Perry ran his hand through his hair and whistled. "You paint a pretty bleak picture. What is the answer?"
"We undertook to set up a general problem which, when solved, would answer the question in all cases of 'How much money does a country need?' We set up the general production-consumption cycle and worked through some problems under the conditions of your period. We should now be able to work the problem in general terms to arrive at the general answer. I believe you could do it with a little thought, but I will state the general answer for you to inspect and approve or reject. Here it is:
A production cycle creates exactly enough purchasing power for its consumption cycle. If any part of this potential purchasing is not used for consumption but instead is invested in new production, it appears as a cost charge in the new items of production, before it re-appears as new purchasing power. Therefore, it causes a net loss of purchasing power in the earlier cycle. Therefore, an equal amount of new money is required by the country.
"This money must be a new issue, not borrowed from the banks, for there is no way to pay it back. To tax it back from the country as a whole is to destroy necessary purchasing power at a later date. To tax it back from the bondholders is a polite name for cancellation. But that was necessary and was eventually done, in a roundabout manner."
"How?"
"By paying off the bonds with new money, then getting it back with inheritance and income taxes. There are several interesting corollaries to our main proposition. Here is one, 'No economic system can create its own new capital.' That must be done by the fiat of the sovereign state. The banks can't do it, even when they are permitted to create money, as they must recover the money they create and loan, plus a charge for the service, or 'interest'. Furthermore, banks should not be permitted to create money at all, because they are, of necessity, interested only in making a profit. They will inflate or deflate the currency to make a profit regardless of the monetary needs of the country. Their interest rates are a reflection of an artificially created money market with no relation to the cost of the service. No, banks must be required to loan only deposits placed with them for that purpose, that is to say, their reserves must be 100%, not 10% as in your day. They must keep entirely separate the funds left with them for commercial exchange, i.e. commercial checking accounts, funds placed with them to invest orloan, and funds deposited for safe keeping. In such a case the customer pays for the service of checking and exchange, pays for the service of safekeeping, and receives interest on funds deposited for investment. But the banker no longer manipulates the money supply of the nation to suit his convenience.
"Furthermore, from what we defined money to be and from our examination of the production-consumption cycle, we reach the important conclusion that there is no necessary one-to-one relationship between taxes and government expenditure. If a country is expanding industrially as the United States has since it was founded, the government is obliged to put out more money than it receives in amount equal to new capital investment in order to avoid deflation. This is new money never received in taxes. In fact the Federal government need not tax at all, except as a regulatory measure. It needs no taxes for revenue. It must never tax as much as it spends or gives away, as long as production is rising. This gives the government remarkable freedom. If a new battleship or a new highway was needed in your day, the economically sound thing to do would have been to go ahead and build, paying for it with new currency. Congress should consider only two things: 'Does the country need this battleship, or road.' And 'Is the country rich enough in manpower and materials to produce it?' If both answers are yes, go ahead and issue new money to do it."
"Just a moment, Master Davis. What is this new money worth, if anything?"
"How do you mean that?"
"Well, in my day money could be exchanged for gold, not very easily, but it could be done. How can one be sure that this new money is anything but pieces of paper?"
"As I told you before, the government will accept it for taxes, and for services such as the postal service. But you want to know what it is worth in terms of real wealth, just as the old style dollar was worth so many grains of gold. Very well. If you present a draft for a thousand credit units or dollar bills to any one of several government warehouses, the bursar will give you an assorted group of basic commodities of weights and standards specified by law."
"Where does the government get these commodities?"
"Grows or makes them, buys them in the open market, and may occasionally accept some of them as taxes."
"That seems awfully cumbersome compared with the gold standard."
"It is cumbersome, but it's worthwhile for it gives a much more nearly stable medium of exchange than gold. As a matter of practice the government keeps very small stocks of commodities because with a stable standard for money the public prefers cash or credit at the Bank of the United States to the trouble of handling bulk in commodities. They are satisfied to know that they can get real wealth in specified amounts, if they choose."
"How about foreign trade? This sort of money would be a nuisance there."
"Gold, as well as platinum, silver, and other convenient commodities, is still used in foreign trade exchange. The government buys and sells these commodities in the open market as a convenience to its citizens."
"I guess that clears it up. It still seems complicated."
"It is, Perry, more or less. But it isn't anything to the anarchistic maze that your old money system was. Let's get back the tax problem. The fact that there is no necessary one-to-one relationship between taxes and government expenditure is startling at first, but is evident from the nature of money. Money in the hands of an individual is a token of a debt to one of us owed by all of us. This token in the hands of the government states that all of us, i.e. the government, owe a debt to all of us, i.e. the government—an absurdity. One cannot owe oneself a debt in any but a poetical sense. Money in the hands of the Federal government is a scrap of paper and ink. It is significant only when held by individuals or groups of individuals.
"We recognize nowadays that Federal taxation is a deflating process, and that Federal government spending is an inflating process. Each process has important secondary effects through which it can be used to regulate for the general welfare. Taxation may be used to prevent unwholesome concentration of wealth. It may also be used to prevent too great a difference in the net income of individuals. The issue of new money is an even more powerful instrument in shaping our economic life to suit our wishes. It is a means of ensuring social security for the entire population through the dividend or inheritance checks. It can stimulate production and prevent inflation of prices through the use of the discount. It is used to assure an equal start for every child. In fact the knowledge of how to use money enables us to inhibit or encourage almost anything without coercion. If we desired, we could institute as near complete a socialism in the United States as we wished, without confiscation and taking over the tools of production. The present set up suits us now. We can change it if we like, when we like, for we understand the economic mechanism. The economic determinism of Marx is an exploded bugaboo, and the American people are the masters, not the slaves, of their economic system."