In his SOTU address President Obama commented on dangerous deficits, inequitable tax policies and the need for Social Security and Medicare Medicaid adjustments to ease the national debt burden now and on future generations.
As the MSNBC camera panned in on Treasury Secretary Geithner, while the President continued his remarks on economic policy. I thought out loud; no I screamed at the TV, "Geithner!! Why don't you advise the President that we are no longer bound by gold standard and fixed exchange rate rules for the management of our currency?
Tell him we are a sovereign currency nation, and can never go broke since we are the sole issuers of our currency unit of account...the dollar. Why don't you tell the President that the government must spend before it can tax and when it taxes those receipts don't pay for anything?
Why don't you tell the President that we don't have to tax and borrow to spend? If you did he wouldn't make the policy mistakes that are inevitable when monetary decisions are based on the wrong fundamentals.
I know why you don't tell him. You don't know. Just like Bernanke doesn't know the difference between a sovereign fiat currency nation with flexible exchange rates and a nation bound by gold standard and fixed exchange rates. Until you two understand how modern money is managed we as a nation will always be second class.
For those who desire succinct insight on how modern money is managed the following Primer is written with you in mind.
Dr. Bill Mitchell, an Australian economist, along with Professorss. Jamie Galbraith, Warren Mosler, L. Randall Wray and, Steve Keen collaborated on the following Primer written for the non-accountant/economist, to dispell the false and misleading arguments born from gold bug rubrics and applied to modern fiat currency nations.
Most people do not understand how the actual real world monetary system ?works?. And that is why they think Modern Money Mechanics describes a new monetary regime. It does not.
We are explaining how our monetary system actually works. No myths, no religion, no magic. This Primer WILL NOT present and critique the orthodox, mainstream approach. It is already in every economics textbook and it is outdated and for todays monetary and fiscal policy decisionmaking grossly misleading, indeed wrong. But it is irrelevant to the purpose of this Primer?which is to explicate how national money transactions between the public sector (government) and the private sector (non-government including the foreign sector) really work.
To understand how the modern monetary economy operates we need to take a step into national accounting. First, a modern monetary system has three essential features:
Second, within a modern monetary economy, as a matter of national accounting, the sovereign government deficit (or surplus) equals the non-government surplus (or deficit), also known as the private sector (and here includes the foreign sector). The failure to recognize this relationship is the major oversight of the current orthodox ( Bernanke-Geithner) analysis.
Further, it is important to understand that while the national government issuing a fiat currency is not financially constrained, its spending decisions (and taxation and borrowing decisions) impact on interest rates, economic growth, private investment, and price level movements.
We should never fall prey to the argument that the government has to get revenue from taxation or borrowing to ?finance? its spending under a fiat currency system. ....
It had to do this under a gold standard (or derivative system) but not under a fiat currency system.....
Most commentators fail to understand this difference and still apply the economics they learned at university which is fundamentally based on the gold standard/fixed exchange rate system.
Third, in a fiat currency system the government does not need to finance spending in which case the issuing of debt by the monetary authority or the treasury has to serve other purposes. (Stabilizing aggregate demand)
This is a fundamental departure from the gold standard mechanisms where borrowing was necessary to fund government spending given the fixed money supply (fixed by gold stocks). Taxation and borrowing were intrinsically tied to the government?s management of its gold reserves.
However, in a fiat currency system, government borrowing doesn?t fund its spending. It merely stops interbank competition which allows the central bank to defend its target interest rate.
The flexible exchange rate system means that monetary policy is freed from defending some fixed parity and thus fiscal policy can solely target the spending gap to maintain high levels of employment. The foreign adjustment is then accomplished by the daily variations in the exchange rate.
You cannot apply the economics of the gold standard (or USD convertibility) to the modern monetary system. All the fear mongering about the size of the deficit and the size of the borrowings (and the logic of borrowing in the first place) are all based on the old paradigm. They are totally inapplicable to the fiat monetary system.
The first thing to consider is that spending by private citizens is constrained by the sources of available funds, including income from all sources, asset sales and borrowings from external parties. Federal government spending, however, is largely facilitated by the government issuing cheques drawn on the central bank. The arrangements the government has with its central bank to account for this are largely irrelevant.
When the recipients of the cheques (sellers of goods and services to the government) deposit the cheques in their bank, the cheques clear through the central banks clearing balances (reserves), and credit entries appear in accounts throughout the commercial banking system. In other words, government spends simply by crediting a private sector bank account at the central bank.
Operationally, this process is independent of any prior revenue, including taxing and borrowing. Nor does the account crediting in any way reduce or otherwise diminish any government asset or government?s ability to further spend.
Alternatively, when taxation is paid by private sector cheques (or bank transfers) that are drawn on private accounts in the member banks, the central bank debits a private sector bank account. No real resources are transferred to government. Nor is government?s ability to spend augmented by the debiting of private bank accounts.
It is myth that deficits are inflationary and/or increase the borrowing requirements of government. The important conclusion is that the Federal government is not financially constrained and can spend as much as it chooses up to the limit of what is offered for sale. There is no inevitability that this spending will be inflationary and it does not necessarily require any increase in government debt.
In general, mainstream economics errs by blurring the differences between private household budgets and the government budget. Statements such as this one from reputed economist Robert Barro that,
?we can think of the government?s saving and dissaving just as we thought of households? saving and dissaving?. These types of references to households and businesses are plain wrong.
However, the reality is far from this erroneous conception of the way the Federal government operates its budget. First, a household, uses the currency, and therefore must finance its spending beforehand, whereas government, the issuer of the currency, necessarily must spend first (credit private bank accounts) before it can subsequently debit private accounts, should it so desire. The government is the source of the funds the private sector requires to pay its taxes and to net save (including the need to maintain transaction balances). Clearly the government is always solvent in terms of its own currency of issue.
What should be clear from this is that when the government has a deficit in any period, by definition the non-government sector (foreign plus private) must have a surplus of exactly the same amount.
The other stuff is where the politics and the ideology come into play but the accounting of federal government deficits is clear. When the government sector runs a deficit, the non-government sector runs a surplus of equivalent size. Draw your own conclusions about what this means in an era of government fiscal austerity.
Mainstream economics also misrepresents what it calls ?money creation?. In the popular macroeconomics text, Olivier Blanchard (1997) says that.
"government can also do something that neither you nor I can do. It can, in effect, finance the deficit by creating money. The reason for using the phrase ?in effect?, is that ? governments do not create money; the central bank does. But with the central bank?s cooperation, the government can in effect finance itself by money creation. It can issue bonds and ask the central bank to buy them. The central bank then pays the government with money it creates, and the government in turn uses that money to finance the deficit. This process is called debt monetization."
This is what mainstream economists call ?printing money?. However, it is an erroneous conception in terms of the monetary system. To monetise means to convert to money. Gold used to be monetised when the government issued new gold certificates to purchase gold.
Monetising does occur when the central bank buys foreign currency. Purchasing foreign currency converts, or monetises, the foreign currency to the currency of issue. The central bank then offers federal government securities for sale, to offer the new dollars just added to the banking system a place to earn interest. This process is referred to as sterilisation. In a broad sense, a federal (fiat currency issuing) government?s debt is money, and deficit spending is the process of monetising whatever the government purchases.
It is actually rather obvious but all government spending involves money creation. But this is not the meaning of the concept of debt monetisation as it frequently enters discussions of monetary policy in economic text books and the broader public debate.
Following Blanchard?s conception, debt monetisation is usually referred to as a process whereby the central bank buys government bonds directly from the treasury. In other words, the federal government borrows money from the central bank rather than the public. Debt monetisation is the process usually implied when a government is said to be printing money. Debt monetisation, all else equal, is said to increase the money supply and can lead to severe inflation.
I will show that as long as the central bank has a mandate to maintain a target short-term interest rate, the size of its purchases and sales of government debt are not discretionary. The central bank?s lack of control over the quantity of reserves underscores the impossibility of debt monetisation. The central bank is unable to monetise the government debt by purchasing government securities at will because to do so would cause the short-term target rate to fall to zero or to any support rate that it might have in place for excess reserves.
In summary, we conclude from the above analysis that governments spend (introduce net financial assets into the economy) by crediting bank accounts in addition to issuing cheques or tendering cash. Moreover, this spending is not revenue constrained. A currency-issuing government has no financial constraints on its spending, which is not the same thing as acknowledging self imposed (political) constraints.
In terms of fiscal policy, there are only real resource restrictions on its capacity to increase spending and hence output and employment. If there are slack resources available to purchase then a fiscal stimulus has the capacity to ensure they are fully employed. While the size of the impact of the financial crisis may be significant, a fiscal injection can be appropriately scaled to meet the challenge. That is, there is no financial crisis so deep that cannot be dealt with by public spending.
In an accounting sense, it is certainly true that any increase of government spending will be matched by an increase of taxes, an increase of high powered money (reserves and cash) and/or an increase of sovereign debt held. But this does not mean that taxes or bonds actually ?finance? the government spending. They do not!
Government might well enact provisions that dictate relations between changes to spending and changes to tax revenues (a balanced budget, for example); it might require that bonds are issued before deficit spending actually takes place; it might require that the treasury have ?money in the bank? (deposits at the central bank) before it can issue a cheque; and so on. These provisions might constrain government?s ability to spend at the desired level. However, economic analysis shows that they are self-imposed and are not economically necessary ? although they may well be politically necessary.
This accentuates the point that a sovereign government with a floating currency can issue securities at any rate it desires ? normally a few basis points above the overnight interest rate target that the central bank has set. There may well be economic or political reasons for keeping the overnight rate above zero (which means the interest rate paid on securities will also be above zero). But it is simply false reasoning that leads to the belief that the size of a sovereign government deficit affects the interest rate paid on securities.
When I am speaking to business forums I make the point that if they do not like the current size of the budget deficit then they can easily do something about it. Start investing, start creating employment and before too long the deficit will be lower.
So you can think of the deficit as being something that the private sector chooses by their spending (and saving) decisions. The more the private sector wants to save from the income that is generated each period, the higher the public sector deficit has to be to maintain that level of income (and related production). This is all a matter of national income accounting.
However, the budget deficit is also increasing at present (in all countries) because governments are acting responsibly and making discretionary decisions to increase their net spending (perhaps by tax cuts but more typically by increasing outlays).
The aim is to stop the decline in aggregate spending and to restore employment growth. The latter is driven by spending despite what the conservatives (and most of the employer associations) will tell you. Their claims that lower wages are the solution to higher employment growth fails to take into account that at the aggregate level lower wages reduce spending which causes unemployment.
So in that case, if the strategy works, and it will eventually ? it is just a matter of increasing the deficit until it does ? then economic growth will resume and ? without there being any further changes in tax structure (rates, exemptions, thresholds etc) ? taxes will be higher!.
What the debt nazis and deficit terrorists want you to believe is that the government will be so heavily indebted that they will have to increase tax rates to pay the debt back. Any sovereign government such as we have in Australia or, say, the US Government, or British Government, or Japanese Government, or the hundreds of other governments around the World, do not face a financial constraint. This means that: (a) the spending does not need to be financed; (b) that any debt instruments (bonds) that mature can be easily paid out by the government crediting relevant bank accounts for the coupon value (face value of the bond) plus interest owed; and (c) that neither of these actions have any necessary implications for future tax rates or interest rates.
The first thing that the Government has to understand, which it currently does not, is that the size of the deficit is a totally useless thing with which to become obsessed. The size of the deficit ? which is just an accounting statement after all ? is not a viable or legitimate policy target.
The fact that the Government is still thinking it has to worry about the particular deficit figure reflects the destructive neo-liberal overhang that still dominates macroeconomic policy.
Nobel Lauerate, Prof. Jamie Galbraith says that:
It is therefore a big mistake to argue that the next thing the administration and Congress should do, is focus on stabilizing the debt-to-GDP ratio or bringing it back to some ?desired? value. Instead, the ratio should go to whatever value is consistent with a policy of economic recovery and a return to high employment. The primary test of the policy is not what happens to the debt ratio, but what happens to the economy.
Galbraith also reflects on a previous commentator?s claims that ?a very high public-debt-to-GDP ratio leaves the
? displays a very vague view of monetary operations and the determination of interest rates. The reality is in front of our noses: Ben Bernanke sets whatever short term interest rate he likes. And Treasury can and does issue whatever short-term securities it likes at a rate pretty close to Bernanke?s fed funds rate. If the Treasury doesn?t like the long term rate, it doesn?t need to issue long-term securities: it can always fund at whatever short rate Ben Bernanke chooses to set ?
The Chinese can do nothing about this. If they choose not to renew their T-bills as they mature, what does the Federal Reserve do? It debits the securities account, and credits the reserve account! This is like moving funds from a savings account to a checking account. Pretty soon, a
The way the modern monetary system works is neither left wing or right wing. The fundamental operations of the system are what they are. You can then impose whatever ideology you like on those operations although I accept a deeper ideological critique can be made of using fiat money in the first place!
Bill Mitchell, et al.
Next Primer Topic...Why Your Tax Dollars Don't Pay For Anything.