02/14/2012 11:13 am ET | Updated Apr 15, 2012

Our Problem Is Not Insolvency: It's Infinite Solvency

Monetary policy is now sexy. The young are into it. "End the Fed" rings out at Ron Paul's political rallies like "We Will Rock You" used to ring out at Queen concerts.

There is, indeed, a direct relationship between the popularity of economics and monetary policy among the under 30s and the overwhelming support of this group for the candidate whose very political career begun on the day the U.S. went to a pure federally monopolized fiat fraction reserve monetary system back in '71 when Nixon closed the gold window.

The fact that thousands of my readers know exactly what the preceding sentence means just proves the exciting change that is going on in this country, mostly thanks to Paul.

This rise of understanding of monetary policy among us commoners (those for whom the creation of money is a crime (the 99.999%)) is wonderful, but it has not yet undone a misunderstanding that prevails even among many of us who are fighting for real economic justice with our Bastiat and Hayek in hand. And this particular misunderstanding is important because it may be playing right into the very hands of the system, and even the people, we oppose.

The error is simply the idea that our government can go bankrupt. The truth is much worse.

Solvency is the ability to pay one's bills. You become insolvent when you run out of money to pay yours.

Obviously, an entity that can create money whenever it wants to spend money can never be insolvent, and cannot go bankrupt. The U.S. government is such an entity. It is an issuer -- not merely a user -- of a currency that is used to buy real stuff.

Most people believe that their government collects taxes to have money to spend. That's a reasonable assumption because no one else can spend money that he doesn't have -- but it is wrong for the government, which creates its own money and so needs no one to give it any.

This error that government can only spend what it collects supports another mistaken belief -- that if federal revenues fall short of federal spending, the government has to borrow to make up the difference. This idea is very hard to shake because the government clearly does borrow -- and why would it borrow if, in fact, it didn't have to?

But think again. The government never needs to borrow if it can create its own money. Indeed, all it ever "borrows" are the very dollars that it previously created and have found their way into the hands of its "creditors."

Which all begs the question: when and how are all these dollars created by the government?

Here's the answer from the horse's mouth.

"When you or I write a check, there must be sufficient funds in our account to cover the check, but when the Federal Reserve writes a check, there is no bank deposit on which the check is drawn. When the Federal Reserve writes a check, it is creating money." -- Putting It Simply, Federal Reserve Bank of Boston

So when Uncle Sam's check to John Doe for welfare, or to Boeing for warplanes, clears, the money is simply created in John or Boeing's account in the private sector without any debit from any government account.

Simply put, the government creates money by spending money.

Two fascinating but critical facts become apparent.

1) The government taxes not to raise money to spend -- but for two other purposes. The first is to create demand for the currency that it monopolizes, ensuring that it can always acquire resources from the private sector by spending that currency, in the safe knowledge that the private sector will take it. The second is to drain money out of the economy to prevent runaway inflation, which would destroy the currency and, thereby, the government's ultimate control of the economy. (Our taxes are not saved in a government account: rather, money used to pay taxes is simply destroyed -- in the reverse of the process of government spending!)

2) Government doesn't borrow money to be able to spend. The truth is the other way around: already-spent-into-existence dollars are lent back to the government because their owners prefer to get more interest on their dollar savings (such as when parked in Treasuries) rather than less or none (such as when dollars are held as cash in the bank).

If the government really could go bankrupt, and had to tax and borrow the money it spent, as per our happy illusion, freedom-loving Americans would be much better off.

A limit would be imposed on the government's spending on social programs that voters like so much and assure the legislators who support them win re-election. A limit would be imposed on warfare, military adventurism and the economic power of the industrial-military complex. Huge bailouts of banks and foreign countries that benefit people and companies whose destructive choices have destroyed real value would be all but impossible.

All of these constraints would be imposed by the simple requirement that the government would have to come to us, the people, for the money it wanted to spend, and we would feel immediately the economic impact of those decisions and much better able to do the necessary cost-benefit analysis of whatever policy was being spent on. The federal government might then feel the true will and superiority of the people who were financing its latest "good idea" .

The system we actually have -- our current system of infinite government solvency -- ensures that those who have the most political power over us also have infinite economic power over us. This is why our government monopoly of fiat currency is an offense against the most basic of our Constitution -- to keep the people free and to constrain our political masters.

When our government chooses to create-spend money, it gives economic (and therefore political) resources to those people, corporations, social groups and ideas that they favor -- with no resistance whatsoever from those whose lives are made worse in the long-run. In so doing, it prevents society from reflecting and supporting the free choices of the individuals that comprise it, and inhibits the economy from rewarding those who would provide what their countrymen most need or desire.

So why, then, does this illusion of government's potential insolvency persist if the true problem is its infinite solvency?

There are surely only two possibilities.

Politicians who use this system benefit hugely from our thinking that there is some natural economic constraint on their actions, for that illusion makes us less scared of their power. Perhaps that is why they stoke the fear of bankruptcy and feign seriousness about preventing it -- when the truth is that not even bankruptcy can prevent their decisions from destroying our society, our liberty and our currency. And note that last item: the government destroys our economy not by running out of currency while the rest of us keep on keeping on, but by destroying the very unit of exchange itself, so when the political elites and their favored cronies fail, they bring down the nation's entire private economy with them.

That, at least, is one possibility.

The other is that those who lead this nation are under the same illusions about our economic system as are the rest of us -- which would mean, of course, that they don't have the slightest clue about what they're doing.

I'm not sure which of those possibilities is more terrifying.