But... it's a REALLY big number!!!
I've recently joined DKos after almost a year of lurking. My thanks to kos and all of you who contribute diaries, comments, and other resources to this fantastic laboratory space. Early on in my lurking, I came across several references to Modern Money Theory (MMT) that piqued my interest, and set me on a new journey of learning.
I am not an economist, but after months of study, I am convinced that MMT provides an accurate description of the nature of modern fiat currency.
I'm equally convinced that in understanding this nature, we can create much more meaningful and effective strategies to make market economies better serve the needs of the people.
This, my first diary, will be a little MMT primer using Joan McCarter's diary "
Senate passes unemployment insurance extension" as a jumping off point. Joan quotes
#WGDB, from which I'll focus on this snippet:
House action is uncertain at best. Speaker John A. Boehner, R-Ohio, has said repeatedly the Senate bill does not meet his test of creating jobs and being fiscally responsible.
Creating jobs? Of course it creates jobs. Government spending always creates jobs.
Sometimes it creates them directly: We pay contractors to build roads and bridges, they hire workers. BAM! New jobs!
Sometimes it creates them indirectly: We send out SSI checks, recipients go buy stuff, stores hire employees to ring them up and restock the shelves, vendors hire workers to make more stuff. BAM! New jobs!
While some types of spending create fewer jobs than others, the only way spending could fail to create any jobs is if there were no unemployed job seekers out there. In that case, workers could only move from one job to another, probably (but not always) leading to inflation, but no net creation of jobs. Of course, there have been plenty of unemployed for the last 40 years, so it has been a while since this problem could have come up.
Until we reach full employment, government spending CREATES jobs.
Carry on below the fold for a discussion of the real meaning of fiscal responsibility.
The idea that Government spending doesn't create jobs is rooted in the belief that the Government must tax before it can spend, and must borrow money to make up for any spending in excess of tax "revenue." Taxation, as everybody knows, removes money from the economy and slows it down, so job creation from spending must be cancelled out by job loss from taxation, perhaps MORE than cancelled out if 'government inefficiency' is factored in.
But now we have a problem: the two tools of fiscal policy are taxing and spending. If we tax too much, we slow down the economy, risking recession (or worse). But if we spend enough to speed up the economy, say by trying to reach full employment, the borrowed money (deficit) will be so large that it will create "unsustainable" debt. If we don't tax ourselves enough, the government will have to "borrow" money from the private sector or (gasp) China! It seems that Fiscal policy has no tools to help us, and the Fed has already told us that it's at the limit of what it can do with Monetary policy. Let's face it:
We're doomed, and must accept unemployment, crumbling infrastructure, shredded safety-nets and stagnant wages for the good of our children! We must strive to be more (dut-dut-DUHHH!!):
Fiscally Responsible!®
Issuer vs. User
Of course, this is hogwash and balderdash, and the root of the misunderstanding is in a failure to recognize that the Federal Government, the Currency Issuer, has a fundamentally different relationship to money than the Currency Users: Individuals, Firms, State, Local, and Foreign Governments. Users, being unable to issue money, must earn or borrow before they spend. Spend too much, debt gets too big to handle, and blammo! Insolvency!
The Issuer, however, doesn't need to collect money before spending, it simply issues the money. It could theoretically do this forever, without taxing anybody, as long as there was demand for the money.
The Issuer cannot run out of money! Ever!
There is NOTHING for sale in its own currency that it CANNOT buy! Ever!
It cannot become insolvent, nor be forced into involuntary default on obligations in its own currency!
EVER!!!
The Real Limits to Spending
The limit to Government spending is not financial, but practical. For money to be useful, it must maintain a relatively stable value. If the Issuer spends so much that it is trying to purchase goods and services that the private sector would like to use, too much money will be chasing too few goods, and money will lose its value (inflation). So in practical terms, the limit to additional Government spending is the unused productive potential of the economy, currently estimated to be around 20% of potential GDP, or approximately $4.3T. The current total government spending is just over 20% of current GDP, about $3.7T. In other words:
The Government could DOUBLE it's spending without creating excessive inflation in the short term!
Of course, we needn't (and shouldn't) spend nearly that much, because money spent in the lower 80% of the income distribution gets spent again, and again, creating a multiplier effect. But that's not all, because banks leverage money by lending, creating an even more powerful multiplier, and when they have more qualified customers, they do more lending. And when private enterprises have access to more customers and more money, they invest in more production, which means more goods and more jobs. And THAT is how Government spending stimulates the private sector into growth, reducing the need for Government spending.
Real fiscal responsibility means using the Government's ability to spend money (and tax) to avoid wasting lives and resources in the ebb and flow of the business cycle.
Let me emphasize that:
20% of the productive capacity of our economy, people who want to work but can't find a job, restaurants with empty tables, factories with idle machines. That 20% is being WASTED because the private sector can't sell their products and the Government is unwilling to pick up the slack, refusing to use the fiscal tools at its disposal to make things better for all of us.
Why Tax?
If the Issuer can spend without revenue, why do we need tax? Well, from the outset, there must be a demand for a currency before anyone will accept it. Taxation (and a credible promise of collection) creates that demand. If enough people need money to pay their taxes, some people will provide goods and services to the Issuer in exchange for the money. Money now assumes its roles as medium-of-exchange and store-of-value, as anyone who holds it knows they can find someone who wants it. This is how society diverts resources to support the public purpose or commons.
Once the currency is accepted, Taxation becomes less important for creating demand, and it's other uses come to the fore: regulating the economy and discouraging activities that oppose the public interest. As discussed above, taxes remove money from the economy, slowing it down. This is critical for preventing excessive inflation when the economy is running at or above its productive capacity. We can also use tax rates to encourage or discourage certain types of business activities, which topic I believe I'll save for my next diary.
Debt and Deficit
What are Government debt and deficit from the perspectives of the issuer and the user? We now know that Government spending adds money to the economy, and taxation removes it. The difference between these numbers during any period (usually 1 year) is called either the deficit (spending > taxes) or surplus (taxes > spending). Thus, a deficit is the net Government contribution to the amount of money in circulation per year. Where does that money go? Into currency User savings, of course.
All financial transactions between currency Users net out to zero. One entity's asset is another's liability. If I loan some of my money to Joe for a promissory note, our net financial positions haven't changed. Joe holds the money as his asset, while the note I hold is his liability. I have traded my asset of cash for the note, which I hold as an asset. Even fees and interest balance out, although through a longer chain.
One person's financial asset is another's liability. Always.
Currency User's savings (assets) are therefore someone else's liability. If I save by stuffing bank notes into my mattress, my savings is the Government's liability. The Government has promised to accept these notes in payment of my taxes.
(Note that they haven't promised anything else: at the most fundamental level, a bank note is a tax credit coupon.)
Let's say that I take my mattress fund to the bank and purchase a CD. Now my asset is the CD account, which is the Bank's liability. The Bank holds the currency, which is the Government's liability. Since the Bank's asset equals it's liability, the net result is the same as if I had stuffed the money in the mattress: My savings is the Government's liability. This same logic applies with any financial investment vehicle I choose. Since one person's asset is another's liability, the chain may lengthen, but it always balances out the same:
Private sector savings equals Government liabilities!
Reserves and Securities
Most money isn't bank notes, though. Most of it is just entries in electronic spreadsheets. If I receive a check from my boss and deposit it in my bank, the amount of the check is deducted from my boss's account and the same amount is added to my account. At the same time, my bank's Reserve account at the Federal Reserve Bank is credited, and my bosses bank's account is debited. My bank holds my deposit as a liability and it's Reserve account as an asset, so the net change in it's position is zero.
The Federal Reserve Bank (system, actually) holds the assets of currency Users in two forms: Reserves and Securities. Reserves are analogous to checking accounts, while Securities (Treasury notes) are more like CD's. Securities are time deposits that pay more interest than Reserves, so banks move money between the two according to their needs.
Federal Debt, as shown on that debt clock near Times Square, is simply the sum of all Securities accounts held by the Federal Reserve Bank. When it comes time to pay these debts, the FRB debits the Securities account and credits the Reserve account.
To pay off the Federal Debt, the Federal Reserve Bank DEBITS the Securities account and CREDITS the Reserve account!
No muss, no fuss, no take-over of the US by China, no taking food from the mouths of unborn generations. Money changes from a slightly less liquid form to a slightly more liquid form (with a little addition due to interest) as a result of some keystrokes at the FRB. Just as there is no limit on keystrokes, there is no limit to the FRB's ability to credit, debit, or transfer between Reserve and Securities Accounts. (In practice, Issuers can and do place self-limitations on these types of transactions, but this is a policy decision, not a requirement.) This is why the government can ALWAYS pay it's obligations, and also why the Federal Debt is a non-issue.
Real Fiscal Responsibility
Taxes and entitlements are natural stabilizers of the economy. Tax receipts increase as the economy heats up, while entitlement spending increases during downturns. This countercyclical pressure dampens the peaks and valleys of the business cycle, allowing us to focus our Fiscal Policy on other policy goals, such as wider distribution of prosperity, full employment, environmental protection, social justice, and equity of outcomes.
Real Fiscal Responsibility means committing to use the fiscal tools at our disposal to create the greatest good for the greatest number over the longest time.
The market was invented to serve people, not the other way around. Thanks for reading, and have a great day!
Next diary: Tuning taxation and spending for optimal social outcomes, or Why bailing out banks and lowering tax on the rich are sub-optimal strategies.
Resources:
New Economic Perspectives - especially this in-depth primer by L. Randall Wray
The Center of the Universe - start with this excellent introduction: 7DIF (.pdf) by Warren Mosler
billy blog - Bill Mitchell
The Big Debt Lie - Mike Norman (I found this whilst searching open-source Debt Clock pics.)
Most of the ideas in this diary come from one of the above authors. If my phrasing resembles their words too closely, I apologize. I'm consciously trying to not plagiarize, but some turns of phrase undoubtedly got through. All of the good is theirs, any mistakes are mine. If you find egregious errors or omissions, please let me know.