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?”