Government tax coercion versus fiat money liberty

This is a polemic.

Let me use a recent post as a jumping off point. You probably saw the Casey Research post on worthless fiat currencies. I don’t believe “hyperinflation is caused by government budget deficits” as Peter Bernholz does.

Hyperinflation is not just about deficits

Hyperinflation has very specific preconditions that are not apparent in the US (yet). In particular, the US has no foreign currency liability, price pressures are still anchored, and currency revulsion has not set in via tax avoidance or use of other currency media of exchange. I should also add that the US has not lost vast amounts of productive capacity as Zimbabwe and Weimar Germany did before their hyperinflations.

I reckon Japan would be the first place to look for hyperinflation if you thought it could happen anywhere in the advanced world. They have a dysfunctional, government, high debt and deficits and have suffered a tragic loss of productive capacity. Yet, as you can see, the Japanese yen is stronger than ever. In the US, despite political dysfunction and the threat of default, US bond yields are remarkably low. None of this speaks to hyperinflation.

People arguing that hyperinflation is around the corner usually are pushing this view because of an ideological bias against fiat money. This is a bias I share because I believe that fiat money allows excessive money creation that winds up as a credit super bubble – and our experience over the past 40 years demonstrates this…The hyperinflation talk is a gimmick used to push a particular ideological viewpoint. While I share that viewpoint and don’t like fiat money, I am not a fear monger, so you won’t see pushing an ideological agenda which has the economics wrong.

On Hyperinflation

That said, I do share hyperinflationists’ loathing of government coercion. This makes me sceptical of fiat money. I called this post “Government tax coercion versus fiat money liberty” because I think this is the juxtaposition which lies at the heart of every hyperinflationist’s prediction of doom. On the one side, we have government coercion with its monopoly of both legally sanctioned physical violence and taxation. On the other side, this coercion is countered by the complete lack of constraint that fiat money represents. This, to me, is the Achilles’ heel of all fiat money.

I’ll try to make this brief but I know I won’t succeed here because I have a lot to say. So, let me go back into the archives for a few quotes from previous posts that express the bits and pieces here and I will try to pull the threads together at the end. I’ll start with government’s role.

Government’s effectiveness and limitations

When I was discussing ideology and economics this Spring, I said:

“My view is that the most logical way of thinking of government’s role is to differentiate between effective and ineffective policy. I am mostly a pragmatist; so what concerns me is the efficacy of government policy, not its size or scope per se.”

I went on to use a quote from a late 2008 on the role of government which basically said that we should be asking ourselves what are our priorities as a people and how best to use government to meet those. I expanded upon this saying “that is not the delineation normally used to frame government’s role in most all economic ideology. Instead, we are presented with arguments about the size and scope of government.” And I think this is the debate largely being waged over the debt ceiling.

I know most Europeans don’t really understand this debt ceiling debate because European countries have universally accepted bigger governmentand for valid reasons. But, in the US, I would say government coercion is less acceptable because it is part of the ethos that has defined America to its citizens as the “home of the free and the brave” since the American Revolution.

The question we should ask ourselves is how we can follow that same Libertarian ethos when revolution is not warranted or desired.

My answer has been predicated on the concept that government has coercive power no other entities in society have. For me, what this means is that government can be a force of benevolence or malevolence, depending upon the mood of the people and who controls the reins of power. When looking at government, it is its effectiveness that counts.

Nevertheless, human nature is such that coercive power can be intoxicating. Left unchecked this power will almost certainly be used only for the benefit of those wielding it and their allies. That is why the U.S. government was established with natural checks and balances via a bicameral representative legislature, an executive and a judicial branch which all shared powers.

I would go further and say that government must always be held in check – even in times of economic distress. If not, a self-perpetuating bureaucracy develops, with a cadre of individuals dependent on government and wedded to institutions or to the coercive power that government allows individuals to exert through their public function. That’s my idea of limited government.

A few quick words on limited government

Let me synthesize these threads by saying this: we want effective government. In the United States, by dint of national history, effective government will usually mean limited government. However, in times of economic plenty or in times of economic stress, this sets up a tension between the ideology of limited government and the exigencies of the times.

What happens is that when times are good, people relax and start to have a ‘deregulated’ mindset which says “times are good. We don’t need government interfering with that. They will make it worse.” This type of ideology reaches an apogee when times are toughest, but then the pendulum swings inexorably in the other direction. “Times are bad. We need government like never before. They will make it better.”

As John Kenneth Galbraith tells it from a control fraud point of view:

At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should perhaps be called the bezzle – amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks."

I don’t think this works differently in other countries. it’s just that the US has a more anti-Government bias than most. Hence the debt ceiling debate.

On coercion and corporatism

Let me go back to that quote on limited government again and underline something. I said:

Nevertheless, human nature is such that coercive power can be intoxicating. Left unchecked this power will almost certainly be used only for the benefit of those wielding it and their allies. That is why the U.S. government was established with natural checks and balances via a bicameral representative legislature, an executive and a judicial branch which all shared powers.

This is the problem – checks and balances, not just within government but of and by government. We see this problem during times of plenty when people are embued with a deregulated mindset.

I happen to be a Libertarian-minded individual, so I have nothing against the free markets or the concept of limited government and deregulation. Freer markets and more limited government are my preferred ideal. However, I am a realist. I understand that markets are never truly free and government fulfils a necessary function.

So, when you hear someone talking about getting government out of the way and allowing the free markets to work, you should be thinking about the influence and control this would naturally engender.

That’s deregulation as crony capitalism. It is not about liberty. It’s not about freedom. It’s about entrenching the interests of a select few at the expense of the rest. The beneficiaries of this cronyism will use all means necessaryespecially ideology, as a means of co-opting those against whose interest this looting works – in order to further their kleptocratic interests. That’s what I meant when I derided the voodoo economics causing the debt ceiling standoff yesterday. Of course, corporations play a huge role in this. So I call this phenomenon corporatism masquerading as liberty.

On coercion and fiat money

I once said:

Some act as if you can pick and choose where government power should be checked. Sure, we can have government dominate monetary policy but it shouldn’t have intrusive social controls. In my view it is consistent to take the sweep of government action across social, economic and military activities and apply the same firm checks on its power.

So go to my quote above about “human nature is such that coercive power can be intoxicating. Left unchecked this power will almost certainly be used only for the benefit of those wielding it and their allies.” That gets you to fiat currency.

Randall Wray asked “Why would anyone accept a ‘fiat’ currency?” and explained that it is because Taxes Drive Money. Taxes are coercive. They are not a voluntary arrangement between two parties like a mortgage. Government tells you that you must pay. If you don’t, you suffer the consequences. This means you need government’s money to expunge your tax liability.

But, why would anyone accept this coercion – especially if “human nature is such that coercive power can be intoxicating?” I call this the confidence trick of fiat currency:

The key to confidence in a fiat currency is the belief of citizens that the government issuing the currency will manage its finances in a way that promotes general “life, liberty and prosperity”. If confidence erodes, tax evasion will rise, citizens will begin surreptitiously using other media of exchange to transact and inflation and currency depreciation will spiral out of control.

The question we are asking right now about the debt ceiling in the US goes to the existence of and need for artificial constraints in maintaining this confidence trick.

Translation: when government is seen as a poor economic steward, inflation and currency depreciation are the result. Currency revulsion steps in – and in very specific circumstances in extremis this can lead to hyperinflation. That’s what those failed fiat currencies were about. Should we impose artificial constraints to prevent this outcome?

Conclusion: The dollar standard must end

Tying this all together, what I am saying then is that there is a kernel of truth in the hyperinflationist’s story. In a fiat world, government has a monopoly of power countered by the ability to create money at will. This is a recipe for excess money creation, trade imbalances, financial crises and all of the ills we have witnessed over the past forty years. The age of fiat currency has been a 40 year experiment in inflation – money and credit creation out of all proportion to the underlying increase in GDP for which they are used.

In the post-1971 period, as emerging economies have grown and developed economies expanded credit, the U.S. has been forced to satisfy global claims for U.S. dollars. This has induced an even larger deficit because there has been no check on balance of payment imbalances without the gold anchor. These imbalances are unsustainable as it puts the U.S. in a situation in which U.S. dollar denominated public and private credit claims cannot be settled with the current dollars outstanding. Either more and more U.S. dollar net financial assets have to be manufactured or the dynamics of debt deflation will kick in.

In plain English: the reason credit has surged dramatically over the last generation has much to do with the monetary system; unless we successfully reflate asset prices, the claims on dollar-based assets cannot be met under this jury-rigged monetary system with the U.S. dollar at the core. I see this as a Ponzi scheme which is now in its final chapter.

There are two exit strategies from this.

  • Manufacturing more U.S. denominated financial assets. Implicitly, this is the strategy we are now following. The goal is to limit the currency depreciation through the additions from the real economy value which ostensibly underpins these new net financial assets. Obviously, if you think spending more money is likely to misallocate resources, as I do, you aren’t going to like this approach.
  • Maintain existing money stock despite the credit claims. Debt that cannot be repaid, won’t be repaid. It’s as simple as that. The problem here, of course, is that this is deflationary. Yes, it rewards savers by not diluting their assets, but there is the real threat of a deflationary spiral and geopolitical tension as a result.

Both of these solutions have major problems. The first solution is a form of Ponzi finance in my view. It’s kicking the can down the road as it leads to debt deflation eventually anyway – unless you want to go the Weimar or Zimbabwe route. The second is deflationary and puts acute stress on economies with high levels of indebtedness due to debt deflation and resulting social unrest that accompanies it.

Ultimately, I hope this highlights the untenable nature of current currency system, because that is what is at the heart of the problem. From a U.S. perspective, a diminished reserve currency role will actually help alleviate much of the problem.

The origins of the next crisis are the debt revulsion we now see all around us. A huge slug of advanced economies are actively attempting to reduce both public and private debts at the same time. This can’t be done under glide-path scenarios unless that debt is defaulted on or written down, which leads to a debt deflation. Of course, governments could attempt to reduce the real value of the debt by depreciating the currency. And this would work for one country in isolation like Great Britain after World War II. However, unless we get a coordinated devaluation, these attempts lead to currency wars, acrimony, and worse.

To me, this makes a very strong case for ending the dollar standard and imposing constraints. I am not advocating the debt ceiling or the gold standard here. We saw during the Great Depression that the gold standard was ineffective at eliminating the trade imbalances that create friction or the super bubbles that lead to financial crisis.

The most straightforward (and least coercive) approach to dealing with this is to end government’s monopoly on money. Allow other monies to be used in payment of tax and as legal tender. But I do think something like Keynes Bancor idea deserves more attention as well. The point is there are ways to mitigate credit creation and the imbalances they create. We are on the wrong path now and I believe that fiat money and the ability to print money at will is central to why. This age of fiat currencies will end badly if remedies are not taken.

  1. fresno dan says

    Some very interesting thinking and some very good points.
    I especially like your view of coercion – I don’t think coercion is the basis of government’s power – to me government follows, as Paul Tsongas would say, the Santa Claus model. G. Bush II and the medicare drug benefit – the biggest entitlement increase since the Great Society. The problem with buying love, even with infinite electronic crediting, is that it is a compound function, and to keep it going there must be banquets for the rich and only crumbs for the rest.
    Now we are in a push come to shove situation, and where does all the money printed go – essentially to financial institutions.
    I wish someone would do a simple calculation on the bonuses paid to bankers this year and many weeks of unemployment insurance that would buy.

  2. Alan Avans says

    The need to limit government’s coercive power is a concern you and I both share, Edward. While I use MMT for analysis, I think it is a tragedy that the sovereign credit of the people has been reduced to a mere tax base and that deficit spending creates a net financial asset that seems to wind up in the hands of bond vigilantes rather than as a increase in the sovereign credit power of the people. I prefer a credit commons over a tax base. If this credit commons, the real credit of the nation, the productive capacity of the nation were formally accounted for, then it would be highly desirable to make the Federal government revenue constrained. But until that day we use what is in our tool box I suppose.

  3. Chaos says

    Fiat money is a bit redundant, all money is fiat. Commodity money is a myth that never has existed (only in the minds of Tea Party types which ignore history and anthropology). Bullion rised because of wars (it’s easy to loot), but since 5000 years ago while there have been cycles of dominant pure virtual credit-money and periods of bullion, almost never (or never) was gold the ‘unit of account to settle debts’ (which is what money is). Periods of bullion have been always related to conflicts between nations (remember, the loot, the ability to force others to pay defeated nations in not a devalued currency, etc.), indeed gold raised in Europe at the age of absolute monarchies deep into the middle age (credit & fiat money, spend by the different governments on the making of medieval Europe) have been dominant until then. When monarchs started to play their games of conquest and later on modern Europe, did the gold power raise and it lasted until 20th century where we had a transition (which finnished at 1971). Yep, it could work as a counterbalance against abuse, but comes with other nasty stuff attached.

    And unfortunately, any attempt at a gold standandard has ended in oligarchy. This is what happened when Roman empire demonetized copper and silver (or alloys) when Caesar got the power: it was a favour to the patricians, the oligarchs of the time. It was unsustainable, off course, much like gold-standard has been unsustainable, in XX and XIX century and has been bypassed someway or an other always.

    Ok, so what do we have left, fiat. Let me get back to XIX century USA, I said later that gold standard was bypassed one way or an other: bank notes, state chartered notes, etc. Pure credit money. I suppose this is what you’re advocating, or something like that. However, again we have problems: first this does not prevent the problem of bubbles, malinvestment and posterior decapitalization (and anyway NEITHER does gold standard, indeed things could get very very bad locally or regionally). Indeed, credit created by banks is not fiat money (even if it’s the same unit of account), and MOST of credit expansion has nos been the cause of governments, but of the private system creating an huge amount of credit (>50 trillion of dollars to start with). Central banks can do so much, and interest rates are too much of a broad spectrum tool.

    Even if you manage to introduce monetary freedom, it does not guarantee much (Australia does not have legal tender laws and neither gold or other currencies are used, for example); this is probably due to the confidence trick you refeer to. First free banking systems in all countries evolved to current system because of a reason: in the end there was always government intervention in crisis and liquidation (regulated by state banks, clearing houses etc.), and anyway notes were backed by something (either government fiat or gold, so the same problem stands). As I’ve seen the evolution of virtual payment systems over the last decades and the rise and fall of docens of them (usually set up in tax heavens), usually as disguissed scams I can see the problem with private currencies: they are even less reliable than government even if government abuses it’s money!

    I still believe that there can be rise of virtual private currency (I’ve some bitcoins) but they are extremely volatile and speculative in nature and probably will always be. And in someway or an other government will always end being involved. I think that for government to accept other currencies as payment of tax is a recipe for disaster in the power game (again!) and capture, when not simply unreliable (because of the above). But we have to explore solutions… so what to do? In my opinion:
    1) More democracy. This means more transparency and more control. The biggest problem is to get out big money out of politics and never let it get back. How politics are financed.
    2) Central banks should dissapeir as they exist, get joint with treasuries and let governments just deficit spend. Issuing of debt (at least long term) should dissapeir. And government should be allowed to tax their own money.
    3) Any “banking” institution that uses government money CAN’T create IOU out of nothing: 100% reserve banking.
    4) Monetary freedom, allow people to contract/settle private debts in any unit of account they want (if they want to use government fiat, it’s their problem, if they want to use gold, the same). Finnish any legal tender laws.

    Would this help solve issues? I really don’t know, money is a complex matter, and issues attached to who and how controls money supply are difficult to solve (even if it can be solved, we would have to fight the status quo, and probably fail), it’s also closely related to power etc. There are probably more ways to solve it. And the international problem would have to be solved someway (anyway, any solution does not have to be a fixed-exchange type between currencies; but could be a flexible basket composed by the value of floating exchange currencies, index of oil and food, whatever).

  4. Alan Avans says

    Complex issues, simple frameworks:

  5. Tom Hickey says

    The basic problem is the dilemma that if money is constrained (fixed rate, convertibility ) then there isn’t enough money, the downside is deflationary (too little money) and if money is not constrained (flexible rate, non-convertible), then the downside is inflation. Those are the choices. There is no alternative.

    Deflationary bias favors low but stable growth, concentration of wealth, and creditors. Inflationary bias favors high but unstable growth, greater dispersion of wealth, and debtors.

    Non-convertible floating rate currency has the advantage of allowing governments to address domestic problems using fiscal policy. This is severely restricted in convertible, fixed rate currency systems and where political sovereigns relinquish currency sovereignty, as in the EZ.

    1. Edward Harrison says

      That is the problem, Tom. A fixed rate exchange system is excessively binding. And that means it would have a deflationary bias in a crisis. Of course, the opposite is true of a fiat system. What we could strive for – if we don’t just use fiat money without government monopoly – is to have a hybrid system. The exchange rates could float freely but there would be the Bancor anchor that would increase in line with nominal GDP.

      1. Septeus7 says

        So what do you think about a dual or multi exchange rate system where every country keeps several parallel rates and mandates the which rate it uses depending on the situation?

  6. Matt Stiles says

    Great post, Ed. Correct analysis and correct conclusion, in my mind.

    I think one of the biggest errors many hyperinflationists make is to ally their mostly correct analysis with a proposed solution of a gold standard. Any ordained standard will naturally create imbalances – just as monopoly in industry does. The answer is to repeal legal tender laws and allow anything to serve as legal tender if two parties wish to use it for exchange.

    This would create some accounting problems and slightly annoying need to convert numerous currencies simultaneously. But these days we already carry around personal currency converters, payment terminals and barcode scanners. Those problems have been solved by technology. The fundamental problems with fiat currencies outlined cannot be solved by technology. They create perverse incentives that serve to perpetuate the imbalances until collapse.

  7. Dave Holden says

    Excellent post, bookmarked. Definitely one I’ll re-read.

    But the old (apparently Tytler quotes spring to mind

    “A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world’s greatest civilizations has been 200 years.”

    “Great nations rise and fall. The people go from bondage to spiritual truth, to great courage, from courage to liberty, from liberty to abundance, from abundance to selfishness, from selfishness to complacency, from complacency to apathy, from apathy to dependence, from dependence back again to bondage.”

    A bit melodramatic I think, but rather pithy. Complicated by the fact that one wonders who the “voters” are – in reality I supsect it is now as it’s probably always been, just the people “that matter”.

  8. nitpickin says

    Bancor? Now we’re getting into Jane D’Arista’s territory.
    “The Evolving International Monetary System”(2009)

    She does make a fairly good argument for it (or the SDR).
    The only problem I see is who will be in control?
    The IMF doesn’t seem to be the bastion of scruples.
    Although, considering it would be a simple mechanical operation devoid of moral judgment, it might be okay to leave them in charge of the accounting.
    In any event, a Supra-national reserve currency would be preferable to the politically charged US$, never mind a “commodity-backed” base principle.
    My intuition tells me there would be some problems in the transition phase, but I can’t quantify what those would be.

  9. john newman says

    Several weeks ago over at Noahpinion there was this:

    As Tom Hicky laid out above you can pick a system with a bias toward deflation, or one with a bias toward inflation. If you care about your money you pick the deflationary bias as the US government, such as it is, is now doing. If you care about your people you pick the inflationary bias as China currently is.

    And if you buy the Tamerlane principle as Noah has laid it out, it is only a matter of time before a ruthlessly effective administrator gets hold of the levers of power somewhere and if that somewhere is one with the bias for money rather than people, in the highly industrialized world in which we now all live, the human cost will beggar all the atrocities of the last century.

    China’s government likes inflation because broad economic growth is its only basis for legitimacy in the eyes of its people. Our government’s pursuit of deflation is rapidly destroying what legitimacy it retains, legitimacy badly corroded by the corruptions introduced extra constitutionally when the Supreme Court decided that money was protected political speech and thus mandated political bribery on the epic scale we now endure. (Look at who gets what from whom here: and the interest served by US politics is very clear).

    My bet is that fiat currency will not go away so long as there are highly vertically integrated economic systems underpinning populations larger than pre-industrial forms of production can support. Competition between states for resources will force states to mobilize their populations and fiat currencies are the easiest way to do this. Such governments will struggle with their legitimacy as they struggle with the inflationary effects of their errors, but unlike those pursuing a deflationary bias, they will not be starving and impoverishing their populations.

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