Overview

Infrastructure Funding with US Notes

Everyone acknowledges that infrastructure funding is urgently needed and yet the legislative actions required are argued about, delayed, or even obstructed – and when passed, routinely do not fund to appropriate levels.  The reason for this is simply that we do not have the resources under current funding methodologies.

For the current state of our infrastructure and the estimated cost of remediation and new construction, see the complete Infrastructure Report Card of 2013[1] by the American Society of Civil Engineers (ASCE) here.  The continuing deterioration and increasing need for funding is clearly seen in the following chart from that report.

Due to the steady accumulation of debt by federal, state, and municipal governments, the ability to pay for the needed infrastructure costs has eluded us.  We have not followed the advice of John Maynard Keynes to pay off debt in times of prosperity but have only followed him to stimulate demand whenever and wherever we felt like it. This has produced the condition shown in the graph below, which demonstrates that anticipated costs are beginning to rise exponentially. 

In our current system of fractional reserve banking as established in all OECD[3] countries, money is created through the issuance of debt by private banks in a process called deposit creation.  For a more detailed explanation of this go to the ‘Answers’ page on the website http://www.RealMoneyEcon.org/.  To have continuing price stability the amount of money in circulation needs to be in a rough equilibrium with the increase or decrease in our total production and services[4].  This is currently controlled through a number of factors, the largest of which under normal times is the management of interest rates by the national central bank, in the US that being the Federal Reserve Bank.  A decrease in interest rates stimulates the economy as it tends toward the issuing of more loans as the price of the lent money (in terms of interest payments) decreases.  This increase in loan volume increases our monetary aggregates.  As the economy comes up to steam, the opposite is achieved through an increase in interest rates, slowing the economy down.  This approach has not always dominated, as over the last two hundred years a number of different methodologies have been used both in the method of creating our money as well as in the control mechanisms of that creation.

We routinely find ourselves in unsustainable situations, as the fractional reserve banking system inherent in its functioning amplifies business cycles both in the expansionary and contractionary phases.  For instance, in order to create banking stability and forestall runs on banks, collateral is demanded for loans, some of which is rated better than others from a regulatory perspective.  One of the more highly rated types of collateral is mortgages and therefore banks lend extensively for these.  The difficulty comes that in the business cycle upswing, house values increase leading to higher levels of mortgage debt for the same properties, which in turn leads to higher prices, leading to higher mortgage debt, leading to higher prices and so on in a continuous spiral until the debt payments become unsustainable.  As banks sense this, they pull back on the mortgage levels they are willing to fund, tighten the credit criteria, and thereby cause a decrease in mortgage funding liquidity.  Although this process is totally rational from an individual bank’s perspective, in the aggregate the resultant shock tends to become systemic leading to sharp drops in house prices, foreclosures, bankruptcies, and general economic mayhem.

A similar problem of financial system dislocation would occur if we rebuilt our infrastructure using the same funding options available with our present monetary system due to its reliance on the creation of interest bearing debt.

Is there a way to order our money system without an ever increasing debt and interest load and could that be used to fund our needed infrastructure?  The answer is yes; it has been done successfully before and endorsed by the Supreme Court. A little historical perspective will help explain how it would work.

Early into the American Civil War President Lincoln realized that the costs associated with it would be unsustainable if funds were to be borrowed from banks or the general public through the issuance of federal government bonds.  In looking for alternatives legal under the Constitution, the government first enacted the Act for a National Loan of July 17, 1861.  In Section 1 of that Act, in addition to interest bearing bonds and Treasury notes, it also authorized the creation $50 million of non-interest bearing Treasury notes, but which were redeemable in specie[5].  Upon further consultation with Congress and monetary experts, a new act was passed, commonly called the Legal Tender Act of 1862.  This supplanted and enhanced the Act for a National Loan of July 1861 by creating $150 million of non-redeemable and non-interest bearing notes, of which $50 million were set aside to replace the original ones created in 1861 as soon as possible so that the federal government would not need to pay out the specie.  There were a number of additional acts increasing the issuance to about $450 million and several to withdraw them as private banks increased money in circulation.  It is interesting to note that this represented about 40% of the monetary aggregates at the time, which would make it equivalent to the Treasury creating about $5 trillion today[6].  According to the Federal Reserve Bank, there are still about $240 million in circulation today as worn notes were replaced by the Fed until 1971.  They were identical in purchasing power once in circulation and were distinguishable only in that at least the serial numbers were in red.  A picture of one can be found here.

This type of currency called US Notes (USN) came to be colloquially known as “Greenbacks”.  As debt represents the acquisition of current purchasing power in exchange for future liabilities, USNs are seen as “notes of credit” as they do not create any future liability.  They are quite distinct from Federal Reserve Notes (FRN) in that FRNs are created through the issuance of debt (personal, corporate, or governmental), and create more of the same as the underlying debt demands interest payments.  USNs on the other hand are issued directly by the Treasury (through the Federal Reserve) and although they are legally listed as debt (there is no formal equity accounting with the government) they are not redeemable by anything other than themselves and accrue no interest payments.  They are in a category one could call "no-debt debt" as they create no future obligation.  This is acknowledged by today's federal debt legislation which explicitly exempts them[7].

USNs were tested in a Supreme Court decision, Knox v. Lee, May 1, 1871, which established that the federal government through the Department of the Treasury had the right to issue paper money as legal tender for the payment of all debts and that this did not conflict with the Constitution.  This has never been overturned.  See 79 US 457.  Some have argued that the Constitution's Coinage clause (Article 1, Section 8, Clause 5) only applies to physical coins in spite of the Supreme Court decision.  A lengthy historical review of that was published in the Harvard Journal of Law and Public Policy, volume 31 called “Understanding the Coinage Clause” by Robert G. Natelson which comes to the conclusion that Treasury was meant to have the right to print paper money.

The history of US Note emissions (Greenbacks) is well documented; see the attached document “Friedman - The Greenback Period” with relevant sections highlighted.  This is taken from A Monetary History of the United States, 1867-1960 by Milton Friedman and Anna Schwarz, considered to be the definitive book on the era.

At times the argument of inflation is raised against USN issuance because they and all US paper currency of the time experienced a significant drop in value vis-a-vis gold.  Only a tiny fraction of our monetary aggregates are in the form of paper currencies today, but the attempt it made to foster this argument on any form of USN issuance, as the majority would be in electronic form today.  Friedman and Schwarz spend many pages explaining that this relative drop in value was not a domestic issue due to "just printing money" but rather due to imbalances in terms of trade with trading partners on the gold standard, and especially England.  See the highlighted portions in FRIEDMAN on pages 6, 7, and especially 26 and 27.  This argument against the further use of US Notes is therefore spurious.

As the issuance of Federal Reserve Notes (now mostly electronic) is only possible through increasing the issuance of debt that demands interest payments, either private or governmental, it has resulted in today’s $18 trillion federal debt plus trillions more at the state and municipal level.  This is in direct opposition to the actions taken by Congress during the latter 1800’s, as those USN issuances have saved the federal government about $14 billion in interest payments.  This figure comes from using an average of $300 million outstanding US Notes for 150 years at an average real interest rate of 2.6% compounded annually.  It is easy to show mathematically that if US Notes had been continued to be used judiciously there would today be no real federal debt instead of the $18 trillion we have accumulated.

A further argument made against USN issuances is that it can be seen as an implicit tax.  There is justification to this if the issuance were not to be matched with commensurate increases in production and services.  Currently we value-match our money production to GDP by the issuance of debt through private banks and controlling that rate of increase or decrease.  We do not consider debt based currency to be an implicit tax because we understand the control functions in place through the fractional reserve banking system i.e. the private sector is creating the dollars, not the government.  The implicit tax argument therefore, in order to be rational either means that we think that USN issuances will not be matched by commensurate GDP increases, or that the current system is also an implicit tax.  Considering that the latter of these tends not to be claimed, the onus therefore is on the careful consideration of control functions which match GDP increases with USN issuance.  This would occur by definition, as using USNs to build a bridge (a real investment) or pay a Social Security payment (income) would increase GDP, ceteris paribus.  In real terms, the USN claim resources like a Fed note, and thus can be seen as a government tax on the private sector.

In 1999, an attempt was made to issue USNs and define these control functions with the introduction of the “State and Local Government Economic Empowerment Act” by Rep. Ray LaHood in the 106th Congress as HR 1452.  The Act ended up attracting 22 co-sponsors from both sides of the isle.  The control functions which were part of HR 1452 included:

1. a provision to limit the amount of funding available to $1400 per person for the total US population with different portions of that allocated to different types of municipalities;
2. the fact that the funding was as a loan and therefore needed structuring to create a payback system, even though the loan was interest free to the municipality and had a maximum term of 30 years;
3. the fact that the funding was only for the construction or improvement of infrastructure projects
4. the stipulation that only $72 billion per year was to be funded through USNs for 5 years, and;
5. an administrative fee would be charged to each loan recipient.

We are not suggesting that a new act would be identical to this one, but that this is a good model to consider.

The reasons for it not passing can be summed up as:

1. Federal debt was not nearly at the level seen today and therefore not perceived as critical as today;
2. The state of our infrastructure had not deteriorated to nearly the same level as today and therefore the need was not seen as urgent, and;
3. The history of US Note issuances and uses was not understood as well.

Ultimately over the life of infrastructure loans (often muni bond issues), approximately 50% of all infrastructure costs are interest payments.  This means that when driving down the highway and seeing a sign which says: “Bridge under construction.  Cost $100 million.” in actual fact, the bridge will cost about $200 million.  This makes the methodology of funding as important as the source.  The need for infrastructure repair, upgrading, and construction are undisputed – how will we accomplish that in today’s financially constrained conditions?  We are advocating that US Notes be again used for this purpose.  In our history we used them to create some of our biggest infrastructure projects including the first transcontinental railway, a national canal network and many others.  They demand no interest payments, do not increase real debt, decrease federal and local deficits, can be value-matched to real increases in GDP, and are counter-cyclical thus stabilizing business cycles.

As long as the government is running a deficit, the net effect of USNs is “neutral”, leaves the monetary system unaffected.  The public is left with the same amount of dollars which become bank deposits, paid directly with USNs or reimbursed by Fed purchases of bonds after lending the money to the Treasury for spending on infrastructure.  The issue of using USNs for deficit financing is handled extensively in a paper by Milton Friedman here.

One issue needing to be addressed is whether or not this compromises the Fed’s control over the monetary base and the money supply.  By determining the amount of USNs issued using a rule of some sort would allow the Fed to “manage around the USN issue”, neutralizing it if they saw fit from a policy perspective.  A simple rule would be the decision by Congress as to how much infrastructure spending was needed in which fiscal years and giving the Fed sufficient time to plan around that.

There is an interesting discussion around the demand for (need for) “riskless assets” as USNs displace the creation of these assets.  These are very important in financial markets today.  We do not believe this to be a significant issue as long as USN issuance only remains a minor part of the federal budget therefore leaving outstanding Treasuries at their current level.  If that level were to significantly decrease in the future this issue will need to be revisited, as it was during the presidency of Bill Clinton.

[1] The ASCE issues these report cards only once every 4 years

[2] The first infrastructure grades were given by the National Council on Public Works Improvements in its report Fragile Foundations: A Report on America's Public Works, released in February 1988. ASCE's first Report Card for America's Infrastructure was issued a decade later.

[3] The club of richer world economies called the Organization for Economic Co-operation and Development, consisting of 34 countries in 2015.

[4] We are well aware that the velocity of money is an integral part of this equilibrium, but because velocity is mean reverting, we are leaving it out of this discussion for sake of simplicity.

[5] Gold and silver coin.

[6] See the FRED information from the Federal Reserve Bank of St. Louis Economic Research here: https://research.stlouisfed.org/fred2/series/M2/

[7] In the website “documents” section is one by the Congressional Research Service showing that US Notes are not part of current debt limitation legislation.  See THE DEBT LIMIT - HISTORY AND RECENT INCREASES which states in page 1, Note 1"Approximately 0.5% of total debt is excluded from debt limit coverage. The Treasury defines “Total Public Debt Subject to Limit” as “the Total Public Debt Outstanding less ...and ... United States Notes, as well as ..." The debt limit is codified as 31 U.S.C. §3101.