Friday, January 25, 2013

A Fiat Currency Makes a Difference

The Albuquerque Journal OP-Ed Page published the following this morning with the title "High Debt Ratio Not a Big Deal - We are a country that can service our own debt." The only changes they made to the original text was to double the number of paragraphs. That edit improved the piece, I think.

In his article of January 19, Professor Gisser discusses some solid economic points about our economy that would mostly be true if we were still on a gold standard. Fortunately, since 1971 we have had a fiat currency with a floating exchange rate.

Consequently, we can always service our debt and have no chance of becoming another Greece, and the Fed, not the external market, establishes the interest rates on the Treasury securities that constitute our public debt (and net private savings).

Further, there is no reason to believe that a 100% debt-to-GDP ratio or more is a matter of great concern. There would be concern for a household but not for a government that issues its own sovereign currency.

The Fed might decide to raise interest rates in anticipation of inflation. But, inflation is a very distant threat when there is excess productive capacity, which we have with millions unemployed. The production lost from those unemployed resources is gone forever.

Professor Gisser cites some past administrations to bolster the idea that tax decreases increase federal revenue. But, he doesn’t tell the whole story. Sometimes tax decreases work the other way.

Not mentioned by Professor Gisser were the rapid rises in deficit after both the Reagan tax cut of 1981 and the Bush II tax cut of 2001. Not noticed by most critics of public debt is that private debt soared to 300% of GDP at the height of the crisis.

It was the private sector that couldn’t pay its bills.

The non-intuitive fact is that the economy cannot be managed effectively by looking at tax revenues and deficits. By simple accounting identity, high government deficits correspond to high private saving and net foreign imports.

The government has no control over the private sector’s desire to save or to import.

Consequently, the deficit is largely beyond government control. Better metrics would be unemployment, use of productive capacity, and inflation.

Contrary to media and political hype, our large deficits are not due to profligate government spending but to high unemployment. Austerity, which passes for responsible fiscal policy, is actually irresponsible as it tends to increase unemployment.

A country that issues its own currency has both the ability and responsibility to spend counter-cyclically to economic cycles to maintain a healthy economy.

Sunday, January 20, 2013

Obama Has Another Chance to Abolish the Debt Ceiling Forever

In the last few days the Republican-controlled House has decided to increase the ceiling for a few months. So, the Republicans put their sword back in its scabbard for use at another time and circumstance of their choosing. Obama now has time to reconsider his options to get rid of the debt ceiling forever.

On its face the debt ceiling is a farce in the present-day economy. Its roots lie in laws passed during World War I when the US was still on the gold standard. Its effect is to deny the administration the means to accomplish spending already approved by Congress. It is unlawful for the administration to refrain from making approved expenditures; at the same time, it is unlawful to exceed the debt ceiling. Something has to give, and two viable options exist.

Natural log of net private savings
First, Section 4 of the 14th Amendment to the Constitution says in part,

“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”

Although it appears to the layman that this would render the debt ceiling unconstitutional, legal scholars have argued both ways on the issue. So far Obama has refused to take up the fight, which might be litigated finally by the Supreme Court. During litigation Obama could boldly pay the nation’s bills.

Second, and preferable, a two-year old proposal to mint a $1-trillion platinum coin1 has resurfaced. Legal scholars have generally agreed that it would be legal for the Treasury to mint such a coin. Economists, including highly regarded Paul Krugman, have conceded the economic feasibility of the coin solution.

The Treasury, by law, can create coins as money out of thin air and a bit of metal just as the Fed can create money out of paper (or computer keystrokes). After depositing the coin in its checking account at the Fed, the Treasury could then write checks on its account without borrowing. Of course, many people, who know neither what money is nor how it works, were aghast at such shenanigans while, at the same time, apparently comfortable with the farcical dilemma presented by debt ceiling.

As the Treasury pays bills out of its coin-enhanced account at the Fed, bank reserves increase. Eventually, if the Fed decides to undo quantitative easing, which also increased bank reserves, it will have to sell Treasury securities to drain the excess reserves. Only at that time, all excess reserves including those enabled by the coin would be converted into Treasury securities that we call debt. That is, excess funds in bank reserve accounts would be converted into savings accounts.

To date, Obama has rejected both the 14th Amendment fight and the platinum coin loophole as means to obliterate the debt ceiling threat forever. Instead he is permitting the Republicans to use this irrational debt-ceiling weapon whenever they like.

In failing to challenge the debt ceiling he is allowing himself or the Senate to be coerced into cutting benefits from the cherished safety nets of Social Security, Medicare, and Medicaid. Perhaps, that is what he wants.

1. With fiat currency the nominal value of the piece of currency does not depend on the market value of the material of which it is made. The difference is called seigniorage and is profit for the Treasury.