As economy and economic policy making is full of complex and difficult to understand terms and words, common people or their representatives are not able to contribute to the policy making with total understanding and conviction, even though it is policies which directly determine their livelihood and survival. The lack of participation of common people, who are the main stakeholders, in this discourse gives space for misrepresentation of facts and fraudulent interpretation, leading to monumental exploitation and continuing fraud on almost entire humanity.
That's how it is possible to institutionalise a system which works to corner the benefits of production and wealth in favour of few people, wrongly citing scarcity of capital as reason. To defeat this diabolical structure, it has to be told in a simple language, so that the truth will reveal itself.
Whoever understand the system of money creation and supply, they will immediately see the falsehood practiced in the name of monetary and fiscal policies. These are not empty words. I owe to clarify any questions raised about what I state here.
Money plays a predominant role in life and those without money is treated very badly by society. It is real resources including human labour, raw materials, plant and machinery which are the primary resources and backbone for the production of goods and services, without which production is not possible. A country with very high real resources could achieve tremendous real growth, and those human resources, which is the backbone of production, can also attain high standard of living.
If that is not happening and they are in poverty and distress, while most of the benefits go to those who rent capital, it is so because availability of capital is assumed to be scarce. But, is the capital scarce? It was, with the gold standard fixed exchange rate currency system, which was given up by most of the countries long time back, as currency issue by government was linked to gold reserves in that currency system and restricted currency supply was not meeting the demands of a growing economy.
Does the capital continue to be scarce with the present currency system which is different from the earlier system? A currency system, in which currency has no intrinsic value, no commitment to convert to gold on demand and no fixed exchange rate to protect, is now followed by most countries (India has been operating on a managed floating exchange rate regime from March 1993 - Research Study, RBI). With this currency system, which is not restricted by gold reserves, the currency supply is not limited by that, as there is no commitment to convert the currency to gold on demand. So, the currency supply from government spending and bank lending is not limited any more by the gold reserves.
The spending of the currency issuing government in the present currency system is constrained only by the real goods and services available to purchase with those spent currency in real economy and regulatorily restricted by the parliamentary approval of the Budget and the Appropriation Bill. The government continues to assume that it has only limited capacity to create currency and so is financially constrained to fund production, when productive capacities are available.
It means that there is not even an attempt to have the right understanding of the present monetary system and a structure and practice based on fraudulent interpretation and undue credit to capital have been established, without any repudiation, highly influenced by the previous currency system. Because of this false understanding, majority of people are made to live in poverty forever, as those renting capital get preferential reverence.
False Understanding 1:
"Government, the monopoly issuer of sovereign fiat currency, must tax, borrow to fund its budget expenditures".
We should first understand that without the currency spent by the government, there won't be any currency in circulation in the country, including the currency to pay the tax liabilities, 'lend' to the currency issuer and save. Government is continuously infusing currency into circulation and removing currency from circulation. Currency removal and infusion by the monopoly supplier are called as revenue, borrowing and spending. We also need to understand what currency is to the issuer and the user. Except the federal government which issues currency, everybody else, including State Governments are currency users. Federal Government issues currency through its Central Bank, the Reserve Bank of India, as legislated by the Parliament.
We need to note from the above, how does casual naming, the resultant wrong nomenclature and narrative can destroy billions of people's life.
Federal Government has the supreme sovereign power of currency issue (creation) and it is the monopoly issuer of national currency. Let us look at on what basis, currency is created and the quantum of currency issue determined, as it is that which decides whether the government needs external source to fund its expenditure. And why is this aspect not thoroughly researched, studied and taken up for public debate is a trillion dollar question.
Government adopts a particular currency system which is the basis for currency creation and issue. As currency is the common nominal exchange factor for internal (within a country) as well as external transactions, it is always based on a system agreed upon by all the countries. It could be a fixed exchange rate currency system like gold standard and gold exchange standard or the fiat floating exchange rate currency system presently followed by most of the countries including India.
The currency could be a commodity like gold, silver or even a paper, whatever the government decides to have as currency. If gold or silver coin is used as currency, then the gold or silver reserves determine the quantum of currency in circulation. If it is a paper currency convertible to gold, then also gold reserves determine the quantum of currency. In both these systems, currency supply is limited and the private capital is scarce.
Gold was used as money since the first gold coin was minted around 700 BC. Silver also was used as money along with gold. In 16th Century, paper money was introduced in Europe. As the introduction of paper money posed some problems, the gold standard emerged as an alternative and in the early 1870s, the global monetary system transitioned from bimetallism to the gold standard.
The gold standard is a monetary system in which a country sets a fixed price for gold and commits to buy and sell gold at that price. And that fixed price determines the value of the currency. The critical factor of the system was the sovereign commitment to convert currency to gold on demand (convertible on demand to a specified quantity of gold) and such commitment was international. (Recent Global Crisis and the Demand for Gold by Central Banks: An Analytical Perspective. DEPARTMENT OF ECONOMIC AND POLICY RESEARCH, RBI, SEPTEMBER 2011). Similarly, other countries fixed the value of their currencies in terms of gold. That is how exchange rate of currencies between countries get fixed. As the exchange rate is fixed in gold standard, it is called fixed exchange rate currency system.
The main characteristics of gold standard are the commitment to buy and sell gold at the fixed price, the currency having intrinsic value as it is defined in terms of a given quantity of gold and the fixed exchange rate with other currencies. The gold reserves play a predominant role in the economy during the gold standard era. As external trade imbalances were settled with gold, export was a necessity to protect the gold reserves and that is why, export oriented economic development became the focus of every country, even though exports lead to real loss of goods and services, which otherwise would be available for local consumption. Not only gold reserves are required to settle trade deficit, it is also required to meet the obligation to buy and sell gold on demand. So, it is the gold reserves which determined the quantum of currency in circulation during gold standard era.
Unless there was new gold findings from mines or trade surplus, there couldn't be any additions to gold reserves and so the government was not able to issue currencies to meet its budgetary expenditures. And so the practice of raising funds from tax imposition and treasury sale was resorted to. When the budgetary expenditures exceed tax revenue, that excess expenditure is called budget deficit. Government sells treasury bonds and securities to fund the excess expenditure. The concept of "balancing the budget" came into being, as inadequate gold reserves failed to meet the demand for additional money supply.
Bretton Woods System which replaced the gold standard also is a fixed exchange rate currency system in which all national currencies were pegged to US dollar, and the dollar, in turn, was convertible to gold at the fixed rate of $35 per ounce. The global financial system continued to operate an indirect gold standard. As dollar replaced gold as common factor among currencies, countries accumulated dollar reserves instead of gold reserves. So, forex reserves, in place of gold reserves, played a critical role in the economy of a country.
After WWII, forced by the funds flowing to countries rebuilding their infrastructure, many countries starting to convert their dollar reserves to gold and the increasing domestic inflation, trade deficit and declining gold holdings, the US Government suspended the convertibility of US dollars to gold in 1971. With that, the Bretton Woods fixed exchange rate currency system collapsed which paved the way for fiat floating exchange rate currency system to emerge as an alternative. Many countries adopted the floating exchange currency system in which the currency creation is not linked to gold, the currency has no intrinsic value, the exchange rate is floated in the forex market and there is no commitment to buy and sell gold at a fixed price. India has been operating on a managed floating exchange rate regime from March 1993. All foreign exchange receipts could now be converted at market determined exchange rates. ( https://m.rbi.org.in/
Impact of this historic change in the currency system on policy options with potential benefits of unimaginable proportion:
1. Government's commitment to convert the currency to gold on demand doesn't apply anymore.
2. The exchange rates between currencies are not fixed.
3. With the floating exchange rate currency system, the exchange rate between currencies is dynamically determined in the forex market, based on the demand and supply.
4. Gold or dollar reserves are not required to be maintained as there is no commitment to convert to gold on demand and no fixed exchange to protect.
5. CURRENCY SUPPLY IS NOT RESTRICTED BY THE GOLD or DOLLAR RESERVES WITH THE PRESENT FIAT FLOATING EXCHANGE RATE CURRENCY SYSTEM.
This is a development which brings enormous fiscal freedom.
6. Federal Government having the sovereign power to create and issue currency should supply the currency to fund the budgeted expenditure, when Parliament approves the Budget and the Appropriation Bill; that is the approval to supply the currency to fund the budgeted expenditure.
When it happened, no country appears to have realised that it has got the magic wand to eradicate poverty and the ignorance still continues.
7. Federal Government need not mobilize funds from taxation and treasury sale to supply currency to meet budgetary expenditures; movie theatres don't collect back the tickets sold to reissue. There are other reasons for taxation and treasury sale. Unlike the Federal Government, the State Governments are currency users like a common man. So, a State Government needs the tax revenue to fund the States's expenditures.
8. As the currency creation originates from the Federal Government, federal government spending itself is creation of currency. That is, WHEN FEDERAL GOVERNMENT SPENDS BY CREDITING A BENEFICIARY'S ACCOUNT, THAT CREDITING ITSELF IS CREATION OF CURRENCY.
9. Scarcity of capital, which emanated from scarcity of gold reserves, is not an issue anymore, as government has the power to spend. Scarcity of real resources including human labour is the defining factor now, not the capital.
10. Spending is a political choice now.
With all the nominal constraints removed, real economy could attain its full potential. With the liberty provided by the new currency system to make available required money supply, the country is in a position to achieve tremendous growth, deploying it's billion strong employable people creating the largest local market and the needed supply.
This hidden truth which could bring about immeasurable benefit to the entire humanity got revealed by Warren Mosler.
Tax revenue to State Governments:
Federal Government is the currency issuer and the State Governments are currency users.
Tax is a revenue to a State Government that funds the States's expenditures. But, to the Federal Government having the sovereign monopoly power to issue fiat currency, tax collection is removal of old currency from circulation, as the Federal Government funds its expenditures by issuing new currency. Federal Government doesn't need to penalise developed States, by using the taxes collected from those States to fund the less developed States' expenditures, thereby preventing the developed States to progress further. So, taxes collected from a State should be entirely left to that State to spend, as that State's progress would benefit the entire country. Federal Government could provide additional funding to the States who are having lower tax revenue, to bring those States' development to the level of the developed States.
Addendum on inflation and private sector:
Understand the monumental impact and importance of the above. Instead of staying with the revelation on how the government gets funded, don't jump to inflation immediately. We are not ignoring inflation at all. We go indepth into the question of inflation and identify all possible causes of inflation missed by other streams.
When we say that government can spend to deploy all available productive resources, we are not at all undermining the relevance of the private sector. Private sector is an integral part of the process, we are only pointing out that it functions within the institutional structure created by the government. When government imposes tax liability, it immediately creates a demand for its fiat paper currency, as it is a tax credit. In the process, government provisions itself with labour, goods and services to serve public purpose, as real goods and services are sold to the government by the non government sector to get the tax credit, so that taxes could be paid with those tax credits. Real tax is paid with those goods and services and not with the nominal currency supplied by the government. It is private sector which supplies those goods and services and it is very much needed to provide those supplies and an inevitable part of the process. Private sector doesn't mean big industries alone, even MSMEs and self employed individuals are the private sector.
Rajendra Rasu
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