Steve Keen puts his money on the Fiat against the Tesla with the backing of Ford.

Elon Musk has been making a lot of comments on government debt recently, and though I have a lot of respect for what he’s done in electric vehicles and space travel, I couldn’t restrain myself from ridiculing his views on government debt. That led to another tweeter having a go at me, on the grounds that someone who knows how to make money knows a lot about money .

But in fact, knowing how to make money — in the sense of accumulating vast wealth from being a successful entrepreneur — doesn’t convey any special knowledge about how to create money in the way governments do. 

My exhibit A here is the attitude to government debt of two equally famous entrepreneurs — Henry Ford and Thomas Edison — which was diametrically opposed to Musk’s.

Back in the early 1920s, these two entrepreneurs joined forces to argue that a huge infrastructure project — the Muscle Shoals hydroelectric plant — should be built using government-created money. Their scheme was literally front page news in the Twitter of the day, the New York Times with headlines including Ford hopes to use Muscle Shoals as Step to End Wars and  Ford Sees Wealth in Muscle Shoals. An essential feature of Ford’s logic was that the government doesn’t need to borrow money, since it is a money creator. He wrote on 4 December 1921:

“Army engineers say it will take $40m to complete the big dam. But Congress is economical just now and not in a mood to raise money by taxation. The customary alternative is 30-year bonds at 4%. The US, the greatest government in the world, wishing $40m to complete a great public benefit is forced to go to the money sellers to buy its own money. At the end of thirty years the government not only has to pay back the $40m, but it also has to pay 120% interest, literally has to pay $88m for thirty years.

And all the time it is the government’s own money. The money sellers never created it. They got it from the government originally. The government first gave credit, now it must pay for the use of what it gave. Think of it. Could anything be more childish, more unbusinesslike!”

Ford’s proposal was that the government should finance the dam’s construction by simply creating the money needed. His argument here — that currency and government bonds are effectively just different forms of government-created money — is very similar to the argument that Stephanie Kelton makes today, that bonds and currency are just different forms of government-created money.

Ford’s proposal was that the government should finance the dam’s construction by simply creating the money needed.

This is Kelton from The deficit Myth in 2020:

“Then why does the government need to borrow? The answer is, it doesn’t. It chooses to offer people a different kind of government money, one that pays a bit of interest. In other words, US Treasuries are just interest-bearing dollars.

“To buy some of those interest-bearing dollars from the government, you first need the government’s currency. We might call the former “yellow dollars” and the latter “green dollars.”

When the government spends more than it taxes away from us, we say that the government has run a fiscal deficit. That deficit increases the supply of green dollars. For more than a hundred years, the government has chosen to sell US Treasuries in an amount equal to its deficit spending.

So, if the government spends $5tr but only taxes $4tr away, it will sell $1tr-worth of US Treasuries. What we call government borrowing is nothing more than Uncle Sam allowing people to transform green dollars into interest-bearing yellow dollars.”

And this is Ford from the New York Times article in 1921:

“Now, I see a way by which our government can get this great work completed without paying a nickel to the money sellers. It is as sound as granite. And there is but one thing hard about it. It is so simple and easy that, maybe, home folks can’t see it.

“The government needs $40m. That is 2m twenty-dollar bills. Let the government issue those bills and with them pay every expense connected with the completion of the dam… the entire $40,000,000 issued can be retired out of the earnings of the plant.”

Ford was asked: “But suppose the contractor would be unwilling to accept that kind of currency in payment?” He replied:

“There is not that kind of “suppose” in the situation at all. He would take the government bonds in payment, wouldn’t he? Certainly! Here,” said the manufacturer, pulling a twenty-dollar bill from his pocket, “he wouldn’t hesitate about taking that kind of money, would he? Of course not. 

“Well, what is there behind a bond or this bill that makes it acceptable? Simply this, the good faith and credit of the American people, and twenty-dollar bills issued by the government to complete this great public improvement would have just as much of the good faith and credit of the American people behind them as any bond or other American currency ever issued.”

So, who does Ford sound like here — his fellow entrepreneur Musk, or the MMT advocate Kelton? And which entrepreneur do you trust on this issue?

You don’t: you work it out from first principles instead. This is something that Musk says he does in his engineering, but it’s clearly not what he’s doing when it comes to his attitude to government debt. As it happens, it’s Ford and Edison who did the first principles thinking and got it right, not Elon Musk.

I guessed that most people would think that industrialists like Ford and Edison were opposed to fiat money —money created by the government— and in favour of “sound money”— money backed by gold or some other commodity. In fact, these two industrialists were outright fans of fiat money and critics of the gold standard and, to a degree, private bank-created money as well.

I decided to find out what the public thought that Ford and Edison would think the best way I could — via a Twitter poll.

It’s hardly a representative sample. Twitter itself is a minority of the public, and people who follow me —and therefore know that I am a proponent of Modern Monetary Theory (MMT)—are a much smaller minority still. Moreover, that minority is likely to be biased in favour of people who also prefer fiat money to credit money.

Having hedged my bets in advance, in an outcome that would surprise neither Ford nor Edison, the majority (54.3%) thought that they were opposed to fiat money 

In fact, Ford and Edison were great supporters of fiat money, and outright critics of the gold standard. They wanted the hydro-electric scheme at Muscle Shoals on the Tennessee River to be financed by the government issuing $40m in US currency, without backing that currency by either bonds or gold.

When challenged that, “in a sense, there would be no security behind this kind of money,” Ford replied that: “There would be the best security in the world. Here you have a river capable of furnishing 1m horsepower… This energy is wealth in a productive form. Now, which is the more imperishable, the more secure, this power site and its development, or the several barrels of gold necessary to make $40m. This site, with its power possibilities, will be here long after the Treasury building is a ruin.”

“When the government needs money it will raise it by issuing currency against its imperishable natural wealth,” (Ford and Edison 1921).

I’ve been informed that Max Keiser thought Ford and Edison were in favour of energy-based currency, and therefore that they’d support Bitcoin.

My reply shows my scepticism. Firstly, Bitcoin uses — and therefore perishes — energy, whereas Ford referred to fiat money being backed by the country’s “imperishable natural wealth”— energy and other resources that are still in the ground. Edison made a similar comment on the basis for paper money: “What are bills and checks? Mere promises and orders. What are they based on? Principally on two sources — human energy and the productive earth. Humanity and the soil — they are the only real basis of money.”

Rather than talking about money being backed by some other specific commodity — whether energy or gold — what Ford and Edison were arguing was that a national currency is backed by the non-financial assets of that country: its physical wealth, manifest in its raw materials and its infrastructure, were what gave authority to the financial assets it issued.

Humanity and the soil — they are the only real basis of money.

Edison even described the use of a fiat currency—a paper currency (in his day), backed only by the power of the government — as the mark of a civilised society: “Now, as to paper money, so-called, everyone knows that paper money is the money of civilised people. The higher you go in civilization the less actual money you see. It is all bills and checks.”

When Edison was asked, “would not Mr. Ford’s suggestion that Muscle Shoals be financed by a currency issue raise some objection?”, he replied: “Certainly. There is a complete set of misleading slogans kept on hand for just such outbreaks of common sense among the people. The people are so ignorant of what they think are the intricacies of the money system that they are easily impressed by big words. There would be new shrieks of ‘fiat money’, and ‘paper money’, and ‘greenbackism’, and all the rest of it—the same old cries with which the people have been shouted down from the beginning.” 

Those misleading slogans are alive and well today, as evidenced by our modern-day Henry Ford, Elon Musk, who declared in a Tweet: “Bitcoin is almost as BS as fiat money.” And gold bugs like Peter Schiff who respond to Musk’s condemnation of fiat money with: “I agree, I just think Bitcoin, which is digital fiat, is even more BS than the paper fiat issued by central banks. Gold is not BS. It’s real  money and better than both”.

Meanwhile cryptocurrency enthusiast Max Keiser said: “Bitcoin is the hard science of money. It is the first time you have algorithmic, mathematically pristine and perfect money. That’s the first time in history.”

Ford and Edison would have none of that. They echoed Keynes’s description of the gold standard as a “barbarous relic”, and both wanted it abolished. Ford’s opposition to gold had tinges of his anti-semitism to it, in that he saw it as being controlled by bankers who then promoted war to make their control lucrative. Ford asserted: “Gold as a metal is all right … But … through its scarcity It has acquired a fictitious value far beyond its value as a useful metal… The people of the world made a mistake which has cost them generations of financial slavery when they consented to making gold a basis for the issuance of currency… because gold is scarce … its total supply can be controlled… There is a group of international bankers who today control the bulk of the world’s gold supply…”

Edison concurred with Ford and sounded just like David Graeber in his analysis: “Gold is not money until the people of the United States and other nations put their stamp on it. It is not gold that makes the dollar. It is the dollar that makes the gold. Take the dollar out of the gold, and leave it merely [as] yellow metal, and it sinks in value. Gold is established by law. Just as silver was, and gold could be disestablished, demonetised by law, just as silver was. When silver was demonetised the former so-called silver dollar became worth about 50 cents.”

Edison also sounded very much like Stephanie Kelton in The deficit Myth when he described dollar bills and government bonds as just different forms of government money. When he was asked: “Then you see no difference between currency and government bonds?” Edison replied: “Yes, there is a difference, but it is neither the likeness nor the difference that will determine the matter. The attack will be directed against thinking of bonds and currency together and comparing them. If people ever get to thinking of bonds and bills at the same time, the game is up.”

He also made the MMT point that a fiat currency is backed by the authority of the government which issues it. “Look at it another way. If the government issues bonds, the brokers will sell them. The bonds will be negotiable, they will be considered as gilt-edged paper. Why? Because the government is behind them, but who is behind the government? The people. Therefore, it is the people who constitute the basis of government credit. Why then cannot the people have the benefit of their own gilt-edged credit by receiving non-interest-bearing currency on Muscle Shoals, instead of the bankers receiving the benefit of the people’s credit in interest-bearing bonds?”

Unfortunately, Ford and Edison’s wisdom here didn’t change people’s minds a century ago, and a century later, we’re still having the same pointless debates. Given their cynicism about the capacity of the public to understand complex issues, I doubt that Ford and Edison would be surprised that the view they championed was still the minority view today. Ford is alleged to have said “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning”. What he definitely did say, in a ghost-written autobiography, was: “The people are on the side of sound money. They are so unalterably on the side of sound money that it is a serious question how they would regard the system under which they live, if they once knew what the initiated can do with it.” (Ford, Crowther et al. 2013, p 163).

The people of the world made a mistake which has cost them generations of financial slavery when they consented to making gold a basis for the issuance of currency.

So on one side, we have Elon Musk as a critic of fiat money. On the other, we have Ford and Edison — the tech-billionaires of their time — as fans of fiat money. Who do you trust? Neither: you work it out for yourself from first principles. And this is much harder than just ranting about fiat money on one side, or barbarous relic on the other.

Doubling up

If you really want to know what happens when a government spends more than it gets back in taxes, rather than just guessing, then you’re going to have to work out what happens in double-entry bookkeeping, since that is the quantum mechanics of money.

The fundamental rules of double-entry bookkeeping are:

• all financial claims are classified as either assets or liabilities; 
• the gap between your financial assets — which are your claims on other people — and your financial Liabilities — which are other peoples’ claims on you — is known as your equity; and
• all transactions are recorded twice, following the rule that assets minus liabilities minus equity equals zero.

 

Now let’s see how a government deficit works. To make it simple, we start without bond sales.  

When a government spends more than it gets back in taxes, it puts more money into people’s private bank accounts via spending than it takes out via taxes. Therefore, since private bank accounts are part of the money supply, a government deficit creates money.

That’s one entry in the double-entry process. The other is an increase in Reserves — which are both an Asset of the private bank themselves, and a Liability of the central bank.

Figure 2: A deficit creates money by increasing deposits (liabilities of the banks) and reserves (assets of the banks)

Private Banks	Assets	Liabilities	Equity	A-L-E Check
	Reserves	Deposits
Spending minus Taxation	+Deficit	+Deficit	0	0

We need therefore to see the process from the Federal reserve’s point of view. The Fed is the banker for both the private banks and the Treasury. The Treasury’s numerous accounts at the Central Bank are lumped together into the Consolidated Revenue Fund (CRF). 

The increase in Reserves shown in Figure 2 is caused by a transfer from the Treasury’s CRF, as shown in Figure 3.

Figure 3: The deficit operation from The Fed’ s point of view

Central Bank	Assets	Liabilities		Equity	A-L-E
		Reserves	CRF
Spending minus Taxation		+Deficit	-Deficit	0	0

The CRF is an asset of the Treasury, and a deficit reduces it. How does this affect the Treasury: where does it get the money from?

The short answer is that it doesn’t: instead, the deficit reduces the financial equity of the Treasury. This is shown in Figure 4. The deficit itself puts the Treasury in negative equity, and  obviously, a sustained deficit would put the CRF account into overdraft as well.

Figure 4: The deficit from the Treasury’s point of view

The Treasury	Assets	Liabilities		Equity	A-L-E
	CRF
Spending minus Taxation	-Deficit			-Deficit	0

This is the step which annoys Elon Musk and other critics of fiat money: the Treasury doesn’t “get the money” from somewhere else: there is no “pot of gold” by which the deficit is financed. Instead, the deficit pushes the government into negative financial equity. This is something that, if any other entity in society did consistently, would lead to bankruptcy.

However, therein lies the clue as to why the government can sustain negative financial equity: a company can do the same, so long as its non-financial assets are much larger than its negative financial equity.

A non-financial asset is an asset to its owners, but a liability to no one: things like houses (and even spaceships). The mortgage against your house is a liability for you and an asset for the bank, but the house itself is your asset and no-one else’s liability: instead, it is part of your total equity.

So, what are the non-financial assets of the US government? This is the point that Edison alluded to when he said that behind government notes and bonds stood the government itself, and “who is behind the government? The people.” Figure 5 illustrates this by showing the USA itself as an asset of the Treasury, and by far the largest determinant of the Treasury’s total Equity. 

Figure 5: The non-financial assets of the country dwarf the government’s negative financial equity

The Treasury		Assets	Liabilities		Equity		A-L-E
	The USA	CRF			Financial	Nonfinancial
Values	100000000	-1000			-1000	100000000	0

The nonfinancial assets of the government and the country back, and far exceed, the government’s negative financial equity. Deficit-financed investments, if well-chosen and executed — like the Muscle Shoals project that Ford and Edison were campaigning for — end up increasing the value of the country’s nonfinancial assets as well. This is the reason that the US government can maintain permanent financial deficits: because they’re backed by the nonfinancial assets of the country, which have grown with, and because of, the deficit over time. Over the last 120 years, the average government deficit has been equal to 2.5% of GDP—see Figure 6.

Far from constituting a burden upon the private sector, the deficit eases the private sector’s financial situation. This is the final piece of the puzzle: what does the government’s deficit do to the non-government sectors? As Figure 7 shows, the government’s red ink becomes the private sector’s black ink: the negative financial equity of the government is, dollar for dollar, the positive financial equity of the private sector.

Figure 7: The government’s red ink is the private sector’s black ink

Private non-bank sector	Assets	Liabilities	Equity	A-L-E Check
	Deposits
Spending minus Taxation	+Deficit		+Deficit	0

What about government debt?

How does government debt — really, government sale of Treasury Bonds — change this picture? It does three things:

• It lets the government’s account at the Fed — the “Consolidated Revenue Fund”— remain positive, so long as bond sales are equal to the deficit plus interest on outstanding bonds;
• It lets the Federal reserve maintain non-negative equity, since it has an essentially limitless capacity to buy bonds off the banks in the secondary market. The asset it accumulates — government bonds — can now match or exceed its liabilities of reserve accounts and the CRF; and
• It gives banks an interest income which, customarily, they didn’t earn from reserves, since — before the global financial crisis— the Fed didn’t pay interest on reserve balances.

This overall system is shown in Figure 8. The deficit creates money for the non-bank private sector; interest payments on bonds creates money for the banking sector, in the form of interest on bonds.

Figure 8: The systemic view of government deficits and bonds

	Assets		Liabilities	Equity
Private Banks	Reserves	Bonds	Deposits
Spending minus taxation	+Deficit		+Deficit
Treasury Bond Sales	-Bonds to banks	+Bonds to banks
Interest on Bonds	+Interest			+Interest
Fed Bond Buying	+Bonds to Fed	-Bonds to Fed

 

	Assets	Liabilities		Equity
Federal Reserve	Bonds	Reserves	CRF
Spending minus taxation		+Deficit	-Deficit
Treasury Bond Sales		-Bonds to banks	+Bonds to banks
Interest on Bonds		+Interest	-Interest
Fed Bond Buying	+Bonds to Fed	+Bonds to Fed

 

	Assets	Liabilities		Equity
Treasury	CRF	Bank Bonds	Fed Bonds
Spending minus taxation	-Deficit			-Deficit
Treasury Bond Sales	+Bonds to banks	+Bonds to banks
Interest on Bonds	-Interest			-Interest
Fed Bond Buying		-Bonds to Fed	+Bonds to Fed

 

	Assets	Liabilities		Equity
Private non-bank sector	Deposits
Spending minus taxation	+Deficit			+Deficit

 

This situation is eminently sustainable, so long as the deficit enables the expansion of the society’s non-financial assets. This can include obvious infrastructure projects like the Muscle Shoals hydroelectric plant that Ford and Edison tried to get the government to build (which it ultimately did), and also an educated and healthy workforce. This is what Edison was alluding to when he said “Humanity and the soil — they are the only real basis of money.”

Further reading

Ford, H., S. Crowther, W. A. Levinson and H. Ford (2013). The expanded and annotated My life and work : Henry Ford’s universal code for world-class success / Henry Ford, Samuel Crowther, William A. Levinson. Boca Raton, Fla, CRC Press.

Ford, H. and T. Edison (1921). Ford hopes to use Muscle Shoals as Step to End Wars. New York Times. New York.

Ford, H. and T. Edison (1921). Ford Sees Wealth in Muscle Shoals. New York Times. New York.

Kelton, S. (2020). The deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. New York, PublicAffairs.