Lately there has been growing interest in what might be called the modern Greenbacker movement, in homage to the historical political party. The new movement deplores the current system under which the government issues interest-bearing debt to commercial and central banks. Instead, the modern Greenbackers want the government to create new fiat money directly to cover its fiscal deficit. The movement has backing from mature authors as well as glib 12-year-olds. But there are dangers in this approach — it could be a cure worse than the disease.
The basic complaint—largely accurate—of latter-day Greenbackers is that the structure of modern banking and monetary systems allows private individuals (the bankers) to effectively issue money out of thin air in the process of giving loans and taking assets onto their balance sheets. When the government runs a fiscal deficit (by spending more than it collects in tax receipts during a given period), it covers the gap by issuing new bonds, which are effectively IOUs in the taxpayers’ name, and thereby enlarging the national debt. To the extent that the banks (including the central bank) end up holding this new debt, the total stock of money is enlarged (causing price inflation) and, to add insult to injury, the taxpayers must then pay interest on this debt to the private bankers.
This is a very convoluted process, but when one drills down to its essence, the Fed and the commercial banks are arguably giant counterfeiters. (Interested readers can see a step-by-step breakdown of the swindle in my article here.) In this light, it is completely understandable that so many people reject the current system and seek to replace it with something seemingly more democratic.
It’s here where the modern Greenbackers go awry. Recognizing the absurdity of allowing bankers to issue new money, then lend it to the government (taxpayers) at interest, the Greenbackers want to cut out the middleman. They want the government to reclaim control of the printing press—which of course need not even “print” money in this age of electronic financial transactions—and to issue new money whenever its spending exceeds its revenue. This would still be inflationary and raise prices (other things equal), to be sure, but modern Greenbackers argue that at least the taxpayers wouldn’t be shackled with a national debt hanging over them, requiring massive transfers just to pay interest each year.
To repeat, this cure could be worse than the disease. The fundamental danger is that an unchecked power to issue new money might prove too tempting for political officials, who would seek to curry favor with the public through various spending programs that were “paid for” through a general rise in prices. Yes, the present system is indeed absurd, but at least citizens understand—however vaguely—that massive government budget deficits will ultimately prove painful. This recognition, as well as the procedural requirement of periodically raising the formal debt ceiling, at least puts some brake on the growth in federal spending.
In the limit, one could imagine the Greenbacker program not only abolishing government deficits but also all forms of taxation itself. Every year, the government could decide how much it wanted to spend, and then simply “print” that much new money. The IRS could be shut down, and no one would ever need to fill out a tax form again. Besides the savings in explicit tax payments, individuals and businesses would be spared the expense of hiring CPAs. Furthermore, removal of the tax burden would instill a massive dose of “supply-side” incentives for more work and output.
At first blush this sounds like a wonderful proposal. Yet there is one tremendous downside: the government would debase the currency, perhaps gradually but possibly in a snowballing catastrophe. For example, in Fiscal Year 2011 the federal government spent $3.8 trillion. In mid-year, the “M2” monetary aggregate was $9.0 trillion. Thus, if we assume (unrealistically) that the demand for money stayed constant, then financing the federal government’s purchases through the printing press would have led to a 42 percent increase in prices in the year 2011 alone.
The problem is deeper than even that, however. Faced with the prospect of such large annual rates of price inflation, and with their inherent unpredictability to boot, people would flee the dollar. In other words, not only would the supply of dollars increase much more rapidly, but the demand to hold dollars would rapidly decline. The result would be a fall in the dollar’s purchasing power much greater than the issuance of new money alone would have suggested.
To be sure, today there is a sophisticated school of thought—called Modern Monetary Theory or MMT—that is aware of these difficulties. For precisely the reasons I have given, MMTers want to retain the government’s power to tax, in order to “extinguish” money from the system when price inflation is unacceptably high. But if we can understand why financing government spending purely through inflation would lead to disaster, such that we need to “rescue” the system by adding taxation, then Greenbacker proposals suddenly seem much more dubious.
Ultimately, all government spending redirects resources away from the private sector and into politically directed channels. Arguments about how to finance this spending—whether through explicit taxation, borrowing, inflation, or some combination of the three—often reduce to empirical claims about each method’s relative ability in constraining the spending in the first place.
So long as Americans think it’s fine for the federal government to stick its nose into just about every facet of our lives, there is no magic bullet to transform Uncle Sam into a mere financial nuisance. No, a massive empire requires massive tribute, regardless of the mechanisms through which it is transferred. The proposal to scrap the current system, and simply hand a raw printing press over to the politicians, should give any conservative pause.