Gov Rick Perry was Wrong

It has been over week since Rick Perry in one of his first idiotic statements as a Presidential candidate suggested the Fed Chairman Bernanke was treasonous. Part of his statement was

“Printing more money to play politics at this particular time in history is almost treasonous in my opinion.”

His apparent dislike of playing politics, which is his game, and giving it an historic perspective made it sound positively profound for a few milliseconds until he threw in treason, which carries the death penalty.

The mainstream media had a field day with his lack of Presidential perspective. But, none questioned the truth of the Fed printing money. That’s where we come in.

Clearly, Gov. Perry was referring to the Fed’s purchase of Treasuries in what has been called Quantitative Easing. QE is not “printing money,” a term used by conservatives to conjure up the specter of uncontrolled inflation. Actually, QE was ineffective as students of modern money expected.

QE and Gov. Perry’s remarks were based on an outdated understanding of old monetary theory that says bank lending is constrained by bank reserves. You may have heard of the old multiplier effect that says: If banks must hold in reserves 10% of their customer deposits, then when one deposits $100 dollars in the bank, the bank can loan out $90, when that is deposited in a bank that bank can lend $81, and the next bank 0.9 x 81= 72.9, and so on. After some more math, we conclude that the multiplier is 10. So, a total of $1000 can be loaned by the banking system.

With modern money banks are not constrained by reserves but only by their capital and the availability of creditworthy customers. So, what does this have to do with QE? Well, QE raised the level of excess reserves in the vain hope that it would encourage lending.

Previously, (here and here) we have discussed how excess reserves are converted into national debt (Treasury bonds) as the Fed tries to maintain its target interest rate and banks try to minimize their excess reserves.

Remember, Treasuries are just interest-earning savings accounts at the Fed. They don’t even come with a gold embossed piece of parchment, they are just numbers on a spreadsheet. Said Treasuries arose from the Fed selling them to drain excess reserves from the banking system. Under QE, buying the Treasuries back returns them to being excess reserves in various bank checking accounts. It is just like someone converting a Certificate of Deposit at a bank back into a checking account. The net balance of one’s wealth is unchanged except for the interest earned.

The consequence of this action is that excess reserves are no longer maintained at zero balance. The excess reserve are now large and the overnight bank rate is driven to about zero. The Fed has recently announced that it will keep that rate at zero for a couple of years. The chart below shows this increase in excess reserves graphically.

Excess reserves as a result of Quantitative Easing, which changed Treasuries back into the reserves from which they sprang.

That $1,600 billion is not new money. It is old money converted back to checking accounts.

What does this mean to you? You won’t be getting any interest on your bank savings accounts for a couple of years, because the banks can get money from the Fed at 0.25% or less. It also means that banks don’t have to charge as much on loans. So, car and house loans will carry less interest. 

Another consequence is that those Treasuries are earning no interest out in the private sector. At say 4% interest that $1,600 billion would have earned $64 billion which is now lost to the private sector. That should be a gain for the deficit hawks.

Related Reading:

Understanding the Mechanics of Quantitative Easing

Let’s talk about QE,...

Money is Debt: A Drama in One Act

In an attempt to understand the national debt better, I thought it might be worth stepping back a bit and ask, what is money? To illustrate, we might try a bit of drama.

My former friend Fred, a really big guy, bought a thing from me for $10.  

In payment he gave a $10 IOU. I was perplexed

Dan: Fred, how about some real money?

Fred: Dan, ole buddy, you know I’m good for it.

Dan: Well, OK. (Reluctantly)

Days later I go to Fred.

Dan: Fred, ole buddy, I came to collect my money.

Fred: Right now the best I can do is give you 10 $1 IOUs.

Dan: What? How about some real money? (Somewhat pissed)

Fred: That’s it.

Days later Fred comes to me.

Fred: Dan, give me back 5 of those $1 IOUs, or I’ll beat the crap out of you.

Dan: What the hell for?

Fred: It’s a friendship tax. 

Dan: 50% is a lot

Fred: Yep. (Raises clenched fist)

Dan: Well OK, I’ll give back 5 of your IOUs, to satisfy my tax liability.

We wouldn’t accept this kind of behavior very long in our private lives, but that is just what our government does. It purchases goods and services from us and pays us with IOUs (Federal Reserve Notes). Then it turns around and taxes some of those IOUs back. What’s left we get to save. 

This drama, OK bad skit, reminds us that the government creates money first and then takes back in taxes money it has already spent. The issuer of currency must always spend before it can either tax or borrow dollars. In either case, it is getting back dollars it has already spent.

Money has been debt for centuries, if not millennia. Any lord, king, or government that can enforce taxes can have money that will circulate based on credit and debt. Money is a claim on the taxing authority and moves around as people go about their trading. 

During the 19th century in the African British colonies, the Brits offered coins of the realm to the natives for them to work in the fields. The natives had no use for British coins and wouldn’t work for them. So, the Brits levied a hut tax payable only in British coin. Soon the workers were willing to work for the Brits and those who didn’t work directly for the Brits sold their goods and services to the workers in order to obtain the now precious coins. That’s all it takes. 

It’s so astoundingly simple, it boggles the mind.

Related Reading:

http://neweconomicperspectives.blogspot.com/2011/07/mmp-blog-8-taxes-drive-money.html

http://neweconomicperspectives.blogspot.com/2011/07/mmp-blog-9-what-if-population-refuses.html

Gold Standard Hangs On

Yesterday morning I heard Secretary Geithner on Good Morning America while I was waking up a bit late. What he said made me stop and groan. He was explaining how reduction of the deficit was good, because it would provide room for private business to grow. 

That is an old, outdated gold standard concept. Maybe his new employer (He will soon be leaving the Administration.) made him say it. In any event, it is weird to hear the Secretary of the Treasury make such a statement in these times.

Under the gold standard government and the private sector competed for a limited quantity of money. Government spending drove up interest rates and crowded out business investment. It is difficult for an economy to grow under a gold standard or other fiscally constrained paradigm, e.g., the eurozone.

Good grief, with 25 million underemployed and production capacity at 76%, this country has plenty of room for the private sector to grow. The reason it is not growing is because there is a lack of aggregate demand rather than crowding out.

When there is full employment and full utilization of productive capacity, government acquisition of available resources may interfere with the private sector. Right now, with the capitulation to the Tea Party, we can only pray that we might someday reach a competitive situation between government and private sectors.

At that point we might be looking at possible inflation. That is when aggregate demand is greater than our productive capacity can supply. That would look pretty good at present. Either too much deficit spending by the government or to much debt in the private sector can bring financial trouble. Given the explosion of the housing bubble, the private sector has had enough borrowing until people reduce their debt. Consequently, spending by the government is all we have for increasing aggregate demand. That isn’t going to happen for about a decade according to the dastardly debt deal just done.

Austerity works for households not for government. Households must live within their means; governments must live up to the nation’s means.

We are five years into our lost decade just like Japan suffered through after its big real estate crash. And, we will be fortunate to recover in a decade. Explain that to your grandkids when they notice that their lives are less abundant than yours.

Related Reading

Welcome to the United States of Austerity

A debt deal that solves the wrong problem

This Morning’s Grim Eurothought

National Debt: Short Version

On the eve of the Debt Ceiling vote in the House of Representatives, I submitted the following Letter to the Editor of the Albuquerque Journal. It is a short recap of my post here on July 22. As a friend told me, "Few people will understand or believe it, but you have to keep trying." So, here goes...

"Few people concerned about the national debt know what it is. Certainly, nobody in Washington, DC seems to know or the discussions would be much more intelligent and beneficial to the nation. 

The national debt is not like a loan one gets from a bank to buy a house or car. Such a loan has to be paid back in a certain time or default with some consequences.

Treasury securities (Notes, Bonds, and Bills) are savings accounts at the Federal Reserve Bank (Fed). Those saving accounts are owned by entities, including people, mostly in the non-government sector. So, why not call the national debt clock a savings clock?

Commercial banks have checking accounts at the Fed. These are called reserve accounts and are maintained at a level to promptly clear checks written on each of the many banks in the banking system. These checking accounts earn very little interest, so banks like to keep their reserve accounts at a minimum. To accomplish this, banks loan to one another in the overnight funds market. Those banks with excess reserves can loan to those with too little. The Fed tries to set the loan rate for these transactions.

Deficit spending by the government tends to increase reserves as recipients of government checks deposit them and draw upon their deposits. When the banking system as a whole has excess reserves, no amount of interbank trading will reduce them. The forces of supply and demand will drive the interbank lending rate down.

To decrease the level of excess reserves in the banking system the Fed sells Treasuries  to the banks. That is, they transfer funds from bank checking accounts to savings accounts. When the Treasuries mature, the funds plus interest are transferred back to the checking (reserve) accounts. There would be no need to sell Treasuries, if the Fed just paid interest on the reserves.

There are two points to realize about these operations. They are accomplished within the US banking system not the international bond market, and there are no grandchildren involved.

We are having an unnecessary crisis over an anachronism in our government accounting system." 

The President is teaching bad economics

President Obama’s speech Monday evening took the starch out of me. It was terrible to hear him deliver the conservative line and not even as ewell as they do. 

Everyone should know a little about economics and that’s all I claim to know, a few basics. In an earlier blog I tried to explain many ways in which private finances differed from those of the government. We all know that government can “print” money and households can’t. This difference has huge ramifications when we stop to think about it.

Perhaps the biggest difference is that households and firms try to make a profit. They save to accumulate wealth over time. Even state governments try to build a contingency fund for bad times. 

The federal government does not attempt to profit and has no way to save. It doesn’t need to because it can “print” all the money it needs. If it were to save, where would it put it? We don’t want government holding large amounts of stock in private firms. Hell, then Congress would try to run them. 

With a few moments thought, it should be obvious that government and private budgeting must be different.

Yet, our ill-advised President centers speeches around phrases like “the government must tighten its belt just like households do.” He must be getting his advice from Paul Ryan who says similar things with more conviction. President Obama is certainly not listening to his former economic advisor Larry Summers, who recently and belatedly wrote that the country needs a WPA project similar to FDR’s in the 1930s.

Early in his speech Monday, the President recited the following nonsense.

“Now, every family knows that a little credit card debt is manageable. But if we stay on the current path, our growing debt could cost us jobs and do serious damage to the economy. More of our tax dollars will go toward paying off the interest on our loans. Businesses will be less likely to open up shop and hire workers in a country that can’t balance its books. Interest rates could climb for everyone who borrows money – the homeowner with a mortgage, the student with a college loan, the corner store that wants to expand. And we won’t have enough money to make job-creating investments in things like education and infrastructure, or pay for vital programs like Medicare and Medicaid.”

He began with the government is like a household nonsense.

Then there is no way to save tax money. Government spending and taxation are separate functions. Government doesn’t need taxes to spend.

Our study of sector balances (here or here) has shown that a government that balances its budget in the face of private sector net saving (not spending) and foreign trade deficits will cause businesses to close as money is drained from the private sector and demand sags.

Obama is teaching the prevailing view of the day, which is out of date - to be kind.

To be less kind, this debt crisis is fabricated to induce enough panic that the polity will accept anything as a solution. Such a solution would be different from anything that would be concluded after public debate. Michael Hudson takes the less kind position. 

Spooky Debt to China

We tend to be spooked by the amount of our debt held by China. It makes good late-night comedy and cartoons abound. 

"Chinese President Hu Jintao was hinting that China may not loan the U.S. any more money. President Obama is now talking to him about a reverse mortgage." –Jay Leno

"The President of China is in Washington. It's a bit like when you're into your bookie for more than you can afford, and he stops by the house to say hello." –Jimmy Kimmel

We seem sure that China finances our profligate spending and resulting trade deficit. Nothing could be farther from the truth. Our spending shows up in our own loan balances.

The myth is that foreign investment funds our trade deficit. To be sure, we typically have imported more than we export for the last four decades.

Suppose we want to buy a Japanese car, many of us have done that. First we go to a bank and get a loan on reasonable terms, we draw on that loan to pay for the car and drive happily away. There is more happiness all around. The bank is happy to have the loan as an asset, and the car company is glad to have the money in trade for the car. 

Big deals work the same way. Walmart gets a boatload of Chinese stuff that it buys with a loan and the intent of making a profit when it sells the stuff to us. In neither case is there any foreign capital involved; there is just our private credit.

However the foreign country, Japan, China, or another trading partner has some dollars after the trade and can buy with those dollars any dollar denominated assets or convert to another currency. If they choose to buy safe US Treasury assets and we wish to sell them, it can be done. It is a matter of making a transfer from their checking (reserve) account at the Fed to a time deposit.

Our credit has funded their desire to acquire US dollar assets. Yes, it is that simple.

Circumvent the Debt Limit Crisis

Why don’t we just retire the debt? We don’t need it, and it causes endless concern. We just borrow or own money back from ourselves and the Treasuries further enrich the rich, as they end up owning most of them.

Recently I posted an idea from Rep Ron Paul as a way to get rid of debt now held by the Fed as a result of Quantitative Easing. A better idea has surfaced that involves coin seigniorage. That is the profit made on the cost of a coin relative to its face value. 

In short it goes like this. The US Mint is authorized to mint coins in any denomination, oh say $2 trillion, which is a huge profit. The Treasury then sweeps the profit from the Mint’s account at the Fed into its own General Account. With these funds it buys back Treasury bonds which reduces its General Account balance and increases bank reserve balances at the fed. It is essentially Quantitative Easing through the Treasury. It would be legal, feasible, and require no new legislation.

Of course, it won’t be done. People’s minds will recoil from the simplicity of it. If it were to happen the President could give the following speech copied from here.

My Fellow Americans:

1) Until now we’ve been borrowing the money the Government created back from the private sector, in order to cover our deficit spending, so the national debt has been steadily growing.

2) That’s silly! According to the Constitution, this Government, of the people, by the people, and for the people, is the ultimate source of all US money. So why should we ever borrow US money back and pay interest on it, since we can create it any time by the authority of the Constitution and Congress?

3) Congress has also imposed a debt ceiling, which, as you know, we've now reached, so we can’t borrow back our own money, anyway. 

4) So, on my order, and in accordance with legislation passed by Congress in 1996, and with the US Code, the US Mint has issued $30 Trillion in a single platinum coin, and deposited it at the NY Fed. It’s legal tender, so the Fed credited the PEF with about $30 Trillion in USD credits using its unlimited authority from Congress to create US Dollars.

5) This is not inflationary because the Fed will put our coin into its vault, and keep it there permanently out of circulation, and we will use the $30 T in USD credits only to pay back debt and to spend what Congress has already approved, which is only a fraction of these credits and far from the amount needed to cause inflation.

6) My action ends the debt ceiling crisis, because we have no further need to borrow our own money back in the markets, so we don’t need the tea party or other Republicans, or even my fellow Democrats to agree to raise the debt ceiling.

7) Now the Treasury, has plenty of money, much more than we need, in fact, to pay for all appropriations Congress has already approved for 2011, and, again, we won’t have to borrow our own money back.

8) So we will pay all Government debts which will come due in 2011. Treasury securities and all other debts included. We will also pay back all debts held by other agencies of Government and the Federal Reserve. When we do this we will lower the national debt by about $7.5 T, reducing the “debt burden” by about half this year, and creating an actual Social Security trust fund with 2.6 T in cash reserves in it; and again, to do this we don’t have to borrow our own money back, and we will also reduce our interest costs on the outstanding national debt.

9) None of the $30 T in new credits created by our actions is “money” in the economy until the Treasury spends it. For now it is just capability to spend awaiting the appropriations of Congress to mandate deficit spending, should it need to compensate for the reduction in demand, probably close to 10% of GDP right now, caused by your own desire to save (which we want to do our best to facilitate), and your desire to import goods from foreign nations.

10) We have created $30 Trillion in new credits even though we needed only a fraction of that to cover anticipated deficit spending and debt repayment until 2021. The reason for this, is that I wanted to have enough capability created in the Treasury account, so that the national debt could be completely paid off (except for a small amount in very long-term Treasury debt still not mature by 2021), and all projected Federal deficits covered over the next 10 years.

11) Of course we can always make new coins if our projections turn out to be wrong; but I thought it would be best to ensure that all $14.3 T of the “debt burden” can be completely eliminated from our political concerns; and also to provide enough funds in our spending account at the Fed so that it would be very clear to Congress and all newly elected Representatives and Senators, that even though they, according to the Constitution, continue to control the purse strings, the national purse is very, very full, and that we will be able to afford whatever deficit spending for the public purpose, including for full employment and Medicare for All, that Congress, in its wisdom, chooses to appropriate now and before the election of 2012.

Good night, my fellow Americans and Sweet dreams! Rest well knowing that our beloved country won't be defaulting on any of its debts, and that I've prevented this without going over the legal debt ceiling, by providing money for spending mandated appropriations, in compliance with the laws authorizing coin seigniorage, while supporting the Constitution's prohibition against our Government ever defaulting on its debts. I hope that in the future everyone will obey the 14th Amendment's prohibition against questioning the validity of Federal Government debts, and think twice before they indulge themselves in such loose talk. America will always pay its debts in US Dollars according to the terms of the contracts it has concluded, and in line with the pension payments and other obligations that it owes. Neither you nor the rest of the world need ever doubt that again!

Further discussion of this approach is found here.

National Debt: What Is It?

Ignorance at the top of our government is appalling. Much time has been wasted by the President and Congress in political posturing around the debt ceiling rather than in meaningful discussion at a time when the economy is in a crisis that no one seems to understand.

In his testimony before the Commission on Deficit Reduction, Prof James K Galbraith made the following comments on June 30, 2010:

“The effect of government check-writing is to create a deposit in the banking system. This is a "free reserve." Banks of course prefer to earn interest on their reserves. Thus they demand a US Treasury bond, which pays more interest without incurring any form of credit or default risk. (This is like moving a deposit from a checking to a savings account.) The Treasury can meet that demand, or not, at its option -- it can permit, or not permit, the stock of US Treasury bonds in circulation to increase.

So long as U.S. banks are required to accept U.S. government checks -- which is to say so long as the Republic exists -- then the government can and does spend without borrowing, if it chooses to do so. And if it chooses to issue Treasuries to meet the demand, it can do that as well. There is never a shortfall of demand for Treasury bonds; Treasury auctions do not fail.”

His full testimony is an exemplary piece of profound brevity. The essence of how money works in the modern era, since 1971 when the USA went off the gold standard, are contained in the two quoted paragraphs.

As the monopoly issuer of currency, the government can create money, at will, by purchasing goods and services from the private sector. Payments for these purchases result in bank account deposits that, in turn, increase reserve balances at the Fed. Federal taxation removes reserves as bank accounts are debited, which effectively destroys money. Government deficit spending is defined as spending in excess of taxation and results in net assets in the private sector exactly in the amount of the deficit.

So far, we have spoken of spending and taxation resulting in a deficit for the government and increased assets for the private sector. So, where does this debt thing come in? It has to do with those reserves - not foreign bond markets.

Those reserves must be adjusted daily to make sure checks written on one bank and cashed at another will be paid (cleared) promptly. Bank loans also create deposits and reserve requirements. The Fed Funds Rate is the interest rate that banks must pay to acquire required reserves in the overnight market. The Fed adjusts its target funds rate to inflate or deflate the private sector appetite for creating money through bank loans. 

An excess of reserves would drive down the Fed Funds Rate, so the Fed sells Treasury bonds to get rid of excess reserves that accumulate as a result of deficit spending. This is just a matter of moving money from a demand checking account to an interest bearing savings account. Banks are eager to put reserves safely in Treasuries rather than hold low-yield reserve accounts.

But, the Fed has another option. It could just pay its target Fed Funds Rate on the reserve balances to the respective banks. This would eliminate the the overnight funds market, let reserves accumulate, and forego the sale of Treasuries.

Hopefully, this clarifies Prof Galbraith’s statement above. Contrary to popular wisdom, the US or any other country with a sovereign, non-convertible, floating rate currency is not affected by the global bond markets.  The US can meet any debt obligation denominated in its own currency and does not borrow to fund its deficit, it borrows to maintain its target rate in the reserve funds market.

So, we need pay no heed to S&P or Moody’s bond ratings. The Fed sets our borrowing rates. 

The national debt is a optional artifact of the national accounting scheme, which has not changed since we went off the gold standard. Always a nuisance, the debt ceiling, a gold-standard hold over, has become a menace.

Related Reading:

Borrowing Does Not Fund the Deficit

Gold standard and fixed exchange rates - myths that still prevail

Saturday Quiz - April 23, 2011 - answers and discussion Q4

Open Market Operations

Understanding The Modern Monetary System

Quantitative Easing Might be Good for Something

In the past, I have mentioned that when the Government sells Treasuries it is affecting only the level of reserves in the banking system and providing a subsidy for the rich rather than financing the deficit. QE1 and QE2 consisted of the Fed buying back Treasuries from the Banks in the hope of stimulating borrowing a low rates. It didn’t work.

Yesterday, Ron Paul, whom we all know well, stumbled on to a good idea here. Perhaps it was tongue in cheek when he suggested just abolishing the debt held by the Fed. The  $79 billion paid to the Fed in interest is just returned to the Treasury anyway.

Dean Baker picked up on this idea here and sized it up this way,

“Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn’t have its bonds. In fact, there is no direct loss of income to anyone associated with the Fed’s destruction of its bonds. This means that if Congress told the Fed to burn the bonds, it would in effect just be destroying a liability that the government had to itself, but it would still reduce the debt subject to the debt ceiling by $1.6 trillion. This would buy the country considerable breathing room before the debt ceiling had to be raised again. President Obama and the Republican congressional leadership could have close to two years to talk about potential spending cuts or tax increases. Maybe they could even talk a little about jobs.”

As Baker explains, this would leave the Fed with excess reserves in the banking system, which would keep the Fed funds rate at 0% where it is destined to stay for some time in any event. Later on the Fed would have to look to other means to hit its target funds rate.

The idea, which is admittedly tarnished by its source, is actually too good to be put into effect by the clowns of Congress. However, even discussion of it would, perhaps, make people think more realistically about our the national debt and Fed bank reserves.

If Balanced Budget Amendment Sounds Good - Think Again

The US House of Representatives led by Majority Leader Eric Cantor will soon vote on a Constitutional Amendment to assure balanced federal budgets. The objective is to ban government outlays in excess of taxes unless approved by a super majority in both the House and the Senate.

This sounds good to people who don’t understand how money and the government work. In fact, it would just give more tools to those who would finesse money from the poor and give it to the rich.

Federal government and households differ in that the government can create money. Households must earn money or borrow it. The government creates money by purchasing goods and services from the private sector. Then the government taxes to get some money back. Spending more than tax revenue is deficit spending by definition and spending less results in surplus. 

Likewise, a private sector deficit occurs when private spending exceeds earnings, and the private sector saves when it spends less than it earns. The private sector net saves or borrows.

With those simple definitions in mind we can follow dollars and ignore the foreign sector (exports and imports) for simplicity. If a dollar goes out of the government sector, it goes into the private sector and vise versa. It follows that when a government is in deficit it is, by definition, putting money into the private sector that can be saved or used to consume. 

Also, when the government is in surplus, money flows out of private sector savings to the government. In extreme cases of government surpluses or low deficits the private sector may be driven into debt. The recent housing crisis is an all too recent example. And, when money flows out of the private sector, from whose pocket does it flow? Hint: Not the ruling class.

The conclusion is that a balanced budget amendment will prevent both the economy from growing and the private sector from saving.

Some might assert that the money created and spent into the private sector just ends up as Treasury securities so no net money is produced. That would be incorrect, because the Treasuries are the result of bank reserves at the Fed being converted from demand accounts to longer term interest-bearing Treasuries. The recipients of deficit dollars are still richer.

Others may say that money is created through bank lending. That would be correct, because banks put money into circulation by making loans. However, that money is taken out of circulation as the loan is repaid. No net money is produced.

The common wisdom that deficits are bad and surpluses are good holds only for households, firms, and state governments. For the federal government, deficits are normal and necessary to keep the economy growing.

Related Reading:

A Balanced Budget Would Change Everything

The land of the free - sliding further into oppression

The CBO Doesn’t Get It

On June 22, the Congressional Budget Office issued its 2011 Long-Term Budget Outlook.

The supposedly non-partisan CBO makes arguments that favor the politically correct deficit terrorists even though they are wrong. The role of the CBO is to make straight forward projections based on current or proposed law. Consequently the projections are prone to be as wrongheaded as the law. The CBO should stick to accounting and stay out of politics.

One can quibble with the CBO assumptions and calculations, but its reasoning and conclusions appear to come from a fiscally constrained paradigm like a gold standard. In the report Summary we have the following.

“In particular, large budget deficits and growing debt would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States.” 

Students of modern money operations could not disagree more with this statement. We know that “national saving” has no meaning for a country that creates its own sovereign currency as it needs it. Growing debt in itself cannot lead to higher interest rates, because the Fed sets those rates not the global market. More borrowing from abroad is optional, and domestic investment would be increased as federal spending puts dollars into the private sector.

We could stop here, but there is more to chew on. In the full report we find the following.

“Increased government borrowing generally draws money away from (crowds out) private investment in productive capital, leading to a smaller stock of capital and lower output in the long run than would otherwise be the case. Deficits generally have that effect on private investment because the portion of people’s savings used to buy government securities is not available to finance private investment.”

This statement might be true in an economy with a fixed amount of currency, that is, a financially constrained system where the private and government sectors compete for the existing dollars and bid up interest rates. 

In the modern view, government does not “crowd out” private investment because the money supply expands through the banking system according to demand. Consequently, there is ample capital available. Further, deficits put money into the private sector, so there are more funds for private investment. It is government surpluses that take funds out of the private sector not deficits.

The negative consequences of rising levels of debt according to the CBO are:

• “Higher levels of debt imply higher interest payments on that debt, which would eventually require either higher taxes or a reduction in government benefits and services.
• Rising debt would increasingly restrict policymakers' ability to use tax and spending policies to respond to unexpected challenges, such as economic downturns or financial crises. As a result, the effects of such developments on the economy and people's well-being could be worse.
• Growing debt also would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government's ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. Such a crisis would confront policymakers with extremely difficult choices. To restore investors' confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.”

These consequences are wild speculation and contrary to observed fact. 

Japan, which also has a sovereign, fiscally unconstrained money system, has experienced high deficit and debt ratios, vastly higher than foreseen by the CBO, for many years while maintaining low interest rates. 

With a sovereign currency, we have unlimited ability to use tax and spending policies to respond to unexpected challenges.

Lastly, there can be no sudden crisis that screws our ability to borrow at affordable rates, because we do not need bond sales to fund our deficit. The government just borrows back its own spending to meet it target interest rate. It is merely conversion of funds in reserve checking accounts at the Fed to interest bearing accounts.

“Bonds? We don’t need no stinkin’ bonds!” In fact, they are a voluntary holdover from the gold standard, when we did need them.

The CBO is only politically correct when it concludes that the US government “will need to increase revenues substantially as a percentage of GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches.” We would prefer that “in the long-term” be substituted for substantially and significantly.

We would conclude just the opposite. The government should reduce taxes and/or increase spending at the present time to accelerate demand during a demand-deficient recession.

Related Reading:

The land of the free - sliding further into oppression

How to avoid our own lost decade