Wednesday, January 23, 2013

US Bonds do not finance anything.

Positing a hypothesis that the sale of bonds by a sovereign state, which has a monopoly on the creation of its own currency, does not serve to finance any government functions. It is assumed that all bonds are sold and redeemed only in the sovereign currency, a necessary condition if the sovereign is to retain the monopoly control of its money supply.

A moment's reflection might make it clear that for a bond to be purchased, it was necessary for the sovereign to have previously issued the money. The sale of the bond then becomes an exchange of one form of liability for another. This exchange does not result in any increase in the money holdings of the sovereign state. In a fiat currency system the state cannot accumulate wealth outside of capital goods it may acquire. Rather it is like a wizard that can control the weather.  The wizard doesn't have storms stored away and has no place to put them when they are no longer desired. In a similar manner, the state neither has nor doesn't have money.

The sovereign would easily issue the necessary currency for its own expenses. When an appropriation is authorized, there is no " bank account" whose balance must be checked. There is a simple entry made on the sovereign's spreadsheet that places the necessary funds in the reserve account of the appropriate bank.

There is no burden placed on the sovereign by the redemption of bonds. Such redemption's, as noted above, are only paid in the sovereign's currency and there is an unlimited supply of that.

Bonds do serve the state as a means of controlling interest rates, if it desires, but the intent to raise operating funds loses its meaning when a country leaves a commodity base currency, such as the Gold Standard.

In the United States there is an artificial constraint placed on the government's operation, the Debt limit. Congress is required, by the Constitution, to approve of the issuance of debt. Congress is also restrained from delegating its authority to another branch of government, in this case the Executive branch, without clear goals and limits being established. In 1917 Congress established the first debt limit to keep from being bothered by the Treasury during the build up to WWI. The limit was set at $11 B which was well above the debt at the time.

Over the years that limit has been kept high and generally out of the way and only recently has it been used for political posturing. As an interesting note, only one other country has a similar limit: Denmark. As a ratio of debt to limit, we would have the limit set to $50T to emulate Denmark.

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