Tuesday, July 28, 2015

Government's Unlimited Source of Fund

"When governments do not feel strong enough to procure by taxation or borrowing the resources to meet what they regard as irreducible expenditure, or, alternatively, so to restrict their expenditure that they are able to make do with the revenue that they have, recourse on their part to the issue of inconvertible notes and a consequent fall in the value of money is something that has occurred more than once in European and American history" (The Theory of Money and Credit, p. 15).

I'm having difficulty "decoding" the meaning of this long sentence by Ludwig von Mises. What is he saying here?

The way I see it, Ludwig von Mises combined four ideas in one sentence: 

1. About government's hesitation between taxing the people and borrowing money or restricting its expenditures with the available funds provided by current taxes, 

2. That if a government is not satisfied between these two options, it will choose to fund its programs using "the issue of inconvertible notes," 

3. That resorting to such way of providing fund for its expenditures will result to currency devaluation, and 

4. That this kind of government action is not new, but has a root in European and American history.

The most difficult part in the above sentence is to exactly find out the meaning of "inconvertible notes". I googled it, and what appears are links to the definition of "convertible notes". I googled it again and add Mises' name, and there we can see links to his book The Theory of Money and Credit, but still I cannot find the exact meaning of the term "inconvertible notes". And so I decided to just deduce its meaning from the definition of convertible notes. 

Reading the Financial Times, I see that "Convertible notes are often used by angel investors who wish to fund businesses. . ." These "notes are structured as loans at the time the investment is made." These notes are described as "convertible" because they can be "automatically converted to equity" later on. 

Now, let us return to the meaning of "the issue of inconvertible notes" that will be used by the government to fund its expenditures. Who will issue this inconvertible banks? The central bank? Why these notes are described as "inconvertible"? I do not know the exact answer. All I can do is guess. Perhaps unlike the convetible notes, these inconvertible notes cannot be converted into equity. But I assumed that they can be converted into cash. For if not, then how can a government provide a fund for its expenditures? 

To me, I understand inconvertible notes as a form of loan that will be used by the government for its programs, which will be financed by the people through taxes in the future. The quote also talks about three ways the government fund its expenditures:

1. Through direct taxation,

2. Through direct borrowing, and

3. Through the issue of inconvertibles notes, which to me is a form of indirect taxation and indirect debt.

Directly taxing the people and borrowing money are better ways to source out fund in a sense that it is obvious and the taxpayers can see their impact on their personal and family expenses. And because of this, each individual and family can adjust financially. This I think what makes inconvertible notes dangerous. I wonder how many citizens understand its nature. But Mises is clear that once the government used this credit instrument, the outcome is monetary depreciation. So inconvertible notes are also taxes, but done in an indirect way that make them invisible. I suspect that the use of these notes has a lot to say about monetary corruption and the ongoing crisis in global economy. Utilizing this tool, politicians can expropriate the people without the latter knowing how it is being done. Government has found people's pockets as an unlimited source of fund.