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Money, debt, promissory notes, reserve currency

by on 19/07/2018

After the conclusion that most of the people don’t understand what actuality money is, how it is created, and how currency like US dollar becomes a reserve currency, i will try to explain the connection between reserve currency, deficit and debt.

Let’s assume there is only one country, and its government doesn’t collects taxes, (a very imaginative scenario). Yet, the sovereign government has to pay for wages or products it purchases. The only way it can pay is by printing money in form of promissory note, (check) that is an obligatory paper, its repayment is guaranteed by its issuer. The definition of promissory note is: “a signed document containing a written promise to pay a stated sum to a bearer at demand”. Usually such  a promissory note has specific issuer, who promises to pay a determinate sum of money to the payee a fixed sum in a specific defined future time or on demand.

But sovereign government, with the power to print money, is a special kind of issuer of promissory note.  

  1. The repayment of its promissory note is to be in form of money, issued by the same government. And what is money? It is a promissory note,  without interest, without specific payee, and without determined time of reimbursement.
  2. When the government issues and transfers this promissory note to employee or supplier, it also guarantees that it is transferable between everyone on demand.
  3. It uses all its sovereign authority, that everyone will respect the face value of this promissory note.

(Since currency exchange is different act than product purchase, let’s assume that this promissory note is not convertible to other currency).

In other words, to create trust in face value of otherwise invaluable piece of paper, the government guarantees, that the face value printed on the bill will correspond the price of any product in the country of its sovereignty. How it is doing it? When anyone attends with money in hand to shop, and asks to purchase anything, the government, with all its enforcement strength, including its army and police, stands behind the promissory note face value. Since so, the one who holds the money, is holding a government promise, that it will be exchangeable against equivalent value of product in the future.

When the money was received by payee at the beginning, it was given him by the government against products or work given and accomplished in the past, while the government still didn’t give against it any exchange value, but a promissory note on governments debt (bill, money). So the promissory note, if taking form of money as defined above, is form of loan, that from personal point of view will be repaid, or rather the liability transferred to third party, when the money will be used to purchase anything, and not necessarily from the government, but from some private entity. What confuses the picture even more is, that while the government, when purchasing some product from you, payed to you with a promissory note, or form of debt of government to you, represented in the face value printed on the bill. The payee, when using this promissory note (money, representing government debt) is going to transfer it against a real product, its supplier is another private entity. This debt of the government is very theoretical, since it will be repaid not by supplying to you products by government, but when you pay taxes, that is the actual repayment time of governments debts, even if it is paid by you and not by the government, that actually is the borrower.  So at first the government paid you by debt, and second time you are forced to pay to government taxes with promissory note you received against this government debts, that will be used to pay next time by the government to pay for wages and products. But you can also say, that the government doesn’t supply to you directly the product, like any other supplier, against your taxes, that are form of payment you pay to the government, but indirectly, by giving you services, like education, health, security, etc, for what the payment is in form of collective taxes. So taxes are payments done in collective way for collective public services, and again not repayment of debts.

But this whole circle can happen only, after the government issued at the first time the first tranche of promissory note, that later will put in circulation thru taxes, then payments to government employees and subcontractors the whole system.

Are you confused? I wonder why.

Still i have to explain how a match between the face value of the promissory note and the product price is created. It will be achieved in act of tender between purchasers and suppliers. The act of tender is a continuous process, that decides the price of the product in relation to the face value of the money. So the currencies face value represents exactly the price of everything sold in exact moment, when it changes hands against the products. Any kind of purchase-sell is a form of act, when one side gives a loan, and the other side repays it immediately. It can be that you give money first and the product will be handed to you few seconds later or in opposite way, and in those few seconds there is a debit credit relationship between the two sides of the deal. To make it happen, there has to be trust between the purchaser and supplier that this debt will be repaid and/or the product will be supplied. The other problem is, that there can be someone else with money in his hands, who is ready to buy the same product, and if there is no other piece of the product you want to purchase, the one who will pay more will get it. In these few seconds when the purchase-supplier deal is taking place, the seller believes that there is no one else who would pay more for the same product, and the buyer believes that there is no one else on the same spot, who would sell for less the same product. This is the essence of a tender.

Now someone from other country, who likes your promissory note bill, because of the picture on it or any other obscure reason, is ready to give to you the same product, for the same price or lower price, you would pay to the local supplier. After this foreigner sells his product and becomes an owner of the bill of country with foreign sovereignty, he doesn’t uses it to purchase product in the country that issued the bill, but rather puts it in a vault. Still the government guarantees, that in the country of its sovereignty, all product suppliers are liable to sell to the promissory note holder anytime in the future any product available in this country, for price decided in tender, equivalent to the face value of the money. So this money, that is in foreign country vault, becomes a reserve currency, meaning a every resident of the country of sovereignty becomes a guarantor of liability towards the foreign holder of this money – bill – promissory note.

As a side effects of this process, because people in foreign country like to hold the bill in their  vault, its value will grow, unless your government will decide to print more to satisfy the demand for its bills – promissory note -money. Then if no new money is printed and part of it goes to foreign countries, it will become rare, and its price will grow against prices of products. It means deflation, or price decrease in the country of the reserve currency. Fortunately the government, because it always purchases more than it can collect taxes, it prints enough promissory note bills to satisfy the demand from the foreign country, that will supply the local market with products. It can happen, because there are enough foreign suppliers of products, who want to use the promissory note of your government as reserves, because they have trust, that the liability behind this promissory note will be fulfilled.

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