Fiscal Dominance and the Politicization of Money
Most of the modern debate about monetary policy focuses on technical questions: whether reserves should be scarce or abundant, whether fintech companies should have large accounts The Federal Reservewhether those accounts should be similar to accounts held by banks, or how far the Fed’s independence should be extended. These are not trivial questions. However these questions they are part of the central issue shaping American monetary policy today: the federal government’s fiscal needs.
The United States government now has problems of more than 5 percent of GDP every year, even during foreign periods of war or emergency.
Funding that deficit requires constant mobilization of financial resources on a large scale. Under such circumstances, it is increasingly unreasonable to expect monetary policy to remain inconsistent with monetary policy. The unusual politics and centralization of monetary policy in recent decades is not an accident. It is evidence of fiscal governance: the imposition of monetary policy on the government’s borrowing needs.
Historically, the central bank did not emerge primarily to stabilize prices or adjust economic fluctuations. Central banks emerged as instruments of public finance. As Vera Smith it was noted long ago, the most powerful reason for government intervention in banking was to help regulate money in the financial sector. The Federal Reserve, like the Bank of England before it, ultimately serves as an institutional mechanism through which governments secure access to credit markets and maintain the capital needed to finance public spending.
This fact becomes clear when we understand the relationship between them lack of fundsfinancial markets, and capital formation. Financial markets are not just abstract ways of making money. They represent claims to real wealth. Their depth and complexity depends on the availability of accumulated funds directed to productive investments. Yet increasingly, the liquid savings of the American public support not productive investment but current spending by the federal government.
When savings are directed toward businesses, infrastructure, productive technology, or capital goods, society’s productive capacity increases. More wealth than the current production structure can produce may be created in the future. But when savings are deducted from chronic federal deficits, the resources represented by those savings are consumed instead of invested. Treasury securities may remain financially liquid and politically privileged, but economically they represent future tax claims rather than claims on newly created productive wealth.
This is one of the reasons why persistent fiscal deficits not only put inflationary pressures but also long-term stagnation. Financial markets may appear “deep” and very liquid, while underneath, the productive capital stock is weakening.
Jacques Rueff’s concept of “false rights” is still very applicable here. This refers to when the political system creates claims on wealth without creating it corresponding wealth. Fiscal expansion and deficit financing allow governments to mobilize existing resources while hiding transfers from producers and savers to current public consumption.
Under these circumstances, there is no point in trusting an untapped monetary system while fiscal irresponsibility continues unchecked. As long as the federal government depends on continued massive borrowing, financial institutions will inevitably be drawn into public debt management. The Federal Reserve may seek formal independence, but operational independence is increasingly fragile when public financial stability depends on low interest rates, abundant capital, and orderly Treasury markets.
Obviously, I’m not against bona fide newly elected Chairman Warsh’s commitment to Fed independence, or sound monetary policy. My argument is about the issues he and his predecessor, therefore, operate on.
After all, this does not mean that all government financial rights are illegal. As I argue somewhere elsethere are economic and moral reasons why a sovereign political society is completely incapable of wresting control over money and finance. National defense needs create exceptional circumstances where governments may need immediate access to resources beyond normal taxation. In times of real emergency, there is a financial system. Political societies may temporarily suspend monetary policy in order to survive.
But norms appropriate to emergencies cannot be the general policy of the government. Ayn Rand once remarked that we should not derive the moral principles of ordinary human life from the situations of those survivors who cling to a raft after a shipwreck. The same principle applies to financial institutions. Laws allowing extraordinary powers which may be justified in time of war cannot become permanent features of government in time of peace, in our constitution, when the state of emergency has passed.
Accordingly, the United States should reciprocate the constitutional distinction between monetary and fiscal power was contemplated in the founding. Then, Congress was entrusted with the power of the fund and responsibility for public finances. Financial institutions were expected to support stable trade and exchange, not finance permanent structural deficits. Restoring that divide will reduce the politicization of money and strengthen both democratic accountability and economic stability.
Yet such recovery is not possible without fiscal prudence. Financial reform without financial reform is an illusion. As long as the federal government systematically takes an ever-increasing portion of the nation’s liquid savings to finance current consumption, fiscal policy will remain below fiscal demand.
The path to a healthy monetary system does not begin with technical debates about the rules imposed or the Fed’s governance, but by restoring morality to the monetary affairs of the American republic.
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Leonidas Zelmanovitz is a Senior Fellow with the Liberty Fund and teaches part-time at Hillsdale College.
