Government Always Pays Using Real Fiat Money

Advocates of the Modern Monetary Theory (MMT) emphasize that government never needs to default on it's obligations because it can always pay by using fiat money. What they intend to convey, although they may not realize it, is that they expect that government can pay using real fiat money that government itself creates. We will outline a conventional ontology, typified with a descriptive phrase, so that we can better understand the mechanics of MMT when making policy decisions..

Why is this important? MMT proposes government spending unburdened by limits of taxation, funded as necessary by the creation of money. We need a standardized way of describing the MMT vision of creating money, We'll propose a common sense catchphrase that starts the user down a pathway of common understanding.

In Defense of a Catchphrase

We will follow an unusual method of development. We will throw out a logical catchphrase, almost a slogan, and then see if we can logically defend it. The beginning thought is that government would always want to settle debts with a real currency that is clearly not counterfeit. Government always pays using real fiat money.

Government can do this. The power to create money is reserved by law to the central government. It logically follows that we would expect that the only real fiat money is that money created by those authorized by government to create it. In the United States, that authority is given to the Federal Reserve System*, a central bank (CB).  

Next we observe that this authority is jealously guarded by government. Private banks are not allowed to create money, nor are private citizens. It naturally follows that private banks and citizens can only reuse the fiat money previously created by government. If we follow this logic, we can only conclude that private banks, when they make loans far larger than the amount of fiat money that they own, must be making loans of real money owned by others. That action places the private bank at risk of having a money shortage should all depositors request their money back at one time (in a bank run). We won't discuss this risk here.

Of course, government could also reuse money it had previously allowed. Government could borrow from private banks, a useful way to control the money supply. Government could 'borrow up' money, thereby reducing the amount of real money available to the private sector.

Real fiat money is easily created by the central bank. The central bank merely makes a notation in a record of deposit in favor of any entity, identical to the method used by private banks in making loans. In the United States, the central bank is (generally) prohibited from making loans directly to the central government but the CB can own bonds issued by the central government. Therefore, to create fiat money while complying with the law, the central bank will increase it's internally held deposit level, trade that increase for a privately owned government bond, and then claim ownership of a government bond. This series of actions leaves leaves no money left on the books as being owned by the central bank but places more real fiat money into the ownership of the private sector (which has seen a increase in owned money on deposit), allowing the private sector to continue buying government bonds.

This is effectively the system we have in place today in the United States. Money created by the central bank is usually called "reserves".

If we want to know how much real fiat money has been issued by the central bank, we can look to the total assets owned by the central bank. We know this must be close to the correct number because of this regulatory background: Central banks have no budget allowance from government and must return all profits to government.

Having no real source of money for asset purchases, we can consider that so called CB total assets are more appropriately considered as a place-holder for deposits previously created by the CB and traded away.

Conclusion:

A simple catchphrase, government always pays using real fiat money, has more implications than first apparent. It assumes a complex network of sequential deterministic actions occurring in the day-to-day world. It symbolizes an ontology of money that is in use in modern fiat currency economies. 

The writing in this blog has been underlain by this ontology for quite some time. I propose that other MMT writers also keep this catchphrase and ontology in mind as they write.

*Here we are thinking about money of record, ignoring the actual printing of green money and coin.

PS. I invite readers to comment. I am certainly no expert on the subject of money supply expansion but the guideline proposed makes logical sense so far as I know. I specifically invite readers to point out any logical or factual errors and to offer better a explanation.

(c) Roger Sparks 2021