...Or just create enough confusion to prevent a timely debt solution?
A leader of the “greatest generation” found the right words for his time when he said: “The only thing we have to fear is fear itself”. But fear… long term, gnawing fear and a gnawing sense of resentment against the limitations by which we are shackled to it … takes on new manifestations with each generation. People know something’s wrong in our time when our economy, so full of potential, is hog-tied by questionable limitations (MMT’s focus) and questionable debt (ours). There is a realization that the common man and woman, often now both working to support the same household once supported by one, are slipping - and perhaps unnecessarily so. It is with that perception of Modern Monetary Theory that we agree. However, we decline to jump off the deep end of infeasible and dangerous ideas because a parade of lemmings has queued up in that direction. There is a better way.
The public is tired of fear - of debt and of austerity – and tired of limitations that bind us to these things. They’re ready to follow someone with knowledge of the unbelievable things they have heard of - billions of dollars made (or lost, but, you know) by instantaneous electronic transactions on Wall Street. Through that portal we can see that maybe we have no limitations! Isn’t that just so today?
Today, conditions are ripe for such ideas. Noted economist Thomas Palley’s more restrained way of saying it is: “MMT currently has appeal because it is a policy polemic for depressed times. That makes for good politics but, unfortunately, MMT’s policy claims are based on unsubstantiated economics.”¹
What can the politicians do but look to the economics establishment to ask if this trending idea is really OK? Who is willing to be the spoil sport and say there are some serious problems with the theory? Quite a few, it turns out. They range from eminent liberal economists like Paul Krugman to eminent conservative economists like Harvard’s Greg Mankiw. They include macro-economists, experts in money and banking, experts in Treasury and Federal Reserve operations and experts in the financial markets. They include people who have done analyses of what happened in the bond market during historic conditions and cycles different from those of the snap-shot present, and who have done the pertinent calculations to test MMT’s assumptions. We will read more of what these experts have to say, not just as snippets but with enough text where and as required to make the facts behind their reasoning clear.
Why is it important for the economics establishment to read an article such as this, lengthier and more demanding than our newsletter’s usual morning cup of coffee fare? Why is it critical for it to come to a firm position on this subject in the near future? Because we are getting close to decision time on some very big issues, and there has been a spate of confusion slowing down action caused by the attention - grabbing MMT theory. We’ve seen it first hand. It’s critical to dig into the matter because, in today’s fiscal planning process, time is short and the stakes are very high.
A BRIEF WINDOW OF OPPORTUNITY TO DEAL WITH THE DEBT-AND-AUSTERITY MONSTER
Many of us watch documentaries like NBC’s Sixty Minutes. Perhaps many of us will remember the segment about a state government unable to pay its share of the Medicare/Medicaid costs of treating
patients, and how this affected a group of cancer patients. They were suddenly informed they would no longer receive chemotherapy treatments under their current healthcare arrangements. Sixty Minutes followed them, to see what would be the outcome. Some patients found other ways of continuing their chemo treatments, but some didn’t. Among those they followed was a man who had done well recovering on chemo, but who hadn’t found a way of continuing his costly treatments. So what happened to him? What one should think inevitably would, for some: he died.
Pick your own example of the consequences of not arriving at a well thought-out plan for dealing with our debt and fiscal crises: The ever-growing debt itself? Insufficient resources to both care for veterans and sustain military preparedness? Childhood hunger in the households of the working poor if food stamps are eliminated? Inability to sustain the costs of disasters of new types and magnitudes? Lack of investment in the economy, leading to a long – term slide? We all want progress in seeking efficiencies and seeking balanced solutions within our means. That progress will be hampered if people take seriously enough to debate such questions as whether, per MMT, there is no debt problem.
Our leaders have talked a lot about budget cuts, but to date have done but a tiny fraction of what many say will ultimately be needed. In doing budget cuts, we can err on the one side, and we can also err on the other – as all of us, these days, know. We have talked about how we can build the revenues of government if we invest in the economy, but to date we have done but a tiny fraction or what many say will ultimately be needed. Prosperous entrepreneurs and the idled poor are both affected by crumbling infrastructure and other critical public needs. The current deficit problem is getting better, at the moment – but the Congressional Budget Office and prominent think tank economists have done studies showing how the deficit can be expected to go up again starting after 2015. Eminent economist Henry Aaron of the Brookings Institution has written a recent article representing a broad consensus in the economics establishment that we do have a debt problem and it does matter! See: http://www.brookings.edu/research/opinions/2014/07/16-ultimate-definitive-guide-budget-deficit-aaron
We have talked about grand bargains, but our bargains to date have mostly consisted of agreeing to kick the can down the road. The day will come – not so far away – when we will have to make more real decisions. If we do not take this opportunity to develop a wise multi-year plan, we will face last-minute panic choices again when something actually has to be done. And our biggest budget difficulty may be some climate-driven or internationally-driven occurrence we aren’t even factoring in today.
What we will show in these pages is that Modern Monetary Theory, as presently developed, represents a course that could come nowhere close to acceptance by the majority in Congress, and that the net effect of its current influence is to throw sand in the cogs of the process of developing a plan. We should know, by now, how readily that happens. The consequences of confusion and inaction can be as much as life and death, as the Sixty Minutes documentary showed … not for everyone, but – as the statistician explained about getting struck by lightning, “if it does happen, it’s 100% for you.” But there are many issues likely to significantly affect us all.
Do these issues call for a full-blown, across-the-board critique of the factual falsehoods of Modern Monetary Theory, as we have undertaken in this special edition? We think they do, and that the time is now. We believe that if MMT is ever to play a role as a practical guide for policy, it is time for its leaders to finally listen to its critics and make some significant adjustments to what they have set forth.
JUDGING MODERN MONETARY THEORY BY ITS EFFECTS
Several weeks ago we contacted an economics professor with an approach made to several of our readers. It went like this:
Dear Professor X: I am the editor of Policy Winners, an e-newsletter sent each month to 1,000+ economists and policy makers in think tanks, universities and congressional offices. In our May and
possibly June issues, we will frame a question as per the May introduction attached – essentially, under any set of restrictions or limitations, should we explore the possibility of re-introducing United States Notes (Lincoln’s “Greenbacks”), issued without a debt burden to the government, for use in funding government expenses? As a point of reference, we have calculated that with less than 5% of the money supply created in this way, we could eliminate the current year deficit and make some headway toward reducing the national debt. (The e-mail then went on to invite him to be a commenter on the subject in the May newsletter – an invitation accepted by six others).
The professor responded:
“As I understand your message, you were interested in money issue without debt and cost to the government. That is currently the case, since the Federal Reserve System issues money based on already outstanding debt.”
That statement is evidently based on Modern Monetary Theory (as we will see). It is parallel in form to other statements in which people have said that all we need to do is “get” the Federal Reserve to buy up all the Treasury bonds the government issues to fund the deficit, because it will return all the interest on those bonds to the government. Last time we checked, the Federal Reserve was holding about 10% of US Treasury bonds and about 14% of all US debt. The essential point is, only a small portion of the Treasury bonds sold to finance the debt are held by the Fed, and the Fed is in no position to send back interest on Treasury bonds owned by investors in, say, China. A lot would have to be changed to create a situation where the Fed could send back all the interest on the national debt, and it is most definitely not a foregone conclusion those changes will be made…for many reasons. So why are we being told “don’t worry about the debt, we don’t have a debt problem” when that is so very far from the truth? That is one of the disturbing effects of Modern Monetary Theory.
Let’s take a look at an underlying issue in the above example. What we mentioned to the professor is certainly an idea, and an obvious one, for easing the debt and fiscal crisis. It is an idea that has been used successfully in this country and others many times, and it would not require any change in spending or any institutional change. It is simply a matter of doing what has been done before under similar circumstances and for similar reasons. Is this an unreasonable proposition upon which to invite discussion? But let’s notice: How much attention to the issue was given by the professor? Exactly none. If we don’t have a debt problem, if everything has been taken care of by the Fed, then we don’t need to take even a moment to think about the issue. But is it actually true that we don’t have a debt
problem, and that everything is already being taken care of, in perpetuity, by the Fed?
We have gotten puzzled looks form young congressional staffers in several offices when we have made mention of the debt problem ... puzzled looks and sometimes more as if to say, “What debt problem?” Our leaning is Democratic, but we have found it very disturbing to walk into the offices of three Democratic office-holders and encounter seeming skepticism on the part of the staffs about whether there is a debt problem. That doesn’t bode well for future elections! One staffer seemed to indicate that his congressman felt it could actually be harmful for the economy if we were to reduce the national debt. Where did that idea come from? It comes from MMT, which teaches – quite wrongly -that fresh government debt every year is essential and that surpluses must be assiduously avoided.
Let’s recap. Those of you in the economics establishment who are working on programs to reduce healthcare costs and reform entitlements and to search out efficiencies in government and find ways to fund infrastructure projects with less federal money, and to work out a “grand bargain”, are in the same boat as us who would like to see a minuscule component of Lincoln’s Greenbacks re-introduced to ease the crisis. (Imagine that!) We are all just wasting our time if MMT persuades enough people there is no debt problem. But if nothing will be done with your ideas because of a trader’s - eye view of “how things really work” in the banking system … with no serious plan devised by MMT itself other than “just spend more” (as we have been told in as many words²) - where will that leave us … Liberals, Conservatives, Libertarians … all of us - when the clock runs out again? Will it leave us with the best plan we could compromise upon and work out? An outsider’s Influence on the system – that of MMT - must be demonstrated to come to more in real life than just sabotaging the work of others!
JUDGING MMT BY ITS CONTENTS
MMT advocate Warren Mosler has written a book titled The Seven Deadly Innocent Frauds of Economic Policy, borrowing words from the title of John Kenneth Galbraith’s last book. In keeping with this tradition, we hereby outline our case against MMT according to the following “Seven Deadly Innocent Frauds of Modern Monetary Theory”. As we see them, they are:
1. The fact that MMT’s theoretical money is nothing like real money
2. The fact that MMT’s theoretical debt is nothing like real debt
3. The fact that MMT’s depiction of the financial markets is nothing like the real financial markets
4. The fact that MMT’s ideas would drive “massive” inflation in two separate ways.
5. The fact that MMT’s Treasury and Federal Reserve are nothing like the real institutions
6. The fact that MMT would “crowd out” credit for the real economy’s needs
7. The fact that MMT is a highly radical and controversial theory, with no testing done or proposed.
A BRIEF OVERVIEW OF MODERN MONETARY THEORY (MMT)
Turning to a relatively objective source, what follows is a series of excerpts from the Wikipedia
article on MMT rev. June 30, 2014.
“MMT aims to describe and analyze modern economies in which the national currency is fiat money, established and created exclusively by the government. In MMT, money enters circulation through
government spending. Taxation and its legal tender power to discharge debt establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation that must
be met using the government’s currency. An ongoing tax obligation, in concert with private confidence and acceptance of the currency, maintains its value. Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government’s deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities per se.”
“In any given time period, the government’s budget can be either in deficit or in surplus. A deficit occurs when the government spends more than it taxes; and a surplus occurs when a government
taxes more than it spends. MMT states that as a matter of accounting, it follows that government budget deficits add net financial assets to the private sector. This is because a budget deficit means that a government has deposited more money into private bank accounts than it has removed in taxes. A budget surplus means the opposite: in total, the government had removed more money from private bank accounts via taxes than it has put back in spending.”
“Therefore, budget deficits by definition, are equivalent to adding net financial assets to the private sector, whereas budget surpluses remove financial assets from the private sector. This is represented by the identity:
(G-T) = (S-I) – NX
Where G is government spending, T is taxes, S is savings, I is investment and NX is net exports
It is important to note that this identity is not unique to Modern Monetary Theory, it is an identity used throughout all macroeconomic theory, because it is true by definition.
The conclusion that MMT necessarily draws from this is that private net saving is only possible if the government runs budget deficits; alternatively, the private sector is forced to dis-save when the government runs a budget surplus.”
“MMT therefore does not support the notion, as some Keynesians do, that budget surpluses are always necessary in periods of high effective demand. According to the framework outlined above, budget surpluses remove net savings: in a time of high effective demand, this may lead to a private sector reliance on credit to finance consumption patterns. Rather, MMT suggests that continual budget deficits are necessary for a growing economy that wants to avoid deflation. MMT only advocates budget surpluses when the economy has excessive aggregate demand, and is in danger of inflation.”
“Modern Monetary Theory provides a detailed descriptive account of the “operational realities” of interactions between the government and the central bank and the commercial banking sector….”
“A sovereign government will typically have a cash operating account with the central bank of the country. From this account, the government can spend and also receive taxes and other inflows. Similarly, all of the commercial banks will also have an account with the central bank. This permits the banks to manage their reserves (that is, the amount of available short-term money that a particular bank holds). So when the government spends, Treasury will debit its cash account at the central bank and deposit this money into private bank accounts (and hence into the commercial banking system). This money adds to the total reserves of the commercial bank sector. Taxation works
exactly in reverse: private banks are debited, and hence reserves in the commercial banking sector fall.”
“Virtually all central banks set an interest rate target level. According to MMT, the issuing of government bonds is best understood as an operation to offset government spending rather than a requirement to finance it.”
“MMT claims that the word ‘borrowing’ is a misnomer when it comes to a sovereign government’s fiscal operations, because what the government is doing is accepting back its IOU’s, and nobody can borrow back their own debt instruments. Sovereign government goes into debt by issuing its own liabilities that are financial wealth to the private sector.”
“This means that sovereign government is not financially constrained in its ability to spend, it can afford to buy anything that is for sale in currency that it issues. (There may be political constraints, like a debt ceiling law). The only constraint is that excessive spending by any sector of the economy (whether households, firms or public) has the potential to cause inflationary pressures. MMTers argue that inflation generally is caused by supply-side pressures, rather than demand side.”
CRITIQUES OF MODERN MONETARY THEORY
With that introduction for those not familiar with MMT (and with suggested readings in the form of primary source books written by MMT leaders at the end of this article), we are now prepared to inventory some critiques of Modern Monetary Theory organized according to our “Seven Innocent Deadly Frauds of Modern Monetary Theory” listed above.
Before we begin even that, however, let’s look at where some agreement exists. Shouldn’t that be our first priority?
MMT advocate Prof. Randall Wray has stated to us, in a recent exchange:
“In the developed nations we have thoroughly monetized the economies. Much (maybe most) of our economic activity requires money, and we need specialized institutions that can issue widely accepted monetary IOUs to enable that activity to get underway. While our governments are large, they are not big enough to provide all the monetary IOUs we need for the scale of economic activity we desire. And we - at least we Americans - are skeptical of putting all monetized economic activity in the hands of a much bigger government. I cannot see any possibility of running a modern, monetized, capitalist economy without private financial institutions that create the monetary IOUs needed to initiate economic activity.
The answer, it seems to me, to our current financial calamities does not reside in elimination of our for-profit financial institutions, even if I do see a positive role to be played by new public financial institutions (maybe some national development banks and some state development banks and a revived postal saving system?). We do, however, need fundamental reform—including downsizing (probably breaking up or closing) of the behemoths, greater oversight, more transparency, prosecution of financial fraud, and putting more of the ‘public’ in our ‘public-private partnership’ banking institutions.”
[Policy Winners]: After we pointed out that we have not advocated elimination of fractional reserve banking and the elimination of money creation by the banks, Wray revised his position as follows:
“I didn’t mean to group the Chicago Plan with greenbackers or state bankers – each is separate. Nor do I reject these policies – as possible additions to / carving out a small space in - the financial system. I think the calls for ‘debt free money’ are fundamentally confused, and in my experience the supporters of each of these proposals tend to be “one issue” promoters.”
According to past articles of Policy Winners we must really be “confused”, to borrow the term, because we have described (as many do) the Chicago Plan as being “Greenback-based”, but taken to the limit in proposing 100% of the money supply to be created by the issuance of Greenbacks rather than 5% of the money supply as we have proposed (leaving the rest to be done as it is now by the banking system). So the Chicago Plan is a subset of “greenbackers”, not separate from, the differentiation being one of degree. As further evidence of the confusion here at Policy Winners, we have supported what Wray refers to as the state banking movement and have referred to it as both the state banking movement and the public banking movement (Policy Winners, December, 2012 and June, 2013 ). Wray mentioned support for the idea of a national economic development bank, which we have advocated (Policy Winners, December, 2012 and April, 2013). In other words, Wray does not disagree with everything we have said and we do not disagree with everything he has said. In large part, where we disagree is in the matter of the extremes to which things should be taken. In times when common ground and compromise must be sought, perhaps some of the most important words in the English language - if you’ll forgive the Yogi Berra-ism – are: “modération en tout”.
Where Wray’s position comes closest to ours – and points of agreement should be the first thing sought – is in his statement, two paragraphs above, in which he says that he does not reject the idea of re-introducing Greenbacks, “as possible additions to / carving out a space within – the financial system.” However, we think that does not express the proper relationship in terms of which is the cart and which is the horse. In fact, the authority that would need to be given to the Treasury Department to actually make the ideas of Modern Monetary Theory work would be the very authority it had and would have again with the re-introductions of Greenbacks as under the Legal Tender Act of 1862. So that step has to be taken to make either idea work.
However, re-introducing Greenbacks (and let’s not get into the whole thing about whether we are talking about the paper notes or electronic representations of the same in transactions) means simply re-implementing something tried and proven. US Notes (Greenbacks) were issued from 1862 to 1971 and we all know there was no practical problem when they were in our wallets next to our Federal Reserve Notes. But by introducing them in 1862 as a way to help pay for the Civil War and Reconstruction without further increasing the national debt, a great deal of good was done by them.
Re-introducing Greenbacks would not require a re-design of our financial institutions and of the political principles upon which they were conceived, nor a re-planning of the way we handle debt and the monetization of new debt (since there simply wouldn’t be any new debt to monetize). So, wouldn’t it make more sense to put the horse before the cart and start with already-proven historic Greenbacks rather than the theory-that-nobody-quite-gets (or agrees with if they do get)?
We think, as it stands, MMT is proposing something that amounts to COUNTERFEIT GREENBACKS (both being alternatives of government-issued fiat money). Let’s use the real and proven thing first and then consider embellishments with any steps separately evaluated as real improvements. But let’s get this year’s $500+ billion deficit under control now and have at the ready an alternative to unnecessary austerities in the next budget coming up.
An expert was once asked how he trains people to detect the difference between real currency and counterfeits. He said the first thing he wants people to do is take a hard look at the real thing.
That will make it easier to detect the flaws in the counterfeits (by which we mean MMT fiat money). With that analogy in mind, we turn to the following experts’ critiques of MMT.
Innocent Fraud #1: MMT’s money is not like real money
Prof. Ronald Davis of San Jose State University has furnished the following comments:
“I would highlight the false definition of money that MMT uses – ‘money is debt’. Of course, when money is borrowed or loaned into existence by the banking system, then that definition is true. But when debt-free government money is spent into existence the way we want to do it (and the way it has been done on Guernsey/Jersey Islands, during the US Civil War, and in Canada between 1935 and 1975), then the definition is false. US Notes (Greenbacks) are not borrowed from a bank or anyone else, they are just printed up and issued into circulation to be circulated in the economy forever without anyone ever having to pay them back to anyone, or pay interest for the fact of their creation. This is a huge difference, and your ‘Professor X’ who would have us believe there is no difference is confused.
Money that is issued by the banking system on the basis of debt implies an increase in debt (either before or simultaneously). Money that is issued by the government without debt does not require an increase in the debt at any time. If government money had been issued into existence debt-free since 1914, we most certainly would not have a national debt of over $17 Trillion at the present time. The plot of Canadian national debt from 1935 to 1975 is virtually flat for the entire duration, no spike at all for World War II. This is not because Canada sat it out on the sidelines, certainly not. It is because Canada was creating its own debt-free money at the time, so it did not have to borrow money for the war effort, it just created it and spent it debt-free in the same way that Lincoln's Congress had done during the Civil War.
The main issues about debt-free government issued money are how to explain what it is based on, and how to limit its growth rate so as to prevent inflation. I answer both of these questions in the white paper presented at monetaryreform-taskforce.net. The condensed version of the explanation is that debt-free fiat money created and issued by the government is backed by the real output of the economy. It can and should be interpreted as a sort of "growth dividend" to reward producers in the economy for having made the real output (RNP) grow over the previous time period(s). To prevent inflation, use of the inflation tolerance inequality I derive in the white paper shows that the growth rate of the money supply must be kept less than the growth rate of the real output less the growth rate of monetary velocity plus the inflation tolerance (set at 2% by the Fed at the moment). In the special case when growth rate of monetary velocity is zero and inflation tolerance is also zero, this means that the monetary growth rate cannot exceed the growth rate of the real output of the economy. Put another way, when the monetary velocity is about constant, then the growth rate of the money supply should equal the growth rate of the real output of the economy in order to keep the CPI constant. This is the modern interpretation of the constitutional directive that Congress must coin (issue) money and "regulate the value thereof." Regulating the value of money means keeping the CPI constant. This inequality cited above is based on a universally accepted money exchange identity V=PQ observed by Irving Fisher, and requires only elementary calculus to derive the dynamic version I present in my paper. The point is that mathematical relationships are available to accurately predict the impact of any given monetary growth scenario on inflation, so that inflation constraints can be put on policy optimization studies. My legislative proposal requires that the new Monetary Control Authority make use of the most advanced and accurate mathematical models for guarding against inflation, and the presence of ex-officio membership given to the CBO, the OMB, and the FED insures that not one, but three different mathematical models will be used to insure that inflation does not exceed accepted inflation tolerance levels. Moreover, the presence of ex-officio membership given to the CBO (representing Congress), the CEA and OMB (representing the Executive Branch) and the FED insures that not one, but three or four different mathematical models will be used to ensure that monetary growth rates will be kept within bounds that insure inflation will not exceed accepted inflation tolerance levels. The probability that all three of the models will be wrong, and err in the same direction, is extremely remote. Under these conditions, inflation fear can be set aside permanently, it simply will not be allowed to happen.”
Taylor Conant of the Ludwig von Mises Institute, in the Economic Policy Journal, has written a series of seven articles on MMT in the Economic Policy Journal. The excerpts quoted below are found in the first article, titled A Refutation of Mosler Economics and Mosler’s 7DIF (reference to Warren Mosler’s book, The Seven Deadly Innocent Frauds of Economic Policy) is found at his link:
http://conant.economicpolicyjournal.com/2010/10/refutation-of-mosler-economics-and.html
Conant’s Introduction: Warren Mosler's 7DIF begins with the first of the "Seven Deadly Innocent Frauds": Deadly Innocent Fraud #1 [as described by Mosler] “The federal government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow.” Fact [as described by Mosler]: “Federal government spending is in no case operationally constrained by revenues, meaning that there is no ‘solvency risk.’ In other words, the federal government can always make any and all payments in its own currency, no matter how large the deficit is, or how few taxes it collects.”
Conant’s text: “From these ‘facts’ (Mosler's face-value observation of what physically occurs when the government finances one of its own expenditures) Mosler proceeds to spin a web of confusion. He starts by pointing out that all government financing today takes place on a series of digital spreadsheets maintained by commercial banks and government agencies. When taxes are paid, a taxpayer's spreadsheet balance is lowered and a government spreadsheet balance is raised. Similarly, when the government spends, one of the government's spreadsheet balances is lowered and the spreadsheet balance of the recipient of that transfer (a contractor, welfare recipient, bribed foreign dignitary, etc.) is raised.
Based on this observed mechanic, Mosler assumes that government finance is similar in arbitrariness to score keeping in a bowling alley or on a football field: [Quoting Mosler]: ‘Your team kicks a field goal and on the scoreboard, the score changes from, say, 7 points to 10 points. Does anyone wonder where the stadium got those three points? Of course not! Or you knock down 5 pins at the bowling alley and your score goes from 10 to 15. Do you worry about where the bowling alley got those points? Do you think all bowling alleys and football stadiums should have a ‘reserve of points’ in a “lock box” to make sure you can get the points you have scored? Of course not!’ [Conant]: This is the first of many of Mosler's confusions about the cosmetic appearance of reality and the actual state of reality underneath it. The analogy he draws is flawed. In a game of sport, the point system is a mathematical abstraction used to keep track of rank amongst the players within the context of the game. Though it is awkward to even contemplate such a possibility, participants in a game such as football or bowling could conceivably recognize that one or another participant or team is "ahead" or "behind" without giving out and assigning numerical scores to each. Similarly, aside from whatever time limits might be imposed on the players according to the rules of the game, the potential score that can be achieved by anyone is infinite -- there is no reserve of points that can be used up, nor is there a need for there to be one. The score does not represent scarcity or ownership over any resource, it merely records relative progress and rank.
This is entirely different from the purpose and operations of a monetary system, even one which is entirely fiat and mostly exists in virtual reality amongst a matrix of spreadsheets, as most modern monetary systems exist in their present form. In a monetary system, the money itself represents potential claims to real, existent goods and services. All else being equal (i.e., the money supply is not increasing or decreasing), the amount of money each person has does not represent how they are ranked against other money holders but rather how much actual purchasing power they might lay claim to.
If I have $20 and you have $10, I am not ‘winning.’ Money balances are not a score keeping system. They're simply a means of storing real value and they provide a means for facilitating exchange between real goods and services. The abject failure of Mosler's analogy should be obvious when you consider the following:
The government does not produce any real wealth for itself; all wealth the government controls must first be produced by private individuals and then taxed into the control of the government. When the government creates new money, it does not create new wealth. That is to say, if the government desires to purchase a $20,000 pick-up truck for a government agency, it must tax $20,000 worth of value from the public, at which point it can exchange that value for an actual pick-up truck. If the government decides to finance this expenditure through the issuance of $20,000 of new money (digital or paper currency), the creation of the new money does not itself summon a new pickup truck into existence. The government still must spend that new money on the truck, and the reason the new money has the value of $20,000 is because it siphoned a fraction of that total value from the previously existing stock of money. Because this transfer of wealth was involuntary and carried out by the government in the name of the public interest, it qualifies as a tax.
Mosler misses this because he never stops to examine where the wealth that the government comes to control by creating new money actually came from in the first place.”
Conant’s articles continue with a number of other points, and they are well worth reading. We stop here, however, as Mosler’s description of money as cited above provides a close look at the counterfeit fiat money of Modern Monetary Theory – money that has no real basis of value within the banking system in which it is to be created. That is the basis for the concerns raised by others (as we shall see) that it represents the ultimately unsustainable plan for the Fed to monetize more and more debt without provision for relief of the debt burden caused by MMT’s counterfeit version of fiat money. But don’t take our word on the monetization sustainability issue during likely future scenarios in the economy or on the potential for disastrous inflation; we will cite a number of true experts on those issues. Right now, we are focused on the issue of counterfeit fiat money based on abuse of the banking system versus legitimate fiat money with an entirely different basis for occasional and much more limited use – and with the provision of a relief valve for government debt instead of continuing to build up the pressure within the banking system until the boiler bursts. (Again).
The Modern Monetary Theory approach superimposes command economy logic (like the official in the booth directing numbers to appear on Mosler’s scoreboard) over the market-based economy of the financial markets. What results is not a superior hybrid but a free market system with a crippling impediment. It’s an attempt to use, indefinitely and without limitation, such an imposition as zero-interest Treasury bonds (more on this later) that the workings of a free market would reject as market conditions governing interest rates and investment options change.
As a money form, there is nothing inherently superior about money created out of thin air by private banks as member banks of the Federal Reserve System vis a vis legitimate “fiat”, “sovereign” or “constitutional” money. Our current fractional reserve lending system fails us sometimes, as when the banks stop lending and the money supply consequently dwindles, causing recessions. Yet, our current system serves us well enough most of the time that we have no desire to do away with it. It is during those periods when the system fails us that a truly free market would provide alternatives, like public banks operating on the basis of the normal money management needs of states and localities and like a national economic development bank drawing upon a reservoir of legitimate fiat money and upon income from public investments in the real economy. So we would like to see an increase in free market characteristics of the financial system, not a diminishment of them, MMT-style.
It’s not that government can’t create money – we propose it doing exactly that, to the tune of about 5% of our money supply, using its own freedom to create resources for its own use according to the Constitution without paying extraneous “tribute” to banks that we don’t need for this purpose. But we realize that the government can’t create money indefinitely by commanding it into being within the banking system as an over-ride to the free market dynamics of the banking system. The government can create some money, Greenback-style, if we are not locked into dependency on false MMT fiat money indefinitely on account of outstanding bonds we can only roll over and over, and when it is not locked into superstitions requiring continuous increases in the debt and avoidance of surpluses lest we fall, as MMT claims we would, into ruination (more on this later).
If we avoid so chaining ourselves to constant increases in debt there is no way to pay off, then at the right times and in the right amounts, the government can create some money as appropriate to carefully evaluated economic conditions, conditions observed in the marketplace, just like any other player can make informed and voluntary decisions based on market dynamics. Our goal should be to neither shackle the government to the banking system to the detriment of both (under MMT), nor to completely shackle the government to the banking system to the public’s detriment (under our present system, where the government voluntarily pays to borrow what it can simply print for itself).
Yet, our present system works, with the flaw of at least much of the national debt; MMT’s system wouldn’t work at all.
That having been said, let’s confirm the MMT counterfeit by a closer look at the real Greenback thing, legitimate fiat money, based on the opportunities market conditions provide rather than command-mentality coercion and abuse of the banking system. Government-issued fiat money having nothing to do with banking systems was the foundation for many of the great civilizations of history. Twice - during the American Revolution and the Civil War, such legitimate fiat money made it possible for there to be a United States of America (referring to the Continentals and to Lincoln’s Greenbacks). But to be as clear as possible about the nature of such money, we draw on an analogy as used in the 11/2013 Policy Winners. It involves a couple on a farm, representing government. Pa harvests the fields (collects taxes); Ma, a good Libertarian, keeps the operation in the black during the lean years by producing and selling in the market something of value: her apple pies (or, Greenbacks).
Actually, here is an example of the government creating wealth but keeping things simple by offering it directly on the market - prospective government vendors, etc. - “déjà vu (Lincoln era) all over again”.
Ma’s apple pies abuse no one’s investment decisions or financial holdings. No one is force-fed or starved because of them. They are a rare treat to be voluntarily sought and earned according to real decisions regarding real income. When the government needs things, it can pay for some of them using Ma’s apple pies. They represent United States Notes, or the real, historic Greenbacks - legal tender for all debts public and private … U.S. Dollars worth exactly the same as Federal Reserve Notes of the same dollar denomination … the same kind as your editor, when he was a lad, earned by the sweating over a lawnmower to pay for his first year of college. There was no great dislocation in the economy observed because of them then. There was simply a matter of curiosity why some seemingly-identical bills had green Treasury seals and some had red ones. If someone has one with a red seal in good condition now (a Greenback), let us know as we would love to acquire and fame it – because that is all we are talking about as a way to save our country from some of the agonies of debt and austerity we otherwise will face. That was real money then, and it will be real money again if we re-introduce it. As Lincoln used greenbacks, they were spent by the government without cost to the government or anyone else, with no complicated theories, to give us a United States of America today.
Brett Fiebiger, Economics Professor at the University of Ottawa, has written in criticism of MMT’s ideas concerning the creation of money in the journal of the Political Economy Research Institute.
His rejoinder to “Modern Monetary Theory: A Response to the Critics” is quoted below.
Fiebiger finds fault with the MMT claim that the creation of money under our current system is initiated by “the government” as if through an imaginary consolidation of the Treasury and the Federal Reserve. With that introduction, we now follow the text of Fiebiger’s comments on Page 27 of the article cited, in which he begins by citing immediately preceding text by MMT advocates Scott Fullwiler, Stephanie Kelton and Randall Wray as “FKW”:
“FKW segment their discussion of fiscal and monetary operations into a ‘general’ case and a ‘specific’ case equating to existing institutional arrangements in the United States. The ‘general case’ asks us to accept the following: (1) a consolidation of Treasury and Central Bank operations into a single entity; (2) that various legal constraints imposed on the Treasury’s operations do not exist. As consolidation effectively transforms the Treasury into a bank (by ignoring that its spending and fiscal-raising activities involve respective debts and credits to its account at the central bank), the analyst can make claims that could not otherwise be made. But the merits of doing so are dubious with relevance the obvious objection. As soon as the analyst starts to discuss the world that exists and separates the activities of the ‘government’, the Treasury becomes a non-bank agent; with its capacity to create/issue money either directly or indirectly depending on the exact institutional context. FKW’s ‘general case’ offers a ‘pre-central banking’ framework that is ill-suited to providing insights on the modern monetary system.
Conflating the central bank and the Treasury into an ambiguous ‘authorities’ which issue HPM [high-powered money] when they spend is inappropriate when the analyst is seeking to illuminate: (1) the
process of money creation; and (2) the roles of fiscal and monetary policy. The ‘authorities’ are dissimilar agents. Whereas the central bank finances all its activities by issuing money, and does not
raise revenues by taxation or debt issuance, the Treasury basically does the opposite (with a side note needed for bank holdings of T-bills). Those familiar with MMT will know that its adherents emphasize that ‘state money’ must be injected before the state can receive payments. It is one thing to say that the central bank’s money must exist before the Treasury can receive payments and another to
conclude, as Modern Monetary Theorists (MMTers) do, that Treasury spending can be thought of as already ‘pre-financed’ with the proceeds of taxation and bond sales unable to be spent. The MMT argument for consolidation falsely supposes that the mere existence of the central bank’s money somehow equals a pre-financing of Treasury expenditures. It is highly misleading to depict Treasury spending as involving money issuance when in reality it is a user of monies issued by banks: the collection of fiscal receipts does not return any funds that the Treasury has created but provides the wherewithal for it to spend. The consolidated approach must be rejected because it leads to erroneous claims that government spending ‘does not require previous tax revenues’ and that ‘the issuance of bonds … is not for financing purposes’.”
Fiebiger’s critique puts in perspective Randall Wray’s previously-cited words (page 7 of this newsletter, first paragraph) stating that Treasury-issued Greenbacks might constitute a “possible addition to / carving out a small space in – the financial system.” The first step toward effectuating MMT’s plan, as we have seen, would have to be to resolve the Treasury’s authority to create money by essentially re-instituting the Legal Tender Act of 1862 pursuant to which the Greenbacks were issued. If MMT wants to help us Greenback revivalists accomplish that common goal, wonderful. But if the Treasury could then issue money debt-free, why not stop while you’re ahead instead of messing around with the whole financial system and creating unnecessary government debt? If MMT wants to do that, they need to come up with a separate justification for it. If they want to update the mechanics to make better use of computer technology, that can be done without creating unnecessary debt.
Joseph Huber, Economics Professor at Martin Luther University in Halle, Germany, has written an article on Modern Monetary Theory with
an especially rich bibliography in the Real World Economics Review, issue #66, 13 Jan. 2014, pp. 38-57.
Huber begins by pointing out the obvious, per the question raised immediately above: He states, on pp. 51-52:
“There is no reason why modern money should not be spent into circulation debt-free by a monetary authority rather than being loaned into circulation as debt money.” He likens debt free government-issued money (i.e., Greenbacks) to pure water, not contingent on banking and finance, and makes clear his critique of MMT’s theoretical money is based on it being, essentially, polluted water, to follow the above analogy.
Huber points out: “If bank accounts are credited, the amount credited is money. This money can, but need not, come from a loan; it can equally be the proceeds of sales, earned or financial income, a
subsidy or welfare payment, or a private gift or donation. In this sense, ‘crediting’ is just another word for adding non-cash money to an account. Accordingly, modern money is surely ‘credited’ to an account, but the kind of underlying transaction – loan, purchase, gift – is of course not at all predetermined by the write process of crediting.
MMT… suggests a re-interpretation of public-private sector balances. The emphasis is on pointing out that for net government debt in the public sector there are corresponding net fortunes in the private sector, which is to say that within the oversimplified framework of this two-sector model, private financial fortunes necessitate public debt – in any case both sides netting out to zero, as if this were to say, “you see, things are netting out, no problem here.”
But problems there are. Interest payments on ever bigger public debt are a drain on tax revenues and curtail a government’s scope of action. Thus either additional debt will have to be incurred, or ever more public functions will be chronically under-funded.
MMT, however, tells us not to bother about the level of public debt and soundness of public finances. The government is not really supposed to pay down its allegedly just “formal” debt. It hardly makes sense for sound finances to enter claims in the bank’s balance sheets and take liabilities on the government’s books, while declaring the corresponding items not really to be claims or debts. To [MMT advocate Warren] Mosler, financial restraints in a fiat money system are imaginary.” (A footnote goes to Mosler, Warren, 1995: Soft Currency Economics, p.147).
Huber continues:
“Wray contends that ‘for a sovereign nation, affordability is not an issue; it spends by crediting bank accounts with its own IOU’s, something it can never run out of’.” (The footnote goes to Wray, Randall, 2012, p.194 – Credit on State Theories of Money – The Contributions of A. Mitchell-Innes, (Cheltenham: Edward Elgar Publishing).
Huber continues further:
“This is not totally unfounded, but over-shooting the mark by far. Any treasurer of a sovereign state with a currency of its own and rotten finances can tell. Printing money cannot compensate for real-economic deficiencies but compounds these through inflation, financial asset inflation and a declining rate of exchange rate of the currency.”
Cullen O. Roche, an investment Manager, has written
a paper titled “A Critique of Modern Monetary Theory” in the Pragcap newsletter.
Roche writes that MMT’s foundation is “fundamentally flawed and inapplicable to the modern monetary system” and that it puts forth “a highly misleading and counter-productive way to present the monetary system.” He provides a chart of “eight fundamental respects in which in which the MMT monetary system contrasts with the actual monetary system”, found within the article at the above link. Since that chart is keyed to the text of the article, we do not provide a further summary of it here.
An interesting thing to note is that the nature of Mr. Roche’s experience in finance bears similarities to MMT advocate Warren Mosler. So it is difficult to argue that MMT clearly represents a breakthrough due to the introduction of a new discipline given the disagreement of individuals with a history of significant responsibilities within the same discipline. We have also seen disagreement among academically qualified economists, notably Prof. Wray and professors of economics cited in this paper.
These disagreements have not been only over details, but over fundamentals. From the standpoint of assessing the probability of imminent adoption by Congress of legislation to implement Modern
Monetary Theory ideas, and assessing whether that adoption will be so imminent as to govern our next budget negotiations, we must realize that we are, in fact, dealing with an untested and highly
controversial theory that would require sweeping changes to the Treasury and the Federal Reserve System involving political principles governing those institutions and involving basic conceptions of the nature of money, the value of money, the expected behavior of the financial system, and those precedents and precepts upon which we will act concerning the handling of our debt and inflationary expectations. Can we be confident enough in the overnight adoption of a radical and controversial theory upon which little in the way of concrete policy recommendations have been put forth that we should “drop everything” we have been working on toward a compromise debt and fiscal policy plan?
Innocent Fraud #2: MMT’s Debt is Not Like Real Debt (Also Involving #3, Markets, and #4, Inflation, As Explained Below)
This subject necessarily involves interplay between the subjects of conceptions of debt, responses of the financial markets to debt issuances, attitudes toward deficit spending, attitudes toward surpluses, and inflation. While we will attempt to treat these subjects individually, certain of the sources address the interplays and the thread of discussion must as well.
Dylan Matthews, Economics writer for the Washington Post, has written
an article in the 2/18/12 paper titled: “Modern Monetary Theory is an Unconventional Take on Economic Strategy”.
Matthew’s article touches on several topics related to the general subject of debt in Modern Monetary Theory, and is the source of several of the citations below. The several topics are the nature of government debt, undesirability or desirability of new debt in all cycles of the economy, according to MMT theory, and the desirability or undesirability of surpluses, according to MMT theory. Excepting the thought of budgeting slightly in advance for the services and investments of government needed for a growing economy, which may imply to many the need for frequent use of some deficits with recoupment of them in mind, a robust belief in the desirability of new debt during all economic cycles and in the premise that surpluses are undesirable even in the stronger periods of economic performance is likely to lead, of course, to long-term growth in debt – the very conflict of purposes with those concerned with debt that comprises part of what we now refer to as “gridlock”.
We shall not neglect to point out (of course) that as a legitimate fiat money, Greenbacks would allow for some deficit spending consistent with Keynesian stimulus in a downturn and/or allow for pre-planning for the needs of a growing economy, without creating debt and without creating inflation except in the rare circumstance where all of Prof. Davis’ experts and models would yield wrong results and the economy faces significant demand-driven inflation (the last example of which, according to economist James E. Galbraith in the above article, was in World War I) - and, additionally, where neither the Fed’s money-tightening nor a tax increase would be effective in cooling down such inflation in the economy. (Are we sufficiently belt-and-suspenders, now, on the inflation issue?)
But if one has a real craving for debt, as we will find of MMT on the following page, then debt can be had, even during times when natural market conditions would lead to surpluses - just as an attentive Italian wait-staff can accommodate a patron’s irresistible desire for an anchovy atop his gelato.
Before anyone says no real economist would fight for debt and against surpluses on all occasions, we turn to an account from the Dylan Matthews article cited above concerning the illustrious James Galbraith, who somehow, and to the surprise of many, found himself in concert with the MMT gang.
We read as follows:
“About 11 years ago, James K. ‘Jamie’ Galbraith recalls, hundreds of his fellow economists laughed at him. To his face. In the White House.
It was April 2000, and Galbraith had been invited by President Bill Clinton to speak on a panel about the budget surplus. Galbraith was a logical choice. A public policy professor at the University of Texas and former head economist for the Joint Economic Committee, he wrote frequently for the press and testified before Congress.
What’s more, his father, John Kenneth Galbraith, was the most famous economist of his generation: a Harvard professor, best-selling author and confidante of the Kennedy family. Jamie has embraced a role as protector and promoter of the elder’s legacy.
But if Galbraith stood out on the panel, it was because of his offbeat message. Most viewed the budget surplus as opportune: a chance to pay down the national debt, cut taxes, shore up entitlements or pursue new spending programs.
He viewed it as a danger: If the government is running a surplus, money is accruing in government coffers rather than in the hands of ordinary people and companies, where it might be spent and help the economy.
“I said economists used to understand that the running of a surplus was fiscal (economic) drag,” he said, “and with 250 economists, they giggled.”
Galbraith says the 2001 recession — which followed a few years of surpluses — proves he was right.
A decade later, as the soaring federal budget deficit has sharpened political and economic differences in Washington, Galbraith is mostly concerned about the dangers of keeping it too small. He’s a key figure in a core debate among economists about whether deficits are important and in what way. The issue has divided the nation’s best-known economists and inspired pockets of passion in academic circles. Any embrace by policymakers of one view or the other could affect everything from employment to the price of goods to the tax code.
In contrast to “deficit hawks” who want spending cuts and revenue increases now in order to temper the deficit, and “deficit doves” who want to hold off on austerity measures until the economy has recovered, Galbraith is a deficit owl. Owls certainly don’t think we need to balance the budget soon. Indeed, they don’t concede we need to balance it at all. Owls see government spending that leads to deficits as integral to economic growth, even in good times.
The term isn’t Galbraith’s. It was coined by Stephanie Kelton, a professor at the University of Missouri at Kansas City, who with Galbraith is part of a small group of economists who have concluded that everyone — members of Congress, think tank denizens, the entire mainstream of the economics profession — has misunderstood how the government interacts with the economy. If their theory — dubbed “Modern Monetary Theory” or MMT — is right, then everything we thought we knew about the budget, taxes and the Federal Reserve is wrong.
This claim, that money is a “creature of the state,” is central to the theory. In a “fiat money” system like the one in place in the United States, all money is ultimately created by the government, which prints it and puts it into circulation. Consequently, the thinking goes, the government can never run out of money. It can always make more.
This doesn’t mean that taxes are unnecessary. Taxes, in fact, are key to making the whole system work. The need to pay taxes compels people to use the currency printed by the government. Taxes are also sometimes necessary to prevent the economy from overheating. If consumer demand outpaces the supply of available goods, prices will jump, resulting in inflation (where prices rise even as buying power falls). In this case, taxes can tamp down spending and keep prices low.
But if the theory is correct, there is no reason the amount of money the government takes in needs to match up with the amount it spends. Indeed, its followers call for massive tax cuts and deficit spending during recessions.”
Further on, the article continues:
“When the government deficit spends, it issues bonds to be bought on the open market. If its debt load grows too large, mainstream economists say, bond purchasers will demand higher interest rates, and the government will have to pay more in interest payments, which in turn adds to the debt load.
To get out of this cycle, the Fed — which manages the nation’s money supply and credit and sits at the center of its financial system — could buy the bonds at lower rates, bypassing the private market.
The Fed is prohibited from buying bonds directly from the Treasury — a legal rather than economic constraint. But the Fed would buy the bonds with money it prints, which means the money supply
would increase. With it, inflation would rise, and so would the prospects of hyperinflation.”
The article continues, further:
“The risk of inflation keeps most mainstream economists and policymakers on the same page about deficits: In the medium term — all else being equal — it’s critical to keep them small.
Economists in the Modern Monetary camp concede that deficits can sometimes lead to inflation. But they argue that this can only happen when the economy is at full employment — when all who are able and willing to work are employed and no resources (labor, capital, etc.) are idle. No modern example of this problem comes to mind, Galbraith says.
“The last time we had what could be plausibly called a demand-driven, serious inflation problem was probably World War I,” Galbraith says. “It’s been a long time since this hypothetical possibility has actually been observed, and it was observed only under conditions that will never be repeated.”
On the subject of surpluses, the Dylan Matthews article continues: Mainstreamers are equally baffled by another claim of the theory: that budget surpluses in and of themselves are bad for the economy.
According to MMT, when the government runs a surplus, it is a net saver, which means that the private sector is a net debtor. The government is in effect “taking money from private pockets and forcing them to make that up by going deeper into debt”, Galbraith says, restating his White House comments.
Matthews quotes Joseph Gagnon of the Peterson Institute, who managed the Fed’s first round of quantitative easing in 2008. “I have two words to answer that: Australia and Canada. If Jamie
Galbraith would look them up, he would see immediate proof he’s wrong. Australia has a long-running surplus now, they actually have no debt whatsoever. They’re the fastest-growing, healthiest economy in the world. Canada, similarly, has run consistent economic surpluses while achieving high growth.”
A very important detail: It should be noticed, in MMT’s appeal to equations which we think are dubiously interpreted (as will be seen), that what they are calling for is not simply enough deficit spending to anticipate the needs of a growing economy, with the expectation of “catching up” with revenues as the economy grows. That could be accomplished very easily with the use of legitimate Greenback fiat money without incurring any debt at all (when the economy is not at full capacity and there is “room” for a small amount of government-created money used directly by the government for approved budgetary purposes). Let it be very clear that MMT’s theory requires not a relatively small amount of spending above what tax revenues bring in. MMT’s theory and what its proponents call for, specifically, is debt as their assumed way by which it is necessary for the government to make the economy work; debt sought with such diligence that there will never be a chance of a surplus.
Our comments on the issues identified in the Matthews Post article begin with the discussion described in the middle of our page 16, where the White House panel members were debating whether the surplus should be used to: (1) cut down on the national debt; (2) cut taxes; (3) shore up entitlements or (4) pursue new “spending” programs. By a straight-line extrapolation of a graph of the reduction in the national debt during Clinton’s second term, it appears that if we had kept going with the same policies (not even accelerating the reduction, as the surplus would have made possible), the national debt would have been eliminated by the year 2011 barring exceptional events (which, unfortunately, there were). Some of us would call “staying the course” on that tack to the greatest extent possible “conservative” in the fiscal sense. Others, with a different definition of the word “conservative”, preferred the second alternative voiced in the discussion - that of cutting taxes, as was done so enthusiastically by the succeeding administration that many believe it had a lot to do with the disappearance of the surpluses.
By “shoring up entitlements”, another alternative mentioned, perhaps the idea was to put back some of the money the government had been borrowing from the Social Security Trust Fund, and putting it into real investments in the real economy – perhaps a “liberal” idea to some, as it was backed by the “liberal” Al Gore, but what we would call a conservative idea fiscally. The last alternative mentioned was “spending programs”… we are left to wonder why is it we so rarely hear of “investing programs” where there really is an expectation of a real, near-term, dollar and cent return for the public benefit.
Let’s compare these alternatives to what Galbraith proposed: Taking some step (presumably reducing taxes) to deliberately reduce the surplus so that “more money would wind up in the hands of ordinary people, where it might be spent and help the economy.” Clinton did sign a tax cut, along with spending cuts, with still a net resulting surplus – anathema to MMT, which says (see the above article) decreases in spending and increases in surpluses are both bad for the economy, in either good times or bad. Clinton’s successor initiated multiple tax cuts, along with increased spending (not all voluntary), netting out in a loss of the surpluses. Deficit spending and avoidance of surpluses are things MMT says are good. Yet, which policy – that or its opposite - has actually had, in those two administrations and all others since 1945, the better outcome in terms of promoting strong economies and avoiding severe recessions?
If we look at all the past administrations since 1945 when we have had significant surpluses (the Truman, Clinton and Eisenhower administrations, in that order of surplus size relative to real GDP), we see that we have had a better economy during and after those periods with the largest surpluses than in those periods when we have had the largest increases in the national debt (notably Reagan and Bush #43).³ Let’s look more closely at the “2001 recession” to which Galbraith referred to see if it actually does provide an indication that surpluses cause recessions, or if that example was just grasped at to refute the MMT pundits.
We will again draw upon a brief narrative in the form of a series of excerpts from a “fairly objective” and quickly-read source, namely the Wikipedia article that pops up when the subject “recession of 2001” in entered into our Google search bar.
That article is titled, “Early 2000’s Recession”.
“The early 2000’s recession was a decline in economic activity which mainly occurred in developed countries. The recession affected European countries during 2000 and 2001 and the United States in 2002 and 2003.
The recession was predicted by economists, because the boom of the 1990’s (accompanied by both low inflation and low unemployment) had already ceased in East Asia during the 1997 Asian financial crisis. The recession wasn’t as significant as either of the two previous worldwide recessions. Some economists in the United States object to characterizing it as a recession since there were no two consecutive quarters of negative growth.
As the Dot Com bubble occurred in the mid and late 1990’s, assorted predictions that eventually the bubble would burst emerged frequently. Because of the October, 1997 mini-crash in the wake of the Asian Crisis, the predictions about a future burst increased, causing an uncertain climate during the first months of 1998, while the Federal Reserve raised interest rates six times between June 1999 and May 2000 in an effort to cool the economy to a soft landing. The actual burst of the stock market bubble occurred in the form of the NASDAQ crash in March 2000. Growth in gross domestic product
slowed considerably in the third quarter of 2000 to the lowest rate since a contraction in the first quarter of 1991. [ed. note: Would it, then, have been better to skip the Gingrich and Clinton tax cut for wealthy and, obviously, contrary to MMT theory, cash-flush investors, creating more of a surplus, further reducing the debt, and keeping credit costs lower for business going into 2001? We think so.]
The NBER’s Business Cycle Dating Committee has determined that a peak in business activity occurred in the US economy in March, 2001. A peak marks the end of an expansion and the beginning of a recession. The determination of a peak date in March is thus a determination that expansion that began in 1991 ended in 2001 and a recession began. The expansion lasted almost 10 years, the longest in NBER’s chronology. According to the National Bureau of Economic Research, which is the private, nonprofit, nonpartisan organization charged with determining economic recessions, the US economy was in recession from March 2001 to November 2001, a period of eight months at the beginning of President George W. Bush’s term of office. However, economic conditions did not satisfy the common shorthand definition of a recession, which is a ‘fall of a country’s real gross domestic product in two or more successive quarters’, and has led to some confusion about the procedure for determining the starting and ending dates of a recession.
From 2000 to 2001, the Federal Reserve, in a move to quell the stock market, made successive interest rate increases, credited in part for ‘plunging the country into a recession’. Using the stock market as an official benchmark, a recession would have begun in March 2000 when the NAASDAQ crashed following the collapse of the Dot Com bubble. The Dow Jones Industrial Average was relatively unscathed by the NASDAQ’s crash until the September, 2001 attack, after which the DJIA suffered its worst one-day point loss and biggest one-week losses in history up to that point. The market rebounded, only to crash once more in the final two quarters of 2002. In the first three quarters of 2002, the market finally rebounded permanently, agreeing with the unemployment statistics that a recession defined in this way would have lasted from 2001 through 2002.”
“Canada’s economy is closely linked to that of the United States, and common conditions south of the border tend to quickly make their way north. However, in the wider economy, Canada was surprisingly unhurt by these [Dot Com, 9-11] events. While growth slowed, the economy never actually entered a recession. This was the first time that Canada had avoided following the United States into an economic downturn. The rate of job creation in Canada continued at the rapid pace of the 1990’s. A number of explanations have been advanced to explain this. Canada was not directly affected by 9-11 and the subsequent wars, and the downward pressure of these events was more muted. Canada’s fiscal management during the period has been praised as the government continued to bring in large surpluses during this period, in sharp contrast to the United States. (Boldface added). Unlike the United States, no major tax cuts or new expenditures were introduced. However, during this time, Canada did pursue an expansionary monetary policy in an effort to reduce the effects of a possible recession.”
The Wikipedia article on this subject concludes with mention of problems in Russia, in Japan and the European Union that negatively affected the US (and Canadian) economies in the early 2000’s.
So, with all these factors bearing on the US economy surplus period during the late nineties and the fluctuations of the early 2000’s affecting the US and Canada, does any evidence stand out indicating that surpluses were a significant cause of a significant recession in the US, or that they harmed Canada? Couple that with what we saw in the cases of the Truman and Eisenhower administrations. We should consider the “case” against surpluses carefully, before deciding to do everything in our power to avoid surpluses, because our debt will only ratchet up without relief if from today ever after if we decide to take MMT’s recommendation and avoid surpluses. We should consider every bit as carefully the claims that continual increases in debt, year in and year out in every phase of the economy, will benefit us more than minimizing or eliminating our debt, like Australia and Canada.
MMT, Debt and Taxes
We return, at this point, to our comments upon the debate at the White House concerning what to do about the Clinton-years surplus and other matters involving Modern Monetary Theory as found in the text of the Dylan Matthews article, returning to the third paragraph found on our page 17 (concerning tax policy). As we have challenged the MMT ideas that consistent use of debt and avoidance of surpluses should be our “default mode” in dealing with those items, we challenge here the idea that raising taxes across the board should be our default response to avoid inflation if the economy is doing well. (What we questioned in our bracketed insertion on our page 19 was a tax cut that may have stoked a speculative stock bubble). Fostering increases of supply of key scarcity-prone items (a topic covered in other Policy Winners newsletters), adjusting discretionary government deficit spending and using monetary policy tools are alternatives to raising taxes precipitously enough to check inflation. Tax policy needs a modicum of consistency, so that people can plan according to it. We also disagree that taxes are necessary to compel people to use the currency “printed” by the government, because both rich and poor people who don’t owe any taxes still will work for and spend money.
MMT, Debt and Bond Finance
Further down in the above-cited Dylan Mathews article, on our page 17, the writer notes: “When the government deficit spends, it issues bonds to be bought on the open market. If its debt load grows too large, mainstream economists say, bond purchasers will demand higher interest rates, and the government will have to pay more in interest payments, which in turn adds to the debt load. To get
out of this cycle, the Fed could buy the bonds at lower rates, bypassing the private market. The Fed is prohibited from buying bonds directly from the Treasury – a legal rather than economic constraint. But the Fed would buy the bonds with money it prints which means the money supply would increase. With it inflation would rise, and so would the prospects of hyperinflation.”
The points above each have significant ramifications. MMT’s Warren Mosler has proposed that the Fed buy only 3-year, zero-interest bonds, citing examples of the acceptance of zero interest for the sake of having a safe place to temporarily store money⁴. In this way, he says, the cost of going through the banking system to fund federal deficits is zero, the same as for issuing Greenbacks. (Of course, that concerns interest, not principal). Asked by Policy Winners what would make it better to do it his way than for the government to issue Greenbacks, Mosler did not provide a response. But the reference points he is drawing on stem from extraordinary times in the wake of the Great Repression and not from the norms of history, which has seen a significant amount of variation in effective interest rates required by the market - not just zero.
If the Fed were to “bypass the private market” and buy all Treasury bonds issued, it would create several issues sooner or later:
The first issue is that a change in the law would be required and, with it, addressing the political balance of rights expressed in the law. The current rule that the Fed cannot buy bonds from the Treasury directly is akin to the prohibition, in the Legal Tender Act of 1862, against the government using printed money to directly pay off debt. The principle is that the holders of government bonds are entitled to payment at the face amount representing an anticipated interest rate in reasonably uninflated dollars. By printing up a lot of money to pay off existing debts, the government could simply pay back in cheap dollars what the bond purchasers paid for in higher-value dollars. In the same way, if the Treasury issued only zero-interest bonds and the Fed bought them all up, then the government would, in effect, be “bidding down” the worth of bonds. There would surely be resistance, and with good reason, to such a change in the law, if it were ever proposed.
The second issue, if the Fed buys all the bonds the Treasury wants to sell, is that it will need to buy a lot of bonds. It only buys something like 10% of them now. Where would the additional money come from? As Dylan Matthews has pointed out (above) “the Fed would buy the bonds with money it prints, which means the money supply would increase. With it inflation would rise, and so would the prospects of hyper-inflation.” In our outline titled “The Seven Deadly Innocent Frauds of Modern Monetary Theory”, we mentioned that MMT would have a tendency to cause inflation for two reasons. Those two have now been cited: first, the stated preference for engaging in deficit spending in all cycles in the economy and, second, the need to print money to buy bonds to pay for the deficit spending.(More, from other experts, later.)
By contrast, In our proposal to re-Introduce Greenbacks, we have no preference for deficit spending in season and out on account of MMT’s theory that deficit spending enriches the public (or at least the wealthiest). Spending funded by Greenbacks would not require printing money to buy bonds. This is a night-and-day difference in the prospects for both debt and inflation.
At risk of seeming too didactic, the thing that gives Greenbacks value is not printing too many of them to be absorbed for the non-inflationary needs of the economy. The government would have an inherent motivation to preserve that value, just as any organization would have in not destroying any other type of asset. Yes, short-sighted organizations can “milk” an asset, which is what would be done in printing too much money. But the framers of the Constitution trusted Congress not to do this when they entrusted to Congress the power to create money. Would the private sector do better? That might be a rationale for paying private banks (and investors) for the use of money that government can perfectly well create and has created for itself. But let’s examine the idea that we should continue to outsource 100% of the power and the privilege of money-creation to the private banks. And let there be no mistake: we are not talking about the “public” governance of the Federal Reserve System, a limited influencer on the banks, because that’s not where the decisions to lend or not to lend are made, or where the fractional reserve lending that creates our money supply is done. The point we are making here does not involve whether those banks are public-minded enough; undoubtedly they give their share to charity. But in making business decisions they are exclusively responsible to their stockholders. The point being?
The point is to ask if it is really logical to have no trust in “We, the People”, through our elected representatives, to act responsibly concerning 5% of our money supply but to have complete trust in private banks concerning 100% of our money supply. Is it that they took an oath of office, or have never been known to have acted recklessly? Are they not financially interested in creating “out of thin air” money they can collect as principal and collect interest on? Are they not financially interested in cutting back on lending and putting their money elsewhere at times of their choosing, an asset-stripping season, which reduces the money supply and exacerbates recessions? This could be seen as “open season” on the banks, but the issue we seek to sharpen is this: Why have we declared open season on ourselves? It’s to point out that 100% trust in businesses that are accountable not to us but to their stockholders is not as reasonable as reclaiming for “We the People” 5% of the trust the framers of the Constitution intended Congress to have and not simply to license out to the private sector in terms of money creation.
MMT’s supports government deficit spending at all times because they see it as the only way money can enter the economy, whereas the truth is that new money is created by the fractional reserve lending of private banks. The idea that the government must spend in order for the economy not to run out of money creates a very big difference in proclivity to increase the national debt and to cause inflation than the far more conservative approach of the “greenbackers”.
The third issue, if the Fed were to buy up all the government’s bonds, is that that’s a lot of bonds to be ordered to buy. The Fed would wind up with a great deal of “reserves” of a form and amount (given that these would be no-interest bonds) not necessarily consistent with fiduciary prudence. Also, an over-abundance of excess reserves could lead to reckless lending by member banks and to their engaging yet more in derivative investments (see or request copy of the Sept. 2013 Policy Winners).
Yet, for all these problems (and more yet to be discussed) – would non-interest bearing Treasury bond “reserves” the Fed would be ordered to buy give the banking system greater stability in the event of another financial crisis? What will be used to shore up failing banks? The sale of zero-interest Treasury bonds by the Fed? Would it need to quickly change the rules and enter the bond market in perhaps not such good conditions and sell discounted bonds with a yield to private investors? Just when and how would the dog catch its tail? And what about those other investments in securities now comprising part of the Fed’s reserves that would be displaced if the Fed is coerced to over-invest in Treasuries? Wouldn’t it be better if the banking system were buying securities representing more, rather than less, investment in the real economy – investments in things like utilities that could either provide an income or be sold if necessary in the event of another banking crisis, which we now know can simultaneously mean an FDIC crisis and a federal financing crisis?
MMT, debt and related subjects: the critics speak
We have provided, in this section, an overview of MMT ideas concerning debt, which necessarily has bled over into deficits, surpluses, market dynamics and inflation. We have compiled comments on MMT ideas made by a number of experts that also involve these overlapping subjects. We begin with comments that lay explanatory groundwork.
Robert Murphy is an Economics Professor at Hillsdale College and a Senior Fellow at the Pacific Research Institute. The article from which we draw here is “The Upside Down World of MMT”, published in the Mises Daily of the Ludwig von Mises Institute on May 9, 2011.
Murphy calls MMT “misleading at best, and downright false at worst”, claiming that “the MMTers concentrate on accounting tautologies that do not mean what they think.” He took exception to the claim “that the government deficit was necessary to allow for even the mathematical possibility of private-sector saving” providing another interpretation of the MMT-cited equation (on our p. 5):
(G-T) = (S-I) – NX
Where G = Govt. Spending, T = Taxes, S = Savings, I = Investment and NX = Net Exports
As the writer of the Wikipedia article cited on our p. 5 put it, “The conclusion that MMT necessarily draws from this is that private sector net savings is only possible if the government runs budget deficits; alternatively, the private sector is forced to dis-save when the government runs a budget surplus”. Murphy provides a different explanation, however. He notes that as G-T (the deficit) goes up, then savings may stay the same with investment going down. “This would make sense”, he writes, “in a risky investment climate associated with a period of high deficits in which taxes may have to go up, investments are risky and people put more money in savings to prepare for higher taxes.” (Government deficits would crowd out private investments – not an unknown concept).
Our view is this: Why should we feel duty-bound to establish a policy of seeking high deficits under all conditions of the economy on the basis of a single theoretical equation that can be interpreted in two opposite ways? Wouldn’t an approach of thoroughly studying multiple historic periods be a more sound one – or at least needed to corroborate the validity of the equation and its interpretation? With the overwhelming evidence behind us that excessive debt build-up can be harmful, isn’t it deficient on the part of MMT to put so much stock in one equation that is part of one model and to use that as a basis for advocating policy?
Robert Murphy raises a related issue concerning savings in the form of government bonds. He claims they are not assets for the private sector as a whole, since the bonds will only be redeemable after the government “raises the necessary funds from the same group of taxpayers in the future.”
Bill Mitchell, an MMT supporter, responds to this point in a 13 Aug. 2011
article titled, “Deficit Spending 101” in the Billy Blog. Mitchell writes that the government doesn’t have to raise taxes to repay bonds, as we can do so by creating [MMT account] currency. But if we can create currency to repay bonds, why not just create the currency to buy things the government needs to buy and not sell the bonds in the first place? If the bond holders use their own money to buy the bonds but are later repaid with money created for the purpose, they are subject to being repaid with cheaper money than they invested. If they are to be repaid with their own taxes, then they also come out behind, just as Murphy wrote. If Greenbacks are used (via checks and electronics and all that) to pay for what the government needs within a deficit, the payee is paid properly and the party who would have bought the bond not issued can invest in some otherwise crowded out thing that will actually help the economy.
Innocent Fraud #3: MMT’s Financial Markets are Not Like Real Financial Markets
Paul Krugman, the luminary economist, wrote an article titled “Deficits and the Printing Press” in the 17 July 2011 edition of the New York Times in which he wrote:
“There’s a school of thought, the Modern Monetary Theory people – who say that deficits never matter as long as you have your own currency. I wish I could agree with that view….But for the record, it’s just not right.
The key thing to remember is that current conditions – lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate – won’t always prevail. As long as those conditions DO prevail, it doesn’t matter how much the Fed increases the monetary base, and therefore doesn’t matter how much of the deficit is monetized. But this too shall pass, and when it does, things will be very different.
So suppose that we eventually go back to a situation in which interest rates are positive, so that monetary base and T-bills are again imperfect substitutes; also, we’re close enough to full employment that rapid economic expansion will once again lead to inflation. The last time we were in that situation, the monetary base was around $800 billion.
Suppose, now, that we were to find ourselves back in that situation, with the government still running deficits of more than $1 trillion a year, say around $100 billion a month, and now suppose that, for whatever reason, we’re suddenly faced with a strike of bond buyers – nobody is willing to buy US debt except at exorbitant rates.
So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. So?
Well the first month’s financing would increase the monetary base by around 12 percent. And in my hypothesized normal environment, you’d expect the overall price level to rise (with some lag, but that’s no crucial) roughly in proportion to the increase in the monetary base. And rising prices would, to a first approximation, raise the deficit in proportion. So we’re talking about a monetary base that rises 12% a month, or about 400% a year.
Does this mean 400% inflation? No, it means more – because people would find ways to avoid holding green pieces of paper, raising prices still further.”
Thomas Palley is a Fellow at the New America Foundation and the writer of works including his well-known books, Post Keynesian Economics: Debt and the Macro Economy and The Economics Crisis: Notes from the Underground. The following material is from
his article titled “A Critique of Modern Monetary Theory” for his Economics for Democratic Societies project.
“There is nothing new in MMT’s construction of monetary macroeconomics that warrants the distinct nomenclature of MMT. Moreover, MMT over-simplifies the challenges of attaining non-inflationary full employment by ignoring the dilemmas posed by Phillips Curve analysis, the dilemmas associated with maintaining real and financial sector stability, and the dilemmas confronting open economies. Its policy recommendations also rest on over-simplistic analysis that takes little account of political economy difficulties, and its interest rate policy recommendations would likely generate instability.
At this time of high unemployment, when too many policy makers are being drawn toward mistaken fiscal austerity, MMT’s polemic on behalf of expansionary fiscal policy is useful. However, that does not justify a blind eye to MMT’s over-simplifications of macroeconomic theory and policy.”
“MMT asserts that the natural rate of interest is zero. (He cites, here, Forstater, M and Mosler, W., 2005, “The natural rate of interest is zero” in the Journal of Economic Issues, XXXIX, #2, pp. 535-542), and that the short-term policy rate should be zero (He cites, here, Wray, R, “A Post Keynesian View of Central Bank Independence, Policy Targets and the Rules Versus Discretion Debate”, Journal of Post Keynesian Economics, 30 – 1, pp. 119-141). Such analysis is fundamentally un-Keynesian, and the policy recommendation is likely to promote major financial instability.
With regard to the former, a core insight of Keynes’ (1936) General Theory was that financial markets get interest rates wrong because of fluctuations in liquidity preference. MT now says park the policy interest rate at zero regardless of economic conditions, which will mean government will get interest rates wrong by mispricing the interest rate on high-powered money.
As regards financial instability, inflation at high or full private sector employment will be positive. Under such conditions, setting the short-term nominal policy rate at zero becomes a recipe for encouraging financial speculation and asset price inflation driven by debt, which ends in financial crisis. Aspromourgos (2011) makes similar observations in connection with Keynes’ policy recommendations of ultra-low interest rates. Lastly, in an international economic context, interest rate policy is subject to market discipline expressed through the CIP relation. The interest rate is also an important policy instrument for addressing instability that can arise from financial capital flows and flight.
In sum, a “park it” zero interest rate policy guarantees an incorrect setting of interest rates, promotes financial instability, and throws away a vital policy instrument in a world where policy makers already confront the challenge of having more targets than instruments.”
Edward Dolan is a Professor of Economics who has taught at Dartmouth, the University of Chicago and several European universities. The following material concerning MMT is from
his economics blog.
“In a series of posts[1] [2] [3] [4] [5] over the last couple of months, fellow Economonitor blogger L. Randall Wray and I have been exploring the conditions under which the government’s debt can be said to be sustainable. Wray writes from the point of view of Modern Monetary Theory (MMT), while I adopt a more eclectic and skeptical approach. A pivotal issue in our discussion turns out to be whether the central bank can or should hold the nominal rate of interest on government debt, R, below the rate of growth of nominal GDP, G. (We could frame the discussion in real terms instead by subtracting the rate of inflation, ΔP, from both sides; it makes no difference.) If R is held below G, then essentially any level of the government’s budget deficit is “mathematically sustainable,” a term we have been using to mean that the debt-to-GDP ratio does not grow without limit over time. On the other hand, if R exceeds G, the budget balance must show a primary surplus, on average over the business cycle, to achieve mathematical sustainability of the debt. (See the first of the posts referenced above for a detailed discussion of the conditions for mathematical sustainability.) It seems well established that the central bank can hold R down to any desired level, if it wants to, by buying a sufficient quantity of government securities. Barring legal restrictions like the debt ceiling, it could, if necessary, buy up all of the outstanding government debt in exchange for currency and bank reserves.
Economists call this procedure “monetizing the debt.” The “should” part of the question concerns whether the degree of monetization necessary to hold R below G would have undesirable inflationary side effects. True, when the economy is operating far below capacity and inflation is quiescent, as it has been these last few years, low interest rates and rapid money growth, backed by strong fiscal stimulus, may be just what the doctor ordered. You don’t have to subscribe to MMT to make that argument. Just read Paul Krugman. However, what happens when the economy approaches full employment and prices begin to rise? Is it still a good idea to hold R below G? That is where I become more skeptical. So far, our discussion has proceeded largely on theoretical grounds. Now might be a useful time to supplement the theorizing with a look at the historical relationship of GDP growth to interest rates in post-World War II US experience. Doing so reveals some interesting and relevant patterns. The following chart shows the evolution of three key variables from 1953 through 2012. The first is the inflation rate, plotted as quarterly averages of year-on-year changes in the Consumer Price Index. The second is the quarterly average interest rate on 10-year Treasury securities. (Rates on other maturities move closely together with the 10-year rate over the medium term, although shorter maturities show more quarter-to-quarter volatility.) The third variable is the growth rate of nominal GDP, plotted as quarterly observations of year-on-year changes.
A quick glance at the chart shows that the interest rate R has been sometimes above and sometimes below the growth rate G. Up to 1980, R was mostly less than G, as MMTers would like it to be. From the early 1980s through the 1990s, R mostly exceeded G. From the early 2000s to the onset of the global financial crisis, G moved back above R, but not by as much as before 1980. During the Great Recession, R has once again fallen below G. We can see another regularity in the chart, as well. The periods when interest rates are held below the GDP growth rate tend to be periods of accelerating inflation, while those when R rises above G show decelerating inflation. The following table brings out that feature by dividing the years shown in the chart into periods broken by major turning points in the trend of inflation. The column labeled ΔΔP shows the average quarter-to-quarter acceleration (+) or deceleration (-) in the annualized rate of inflation during each period. The column labeled G-R shows the amount by which the average annual rate of NGDP growth exceeds (+) or falls short (-) of the nominal interest rate. Comparison of the two columns shows that inflation tended to accelerate during periods when G-R was positive and to slow when G-R was negative.
The apparent regularities shown in the chart and table have a direct bearing on the debate over sustainability of fiscal policy. MMT proponents argue that the interest rate on government debt is a policy variable that the central bank of a country with a sovereign, floating-rate currency can set wherever it wants. As long as R is held below G, they say, the debt can never become mathematically unsustainable. By holding R permanently below G, the government can focus fiscal policy on achieving full employment without worrying about the budget deficit or the debt ratio. On the other hand, if a policy of holding R below G produces accelerating inflation as a side effect, it starts to look less attractive, at least to observers outside the MMT camp. Let’s now add another variable, unemployment, to the discussion. The next pair of charts, like the familiar Phillips curve, plot unemployment on the horizontal axis and inflation on the vertical axis. However, the patterns in these charts look nothing like the classic Phillips curve, which posited a smooth menu along which policymakers could choose lower unemployment at the expense of a bit of inflation, or vice-versa. Instead, the left-hand chart, which covers 1961-1982, shows an unstable stop-go cycle with a distinct inflationary bias. Each repetition of the cycle reaches a higher inflation maximum and turns up again from a higher inflation minimum. The minimum and maximum values of unemployment also increase with each that federal debt averaged less than the growth rate of nominal GDP. The stop-go pattern coincides with the period during which interest rates on the federal debt averaged less than the growth rate of nominal GDP. After 1982, the pattern changes sharply, as shown in the right-hand chart. There is a transition period in the mid-to late 1980s, after which, from the early 1990s up to the start of the global crisis, the economy exhibits remarkable stability. These were the years we call the Great Moderation. The transition and the early part of the Great Moderation coincided with a level of R significantly above G. After 2002, G rose above R once again. Most readers are probably familiar with the argument that the Fed’s attempt in the mid-2000s to prolong the Great Moderation by holding interest rates low contributed to the housing bubble and set the stage for the crisis. Of course, these are only charts. They show associations, not causation. Even so, the charts by themselves pose an inconvenient truth for proponents of MMT, in much the same way that charts showing an association between atmospheric CO2 and rising global temperatures pose an inconvenient truth for climate skeptics. In both cases, the hypotheses of causation, which leap out from charts even for naïve observers, are backed by bodies of theory that many experts in the fields find plausible. The associations, backed by plausible theory, are not irrefutable, but they do shift the burden of proof.
The question stands then: Is it not just possible but also desirable for the central bank to hold nominal interest rates on government debt below the rate of nominal GDP growth, and to do so not just as a temporary measure during a deep slump, but as a long-term policy? Do past episodes when low interest rates were associated with accelerating inflation and stop-go instability provide grounds for caution, or does each such episode have some benign, extrinsic explanation? I look forward to learning more about how MMT proponents interpret the features of the charts presented here.”
Innocent Fraud #5: MMT’s Policies Would Drive Inflation in Two Ways
Many of the experts cited have said MMT’s policies would cause inflation. The constant deficit spending deliberately seeking to create debt because of the belief that debt is good for the economy and the surpluses are bad for the economy and must be avoided, creates a “ratchet” effect requiring deficit spending in all cycles, even in when the economy is over-heated. Their writings have made mention of increasing taxes to cool an over-heated economy, but the instead of the cruel tax of inflation the public the public would be subjected to the cruel tax of more taxes. Were tightening of the money supply to be used, that is not a painless solution, either. It would hamper the ability of businesses to increase supply, and increase the cost of credit not only in the year when loans are made but in all other years of the life of the loan. A good analogy, we believe, is the driver who keeps his foot on the gas at all times, relying only on braking to slow down the car. That would be an inefficient and costly way to control a car, even as MMT theory provides only inefficient and costly ways to control inflation.
The other way that has been cited in which MMT would drive inflation is through the constant need to raise new money through Treasury bonds and to roll over existing ones. As has been pointed out by several of the experts cited, the Fed cannot realistically buy up all the bonds itself and the interest required to attract buyers would indeed rise as market conditions can be expected to change as they always have.
Further confirmation that experts expect MMT policies to increase the debt burden and cause inflation is provided by the statements here cited:
N. Gregory Mankiw, Chairman of the Economics Department at Harvard University, has been quoted in Washington Post article by Dylan Matthews, earlier cited (our p. 15) as agreeing that the government could print streams of money and never default. But Mankiw has pointed out that could trigger a very high rate of inflation. This would “bankrupt much of the banking system” and, at that extreme, “Default, painful as it would be, might be a better option.”
Karl Smith, Economics professor at the University of North Carolina, Chapel Hill, has been quoted in the Dylan Mathews article cited above as saying, “You can’t just fund any level of government that you want from spending money, because you’ll get runaway inflation and essentially the rate of inflation will increase faster than the rate that you’re extracting resources from the economy. This is the classic hyperinflation problem that happened in Zimbabwe and the Weimar Republic.”
John Aziz, Economics writer for The Week and Pieria View in the U.K., has written an article titled “Why Monetary Theory is Wrong About Government Debt” in
his Azizonomics blog.
In it he states: “…the point I am trying to make in worrying about total debt levels is not the danger of mass default (although certainly default cascades a la Lehman are a concern in any inter-connective financial system), but that large debt loads can lead to painful spells of deleveraging and economic depression as has occurred in Japan for most of the last twenty years.”
L. Randall Wray, Economics professor at the University of Missouri at Kansas City and an MMT leader cited previously, has stated to us: “The Greenback is a red herring. What we want is more government spending, via keystrokes. It needs to be budgeted. No one needs to worry about exactly how the government spends – Treasury and Fed know how to do this. We just need the budget authority. Focus your energy on that”. ⁵
Innocent Fraud #5: MMT’s Treasury and Federal Reserve are not like the real ones
The American Monetary Institute is an organization which for many years has been devoted to the study of history and policy matters concerning money and banking in America. Its founder, Stephen Zarlenga, has collaborated with monetary expert Steven Walsh of that organization to provide
well-researched responses to claims made by Modern Monetary Theory advocate Randall Wray of the University of Missouri at Kansas City.
We provide, from that article, a number statements made by Prof. Wray and responses to them by the American Monetary Institute.
Wray Statement: “Treasury spends before and without regard to either previous receipt of taxes or bond sales.” (from his book, Understanding Modern Money: the Key to Full Employment and Price
Stability, p.78, and “Functional Finance and US Government Budget Surpluses in the New Millennium”, 2003, p.5)
AMI Response: “In fact, Treasury must receive taxes on the proceeds of bond (or other debt) sales into its general (checking) account at the New York Fed before payments can be made from it, as the law prohibits the Fed from making loans or overdrafts to Treasury.” (Citation is to Federal Reserve Act, Section 14, Subsection (b)]. AMI continues: “The Fed has to debit Treasury’s account to credit bank’s accounts, otherwise its books couldn’t balance. Therefore, Treasury cannot spend without regard for how much is in its account.”
Wray Statement: “Treasury cannot withdraw taxes from the economy before spending.” (Wray, 1998, op. cit, p. 78 and Wray, 2003, op. cit, p. 5)
AMI Response: As we’ve seen before, Treasury’s account is debited when it spends, so it must get funds from the economy (since the Fed can’t lend it funds).
Wray Statement: “Tax receipts cannot be spent”, as “the money is literally burned, or simply wiped off the liability side of the central bank’s balance sheet.” (Wray, 1998 op. cit., p. 78 and p. 111)
AMI Response: “In fact, Treasury publishes daily statements of its accounts showing that tax funds are transferred to its account at the Fed, and the weekly statements showing these amounts as liabilities on its balance sheet; they are not wiped off. As for burning money, that is a federal crime. Currency re-enters circulation until damaged or worn. (Multiple official government statistics and document are cited, as can be seen via the above link to the paper, footnotes 11, 16 and 17).
Wray Statement: “Taxes are used to drain excessive disposable income”. (Wray, 1998, op. cit, p. 85 and Wray, 2003, op. cit, p. 2).
AMI Response: “In reality, we’re in a deep recession (or depression) right now, most people certainly don’t have excessive disposable income, and yet most people are being taxed.”
Wray Statement: “Treasury’s ability to issue fiat money” means “full employment with price stability can be achieved, now.” (Wray, 1998, op. cit, p. 124 and p. 180)
AMI Response: “As we’ve seen before, Treasury does not do this at present, banks do, so government is not in a position to create and spend money into the economy to achieve full employment and price stability right now.”
Wray Statement: “What if we have erred in our understanding of money, and in our analysis of government budgets? In that case, we must take [Federal program] costs seriously (Wray, 1998, op cit, p.180)
AMI Response: [To the effect that it’s important to get the facts straight in the first place].
AMI’s general comments in response to Modern Monetary Theory as represented by one of its leading advocates, Randall Wray (in the AMI paper cited):
“We haven’t found any real, officially-confirmed evidence to support what MMT claims. All the official sources we’ve checked indicate the facts are contrary to what MMT claims, under the monetary arrangements that prevail at present.”
“We need bank money before anyone can get cash, buy government bonds, or pay taxes. Thus banks have total control over our money system: nobody (including government) can get any money unless a bank decides to make a loan or purchase. MMT fails to recognize that this vast power is in private hands, not in the hands of society through government.
AMI also faults MMT (in the same article) for:
“Ignoring the continuous transfer of wealth from poor to rich due to government debt; that a big part of our taxes go to pay interest on the debt, held disproportionately by the upper 1%
“Ignoring banks’ ability to counteract government’s effect on the economy at any time” – “Banks can shrink the economy by shrinking the money supply (e.g., Great Depression), or expand it with bubbles (e.g., housing) regardless of government deficits or surpluses.”
Innocent Fraud #6: MMT’s Theory would crowd out credit for non-government users and force the Fed to invest in excessive government debt paper instead of a mix with more securities investments in the real economy
What we should be steering toward, we believe, is a system where the Federal Reserve and its member banks should be encouraged and perhaps, to a small minimum percentage, required, to invest in reserves other than those that document the indebtedness and therefore weakness of the federal government (outstanding Treasury debt). The federal government was, after all, the last and as it turned out, and as Hank Paulson and Tim Geithner acknowledged – a necessary defense the last time we had a banking crisis.
Are the banks that comprise the Federal Reserve system paupers? Why should they not be required to provide for their own rainy day fund? If we believe in self-sufficiency and accountability for individuals, then why not for corporate individuals, in this case banks? But we can’t hold them accountable for that kind of responsibility if we take away from them (them being the public/private construct known as the Federal Reserve System) the freedom not to buy zero-interest Treasury bonds until they choke on them. If we require taxi drivers to be insured, and so many other requirements as public entities and, to a much greater extent, private entities impose on businesses as part of the cost of doing business (think contract requirements, etc.), then why should we not impose a requirement for a certain amount of meaningful, functional, income-producing assets as reserves that can be sold, in a downturn without competing with the government selling the only thing it can practically sell in a crisis – Treasury bonds?
This subject was raised in our September, 2013 Policy Winners, where we traced through what became of the TARP funds. (They so often enabled banks to speculate, again, in high-risk derivatives.) We also reported on the “bail-in” provisions being made for banks around the world to dip into depositor’s funds in the event they get into trouble again.
We believe that what constitutes bank reserves and Fed reserves is a very important issue. So we re-print, here, a passage excerpted from the September, 2013 Policy Winners concerning how the banking system can and should invest in profit-making reserves for the good of the banking system and the good of the public. The excerpted passage follows:
“We would actually like to see the banks invest in things like power plants, but not as part of a whole raft of investments outside the banking sphere, and not at the expense of reduced lending. Let’s focus on power plants, for a moment, as that is certainly one of the more sensible investments mentioned when it comes to institutional stability.
During the 1950’s, when the Eisenhower Administration was pursuing its Atoms For Peace program, the government explored several alternatives for the engineering of nuclear power plants. One was a Thorium reactor, which did not generate highly radioactive waste materials and was not a source for enriched uranium (for weapons). However, the administration chose the uranium model precisely because of the concerns of the Cold War and because it had the benefit of providing enriched uranium for nuclear weapons.
Somehow, the Atoms For Peace idea got a little muddled in the context of a two-superpower world. Nevertheless, we have the example of the French shouldering on to help develop uranium reactors in Iraq. Some time later, the Israelis perceived a need to un-develop them, and part of the rationale for the US invading Iraq was the suspected nuclear component of “weapons of mass destruction.”
Today we tell countries around the world they cannot have the benefit of Atoms For Peace held out to them not too many years ago by our country … that developing nuclear power carries with it the risk of economic sanctions, sabotage (as not verbally threatened but demonstrated in Iran), or military attacks by the United States or its allies. Paradoxically, there are risks to our national security from climate change, not to mention those involving conflicts over oil and coal and economic crises involving multiple nations – risks not insignificant when stacked up against the risks of nuclear proliferation. How long will saber-rattling without using the saber (present policy, it would seem) work in a world in which urbanization and industrialization are proliferating, the cleaner fossil fuels running out in areas less endowed with them than we are, and nuclear technology is proliferating?
Recent literature suggests that the Thorium reactor remains a viable alternative. Many believe nuclear fusion may not be that far away if we, globally, give the research effort a concentrated push.
Consider the cost of defense against nuclear war or terrorism, the costs of climate change disasters, the need for clean power in the US as periodically emphasized by brown-out and black-out scares, and the potential for greater prosperity for the US if a fulfillment of Atoms For Peace promotes US exports and economic development throughout the world. Shouldn’t investments in nuclear research (at least to bring the US up to par with Europe) qualify as a national priority? Shouldn’t available funding to build a bevy of new plants be something we should plan for?
Some things governments do best. Our government could partner with European governments and others throughout the world in an effort to conduct appropriate nuclear research, and could raise the funding to do so without increasing government debt. For one thing, we could do so by simply printing money. No one has yet explained why we couldn’t print a limited quantity of US Notes or “Greenbacks”, just as the (Republican) Lincoln Administration did, and put them to good use now while we are still recovering from the recession rather than in an over-heated stage of the economy. (It should be noted that the Greenback-based Chicago Plan, proposed during the 1930’s, had the active backing of 235 economists and 157 universities and today is eliciting renewed interest at the highest levels). Of course, if we do enter an over-heated stage of the economy, the classic solution (and a reason we are supporters of the Federal Reserve System) is to increase and to a minuscule extent direct required reserves – money going into the pot we propose to create). Plants financed using today’s technology would provide near-term cash flow; R&D in proportion would provide a prospective upside. Meanwhile, since no one has given a reason why Greenbacks could not be used, they could fund a federal government co-investing role to fund research.
In our May issue our guest contributor (Michael Kirsch) described how the historic Bank of the United States converted government debt from the revolutionary war into shares in investments in economic development, and how new investors were attracted as subscribers to the Bank. During the Second World War, the government had no trouble selling war bonds, as people believed the cause was linked to their own survival (and because the Federal Reserve bought so many of them). If we created an investment vehicle for which outstanding Treasury notes could be traded in, we could afford even to guarantee returns on the new security when used as a replacement because we would only be replacing a guarantee already in effect. So instead of paying off or re-cycling a certain number of outstanding T-bill’s, we could use that money to fund two things: research and operations, as we already have a need for new plants using existing technology that the government is in a position to expedite. A good start-up is one that has promise; a great start-up is one that has promise and a positive cash flow.
Dr. Armen Papazian has proposed the use of “public capitalization notes” as part of a transition from a debt-based financial system to an asset-based financial system. His thoughtful article is relevant, here, and included via hyperlink in our bibliography.
Where would the banks come in? The renewed Atoms For Peace project (a Republican initiative, conservative readers note) should be among a limited class of investments of national importance worthy of special treatment by the government including possible co-investment and return-of-principal guarantees. This limited class may include others, such as revenue-generating infrastructure investments and the NAWAPA initiative of the Kennedy administration to bring not an oil pipeline (which shows it can be done, if the Romans hadn’t) but a water distribution system from areas of the northwestern US and Canada – areas where there are great excesses of fresh water – into the dangerously parched western states.
What do these investment types have in common? Once financed and in operation, power plants generate (so to speak) consistent income little affected by recessions. Infrastructural investments such as toll roads and bridges generate income through and beyond recessions, though slightly affected by recessions. There are many parts of the country where water can be sold consistently, and at a good price. These kinds of assets can bring stability in the form of ongoing income through periods of economic crisis, and could be pledged or sold on the world market to raise major infusions of cash to meet the kinds of financial crises we are not prepared to meet now.
There has been much discussion of bank reserves being too low. We think the focus should be on not only quantity of reserves, but quality of reserves. The Federal Reserve Act of 1913 provided for reserves so that in the event the government had to nationalize the Fed it would acquire assets to balance its obligations. What kind of asset for the government is a bunch of Treasury notes only evidencing its existing debt? What is the real value of some of the other securities held by the Federal Reserve, and those we have described above in the ownership of bank holding companies but not necessarily in their banking arms, if and when the economy goes really sour?
Taking a step back from it all, the big banks are dependent on “we, the people”… which includes the banks and the other third of the Federal Reserve Board of Governors … establishing a sound, long-term direction for the economy. They are dependent on the services of government which have included bailing them out. Is it not a fair quid pro quo that they be required to participate in the establishment of reserves a small amount of which need consist of programs for economic development that are of critical national interest and of a type that will provide for increasing stability in our financial system through the provision of consistent income?”
Thomas Palley, an economist with the New America Foundation who we have cited previously (p. 24), makes a comment that seems to indicate he has some thoughts along certain of the same lines in a Feb., 2014
article on his web site titled: “Modern Money Theory (MMT): The Emporer Still Has No Clothes”, p.17.
Palley writes: “For over a decade, and long before the financial crisis of 2008, I have argued for asset based reserve requirements (Palley, 2006, 2003b, 2008) as a constructive framework for stabilizing financial markets and dealing with asset price inflation. However, while MMI recognizes the need for financial regulation, it fails to see that its interest rate policy recommendations promote financial instability.”
Innocent Fraud #7: MMT is just a theory, a very controversial theory among our economic theoretists and likely to be more so among the voting public and their representatives when all is said and done.
It is a theory and not an accurate description even of the way things supposedly work (meaning a description of the way they would like them to work), as several of our cited experts have explained. MMT’s policy recommendations are barely developed, and would require major changes to our institutions and the principles behind their design to accomplish them.
Thomas Palley, previously cited on this page, provides a good summary of our expert’s views in the article cited above. He writes as follows:
“MMT claims to provide new insights into monetary theory and macroeconomic policy possibilities. As regards monetary theory, there is nothing new. The ability of sovereign issuers of money to finance deficits by printing money, the role of taxes in supporting monetary demand, and the difference between the government budget restraint and the household budget constraint were all well understood by old Keynesians. The notion that MMT has discovered of even just recovered those features is a fiction.
As regards macroeconomic policy, MMT’s claims are unsubstantiated. The claims that government can easily obtain full employment with price stability (Wray, 1998, p. viii) does not stand up to scrutiny, and nor does the claim about the optimality of “parking” the policy interest rates at zero.
Given this, why is MMT attracting more attention? The answer is that it is a policy polemic for depressed times. A policy polemic that promises full employment and price stability at little cost will always garner some attention. However, such a policy polemic will be especially attractive in depressed times. Furthermore, depressed times actually make MMT’s claims more possible. That is because the inflation constraint effectively vanishes and depressed animal spirits suppress immediately financial sector stability concerns.
Finally, it is noteworthy that MMT appears more plausible to US audiences than to other country audiences. All countries face inflation and financial sector stability constraints, but the US is essentially free of a foreign exchange market constraint. However, that constraint is very visible in many other countries, which explains their greater skepticism about MMT.
Concluding a conversation with William Mosler
Our original intent was to have several MMT advocates express their own views in writing, with an introduction we submitted for their approval. We wound up relying on published materials they had written previously and on questions and answers. Nonetheless, there were a number of conversations back and forth, essentially interviews.
One of the questions we asked (of MMT advocate Warren Mosler) was this: “If the government prints $10,000 in United States Notes (Greenbacks), then it has that $10,000 in hand without having to sell a bond to anyone. Why wouldn’t it come out ahead by doing this?”
The answer he gave was this: “Because when that $10,000 gets deposited in a bank, the risk free rate will drop to 0 (zero), and the government doesn’t pay interest on it”. He went on to say: “US Notes are functionally no different than the Federal Reserve Notes we already have. Nothing changes regarding interest paid by government which remains a policy decision and not a cost of funds decision imposed by markets.”
From what we have read and presented here, there is a cost of funds issue imposed by markets when the government relies on the ultimate sale of Treasury bonds to finance deficits.
If the government has a deficit spending need to buy, as the example one of the experts used, a pickup truck, and it uses honest to goodness Greenbacks fiat money deposited (probably not in the form of $5.00 bills, of course) into one of its Fed accounts to buy it, then the dealer will get a check for so many dollars –just US Dollars, as the two types have always been interchangeable in use and had identical value. But as drawn from a Greenback federal account deposit, there will be no need for the rate on Treasury bonds to “drop” to zero. (It would be nice, we think, for Treasury bond holders to do better than that and, indeed, they may require better than that at the time proximate to this transaction.)
There is, indeed, a difference between US Notes or Greenbacks the way our forefathers used them (by the way, they didn’t use wagon loads of paper bills then, either) versus Federal Reserve Notes (paper or electronically symbolized), when the one versus the other is used for deficit spending. The limiting factor, in either case, is that the government shouldn’t deficit spend too many US dollars, be they either Federal Reserve Notes or United States Notes (Greenbacks). Greenback dollars are the better deal because they cost the government essentially nothing whereas every Federal Reserve Note dollar used for deficit spending requires the issuance of Treasury bonds which in the real world and in normal times require repayment of both principal and interest. In the real world, the vast majority of those bond holders are totally outside the Federal Reserve System, won’t sell their bonds to the Federal Reserve System and the Federal Reserve cannot “send back” interest the government pays on those bonds. That is the explanation of that very real part of the annual federal budget called “Interest on the National Debt” – a smaller number next year if we use Greenbacks this year, providing some money to reduce the sting of austerity without “extra spending”.
So again, to ask the question that we think was not really answered, why wouldn’t the government come out ahead by issuing its own Greenbacks rather than raising money through the financial system to use Federal Reserve Notes? Are we ready to recognize, now, that reference to either variant of the US Dollar, issued pursuant to either enabling legislation and authority, has nothing to do with the paper versus check versus electronic mode of transactions chosen in using them, and so that is in no way involved in the answer? Do you maintain there’s no difference, Warren, where the one alternative requires issuance of hundreds of billions of dollars worth of bonds required each year and the other requires none? Do you have an answer for our question as to why Greenbacks would not be better from a debt-minimization standpoint, or will you come out and say that that is, your concern, that your theory calls for a substantial increase in the debt each and every year, and Greenbacks would threaten that notion?
Some years ago, now, MMT had an idea that fit the very unusual circumstances of the time … but time is going by, and we have already moved into the more normal times that the old rules described. It is now time to do some updating of what you have proposed in order to accomplish what you really wanted to accomplish. You have already had an impact in causing us to think differently about what can be done with fiat money and how we can be more confident, in dealing with future recessions - that the nation won’t go broke right away if we do deficit-spend … that the ways to outlast our difficulties are greater than some assume, given a deeper understanding of our resources and options. You will have the thrill of satisfaction of contributing to a big step forward in the final analysis if you let go enough of some of your ideas to let a necessary first step for your ideas as well as ours happen.
With a little reminding of it, the public can get on board with what our founding fathers planned in writing our Constitution and with what they used to achieve the feats of winning the American Revolution, the Civil War, and the peace that followed both. That is something we can all “get” and not have so many debates about, which is what is needed at this time.
It is time to back an off-the-shelf and ready-to-go solution as at least a first step in what we ultimately want to accomplish. That first step will allow the re-introduction of a small amount of government-issued money to be approved each year according to the conditions of the economy – a key break-through toward what you want to accomplish. With only a few days worth of work, legislation drafters can update the previously passed, Supreme Court tested Legal Tender Act of 1862. With that we can bring back the United States Notes that have circulated longer than any other form of US currency, with no insurmountable problems encountered (even in years of Civil War shortages), as United States Notes have circulated for 150 years. We can immediately use them to minimize our current deficit and thereby reduce the pressure for ruinous austerity based on fear of a too rapidly spiraling debt and cost of outstanding debt in the next budget. It’s a do-able way to deal with what reasonable people on both the Conservative and Liberal sides must realistically see as the twin-headed monster of debt and austerity.
It’s something that can be sold to the people and their representatives. Once settled upon by the economics establishment, it will be like selling the founding fathers, the Constitution, Lincoln, motherhood (Ma), and Ma’s apple pies! It will all come together. It will be like the fourth of July.
None of us may want to give up some of our pet ideas, but it will all be worthwhile to see some others result in a significant public benefit in as little as a matter of months.
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Footnotes
1. Palley, Thomas. Modern Monetary Theory (MMT): “The Emporer Still Has No Clothes”. P.1
February, 2014 newsletter found at: http://www.thomaspalley.com/docs/articles/macro_theory/mmt_response_to_wray.pdf
2. Wray, Randall. Interview with Policy Winners for this newsletter via e-mail June 23, 2014
Note, also, the sense of other citations made throughout this newsletter.
3. Wikipedia articles on each of the administrations from President Harry Truman to the present, articles found under the search topic of “national debt by administration” and graphs observed under the search topic of “Gross National Product”
4. Mosler, Warren. Interview with Policy Winners for this newsletter via e-mail June 22, 2104
Note, also, comments on his permanent zero rate interest proposal by other sources throughout this newsletter, and his publication, The Natural Interest Rate Policy is Zero, found at www.moslereconomics.com
5. Wray, Randall. See footnote #2 on same subject, above
Further Reading
Mosler, Warren.
The Seven Innocent Deadly Frauds Of Economic Policy.
Wray, Randall. Modern Monetary Theory: A Primer on Macroeconomics for Sovereign Monetary
Systems. 1992: Palgrave Macmillan
