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George Reisman

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Only A Gold Dollar Will End Deficits*


George Reisman**

(February 17, 1997)

The United States government has had a budget deficit in almost every year since 1933. Repeated pledges to end the deficits have come to nothing. The latest pledge, President Clinton's plan to eliminate the deficit by the year 2002, is only one more such empty promise. Seventy-five percent of the spending reductions he projects are to take place in the last two years of his plan, which happen to be years that come after he will have completed his second term and have left office.

In desperation, because of this dismal record of failure, opponents of budget deficits have come to the conclusion that the only hope of success in eliminating them is the enactment of a constitutional amendment that will mandate the achievement of a balanced budget.

The goal of a balanced budget is certainly an extremely worthy one. But the enactment of a constitutional amendment is simply not the way to accomplish this objective. It is not, because it will almost certainly contain major loopholes, as a condition of its being enacted in the first place. If it is enacted without major loopholes, it is almost certain very soon to be ignored, and thereby help to further undermine the authority of the Constitution. What is even worse is what would have to be done to prevent such an amendment from being ignored.

And that is, the amendment would have to provide the Supreme Court with some kind of enforcement mechanism, so that after perhaps a few reminders to Congress that it was in violation of the Constitution, the Court would be in a position to compel Congress to comply. In other words, to make it enforceable, the amendment would have to provide for the Supreme Court to be able to step in at some point and impose a balanced budget. The Court would have to be given the authority to take control of the government's revenues and expenditures and see to it that they were brought into balance.

What this would mean is the destruction of our whole constitutional system of division of powers among three independent and equal branches of government, namely, the executive, legislative, and judicial branches. The Supreme Court would have to be enabled to usurp both the constitutional authority of Congress and important executive powers as well. It would have to be transformed into a virtual judicial dictatorship. In other words, to be effective, a constitutional amendment for balancing the budget would have to serve to nullify most of the rest of the Constitution.

I don't think that any American wants to balance the budget by means of destroying the American system of government. Thus, the balanced-budget amendment must be given up as certain to prove highly ineffectual. If it were not to be ineffectual, it would constitute a revolutionary danger.

Fortunately, there is a way to achieve balanced budgets, one which would almost certainly be highly effective and, at the same time, would constitute absolutely no threat to our constitutional system of government, but, quite the contrary, would greatly reinvigorate it.

The nature of this method is indicated by the very fact that deficits have been a chronic problem in this country only since 1933. Before that time, the government's budget in years of peace was in balance almost as often as since that time it has been in deficit. Indeed, in that era, the budget deficits that were incurred in wartime were followed by actual budget surpluses in the postwar years, in order to reduce the size of the outstanding national debt.

What has been different in the years since 1933 compared with the years before 1933? Is it simply a matter of choice on the part of the President and Congress? Or is it a matter of the presence or absence of some external circumstance that powerfully affects their choice concerning whether or not to balance the budget?

The answer is that it is a matter of the presence or absence of gold dollars. Prior to 1933, our monetary system was based on gold dollars. Since 1933, it has been based on irredeemable paper dollars. Few differences could be more profound.

Gold dollars are dollars that the government is simply physically incapable of making. They are pieces of actual gold. In essence, they have to be laboriously dug out of the ground. Irredeemable paper dollars in contrast, can be manufactured by the government, virtually without cost and without limit.

When gold dollars prevail, the government is compelled to obtain all the money it spends from the citizens. It has absolutely no money of its own. Its ability to spend is thus absolutely limited by its ability to obtain money from the people.

True, the government could borrow for a time even under these circumstances. But whatever it borrows comes from the people, and every dollar that it is obliged to repay must also come from the people--together with interest. And this is the rub in borrowing gold dollars. To the extent the government borrows and runs up debt, it has to obtain more and more money from the people--the interest and the principal payments added to the funds required for its regular operations. This has limits. To press the limits means to confront the day when the government simply runs out of money. To go down the path of borrowing at all, means that it becomes financially more and more difficult to run the government.

Under a system of gold dollars, the President and the Congress know all this very well. They live in the same financial world as the citizens--a world of limited financial means. They are compelled to act responsibly because there are serious negative consequences for them of not acting responsibly, consequences which they easily recognize. Thus, they avoid deficits for the same reason that every responsible private citizen avoids deficits and for the same reason that they avoid any other kind of obviously self-destructive behavior, such as jumping from high places or eating spoiled food. No constitutional provision is required: perception of the facts of reality is enough.

But under a system of irredeemable paper money, such as we have had since 1933, everything is turned upside down. Now the government has its own money--money that it itself manufactures. It is no longer financially dependent on the people. If the tax revenues obtained from the people are not enough, the government can supply the necessary funds from its printing presses--or by the stroke of a pen or the use of a computer keyboard. (With these last, it can have as many new dollars credited to its checking account as it wishes.)

Government borrowing takes on a very different character. A substantial part of government borrowing even ceases to be actual borrowing. It is money creation that is called borrowing--i.e., the Treasury sells securities in one part of the market and the Federal Reserve System (a government agency) buys government securities in another part of the market, paying for them with irredeemable paper dollars that it creates virtually out of thin air. Even the borrowing from the citizens that goes on undergoes a radical change in its significance. Because it can manufacture its own money, the government need no longer be concerned that it will lack the means of paying its debts. If need be, it can simply manufacture the necessary additional funds.

But the most profound change that results is the total reversal of the financial relationship between the citizens and the government. When the government has the power to manufacture money, not only is it no longer financially dependent on the citizens, but the citizens become financially dependent on it. The government becomes a source of money to them. Its financial role is switched from that of a dependent, who must obtain its funds from the people, to that of a financial provider, from whom the people obtain funds. It is because of this, perhaps more than anything else, that the people of the United States have come to look to the government as a source of wondrous free benefits.

To make fully real the implications of the government's financial position under today's system of irredeemable paper money, the reader should imagine that he himself had a license to create money--accompanied by a printing press in his basement or garage that could turn out $100 bills, say. In such circumstances, would anyone feel a need to balance his personal budget? Suppose he spent a few thousand, or a few hundred thousand, dollars more than he earned in a year? Did he have to borrow that money? If he did borrow it, would he have any difficulty in repaying it? Why should he ever stop spending more than he earns? If once in a while he feels bad about his behavior and now and then resolves to change his ways, can he really be expected to change? How will his friends and relatives, and the merchants he deals with, perceive him? Won't they view him as a wonderful sort of Santa Claus and won't they be constantly pressuring him to spend? After all, he can obtain the money so easily and effortlessly.

Essentially these have been the financial circumstances of the United States government since 1933. The government will not abandon its policy of deficits until these circumstances are changed. This means, it will not abandon its policy of deficits, until it loses the power to manufacture money, which in turn means, until the United States dollar is once again gold.

Reinstituting a gold dollar will certainly not be quick or easy. But there is one step that could be enacted that would also be immediately and directly helpful in ending budget deficits. This is for a simple majority in both houses of Congress to pass a law prohibiting the Federal Reserve System from increasing its holdings of U.S. Treasury securities beyond their level existing at some definite date, such as the date of the law's enactment. Thereafter, apart from replacing expiring government securities with equivalent new government securities, the Federal Reserve's open market operations would take place exclusively in the gold and silver bullion markets.

One major effect of this would be that the increase in the supply of Federal Reserve notes and deposits would then occur in conjunction with the System's acquisition of new and additional precious metal reserves. This would substantially raise the price of gold and greatly increase its monetary role, both of which are necessary preliminary steps toward the reinstitution of a gold dollar. At the same time, the Federal Reserve System would cease to serve as a money machine for the United States Treasury. As a result, further additions to the national debt beyond modest proportions would have an immediate and significant depressing effect on the market for government securities. This would operate to limit such additions, i.e., to limit, if not end, deficits.

Such a law would be far more effective in eliminating deficits than would a constitutional amendment explicitly forbidding them, and would certainly be far less difficult to enact. Naturally, for the time being, it could allow for exceptions to the prohibition on the Federal Reserve's purchase of additional government securities, such as the outbreak of a war declared by Congress, or the purchase of Treasury securities issued in exchange for the assets of banks that had failed or were in danger of failing. (This last provision would serve to prevent a deflation of the existing money supply, which might otherwise be possible.)1

Enacting such a measure, and going beyond it, to a new gold dollar, to balanced budgets, and to a government that is once again the dependent servant of the people rather than their increasingly powerful master, will be a difficult struggle. Along the way, all of the enormous errors and misconceptions surrounding the gold standard will have to be addressed and overcome, such as the claims that it is deflationary, causes depressions and unemployment, and inhibits economic progress. But this can certainly be done if the friends of sound money, limited government, and the sovereignty of the individual citizen take the trouble to learn sound economic theory.2


1. Allowing for these exceptions is not to advocate either wartime inflation or government subsidies to banks. Both of these powers presently exist and will go on existing for some time. In the interest of obtaining important movement in the direction of gold and consequent major limitation of the powers of government, my proposal would simply leave these particular powers alone for the time being. It thus represents what I have described elsewhere as an "appropriate compromise." See George Reisman, Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996), p. 974. Moreover, the situation of fractional reserve checking deposits and their potential for deflation is one that has been created by generations of government intervention in money and banking. Avoiding such deflation in conjunction with movement toward gold is consistent with the process of the government's making an orderly retreat from this intervention. On this subject, see ibid., pp. 959-963.

2. I deal with the errors and misconceptions concerning the gold standard in ibid., pp. 951-963. For an example, use the link immediately below.

*Copyright © 1997 by George Reisman. All rights reserved.

**George Reisman, Ph.D., is professor of Economics at Pepperdine University’s Graziadio School of Business and Management and is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). 

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