Federal Deficits are Necessary

 A 600-word version of this was submitted to the Santa Fe New Mexican in early September and this version to the Albuquerque Journal by Duane and I as co-authors. Figure was not submitted. Neither has been published. I suspect that the title/subject matter is too radical for editorial staffs. We will have to keep trying.
*************************************

Our economy is struggling under high unemployment and slow growth because of widespread, irrational fear of deficits and public debt. Candidates for the upcoming election promise to increase austerity and repay the “national debt.” Even the White House is bragging about small and decreasing deficits. But, deficits are necessary, more so for a languishing economy. This discussion illuminates how federal deficits reduce unemployment and result in private savings.

Most of our money is created in the private sector by bank loans driven by business investment activity in response to consumer demand. Contrary to common understanding banks do not simply lend out deposits. A quote from a recent Bank of England report says it succinctly:

    “Whenever a bank makes a loan, it simultaneously creates a matching deposit in the
    borrower’s bank account, thereby creating new money.”
 
Because money created by bank loans must be repaid, there can be no net savings from loan activity. It is a zero-sum game in which prosperity is experienced only if loans are made faster than they are repaid. The domestic private sector deflates unless continually boosted by new loans.

The economic risk is that unrestrained bank credit can lead to unsustainable private debt, as in the recent housing bubble. Unable to service their debt, borrowers reduce consumption, which leads to unemployment as firms cut back production due to reduced consumer demand.

Private loans drive our economy, but when the economy falters, either the federal government must intervene or export trade must increase to restore employment and stabilize the economy.

Like bank loans the federal government creates new money when it makes deposits into bank accounts to pay for purchases from the private sector. Unlike bank loans there is no corresponding private liability created, and the deposit remains in the private sector unless removed by taxes. Federal spending increases both net private savings and consumer demand while taxation decreases them.

Exports to foreign nations can also provide income to our domestic private sector. However, the US has been a net importer since the 1970s. Consequently, our foreign trade deficits reduce our domestic financial assets and cause unemployment as jobs go overseas.

In good times businesses borrow to invest, consumers borrow to consume, and government tax revenue is high. But, if federal fiscal policies result in low deficits or surpluses while imports are high, financial assets decrease in the private sector, consumer demand decreases, and businesses slow production causing increased unemployment.

Businesses focus on profits and have no incentive to maintain high employment. Our slow economic recovery and continued high unemployment over the past six years have shown that the monetary operations of the Fed have failed. However, Congress can always increase deficit spending or reduce taxes to restore both demand and employment without inducing inflation. Unfortunately, irrational fear of deficits led to austerity instead of the needed government investment to generate a faster economic recovery.

Historically, low deficits precede economic downturns, and surpluses precede depressions. 

Stacked bar chart from BEA data shows dollar flows to/from government, private and foreign sectors quarterly from 1960 Q1 to 2014 Q1. Note government deficit always equals sum of private surplus and net imports.

During five periods in the 19th century the government had budget surpluses, and each was followed immediately by an economic depression. In the 20th century, surpluses in the 1920s immediately preceded the 1929 Great Depression, and the “Clinton” surpluses in the late 1990’s preceded a recession in 2001 and the Great Recession in 2008. Throughout the decade leading up to the 2008 crisis, the combination of surpluses, low deficits, and high imports sucked $1.6 trillion out of the private sector.

Invested in research, education, and infrastructure government expenditures provide the real assets to modernize our public structures and institutions so necessary to assure our children’s future productivity. The “national debt,” which is the sum of deficits since the formation of the republic, unlike a bank loan, is never repaid, and provides financial assets that help secure our financial future. In our economy, only federal deficits result in both net private savings and reduced unemployment.


Both authors are retired PhD physical scientists and students of Modern Money Theory, which describes monetary operations for a sovereign fiat currency.
References:
Bank of England
"Money creation in the modern economy"
http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspxhttp://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx

History of surpluses and depressions
https://www.dropbox.com/s/jw2ywdaxeeg6eft/Thayer%20Frederick%20Balanced%20Budgets.pdf

BEA Data to compute private savings loss FY1998QI through FY2008QI
https://research.stlouisfed.org/fred2/graph/?graph_id=191120

It’s time to change federal fiscal policy

Today I submitted this to the Albuquerque Journal. My tendency to try to say too much with too few words has made me a bit hesitant, but I decided to give it a shot. It seemed timely after I read Milbank's column. 
*****************************************************

My heart sank Sunday, August 17 as I read Dana Milbank’s column in the Journal entitled “American optimism is a thing of the past.” Surveys show that most Americans think the next generation will not do as well as we have.

No doubt, our current economic policies have harmed the future of our grandkids. Mainstream economists blame it on “secular stagnation,” and suggest we will have to live with slow growth and high unemployment.

As we have observed, the Fed has been unable to stimulate the economy with its purchases of privately held securities. The-Powers-That-Be tell us that government must tighten its belt just as households must. So, the White House brags about lower and decreasing deficits. TPTB tell us there is no alternative. Well, there is an alternative; the die is not yet cast.

For years TPTB have told us that our high public debt and deficits would cause interest rates to rise, and we would be unable to service our debt. That didn’t happen, because the Fed sets interest rates. TPTB didn't know that.

Also, TPTB told us that “money printing” by the Fed to purchase private securities would cause inflation, even hyperinflation. That didn’t happen, because those purchases were just asset swaps. Nobody ended up with more money in their pockets. TPTB didn't know that.

Additionally, TPTB said that the excess reserves caused by Fed security purchases would lead to a lending binge by banks and debase the dollar. That didn’t happen, because banks don’t lend reserves. TPTB didn’t know that reserves stay in the banking system.

TPTB still believe we have a trickle-down economy, but we know now that it’s really a trickle-up economy. TPTB shut down government last year over debt ceiling negotiations because of a wrong-headed aversion to deficits and debt, not knowing there is little to fear from either.

Why do we continue to listen to TPTB when they are consistently wrong.

We live in a demand-driven economy where my spending is your income. Workers are paid to produce goods and services. If all workers spent all their income, demand would be such that all products would be consumed. But, there are inevitable “leakages” in total demand. 

We need to renew infrastructure. It's a matter of available resources not money.

Some elect to save part of their earnings. Unless others spend more than they earn not all goods and services are consumed. Then producers cut back production causing unemployment.

Another leakage is spending on foreign imports. While imports have many benefits, they result in reduced demand and unemployment here at home.

Taxes are also a leakage, if they are greater than government spending. But, if taxes are less than government spending, the resulting deficit increases demand and reduces unemployment. High unemployment means that federal deficits are too low to make up for leakages.

Federal spending and taxation are fiscal operations that we always have available to stimulate the economy, especially when the Fed’s monetary operations fail as they have these past seven years. We are prevented from employing fiscal policies by the deficit and debt scare tactics of TPTB, of course.

Deficits reduce unemployment, the costs of unemployment benefits, and the human suffering caused by involuntary unemployment. For our economy, there is nothing closer to a free lunch than putting the unemployed to work.

A household’s debt represents a financial asset for their bank and has to be repaid. The “national debt” is completely different as it represents financial assets for the whole private sector and never has to be repaid. Rather than a burden on our grandchildren those assets will be passed on to them.

It really boils down to this. Whether we rely on Social Security, pensions, or private portfolios we need a highly educated, productive work force to support us in our old age. With well constructed fiscal policies, we can assure that our kids and grandkids will have the knowledge, education, and infrastructure to provide for themselves and us.

Now is the time. Let’s get people, who understand basic monetary operations, into Congress and newsrooms.

Related Reading

Demand Leakages: The 800lb Economist in the Room

American optimism thing of the past

The federal budget process: What did Leon Panetta mean?

Duane and I worked together on this to submit as a letter to the Helena, MT Independent Record. We hope to make the point that the US Budget, unlike households, is about resources instead of money. Duane submitted it today. It was published here and received some nice kudos here and here and here.

*********************************************************

Leon Panetta was recently the guest lecturer at the University of Montana’s annual Jones-Tamm Judicial Lecture.  Mr. Panetta is a true patriot, having served with distinction for over 20 years under two presidents. Under President Clinton he directed the Office of Management and Budget and later served as Clinton's Chief of Staff. Under President Obama he served as Secretary of Defense and later as Director of the CIA. 

Leon Panetta

 Mr. Panetta stated that “the nation's biggest security issue was its inability to deal with the budget.”  Although many will interpret his statement as a call to cut the deficit, what he was really criticizing was the Congress’ inability to produce and pass a spending budget that would put some certainty into the ability of the nation to do strategic long term planning.

Like most Washington public servants, Mr. Panetta holds the old-fashioned view that federal budgets should be balanced and the magnitude of deficits is an important metric for the economy. This view is appropriate for households and businesses that have limited financial resources. However, the federal government issues the nation's currency and is not constrained by financial resources. It has all the financial resources it needs and is constrained only by the nation's productive resources.

Both political parties are dominated by the false view that the federal budget must be balanced. The only difference is that conservatives think the government has a spending problem and liberals think it is a revenue problem. Both are wrong and it is hurting America's competitive global advantages.

In the modern world of fiat currency the federal government must focus on real resources (available materials, factories, infrastructure, labor, knowledge) instead of financial resources (money and bonds) in managing the economy. Money is the vehicle that allows the smooth movement of goods and services from sellers to buyers in the economy. The federal government as the sole issuer of the U.S. dollar can issue all the money it needs to move any resources of the nation. 

The US and most other nations of the world have used a fiat monetary system since President Nixon defaulted on the gold standard in 1971. Under a gold standard the quantity of money available to the nation is determined by its store of gold, which limits economic growth. Under a fiat system the available money varies with the growth of the economy, and depends on bank loans and federal spending. In the absence of adequate bank loans to make investments in our main-street economy, Congressional budget decisions are responsible for reviving a depressed economy.

The Congressional budget exercise should not be about achieving a balanced federal budget. The budget should be developed to assure that all available resources of the nation are put to good use. There is plenty of work to be done, and we can avoid high unemployment. The federal government can employ all the resources not employed by private industry. If unemployment is high, as it is now, federal deficits are too small. 

Many will denounce deficits as causing inflation or adding to a gigantic national debt. They forget to mention that inflation results from demand greater than our productive capacity. But, government purchases of either goods or services from labor, which are readily available because of high unemployment, increase total production along with demand and that benefits businesses.  Such purchases are not inflationary. 

They also fail to mention that the huge national debt is in reality a huge private asset.  The national debt is nothing more than government bonds that individuals, banks, and pension funds hold in their accounts as secure savings instruments.

Mr. Panetta is correct that the nation is weakened when it fails to deal with the budget. But, forcing the federal budget to be balanced either by reducing spending or increasing taxes only hurts our main-street economy by preventing it from growing. Such austerity measures are appropriate only on the rare occasion when the economy is overheated and threatening inflation. A depressed economy, which is what we have today, requires higher spending and lower taxes. 

The threat to our future generations is not from a gigantic national debt, which is in reality a gigantic collection of safe and secure savings instruments that will be held by our future generations. The real threat results from the U.S. Congress’ failure to responsibly spend money into circulation to fix our failing bridges, highways, waterways, sanitation systems, public schools, state universities and other public services that we citizens rely on in our daily lives.

Duane Catlett Bio: Duane lives in Clancy, MT.  He is a retired career PhD chemist and materials technology manager.  He is a student of Modern Money Theory and the role of government in our economy. 

Dan Metzger Bio: Dan lives in Santa Fe, NM.  He is a retired PhD physicist and engineering manager.  He is a serious student of Modern Money Theory.

Federal employment policy exploits labor

This has been submitted to the ABQ Journal as a Letter to the Editor. We'll see if it flies.
**********************

Recently, people like to find fault with the Federal Reserve Bank (Fed) for Quantitative Easing and related issues. Of the actions the Fed takes, none is more startling than its exploitation of labor.

In a growing economy, it is possible for a shortage of labor to occur and for employers to bid up the price of labor, which might lead to inflation. In response to the threat of inflation, the Fed will take action to increase unemployment to a rate usually above 5%.

That’s right, our government has a policy to increase unemployment to forestall inflation. As this policy also preserves the value of the US dollar, it is considered a reasonable price to pay. This is just another way that people get the shaft when they don’t understand the game.

There is always work to be done. There is no need for unemployment

To initiate this policy the Fed increases the cost of borrowing to cool the economic expansion and increase unemployment. When unemployment is too high, the Fed lowers the interest rate to encourage borrowing that normally stimulates the economy to employ more people.

Currently, this policy is not working well. The Fed has lowered rates to almost zero and many businesses still can't or won't borrow to invest and hire, which is necessary for economic growth when Congress limits federal deficits.

Even though unemployment is high and decreasing very slowly, investors are anticipating increased interest rates that will keep unemployment at a noninflationary level. These unemployed, whom the Fed use to guard against inflation and maintain the value of the dollar, suffer like all the unemployed. Children go hungry; crime, including domestic violence, increases; and opportunities for education are lost. 

Such is the price of this policy. Adding insult to injury, some members of our Congress will denigrate the involuntarily unemployed as lazy ne’er-do-wells.

There is an alternative to this terrible policy. Instead of a labor pool of the unemployed to manage inflation, we can have a labor pool of the employed. The pool will naturally expand or contract as private industry fires or hires, respectively. 

Every unemployed person, who is willing and able to work, can be employed by the federal government at a minimum living wage. Such a program is often called a Job Guarantee (JG).

The JG would set the minimum wage at which employers could find employees from the labor pool of people, who are already working every day. It would minimize unemployment and continue to allow employers to reduce staff when necessary. The negative social consequences of unemployment would be greatly reduced, and the Fed would be able to meet its dual mandate. While the productivity of JG employees might be less than optimal, it would be much greater than for unemployed people.

The cost of such a program would be offset by reductions in unemployment insurance, food stamps, and minimal loss to the economy of reduced consumption by households. Most importantly, it makes good sense for the government to minimize the ravages of unemployment on good people when there is a viable alternative to existing policy.

Fundamentally the JG, which requires real production, seems to be superior to the Swiss idea of an Unconditional Basic Income that was featured on PBS recently.

Neither Bitcoin nor dirty socks are money

Today, I submitted this to the Albuquerque Journal. They didn't publish my last one. I thought this one might be more fun. It was published on March 20 under the title "Bitcoins may be bartered, but they are not money."  http://www.abqjournal.com/371415

****************************************************

In recent, interesting, Journal articles Winthrop Quigley has pointed out that any things can be used as currency (money) if people accept those things. Dirty socks were used as an example. Hyman Minsky has pointed out that anyone can issue money, the problem is getting it accepted. So, what is money? And, why should we accept it?

Bitcoin and old socks are just things. In order to be money things, they must represent debt. Debt is just an IOU (I owe you), and for thousands of years money has been IOUs. For Joe's old socks to be money things, Joe must be willing to redeem them for something of value say, a dollar bill, a bit of gold, or a cup of sugar. Otherwise, if Joe gives Mary a pair of old socks for an old toaster it is just a straightforward barter agreement. But, if Joe is willing to redeem the socks for something of value, Mary can give the socks in trade for something else and Joe will be in debt to that third person.

So it is with Bitcoin, which is just a thing even though it is only a number on a spreadsheet in a computer somewhere. Indeed, the dollars we generally use are mostly entries on spreadsheets at our banks. As Bitcoin is not an IOU, it is not a money thing, and any exchange of it for something is just a barter agreement. Consistent with this argument, the governments of Japan and Canada have declared that Bitcoin is not money.

A grocery store coupon is money. It is an IOU issued by a company for a limited time and is a credit against our bill at the checkout counter.

Even though an IOU is money, it may not be generally accepted. If Joe's socks represent cups of sugar, there may not be many takers, but there may be more takers for gold. Then there is the US dollar. Why is it generally accepted? After all, it offers less than a cup of sugar. 

The dollar is an IOU of the government, and it offers only itself in redemption. A ten-dollar bill will get you ten one-dollar bills. Big deal, what's the attraction in that? 

What drives our need to acquire dollar IOUs? It might be that the government has declared dollars to be legal tender or that we generally agree to use them. Actually, we all need dollars, because we must pay our taxes with them. As a grocery store coupon is a credit at the checkout counter, so a dollar is a credit against your tax bill. Even a child with no tax liability, must pay for candy with dollars, because the candy maker needs them.

A sovereign money thing is issued by a sovereign government and is a tax credit. Bitcoin was invented supposedly to bypass government money. Money in any form can not compete with state money for acceptance.

Economists and politicians need to step into the light.

Today, I submitted this to the Albuquerque Journal as a Letter to the Editor. 

The Journal editorial page on Tuesday, February, 18 included a column by Robert Samuelson that concluded correctly, “To regain relevancy, economists are searching for a new light bulb - or better use of the old. Meanwhile, most are still sitting in the dark.” And, that includes Mr. Samuelson.

That new light bulb is shining brightly in those who recognize that our economic system changed fundamentally when President Nixon took us off the gold standard and introduced modern fiat money with a floating exchange rate. 

Modern Money Theory is a new light for a better economy.

Those who understand and embrace the insights of Modern Money Theory that anticipated the Great Financial Recession, foresaw the Eurozone crisis, and explains how federal deficits help a listless economy know full well that our economy need not struggle as it has. 

Samuelson fears federal deficits and supports austerity while searching hopelessly with the OECD for answers to why austerity has not worked out well. He need look no farther than the new lightbulb shining in his face. Deficits are the source of net savings in the private sector. They stimulate consumption and reduce unemployment.

He and other economists sitting in the dark are bewildered that the trillions of dollars the Federal Reserve has poured into the economy have not caused the expected inflation. They still refer to Quantitative easing (QE) as stimulus when obviously it is not.

The answer is simple. When the Fed buys Treasuries (or other financial assets) from Jane, the total financial assets of Jane remain the same. It’s a straight up asset swap. It only changes Jane's preferences for assets (cash or something riskier). However, fiscal stimulus, government buying goods and services from Jane, actually increases Jane’s financial assets.

It’s quite clear, QE fails to stimulate the economy, because it tries to increase one's spending out of existing income. Fiscal stimulus works, because it increases one's spending out of increased income.

To the delight of many including Republicans, Democrats, progressives, and conservatives the deficit is falling fast and according to the Congressional Budget Office will be at or below 3% of GDP this year and the next two. Alleluia, our economy will be saved! Or, will it crash like other economies around the world that have followed the same policy of austerity? We are fortunate to have been on austerity-lite. 

As the deficit has fallen unemployment has remained high, capacity utilization has declined and with it industrial production, which has been declining overall since mid 2010. Year over year retail sales and mortgage applications are falling. 

The weak stimulus of the 2009 American Asset and Recovery Act has disappeared and our economy languishes unnecessarily. Inflation is too low while unemployment is too high. That likely will continue until economists and politicians realize that deficits and national debts are terrible metrics for steering the economy. Inflation and unemployment would be much better in an enlightened economy.

Let's pick the path FDR chose

The continuous stream of Congressional "debt" crises has been crippling our main street economy, killing jobs, and creating unnecessary hardship for many Americans.  Every quote by a Republican politician regardless of subject always refers to "out of control federal government spending and unsustainable debt and the need to cut entitlements."  There not only is no push-back from Democrats, they seem go out of their way to pay homage to the "federal government debt" problem, which only  reinforces the myth that the federal government is no different than a family and must therefore balance its budget or go broke.

I wrote the following editorial published in the Helena Independent Record October 28, 2013.  The motivation was two especially scary editorials that had appeared in the same paper during the previous couple of weeks.
**********************************************************
FDR: "The only thing we have to fear is fear itself."

Have you noticed every time a politician speaks, we’re told we should be very afraid for our future?  “Our federal government is going broke, we’re going to have to borrow more money from the Chinese, inflation is just around the corner, and our children and grandchildren are going to be saddled with an unbearable debt burden.   Revenue is not the problem, taxes are already too high.  Spending is the problem, it’s out of control and “entitlements” are the reason.  You’re just going to have to sacrifice more.”

The fear stories range from the hyperbolic overreach (IR, October 1) of the uninformed like Joe Balyeat, the Montana mouthpiece for the fossil fuels billionaires Koch brothers, to a more respectable John Snow, former Treasury Secretary under President Bush II, who undoubtedly knows the above fear stories are not true (as reported  by Bob Brown in the IR, October 16).

We’ve just witnessed a manufactured 16 day government shutdown engineered by the U.S. Congressional Republicans that caused ~$30 billion in lost GDP, the furloughing of nearly one million federal government workers, and a narrowly averted globally catastrophic economic meltdown that would have resulted if the Republican Congress had refused to allow the government to make interest payments on holders of U.S. Treasuries.   

These fabricated crises have caused over $700 Billion in lost national GDP since the Tea Party emergence in 2010.  Republicans are intent on scaring us all into believing that the U.S. government is going broke unless we dismantle Social Security, Medicare, and Medicaid.  But it’s all nonsense.

Many have been duped into believing the “government is going broke” storyline we are being fed by this anti-government rhetoric.  But consider this: never in its entire history has the country gone broke, yet it has carried a so-called “national debt” every year of its existence except for three years between 1834 and 1837.

If Congress spending creates a heavy debt burden on future generations, why haven’t those of us alive today had to pay back past “national debt?”

Ask yourself this.  Where do the Chinese get their U.S. dollars to lend us, when the U.S. government is the sole producer of the dollar?

Also ask yourself how the U.S. government can afford to spend trillions to bail out Wall Street and its mega-corporations every time they create a private-sector bubble that bursts, yet they cannot help the citizens who were financially destroyed by the explosion.

A brief review of America’s past century is revealing.  The wealth inequities of the 1920s were remarkably similar to the wealth inequities of the decade preceding the 2007 market crash.   The real estate and stock market behavior of the 1920s was nearly identical to the markets behavior of the 1990s and early 2000s.  Market values were artificially high and the wealth gap between the ultra-wealthy and the rest of us were at all-time highs at the times of both crashes.  

The end result of both periods was complete collapse of the economy, the Great Depression of 1929 and the Great Recession of 2008 respectively.  We’re still trying to recover from the latter, and today we sit at a tipping point much like the one Franklin D. Roosevelt faced in 1933.  

Rather than cut federal spending, FDR took a different approach in taking office in 1933.  At the depth of the depression, he recognized that only the federal government had the capability to provide jobs so desperately needed.

In his inauguration speech, FDR spoke these famous words, “The only thing we have to fear is fear itself.”  

Then he brought a conservative Utah banker, Marriner Eccles, to Washington to serve as the architect of FDR’s financial markets regulatory reform and New Deal jobs Programs.  Under Eccles’ leadership, a tightly regulated financial market coupled with government deficit spending lead America into an era of unprecedented worldwide prosperity.  We built gigantic modern public infrastructures like dams, airports, highways, and schools in America while at the same time propping up the economies of war-torn Europe.  During the 1940s through the 1970s, the federal government funded public education for all, developed the atomic bomb, and sent men to the moon.  The government funded all these inspirational things that provided people with jobs and did it with so-called government “borrowing.”  

Today we again stand at a cross-road and our federal government is faced with two options: 1) continue the current path of job-killing austerity, or 2) take the FDR path to return to prosperity by directly funding job creation programs to modernize our infrastructures, fully fund our safety net programs, and fund public education and state sponsored research institutions.  

The so-called “national debt” problem is pure political fabrication.  The real crisis we face today is very same one created by the extreme wealth inequity in America of the 1920s.   It is the failure of our federal government to directly fund job creation programs to rebuild our great nation as FDR did in the 1930s.

The fact is that the private sector businesses are not the only creators of “real” jobs, regardless of what the “small government” ideologues tell us.

The choice of America’s path belongs to us voters because it is us who send our representatives to Washington to create “our future” we demand of them.  Is it job creation or is it job-killing “debt” reduction. 

The 2014 mid-term elections are looming large!

Make our monetary system work for us.

Today, I submitted this to the Albuquerque Journal. It is possibly too wonky, but I wanted to make a credible statement that there is another way to look at our national finances. The Journal published this on November 17, 2013 with the title "U.S. Monetary System Widely Misunderstood." 

*******************************************************************************

Recently Professor Stephanie Kelton, Chair of the Economics Department at the University of Missouri-Kansas City, cited an illuminating quote from a Federal Reserve document revealing that at least some people at the Fed understand our monetary system. The quote below rings quite differently from the prattle we hear incessantly from politicians and undiscriminating media, especially during the recent shutdown/debt ceiling fiasco.

“As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets to remain operational. Moreover, there will always be a market for U.S. government debt at home because the U.S. government has the only means of creating risk-free dollar-denominated assets (by virtue of never facing insolvency and paying interest rates over the inflation rate,...?" (St Louis Fed Publication 2157)

New York Fed Building

Professor Kelton is a leading member of a school of economists and fund managers, who realize that the monetary system changed when President Nixon defaulted on the gold standard in 1971. Since the early 1990’s this community, exploring Modern Money Theory, has published widely and has gained followers from around the globe.

Significantly, MMT followers foretold the monetary problems of the Eurozone, where members gave up their monetary sovereignty for a de facto gold standard. Thus, their debt was not in their own currency. MMTers were among those, who foresaw the private debt crisis that caused our Great Recession. Further, MMT explains why the Fed’s Quantitative Easing did not and cannot stimulate the economy and why federal deficits do not and cannot in themselves lead to high interest rates or inflation.

When we get away from the gold-standard thinking that dominates current fiscal discourse, we realize that as the monopoly issuer of the dollar the U.S. government does what monopolies do. It sets the price (short-term interest rate) of the dollar and issues dollars in the quantity desired at that price by government spending and private investment. Dollars enter the economy through bank loans, which must be paid back with interest, and through government spending. Government deficits are the only source of net saving in dollar-denominated financial assets in the non-government sector. Government debts are private assets to the penny.

Also, we realize that government spending is not contingent on our ability to borrow dollars from foreign lenders. China, for example, does not create dollars; it gets them because we buy stuff from Chinese manufacturers. With their earned dollars, China can purchase anything for sale in dollars. That includes AMC Theaters, Smithfield Hams, or U.S. Treasuries. We don't need China or anyone else to fund our government spending, they get dollars from our spending.

It is the same for Government taxes. In a fiat money system there are no dollars in the non-government sector until banks lend them or government buys goods and services. Taxes serve to retrieve money that has already been spent. Government deficits result in net saving of financial assets in the non-government sector. Likewise, government surpluses reduce savings in the non-government sector.

This is just basic accounting. If government happens to have a balanced budget (spending minus taxes is zero), the non-government sector (domestic plus foreign) will also  balance to zero. This would result in reduced savings for the domestic private sector to pay for the foreign trade deficit. Federal deficits help the domestic private sector keep its head above water.

Repeatedly, we hear both political parties extolling the virtue of reduced deficits, even balanced budgets. John Boehner, Speaker of the House of Representatives, often bellows that no household or business can spend more than its income, so neither should the government. President Obama and his bedfellows blindly accede to this demonstrable falsehood.

Because government creates the money, it is not constrained in spending like a household - not that government should spend more than is needed. Also, government is unable to save for future expenditures like a household can. Saving has no meaning for the currency creator.

Clearly, Government finances are distinctly different from household finances!

Government invests in the future by spending on research and infrastructure in the here and now and can continue until full employment is reached. Then our descendants get the benefits of real assets AND possession of the financial assets (Treasury bonds) that constitute the national debt (national net savings).

One need be neither nerd nor economist to understand the rudiments of our monetary system. Our fiat monetary system can facilitate domestic prosperity. We should demand it.

America's Main Street economy versus Wall Street

An article written by a local bank officer and published in the Helena Independent Record  on the relationship of the Fed to the rising mortgage interest rates stated that when the Fed buys Treasuries on the secondary markets it is "printing" dollars that  increase the number of dollars in the global economy.  The fact that a bank manager seemingly does not understand the Federal Reserves operation and is misleading the public from a position of supposed credibility caused me to write an article that was published on the Opinion page of the Helena IR on July 29.  My article was discussed on Professor Randall Wray's EconoMonitor blog site on July 30.

*********************************************

America's Main Street economy versus Wall Street

You might have noticed that Wall Street no longer is a thermometer for measuring Main Street’s economic health.  While the stock markets have recovered from their 60% collapse caused by the 2007 Great Recession and are now at an all-time high, the health of the Main Street economy as measured by the quantity and quality of jobs is not doing so well.

Jobs being created tend to be lower paying with fewer benefits than the jobs that were lost as fallout from the Great Recession and the recent government budget cuts.  Most concerning of all is the fact that the income and wealth gap between the richest and the working American continues to increase even as the stock markets continue their advance to higher highs.

Politicians, analysts, and media pundits provide all kinds of rationale for these discrepancies between Wall Street and Main Street and the failure of the job market to improve.  Almost all are wrong.

A new branch of economics called Modern Money Theory (MMT) perfectly explains these discrepancies.  It emerged during the early 1990s and foretold the euro zone crisis and the recent 2007 Great Recession.  And, it explains why the Fed’s Quantitative Easing (QE) program has been insignificant in stimulating the economy.  QE did have an effect of stimulating the stock market’s recovery while continuing to accelerate the income and wealth gap.

MMT is actually not a theory and it has no political ideological basis.  It is an objective study of modern (fiat) money and the way a sovereign country with its own fiat currency works.  It has nothing to do with big government versus small government, and it has everything to do with our government functioning effectively as our forefathers intended, using the constitutionally mandated financial tools at their disposal.

Warren Mosler, a former hedge fund manager who made his billions from these insights, challenged the economics profession that the U.S. would be far more prosperous if we stopped basing our fiscal and monetary policies on theories designed for a country whose currency was still tied to the gold standard. 

Today, tens of thousands of professionals in academia, finance, business, and government also champion Mosler’s insights that (1) our fears about the national debt and deficit are the result of a failure to understand how modern money works and (2) that lack of understanding is holding back progress on all economic fronts in America.  

And recently, the mainstream media has begun to take notice of MMT and is beginning to print articles about the economy discussed in a MMT framework.

While the actual details of how the United States government’s financial management system works are complex, MMT describes the government’s basic financial management framework in a way that is simple and straight forward that most of us can understand.

• The U.S. government’s finances are nothing at all “like a family sitting around the kitchen table working its budget” as has been metaphorically described by countless politicians. 
• The U.S. dollar is not tied to a commodity.  It is only a medium of exchange backed by the strength and power of the United States economy.
• The U.S. government’s financial management system consists of two components, fiscal (spending and taxing) and monetary (monetary operations and interest rates control).  
• Effective financial management requires that both the fiscal and monetary parts of the government work together in sync. 

Congress is solely responsible for the fiscal part.  It literally puts U.S. dollars into the main street economy by its spending and taxing directives and policy decisions.   To be effective, Congress must put the dollars where they are needed and in the amounts needed, coupled with effective tax policies, to reach its economic and societal objectives.  

The Federal Reserve Banking system (the Fed) is responsible for the monetary part.  As the central bank of the U.S. government, it manages the federal government’s financial balance sheet.  The U.S. Treasury and all states and commercial banks, both foreign and domestic, that want to do business with the U.S. government must have an account at the Federal Reserve Bank.  

The Fed is the most misunderstood part of the U.S. government’s financial management system, and its power is greatly exaggerated.  It is only the U.S. Congress that has the power to create jobs and stimulate growth in the main street economy.  

The Fed does have the authority to change the supply of reserves in the commercial banking system by exchanging reserves with Treasuries on its central bank financial balance sheet as it is currently doing with its QE program.  This action by the Fed does have great influence on the stock markets by changing the supply of reserves in the banking system (the financial industry).  But, increases in bank reserves do not make it into the general economy until or unless banks give loans to credit worthy customers in the private sector of the economy.   Therefore, the Fed’s QE action artificially inflates Wall Street while doing nothing to grow the main street economy that we all depend upon.

Real job creation and main street economic growth comes only from U.S. government deficit spending at times when the private sector is not producing enough jobs to generate disposable income in family budgets.

Just as the Fed is the “lender of last resort” for commercial banks if they need reserves to balance their capital accounts, the U.S. Congress must be the “job creator of last resort” for our economy.  For the United States to regain its status as the most prosperous and socially mobile country in the world, Congress must create a modern work program similar to FDR’s New Deal Programs of the 1930s.

A Defense of Federal Deficits

Yesterday evening I submitted this to the Albuquerque Journal in hope of making the Op-Ed Page. Will report back later. 
This was printed in the Journal on the Op-Ed page for July 7 with the title "Build a modern version of WPA" with the subtitle "High employment is a symptom that the deficit is too small" This time I liked their title.
 *********************************************************
As a convicted deficit denier, I offer the following as counterpoint to the Sunday, June 30 Op-Ed by Carroll Cagle.

A Defense of Federal Deficits
Preoccupation with federal deficits and debt is counterproductive. The $12 trillion national debt held by the public means that $12 trillion in assets are saved in the private sector predominantly in the form of Treasury securities. To reduce the debt, some of those savings will have to be given up. The national debt problem is minuscule compared to unemployment that has resulted in trillions of dollars worth of potential production being wasted never to be recovered.

It all comes down to customers’ demand to buy products. If demand is not sufficient for firms to sell what they produce, they will cut production by shutting down machines and laying off workers. Firms will not ramp up production without increased customer demand. That leaves government spending to prop up demand by getting money into customers’ pockets. Cutting government spending just makes matters worse. 

A photo taken during the Occupy Wall Street in New York in 2011 and posted on "The Center of the Universe"blog.

Yet, here we are with sequestration cutting government spending out of either an obtuse conviction to cut the size of government no matter the consequences or the simplistic logic that cutting spending while holding the line on taxes will reduce the deficit. Any government or private action that increases unemployment affects the deficit outcome, because tax revenue is decreased and unemployment benefits increase.

Three such actions are significant. Because these actions are beyond government control, the deficit is largely uncontrollable; it just happens. First, if a single household withholds consumption to save or pay down debt, that household benefits. If the whole private sector saves in aggregate more than usual, overall demand decreases and workers become unemployed. This is the famous “paradox of thrift.”

Second, imports bring the benefits of quality or cost to consumers. But, the spending outside our economy enriches a foreign one and results in unemployment here.

Third, increases in productivity bring benefits to the firm employing them and their customers. Again, unemployment is increased.

As we enjoy the benefits, we should have policies to deal with the resulting unemployment. Instead, we tend to demean the unemployed and let the economy languish.

Simply stated, high unemployment is a symptom that the deficit is too small. Increased federal spending increases demand by putting money into the pockets of customers. Many folks are convinced illogically that deficits inevitably lead to the dire consequences of profligacy, which are high interest rates and inflation, even hyperinflation. These are neither inevitable nor uncontrollable.

Importantly, short-term interest rates are set by the central bank in any country with a sovereign currency. Our central bank, the Fed, will increase interest rates when the economy is doing so well that the Fed decides to cool it off by making borrowing more expensive. In that case, employment will be up and the need for federal deficits reduced.

We usually think of inflation as the result of too much money chasing to few goods. Too much money in circulation can be remedied by taxing some money back out of circulation. Too little production could also cause inflation in which case the remedy is increased production. One thing the USA is (or was) famous for is its ability to rise to the demand for increased production. The two instances of hyperinflation in the modern world were after the fall of the Weimar Republic and Zimbabwe. In each, the means of production were ruined and could not be reestablished rapidly.

Around the globe economies are crashing because of ill-advised attempts to slash the deficit. Politicians have committed their careers to this mistake and must now wait it out while hoping for a miracle. The USA has been spared up until now because of it’s automatic unemployment benefits and a mini-stimulus about four years ago. Unfortunately, we now seem to be hell-bent to follow the course proven to fail.

To reverse course, we need to repeal the sequester and build a modern version of the WPA program that assisted our recovery from the Great Depression.