By Marshall Auerback, an investment strategist and analyst who writes for New Deal 2.0.
A major shortcoming in an otherwise thoughtful post by DoctoRX on deficit spending is a traditional mistake in which analysts seek to analogise the expenditures of government with that of a private household or business. The government is sovereign. This fact gives to government authority that households and firms do not have. In particular, government has the power to tax and to issue money. The power to tax means that government does not need to sell products, and the power to issue currency means that it can make purchases by emitting IOUs. No private firm can require that markets buy its products or its debt. Indeed taxation creates a demand for public spending, in order to make available the currency required to pay the taxes. No private firm can generate demand for its output in this way. Neither of these statements is controversial; both are matters of fact. Nor should they be construed to imply that government should raise taxes or spend without limit. However, they do imply that federal budgeting is different from private budgeting, and should be considered in its proper, public context.
It simply means that the government does not "need" money to "fund" its operations. It seems counter-intuitive, but the public actually needs the government's money to pay its taxes rather than the government needing taxes to pay for highways, bridge repairs, schools, national defense, etc. For the household, paying back debt means they have to sacrifice current consumption (spending). For the government, no such financial constraint is imposed. Its ability to spend now is independent of how much debt it holds and what is spending was yesterday. That situation can never apply to a household or business firm.
Because the government is the only entity that gets to create money, it can "buy" whatever is for sale in terms of its money merely by providing that money to the public, which opens up a huge range of policy options. Putting this in concrete terms, the government"“"?buys' a new highway or a new aircraft carrier, as long as the construction materials and workers' wages can be paid for in its own currency.
Where does the government get the money? The government creates this money by crediting bank accounts. It creates money with the stroke of a computer keyboard. New money is an entry on a spreadsheet, nothing more.
To put this in everyday terms, the dollars the government creates function something like tickets to the Super Bowl. As you go into the stadium, you hand the man a ticket worth $1000, and then he tears it up and throws it away. Why? Because the ticket has served its function: it has enabled you to gain entry to the event in question; similarly, a tax is paid to extinguish a state liability, but as soon as the tax is paid, it has no further value to the government. The tax receipt can be sent to the shredder. Tax payments (which discharge a liability to the state) then "drain" the money we call legal tender (otherwise known as "fiat currency"), which can be pictured as a movement of funds away from the private sector and "down the drain" as the money is literally burned, or simply wiped off the liability side of the Federal Reserve's balance sheet.
How does the government taking your tax money and throwing it in a shredder pay for anything? The answer is that it doesn’t.
Taxes function to reduce aggregate demand, also known as spending power, and not to collect what the government needs to spend on something else.
As a matter of conceptual clarity, it makes no sense to say that a government ever "builds up a store of savings" that allows for higher spending capacity in the future. The government neither has or doesn’t have any dollars; it simply makes computer entries on a bank's balance sheet, as Federal Reserve Chairman Bernanke described in the "60 Minutes" interview above.
It spends by changing numbers upwards in our bank accounts. Think of this like a football game. Awarding 6 points for a touchdown doesn’t "use up" some stock of points held by the stadium. It is "electronically credited" via the scoreboard. Nobody asks that the 6 points be "repaid" somehow.
You don’t “save” what you have the option of creating or not creating (i.e. fiat currency). Not spending, not “creating currency” via crediting bank accounts, simply means less present day economic output.
We all learned this as the paradox of thrift.
There is nothing to "save". The government is never revenue constrained.
This is in contradistinction to the way users of the currency, versus the issuer of a currency, such as a household functions.
For them, spending is constrained by income. Their checks will bounce if there is no money in their accounts. And for users of the currency monetary savings can be stored to permit higher consumption in the future. And households don’t have an electronic printing press in their basements which would eliminate that constraint. As Rob Parenteau has already noted, this is called “counterfeiting” and it’s a jailable offence.
True, if a government spends too much after getting us to a state of full employment and higher economic growth, excessive government spending can create inflationary pressures. So to that extent, there is a limit. But acknowledging that unconstrained government spending can create inflation is not the same as arguing that it is in any way operationally constrained. Contrary to conventional “gold standard” thinking, where it is said that every DOLLAR SPENT HAS TO BE "?FINANCED' BY AN OUNCE OF GOLD ALREADY IN EXISTENCE, our government can afford anything that it is for sale in its own currency.
The debate therefore should not be focussed on “affordability” but on what our the national priorities of our government? The political process, not a non-existent gold standard, determines that if we want more killing toys then the national government can always meet those expectations in a fiscal sense, unless we run out of real resources. Likewise if we desire universal health care, in a manner where the government provides this as a national right, rather than foisting it on business as a marginal cost of production (remember, businesses are constrained in a way that governments are not). Further, if there is a problem with excessive private indebtedness and overspending, then the mirror image of that has been the excessive fiscal drag that the national government inflicted on the USA between 1996 and 2007. If you want the economy to grow and produce the saving capacity (via income growth) to allow the private sector to repair their precarious balance sheets then the last thing you would want to do is run "tight Budgets "¦ for a long time into the future".
What is needed when the economy has been driven by private spending funded by ever-increasing levels of debt (and a contracting public sector as a proportion of total output) then what is required is a change in the composition of final expenditure "“ from private to public "“ unless you want to "scorch the earth" and deliberately contract the economy.
The consequences of overspending might be inflation or a falling currency, but never bounced checks a government creating its own currency can never go broke. Government spending limits ought to be set by our policy makers by considering what we, as a society, want, like universal healthcare, full employment, a well-functioning economy and our ability to accomplish this"”not out of some preconceived notion of what is "affordable".
Excellent post, giving great clarity to me. Thank you.
When “affordability” is measured in real terms, not nominal terms – and I would argue that it is the only measure that counts – governments are effectively constrained. So no, policy makers cannot introduce unlimited universal healthcare, full employment and anything else by pure fiat. “scorching the earth” through mis-allocation of public credit (like, say, fighting useless war)is frequently worse than “scorching the earth” doing nothing.
read or re-read Bastiat’s broken window.
I don’t think the point of the post was to argue that the government wasn’t constrained at all. The point was that the government wasn’t constrained by revenue to “spend” more in a fiat money system. The point was not that the government isn’t revenue constrained in acquiring a set amount of goods and services.
I think the post would have been more concise and clear if it simply said flat-out that the decisions about deficits have a bigger effect on distribution of wealth rather than creation of wealth. Who to tax, how much to tax, where to spend, on whom to spend, whether there will be inflation, all these have profound effects of distribution of wealth, regardless of any effect on creation of wealth (which they almost certainly have as well).
Also, I hope someone has pointed out to you the limits of the “fallacy” of broken windows. You have to assume a non-redistributive system and only evaluate the “closed” part of the system. If I break all the windows in San Diego and then tax everyone in Boston to pay for it, I can assure you that San Diego’s economy will be better off for it. This is not as far-fetched an example as it seems, if you consider that a huge amount of the western states’ wealth has come from hugely inefficient wealth transfers from the eastern states in the form of “ten cents on the dollar” water projects. Yes, if you look at the US as whole this shows the fallacy of using inefficient government spending for “growth.” If you only examine the western states, however, you would could get lost in what appears to be an oasis of growth. [Not to confuse the issue, but if one accepts that hard-to-measure negative externalities are inherent in radically skewed wealth distributions, "inefficient" wealth redistributions could actually be efficient when viewed in totality. I'm not arguing that, but it is not impossible.]
As with every policy, it’s not just about whether it increases efficiency or decreases efficiency, but about who wins and who loses. In fact, I would argue that the latter distinction causes more of the anger we see regarding government policy, and perhaps we should spend more time on that subject than the former.
So government spending is a bit like equity then… there’s no limit to issuing new equity, but diluting existing holders isn’t necessarily such a great idea. In theory the federal reserve is independent, but there’s no reason congress couldn’t nationalize it if they they chose to, so effectively it is part of the government.
There is also one other important factor, which is that the holders of currency need to have faith that the government is not going to go creating money. Even if the government does not create the money now, just the perception that it might can significantly change behavior.
So deficit spending (with federal reserve involvement) is really taxation-by-inflation, since there is no difference for the government to spend $x by creating new money vs collecting $x in taxes. Is taxation via inflation such a good idea?
This would not apply for Euro-member countries, since they do not have the power to issue Euros. It also does not apply to debt issued in foreign currency.
the public actually needs the government's money to pay its taxes rather than the government needing taxes to pay for highways, bridge repairs, schools, national defense, etc
…
The political process, not a non-existent gold standard, determines that if we want more killing toys then the national government can always meet those expectations in a fiscal sense, unless we run out of real resources.
The post is, if nothing else, a demonstration of just how deep into self-evident absurdity a fiat currency system can take you.
Makes you wonder what kinds of theories Roman thinkers were churning out back when the denarius was being denuded of its precious metal content.
Graphite,
I was recommended reading Randall Wray’s understanding modern money http://www.amazon.com/Understanding-Modern-Money-Employment-Stability/dp/1840640073.
This post follows the logic of functional finance or chartal money:
It is a fascinating read, if a bit thick (a la keynes). My initial gut reaction is like yours, that it is non_sense. I have been thinking about this for the past weeks. I
Particularly i believe one of the sources of confusion is due to the attributes of money. It serves both as a store of value and a medium of exchange. Obviously as a medium of exchange it stimulates the economy. You print money and all you do is create economic activity in a very straightforward keynesian way. You print money are you stealing from the people? I think the answer is a matter of ideology. Since the people is the govt and vice_versa then strictly speaking, you are stealing from yourself; taking from your left pocket to your right but stimulating economic activity in the meantime. If however you view the govt as an evil 3rd party thing that steals from your pocket to give it to someone else; then you will view such propositions with horror.
This of course does not apply to international relations. When a government prints money, as the US is doing currently, it is at the expense of foreign entities, bar an FX re-adjustment.
The US is currently applying functional finances. An un-apologetic embrace of printing presses.
Somehow this fails the common sense test. Certainly all governments have the same ability to print money, why pray tell do that not have the same ability to spend it?
Why are some governments “richer” than others?
just because a government is not revenue constrained (it doesn’t need to tax or borrow in order to spend) doesn’t mean there are no constraints. one limit, if i understand correctly, is the capacity of the economy to produce (which, btw, i think also addresses your question on why some governments are “richer” than others — it’s the productive capability of the economy)
Hi William,
To the foregoing comment about productive capacity, I would add that the dollar’s role as reserve currency allows the US government to tap the world’s productive capacity to the extent that the world wishes to hold dollars. This well has proven to be quite deep in the past, and may still have a ways to go, but we seem determined to find out where the limit lies.
Taking this argument to its logical conclusion, Go’mint has no need to BORROW money and pay interest on the debt. Lincoln understood this and issued Greenbacks to finance the North victory in the Civil War. The bankers wanted to charge him 21% and he felt this was a bit high. Now you understand why Federal Reserve operations are a fraud and that the income tax exists to finance payment of the interest on the Go’mint debt. The principal never gets paid off, just keeps growing to provide money. Henry Ford said that if people understood money there would be a revolution tomorrow morning.
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