Below, please enjoy a guest article by Clayton Slade. Clayton is in the information technology field by trade, but has been an economics/finance buff for most of his life, as well as a believer in liberty and the free market.
Clayton’s article succinctly explains a rather complex concept rarely discussed, the effect of inflation as a tax on all those who hold dollars, both domestically and abroad.
As always, feel free to discuss in the comments. Clayton can be reached at [email protected].
Treatise on Property Tax Through Fiat Currencies
By Clayton Slade
The United States has a property tax that applies to the entire world. In fact, all countries with fiat currencies do, but the extent to which they can tax is directly related to the distribution of currencies in circulation. This tax is called a fiat property tax. The tax rate varies between different currencies.
First, it must be understood that at any given moment, there is a finite total value of resources and services. Second, there is a total amount of currencies in the world, which can be manipulated. These two values form a ratio of Currency:Stuff. If more of a currency is created, such as new federal reserve notes, the total economic value of everything is not increased; this merely increases the currency side of the ratio, meaning that in the long run, it takes more currency to get the same amount of stuff. This amount of time is the response time or lag time of the market to realize the increased currency.
When more federal reserve notes (FRN) are created, the ratio of FRN:Stuff shifts accordingly, making it take more FRNs to get stuff. This means that each individual FRN is worth less than it was originally. The value of the “new” FRNs is derived from taking value away from the original FRNs. This is true for all fiat currencies when the quantity of a given currency in circulation increases.
The devaluing of each FRN is more than mere inflation. This is a property tax. It takes value away from assets, in this case currency owned by the holder, and redistributes it to the entity that creates the new notes (e.g., the Federal Reserve). Whomever has the power to create new currency inherently has the power to tax anyone and everyone who is holding that currency.
When the United States used the gold standard, people saw the US dollar as a sanctuary. The dollar was no more than a receipt (certificate) for a certain weight of gold, and the gold was protected in a safe location, which allowed the dollar to permeate throughout the world. When we moved off the gold standard domestically, we still met our obligations for foreigners who had gold certificates, and we also used relatively responsible monetary policies. This kept foreigners comfortable with using the US dollar.
At the same time, a very real economic boom after WW2 made the United States rich and a marketplace that other nations want to sell to. When the United States imports, it also exports federal reserve notes, which further serves to spread FRNs to all parts of the world. Some other consequences of WW1 and WW2 were that the borders in the Middle East were redrawn, and other political changes ensued that, for better or worse, involved making the US dollar the currency used in all major petroleum transactions. If anyone wanted to buy oil from Iran, Iraq, Saudi Arabia, etc, they first had to buy US dollars (now FRNs) on the foreign exchange market.
As a consequence. the world has been saturated with dollars, and then federal reserve notes, during the past century.
When the federal reserve creates new notes, it steals value from all existing notes. Since many existing notes reside outside of the United States, the property tax effect applies to anyone holding a FRN. This is a property tax on all notes that exist, and thus, the world.
When this newly taxed money is spent domestically, there is a net benefit to the United States. This has worked well for 30-50 years and is one reason why the trade deficit is not so bad. Money flows out of the country, but the value of it is then just taxed right back when new money is created. One must also consider that this is a tax on holdings, and not just cash flows. A country such as China that possesses a large quantity of federal reserve notes and treasury securities is taxed not only on the trade deficit, but also the notes from all previous trade deficits that are still held by the country.
That sounds great, right? The United States gets to tax the whole world and spend it in ways that benefit itself! All moral issues aside, it would be wonderful if this could be done forever. However, other countries are not stupid and are wising up to this.
This most recent round of bail outs (paid for by fiat property tax) in the financial markets (sub prime, etc) is really waking people up. Take a look at the dollar against other competing currencies or even gold and silver. On it’s present course, the FRN will not be able to maintain reserve currency status much longer.
It seems like every year or two, another oil producing country moves away from the FRN in favor of other currencies that are destroying themselves slower. Most notably, Iran has been switching to Euro and Yen for oil transactions.
Effectively, all fiat money has a property tax rate associated with it. This system of fiat property tax only works when people are willing to accept a given currency. They have to either be naive to what is going on (general public), accepting it because it is the best option available (central banks, foreign governments, investors), or coerced (OPEC?). The Europeans are destroying (taxing) their currencies in order to help their exports, but they are doing it slower than the United States, making the Euro and £ the current better choice for maintaining value. This is why treasuries, central banks, regular banks, etc are shifting away from the federal reserve note to currencies such as the £, Euro, and gold – the fiat property tax rate is lower with those currencies.
It is a fragile system. Once the international community stops accepting federal reserve notes, the decline will be rapid. The decline may have already started. Depending on how widespread this rejection and decline is, the United States could experience massive inflation (WW2 Germany style).
There are a only few ways to stave off a total rejection of the federal reserve note. One way is more conservative fiscal policies in congress that involve balanced budgets.
The other is to float some sort of commodity based currency that forces the value of individual currency units to be finite and relatively unchanging true value over time. If an option like this were adopted, it would be key for the new currency to be issued in a “natural” and non-obligatory manner in order to not shock financial markets. One such way would be to simply allow such currencies to float freely on the foreign exchange markets. If consumers of currencies wish to use that currency as a sanctuary, such as the dollars of old, they should be free to do so in a liquid manner. It would also be advised that consumers who are active within the Foreign Exchange Market use software to support them in making informed decisions. A good starting point would be this FXTM review to give them an idea of what they need to look for in software, thus allowing them to find one that helps them best.
The United States and some other super powers have had the luxury of a lifestyle that is subsidized through the taxation of the world with the practice of fiat property tax. One way or the other, those who currently are accustomed to the benefits of this system should begin to wean themselves off of it on their own terms as more and more people and organizations realize how this system works and refuse to participate.
Seigniorage is alive and well. Why should someone choose to hold federal reserve notes if there is an alternative that has a lower tax rate?
Aside: There is probably only one candidate running for president who is concerned about this or even understands the situation. That person is Ron Paul. If someone does not understand how taxation through inflation works, they should not be president.
All conservatives, especially rich ones and those who would like to become rich, should be opposed to this system. It is a progressive tax that directly attacks savings, affecting those with more cash more than those with less. Such a property tax is contrary to conservative or libertarian principles. Anyone who wants to save money should be opposed to this.
This is a tax just like any other. The only difference is that congress does not have to pass a bill to raise or lower the tax rate and the general public does not even know what the rate is. It is meaningless to focus on marginal income tax rates, capital gains, dividend tax, etc while at the same time the government can tax all the money it needs regardless. And they do not even have to ask you for a dime. They simply confiscate it from your bank account.