Can A Government Finance Itself Simply By Issuing Money?
July 31, 2015
(This item originally appeared at Forbes.com on July 31, 2015.)
A popular notion these days, particularly among the “Modern Monetary Theory” types, is that a government can finance itself simply by printing money, thus relieving itself of any need to raise taxes.
For example–this, written in 2013: “Governments with the power to issue their own currency are always solvent, and can afford to buy anything for sale in their domestic unit of account even though they may face inflationary and political constraints.”
Is this possible? Sort of. But, not really.
A government can certainly make pieces of paper with politicians’ heads on them, in very large numbers. But, it does not take very much abuse of this ability before people are not particularly interested in giving valuable goods and services in trade for these bits of paper anymore. If we look at the history of all the currencies in the world since 1949, we find that “hyperinflation,” at least of the milder definition of the term adopted by the International Accounting Standards Board, is so common as to be near-ubiquitous.
There is a certain profit inherent in producing money, known as “seignorage.” The word derives from the French seigneur, which means “lord.” Money is a useful good just like any other useful good, such as a lightbulb or an automobile. It is useful in monetary transactions, and thus we want to have some. Unlike an automobile, the cost of producing money is virtually nil, and the profit margin is near 100%.
Today, this “seignorage” takes the form of the interest income earned on the reserves of currency issuers, which today are generally central banks. The reserves are usually government bonds, although other assets and direct lending are also quite common. These assets are purchased with newly-created money. You could consider the assets themselves (the “reserves”) as accumulated profit, but they normally need to be kept as reserves against the possibility of a decline in demand for base money, which would entail the sale of reserve assets to maintain currency value. So, they are not quite assets that one can do with as one pleases.
Today, the seignorage income of the Federal Reserve is officially paid back to the U.S. Treasury. In 2013, these payments supposedly came to $77.7 billion. I personally doubt such payments are actually made, because those that set up the Federal Reserve were not in the charitable business of helping the Federal government fund itself—as documented in books such as The Creature from Jekyll Island, by G. Edward Griffin. And if that $77.7 billion doesn’t go to the Treasury, where does it go? But, those are just my own personal suspicions.
If the Fed is actually making such payments to the Treasury, then the Treasury is already the beneficiary of all of the profits from currency issuance. In this case, the interest payments on the debt simply round-trip back to the Treasury. The real “profit” is the ability to issue what amounts to semi-perpetual no-interest debt. “Semi-perpetual no-interest debt” is a lot like free money. Recently, the Fed held about $4.45 trillion of debt, which is historically a very high number in proportion to nominal U.S. GDP.
Thus, the Treasury has been able to “finance” $4.45 trillion of spending essentially by printing money, via the Fed. This is not $4.45 trillion per year, but $4.45 trillion cumulatively, in all of history. The practical per-year figures can jump around a lot, but, with considerable smoothing, might roughly coincide with nominal GDP. So, if we make a very large number of assumptions including nominal GDP growth of perhaps 5% per year, then perhaps this total monetary base could also expand by perhaps 5% without debauching the currency, which means about $223 billion per year.
So, we can postulate that the Federal government could finance something like $223 billion per year essentially through the mechanism of money printing. That is a meaningful amount of money, but it certainly does not cover Federal spending of roughly $3.504 trillion in 2014.
However, the Federal government used to be a lot smaller. In 1910, before the introduction of the Federal income tax in 1913, Federal spending was around 3% of GDP. Today, that would be around $531 billion. This is still more than $223 billion, but we can see that it is in the same ballpark. We could almost fund the Federal government of 1910 with seignorage income alone. So, you can see how these kinds of ideas would have emerged, in the nineteenth century.
There is another sort of “money,” which is checkable bank deposits. This is not really money, I have argued, because it is not actually usable in payment. It is really a form of debt. But, it is commonly a non-interest-bearing form of debt, which is actually a lot like the money-creation methods of the Federal Reserve, and which might be of some interest to a government that wants to finance itself through these sorts of means. U.S. banking system demand deposits amount to $1.206 trillion today. Not enough to move the needle much, alas. Interest-bearing savings deposits (including small time deposits and money-market funds) come to an additional $7.888 trillion, which is a lot. However, the interest paid here is probably pretty close to the yield on shorter-term government debt, so there wouldn’t be much advantage to be had there in terms of seignorage income.
The “Modern Monetary Theory” people don’t really have much to go on. I am intrigued that such ideas – which are hardly “modern,” and have been around forever — are popular today at all. People don’t embrace such things because they make sense, but because they want them to make sense. Otherwise, the very high levels of government debt today might be a real problem.