Randy Wray explains the process of creation of state money aka "currency" and destruction of previously created state money through taxation.
What is a sovereign currency? It is (mostly) a keystroke that results in an electronic entry on a bank’s balance sheet. (Yes it can also be shiny coins, paper notes, and watermarked checks—but those are increasingly less important.) To be more accurate, it is two entries: an entry in the deposit account of the fighter plane’s producer and a reserve credit at the central bank for the producer’s bank.Global Economic Intersection | Op Ed
In the case of a modern “fiat” sovereign currency, what does the government promise? To “redeem” its currency in tax payment. When the fighter plane producer pays taxes, the keystrokes are reversed: the deposit is debited and the bank’s reserves at the Fed are debited. Presto-change-O the sovereign currency disappears in redemption.
The fighter plane ends up at the government. That, of course, was the whole purpose of the keystrokes.
Now let’s take Bradford’s example. Instead of keystroking a deposit, the government issues a “tax credit” to be used later in redemption of its tax liability. When tax time comes, the tax credit is sent on to the Treasury (presumably, it will be an electronic entry so little electrons pulse their way to Washington). Presto-change-O the tax credit is gone.
Yep, [David] Brooks has that part right. It is exactly the same thing. The fighter plane is moved to the government.
After all, that’s what it is all about, right? From inception, the purpose of the monetary system is to move resources to the public sphere.
Sovereign Currency as a Tax Credit: Confusion for David Brooks
L. Randall Wray
(h/t beowulf in a comment at MMR)
Public sector expenditure adds financial assets to the domestic private sector by marking bank accounts. Taxation withdraw financials assets previously created through public expenditure by marking down bank accounts. Account entries appear with spending and disappear with taxation. Public spending "creates money," and taxation "destroys money."
Note: For those wondering about notes and coin, government does not issue either notes or coin directly into the private sector. Banks exchange reserve balances for vault cash to meet window demand.
3 comments:
Here's my simple explanation of why taxes destroy money. Please let me know what you think.
Imagine that there is only one dollar in existence, held by Mr JP Morgan in the form of a $1 Federal Reserve Note.
We can say the following:
Mr Morgan has a $1 asset, and the Federal Reserve has a $1 liability.
The Treasury has $0.
Given that Fed liabilities are US government liabilities, the US government has a $1 liability.
A $1 tax is then imposed on Mr Morgan, resulting in the $1 note being transferred from him to the Treasury.
Mr Morgan now has $0.
The Treasury now has a $1 asset, and the Fed still has a $1 liability.
Given that Treasury assets are US government assets, the government now has both a $1 liability and a $1 asset.
However, the government's $1 asset is also its $1 liability, and vice versa.
As such the government has net $0.
- Money has been destroyed.
The Treasury then pays Mr Morgan for a service with the $1 note (the US government spends $1).
Mr Morgan now has a $1 asset and the US government has a $1 liability.
- Money has been created.
We can therefore say that the government destroys money when it taxes and creates money when it spends.
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Question: how can money have actually been ‘destroyed’ if the Treasury holds the $1 note as a $1 asset?
Answer: The note is no longer money when it is held by the Treasury. It is simply a piece of paper with numbers and pictures on it. It is simply a physical record of tax collected, of liabilities extinguished (withdrawn from the non-government). Calling the note an asset is simply a method for keeping count of government liabilities returned to the government (liabilities extinguished).
- The $1 note is a liability of the US government. When the US government holds the $1 note it is holding its own $1 liability. As such it has $0.
In the example above, the Fed and Treasury simply represent different sides of the government’s balance sheet.
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Another example:
Imagine that you are the government. You decide to issue liabilities (IOUs written on pieces of paper) with your right hand, and to collect them through taxes with your left hand.
Given that your liabilities are issued by your right hand and collected/held by your left hand, you say that they are liabilities of your right hand and assets of your left hand.
Say you issue a $1 liability (a $1 note) with your right hand, in exchange for a good or service from Mr Morgan. Later you impose a $1 tax on Mr Morgan, which he pays by placing the $1 note in your left hand.
You are now holding your own liability, your own IOU. As such it is no longer a liability. It only becomes a liability when it is issued to and held by someone other than yourself. Your liability is then that other person’s asset.
Money is a liability of the issuer and an asset of the holder. If you hold your own $1 liability as your own $1 'asset', you have net $0. You have $0 money.
When your left hand is holding the $1 note, the note is simply a physical record of tax collected, of liabilities returned. As such, calling it an asset of your left hand is simply a method for keeping count of liabilities returned/extinguished.
If you then spend the $1 note with your left hand, you once again issue or create a $1 liability. You create/issue money.
But these simple examples dont take account of the fact that private banks create over 90 percent of the money in circulation ie most money is not spent or created by the government. How does this square with the above explanations?
@Clrifton Downs
M1 money supply (demand deposits and cash in circulation) is created by government injection (spending and transfers) and bank lending and destroyed by government withdrawal ((chiefly taxation)) and repayment of bank loans.
Bank lending nets to zero. Government injection minus withdrawals results in non-government net financial assets. In the case of a fiscal deficit, non-government net financial assets increase and vice versa in case of a surplus. In case of an equal balance, the amount of non-government net financial assets is constant.
The creation of non-vernment net financial assets accommodates non-government saving desire with out increasing non-governemtn debt denominated in the currency.
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