Assymetry in Fiat Money Creation and Destruction

The money that is created by the government of the USA is called fiat money because it is created by a decree. Modern money theory (MMT) gives the theoretical underpinnings of how such money works. The theory does discuss the possibility of inflation and deflation of the money in such a system. If the government puts too much money into circulation, then a unit of money will buy fewer and fewer real assets. To counteract inflation the government merely needs to take money out of circulation.

The theory is just so simple, but looking at practice, we see that the means pf putting money into circulation is easier than taking money out of circulation.

To put money into circulation, the government merely has to buy stuff and credit the supplier of the stuff with some fiat money. Some of that stuff that gets bought, could be bought by the Fed in the form of paper assets of the private sector (this has recently been called quantitative easing) Quite a bit of putting money into circulation can be completely controlled by the Fed without any possibility of interference from Congress or the USA President.

To take money out of circulation the government can raise taxes which is politically difficult to do. It can also sell government bonds. The raising of taxes or the selling of newly issued bonds is not something the Fed has control of. The bond, when sold by the government, takes a large amount of money out of immediate circulation, with the promise to pay you smaller amounts of interest for immediate circulation, and the full principle at a later time, also for full circulation.

If inflation is already stating to get out of control, the government may have to pay you a lot of interest in order to get you to give up immediate spending of your money. Suppose that they had to pay you 20% per year interest. Then in five years the government interest would put as much money back in circulation as the bond had taken out. After that, and particularly when the bond matured, there would be more money in circulation than when they sold you the bond and took some money out of circulation. Depending on how circumstances may have changed over that period of time, this putting the money back in circulation could be counter productive to controlling inflation.

Taxing the money out of circulation and running a budget surplus (meaning taking in more taxes than the government spends) would not have the consequences that bond buying and selling would have, but it would require much more political will than the government could muster.

It is too easy to explain MMT theory without also explaining the practical limitations. In the long run, this is a very bad way to introduce the ideas of MMT to the novice. In the long run, that novice may find out about the practical aspects and feel bamboozled by the initial simple explanation. If MMT is taught and explained without seeming to be hiding anything, then the long term acceptance of the ideas of MMT is more likely.

What the political system needs to remember is that when a concept is introduced to the public with proper explanation and it gets accepted, then over time, new people come into the system who have not been taught the explanation. You can’t assume they understand the purpose of the fiat monetary system if it is not adequately explained to the newcomers.

Leave a comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.