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HOW SOCIALISM IS INEXTRICABLY LINKED TO OUR MONETARY SYSTEM

Mark Anderson
April 8, 2002

To understand how socialism is inextricably linked to our monetary system, one must understand the difference between fiat "money" and commodity money, and also how our "money" is really created. Our "money" is fiat, and the process for creating our "money" is fragmented between governments and the Federal Open Market Committee.

Fiat "money" is created out of thin air. It is not redeemable in a fixed amount of species, nor does it necessarily exist in paper form. Fiat "money" also requires a process of devolution in order to become fiat "money." To understand this process of devolution, I suggest reading Ludwig von Mises' regression theorem. In summary, in order for something to become accepted as money it MUST have a pre- existing demand. This makes a tremendous amount of sense, as nobody would accept something that does not fulfill their demands in exchange for something that fulfills the demands of another. Essentially trading something for nothing. Unless, of course, that something, which doesn't fulfill the recipient's demands, fulfills the demands of somebody else. That is called indirect barter. However, fiat "money" doesn't fulfill anybody's demands. Fiat "money" is only good for the ends that can be achieved with it, which only comes because of the anticipation of liabilities that gives people an unnatural demand for it. The ends that can be achieved with it is also a constantly moving target, subject to the arbitrary discretion of the inflator.

If I made a bunch of cute looking paper and called them, say, Andersons, nobody would accept them for anything. Likewise, nobody just accepted fiat "money." The dollar started out with gold backing. Gold was already in use for indirect barter. To help you understand the necessary devolution into fiat "money," I am going to explain how banks, prior to the nationalization of the scam, used fractional reserve banking. Depositors would bring gold into bank warehouses in exchange for warehouse receipts. Eventually banks - realizing that people seldom came to redeem their warehouse receipts for the actual gold - began to issue excessive amounts of these warehouse receipts, creating multiple claims on the gold supply. The issuance of the warehouse receipts came via banks lending them into circulation. Despite the fact that the warehouse receipts were not really backed, people would still borrow them because of the perception that they were. Since this perception existed, producers would accept them. Since producers would accept them, there was a demand for them and so people would be willing to borrow them. The act of borrowing actually self perpetuated a demand for the warehouse receipts themselves, now that people had debt, in terms of these warehouse receipts, which they had to negotiate.

If banks were to lend out these warehouse receipts, but not require payments in kind, eventually redemption of the receipts would reach it's capacity with extra receipts left over. People would then begin to realize how worthless the so called receipts are, and then nobody would accept them. Imagine for a moment that somebody offered you a bunch of monopoly money in exchange for your car. You would probably laugh at such a proposal. However, if you knew that the monopoly money was redeemable in a fixed amount of species - say, a better car than your's at the local car dealer - then you would probably accept such an offer. Our "money" is substantively worth only what monopoly money is, yet people accept it. Why? Because of the anticipation of liabilities - a.k.a. the debt that can be discharged with it. While everybody is not necessarily in debt, somebody, somewhere, is. A can make a payment to B with dollars, in exchange for goods, because of the debt that B has to pay off. A may have no debt whatsoever, but since A can redeem those dollars for goods from B, A will now accept payments in dollars from C.

This brings us to understanding why the need for the income tax - or the property tax at the local level. If the Federal Government, or any state or local government, borrows or sells bonds to banks - subsequently creating more "money" out of thin air - to raise revenue for expenditures, there MUST be an accompanying liability. The income tax is that liability. If the Federal Government, or any state or local (property taxes for local) government, did not impose the income tax, that would be akin to watering the milk, and eventually people would catch on to the worthlessness of the dollar. The income tax actually makes all other forms of taxation work. For sake of illustration, I am going to use a hypothetical example. If banks began to lend out fiat "money" and told their customers not to worry about paying the "money" back in scheduled payments, but instead the bank would merely ask for a percentage of the "money" exchanged for goods and services (equivalent to a sales tax), people would be left with a bunch of "money" that would be good for nothing. Remember, fiat "money" is only worth what liabilities can be paid off with it. Since people would discover it's worthlessness, nobody would accept it for transactions. Hence, the income tax actually makes all other forms of taxation work. Including taxation by inflation, which I will discuss in greater detail later in this article.

So expenditures by governments made out of revenue derived from newly created fiat "money" MANDATES a future collection of the exact amount. But how does fiat "money" come into existence? By banks accumulating "reserves" which they can lend out.

Say a bank receives a $1,000 deposit, being the "reserve" requirement is at ten percent, ninety percent of the deposit is called excess reserves. So the bank can turn around and lend out $900 to a customer, which in turn gets redeposited into the banking system, expanding the "money" supply by an additional $900. Now ninety percent of that $900 can be lent out, expanding the "money" supply by an additional $810. Since the "reserve" requirement is ten percent, then deposits can be multiplied by ten. If the "reserve" requirement were, say, twenty percent, then deposits could be multiplied by five. This means that a $1,000 deposit becomes the source of an additional $9,000, for a total of $10,000. And if you do the math you can see that every deposit is a marker for what the "money" supply can be turned into. For example, out of $1,000 comes $900. The $1,000 can be multiplied by ten. That means $10,000 is the limit. The difference between $10,000 and $1,000 is $9,000. That $900 gets redeposited and it becomes the basis for $9,000! Being the amounts get smaller and smaller, it goes through this process roughly twenty-eight times before reaching the ceiling.

Where did the initial deposit come from? FROM GOVERNMENT EXPENDITURES MADE OUT OF REVENUE DERIVED FROM BONDS! ANY government with the power to tax can issue a bond which can be used for bank "reserves." This power to tax is crucial for maintaining the scheme (see the above part on the anticipation of liabilities giving fiat "money" it's purchasing power). Say the Federal Government sells a $1 billion bond, created out of thin air and backed by the Government's power to tax, to Bank A in New York. The Federal Government now has $1 billion to spend, and now the FOMC can purchase $100 million of OLD government bonds. When a government bond, which was used for bank "reserves," comes to maturity, the "reserves," plus whatever amount was pyramided on top of the "reserves," would be extinguished. Thus, the FOMC waits for new bonds that are good for ten times the amount of the old bond before purchasing it, in order to protect the ninety percent of the "reserves" which is pyramided (see the above example of $1,000). The FOMC purchases bonds with ALL NEWLY CREATED MONEY. Keep in mind that the Federal Government also got it's $1 billion to spend. It is that newly created money which becomes the base bank "reserves." These new "reserves" make it possible to keep inflating the "money" supply even more.

So now we can see that the source of our "money" is actually GOVERNMENT SPENDING. Thus, socialism is INEXTRICABLY linked to our monetary system. Furthermore, there are some immediate implications of this. One of those implications is that, in abstract, revenue for expenditures by governments CAN'T come through a sales tax or an income tax. Have you ever wondered why Federal Government employees have to pay income taxes if their salaries are paid out of revenue derived FROM income taxes? Or the same with state employees and their respective state government? Well, the answer is that their salaries are NOT paid out revenue derived from income taxes or sales taxes.

Suppose that the Federal Government, working in concert with the FOMC, creates $500 billion of new bank "reserves." For sake of illustration, forget about all other governments and pretend that this is the only "money" in existence. Now the banking system can create a total of $5 trillion from that initial $500 billion deposit. Now suppose the Federal Government derived it's revenues for expenditures through the sales tax and income tax. What would be happening? One, the "money" supply would not be shifting whatsoever from anything the Federal Government is doing, as the Federal Government would merely be shifting around aggregate bank savings and checking accounts. Two, the "money" supply would be shifting upwards by banks lending to private customers. Three, if given enough time, eventually the "money" supply would hit a ceiling ($5 trillion). Four, eventually the bonds used to create the initial $500 billion of bank "reserves" would come to maturity and then the ENTIRE "money" supply would be extinguished. Subsequently, you would also have bank runs and bank drains.

This means that not only is our "money" created through socialistic endeavors, but also in order to keep the system alive governments MUST be spending revenue derived from bond sales. The implication of this is that governments are taxing us twice. It is a one-two punch at the taxpayer. First, they tax us the moment they spend, as it is all newly created "money" out of thin air. That is taxation by inflation. Remember, as I have discussed in previous articles, inflation is a tax like any other. There is no difference between me taking half of the nation's "money" supply or me simply duplicating the nation's entire money supply, cutting the purchasing power of every other dollar in half. Second, they tax the "money" back in order to extinguish those bonds. And generally it isn't the recipients of the "money" to begin with who pay the "money" back in taxes. This amounts to a massive wealth redistribution scam.

The fact that, in abstract, governments must spend newly created money into existence explains why the need for the income tax. Remember, as I previously stated, fiat "money" REQUIRES a liability in order to give it any purchasing power. The income tax is that liability. If the Federal Government derived it's revenue for expenditures through the sales tax or the income tax, or even through borrowing if it was COMMODITY money, then there would be no need for the income tax. The income tax, or property tax for municipalities, gives governments the capacity to spend all newly created "money." Governments then spend that newly created "money" into existence, which then becomes the base to keep inflating the "money" supply.

There is a huge contrast between fractional reserve banking and what we have now. Fractional reserve banking is the process of creating double claims on the same amount of ASSETS. We have something called a "reserve" requirement, but it is deposits of FIAT "money" that constitutes those "reserves." Thus, a good name for what we have today is fictional reserve banking.



-Mark Anderson mark@thefederalreserve.org or libertyeconomics@yahoo.com

To view Mark Anderson's article archives please visit: thefederalreserve.org/articles.html

Mark is a 24 year old ordained minister who served 4 years in the Marine Corps. He also served on Pat Buchanan's Minnesota state steering committee in 2000. His website is dedicated to macroeconomics & restoring a free market exchange economy by returning the the classical gold standard.

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