Replacing Debt with a Guaranteed Minimum Income
as the bulwark of the economy
[Please bear with me; much ground must be covered.]
The economy is the process of producing and acquiring goods and services. The economic system is the set of institutions through which that process proceeds.
With only a few scattered exceptions, such as North Korea, every nation in the world now has the same basic economic system. It consists of money, a banking system headed by a central bank, and the nation’s central government. (The EU, with central banks in each nation plus a European central bank, is a more complicated version of the system.) The central bank and the central government in each nation are thereby a (sometimes uneasy) partnership. (Also, that does imply that regarding the economy the central bank is a separate governing entity on a par with the government.)
One function of the central government is to establish and enforce the rules governing participation in the economy. Those rules are also part of the system. To be sure, it is those rules — and only those rules — that distinguish one nation’s economic system from another. Otherwise, all have the same system, from the U.S. to ‘Communist’ China.
It is the case that economic sovereignty is a function of economic power. Central governments and central banks of nations with bigger, stronger economies have more freedom to act as they see fit. Still, even the smallest nations on the planet have the same basic economic system as the biggest nations do.
In that system as it currently exists in any nation the functioning of the economy is based on debt. Debt produces the fuel on which the economy runs: money.
That happens two ways.
One way it happens is when banks issue loans. When they do that they do not hand over money that a bank has on hand. Rather, they ‘extend credit’: they credit the borrower’s account with that amount of money.
That money-as-credit is then used to purchase goods/services and becomes income for whatever entity receives it. Income is, most precisely, the actual fuel of the economy. It is what people and businesses depend on in order acquire wants and needs — and paying their taxes — as well as repaying their debts.
[Back in the days of horses and buggies, using debt-as-money-cum-income was more obvious. Checking accounts did not yet exist, much less debit cards, much less phone-based transactions. When people would borrow money from banks they would receive ‘bank notes’ (in varying amounts), actual pieces of paper that promised to remit to whoever appeared at the bank with a note the amount of money indicated on it. The borrowers would then use those notes to purchase whatever goods or services they had borrowed the money to procure. To redeem a note a person had to go physically to the bank that had issued it (or another bank willing to accept that other bank’s notes, which back then was a far from certain prospect). Rather than go to the trouble of going to a bank to redeem notes (which in those days could easily be a chore that would eat up a day), sellers might just use the notes they had received to make their own purchases of goods and/or services. In that way bank notes could stay in circulation indefinitely, flowing as income to this entity and that. Debt-as-money-cum-income in today’s highly integrated, computerized, digitized financial world is essentially the same thing that it was back then, only now it has become the bulwark of the economy. (Anyone remotely interested in the history of banking who has not read Hammond Bray’s Banks and Politics in America from the Revolution to the Civil War ought to.)]
When money-as-income is returned to the bank in repayment of the loan, part of it is interest and part of it is applied to the principal of the loan. The interest is income for the bank. The amount of the payment that is not interest and an equal amount of the principal of the loan are both ‘written off’, i.e., removed from the ‘books’: annihilated, like a particle of matter and its anti-particle encountering each other in space.
The other way that money gets created is when it is created for the central bank/central government economic amalgam (the ‘central authorities’) to use for their purposes. Central banks are ‘lenders of last resort’ for their respective central governments. That is, they are required to make certain that all debt issued by the central government is purchased. As part of its normal operations a central bank decides whether to have money created for it to purchase some of that debt. If it does, that money is ‘created out of thin air’ (with assets moved around to balance the books).
Money created for the central authorities to use for their purposes is currency. It, too, becomes money-as-income. As such, currency is indistinguishable from money-as-credit that has become money-as-income. In other words, income is what makes the economy go ‘round.
There is, however, this most significant difference between the two forms of money: unlike money created when loans are issued, currency is never “annihilated.” It stays in the economy forever. Central banks can take measures to increase the mount of money it and other banks are holding in their reserves, and central governments can (in theory) run surpluses to remove money from circulation, and currency issued by one nation can flow to other nations, but money as currency, once created, is always somewhere.
There was a time when the only reason that currency was created (in anything like significant amounts) was for a central bank to purchase newly issued debt of the central government. It was always a very small portion of the total supply of money in the economy at any one time.
Then came the financial crisis of 2008. In response to that economic debacle currency was created on a vast scale for central banks to use to purchase other debt, debt held by private entities such as banks, insurance companies, pensions, and hedge funds. That was/is called ‘quantitative easing’ (QE).
Even with QE, debt was still at the center of the creation of currency. Then came the Covid crisis and the temporary shut-down of the economy. Currency was created to issue directly to businesses and individuals to replace lost income. For the first time, the currency that was created was not used to purchase debt of any kind. It was created as income for people and businesses, without going through the chrysalis stage of debt.
Why not expand that and make it permanent? Why not make income going directly to individuals the base of the economy, rather than debt?
In the traditional course of things debt has been immediately turned into income. To create debt is to create income. After all, the only sane reason for borrowing money is for purchases of some kind. That is why using debt to create money does ‘stimulate’ the economy.
Debt, though, incurs costs. Borrowers must dedicate a portion of their incomes to repaying the loans: principal plus interest. That income is therefore not available for other uses.
So borrowing creates an immediate stimulus for the economy, but it creates a longer-term drag on it. Since the late 1970’s debt has been used routinely to stimulate nations’ economies to maximize the total output of goods and services. That maximizes employment, total income, and the collection of taxes at existing rates.
The problem is that stimulating the economy that way is inefficient. It takes more and more debt to achieve the same amount of growth. The more debt that is accumulated, the more income is needed to both service that debt and have as much (much less more) purchases of goods/services.
Any graph showing the relationship between total debt and total output (GDP) will illustrate that point starkly. In the U.S., for example, since 1980 GPD has generally continued at something very much like its rate of growth between World War II and 1980. Meanwhile, the graph of debt looks like the path of a fighter jet taking off — using its afterburners.
Making income rather than debt the base of the economy would make the economic system more efficient. It would support the purchasing of goods and services without itself creating a future drag on the economy.
Keep in mind, we are talking here about creating the money for that income as needed. It would not involve taxes in any way.
No doubt, that brings us in every reader’s mind to the bugaboo of all macroeconomic proposals involving money: inflation.
There is a misunderstanding about inflation that is perpetrated by many people — including economists — that creating additional money causes inflation. Inflation is described as ‘too much money chasing too few goods’. Not really.
Rather, inflation results when demand exceeds supply. That can happen if demand increases and supply does not keep pace. It can also happen if demand stays the same but supply decreases.
Sure, for demand to initiate inflation it must be backed up by money to fund purchases. But which is more likely to initiate inflation, a sudden increase in demand or a sudden fall in supply?
More generally, the point is that money is fuel for inflation, but the presence of fuel does not mean a fire will necessarily ignite. Some precipitating event is required.
There are four sources of inflation, four possible “precipitating events.” I’ll list them before discussing each of them. One is an exogenous increase in money-as-income. Another is retail sellers raising prices. Another is a shortfall of supply: a ‘supply shock’. The other is an increase in costs related to the production of goods/services.
In economics all things are related, and each of those sources of inflation can contribute to all the others. When enough of those sources of inflation conspire, the classic ‘inflationary spiral’ is born, in which inflation generates yet more inflation. Still, we can look at each of them as a separate, if not exactly independent phenomenon (from last to first).
Increases in the cost of production can have two sources. One of those is related to the, well, nature of natural resources, which are the ultimate source of all goods. Those resources are not infinite. As the more readily accessed are consumed, less accessible sources of them that take more time and effort to procure are accessed, but at a higher price. That can be called ‘natural’ inflation. Another source of higher costs of production related to natural resources can be unnatural. That happens when an entity that controls a resource arbitrarily raises the price of it, either directly or by restricting the supply of it.
Most people are familiar these days with the term ‘supply shock’. It refers to a sudden decrease in supply. That, again, can be the work of entities controlling supply, but we have seen that it can be the result of a disruption of the status quo that was not induced for the purpose of raising the price of some good or service. Covid caused a supply shock and wars have caused them.
Retail sellers are rarely a source of general inflation. There are too many sellers of essentially the same goods. Once inflation gets initiated, though, sellers in general can start to do what they always want to do: increase prices in order to increase their margin of profit. That leads to the ‘Merry-Go-Round’ effect: with prices going up in general all sellers then must raise their prices, to stay ‘ahead of the curve’, to keep from losing money. Soon, employees start to demand higher pay. Meeting those demands increases the cost of doing business, and the classic ‘inflationary spiral’ is born.
Finally, inflation can be caused by an exogenous increase in income. Back when gold and silver were used to make coins (and were even used in their raw form to make purchases), discoveries of deposits of those metals could and did initiate inflation. To mine those metals was to acquire money that could be used to make purchases, i.e., to acquire income. That source of increased income came from outside the economic system, directly from the ground. That is why it can be called “exogenous.”
In the ubiquitous economic system as it currently exists, income from credit-as-money or even currency is not exogenous. It comes from within the economic system. The total amount of credit that will be created is determined by existing conditions in the economy. Even the creation of currency, which is directly controlled by the central authorities, is informed by the existing conditions in the economy.
Even so, in the relatively brief period of history in which gold and silver have not been legal tender (since the 1930’s in the U.S.), the currency created to be income for people and businesses during the Covid shut-down of the economy is the closest thing there has been to an exogenous source of income. Clearly, it was not exogenous, in the sense that it was instituted by the central authorities as a result of economic conditions (that central governments had created to save lives). Still, for the first time in our contemporary economic era money (as currency) was created without involving the creation or purchase of any debt, and that money entered the economy directly in the form of income.
Yet, it is a simple fact that those ‘Covid relief funds’ contributed to the inflation that has emerged. That money-as-income sustained demand even while there was a shortfall of supply: demand exceeded supply — not because those funds increased demand (though some people’s incomes did actually increase), but because demand did not fall as much as supply was falling. Still, most of the increase in prices has been experienced since the end of the shut-down. That has been the result of pent-up demand (backed by ample savings, given the decreased opportunities for spending during the shut-down) once the shut-down ended. That increase in demand was immediate, whereas it would take time for supply to recover sufficiently. It is also a fact, though, that the presence of inflation encouraged sellers in general to raise prices. That began leading to demands for higher pay, with a nascent inflationary spiral as the result. Supply has been increasing, but a generalized inflation in prices has already been initiated.
[A better, if more technically demanding approach would have been to create money for affected people and businesses to cover debts, rent, and insurance and having people collect regular unemployment to be able to pay for groceries and utilities. That would have covered all basic needs while preventing a subsequent splurge in spending funded by accumulated money.]
At any rate, the question is this: Is it possible to establish a permanent income for people in the form of currency that would not cause inflation?
The short answer is, ‘Yes’. Yes, it is.
Creating such money is simple and easy. As we have seen, in a limited, temporary way it has already been done.
It is only slightly more difficult to imagine criteria for making the income permanent. It could range from being a universal basic income to being a guaranteed minimum income that would not be paid to everyone, but would be an income for which any (adult) citizen could become eligible.
That money, whatever the criteria for receiving it as income might be, would be currency. The most important part of a proposal to establish a permanent income in the form of currency must be to counteract the permanency of currency. There must be some mechanism for capturing some of that money. It would then be annihilated and other money created as needed for the income, or it could be re-issued as income. Either way, the important point is that there would not be a one-way flow of money infinitely accumulating in the economy.
It cannot be denied that initiating such an income would risk inflation. Whatever form the income took, there would be an increase in total personal income. After all, besides making the economic system more efficient, the other obvious reason for taking this approach to supplying currency to the economy is to make the income sufficient to eliminate poverty.
On the other hand, that risk would be limited to the period in which the income was being instituted. As long as the increase in total income — implementing the income — happened gradually enough for supply to keep pace, demand would not exceed supply and inflation would not result. In eliminating poverty, the increase in demand would come mostly in food and clothing.
Those are not supply bottlenecks. Enough food gets wasted to supply that increase in demand. There is no shortage of clothing for people at that level of income. Besides, much of that increase in demand would be to substitute goods of somewhat better quality for more inferior versions of the same kinds of goods: shopping for clothes at this middle-class store rather than that cut-rate, bargain basement store; eating at a better restaurant than fast-food. People’s increased incomes would be absorbed by higher existing prices.
Once the income was fully in place, it would actually help to hold prices steady, by serving as a kind of governor on total demand. More generally, to confuse the metaphor, it would form the ballast in the ship that is the economic system in which all of us are afloat. It would serve to keep the whole of the economy — demand, supply, and prices — on a more even keel.
Again, the particular form such an income might take is a different matter. This author has developed a paradigm involving such an income. In it the income would actually be sufficient for a person to live on — being based on the median income. It would not be paid to everyone or even every citizen or even every adult citizen, but any adult citizen could become eligible for it. To be clear, there are built-in safeguards against inflation.
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further reading:
“Same Economy, Way Better Outcomes for Society” and “Paradigm Shift:” the former focuses on details regarding the implementation of the paradigm (with the U.S. as the illustrative example) while the latter relates the paradigm in a much more technical but more generic way. For those who prefer more income equality there is “The Unnecessariness of Marxism” (for society to go where Marx foresaw). All linked articles are in Medium, but not behind the paywall.