Executive Summary: A quick overview
Fiat money is inferior to money backed by hard assets. But some forms of fiat money are superior to others. This paper makes the case that, from a conservative or libertarian perspective, pure or “unbacked” fiat money is much less destructive to the economy and to personal liberty than the “debt-backed” fiat money we use today. It suggests a moral, legal and practical method for transitioning from debt-based money to debt-free money.
Conventional wisdom says that the U.S. deficit and the national debt go hand in hand – the national debt supports financial stability by providing “backing” for our ever-increasing money supply. In reality, the opposite is true: The national debt destabilizes the dollar and generates a massive misallocation of resources in the U.S. economy’s public and private sectors.
Much of the damage inflicted on the U.S. economy since we went off the gold standard has been caused by issuing debt to fund the deficit, not by issuing fiat money itself. To cite just one example: interest payments on the national debt amount to a steep $2,000 per year for each person in the U.S. over the age of 18. This amount must be paid each year by taxpayers or funded by going still further into debt.
This paper will show that unbacked fiat money, while not ideal, is vastly superior to the “debt-backed” money that exists in the U.S. today. We will first summarize the idea’s benefits, then address the most serious practical and moral arguments of its detractors, and finally explore some of its advantages in more depth, making the case for a gradual transition to a debt-free monetary system.
- Debt-free money will allow us to slowly pay down the national debt without a lengthy, unpopular and economically damaging austerity program.
- Debt-free money does not saddle future generations with unchosen obligations.
- Debt-free money poses a lower risk of hyperinflation and economic collapse than debt-based money.
- Debt-free money helps shift monetary control from the Federal Reserve back to Congress.
- Debt-free money is less destructive to individual liberty than debt-based money.
- Under both a gold standard and a fiat money standard, increasing the money supply (up to a point) is necessary to keep the value of the dollar stable.
- Debt-free fiat money is far from perfect, but it is vastly superior to the debt-based monetary system we have now.
Here are the key benefits of issuing unbacked fiat money rather than debt-backed fiat money. (We address the supposed drawbacks in the next section.)
Issuing pure fiat money freezes the national debt at its current level. This gives the economy “breathing room” to begin paying down the debt. It prevents the national debt from growing to the point of triggering an economic collapse.
It allows us to slowly pay down the national debt, without massive tax increases and politically unacceptable cuts to “entitlements”. A large majority of the federal budget, including Social Security and Medicare, requires increased spending each year but is politically “untouchable”. Under these circumstances, the continued use of debt-based money will require a substantial increase in the national debt, while debt-free money will permit us to begin retiring it.
It steadily reduces the amount of taxpayer funds diverted to pay interest on the debt. Most people are unaware that annual interest on the national debt is currently approaching $500 billion dollars, an amount equal to $2,000 annually per adult American! And this amount is slated to rise substantially as the government is forced to refinance its current debt at higher interest rates, and as the debt itself continues to increase. Decoupling the deficit from the debt allows these funds to be invested in more productive enterprises.
It removes a major impediment to implementing deep, across-the-board tax cuts. We no longer have to “pay for” tax relief by taking on more debt.
It eases debt-related pressure on the federal budget. Instead of increasing each year and “crowding out” funding for necessary government services, interest on the national debt decreases each year and frees additional funds for other priorities.
It shifts some of the Federal Reserve’s power back to Congress. While transitioning away from debt-based money does not “end the Fed”, it does limit the power of the Federal Reserve to control U.S. monetary policy, restoring much of this authority to Congress as originally specified in the Constitution.
It ends our financial dependence on our international creditors. Debt-free money removes any influence on U.S. policy that foreign governments might enjoy by virtue of their ownership of U.S. government bonds.
It removes a major cause of government “shutdowns”. Ending the debt “backing” of our currency puts an end to the periodic political crises brought on by the continuous need to raise the national debt ceiling. It thus reduces uncertainty about the ability of the government to perform its responsibilities without interruption.
It halts the practice of “kicking the can down the road”. Any adverse consequences of overspending will be felt in the near term, with no additional mess left for our “grandchildren” to clean up at a later date.
Unbacked fiat money is less destructive of individual rights and personal liberty than debt-backed fiat money. This issue will be more fully discussed later in this paper.
These benefits are not especially controversial among advocates of free markets. However, many conservatives and libertarians consider the benefits to be outweighed by the disadvantages of pure fiat money. We address this issue in the next section.
When discussing monetary policy, conservatives and libertarians are most likely to object to debt-free fiat money on the following grounds:
- An unbacked currency will lead to uncontrolled inflation, as happened in Germany, Hungary, and more recently Zimbabwe.
- Unbacked fiat money has no real value. The government cannot create value out of thin air.
- Removing the dollar’s debt backing will encourage Congress to engage in excessive deficit spending, since many of the negative consequences of such spending will no longer apply.
- Removing the dollar’s debt backing will damage the perceived integrity and soundness of our monetary system in the eyes of the rest of the world.
- Removing the debt backing will cause a worldwide flight from the dollar. Foreign governments and investors will rush to rid themselves of both dollars and the bonds backing them.
These arguments appear persuasive, especially when presented as a group. Yet there are compelling reasons to look deeper into these objections and see if they make sense from a free market point of view. We consider each of these arguments below.
Objection: An unbacked currency will lead to uncontrolled inflation, as happened in Germany, Hungary, and more recently Zimbabwe.
Answer: The German (1921-23) and Hungarian (1945-46) hyperinflations were the products of special circumstances and were not triggered by a political desire to spend recklessly. Each country was on the losing side of a world war and found itself weighed down by a huge and unpayable war debt imposed by the victors (the Soviet Union, in the case of Hungary). Reparations had to be delivered in the form of gold, goods and hard currency. In an attempt to pay off these debts, each country printed massive amounts of its official currency to purchase the assets required to pay these reparations. Neither country had any alternative. This practice directly triggered both ruinous hyperinflations.
The more recent bout of unrestrained money printing in Zimbabwe, which led to hyperinflation, was facilitated by massive government corruption, draconian political and economic controls, and widespread expropriation and destruction of farms and other productive enterprises. These preconditions for hyperinflation do not exist in any advanced market-based economy. If such circumstances do arise someday in the U.S., backing our fiat money with government bonds will not save the country from a financial meltdown; it will likely make matters worse.
It’s worth noting that the U.S. today has one thing in common with postwar Germany and Hungary: the presence of a government debt that we are increasingly unable to pay back. We can continue “kicking the can down the road” as our national debt continues to become more unmanageable, or we can begin to gradually pay it down. Given our present political and economic circumstances, the only way we can accomplish this is by breaking the link between the federal deficit and the national debt.
Objection: Unbacked fiat money has no real value. The government cannot create value out of thin air.
Answer: If unbacked fiat money has no “real value”, then fiat money backed by a bond redeemable only in that same fiat money can have no “real value” either. How can a promise to pay in a currency that has no “real value” realistically serve as backing for the currency itself?
Although inferior to a gold-based currency, fiat money does in fact have real value. The U.S. dollar’s value derives from the fact that it is the official medium of exchange and unit of account within a large, productive and reasonably stable economy. It does not derive from the fact that $20 trillion in U.S. government IOU’s are “backing” the nation’s currency.
Objection: Removing the dollar’s debt backing will encourage Congress to engage in excessive deficit spending, since many of the negative consequences of such spending will no longer apply.
Answer: In our current financial system, there are two types of negative consequences that arise from excessive money creation. There is the immediate, natural and obvious consequence of reducing the value of each currency unit in terms of the quantity of goods and services that it will buy. This consequence occurs whether the currency is debt-backed or unbacked. There are also artificially imposed consequences, which arise from the issuance of additional government debt rather than from the money creation process itself. These consequences are less immediately felt and are cumulative. They eventually manifest themselves in a higher level of taxation and lower economic productivity, as more and more resources are diverted to support rising interest payments on the national debt.
As recent experience shows, a huge and growing national debt is not a meaningful deterrent to an ever-increasing deficit. For the past several decades, Congress has authorized excessive spending despite the explosive growth of the national debt. Today, much of this spending growth is institutionalized and automatic, such as spending linked to Social Security, Medicare and yes, interest on the national debt. It would be political suicide for Congress to seriously cut “entitlements” or fund current spending with massive tax increases. A guaranteed, built-in deficit is with us for the foreseeable future. Our economic fate depends on how we choose to deal with it.
Most Republican members of Congress, along with their constituents, are already on board with reining in excessive federal spending. As long as they control at least one house of Congress, they will be able to limit such spending and prevent it from spiraling out of control. And if the Democrats should regain the presidency and both houses of Congress, a ballooning national debt will not serve as a meaningful barrier to a wild government spending spree. The Obama experience is proof of that.
Objection: Removing the dollar’s debt backing will damage the perceived integrity and soundness of our monetary system in the eyes of the rest of the world.
Answer: Being on the hook for a $20 trillion (and growing) national debt is not a realistic basis for inspiring confidence in the “integrity” and “soundness” of our monetary system. Taking meaningful steps to pay down this debt is much more likely to accomplish that goal. Such steps can only be undertaken using money that is independent of the national debt that it is paying off.
Objection: Removing the debt backing will cause a worldwide flight from the dollar. Foreign governments and investors will rush to rid themselves of both dollars and the bonds backing them.
Answer: The gradual transition from debt-based money to debt-free money is less likely to cause a financial crisis than earlier restructurings, such as the dollar’s devaluation in 1933 or removal of the dollar’s gold backing in 1971. These abrupt changes in monetary policy did not cause the dollar to collapse. There is no reason to believe that this one will either, especially as it will be phased in over a period of years.
How the world views the future of the dollar depends on our ability to maintain its value. We will be better able to do so if we are not obliged to deal with an increasingly large and unpayable national debt.
Can we (conservatives and libertarians) achieve our policy goals using today’s debt-based money?
In terms of monetary and fiscal policy, a typical conservative/libertarian “wish list” includes the following:
- Fund all essential government services.
- Reduce federal taxes.
- Balance the budget.
- Pay down the national debt.
Items 1 and 2 present no problem. Advocates of limited government agree that essential government services must be funded, and a general consensus exists as to which government functions are essential. We also agree that taxes should be as low as possible without compromising the government’s ability to perform its proper functions.
However, achieving the first two goals puts the last two out of reach. If we fully fund essential government services and make substantial tax cuts, then balancing the budget using today’s debt-based money would require a politically suicidal level of cuts to “entitlement” spending. And if we cannot bring the deficit under control, then how can we even begin to pay down the national debt?
The answer is that we can’t, as long as our money is “backed” by debt. There is no politically viable means of making the numbers work. The only possible way we can pay down the national debt in a debt-based fiat currency is to arrange for tax revenue to exceed government outlays, applying excess tax receipts to the debt. This process would entail a massive, decades-long austerity program requiring significant tax increases along with extensive cuts to Social Security and Medicare spending. Voters have clearly shown that they will not support such draconian measures.
And from a free market point of view, implementing such an “austerity” policy in today’s economy would force us to put our other goals on indefinite hold. An “austerity” budget would doom any chance of achieving meaningful tax cuts or adequate funding for critically needed government services, such as infrastructure maintenance and repair. Moreover, it would depress overall economic activity for an extended period of time, making nearly everyone worse off.
If a federal budget surplus is not an option for the foreseeable future, then there is no way that today’s monetary system can be employed to roll back the national debt. Debt-based money is simply not an appropriate tool for the job.
What about debt-free fiat money? With no offsetting liabilities, any new money applied to paying off the national debt reduces the principal by the exact amount tendered. In theory we could pay off each bond or treasury bill as it matures. In practice this would not be a good idea, as it would risk introducing too much cash into the economy at one time. Paying off part of the maturing debt and rolling over the rest makes more sense. Such a program would remove a huge burden from the U.S. economy, as it would require no extended period of forced austerity and no tax increases.
In today’s U.S. economy, high levels of deficit spending are “locked in” for the foreseeable future. This will continue putting upward pressure on the general price level. Despite this circumstance, we can use debt-free fiat money to limit price inflation and other harmful consequences of this deficit in two ways: (1) Support a federal budget that fully funds essential services, along with the minimum amount of “entitlements” that the voting public is willing to accept. And (2) reduce taxes to the point where the advantages of allowing taxpayers to keep more of their own money are offset by the disadvantages of further money creation.
Debt-free money enables conservatives and libertarians to achieve three of the above four policy goals: fund essential government services, reduce federal taxes, and begin paying off the national debt. It does not accomplish the remaining goal, balancing the federal budget. But as we show in the next section, balancing the budget is not really a worthwhile goal until we return to a hard money standard.
Is balancing the budget a good thing? What happens if we don’t?
Surprisingly, the answers to the above questions are not the same in a fiat money system as they would be under a gold standard.
To understand why, imagine for a moment that you live in a country on a gold standard. One day the government decrees that henceforth it will no longer issue any new gold coins, and further decrees that its existing gold coins are the only forms of legal tender that will be officially sanctioned. The country’s money supply is now “stable”, but its value is not. As the economy continues to grow and the demand for money increases, existing gold coins quickly acquire a premium over other forms of gold, because of their value as that country’s units of account and media of exchange. If the “no new coinage” policy continues for long, this premium will continue to increase, and distortions such as trade and credit imbalances will begin to appear. By freezing the money supply, the government undercuts the ability of gold to effectively perform its vital role as a stable unit of account and medium of exchange. Eventually such a country must either resume gold coinage or consider itself, for all practical purposes, to be off the gold standard.
The above exercise demonstrates that an increase in the money supply is not bad in itself. Within a productive economy, it is a natural and necessary means of providing a reasonably stable unit of account and medium of exchange. This is true whether a country’s monetary system is fiat or gold-based.
Under a gold standard, the government provides a mechanism for this necessary increase in the money supply: turning gold bullion into coins. Each gold coin minted increases the amount of money in circulation, even though the existing amount of gold in the country and the world remains the same. And the government can transform any amount of gold into coins and release them into circulation without creating an imbalance in its budget. Under a gold standard, both a balanced federal budget and a continuing increase in the money supply can easily coexist, because neither policy creates a problem for the other one.
The exact opposite is true in a fiat money system. A balanced federal budget and an increase in the money supply cannot coexist at all, because the amount of money in circulation at any time is tied to the government’s accumulated budget deficit.
If the U.S. government begins balancing its budget, it will issue no new money. Therefore the money supply will remain constant while the amount of goods and services increases. This will lead to the same distortions that would be encountered in a hard-money economy if the mintage of gold coins were suspended: the value of each dollar will increase relative to the amount of goods and services it can buy. This may appear to be a good thing compared to the opposite situation we face today, but it isn’t. At present, excess money creation favors debtors over creditors, allowing them to discharge their debts in ever-cheaper dollars while their nominal wages are rising. Freezing the currency in place would favor creditors over debtors, who would be forced to pay back their debts in appreciating dollars as their nominal wages were being forced down. Neither of these outcomes is desirable. Either too much or too little money creation leads to imbalances within the economy. If the goal is a stable unit of account and medium of exchange, one which neither appreciates nor depreciates, the growth rate of the money supply must approximate the growth rate of goods and services in the economy.
To create the additional money needed to keep the dollar’s value stable in a fiat economy, the federal government must spend more money than it receives in taxes. There is no way around it. But the consequences of this deficit spending are very different for debt-based money and debt-free money. Under a debt-based monetary regime, the national debt (and its taxpayer-funded interest payments) must increase in lockstep with the increase in the money supply. Under a debt-free system this money supply increase can be accommodated even as the national debt is being slowly paid off. Clearly debt-free fiat money is the better alternative in this regard.
Which type of fiat money, debt-backed or unbacked, minimizes the harmful effects of an excessive budget deficit?
To answer this question, a simple comparison can be made. When using debt-based fiat money, a budget deficit means the government must borrow more. This adds to the principal amount of the national debt, and increases the interest that must be paid annually to maintain the debt at its new elevated level. There are three ways to pay this additional interest, none of them good for the economy: higher taxes, cuts in government services, or still more government borrowing. There is no “free lunch” here.
A rise in the national debt is accompanied by a higher perceived risk of default, lowering public perception of the soundness of the debt. And the sale of government bonds diverts investment capital from more productive uses, such as funding the growth of private businesses.
None of these outcomes occur when the deficit is funded with debt-free money: no new borrowing, no additional interest, no higher taxes, no reduction in government services, no diversion of private capital from more productive uses, and no additional risk of default. The disadvantages of fiat money compared to gold-based money still remain, but these disadvantages apply equally to debt-based and debt-free fiat money.
So the answer to this question is: excessive government deficits create much less harm when financed using debt-free fiat money.
The morality of debt-free fiat money
Given that fiat money is with us for the foreseeable future, which type of fiat money is less destructive of individual liberty – unbacked or debt-backed?
Many conservatives and libertarians favor money “backed” by government bonds, on the moral ground that such money is somehow more “honest” and “legitimate”. But is it really? How “moral” is it for a government to base its monetary system on the ability to impose burdensome financial obligations on present and future taxpayers? In the end, debt-based fiat money is nothing more than money backed by forced labor. Is this moral?
Debt-based fiat money requires us to pay interest on the national debt, a drain on our income and wealth that currently amounts to a steep $2,000 per year for each and every adult American! Meanwhile, essential government services such as court systems and infrastructure maintenance are increasingly underfunded and neglected, “crowded out” by the need to service the national debt. Is it moral for a government to force its citizens to pay heavily for the “privilege” of using a debt-based currency, while shortchanging them in the delivery of essential services?
The growth of the national debt creates psychological effects that discourage virtues such as prudence, productiveness and thrift. Such effects do not show up in economic statistics, but they are real nonetheless. Why strive to get out of personal debt if you remain on the hook for your “share” of a growing government debt? Why strive to be more productive when the government demands an ever-increasing percentage of your earnings to service this debt?
With debt-free money, these serious moral issues do not arise. Debt-free money does not burden future generations with unchosen obligations. It does not force taxpayers to make higher and higher interest payments on a growing national debt. It does not discourage the virtues of self-reliance and productiveness. It does not prevent the government from fulfilling its obligation to adequately fund essential services. It does not give the government an excuse to keep taxes high. These are just a few examples of why, in moral terms, debt-free fiat money causes less harm to free markets and individual liberty than debt-based fiat money.
Getting there from here
The federal government already issues unbacked fiat money in the form of the nation’s coinage. Our coins are not backed by government debt instruments, and we do not pay interest for the privilege of using them. However, they constitute only a small portion of our total money supply.
A possible way to launch a major transition to pure fiat money would be to implement a proposal that was briefly considered several years ago: issue high-denomination coins to gradually replace government bonds as “backing” for our currency.
The idea works like this: the Treasury Department mints one or more high-denomination coins. It deposits them at the Federal Reserve, which retains the coins and credits the federal government’s account with their face value. The government then gradually spends this newly created money (but only to the extent authorized by Congress) by “writing checks” on this account to fund the annual deficit and gradually pay down the national debt. This process is repeated as necessary.
Basically, this is a constitutional means of funding the U.S. government deficit – the difference between tax receipts and government spending – without issuing a corresponding amount of interest-paying government bonds. Over time, “debt-backed” fiat money is gradually phased out, as are the taxpayer-funded interest payments needed to service the national debt.
When this idea was first brought to public attention in 2011, most conservatives and libertarians disliked it for reasons pointed out earlier in this essay, and no serious attempts were made to implement it. But it remains a possible means to begin transitioning from a debt-based fiat system to a debt-free one. Legislation permitting the Treasury Department to issue such coins appears to be already in place. If further enabling legislation is needed, Congress has the constitutional authority to pass it.
We must sever the link between federal deficits and the crushing amount of interest we are paying each year to service the national debt. Given the budgetary constraints we face, converting to debt-free fiat money is the only realistic way to retire the national debt and begin spending our hard-earned dollars on more productive endeavors.
 31 U.S.C. 5112(k): “The Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.”
 U.S. Constitution, Article 1, Section 8: “The Congress shall have Power . . . To coin Money, regulate the Value thereof . . . “
Copyright © 2017 by Charles Barr