17 Aug 2010

Is Our Money Based on Debt?

Shameless Self-Promotion 7 Comments

As the Magic 8-Ball would say, “my sources say yes.” Details here. An excerpt:

Different groups often notice different aspects of the same phenomenon — this is the point of the famous tale of the blind men encountering an elephant. When it comes to the Federal Reserve, Austrians usually focus on how its tinkering with interest rates leads to the boom–bust cycle.

However, plenty of non-Austrians hate the Federal Reserve System too. For some of these critics, one of the most perverse features of our present monetary system is its basis in debt. Specifically, if Americans ever began seriously paying down their debts, the supply of dollars would shrink. In the present article I’ll explain this strange fact.

This is one of those (rare) instances where my position has totally changed. In fact, I used to have inside jokes with one prominent Austrian thinker (who shall remain nameless to protect his identity) about these “cranks” who would always criticize us for not bringing up the crucial fact that our money is based on debt.

I was reassured in my stance when I came across an old 1970s or 1980s clip of Murray Rothbard fielding a similar question from someone at a liberty event, and Rothbard had no clue what the guy’s point was.

Well, I now see the light. It’s true, more often than not the person bringing up this fact will then go on to denounce interest per se–or worse yet, to say that the “optimal” monetary system involves zero-interest money printing by the Treasury–but there really is an important sense in which our money supply right now is tied to public and private debt.

Next week, I have a Mises Daily tackling the follow-up question: If the creation of new money is tied to expanding the debt, then don’t interest payments necessarily require the creation of more money (and hence more debt)? I know you want my answer right now, but you have to wait. It will build character.

7 Responses to “Is Our Money Based on Debt?”

  1. ADA says:

    Two issues:

    1. When the Fed buys preexisting debt instruments or anything else; a car or a chair, he is creating money that is not tied to debt. Given the amount of open market transactions recently that did not involve monetizing treasury debt, I would say that our system is not all based on debt. No?

    2. Regarding the answer to your question for next week about creation of more money to pay off the debt…. Be careful with this one, because those other people you were alluding to (who observe the same thing the Austrians have but from a different perspective, etc…) lack a theory of interest and capital. Thus, they falsely conclude that the problem is interest per se and not that interest is artificially low and there is a intertemporal misallocation, or anything like that. This is the origin of the famous “debt virus” fallacy that is very popular with these folks, which is obviously absurd.

    • Fascist Soup says:

      1. Sure, but printing money isn’t exactly a solution now is it? No new real wealth is created, and the money that is created is politically allocated, further distorting the market.

      The new money moves the interest from the private sector into the revolving door of government collecting interest on its own debt – which I find to be an utterly ridiculous way of managing an economic system. How this is supposed to be superior to a hard money system is beyond me.

      2. If the principle is the only money created in a fractional reserve loan, where does the money for the interest payments get created? Through more open market operations?

  2. Robbie says:

    I think the reason they call it debt based money is because the establishment gets the money for free and we have to work for it. If the establishment needs the money they print it at whatever interest rate they choose. You have to remember that any interest income to the Federal Reserve gets paid back to the Treasury where as any interest that they make from a private borrower doesn’t get paid back to the private borrower.

  3. Impairment says:

    Well, maybe there is even more behind that. Sometimes the argument goes like that: “Money is debt and debt is actually nearly the same as money. So why do you blame the banks for inflating the money supply? Anyone who lends money does that.”

  4. AC says:

    Maybe you can examine the proposal arguing that Congress should be able to print money to pay for stuff, and not allow private banks to create money and receive the benefits that this entails. Here’s an example:
    I’m not sure how prevalent this idea is. Even aside from the incentives of Congress to inflate, it seems to me that this “free lunch” of cost savings is not really there.

  5. Perry Mason says:

    In the Creature from Jekyll Island, I believe the same question as your follow-up question was posed. If I recall, the answer is no. The interest is not necessarily paid with guaranteed inflation, but by work, from which we are taxed to pay the interest.

    Thus, it is not entirely inaccurate to call the American system “debt-slavery” with respect to the operation of the Fed (rather than implying that debt itself is enslaving, which it is not). It is another side to the same coin as taxes.

    Of course, I could be wrong here.

  6. The Grand Muffdiver says:

    Isn’t this just subterfuge? The FED monetizes central government debt, but that’s only because of the (false) legitimacy the government is able to command. It’s a state theory of money.