could give you cash if you don’t want a bank deposit. Instead of cash it will also give you a treasury bond.

People will do all kinds of things for these dollars.  I wish I could issue IOUs as desirable as dollars.  Obviously, households cannot spend by crediting bank deposits and reserves, or by issuing currency.  That's why it is dishonest to compare a household budget to that of the US government.

The government has a theoretically unlimited license to print money; the only curb on this is the danger of ruinous inflation.  There is a fear that if the government continues to run deficits, some day the dollar’s value will fall due to inflation; or its value will depreciate relative to other currencies.  Still, who would not accept dollars today in the belief that at some they might be worth less at some point in the future?  

The next time a politician claims that government budget deficits are unsustainable, and that we must eventually pay back all that debt, ask them why the US has managed to avoid retiring debt since 1837.

The economist Philip Maus explains "...the term, "the government," includes "the entire federal government including the Treasury and the Federal Reserve. And the part of the government which runs the deficit is not the part of the government which decides to "print more money." The government taxes, spends and, if there is a shortfall, the Treasury issues bonds to make up the difference. In this respect, the Treasury superficially appears to be like a private sector entity which has to balance its books. However, the Federal Reserve can and does buy these Treasury bonds (and bills). Again, to make things more complex, the Federal Reserve does not buy the bills directly from the Treasury but buys them in the secondary market. And, when the Federal Reserve buys Treasury securities on a net basis it essentially creates new money - not actual currency, but its electronic equivalent. It all takes place in a confusing and indirect manner (through what we, in law school, used to call a step transaction) but one part of the government prints money so that the other part of the government can spend more than it collects. At the end of the day, one part of the government owes another part of the government some money. And the Federal Reserve, oddly enough, returns to the Treasury its "profits" generated by the interest on the Treasury bonds it collected from the Treasury.

This system, while widely used in the world today, is not inevitable and I think it is useful to reflect on alternatives. A government could simply tax and spend money, retiring the money collected in taxes and printing new money to cover its spending. In deficit years, more new money would be created than old money retired. It would then be abundantly (and perhaps painfully) clear that the only constraint on spending is inflation. For a whole series of reasons, our system is superior to such a system but with in a fiat money world we could go to such a system, and, if we did, "federal government debt" would be a thing of the past."

So not only do we not need to worry about the deficit too much, it is theoretically possible for the federal government to operate without tax revenue.  

Originally posted to Zygoat on Thu Aug 30, 2012 at 08:29 AM PDT.

Also republished by Money and Public Purpose.

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