Trying to ignore everything we think we know about money, let's imagine setting up a new country - call it Alba - and discover how to create a money system [*]
Creating currency, a tax system, and unemployment
To start with, there is no government; the population is beavering away, living their lives as best they may, and then a group of people decide that there needs to be services provided in common.
Perhaps the first service they think of is a police force that monopolises physical power. The police force will need to be given food and shelter, somehow, so that they can focus on strutting around waving guns.
To give the police a living, the group creates unemployment. How do they do this? They print a bunch of cards with the words "One Smackeroonie ($1)" written on them. The first police person is Leon The Professional, and he sports a 9mm. Leon lets everyone know that either they pay him $1, or they get shot.
This creates unemployment.
Suddenly, the tranquil world is seething with unemployment. The cry goes up - I'll do anything to get me a $1. The group behind Leon offer to employ people to build Leon a house and grow him food.
Perhaps the group decides to only print 100 cards, but there are 120 people in Alba. 20 people get shot, which isn't a good thing, but reinforces the idea that getting your hands on Smackeroonies is not to be sneezed at.
This is how a currency, a tax system and unemployment are created. The cards are a currency that everyone wants. Scrambling to get hold of limited cards creates unemployment. The work provides for Leon, the public service. In this way, the group achieves its aim of moving resources from the private to the public domain.
Creating a banking system
The group relents and prints enough cards to keep everyone happy, and decides to call itself "the government".
Some people do more government work than required to avoid being shot, and save a few $1 in a sock for a rainy day.
A second group of people - The Charlatans - get their hands on a few extra $1 and, through advertising, create the impression that they have bucket loads of $1 stored in their safe. People with grandiose schemes, and people momentarily skint come to them for loans.
It's all a confidence trick: The Charlatans do nothing more than operate an abacus - when someone borrows $100, they rack up 100 negative points. People with extra Smackeroonies ask The Charlatans to look after them - these people rack up positive points.
Luckily no one ever gets to see into The Charlatans' safe so no one finds out the awful truth: there is next to nothing there.
However, this doesn't matter - so long as everyone repays their loans, there are no problems. If anyone abuses the system by not paying back what they've borrowed, The Charlatans call in Leon The Professional.
The Charlatans decide to call themselves "a bank".
Government deficits
If a punter runs up a deficit with the bank, eventually they will have Leon to reckon with.
The government is different. If it prints more cards and offers matching work than is required to pay the tax, then the extra $1 remain in the economy and can be saved. A government deficit (spending more than it takes back) matches, identically, private sector savings.
If the government issues fewer cards and work than is required to pay the tax, the government drains Smackeroonies out of the economy, leading, eventually, to people getting shot.
We see that government surpluses are bad; government deficits are good.
Why taxation? Why unemployment?
The common idea that taxation is necessary to pay for government spending is nonsense, as can be seen from the process of creating the currency described above.
First the government issues the currency. The currency is in itself just a bunch of cards with no use nor value. They acquire value only because of Leon the Professional. First, the currency is issued, then the public pays it back as tax.
The government has no need for the cards - they will
typically destroy them in a shredder, and print some new ones. The
government can print as many cards as it likes - it is
impossible for the government to run out of its own currency.The creation process also makes it clear that unemployment is a creation of government. An unemployed person is someone who cannot find the work required to get the money necessary to pay the tax. If there is unemployment, it is because the government has not spent enough (not issued enough cards and matching work).
The point of taxation is to move resources from the private to the pubic domain. Resources are real; Smackeroonies are just cards. The government can also use the currency or taxation to control certain economic variables, dependent on its ideology.
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[*]This presentation is a reworking of the videos by Warren Mosler, a founder of MMT