Why doesn’t our economy work for everyone?

This is a bit of a rant. Thanks to Duane for getting me focused on what I really wanted to say. 

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Due to the anemic recovery of our economy from the Great Financial Crisis (GFC) of 2008, too many people are struggling. They have little hope of regaining their former economic condition or climbing out of poverty. But, we wouldn’t know it from the rosy reports of the mainstream media (MSM). It offers seemingly optimistic headline unemployment rates as evidence of recovery.

Apparently the MSM does not recognize that the total industry capacity utilization is below 80% and falling. Also, the civilian labor force participation rate is at a 40-year low and decreasing. Over 10 million people are unemployed or underemployed, and most current income increases are going to the top 1%. Worst of all, many children needlessly go hungry. Yet, politicians and pundits are hell-bent on cutting government spending as if it were a problem.

Civilian Labor Force Participation Rate

An old Mark Twain quote seems appropriate:

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

The unquestioned premise that federal austerity is good policy, which the MSM supports, has gone on too long. In 2010 President Obama established the so called Deficit Reduction Commission and appointed two deficit hawks, Alan Simpson and Erskine Bowles, as co-chairmen. In his testimony before the Commission renowned economist Professor James Galbraith rejected the austerity premise outright. 

More recently, in March the US Senate Committee on the Budget held hearings titled “The Better Way: The Benefits of a Balanced Budget.” Despite the biased title, a distinguished political economics professor, Mark Blyth, testified that there are no such benefits. Moreover a balanced budget would harm the economy. 

Contrary to widely accepted theory and worldwide experience, the MSM clings to the false austerity premise. Its basis is the neoliberal paradigm codified in 1989 by the ten commandments of the Washington Consensus. These commandments are not applicable, because they fail to recognize that our economy uses a fiat monetary system not a gold-standard. 

Deficits and debt-to-GDP ratios have preoccupied mainstream economists, politicians, and the MSM. Consequently, they missed the most important point; exploding private debt caused the GFC. Only a few heterodox economists foresaw it, because they focused on the whole economic picture including private debt. A retrospective study by Richard Vague, co-founder of two credit card companies, has shown that financial crises worldwide are caused by rapid increases in private debt.

The austerity required to implement the neoliberal commandments, since the GFC, has weakened economies around the world. Because of its fiscal stimulus in 2008, America has fared better than most. But, thanks to its commitment to these commandments, America takes the prize for inequality of income and wealth. 

The MSM should ask: “Who benefits from reduced government deficits and debt when the real culprit is private debt?” And, “Who benefits from reduced financial and environmental regulations?” Also, “Who benefits when underfunded public programs fail, so they “need” privatization?” The answer to each is, the financial elite!

With a fiat monetary system, a country can manage its economy for shared prosperity with full employment and stable prices. Why then would the “best Congress that money can buy” continue thinking and acting like we still have a gold standard?

The answer lies in this self-indicting quote recalled from the real gold-standard days of 1863. To their associates in New York, the Rothschild brothers of London wrote,

“The few who understand the system will either be so interested in its profits or be so dependent upon its favours that there will be no opposition from that class, while the great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system, will bear its burdens without complaint, and perhaps without even suspecting that the system is inimical to their interests.”

Financial interests, supported by a compliant MSM, are ruling our world while leaving millions of people in financial servitude. To grow our economy we need to get rid of the gold-standard, neoliberal paradigm that works only for the elite and take advantage of our existing fiat system that will work for everyone.

Gold standard or fiat: Why it matters

Most people especially pundits and politicians do not understand our fiat monetary system. Their understanding is based on a gold-standard system, which we gave up completely in the mid 1970s. Here we look at simple, basic differences between these two monetary systems. 

For simplicity, we will imagine colonizing two islands with primitive but productive populations. Both islands have a culture, but have not established monetary systems. They barter goods and services as best they can, and they are poor by our standards but content.

We arrive at each island intent upon establishing production of goods and and services within a capitalist economy based on a monetary system. 

Gold Island

To get the gold we need for our monetary system, we offer paper money to the people to mine gold. They are not at all interested until we demand that they pay taxes with the money we pay them for the gold. Of course, there will be some unpleasant consequences should they not pay their taxes. Taxes are always imposed through coercion.

Gold Island: Spending limited by amount of money. 

This is similar to the actual experience of the British when they colonized part of East Africa late in the 18th century. They imposed hut taxes enforced by the threat to burn down the huts of delinquent tax payers.

By imposing taxes we have made the population unemployed. And, they will have to work to earn the money needed to pay their taxes. 

This may be a strange notion to some. Introduction of a monetary system causes unemployment through taxation.

At last, the miners take the money in proportion to the amount of gold they deliver. In terms we understand the miners and those who feed and house them are the private sector. Our government now has the gold, which it buries in a safe place. And, the private sector has the money with which to trade among themselves.

The private sector can set up banking to facilitate loans between those who wish to save and those who wish to invest in business development. Historically banks have extended the money supply by issuing their own bank notes. That’s a practice leading to bank panics.

As the island prospers we want the government to provide armed forces for our defense. Also, we want it to establish a legal system that protects ownership of our property and punish those who steal. Other services might include health for the poor and walking canes for the elderly the better for them to go dumpster diving.

Because the private sector has the money, the government must borrow from or tax the private sector to get back the money it needs to provide services. This puts government and the private sector in competition for the limited amount of money available. The more government spends the less money remains in control of the private sector. As a consequence, there is pressure from the private sector to keep government and its spending small.

The advantage of a gold standard is that the value of money and prices are stable. But, there are disadvantages. Banks might lend too much and be unable to cover depositor withdrawals leading to panics. There may be too little money available to provide for the poor, sick, and disabled. Also, competition between the private sector and government for money causes interest on loans to rise. Most important, with a fixed amount of money the economy can not expand to accommodate a growing population. This leads to constant unemployment.

Fiat Island

As we need no gold, we offer our fiat money to the people for work we want them to do. When they demur, we impose taxes or else. This coercion, as on the gold island, causes unemployment so that people work for the money that will be accepted for taxes.

Fiat Island: Spending limited by available workers.

Unlike Gold Island, the quantity of Fiat Island money is not limited. Government can provide services without interfering with the private sector. There is no need for government to tax or borrow to spend. Where Gold Island is limited by the amount of money available, Fiat Island is limited by the number of willing workers.

When government does tax or borrow it is retrieving money that it has already spent. This is also true on Gold Island. The difference lies in what is bought. On Gold Island it is gold; on Fiat Island it can be whatever can be done with the available workers.

Banking can be set up as either private or public functions. In either case government must allow banks to create money for private investment. And, government controls the interest rate at which banks obtain money.

With both the government and private business able to spend at will, there might be too much money in circulation. When people have too much money to spend, demand for products exceeds our productive capability, and inflation occurs. Inflation manifests as increased prices for goods and labor. 

Taxes are a ready remedy for inflation. Government and private spending put money into circulation. Taxes take money out of circulation. This allows control of the economy through appropriate spending and taxation (fiscal) policies. Another tool against inflation is interest rate (monetary) policies. The cost of borrowing is set by Government and can influence how much the private sector borrows to spend.

Or, the economy can deflate, the opposite of inflation. If the private sector borrows too much, debt service may become a problem, and people will reduce consumption. 

Why it matters

Anything that causes reduced consumption results in unemployment. Such causes are taxes, consumer decisions to save rather than make purchases, increased interest rates, or decisions to import from abroad. Under a fiat monetary system, government can offset reduced consumer demand by hiring the unemployed at a fair minimum wage.

A fiat system allows government more options than the gold standard. There is no reason that anyone should go without a job or suffer substandard wages.

Government budget decisions will always involve political interactions. And, there will be clashes among different points of view. Under a gold standard private business is at the center of discussions and the push is toward a smaller government role. A fiat system puts government at the center of regulating the economy, and it can make fiscal and monetary decisions looking at how they effect the whole economy.

Around the world, nations with fiat systems are running their economies as if they were on a gold standard. Politicians spread fear of running out of money to convince their electorates to make decisions against their best interests. Running out of money is not a problem with a fiat system. One might wonder if this fear mongering is because of ignorance or undue influence by big business.

A balanced federal budget is dangerous

This is a rewrite of the previous post. It starts and ends the same, but the argument is different. Hopefully, it is easier to follow, because it is important.
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On March 11, 2015 the US Senate Committee on the Budget held hearings titled “The Better Way: The Benefits of a Balanced Budget.” But, a distinguished political economics professor, Mark Blyth, testified that there are no such benefits. Moreover, a balanced budget would be harmful to our economy. 

Prof. Blyth’s testimony was in stark contrast to those of the Committee for a Responsible Budget and the Business Roundtable, who also testified. They echoed the deficit hysteria that has obscured rational discussion of the federal debt and how it affects our economy.

It is a fallacy to think the federal debt is like a household mortgage that we must repay with interest in a certain time. If we fail to pay, the mortgage holder may repossess our property. Federal debt has no time limit, so we never need to pay it off.

Federal debt is an asset of the private sector and consists initially of Treasury securities. By law, the Treasury sells securities to cover federal deficits. These securities are rock solid investments for pension funds and are risk-free collateral. Their only financial burden now and in the future is interest service. For the most part, that interest is income to the domestic economy.

We should remember that our fiat monetary system replaced the old, gold-standard system years ago. Since then, federal spending is not limited by a fixed amount of money. It is limited only by the availability of productive workers and facilities. Deficit spending puts unemployed workers back to work, and the risk-of-inflation bugaboo exists only if we are already at full employment. 

Our economy consists of a federal sector and a domestic private sector. Within the private sector every financial asset has a corresponding debt. Financial assets and debt net to zero. The private assets associated with federal debt involve no corresponding private debt. Those assets can remain as savings in the private sector for as long as the republic exists. To the penny, “national debt” equals net private savings.

Let's not be stupid.

To be crystal clear, when federal spending exceeds revenue from taxes, we have a federal deficit. Likewise, a private sector deficit occurs when the sum of everyone’s spending including taxes exceeds their income. When one sector has a deficit the other will have a surplus. But, there is another sector to consider. 

Year after year, we have imported more from the rest of the world than we have exported to it. This causes a persistent outflow of financial assets from our economy to the foreign sector. As a consequence, one or both of the domestic sectors, federal and private, will sustain a deficit. Simply put, the sum of domestic deficits will equal the foreign deficit. It’s a matter of bookkeeping.

If the federal sector somehow manages to have a balanced budget, financial assets will go out of the domestic private sector. We can bet that within that sector Main Street will take the hit.

We should understand that, without full employment, federal deficits help grow the domestic economy. And, it will shrink if federal deficits do not make up for the foreign trade deficit. “Balanced budget” is just a euphemism for austerity. 

A more harsh form of austerity is when the federal sector must run a surplus in the face of a foreign deficit. That would be like Greece!

Still, we have Presidential candidates, who offer up balanced-budget myths. A favorite is, “We must not saddle our grandchildren with a burden of debt.” According to Prof. Blyth they might as well say, "Let’s shrink the economy today so that the parents of today earn less money and pay more for services. That will make sure that their grandchildren grow up poorer, with a smaller economy, and a worse education.”

We must not condemn our grandchildren to such a future! Unfortunately, on our present course of austerity we will.

The benefits of a balanced federal budget

On March 11, 2015 the US Senate Committee on the Budget held hearings on “The Better Way: The Benefits of a Balanced Budget.” A distinguished political economics professor, Mark Blyth, told the Committee there are no such benefits. Moreover, a balanced budget would be harmful. 

He acknowledged that our intuition tells us that to spend more than we earn leads to bad outcomes over time. To take on debt now to spend more brings on future debt and interest payments that result in having less in the future. This leads to the idea that saving is always better than spending. When applied to the federal government this idea is wrong and counterproductive.

It is a fallacy to think that the federal debt is like that of a household or firm, which we must pay off in a certain time. Otherwise, the mortgage holder may repossess our property. Federal debt has no time limit, and we never need to pay it off. Government issues the money it borrows. So, it can always make its interest payments, most of which return as income to the economy.

Prof. Blyth reminds us that government debt is an asset of the private sector and consists of Treasury securities. By law the Treasury sells securities to cover federal deficits. These securities are rock solid investments for pension funds and are risk-free collateral. To say we want less government debt is to say we want less private assets. Further, paying down the debt takes financial assets out of the private sector.

About sustainability of government debt, Prof. Blyth points out that only three things matter. They are the rate of growth of the debt, the rate of growth of GDP (Gross Domestic Product), and the rate of growth of population. If these are growing, as they can in the US, promises made now will be redeemed in the future by a larger population and a larger economy. Then our federal debt as a share of GDP can decline, and our ability to service the debt increases. 

Because of the financial crisis, recent increases in debt relative to GDP resulted from a combination of increased deficits and reduced GDP. We can trace the financial crisis back not to government debt but to an explosion of private debt. Private debt is the real villain in this story.

A country with a sovereign, fiat currency can always pay its bills. It can not become insolvent. That means the concept of saving has no meaning for a sovereign state. Thus, it makes no sense to save financial assets today so that the country can meet its commitments tomorrow. So, it is important to invest financial assets today to assure that real assets are available in the future. No amount of future financial assets can enable our grandchildren to access a health facility or cross a bridge that does not yet exist. 

Prof. Blyth noted that we can invest government debt in long-term developments. Private investment prefers short-term developments leading to profit.  He pointed out that the National Institute of Health has provided about 40% of the R&D in the biotechnology and pharmaceutical industries. Other government developments benefited, for example, Apple, Inc. It integrated into its iPhone the TCP/IP Internet protocol, the GPS network, and the touch screen. These Department of Defense developments helped make Apple, Inc. the most valuable company in the world.

Prof. Blyth contends that following current myths leads to unfortunate consequences. "We can not saddle our grandchildren with a crushing burden of debt." and "We need a painful budget today to protect future generations." are two such myths. They translate to "Let’s shrink the economy today so that the parents of today earn less money and pay more for services. That will make sure that their grandchildren grow up poorer, with a smaller economy, and a worse education."

We need not condemn our grandchildren to such a future! Unfortunately, on our present course of austerity we will.

http://www.budget.senate.gov/democratic/public/_cache/files/70913d8f-7954-4f75-a75e-1c71264b615f/blyth---senate-testimony-on-balanced-budgets-copy.pdf

Strive for shared prosperity

Albuquerque Journal columnist Winthrop Quigley, in recent columns complained that there were too few rich people in New Mexico to stimulate the economy. His discussion was interesting, but I took issue with the following letter to the editor.

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In his UpFront columns on February 5 and 7, Mr Quigley presents some interesting discussion on the state of wealth in the state. However, he fails to consider the role of sales upon which capitalism runs. Investments are made in anticipation of sales and fail if sales are not forthcoming.

Mr Quigley champions the mainstream, neoliberal line that investment by the rich drives the economy. That is the decades-old, failed, “trickle-down” story that leads to the idea that we need to coddle the rich so we can all prosper. So far that isn’t working.

Rich people putting money in the stock market doesn’t create jobs. That is just a manner of saving. It’s nice to have some rich people around; they are the result of a prospering economy not necessarily its wellspring.

Sale of products, from socks to computers, drives investment in production. One doesn’t need a rich uncle to expand her business. If there is consumer demand and a good business plan, a commercial bank can make the loan. Bank credit is largely the source of investment funds in the whole economy. It is not widely recognized that commercial banks create money upon making loans. Contrary to the common view that saving deposits create loans, the opposite holds; loans create deposits.

Rich people are nice to have around.

Banks will not loan to build inventory that will go unsold. The empty restaurant does not hire more busboys. And, no producer increases production unless sales are increasing. 

In the absence of federal fiscal stimulation, which could be done readily without raising taxes, the state must find ways to increase customer demand in addition to creating new businesses. Of course, great products create their own demand, if people have money to spend. To bootstrap itself the state will need to generate more revenue and increase consumer demand.

As a start, higher minimum wages create more customers with money to spend. Right-to-work legislation is just a way to keep wages low. Higher wages may threaten a single business, but across the whole economy higher wages mean more sales. To free up funds for current consumption, the state might create incentives to refinance loans for those deep in debt.

Investment in more and better education should be a high priority to develop a more capable workforce. The young are our future. Rather than an expense, they are an investment for all of us.

Although the state has programs to assist new businesses, it will require more revenue and new approaches. A gasoline tax with a sliding rate to keep the price constant would counter severance tax losses. Perhaps the state should expand the New Mexico Finance Authority into a public bank to increase its ability to fund development. A more progressive tax structure would help. Also, the state might add tax-backed bonds at lower rates to its panoply of offerings.

By pursuing both sales and investment, we can have more rich and fewer poor people. That is shared prosperity.

A new light shines in the US Senate

This was submitted to the Albuquerque Journal and the Santa Fe New Mexican today. If either publishes it, I'll update this post.

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Senator Bernie Sanders has lit a spark in the US Senate Budget Committee. Recently appointed ranking minority leader of that committee, the Senator has tapped Prof. Stephanie Kelton as his Chief Economist. Such appointments usually go unnoticed but not in this case. Already the appointment is being cussed and discussed, because Prof. Kelton advocates alternatives to the economic policies that have failed us for the past thirty years.

Prof. Kelton was recruited from her job as Economic Department Chair at the University of Missouri - Kansas City. Yes, the “show me” state. This department is an intellectual center of Modern Monetary Theory (MMT) that describes the way a sovereign, nonconvertible, fiat currency with a floating exchange rate actually works in the economy. Much confusion in the economic world today stems from a basic misunderstanding of how a fiat currency differs from one based on say, gold. This sheds a whole new light on the way we view current news and political discussions.

MMT recognizes that household and state budgets are not the same as the federal budget, because the US government is the only source of US dollars. The US government stands opposite the private sector on our national balance sheet. That is, federal deficits become private assets.

The private sector by itself cannot accumulate net savings. In our economy one household’s spending is another’s income. If one household saves by spending less than its income, it will prosper. But, if all households save there will be less spending overall, and less income overall. So, the economy will suffer unless the saving of some is offset by the borrowing of others. However, federal spending puts dollars into the private sector, so federal debt provides net private savings to the penny. Strange as it may seem, the highly scorned National Debt Clock is also the National Savings Clock. 

This chart from the CBO has been annotated to show that recessions tend to occur after periods of low deficits.

While liberals and conservatives argue about how to balance the federal budget, MMT realizes that balancing the budget can weaken the economy. The MMT understanding of monetary operations is consistent with observations of economic recessions following periods of too-small federal deficits and that federal surpluses are even worse. Presidents Bill Clinton and Andrew Jackson have in common that both were praised for running federal surpluses even though both were followed by devastating economic collapses. History shows that over the last 200 years each of the seven periods of significant federal surplus was followed by a depression. 

MMT also realizes that inflation can arise from too much spending by either the federal government or the private sector. Recently, our economic woes resulted not from federal deficits but from the private sector’s inability to pay its bills. 

MMT advocates alternatives to the policies of austerity that have led the economies of many nations around the world down the rabbit hole. Prof. Kelton brings new light by which we might find our way out of the hole.

How to fix the economy

This post, written by Duane and me, was submitted to the Albuquerque Journal in response to an article by two mainstream conservative economists. It doesn't look like the Journal is interested, but we keep trying.
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In an article published in the Journal on October 6 Micha Gisser and Kenneth Brown offered five policies they claim could fix the economy. While some of their ideas are on the right track they are really repetitions of old, ineffective, conservative policies. 

Our economic solution takes issue with conservatives and liberals alike. Both Democrats and Republicans are obsessed with deficit reduction. Democrats think the government has a revenue problem, while Republicans think government has a spending problem. They are both wrong. Our real problem is unemployment caused by a lack of demand for consumer goods and services. Until we conquer unemployment by increasing demand our economy will continue to struggle.

Employment ratio is not recovering after recent recession as in the past.

The symptoms of our economic woes are that national production (GDP) has been running approximately $800 billion per year below its potential capacity, and year after year the wealthy gain more of the national income than the workers. To fix this, we need to reduce corporate welfare and initiate policies that put more money into workers’ pockets.

Certainly, we should decrease corporate taxes. They are just production costs passed on to consumers. And, we should simultaneously increase minimum wages so that the money saved from taxes goes to workers, not to corporate executives and stockholders. We should also revive the successful FICA tax holidays on both businesses and workers.

Keeping wages low only works to improve profits for a single company. To think that it works for all companies in the aggregate is a fallacy of composition well known to most economists. If wages are low in the aggregate, it hurts demand, sales and profits for business in general. 

We must invest in the future. Because demand is not growing, businesses in the aggregate are not investing. A recent Bloomberg report says S&P 500 companies are using 95% of profits for share buybacks. That is good for stockholders but not for workers and is a large contributor to the increasing wealth gap. In our credit-driven economy there must be borrowing to invest and expand the economy. If not business, the federal government must invest.

According to the American Society of Civil Engineers we need $3.6 trillion by 2020 to renovate  our infrastructure in energy, water, transportation, and health. Instead of #FixTheDebt we need to #FixTheInfrastructure. Only the federal government can make the necessary investments.

Recently the International Monetary Fund, a hard-nosed enforcer of austerity, has done an about face and recommends government deficit investment in infrastructure for the US and other countries. By including benefits as well as costs, the IMF calculates that 1 dollar invested yields 3 dollars in production. It concludes that infrastructure investment pays for itself.

While making government investments, we should look to the future. Currently, we need fossil fuels for baseline energy complemented with the green-energy alternatives of nuclear, solar and wind. Our investments should reduce our continued dependence on fossil fuels in the future by expanding our technologies in zero-carbon producing energy sources. 

To reduce regulations is to say we don’t care much about health, safety or our environment. We need clean air and water, and infrastructure investment can assure them along with jobs. We don’t need dirty energy for jobs.

While the health-for-profit lobby threatens that healthcare costs will increase from 14% to 20% of the economy, we know that other advanced countries get better care for 10% or less. Also, we know that health care costs are falling, and more people are leading healthier lives as they get health care previously denied. Nevertheless, both political parties have failed to bring healthcare to all at a reasonable cost.

It is appropriate for government to sustain deficits for investment in national security and for investment in our infrastructure. At the same time, it reduces unemployment, which is our biggest problem, and assures that our grandchildren are well positioned to excel in a competitive global market place.

Deficits do not harm our grandchildren. The national debt is the sum of all deficits since the formation of the republic and represents net financial savings of the non-government sector. We pass those savings on to our grandchildren along with the renovated infrastructure.

Both authors are retired PhD physical scientists and follow Modern Money Theory, which describes monetary operations for a sovereign fiat currency.

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.
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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. 
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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.

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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.