Here's what the fiscal cliff is about.

In short, the fiscal cliff is an idea developed last year (2011), when Congress couldn't agree on spending and tax measures as part of talks about raising the debt ceiling.

The debt ceiling is basically the borrowing limit on the nation's credit card. If the debt ceiling wasn't raised, the government couldn't borrow enough to operate. A compromise was reached that allowed the federal government to keep running, without the steep budget cuts. That deal expires in January

The fundamental issue is whether to allow spending without increases in taxes. Many economists (Galbraith, Mosler, Wray, Kelton, Keen, Mitchell, Hudson) are convinced that this is issue is based on faulty premises, and therefore, economic policies emanating from them exacerbate an already dysfunctional economic environment.

This discussion is based on historical events leading to the United States becoming a sovereign currency issuer. And, the indisputable fact that a nation sovereign in its own currency never faces insolvency issues, only the issue of managing inflation.

To begin, policy makers who support tax increases as a means to raise revenue to spend and pay our bills do so based on the mistaken belief that tax revenue actually funds Federal Government spending. Nothing could be further from the truth in our fiat currency system.

Historically, revenue needed to spend was an operational fact under the gold standard. If Congress appropriated more than tax or borrowing revenue would cover, the value of the dollar was negatively affected, and holders of dollars would demand gold to preserve the value of their holdings. This rule was designed to limit deficit spending under a fixed exchange rate regime

Because the U.S. had huge Vietnam war related deficits in the 1960s other nations demanded gold instead of holding a depreciating dollar. Nixon refused to convert dollars to gold....and defaulted on convertibility in 1971. By 1973 the entire world's monetary system was turned upside down. Flexible exchange rates replaced fixed rates, and all governments issued fiat currency. That is, currency backed by the "Good Faith and Credit of the Respective Governments", the U.S. Canada, England , Australia , Japan , Germany , and many others. Other nations pegged their currency to the dollar or some other strong internationally accepted currency.

This paradigm shift in monetary policy brought on a similar shift in how money was managed to fund obligations in nations sovereign in their own currency. None of these nations would ever need to face the issue of insolvency in their own currency. They would only need to manage inflation. However, American legislators failed to understand that this new monetary system rendered self imposed legislative constraints moot. No longer relevant would be legislation mandating a debt ceiling and prohibitions on Treasury overdraft authority or Congressional concerns about revenue equaling expenditures...balancing the Federal Budget.

Unwilling to repeal these constraints has lead to economic dysfunction year after year simply because Congress does not trust itself to spend responsibly. There are no relevant economic constraints on the Federal Government's spending that can't be managed with appropriate use of tax and borrowing policy tools. Yet, not until President Obama entered the Oval Office has there been a serious Congressional threat to oppose increases in the debt ceiling.

Not understanding the role of fiat currency management it is no wonder that elected and unelected participants in the debate on the Fiscal Cliff also fail to understand that taxation and borrowing do not per se generate revenue to fund Federal Government expenditures. All such expenditures are funded from Treasury's General Fund Account no matter the number of Trust Fund accounts there are or the balances in those Trust Funds. They are simply bookkeeping records. They don't disperse funds. The Social Security Trust Fund is major among these bookkeeping records. No matter what the level of receipts in that Fund beneficiaries will receive their checks because Treasury checks don't bounce.

It is indisputable that a nation sovereign in its own currency can issue as much of it as it wants to pay any obligation denominated in its own currency. It does not need to " GET " revenue to pay its bills. It simply issues more of its fiat currency to satisfy its obligations. Why would it need revenue/income to spend?

The Federal Government levies taxes to manage inflation, distort income distribution and market prices, and forces acceptance of the currency. It does not, levy taxes to raise revenue per se to spend. All statements from any source that tell you "tax payers fund this or that" simply displays the near universal misunderstanding in this nation of how our monetary system's tax policy functions post gold standard.

Lastly, the fraud of "The Balanced Budget." From the President on down society is bombarded with the silly mantra,

"We must balance the Federal Budget just like

businesses and households must balance their

budgets or face the financial consequences of

bankruptcy."

Again, this was likely under a gold standard, not so under a sovereign fiat currency system with flexible exchange rates. Why? Because until the government spends its fiat currency into the economy there is no money in the economy. And there is no legal alternative, i.e.,gold...which could be used as legal tender. Moreover, all of the currency spent into our economy is interest bearing...it is debt money. When the government taxes it withdraws that debt money from circulation, it liquidates its own liabilities. It doesn't use those liabilities to balance anything. How could it? It would just be issuing more debt money if it did.

The states, businesses, households, and individuals do not issue their own currency. They are currency users and must have income/revenue to balance their respective budgets or they will indeed be faced with the issue of bankruptcy/insolvency. There are currency issuers and currency users, only the latter and non sovereign currency issuers like the 17 Euro nations (Greece among them) must balance their budgets.

Because our Federal decision makers have this all wrong, society is over burdened with the maldistribution of health care, housing, education, and transportation resources. Clearly the Federal government can't spend at will. Congress is responsible for either providing enough or too little funding to meet Federal government responsibilities defined by laws Congress has enacted. If Congress fails to appropriate sufficient funding then it and it alone is responsible for the deficit. The President does not have Constitutional authority to authorize spending.

Then there's the fraud over the deficit. We're told that it's too large relative to GDP. But none of the Deficit Terrorists can precisely define what that means in the face of the fact that many sovereign currency nations have higher deficit/GDP ratios than ours with no real economic impact on production and income growth.

What these Deficit Terrorists either don't understand, or don't want a majority of Americans to understand, is that in a three sector economy, Foreign Sector, Public Sector and the Private Sector, each sector has income and expenditures and can be in deficit or surplus but all of them can't simultaneously have a deficit or surplus in the same accounting period.



At least one sector must have either a deficit or a surplus. When we look at the $16 Trillion in Public Sector Deficit spending we are also looking at $16 trillion in Savings in the rest of the economy. that's where the public sector spends it's money.



The symmetrical graph above proves the accounting identity, that where ever there's a surplus there's a deficit. In our economy the sum of the balances in all three sectors must equal zero. Or, put differently, deficits in the public sector must equal, to the penny, net financial assets in the private sector.

In sum, our elected and unelected decision makers need to enter the 21st century of modern money management and disabuse themselves of gold standard rubrics which today as the basis for fiscal policy decisions which severely exacerbate every aspect of economic life in America .

Review the following questions and common sense responses and you will be convinced that the President and all of the Congressional, Media Experts, Pundits, and Gurus don't have the first clue about how this government can avoid the Fiscal Cliff without inflicting unnecessary financial hardship on hundreds of millions of Americans and tens of thousands of businesses.

1. Is the U.S. dollar backed by or convertible into gold or silver?

No. That system of gold backed currency was abandoned by Nixon in 1971.

a) There are remnants in legislation which force the fiscal cliff issue.

They are the debt ceiling, and the prohibition against Treasury having overdraft authority. These legislative relics of the gold standard should have been repealed in 1971.

b) Because the Federal Government is the sole issuer of fiat currency there are no operational constraints, only political, on its ability to buy or pay for anything for sale in dollars.

2. What, then, backs our U.S. dollar and where does our currency, paper and coin, come from before either enters the economy?

Our currency is backed by the "Good Faith and Credit of the U. S. Government...the people." The Federal government through the Treasury and Federal Reserve issues our currency by "fiat". That means it creates the currency from nothing. It uses computers to mark up checking accounts.

It's like the scoreboard at Redskin's Park. When the Skins score, six points show up on the scoreboard. Where did those points come from? The score keeper's computer never runs out of points and can also deduct points.



That's precisely how money is created by the Federal Government and the Federal government is the only entity authorized to create dollars. It prints dollar bills but these represent less than 1% of the "money" in savings and checking accounts worldwide.



3. Where does the Federal Government get the currency?



As stated above, the Federal Government doesn't have to "Get" currency. 99.7% of all currency is created by fiat, from thin air, by computer keystrokes. The remainder, bills and coins are produced by the U.S. Mint.



4. What does the Federal Government use to pay for goods and services?

It uses the 99.7% of the currency it creates by fiat. It is the sole issuer of the dollar and can pay any obligation denominated in dollars. As the sole issuer the Federal Government can never go broke or be insolvent in its own currency nor can any of its Federally Funded Programs for which there exists a Congressional Appropriation.

5. Why doesn't the Federal Government use tax and borrowing revenue to pay for goods and services instead of fiat currency?

As the sole issuer of the currency the Federal Government never needs revenue per se to spend. Why would it need revenue/income when it is the only entity legally authorized to issue the currency? The money to pay taxes and to borrow comes from government spending.

6. Why then are we taxed and why does the federal government borrow?

We are taxed to make us accept the otherwise worthless paper upon which we depend as a medium of exchange, the dollar. We have a tax driven currency. That means the government levies a tax and will only accept its currency, the dollar, in payment of that tax. Therefore, all other economic units must "get" revenue/income to pay the tax.

Government also uses its power to tax to manage inflation, distort income distribution, market prices, and to subsidize various segments of the population including the business sector.

The government borrows to also manage inflation using the Federal Reserve's authority to set the Federal Funds rate. Like taxation borrowing withdraws money from the economy to reduce spending.

7. So, if taxing and borrowing doesn't raise revenue for the government to spend and the government can issue all the fiat currency it needs to pay its bills, why this debate over the deficit, debt ceiling, and cutting discretionary programs?

The debate is a fraud. The Congress has the Constitutional authority to appropriate funds in any amount needed to meet all U.S. obligations denominated in dollars. Because it fails to do so is why the Federal Government runs a budget deficit. There is no operational reason for the deficit. The deficit exists because of politically self imposed constraints such as the debt ceiling.

Those involved in this charade claim we can't "afford" to appropriate funds for all of this society's needs. All of them are lying. Dr. Stephanie Kelton writes, "....when I look at the data I see around 16 per cent of available labor idle in the US and capacity utilization rates that are still very low. That tells me that there is a lot of "means" available to be called into production to generate incomes and prosperity. A national government doesn't really have any "means". It needs to spend to get hold off the "means" (production resources).

Given the idle labor and low capacity utilization rates the government in the US is clearly not spending enough. The US is currently living well below its means. But the US government can always buy any "means" that are available for sale in US dollars and if there is insufficient demand for these resources emanating from the non-government sector then the US government can bring those idle "means" into productive use any time it chooses."

Dr. Kelton continues, "Spending equals income. Someone has to spend for incomes to exist. For incomes to grow there has to be growth in spending. There are three sources of spending growth in a macro economy -- the external sector (if net exports are positive); the private domestic sector; and the government sector (if the budget is in deficit).

That is indisputable. Economic growth is defined in terms of production and production only occurs if there are goods and services being purchased. Firms do not produce to hold inventory. Firms may invest in response to their guesses about future sales. These guesses will be heavily influenced by current consumer actions.

So when you get commentators and high-level monetary officials arguing that growth comes from not spending you have to ask why anyone would listen to their views and why they are paid to express them."

Read more at http://www.nakedcapitalism.com/2011/05/stephanie-kelton-what-happens-when-the-government-tightens-its-belt.html#D7iykfLTE752WCeR.99

8. But if the government just issues currency without constraints like the debt ceiling won't the economy suffer high rates of inflation?

Yes, it could but it is not likely over the medium term...5-10 years...because we have what economists call a huge output gap with 20-30 million Americans unemployed, under employed, or no longer looking for work. These people are no longer your average consumers and, therefore, will not be the vanguard spending wildly, inflating the economy with too much money chasing too few goods. They need jobs, incomes and then they spend but it won't be all at once. And to get them there, the government should deficit spend on Employer of Last Resort Programs until unemployment is reduced to 4% or 5%.

9. So how do we avoid the fiscal cliff in January 2013?

Americans need to rally around the fact that Congress is the villain not the President. Congress is the only Constitutional body with the authority to appropriate. It all boils down to that. What Americans need to tell Congress is that we are no longer bound by gold standard principles defining "affordability" and that it can and should appropriate the "means" for this nation to achieve economic growth.and that Congress is the only constraint to doing this. It's resistance is purely political with not a shred of economic evidence to support its ideological austerity argument.