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Modern Money Operations

We discuss  modern monetary policy solutions most feared by the Plutocracy.

America Can Never Go Broke

Warren Mosler

Academically, he is known for his writings on Modern Monetary Theory, an economic theory that describes the way fiat money is created and utilized in modern economies.  Professor Mosler is also a Fixed Income fund manager specializing in monetary policy; Founder, MMT

Deficit Reduction Super Committee Fighting the Battle of  New Orleans


I realize it's not a perfect analogy, but due to poor communications, the battle of New Orleans was fought well after the War of 1812 had ended. Likewise, the Congressional super committee is fighting the battle for deficit reduction long after the vaporization of the primary reason driving that move towards deficit. 

The main difference is the stakes are much higher this time, with the real cost of the lost output from the excessive, ongoing, global output gap far exceeding all the real losses of all the wars in history combined.

The headline reason for deficit reduction was the rhetoric about the immediate danger of the United States suddenly becoming the next Greece, with the U.S. government being cut off from credit, with interest rates spiking, and with visions of the US Treasury Secretary on his knees, hat in hand, begging the IMF for funding and mercy. The looming flash point was the threat of a downgrade to the U.S. if a credible deficit reduction package wasn't passed before the August 2 deadline, when the congressionally self-imposed U.S. borrowing authority was to expire.

After a prolonged Congressional process that was even uglier than the healthcare process, with already dismal Congressional approval ratings moving even lower, the debt ceiling was extended with a measure that contained some deficit reduction, and also set up the current super committee to ensure further deficit reduction.

Soon after, however, Standard and Poor's decided it all wasn't enough, and the dreaded downgrade was announced. Then the unexpected happened. Rather than spike up as widely feared, market forces drove U.S. Treasury interest rates down, substantially,

What was happening? Where had the mainstream gone wrong? Former Fed Chairman Greenspan and celebrity investor Warren Buffet both immediately had the answer. S&P was wrong. The U.S. is not Greece. The U.S. government prints its own money, while the Greek government does not. The U.S. always has the ability to pay any amount of dollars that markets can't take away. Everyone agreed.

The driving force behind deficit reduction was suddenly not there, and the rhetoric of becoming the next Greece vanished from the national TV screens. Unfortunately, just like the news that the War of 1812 had ended didn't get to New Orleans in time to prevent thousands from losing their lives in that bloody battle that would otherwise not have been fought, the news that the U.S. isn't Greece apparently hasn't gotten through to the Congressional members of the super committee now fighting the current battle over deficit reduction.

What was learned after the downgrade was that there is no such thing as a solvency problem for the U.S. government, either short term or long term. True, excessive deficit spending may indeed someday cause unwelcome inflation, but the U.S. government is never in any danger of not being able to make any payment (in dollars) that it wants to.

And yes, the discussion could be shifted to a discussion as to whether current long term deficits forecasts translate into unwelcome inflation in the future that may demand action today.

However no specific research has been done along those lines. In fact, inflation forecasts, which all assume our current fiscal trajectory, don't show any signs of an inflation problem. Nor are the long term U.S. Treasury inflation indexed bonds flashing any inflation warnings. In fact, the Fed and most other forecasters remain more concerned over the risk of deflation. Also, Japan, with a debt to GDP ratio about triple that of the U.S., has been fighting its battle against deflation for nearly two decades.

So, clearly, shooting from the hip on this issue, by suddenly declaring long term deficits must be immediately addressed with cuts to Social Security, and with tax hikes, to prevent a looming inflation problem (now that the prior errant reason, that the US could be the next Greece, has been dismissed), could only be considered highly irresponsible behavior on the part of the super committee.

An informed Congress might recognize the reason for the urgent action to reduce the federal deficit, and the reason for the super committee, is no longer there. Therefore, an informed Congress might suspend the super committee, regroup and reconsider before taking action.

It is widely agreed the current problem is a massive lack of aggregate demand. It is widely agreed that a combination of tax cuts and/or spending increases will restore sales, output and employment.

However, instead of a compromise where the Republicans get some of their tax cuts and the Democrats some of their spending increases, and the economy booms, both sides are instead going the other way and pushing proposals to reduce aggregate demand, even though they no longer have good reason to do so.

The battle of New Orleans was fought after the reason for fighting it had ended.

The battle of New Orleans was fought after the reason for fighting it had ended. Likewise, long after the reason for deficit reduction vaporized, this battle continues to be fought with both parties continuing to act counter to their political agendas of serving their voters who want jobs.

How High ?Should? the Deficit Be?

When ?inflation? is ?low,? unemployment ?high,? and the output gap is growing, the deficit is probably way too small. The economy is screaming for more net financial assets that only government deficit spending can provide. When unemployment is very low, prices rising, and excess capacity at a minimum the deficit is probably too high.

But solvency is never the issue. The economy is the issue.

During the last two recessions the economy did not improve in a meaningful way until after the deficit reached about 5% of GDP. This time around the deficit is now at about 5% of GDP and from the latest economic statistics it?s obvious that this time around a much higher deficit will be required to turn the economy. This is because the previous government surpluses of the late 1990?s deeply eroded savings, which, for all practical purposes, only a budget deficit can replenish.
Additionally, the large trade deficit that foreigners allow us to sustain, means we can have a budget deficit that much larger without increasing the risk of inflation.

Here?s how that works. When Americans purchase foreign goods and services, we use up some of our ?purchasing power.? That can mean we don?t have enough purchasing power left over to buy all of our own goods and services we can produce at full employment, UNLESS our government conducts sufficient deficit spending to make up for this shortfall.
So our negative trade balance allows us to enjoy either lower taxes or the benefits of higher government spending, so we can consume BOTH whatever we can produce AND whatever the foreign sector wants to send to us.
The economic fundamental at work is that exports are real costs and imports real benefits. Economically, scripture notwithstanding, it?s better to receive than to give!

Our well being depends on appropriate policy response. Current circumstances allow us to run much higher deficits to sustain sufficient aggregate demand to close our output gap. That means lower taxes or more government spending is in order to sustain output and employment.

How We Can All Benefit from the Trade Deficit

The current trade gap is a reflection of the rest of the world?s desires to save $US financial assets.
The only way the foreign sector can do this is to net export to the US and keep the $US either as cash or securities. So the trade deficit is not a matter of the US being dependent on borrowing offshore, as pundits proclaim daily, but a case of offshore investors desiring to hold $US financial assets.

To accomplish their savings desires, foreigners vigorously compete in US markets by selling at the lowest possible prices. They go so far as to force down their own domestic wages and consumption in their drive for ?competitiveness,? all to our advantage.
If they lose their desire to hold $US, they will either spend them here or not sell us products to begin with, in which case that will mean a balanced trade position. While this process could mean an adjustment in the foreign currency markets, it does NOT cause a financial crisis for the US.

The trade deficit is a boon to the US. There need not be a ?jobs? issue associated with it. Appropriate fiscal policy can always result in Americans having enough spending power to purchase both our own full employment output and anything the foreign sector may wish to sell us. The right fiscal policy works to optimize our output, employment, and standard of living.
Our steel industry, however, is an example of a domestic industry with important national security considerations. Therefore, I would propose that steel tariffs be eliminated and instead defense contractors be ordered to use only domestic steel. This will ensure a domestic steel industry capable of meeting our defense needs, with defense contractors paying a bit extra for domestically produced steel, while at the same time lowering the price for non- strategic steel consumption for general use.

Using a Labor Buffer Stock to Let Markets Decide the Optimum Deficit

To optimize output, substantially reduce unemployment, promote price stability, and use market forces to immediately promote health care insurance nationally, the government can offer an $8 per hour job to anyone willing and able to work that includes full Federal health care benefits.

To execute this program, the government can first inform its existing agencies that anyone hired at $8 per hour ?doesn?t count? for annual budget expenditures. Additionally, these agencies can advertise their need for $8 per hour employees with the local government unemployment office, where anyone willing and able to work can be dispatched to the available job openings. This job will include full benefits, including health care, vacation, etc. These positions will form a national labor ?buffer stock? in the sense that it will be expected that these employees will be prone to being hired away by the private sector when the economy improves. As a buffer stock program this is highly countercyclical- anti inflationary in a recovery, and anti deflationary in a slowdown. Furthermore, it allows the market to determine the government deficit, which automatically sets it at a near ?neutral? level.
In addition to the direct benefits of more output from more workers, the indirect benefits of full employment should be very high as well. These include increased family coherence, reduced domestic violence, reduced crime, and reduced incarcerations. In particular, teen and minority employment should increase dramatically, hopefully substantially reducing the current costly levels of unemployment.

James Galbraith
Townshend VT
July 17th, 2010
4:01 pm

Paul?s argument is that *infinite* inflation is a theoretical possibility. Well, yes. It happened in Germany in 1923.

There is no reason to cut Social Security benefits or Medicare now, with effect in the future, in order to avoid the theoretical possibility that some combination of policies might at some time in the future give us the economic conditions of post World War I Germany.

Those conditions were desperately resource-constrained.

In the actual world we live in, government does not have to "persuade the private sector to release real resources." In the actual world, the private sector has already released those resources by the tens of millions of people.

All the government has to do, in the actual world, is mobilize those resources, which it does by issuing checks, preferably to pay people to do useful things.

There is no reason why this should be considered "costly." Done correctly, in economic terms it amounts simply to the reduction of the waste that is associated with unemployment.

Nor is it necessary, when the government issues a check, that it issue a bond to "borrow" the money behind that check. The check creates money in the first place. (Yes, it does this from thin air, by changing numbers in bank accounts.)

Operationally, this is a free reserve in the banking system. The reason the government issues a bond later, is that the banks like to have a higher rate of interest than they can earn on reserves, and the government likes to oblige them.

This is why Treasury auctions don?t fail: the government has already created the demand for the bonds, by issuing checks to the banking system.

If the government spent but declined to "borrow," what would happen? Nothing much. Banks would hold their reserves as cash rather than bonds, and their earnings would be a bit lower. It is *not* true, as a rule, that people (or banks) move readily to substitute lumps of coal for dollars, unless the price level is already moving up and out of control.

It is very difficult to get other people to accept coal in place of dollars!

Paul?s logical error here is that of assuming-the-consequent. He assumes the inflation which causes dumping of money. But if there is no dumping of money, the inflation will not generally occur.

Yes, again, it?s technically possible that the banks and others would start dumping dollars and buying up oil, wheat, rubber, and so forth (and leasing storage facilities for the stuff) thereby driving up the price level.

I wrote ? correctly and deliberately ? that bankruptcy, insolvency and high real interest rates were not risks. Inflation *is* a risk.

By this, to be clear, I mean an ordinary garden-variety increase in the inflation rate is a risk ? not the *infinite-inflation* scenario.

Inflation, though unattractive, is not remotely comparable to bankruptcy or insolvency, unless you get to Paul?s *infinite* inflation scenario. So what about that?

In his model, it is driven by his monetarist (quantity-theory) simplification, that the increase in money flows directly into prices. But this is just a modeling error. In the real world, especially in broadly deflationary conditions, people ? and banks ? simply hang on to cash. There is a Paul Krugman who understands this, from close study over many years of the Japanese stagnation.

However, and again, in the present state of the world economy, and for the foreseeable future ? and except for the energy sector ? surely a small rise in the inflation rate is a trivial risk.

My position is that the government should focus on real problems: unemployment, care for the aging, energy, climate change, and the disaster in the Gulf of Mexico.

The so-called long-term deficit is not a real problem. And the capital markets demonstrate every day that they agree with this judgment, by buying long-term Treasury bonds for historically-low interest rates.