Quick - how is Japan's lost decade like the current U.S. crisis?
They both began with a few years of budgetary surpluses!
When you look back at what happened in Japan right before their horrible times began, you notice similarities with the U.S. Of course, we all know about two large similarities:
- Huge stock market bubble
- Huge real estate bubble
But have you heard about this third similarity?
3. Large government budget surplus
If budget surpluses are so good, why did they precede a lost 15 years for Japan, an economy that previously had an uninterrupted 40 years of growth, and also immediately precede the slowest expansion in U.S. history, with a lost decade for U.S. workers wages?
Most people think that government surpluses are good for the economy. I understand this reasoning as until recently, I believed that surpluses were great for the economy. This idea makes superficial sense, because surpluses are good for personal and business accounts, so it is reasonable to assume that surpluses are good for governments. Even Paul Krugman thinks that surpluses are good for the economy in most cases.
However, surpluses are horribly wrong and economically dangerous.
For those who need some historic proof, here is a long list of U.S. recessions and depressions following U.S. govt. surpluses or significant reductions of U.S. debt.
This idea is important for progressives to understand. We can and must use a better economics to combat the free market fundamentalists that dominate our economic discourse. I hate to see people like Larry Kudlow on CNBC every day, when it should be Jared Bernstein.
I will be expanding on these ideas over a series of posts, and I hope that you join me on this. They are not my ideas. H. Randall Wray, a student of Hyman Minsky, is one of the leading lights of the economic community and the leading proponent of these ideas within the academic community.
The government, with control of the issuance and acceptance of money for taxes, is fundamentally different than individuals and businesses. Because of this difference, governmental surpluses are horrible for an economy and tend to drive them into a depression or very deep recession.
Here is the logic in a few bullet points.
- Money gaining in value relative to assets is what causes deflation.
- Deflation causes individuals and business to want to hold cash because it is gaining in value, instead of spending or investing the cash, resulting in recessions and depressions.
- Money can only be created by deficit spending (Yes - it is! I will demonstrate).
- Because of #3, U.S. govt surpluses reduce the amount of money relative to the amount of goods, causing deflation.
- Deflation caused by insufficient government spending causes recessions and depressions, due to #2.
I will be introducing a few important ideas.
- Govt. Surpluses lead to depressions
- Money (a currency) is given value through its unique acceptance for payment of taxes.
- Money is created through government deficit spending.
Prof. Wray has written a book Understanding Modern Money, which is a must read for progressives interested in economics. He presents and backs up these ideas over the course of a well written book
This is going to be a post without as many links as I usually like, but one that introduces lots of important concepts.
First, we must answer a question. Why is money valuable? More precisely, why is a specific currency valuable?
The standard thinking is that it evolved because people became habituated to using a certain currency and next you know, it is accepted everywhere, for almost all transactions. Well, I propose another, more concrete reason why a specific currency is valuable.
A currency has value because that is the only thing the government will accept for payment of taxes.
This is known as the Chartalist approach to money
Think about this statement about the relationship between demand for a currency and taxes for just a moment. You can only pay taxes in U.S. treasury issued currency, so of course, you have demand for it. Imagine that you were paid in gold. You would have to sell the gold for dollars to be able to pay your taxes, because the U.S. treasury does not accept gold, only U.S. currency. If you are paid in anything but U.S. currency, you must exchange this for money at some point so you can pay your taxes.
Money is given its value from acceptance, and the most fundamental acceptance is the exclusive acceptance of U.S. currency for U.S. treasury tax payments. In any transaction, acceptance is what validates the transaction. Taxes therefore drive the demand for a currency.
We have a choice between two theories on why money is used and accepted. One says, well we do not really know, but people seem to accept it and therefore they accept a currency. The other theory has a concrete reason why there is demand for a currency. In fact, the theory that taxes drive demand for a currency is a testable theory, and therefore a scientific theory of monetary demand. The theory that demand for a currency is a result of habit is not scientific.
So, why do Surpluses cause depressions? Well, depressions tend to be caused by deflation. What is deflation?
Deflation is when money becomes more valuable relative to real goods. In other words, when the demand for money is too high relative to the value of real goods.
This is happening right now. When deflation happens, like is happening right now, the cost of goods fall. Like for example, housing values fall, the price of gas falls, computers, clothes, cars, you name it, it will cost less tomorrow. How can this happen?
According to the Chartalist approach, the demand for a currency is given through taxes. If the demand for a currency is too high, this means taxes are too high relative to government spending, then the demand for the currency outstrips the value of goods.* The same amount of money will buy more goods than in the recent past. In other words: Surpluses cause deflation, which then causes depressions and recession because simply holding money makes it increase in value.
The way to decrease the demand for a currency is to deficit spend or lower taxes, or both.
As for deficit spending creating money, imagine a world with no U.S. dollars. How is the first net U.S. dollar for savings created in the case of a balanced budget? Run through the accounting cycle: The govt borrows money, spends money, then collects 100% of those dollars back. How many U.S. dollars are left? zero. No net dollars created.
The government must then spend money in excess of what it collects in taxes for their to be net dollars in existence.
The conventional view of money creation begins with the fed purchasing treasury notes. A fantastic explanation of this conventional view of money creation is located at econbrowser. Note that this view requires a treasury bill or note to exist to work, which is why I say the treasury deficit spending is what creates the money, not the fed operation.
Wow this post is all over the place - feel free to rip into it! See you soon!
*Now I know that low taxes are something of a bugaboo here at the daily kos. I am not suggesting that we eliminate taxes - no, taxes are necessary to drive the demand for a currency. And I am deliberately not going into tax bracket structure in this post, but I will say I favor higher taxes on high earners, lower taxes on the middle class and negative taxes on low earners. By middle class, I mean the real middle class, people making $40,000 a year and not Mitch McConnells version of the middle class that makes $2M a year. I will have more about tax brackets, but this post is already way too long!