Schwarznegger to Obama: Watch and Learn, by Marshall Auerback: According to the San Diego Union-Tribune, Republicans and Democrats alike embraced legislation last Friday that would make California IOUs legal tender for all taxes, fees and other payments owed to the state.
Effectively, California is using its IOUs to create a currency. If this bill passes it would allow California to deficit spend just like the Federal Government and with the IOU’s acceptable as payment of state taxes, it instantly imparts value to them. In effect, what you have is a state of the union creating a sovereign currency right under the noses of Treasury, Fed. They are stumbling their way into it… It will be viewed as a stop gap measure at first, and then could very well become entrenched as states realize they have a way to escape balanced budget requirements. …
The … Federal government retains this monopoly under our existing monetary arrangements. If California is successful here in allowing its IOUs to pay tax, it has profound constitutional ramifications. …
It will be interesting to see what the exchange rate is between California IOU and US currency – the IOUs do offer a yield, so should be less than par by design. I wonder if NY is next.
This is like some sort of return to the 13 colonies with all kinds of ersatz currency floating about. It’s hard to believe the Rubinite wing of the Democrats will just let it be, given the threat it represents to Wall Street’s prevailing economic interests, but it is an understandable response…
There are political benefits for Obama…: If the Federal government allows this proposal of the state of California to go unchallenged, it would relieve the President of a major political quandary, which is, does he help California and then open himself to aid requests from other states?…, or, does he let California go and lose 56 electoral votes in the next election?
By allowing them to “solve” their own problem in the manner proposed by the legislation he avoids the quandary. And … they just might let them do it until the import is fully understood.
It is true that this legislation represents a profound break from all federal laws. It is almost bound to incur some sort of constitutional challenge, representing as it does, a profound threat to the Federal government’s currency monopoly powers. But this is another instance where Obama’s inattentiveness to the ramifications of the states’ respective fiscal crises has come back to haunt him. This situation would not have arisen had Obama embraced a simple revenue sharing plan with the states (so that the states’ respective fiscal policies would be working in harmony with his proposals, rather than mitigating the impact of the Federal fiscal stimulus), as recommended by any number of prominent economists…
It will be interesting to see how this plays out. As California goes, will the nation follow? …
Setting aside the particulars of the California case and whether or not the IOUs are actually functioning as money – that’s debatable – very, very generally, the federal government has a budget constraint just like everyone else, well sort of like everyone else anyway — most of us can’t levy taxes or print money. Federal government finances must satisfy
G – T = ΔM + ΔB,
where Δ means “change in,” G is government spending, T is taxes, M is the money supply, and B is bonds. The left-hand side is the deficit, and the right-hand is how it is financed. Thus, when G is greater than T so that there is a deficit in a given budget period, it must be financed by printing new money (ΔM) or issuing new bonds (ΔB). (If it helps, think of G as being 100 and T being 70 so that the deficit is 30. The deficit can be financed by printing 30 new dollars, by borrowing 30 dollars from the public, or some combination of the two)
Now, for states, ΔM is zero since that would be money creation, and they are not allowed to do that. Thus, a state’s budget constraint is:
G – T = ΔB
This must be satisfied each budget period. Because this constraint must hold each budget period, notice what happens if there is a legal or political debt limit — in some states it is effectively B=0 — and B is already at the limit (which means ΔB cannot be positive since that would add to the debt). If the state’s budget deficit rises in a recession due to decreased tax revenue and increased spending on social services, then G must fall to eliminate the deficit, or new taxes must be levied, and the cutback in spending and/or increase in taxes makes the recession worse.
But what if a state was suddenly granted the power to print money? Then it could pay for that year’s deficit without increasing bonds (i.e. debt) any further, i.e. G – T could be financed solely by ΔM if it so chooses. That is, the state now has the constraint
G – T = ΔM + ΔB
If B is maxed out politically or legally so that ΔB must equal zero (or be negative), then a deficit, G – T, could still be financed with ΔM.
Having fifty different currencies isn’t necessarily bad, there are pros and cons to having a single currency across all fifty states, i.e. to forming currency union. With a currency union, individual members lose the ability to conduct independent monetary policy – there is one money and one policy so everyone in the group gets the same treatment – but that is less costly when the the economic differences among the members of the union is small and the same policy is generally applicable. There are many advantages to having a single currency (no exchange rate uncertainty and lower transactions costs to name just two), and for countries considering forming a currency union, there is a list of factors that are cited as working for or against unification. Many of these factors involve social, political, economic, and geographic factors, and generally, though not always, the more similar the countries are, the more likely it is that a currency union will be beneficial (e.g. similar levels of development, a similar mix of products, similar legal institutions, same language). In the case of the fifty states within the U.S., I believe the advantages of a single currency far outweigh the disadvantages, and states should not be allowed to create their own currencies.
Originally published at Economist’s View and reproduced here with the author’s permission.
One Response to “Money Monopoly”
We have seen reports of small towns creating their own currencies to purchase every day, local goods as a response to the recession. Since the Federal Reserv/Treasury is allowed to debase the currency, effectively stealing from the middle class, people have no way to battle inflation or bad monetary policy. Allowing states and communities to compete against the US dollar would force the federal government to manage the money supply more wisely, not by what is political expediant. Imagine the flight to competing currencies (ie gold/silver) if other monies were allowed to be developed. Moreover, Congress abdicated its duty to the Federal Reserve to monetize the currency. AUDIT THE FED and the END THE FED.