The Modern US Monetary System

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On Modern Monetary Realism

By Rick Kahler MS CFP® ChFC CCIM www.KahlerFinancial.com

In a previous ME-P column I explained why any currency-issuing country, like the US, will never default on its obligations or run out of money with which to purchase goods and services priced in its own currency. Sovereign nations that are currency issuers have no solvency constraints, unlike currency users such as individuals, corporations, and government entities that don’t issue currency.

Why the Government is Not-Like Medical Professionals

On Modern Monetary Realism

To follow up, let’s look at what has become known as Modern Monetary Realism (MMR).  Economist Cullen O. Roche describes it in a 2011 article on his Pragmatic Capitalism website titled “Understanding the Monetary System.”

This theory came into existence in 1971 when President Nixon eliminated the gold standard and allowed the government to print money at will. This was a paradigm shift in our monetary policy that’s gone largely unnoticed for decades by many educators, economists, and politicians.

Guiding MMR Principles

The principles of MMR are:

  • The Federal Reserve works in partnership with the US Treasury to issue currency. All other units of government, private entities, and individuals are users of the currency.
  • The government creates money by minting coins, printing cash, and issuing reserves. The private banking sector creates money by creating loans and bank deposits.
  • The Federal Government cannot “go broke.” It is inaccurate to compare it to households, companies, and local governments, which all are users of money and can go bankrupt.
  • The major constraint on currency issuers (sovereign governments like the US) is inflation. It behooves governments to manage the money supply prudently in order to avoid impoverishing their citizens through devaluing the currency.
  • Floating exchange rates between countries are a necessity to help maintain equilibrium and flexibility in the global economy. Nations that unduly inflate their currency suffer the consequences of devalued currency, shrinking purchasing power, and contracting lifestyles.
  • The debt of a sovereign currency issuer is default-free. The issuer can always meet debt obligations in the currency which it issues.

Cullen O. Roche Speaks

Roche suggests that a functional government supports the country’s financial system in four ways:

  1. The US government was created by the people, for the people. “It exists to further the prosperity of the private sector—not to benefit at its expense.” Roche argues that when government becomes corrupt by obtaining too much power or issuing too much currency that results in high inflation, it then becomes susceptible to a revolt and dissolution.
  2. Government’s role is to be actively involved in regulating and helping to build an infrastructure within which the private sector can generate economic growth. Roche views regulation as not only beneficial, but necessary to temper the inevitable irrationality that can disrupt markets. Still, he emphasizes that it is the private sector, not the public sector, which drives innovation, productivity, and economic growth.
  3. Money, while a creation of law, must be accepted by the private sector while prudently regulated by the federal government, keeping in mind that the purpose of the regulation is to maximize private sector prosperity.
  4. “Because the Federal government is not a business or a household it should not manage its balance sheet for its own benefit,” notes Roche, “but in a way that most benefits the private sector and encourages private sector prosperity, productivity, innovation and growth.”

Assessment

Like me, you may need to re-read this a couple of times to begin to grasp the concepts. Once you throw off the outdated pre-1971 model of the monetary system, understanding the basics of MMR isn’t difficult. Knowing the basics of how our monetary system works will help physicians, and all of us, frame the important issues in the turmoil unfolding in Europe and in our own upcoming elections. 

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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4 Responses

  1. Money Supply Measures

    M1 demand deposits (checking accounts)  money in circulation (cash and coins), plus NOW (negotiated order of withdrawal) accounts.

    M2 is the most reliable measure of the money supply. It equals M1 plus savings accounts  money market accounts.

    M3 equals M2 plus other large financial institutions and large time deposits

    The Velocity of Money

    The velocity of money is the rate of circulation in the money supply. The more often money changes hands, the greater the level of commerce. The velocity of money is
    determined by money supply, interest rates, inflation, commerce, and the Federal Reserve.

    Medical professionals, like most consumers, tend to hold less money as interest rates and inflation increase, and therefore the velocity of money increases. Velocity is
    reduced when people increase their money holdings. This occurs in periods of low interest rates and low inflation; the opposite when rates and inflation are high.

    The Health Economist

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  2. Rick and the Health Economist

    Nice review; I first started learning about this subject, from my grand mother, in high shool. She lived thru the first GREAT depresion. So, here is my historical take:

    Monetary and Fiscal Policies

    Government intervention attempts to bring a social and economic justice to a system that tends to distribute its resources efficiently, in the manner supply and demand naturally creates. Democracy and capitalism work as countermeasures within our economic system. Economic policies can have a dramatic effect on financial planning
    results for the medical professional, and it is important to understand them in order to position investments accordingly.

    By controlling interest rates and the money supply, the Federal Reserve Board tries to entice or suppress the consumption spending in the economy. In some cases,
    monetary policy is designed to stimulate the economy, thereby avoiding a recession. In other cases, it is designed to suppress economic growth and slow down or lower inflationary pressures.

    Congress, on the other hand, controls taxes and government spending. Congress and the president are not always in agreement with the Federal Reserve Board. For example, after the Great Depression of the 1930s, Congress believed that deficit spending would revitalize thedepressed economy. In 1936, John Maynard Keynes introduced the concept of demand-side economic policy. The government would become the ultimate consumer and therefore push up the system’s capability for production. This would increase employment and wages, and push the economy forward. This pump-priming policy was used to solve a demand-side problem. When inflation occurred, the government would enact policies to retard the economic system, thereby suppressing inflation. This did not work in the 1970s when monetary manipulation, combined with government’s fiscal stimulus, actually caused inflation to increase.

    Tax policies were also used to achieve economic justice. Congress could stimulate the economy by striving for certain social initiatives. Hence, the marginal income
    tax rates (MITR), which became progressively higher with higher incomes; allowed tax payers to only keep the percentage of income that was left over, and above,
    their tax rate (1-MITR), or (1-28% .72), for example. This redistribution of wealth was seen as fair and a way to stimulate growth. With the 1970s only a memory,
    Congress adopted a new fiscal strategy that later became known as supply-side economics.

    Congress needed to boost productivity capacity and proceeded to cut income taxes. The idea was that the prevailing high tax rates were creating a disincentive to invest, save, and produce. It was later found that, although tax rates were lower, tax revenues increased. Because after-tax revenue was now higher, this created an incentive to work harder and longer. Lower taxes were levied on greater revenue, thereby increasing tax receipts.

    By 1993, the new tax act put a damper on supply-side economics by increasing the marginal tax rates on income and the capital gains rates. Currently, the pendulum
    was swinging back the other way with the recent reduction in capital gains rates and the Economic Growth and Tax Reduction Reconciliation Act of 2001 [Bush era].

    Physician and citizen financial wellness may yet be determined by actions taken in response to upcoming monetary and fiscal policies after the next presidential election in November, 2012.

    I hope to have more on the major economic theories, later.

    Dr. David Edward Marcinko; FACFAS, MBA
    [Editor-in-Chief]

    Former, American Society of Health Economists (ASHE) member
    Former, American Health Information Management Association (AHIMA) member
    Former, Healthcare Information and Management Systems Society (HIMSS) member

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  3. Major Economic Theories

    The above led to the development of the two dominant economic theories today.

    [1] Monetarists

    Monetarists believe the FOMC reserve should not be used to influence the business cycle or economy. Money supply is believed to be the prime mover of the U.S.
    economy. Monetarists control demand, and money becomes more or less expensive, in relation to domestic or foreign markets via the International Monetary Fund (IMF).
    while the latter do not.

    [2] Keynesians

    Keynesians believe the FOMC should not be used to influence the business cycle or economy. Supply and demand is the prime mover of the U.S. domestic economy.
    Fiscal policy uses spending and taxes to control supply.

    Dr. David Edward Marcinko; FACFAS, MBA
    [Editor-in-Chief]
    Former, American Society of Health Economists (ASHE) member

    Like

  4. On Capitalism

    Those record-breaking 19 Olympic medals that Michael Phelps received? He didn’t really win them. Somebody else made that happen.

    True, Phelps was the one who swam those thousands of miles over the years. True, it was his commitment that kept him at the pool for hours when he could have been playing video games like “normal” teenagers. True, it was his muscles that ached as he practiced and honed his skills.

    According to our President, none of that means Michael Phelps won his medals. The people who really won them were his coaches, the people who supported him, and those who built the pools he swam in.

    Of course no one succeeds at sports competitions like the Olympics without coaching, support, encouragement, and help from many others. The athletes are the first to acknowledge this. Yet it’s the athletes we reward with medals, because we understand that, ultimately, they are the ones who have the dream, make the sacrifices, take the risks, and do the work. It would be absurd to tell them, “You didn’t do that. Somebody else did.”

    It’s just as absurd to tell successful business people, as our President so famously did, “If you’ve got a business, you didn’t build that. Somebody else made that happen.”

    It’s always important, in quoting someone, not to take their words out of context. So here is what President Obama said in leading up to his “you didn’t build that” line: “If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges.”

    Up to a point, of course, he was right. Just like successful athletes, successful business people have help and support from family members, teachers, mentors, and their communities. Yet, just like athletes, they are ultimately the ones who take the risks and put in the long hours to fulfill their dreams. And if a business fails, as many new ones do, it’s the owner who is responsible for paying off the losses.

    And the “somebodies” who invested in roads and bridges? Those would be taxpayers. Taxpayers who only had the money to pay taxes because they made profits from their own businesses or earned wages in someone else’s businesses. Governments may contract for the projects that build our infrastructure, but taxpayers fund those projects.

    Listening to our President, one could conclude that it’s the success of government, not the successes of entrepreneurs, that gives us our high standard of living. Government does have a role in supporting a country’s economy, which is to provide services and infrastructure that support entrepreneurship. Yet the government can only pay for those services with the tax dollars of its citizens. A government can’t be economically successful unless the citizens are economically successful first.

    In the aftermath of the Olympics, how many kids are swimming laps because they want to emulate Michael Phelps? Or practicing gymnastics moves because they’ve been inspired by Gabrielle Douglas? Because of their success, these athletes are admired role models.

    When it comes to business, however, our high achievers too often are seen as enemies to be despised instead of role models to be emulated.

    There is one point on which I absolutely agree with the President. Our American system—otherwise known as “capitalism”—is what has allowed business owners to thrive. The more our government discourages individual ingenuity, risk-taking, or labor instead of supporting and rewarding it, the more we endanger that system.

    Rick Kahler MS CFP® ChFC CCIM
    http://www.KahlerFinancial.com

    Like

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