Government's Shell Game of Taxing, Borrowing and Monetizing Debt

The world is not yet ready to give up its addiction to paper currency. Actually, the world may be getting a snoot-full of it, but governments are not. You see, paper currency has an unbelievably strong attraction for governments. Do you know what it is? Do you wanna know?

It’s elastic. And, boy, oh boy, can it stretch. You see, if governments cannot operate under paper money, they can’t inflate the currency. If they can’t inflate the currency, then they can’t spend with reckless abandon. Perhaps you’re asking yourself what rising prices have to do with government spending. And if you haven’t been around this bar much… that’s a very good question. So let me sum it up quickly.

The basic theory of government operation as it is taught in school and propounded by the media is that the government spends money to provide us services that we would be unable to provide ourselves. To pay for those services, they extract from us, you guessed it, TAXES.

STOP! Wait! Don’t you believe it!

The amount of taxes collected here in the United States last year would not have been enough to fund Social Security and Medicare. It’s hard to believe, but true. So where does all the money come from to pay for the infinite number of other expenditures of the federal government?

How do they pay for schools? Not just the aging and dilapidating buildings, but the books, supplies, teachers and the massive bureaucracy? How do they pay for the military… guns, tanks, soldiers, computers, jets, ships, submarines and planes? How do they pay for the Senate, House, Supreme Court, president, Secret Service, CIA, FBI, NSA, NASA, DOJ, DHA, HUD, DHS, ATF, IRS? Not to mention welfare programs of multitudinous varieties, college grants and national parks. How do they pay for all this? By means of two devices about which the man on the street knows little.

The first is through bond and Treasury auctions. We — as in “we the people’ — sell these instruments to people who believe that we are a good risk. Then we pay them to let us borrow their money. Of course, borrowing money costs money… it’s never free. But when a country borrows more than it takes in by taxation, because it is spending more than it takes in by taxation, the result is a growing debt problem, which never gets paid down. So how can the United States, or any country, continue on this cycle of never-ending borrowing? Not to worry, my friend. Because here is where the second device comes into play.

Countries begin paying off their debt with money that they “print.” It is commonly called monetizing the debt. It’s not hard to understand, but they try to make it hard. When you’re stealing from your citizens, it is better if they don’t know it. If you make the example and the problem personal, it all falls into place.

If I had a nearly endless source from which to borrow, some deep-pocketed uncle for instance, I could borrow from him indefinitely, as long as I could pay him back in money that I printed myself. If he did not know the money I gave him was fake, or if he just didn’t care, I could continue that scam in perpetuity. I could borrow millions… billions… TRILLIONS! But let’s not get ahead of ourselves.

Technically, I could only borrow from him until he was out of money. Right? Well, no… not exactly. If he had creditors who would take my fake money as real money, he would never have to stop lending. Until someone held his “wallet to the fire.” That is essentially what is happening. Only it is our Uncle Sam who is doing the borrowing. Then he prints his own money and uses it to pay his bills to his creditors around the world. Up until recently, our creditors had to take it. Because we had the bully power to force it on them. Plus since all the countries in the world were doing the same thing, our funny money was considered the best. That gave it some sort of intrinsic value.

But now there are currencies more valuable than ours. And now we do not have the military firepower to force it on others. Some feel that means that the whole jig is up. If our paper money is refused, then everyone’s paper money will be refused. But just because our government has spent us into trouble and is trying to make it worse with bigger and bigger spending projects from stimulus to healthcare doesn’t mean that the other major economies of the world are ready to throw in the towel. Indeed, if they can hang on, they will, because perhaps they will move into the position of world’s reserve currency and can produce prosperity out of nothing, all while impoverishing their citizens and neighbors.

Thus this will be but another round in dumping the dollar. The other currencies will look out for themselves. And playing those currencies could mean more currency option opportunities for us.

Bill Jenkins

December 11, 2009

The Daily Reckoning