By now we’ve all heard about California’s fiscal crisis and the state’s seemingly desperate move to print IOUs for payment of their debts. As much as it may seem California lawmakers are grasping at straws, some (like New Deal 2.0 ‘s Marshall Auerback) believe it may actually be a very shrewd move.
By accepting the IOUs as legal payment for state taxes, the state is imparting legitimacy on the notes—a move that could go a long way toward greasing the gears of commerce that have been so badly gummed up lately.
Here’s more  from Auerback, writing for nakedcapitalism.com:
Republicans and Democrats alike embraced legislation last week that would make California IOUs acceptable payment for all taxes, fees and other payments owed to the state – an action that effectively would mean that California is entering the currency business. Some commentators, notably Lex of the FT, have suggested that the proposed California “IOUs” “would create a vicious circle for the cash-strapped state, forcing issuance of even more IOUs.”
Quite the contrary: In fact, California’s innovative IOU proposal represents a way of alleviating the state’s fiscal crisis, not exacerbating it.
While it might appear that the new law seems merely to allow California to deficit spend just like the Federal Government – in actuality, the effect is far more profound than that. Allowing the IOUs to become an acceptable payment method for state taxes, instantly imparts value to them – in effect, what you have is a state of the union creating a parallel currency right under the noses of the Treasury, alleviating its fiscal straitjacket in the process.
So why are so objections being raised? The confusion seems to arise because of a mistaken understanding of the nature of modern money. Modern money has no intrinsic value in the absence of state sanction. In the words of economist Abba Lerner:
The modern state can make anything it chooses generally acceptable as money…It is true that a simple declaration that such and such is money will not do, even if backed by the most convincing constitutional evidence of the state’s absolute sovereignty. But if the state is willing to accept the proposed money in payment of taxes and other obligations to itself the trick is done.
The modern state, then, imposes and enforces a tax liability on its citizens and chooses that which is necessary to pay taxes. The unit of account has no real value if not ultimately sanctioned by use from the State. By extension, the state is never revenue constrained because it alone determines what is money. The tax is what gives the currency its value insofar as it functions to create the notional demand for federal expenditures of fiat money, not to raise revenue per se. Value has been given to the money by requiring it to be used to fulfill a tax obligation, but the money is already in existence, not “created” by the revenue.