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Money printing, legal tender, and bitcoins

By David Luhman on Fri, 10/31/2014 - 12:25

Now THIS is money printing

As a follow-up to Quantitative Easing (QE) is not "money printing", we're now starting to see some real proposals for "money printing".

As related by Jamese Grant, Financial Times columnist Martin Wolf has proposed that US Treasury simply print "dollars" and distribute them directly. This would be more effective than going through a "central bank" with its messy assets and liabilities.

In other words, to have the Federal Reserve issue new assets called "dollars" (Federal Reserve Notes as currency), the Fed needs an offsetting asset, normally a US Treasy bond but lately mortgage-backed securities as well.

As James Grant aptly puts it :

Even the 21st century paper dollar pays some small homage to classical methods. On the Fed’s balance sheet, notes and bonds “secure” greenbacks and deposits. You can’t convert a wad of dollars into Treasuries or mortgage-backed securities (MBS), but the assets do — in a formal bookkeeping sense — anchor the liabilities. A note is a promise to pay; it is a debt instrument. The bills in your wallet, you US readers, are Federal Reserve “notes.” The nomenclature is a kind of echo, a tip of the hat to the distant days of gold convertibility. Under the Wolf plan, the newly printed dollars would be secured (or backed or mirrored) by no asset. The Wolfian dollar, pound, or euro would be the purest kind of scrip, a wolf in wolf’s clothing.

Unbacked "money" like US Greenbacks

The US actually has a history of issuing such unbacked scrip -- the "greenbacks" issued during the US Civil War. Unfortunately, this Civil War greenbacks have a bad history, with their value dropping from 30 to 60 percent within a couple years after their issue.

So to illustrate the difference between the Fed's recent regime of Quantitative Easing ("IOU/note printing") and REAL money printing imagine this. The Federal Reserve Note in your wallet at least theoretically represents a claim on an asset. It's either a claim on a US Treasury bond, or a mortgage. So, conceivably, the note in your wallet represents a fractional claim on someone's house. If push came to shove, maybe you could somehow convert lots of "Federal Reserve Notes" into a nice home (good luck with that).

The perniciousness of unbacked currency

Now let's look at the REAL money printing Wolf is proposing. Suppose that in addition to the Federal Reserve Notes in your wallet, the government gave you a roll, much like a toilet paper roll, of new "Treaso-dollars". These were issued by the US Treasury, in convenient roll form, to every "needy" family. Of course needy campaign contributors would receive the most rolls, but that's a detail that clouds the issue at hand.

Luckily you have received at least one roll of Treaso-dollars. What to do with it?

You owe $50 "dollars" to your friend, so you try to discharge your debt with your new roll of Treaso-dollars. But your friend already has enough rolls of Treaso-dollars, and he kind of likes the old fashioned "Federal Reserve Notes" (FRN) which are backed by assets, so he demands payment in FRNs. But you don't have FRNs. You just have this roll of Treaso-dollars. What to do?

Legal Tender Laws - The Debtor's Friend

This is where the debtor's friend "legal tender laws" come in handy. The campaign contributors get their friends in the legislature to pass a "legal tender law" that says that when I present one Treaso-dollar, it's equivalent to one FRN (asset-backed) dollar. Problem solved.

Now, to erase your "dollar" debt, all you have to do is get enough rolls of Treaso-dollars. You could conceivably obtain your Treaso-dollars through something called "work", but it's much easier to ask your friends in the government to give you a few rolls of the stuff when you need it. You do have friends in the government, don't you?

This is where we get the word "fiat" when we talk about fiat money. Government "fiat" (law, rule, edict) forces people to accept fiat money even when it's not in their best interest to do so.

Note that, as the largest debtor, legal tender laws are most convenient for the government. Governments can default on their debts, but that's so unseemly. Instead, it's much better to conjure up some "money", declare it legal tender, and pay off your debtors with your newly discovered "money". Again, problem solved.

Other forms of "unbacked" money

Actually, an "unbacked" money system like Treaso-dollars can work. For example, bitcoins are not really backed by anything. But there is a key difference between bitcoins and Treaso-dollars. It requires something called "work" to get bitcoins. In fact, the "work" provided by bitcoin miners actually provide useful work because they enable bitcoin transactions and secure the bitcoin network.

I suppose it may require some "work" to find friends in the government who would give you varying rolls of Treas-dollars, but it's arguable if such work is useful.

The other difference between bitcoins and Treaso-dollars is limited supply. The supply of bitcoins will grow at a known rate, and will eventually top out at 21 million. This certainty allows bitcoin users to get a handle on the value of a bitcoin. But how many Treaso-dollars will be issued? I guess that depends on how many the government "needs" and how many friends-of-the-government there are.

Gold is another unbacked form of money. There are no assets like a house backing gold. It's just a lump of metal that has some marginal utility in electronics, dentistry, and fashion. But it has a couple traits that are different from rolls of Treaso-dollars. Although the future supply of gold is not exactly predictable, it is quite hard to produce gold. You can't just call your friends in the government and ask for a few surplus tons. Also, gold has a five-thousand-year history of convertibility into useful assets like food and shelter. I'm not sure how long a roll of Treaso-dollars will be convertible into things of use.

So there's a quick explanation of the difference between asset-backed Federal Reserve Notes denominated in "dollars", unbacked Treaso-dollars, bitcoins and gold.

In God We Trust

As you ponder this, you may want to pull out a Federal Reserve Note and read the inscription of "In God We Trust". We invite you to place your trust in God, but to also put a bit of your money in the Bitcoin blockchain.

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