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From the Comments: A Conversation with Ed

August 1, 2011

PaulJ added this in the comments, and it’s too juicy to keep for myself.

[Update: Welcome Pragmatic Capitalists! For an indication on what the Traders Crucible is all about, click here and here.]

I think this should be turned into a video ala the video about the fed printing money:

A CONVERSATION WITH ED

me: Ed, how much money do you have in your wallet?
Ed: I dunno, probably about $50.00. Why?

me: Where did it come from?
Ed: I earned it.

me: That’s not what I mean. I mean where did the money come from originally?
Ed: I guess from the bank.

me: No, that would mean you borrowed it. You said you earned it.
Ed: OK. I guess it came from the government?

me: Right. Where did the government get it?
Ed. They issued it based on the amount of gold we have in Fort Knox.

me: No. We haven’t been on the Gold Standard since 1971. There is no gold backing the US dollar.
Ed: You mean the dollar isn’t backed by anything?

me: Not exactly. But let me ask you again. Where does the government get it’s money?
Ed: They print it?

me: Right. So if they print the money, how does it get to your wallet?
Ed: I don’t know…I guess through banks.

me: No. If you got your money through the bank you borrowed it. We already covered that.
Ed: Well, how then?

me: The government spends the money into the economy. Every time the government buys something from private businesses, or pays government worker’s salaries it is spending money into the economy.
Ed: Yeah but I earned the money in my wallet. It didn’t come from the government.

me: Where did it come from then?
Ed: From whoever I worked for.

me: Where did they get it?
Ed: From whoever they earned it from.

me: Now we’re going in circles. Money had to exist before anyone could earn it. Where did it come from?
Ed: From the government?

me: OK so you agree that before anyone had any money the government had to create and spend it first.
Ed: I guess so.

me: So every year the government spends into the economy a budgeted amount and at the end of the year it taxes all of the money it created that year back out. Otherwise we would have a budget deficit.
Ed: But we do have budget deficits. That’s what’s wrong with the economy now.

me: So budget deficits are bad?
Ed: Yes.

me: Why are they bad?
Ed: Because then we have to borrow money to pay for the deficit, and then the government has to raise taxes to pay the money back.

me: The government creates the money. Why would it borrow back money it previously created? Wouldn’t it make more sense to just print more money?
Ed: No. That would cause inflation.

me: Why would that cause inflation?
Ed: Because there would be too much money in the economy. That would make money worth less so we would have inflation.

me: Maybe. But if the government didn’t spend more money into the economy than it taxed out there would be no money in the economy. How would you get the money that’s in your wallet? And how would there be inflation in that circumstance?
Ed: Good question. This is making my head hurt. I don’t know.

me: Yeah learning simple things can be hard. So you can see why deficit spending is required for the economy to grow.
Ed: I guess so. But we have to borrow to pay for the deficit and the borrowing is killing the economy.

me: We’re going in circles again. The government doesn’t have to borrow, it is the creator of the money. It creates money at will out of thin air as needed. It does not necessarily lead to inflation. That depends on how the government spends the money.
Ed: Then why does the government borrow money to pay for the deficit?

me: That’s another discussion. We can talk about that some other time.
Ed: OK. But what about the National Debt?

me: What about it?
Ed: Don’t we have to pay it back?

me: If we paid it back, there would be no money left in the economy. How would you get money in your wallet then?
Ed: You’re making my head hurt again.

me: Thinking is hard. That’s why we rarely do it.
Ed: So what is the National Debt?

me: The National Debt is the amount of money to the penny that the federal government has created since it began creating dollars. It includes all of the dollars held by the public plus all of the dollars held by foreign companies that have done business with the U.S. There is no taking it back. Paying off the National Debt is impossible and it makes no logical sense to think of the National Debt in th way we have been taught.
Ed: You’re killing me. Theres no way anyone could understand this stuff.

me: I give up.

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