I’m nearly finished with a very long book that may well be the best illustration of the basic principles of Modern Money Theory available. The book is “A Call To Arms,” by Maury Klein. It is an historical account of the U.S. mobilization as it prepared for, and engaged in, war with Germany and Japan. The scale of the task was unprecedented in human history—and the accomplishment of it changed not just the structure of the American economy, but American society as well. What is striking about the story—and the monumental effort to quickly build, virtually from scratch, the largest and most sophisticated war machine ever to exist on the planet—is that there is nary a peep of concern or argument about how this enormous task would be paid for. All of the anguish and struggle had not to do with finding enough “money” to pay for things, but rather with finding enough things to buy—and enough skilled labor to properly marshal it all together. In the end, virtually every real resource available in the continental U.S.—oil, gas, steel, aluminum, rubber, copper, sugar, tin, and man-hours of labor—was purchased by the Federal government to build the Army, Navy, Air Force and Marine Corps that ultimately defeated the Axis powers. The scale of the sovereign spending is almost beyond comprehension—especially given the fact that, at the starting gate, the U.S. economy was still decimated and impoverished by the Great Depression. At the finish line, however—VJ day, September 2, 1945—the U.S. had become the most powerful, efficient, and equitable economic power the world had ever seen. So how did it all get paid for? And even more important, how did we travel from that VJ day of economic triumph to our sorry state of today, where we think we are so “broke” we can’t even afford to hire enough fire-fighters and equipment to put out the forest-fires raging in our western states?
A lot of people will say the mobilization and war were paid for in the same way the federal government always has, and always will have to pay for anything: by collecting taxes and selling bonds. Evidence for this will be the $186 billion in War Bonds the U.S. government sold to the American people between 1941-1945, and the Revenue Act of 1942 which doubled federal tax revenues. Let’s assume, for the sake of argument, that the War Bonds and taxes did pay for the mobilization and war effort. Conceptually, when we say that, what we’re proposing is that the American people had a whole lot of what we call “money” stashed away in bank accounts and mattresses, and the sovereign government needed that money to build an Army and Navy and Air Force. So the sovereign government collected some of the people’s money, and borrowed even more by selling them War Bonds. Now, what did the sovereign do with the “money” it collected and borrowed? It paid the money back to the people in exchange for the materials and labor to build ships and airplanes and bombs and tanks. The war was fought and, through perseverance, the sovereign defeated the Axis powers, while a great deal of the war machinery the people built was destroyed, spent or ruined in the process.
Looking at it from a simple balance sheet perspective, what is the net position after the war is over? The people have gotten their “money” back, apparently having used it to pay themselves (through the actions of their sovereign government) to build all the stuff they had to build, and do all the things they had to do, to win the war. On the sovereign’s side of the balance sheet there’s a big debt: When the sovereign government traded its War Bonds to the people for their “money”, it made a promise to redeem the bonds at maturity, with interest. To redeem the War Bonds with interest, the sovereign needs…what? It needs the people’s “money” all over again! And, once again, our “logic” tells us there’s only two ways the sovereign can obtain the people’s “money”—by collecting taxes or by issuing (what we might this time call) Peace Bonds. Let’s say this is done, and now the sovereign has collected the people’s “money” back again, enabling it to do…what? It pays the “money” once more back to the people to redeem the original War Bonds with interest.
Now the people have their “money” once again—but what has actually been accomplished? The sovereign government now has a new debt: when it sold the Peace Bonds it promised to redeem them at maturity, with interest. To redeem the Peace Bonds with interest, the sovereign needs…what? It will have to get the people’s “money” back again! And, as before, there are obviously only two ways the sovereign can “get” the people’s “money”….
According to my calculations, the people have now paid for World War II three times over: first, when they bought the War Bonds, second when they bought the Peace Bonds so the sovereign could have the money it needed to redeem the War Bonds, and thrice because now the sovereign needs to tax and borrow their money one more time to redeem the Peace Bonds! Can this possibly be the way things actually work?
Fortunately, there’s another explanation for how the U.S. mobilization against Germany and Japan was “paid” for—an explanation that doesn’t, by logic, devolve into mathematical absurdity. Here it is:
When the mobilization began, the U.S. was still struggling to emerge from the Great Depression. Most households had scant savings to spend on War Bonds, and could hardly afford the burden of higher taxes, so the idea of taxing and borrowing their money to pay for the building of a great war machine was not even a viable option. Nor was it necessary. Instead, the sovereign government simply issued the U.S. dollars, by fiat, as it needed them to buy materials and pay wages: It declared the dollars into existence—and then it paid those dollars to the American people to build the ships and planes and guns. In the historical narrative by professor Klein, we never encounter someone saying, “Sorry, Mr. Roosevelt, we need to sell another billion dollars in War Bonds before we can build that new aircraft carrier.” That conversation just doesn’t come up. By the time 1941 rolls around—and especially in the months after the Pearl Harbor attack—mobilization has pushed the economy to virtually full employment: Millions of previously unemployed people (including women who’d never before been in the workforce) were suddenly pulling paychecks as engineers, technicians and machine operators.
These, now, were the well-paid workers who were able to buy the War Bonds—using dollars the sovereign government had already paid them. But why, if the sovereign could simply continue issuing dollars by fiat, did it sell War Bonds—and by so doing, appear to be eliciting the financial help of the people in the war effort? And why, if the sovereign could simply continue issuing dollars by fiat, did Roosevelt feel compelled to force Congress to impose the large tax increases? In a pivotal chapter in the middle of his book, professor Klein gives a very clear answer to these questions—and it’s an answer that is a text-book illustration of the basic principles of Modern Money Theory.
Between 1941 and 1942 the cost of living in the U.S. rose over 16%. Labor was threatening to strike for wage gains matching the rise in living expenses—putting the mobilization effort at risk. A looming inflationary spiral threatened to undermine America’s ability to accomplish what it so desperately needed to do: continue to pay itself whatever dollars were necessary to build the machinery required to defeat Hitler and Hirohito. The cause of the inflationary pressure was clear to everyone: The U.S. was at—or even beyond—full employment. American workers were pulling in more paychecks every week than they’d ever seen before, and were flush with cash to go on spending sprees. At the same time, however, virtually everything there was to buy had been diverted to the war effort: gasoline, tires, sugar, nylon, shoes, clothing, canned foods and automobiles. (Production of new automobiles was halted in February 1942, and all the auto-plants converted to war production.) There was suddenly very little to buy, and the excess money in the private economy began quickly driving up prices for what was available.
In the face of this crisis, the Roosevelt administration had to do everything it could think of to take spending money out of the hands of the people. In other words, it had to destroy money in the private sector to create the “space” that would allow it to continue to pay those same people to produce the war machinery that would still be required to defeat the Axis powers. The War Bonds and the Revenue Act creating the personal income tax, then, were specifically created not for the purpose of “collecting” money so the government could have it to spend—but rather for the purpose of destroying money so the government could then issue and spend even more dollars without feeding an uncontrolled inflationary spiral.
The most astonishing thing is what the unprecedented sovereign spending of the U.S. war mobilization accomplished. The people had paid themselves—through the fiat monetary actions of their sovereign government—to build a monumental war machine that defeated the Axis powers. But more than that, they had also paid themselves to invent an array of new technologies and apparatuses originally conceived for waging war, but which now were clearly seen to have useful applications to peaceful life as well—and they had paid themselves to build a great many factories, research and production facilities capable of adapting and producing these useful things to civilian life—and they had paid themselves to train a very large workforce of engineers, technicians and skilled workers who knew how to make it all work. This was a powerful economic brew—and it was spiced by the fact that the returning G.I.s were getting paid to go to college to explore how to make the whole thing run even better. America never looked back (until now.)
But what happened to the War Bonds? Didn’t the sovereign have to redeem them with interest? Of course it did—but it did not have to fool itself into thinking the only way it could “get” the dollars necessary would be to collect taxes or issue new bonds. It redeemed the War Bonds in exactly the same way it built the aircraft carriers and bombers of World War II: When the War Bonds came due, the sovereign issued the dollars necessary to redeem them by fiat—and then it paid those dollars to the American people who held the bonds.
By my calculations, the fiat money flowed like this: First, the sovereign government issued and paid the people dollars to build the war machine; second, the people paid the sovereign government back some portion of the dollars they’d earned by purchasing War Bonds and paying taxes; third, the sovereign government destroyed the dollars it received in taxes and for War Bonds, thus enabling it to pay the people even more dollars to produce ships and bombers without creating a spiraling inflation; fourth, the sovereign government redeemed the War Bonds with interest, paying the people with new fiat money—but rather than being inflationary, these new dollars were absorbed by the rapidly growing post-war economy, the people using the money to buy the newly abundant goods and services produced by what was now the most technologically sophisticated, creative, well educated, productive and equitable social economy in world history.
But now, somehow, we’ve lost our way and our momentum. We’ve convinced ourselves that our sovereign monetary system works by a different logic—a logic that leads inexorably to a perpetual and growing shortage of Federal spending power. Given the real threats now racing our way with the same inevitability as was Nazism in 1938—climate change, rising sea levels, super-storms, extended droughts, gigantic forest fires, loss of fisheries and ocean acidification, water and food shortages, nuclear terrorism, and the possible failure of democracy itself—it seems we might want to consider another great mobilization to defend ourselves—if we can ever remember how to do it.