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Straight borrowing - A government borrows money via issuing bills or bonds at a discount on face value, promising to repay the purchaser the face value at some specified date in the future. The interest rate is the difference between the face value and the purchase price. Money accounting totals are strictly tied to actual reserves or revenue. As an example, US state govern- ments use straight borrowing. - Expansion borrowing - The government may also borrow via money expansion, with newly allocated currency units functioning as national economy shares that are either publicly or privately owned. The money accounting totals are divorced from direct relation to actual reserves or revenue, under the control and ownership of the money manipulation authority. Virtually all national governments use expansion borrowing. Even though, in this case, the standard overt procedure of "selling a bond" seems identical to the prior case of government borrowing, the underlying mechanisms and effects of the transaction are fundamentally different. Straight borrowing - A government borrows money via bank. The banks may further be either publicly owned or issuing bills or bonds at a discount on face value, promising to privately owned. An even more precise distinction requires more repay the purchaser the face value at some specified date in the sophistication than this overview and is pursued further below. future. The interest rate is the difference between the face value In economics literature and popular accounts, the following two and the purchase price. Money accounting totals are strictly tied cases are also not always carefully distinguished. Current prices to actual reserves or revenue. As an example, US state govern- in an economy may shift under two separate, distinct key factors: ments use straight borrowing. - Supply and demand — Demand for a particular good or ser- - Expansion borrowing - The government may also borrow vice may fluctuate due to changing economic conditions. This is via money expansion, with newly allocated currency units the "invisible hand" of Adam Smith's theory. The value or functioning as national economy shares that are either publicly or | demand of the underlying assets has changed. privately owned. The money accounting totals are divorced from = Money manipulation - Wherever there is not a strict policy direct relation to actual reserves or revenue, under the control and commitment by the monetary authority to a one-to-one or invari- ownership of the money manipulation authority. Virtually all able accounting relation between money units and assets (i.e., national governments use expansion borrowing. Even though, in basically fiat money, or other systems corrupted into fiat money, this case, the standard overt procedure of "selling a bond" seems maybe advertised or feigned otherwise), the total money units can identical to the prior case of government borrowing, the be arbitrarily modified or varied under the title of "money expan- underlying mechanisms and effects of the transaction are sion". The intrinsic value or demand of the underlying assets is fundamentally different. not changed. Adjustments in conventional taxes, on the other hand, have Note that both cases involve a "shortfall of funds", but the first uneven and unpredictable effects which are notoriously difficult case does not constitute seigniorage to anticipate by government agencies, whereas the second does. If a a . . . politicians, legislatures, experts, government's expenditures exceed Thus, our national circulating economists and the public alike. revenue (government revenue is medium is now at the mercy generally from taxes), it can make up The economist Keynes helped some difference via borrowing such of loan transactions of banks, analyse the process of publicly owned that additional funds bec availabl i ansion and considered th viaa free-market loan by bond-holders. | Which lend not money but Bh oncting inflation as a pernicious Demand for these bonds is mainly tied promises to supply money "hidden tax" on the masses. However, to the interest rate offered by the " many monetary reformists have government; higher interest rates spur they do not possess. proposed publicly owned money higher demand. However, even after . | expansion as a very useful means of the "auction of debt", the additional — Irving Fisher (1936) taxation superior to alternatives, available borrowed funds may still be presuming it is limited and erected inadequate to cover a budget deficit with the full knowledge and political fully. In that case, another last resort (other than raising bond consent of citizens (see, for example, Gause'’). Via such a system: interest rates) is money expansion. Hence the latter case can be The state can obtain spendable revenue that requires no vast, considered, in a sense, a "double shortfall" (a shortfall of demand complex and cumbersome accounting system in the way the or of buyers agreeing to loans). income tax, for example, does. A further key distinction must be made on money expansion. A * It also is an extremely uniform taxation system, representing a bank may lend funds either to individuals or to the government. per cent of every dollar in circulation, in contrast to every reported In the former case, typically the "noncentral" bank lends funds dollar or every dollar in only particular types of transactions. deposited by other individuals. In the latter case, typically the Conventional taxes, on the other hand, have uneven effects which government borrows money from the nation's central bank, which are notoriously difficult to anticipate by a legislature. controls issuance of the nation's currency; that is, when the bank * Tax evasion is essentially impossible under publicly owned buys government bonds. In either case, if the bank ha money expansion—precisely as inescapable as inflation! deposit equivalent to the borrowed funds, it's "s borrowing". If only a fraction of the loan is backed by assets, it's Privately Owned Money Expansion "expansion borrowing". This latter case is called fractional Consider the strange worldwide case of privately owned money reserve banking (or lending, or borrowing). The fraction of expansion. Here, a private bank is allowed to issue banknotes deposits to loans that a bank is required to hold is called the based on fractional reserves, i.e., lend out more money than it has reserve requirement. in reserves, either to a government or to citizens. The idea of Hence money expansion can be localised to a given bank's own money expansion as equivalent to a fractional reserve system is banknotes in the noncentral system, or affect the entire nation's not an explicit observation of modern economics, but it's currency in the case of a central bank. In terms of the cui bono, transparently identical. caveat emptor error, most economics literature does not apply or With straight borrowing, a lender provides immediate money- blurs the concept of the central bank's owning assets to back the energy in return for the money-energy returned plus a fee at a government loans, not using the idea of a "reserve requirement" future time. (That fee, "interest", may therefore be regarded as relative to it. the price or market rate of instantaneous money-energy per The above establishes an important direct correspondence repayment time.) But by the money-energy conservation between commodity or receipt money and straight borrowing, and _ principle, no money-energy is provided by the lender via privately fractional or fiat money and expansion borrowing. Moreover, the | owned money expansion; this holds regardless of changes in GDP. two types may be practised by either noncentral banks or a central The "illusory" money-energy that is spent by the borrower is "Thus, our national circulating medium is now at the mercy of loan transactions of banks, which lend not money but ee naa = Ae 5 TaN | Slee ee ara promises to supply money they do not possess.” Privately Owned Money Expansion Consider the strange worldwide case of privately owned money expansion. Here, a private bank is allowed to issue banknotes based on fractional reserves, i.e., lend out more money than it has in reserves, either to a government or to citizens. The idea of money expansion as equivalent to a fractional reserve system is not an explicit observation of modern economics, but it's transparently identical. With straight borrowing, a lender provides immediate money- energy in return for the money-energy returned plus a fee at a future time. (That fee, "interest", may therefore be regarded as the price or market rate of instantaneous money-energy per repayment time.) But by the money-energy conservation principle, no money-energy is provided by the lender via privately owned money expansion; this holds regardless of changes in GDP. The "illusory" money-energy that is spent by the borrower is APRIL — MAY 2004 NEXUS 13 — Irving Fisher (1936) www.nexusmagazine.com