Blogger Rodger Mitchell I disagree on many things, but we agree (mostly anyway) on economics. I’d like to paraphrase one of Mitchell’s posts here, and add some illustrations.
The topic is U.S. government finances, and the nature of money. Mitchell and I say that the U.S. government creates its spending money out of thin air, simply by making ledger entries. And the government likewise destroys money (i.e. sends it back into thin air) by making ledger entries. Therefore the U.S. government has no need for tax revenue.
This fact annoys people who are programmed to think of money as physical and limited, and that only physical money is “real” money (even though no money has ever been physical, just like the number “2” has never been physical). Because of people’s programming, they believe the lie that federal social programs are “insolvent,” and that the U.S. government has a “debt crisis.”
Here’s Mitchell (paraphrased)…
The federal government is comparable to the board game Monopoly.
Monopoly generally involves several players plus a “Bank,” which, like the U.S. federal government, is Monetarily Sovereign. That is, the monopoly Bank never needs to run short of dollars.
To play the game, participants buy and sell Monopoly real estate, and they charge each other rent on the properties they buy. The winner is the player who gains the most Monopoly dollars.
The purpose of the Bank is to provide the money for the game, and to sell the real estate properties to the players. The Bank is a corollary to the U.S. Treasury.
Imagine that you and three friends want to play Monopoly, but when you open the box you discover that there are no Monopoly dollars inside.
No problem. You simply draw four columns on a piece of paper, one column for each player. The Bank then provides each player with a given amount of Monopoly money (say 5,000 Monopoly dollars) by writing the number “5000” at the top of each column.
Thus, the total Monopoly “economy” would consist of 20,000 Monopoly dollars.
As the game is played, the players receive 200 Monopoly dollars from the Bank each time they pass “GO.” Each time a player receives money, that amount is added to his column. Of he must pay money, that amount is deducted from his column.
Where does the Bank get the $200? The same place it got the 20,000 start-up dollars: out of thin air. The Bank, like the U.S. federal government, creates dollars by writing numbers into each player’s column (i.e. their bank accounts). The Bank has no source of dollars other than the rules of the game.
At various points in the game, players are required to pay money to the Bank, either for properties, for fines, or for taxes.
Let’s say a player must pay a $100 tax to the Bank. In that case, $100 is deducted from that player’s column.
Where did the $100 go? It simply disappeared. In effect, those 100 tax dollars were destroyed. The Bank itself has no column. This is exactly how federal dollars work in the real world.
If this bothers players who are accustomed to double-entry accounting, then we can create a separate column for the Bank, and we can add the 100 tax dollars to the Bank’s column.
It would make no difference to the game whether or not we make a column for the Bank. The Bank is not part of the game “economy.” And since the Bank has the unlimited ability to create Monopoly dollars from thin air via ledger entries, there is no way to determine how much money the Bank “has” at any moment in time.
Whether or not the Bank has its own column has no effect on the Bank’s ability to create money via ledger entries. The Bank can be said to have zero dollars, or infinite dollars. Thus, when a player sends tax dollars to the Bank, this does not affect how many dollars the Bank has available to spend.
Similarly, the U.S. Treasury is not part of the U.S. economy. The U.S. Treasury, like the Monopoly Bank, creates dollars at will by spending dollars into the economy. That is, by crediting bank accounts (i. e. by simply changing the numbers).
Any U.S. dollars in the Treasury’s “column” are not part of the U.S. economy, and are not part of the economy’s money supply. Only dollars in the economy (i.e. in the players’ columns) are part of the money supply. So, like the Monopoly Bank, the U.S. Treasury can be said to have zero dollars, or infinite dollars. It makes no difference. And the tax dollars you send (or don’t send) to the Treasury have no effect on how many dollars the Treasury can create and spend via ledger entries.
Although the U.S. Treasury does keep accounting records, these records do not measure the Treasury’s ability to pay its bills. The records don’t measure what the Treasury “has,” because what the Treasury “has” is irrelevant.
So take your pick. The U.S. Treasury either does or does not destroy the tax dollars that you send it. Either way the tax dollars affect nothing. The Treasury can create money forever, whether or not we pay tax dollars.
If the Treasury’s balance sheet is irrelevant, and federal tax dollars don’t fund federal spending, then why do we pay taxes?
 Inflation: The Value of a dollar = Demand/Supply. If the Supply goes up more than demand, the value goes down. We have inflation. Taxes reduce the supply. However, interest rate increases, which increase the demand for dollars, are the more effective, anti-inflation approach used by the Federal Reserve.
 Control: Taking tax dollars from specific segments of the economy is one method that Congress uses to control the economy. This approach has been perverted by business interests that have bribed Congress to create tax loopholes.
 Politics: Very rich people pay Congress to widen the gap between the rich and the rest of us. The tax code is designed to do this, as the vast majority of taxes are effectively regressive. At the behest of the rich, Congress levies taxes to widen the Gap, and spends money to get votes.
In short, you pay tax dollars to the U.S. Treasury, which has no need or use for those dollars. Though the U.S. Treasury keeps track of the dollars in balance sheets, the dollars do not affect the Treasury’s ability to spend.
So do these dollars, which have no value and are not part of the money supply, actually exist, or have they been destroyed?
The question is one of semantics, having no economics purpose. I vote for “destroyed,” but if you want to say these useless dollars exist, I won’t quibble.
++++++++++++++++++++++++++++++++++++++From this we see that deficit spending is the process of adding money to the ledger columns by changing the numbers. Taxation is the process of removing money from the ledger, again by changing the numbers. In this way, money is added to the economy, or taxed out of the economy. The U.S. government can no more become “insolvent” than our Monopoly ledger can, or a sports scoreboard can become “insolvent” of points.
U.S. federal politicians push austerity (i.e. push deficit reduction) to remove money from the economy, and thereby make you poorer. Politicians do this in order to widen the gap between you and the rich, who get most of their money from speculating in the markets. That is, rich people get their money from Wall Street (i.e. the financial economy) while the rest of us get our money from Main Street (the real economy).
Regular banks use ledger entries to create money for lending, just as the U.S. government uses ledger entries to create money for spending. Contrary to the fractional reserve myth, banks don’t need to “lend out” depositors’ money, since money consists of ledger entries. (Currency notes can be traded and spent like money, but technically they are not money. Currency notes represent money, i.e. they represent ledger entries. True money exists in bank accounts, which are the ledgers.)
There are two ways money is created: by federal government spending, and by bank lending. Both ways involve simply changing ledger numbers. Some people falsely believe there is no government spending; only bank lending. That is, they think all dollars are lent into existence. I’ve covered that error many times, and I will do so again if asked.
There are two ways that money is destroyed, namely by federal taxation, and by paying off loans. Both ways involve simply changing ledger numbers. If a bank lends you $100,000, then the bank makes a 100,000 ledger entry in an account for you. Voila: the bank has created $100,000 in loan money. As you pay down the loan, the number in the ledger is repeatedly changed until it reaches zero. The $100,000 in loan money has been destroyed. The bank makes its profit on the interest that you paid along with the principal.
These simple facts are difficult for people to understand because people don’t want to understand. By denying these facts, people can say, Yes the U.S. government is bankrupt, and the wars did it! (Or Social Security did it. Or whatever did it.)