Saturday, April 26, 2014

Trickle-Up Economics

Government stimulus directed to businesses such as tax credits and access to low-cost loans create increased wealth at the top end of the economy. Some claim this is the best way to improve the economy since incomes and jobs will flow down as the businesses expand and hire new workers.

From an employment and income perspective, the result tends to be an increase in profits for businesses, increased incomes for those in higher paying/higher skilled jobs, and some incremental “hiring off the top” of the best available talent from the ranks of the unemployed. Those at the other end of the spectrum are left hoping that employment becomes scare enough over time that eventually they might get an offer for some “trickle-down” job in the future.

Unfortunately, the bottom of the labor pool never gets fully utilized. Like the mean bullies picking up teams for a game on the playground and deliberately rejecting the least athletic kids from participating, the monetary and fiscal policy wizards stop their policies well before employment levels are considered “full” out of tragic and mistaken belief that full employment causes unwelcome inflation. In other words, we say to the millions who want employment: "The rest of society needs you to stay unemployed and impoverished in order that the cost of bread and milk for the rest of us doesn’t go up too much."

Meanwhile at the top, the increased profits and wealth is often siphoned off into cash and bond hoards, and funneled into exclusive investments before it can circulate in the economy as spending which would have helped create jobs & incomes for others. The wealth stream dries up long before it trickles down. 

We need to reverse the flow! A job guarantee creates a floor of income and ongoing work for those rejected from the private sector, employs from the bottom of the pool rather than the top, and provides essential income to those currently relying on government benefits and welfare.

Businesses invest in capital and new jobs when there is a prospect for increased sales, not because they get tax breaks. It is a forecast of increased demand that drives investment. Those in a job guarantee program would spend most of their income directly into the economy, creating the necessary demand stimulus for business to have an incentive to hire from the pool. It also stimulates the portions of the economy that best benefit society as a whole (food production, household goods, medical care, etc.), rather than the goods & services that only the elite can afford (like yachts, castles & cosmetic surgery).

Trickle-down economics is a farce. 

Trickle-up economics would provide the kind of buffer the economy needs to maintain a base of demand during downturns, while reducing the personal tragedy of structural unemployment and the ruined communities and social burden left in its wake.

At the core of trickle-up economics is the job guarantee. And don't worry, the top 0.1% will still get their fair share…eventually.

Tuesday, April 22, 2014

Why do we think so wrongly about money?

Words matter.

“Debt” is a word that evokes powerful emotions. When used in association with our government it implies a burden on the people, irresponsibility, fiscal cliffs (whatever that is), sovereign bankruptcy, or worse! The media, blogosphere, and water cooler is rife with such sentiment.

Over forty years ago when some currencies were convertible to gold, national debt DID have meaning. Nations like this (and current European nations that use a currency and do not issue their own currency) have to run trade surpluses to keep reserves of gold (or Euros) or they risk going to the bond market to borrow at rising interest rates. Nations that issue their own currency (US, UK, Japan, Canada, New Zealand, Australia etc.) control the rate they choose to pay those who save their currency. "Debt" is their choice to give savers an interest-earning alternative to reserves. It is NOT the same thing as real debt, and the word keeps us from using our national money to help the economy and maintain full employment.

Debt carries weight and meaning. It affects our perceptions of right and wrong. It fills our minds with worry about the future. 

Debt implies borrowing. We are led to believe that the government has to borrow money from the people. 
It doesn’t.

Borrowing implies someone first had to save that money. We are led to believe that our government takes money from private citizens to spend on people (so-called “transfer payments”) or things, leaving the private sector with less money. 
It doesn’t.

Saved money implies that when the government borrows, money is being “used up” that could be invested in something else. We are led to believe the government “debt” takes away our opportunity to invest in more productive things. 
It doesn’t.

Debt implies a lengthy financial burden. We are led to believe the government must make future generations labor under its weight and suffer lower quality of life until it is all paid back. 

Perhaps we should banish the word “debt” from all discussions of national government money! (Of course debt is still highly relevant to cities, states, households and businesses because we don’t issue our own currency!) National debt is an entirely unhelpful term, terribly misleading to the public, and wreaking havoc in political discourse and public policy.

We can simply say that we do not have national "debt". Any government spending that is not taxed back becomes our savings in the form of currency, bank reserves, and bonds. We get all the benefits of that spending for the common good if we use it well. Let's shift our discussion from debt ceiling despair and deficit hysteria to a more hopeful perspective; how best to use our national money for our current needs and those of the next generation.

Sunday, April 20, 2014

Drawing some initial conclusions

Money is a form of credit created by the government, and it typically becomes the national unit of account for all money things. When that government itself is the creation of the people, we can safely say that our money is of the people and for the people. It’s ours to use for the public good – which is exactly why we created government in the first place!

Stable prices and full employment are the stated mandates of the US Federal Reserve Bank (called the “Dual Mandate”). I believe these to be noble goals but they cannot be realistically achieved via central bank monetary policy (i.e. raising and lowering interest rates and managing bank reserves) for reasons I won’t go into yet, although our experience alone is enough to confirm the validity of this statement. 

However, we can achieve these goals if we use our monetary system to its full extent, and that means we have to use fiscal policy (i.e. government spending and taxation). In particular, the implementation of a job guarantee would provide employment to everyone who can and wants to work, while functioning as a stabilizing buffer stock in the economy (the pool of labor in the program will rise and fall as the economy expands and contracts). More on this in later posts.

So why don’t we? Because we are held back by the mistaken belief that we can’t afford to, or that we can’t spend money that way, or that if we do there will be bad consequences. For the record, there are plenty of bad consequences evident all around us today for NOT doing so!

I have attempted to explain that government money works very differently than how households and businesses are managed. The differences are highly significant and we ignore them at our peril. Failure to use the system properly does more harm than good.

What have we learned?
  • Taxation and bond sales do not finance government spending, and governments have no need to balance revenues versus their spending.
  • Taxation plays a very different role in the economy than the mistaken notion that it is used for funding government; we need to use taxation appropriately.
  • Government “debt” is really just money the rest of us have saved (or we can also say it is money that the government has spent into the economy but not yet taxed back out, so we get to save it). As such, this so-called "debt" is not to be feared and there is never a need for government to have to earn more (i.e. increases taxes) in order to pay it off.
  • The hyperinflation monster we have been taught to fear lives in a different monetary system than ours. It lurks in the world of societal destruction combined with gold standards, pegged currencies, external currencies, or foreign denominated national debts.
  • In short, we can afford to do what is in our best interest.
So how should we best use the people’s money for public purpose? We can certainly have legitimate debate over the “what” and the “how” (indeed, this is exactly what our politicians should be doing), but for now let’s just imagine some possibilities now that the blinders are lifted off:
  • We can afford to provide housing, food, and care for our elderly.
  • We can afford to provide education to our youth so they have the skills and knowledge to be productive citizens and future innovators.
  • We can afford to provide essential health services to everyone.
  • We can afford to grow our economy without harming our environment.
  • We can afford to repair our national infrastructure, and to invest in new infrastructure (a national high speed electric rail system linking all major cities?)
  • We can afford to provide employment to everyone who is ready, willing and able to work.
  • We can afford to invest in research and development of groundbreaking science and technology, and to help commercialize innovative technologies.
  • We can afford to cut income taxes and increase the real incomes of families.
  • We can afford to help struggling municipalities and states and not let their citizens suffer the loss of essential services because of mismanagement of some previous politicians.
Lest you misunderstand the message, let me emphasize that 1) just because we can afford something it does not mean that everything is an appropriate use of public money, and 2) there is a big distinction between the public’s money being used to pay for something and government employees doing or managing that activity (the two do not have to go together). For example, there are ways to provide health care for every citizen without a government run medical industry if that is what the people prefer. 
J Fagg Foster, Denver University Economics Professor, wrote in 1966.
Whatever is technically feasible is financially possible. To the perpetual question ‘Where is the money coming from?’ the answer is now clear. It comes from the only two institutions we permit to create money funds: the treasury of the sovereign government and commercial banks. And the rate at which we permit either to create funds is pretty much a matter of public policy.” (emphasis added)
Of course we have to consider the effect of what we do on the economy (i.e. it would almost certainly cause inflation if we decided to give every citizen one million dollars in cash tomorrow), but the key point is that affordability is never the issue for the government (i.e. "us acting collectively for the common good"). We have unlimited ability to credit bank accounts if we direct the government to do so.

After too many years of economic malaise, isn't it time to begin to see and act rightly? We have an incredible system of money and government that was formed for our benefit. Let’s use it. Start to imagine a prosperous and just future for all. It is within our reach. 

Sunday, April 13, 2014

Money Myth 10: Persistent government deficits lead to high inflation.

FACT: There is simply no evidence that increases in the money supply and/or government "debt" cause hyperinflation. The propensity to save and a nation's underutilized productive capacity are two major mitigating factors to inflation.

The fear of hyperinflation (especially in the US) is a common theme behind the many "doom & gloom" authors, precious metal fund promoters, and other economists and investor newsletters that warn of the next dire economic crisis caused by too much government debt. The story usually goes that the US debt is reaching crisis proportions, and that we are one tragic financial crash away from the hyperinflation experience of Zimbabwe, Wiemar Republic, or more recently, Greece.

It should be clear by now that the currency of nations like the US function very differently than those of nations that don't issue their own currency (e.g. the Euro), peg to another currency (e.g. some countries promise to convert their currency on demand to the US dollar), promise to redeem in gold, or hold significant foreign currency-denominated debt. It was these factors that gave rise to hyperinflation in Zimbabwe and the Wiemar Republic, along with the destruction of those nations' productive capacity. In other words, they had promised to meet financial obligations in a currency they did not issue, and with the productive capability of their countries decimated, they had no ability to produce enough surplus to meet those obligations. The conditions for hyperinflation are extraordinary factors (often external) such as war, civil war, foreign denominated debt or other significant external obligations, or rampant corruption.

Inflation is a complex subject and there is no doubt that the fear of inflation has a significant influence on consumer and business confidence. Inflation is hard to measure since innovation and productivity gains make direct comparisons between products we use today and those of the past quite difficult. This, among other factors, has led to much debate (and mistrust) over the government methodology for calculating inflation-tracking statistics such as CPI. However, it is still reasonable to take the position that inflation has been consistently low for many years in many countries, despite consistent and even significant deficit spending. 

Too much inflation can certainly reduce the desirability of a currency for savers, and can have a disproportionate negative impact on the poor since a higher percentage of their income is spent on life's essentials. This is one of the areas where our monetary system, once properly understood, can be used for the public good (mitigating inflation's effects on the poor, promoting employment, and using tax increases only when necessary to cool a frothy economy.

So with this background, we can make some general comments about inflation.
  • For better or worse, modern economies seek to maintain a constant low level of inflation. This is generally viewed as positive in order to attract continued investment (deflation tends to cause the private sector to retract and stop investing since they can't see how new investment will produce financial returns).
  • Any inflation has its drawbacks and we should consider how to mitigate the impact on the poor in public policy and fiscal policy.
  • The job guarantee provides a framework for using employed labor as a buffer stock and a price control mechanism that would bring price stability with full employment. 
  • Inflation is NOT caused automatically by an increase in money supply. This dynamic has been evident in Japan for about two decades.
  • The conditions for hyperinflation do NOT exist in the US or other countries with a similar monetary system, and history seems to have borne out this distinction. 
  • We may see continued asset and commodity price inflation as investors chase yield. This dynamic has much to do with our financialized economy and the structural & tax incentives for pooling wealth under the control of the financial sector.
  • If the private and public sector desire to save and hold government securities at least equal to deficits and trade balances (which is very much the case with the US and many other developed countries today), the "not-yet-taxed government spending" (deficits) do not result in a rising rate of inflation. 
  • When a nation has high unemployment and its productive capacity is below maximum output, inflation is a very low risk as increases in deficit spending are absorbed by expanded output, hiring, etc.
  • There is little evidence that inflation levels higher than what we typically experience (even double digit inflation rates) cause significant negative economic effects. Unfortunately, our fear of inflation has kept us from implementing the very policies that could help those in need the most. Read chapter 7 in Modern Monetary Theory, and this Levy Institute working paper for a more detailed treatment of this topic.
  • If full employment is reached, the economy is booming, and the rate of inflation truly does start to increase above a desired level, higher targeted taxation is an appropriate fiscal policy move (the government removes excess money from the economy, cooling demand).
In conclusion, the fear of hyperinflation is unfounded and is causing much harm. Refusal to increase deficit spending when it is needed the most leaves millions unemployed, perpetuating deficits as the economy languishes, tax receipts fall, and the government safety nets fill up.

We can and we should direct our elected officials to end unemployment now. 

Additional reading

Rob Parenteau has provided an excellent succinct summary of the unique dynamics of hyperinflation, showing why extreme conditions must exist in both demand and supply.

Also read Mythologies: Money and Hyperinflation by Arun DuBois.

Check out the series of posts on the topic by Cullen Roche of Pragmatic Capitalism, especially Hyperinflation - It's More Than Just A Monetary Phenomenon

Bill Mitchell's billy blog has a thorough overview of inflation from the perspective of modern monetary theory in two posts. Part 1 and Part 2

Saturday, April 12, 2014

What I am NOT saying...

This blog is about understanding how our monetary system actually works. Not how we wish it would work. Not how some best-selling “next-big-market-crash” author says it works. Not how the gold exchanges want it to work. Not how the Tea Party, Republican Party or Democratic Party thinks it works.

The myths and facts I have laid out can be verified by those who know the inner workings of the Treasury, the Federal Reserve Bank, and the banking system. Extensive research has gone into uncovering, explaining, and validating this system (see the links and books on the blog for reference).

This blog is also about choices. It is about options that we did not know about or were taught were harmful.

In our ignorance, we have invented problems and proposed cures that harm our economy and our lives. And we have given the controls to those who use the monetary system for their personal gain, to the detriment of the citizenry. Once we properly understand how our money works we can begin to think how to use it for the good of all, and to hold our elected representatives accountable to do what is right.

I know many of you have been a bit stunned, perplexed, or confused by my recent Money Myths posts. This is to be expected since belief in these myths is quite pervasive. My hope is that I get you thinking…that maybe, just maybe, things are not the way we thought.

I realize that I have left much unsaid – deliberately. Too often we reject ideas before we have thought them through because they appear counter-intuitive. And without a doubt, government monetary systems do appear counter-intuitive at first blush.

Here’s what we’ve covered so far:
  • Taxes do not fund government spending; all government spending is via the creation of new money.
  • The government does not borrow from the private sector to fund deficit spending.
  • The government does not borrow from China or other nations to fund the national “debt”.
  • We are not leaving a debt burden to our children.
  • Fiat money is “backed” by a nation’s authority to tax.
  • The Fed does not print money; it manages interest rates and bank reserves.
  • There’s no such thing as “unfunded liabilities”; the government can always “afford” any monetary obligation such as Social Security.
  • Interest rates are controlled by the Fed; foreign nations or bond investors cannot drive rates higher.
  • Government deficit spending increases the net financial assets of the private sector; it does not take away from private sector financial wealth.

With that said, it is time to give a few clarifying words about what I am NOT saying.
  • I am specifically addressing the operational functions of how a national monetary system like the US or Canada or UK can work. For nations that do not issue their own currency, do not allow that currency to float, peg their currency to gold, or promise to convert it to another currency they do not issue, the principles and options described here may not apply or will be greatly limited.
  • I am not saying that nations cannot (many in fact do) choose to pass laws to put limits on monetary functions (debt ceiling limits, balanced budgets, mandatory Treasury account balances, etc.) that unnecessarily restrict the operational value of the monetary system or render ineffectual its capabilities.
  • I am not describing or advocating for a centrally planned economy, or greater government control over the means of production, but I do support the necessary “rule of law” and appropriate regulatory framework that functioning societies and economies require.
  • I am not saying that taxes are unnecessary or that insufficient taxation is not harmful to the currency (in fact taxation is what drives currency).
  • I am not saying that government spending levels do not matter, and that what the government spends the people’s money on has no economic effect (in fact fiscal policy has been greatly overlooked since we created the Federal Reserve, to our detriment).
  • I am not saying that the more governments spend and the less they tax the better off we are (although as I write this there is a great need for more spending and less taxation).
  • I am not saying that inflation cannot happen if governments spend too much relative to taxation levels, savings desires, and the productive capacity of the country (although we are a long way from this today). 
  • I am not saying that even moderate inflation has no negative effects (hence the need for a job guarantee to provide a floor for those who bear a disproportionate impact of inflation).
  • I am not saying that we will not have another harmful economic crisis (rather that the causes are usually not government debt but private sector excesses).

Finally, I understand (to some degree) the concern many have in inefficient and overreaching government. I see the fear and anger in many online forums. I only suggest that we do what our representative system was design for… understand first what needs to be done, and then collectively let’s change it. 

The good news is that there really is a clear and hopeful path forward. 

Additional reading

Check out the Levy Institute paper Modern Money Theory 101: A Reply to Critics by √Čric Tymoigne and L. Randall Wray.

Time for a quiz!

To see who has been paying attention, let's have a little quiz. This is from a presentation given by UMKC professor Randall Wray in 2012. See the full presentation below or click here.

True or False?

  1. Just like a household, a government has to finance its spending out of its income or through borrowing.
  2. The role of taxes is to provide finance for government spending.
  3. The National Government borrows money from the private sector to finance the budget deficit.
  4. By running budget surpluses the government takes pressure off interest rates because funds are then available for private sector investment projects.
  5. Persistent budget deficits will burden future generations with inflation and higher taxes.
  6. Running budget surpluses now will help build up the funds necessary to cope with the ageing population in the future.

Friday, April 11, 2014

News is spreading ...

PBS explains how taxes empower money, but does not fund government spending. A useful comparison to Bitcoin and cryptocurrency also. 

Thursday, April 10, 2014

Money Myth 9: Government "borrowing" takes away from the private sector.

Much of our thinking about money dates back to the gold standard days. We think of gold as a limited quantity commodity and hence we have been conditioned to think of our national currency this way also. When the government "needs" money to spend and "borrows" from the public of foreign sectors to "fund" that spending, the logic implies that the government must be taking away money from those sectors. Government borrowing therefore reduces investment opportunities in the private sector. 

Fortunately, this is all a false assumption.

FACT: Government "borrowing" is generally a result of deficit spending. Deficit spending adds financial assets in the form of cash or reserves to the private sector. What we call "borrowing" simply provides an interest-paying alternative to holding cash or reserves of government money that has already been spend into existence, and is really a method of removing excess reserves from the banking system in order to maintain the Fed Funds Rate. 

The net impact to the non-government sector is doubly positive due to the addition of a flow of interest payments into the private (or foreign) sector from the government (which are also simply created by crediting bank accounts with new money).

If the private sector buys government securities, it is because they think that is a good investment. Private sector borrowing and investment is never constrained by the amount of government sector debt. The only constraint on private sector borrowing is the availability of creditworthy borrowers.

We are not fighting over who gets a limited quantity of a rare commodity. Government "borrowing" is the result of a flow of financial assets into the private sector (i.e. deficit spending) and it also creates a secondary flow via interest payments. Contrary to popular belief (such as the debt ceiling debate and those who perpetrate national debt fear mongering), removing deficits and running surpluses will suck funds out of the private sector and lead to inevitable economic crisis and depression. 

Tuesday, April 8, 2014

Money Myth 8: Too much government "debt" will eventually cause interest rates to rise.

FACT: For sovereign currency-issuing nations, the interest rates on government-issued securities are actually set by and are under the control of their Central Bank. 

There is a prevailing fear in the US that the trillions of dollars of outstanding government "debt" (actually better described as private and foreign sector savings, as we've discussed) will one day (soon according to many) cause an inevitable rapid escalation in interest rates. 

"What if interest rates rise and the payments become a huge part of our national budget", they say. 

The fear is driven by the false notion that interest rates on government "borrowing" are market-driven, and that as soon as China and other bond holders stop "buying our debt", rates will rise rapidly. Secondly, they claim that when that happens, the "bond vigilantes" will force the US to borrow at higher and higher rates since our debt will be deemed "unsustainable". Just like Greece in 2011-12. 

Of course, according to these doomsayers economic catastrophe is always the inevitable result. The interest payments will get so big we either won;t be able to pay them, or taxes will have to be raised on our children, or there will be hyperinflation as we "print" money to pay the mountain of interest on the debt.

Scary stuff, right? Books and blogs are filled with these Halloween tales, and always, the apparent answer is: 1) buy gold & silver, and 2) get the government to balance the budget and pay down the debt. 

What these prophets of doom don't realize is that they are sowing the seeds for a self-fulfilling economic disaster because they understand the economy through the lens of an obsolete monetary system! 

Once again, we see how the vestiges of the gold standard are affecting our thinking. When a nation gives up the ability to issue its own currency, or makes promises that it can't guarantee (such as a promise to convert that currency to something it cannot issue or produce on demand in unlimited quantities), then governments can get in trouble with the financial markets. They lose control over their interest rates and become dependent upon those with money to lend it to them. 

None of this is true for sovereign nations that follow these basic principles of modern money:
  1. Do issue a national currency.
    • One nation, one currency is a good rule!
    • Now they can never run out and don't have to borrow it from someone who does issue it - like the Euro nations.
    • National currencies provide the maximum policy space for a people to direct the resources they need for the public good without fear of financial troubles.
  2. Don't promise to peg that currency with a fixed exchange rate to another currency.
    • A floating exchange rate gives the most flexibility to the nation. 
    • When they fix exchange rates (e.g. to the US$), nations lose the flexibility to issue currency when needed for domestic purposes as they are forced to defend the peg. 
    • Failure to do so causes interest rates to rise and their foreign reserves to be drained.
    • Their only way out of to destroy their domestic economy until their wages are so low that their exports begin to rise. This is Germany's prescription for Greece and all of southern Europe.
  3. Don't promise to convert that currency on demand for a commodity such as gold.
    • Much the same problem as above. 
    • No nation has ever stayed on a gold standard because it is impossible to do so when wars break out or other crises requiring an ability to issue currency arise. 
  4. Don't hold significant national debt denominated in a foreign currency.
    • Debt owed in a foreign currency, like gold reparations for Germany after WWII, create a need to obtain that currency.
    • If that need is too high relative to the productive capacity of the nation, the country becomes forced to export heavily or otherwise buy that currency to pay the debt. 
    • "Debt" denominated in the local currency is never unable to be paid since the sovereign government can always issue it. 
  5. Do maintain adequate taxation to ensure domestic demand for and circulation of the sovereign currency.
    • Taxes drive state-based money, but do not fund governments. 
    • An adequate taxation will ensure the sovereign government can issue money as needed into the economy and that money will be accepted in payment for the resources needed.
  6. Do have a Central Bank.
    • Central banks provide for sovereign nations to issue their own currency as and when needed, and provide stability to the banking system. (Yes, there are things we can do better in how we use them and how we regulate banks - see here).

You should recognize now that there is a huge difference between a nation like Greece (not a currency-issuer), or a nation like Argentina (pegged to the US$ and has massive debt in US$) and other nations like Japan, USA, Canada, China, etc. 

Japan has far more "debt" than Greece ever had and it still has interest rates about zero percent. 


If the central bank wants interest rates to rise or fall, they do so through what is called monetary policy - primarily by buying or selling government bonds. When the interest rate is too high for their liking they sell more bonds, and when it is below their target they buy bonds. 

No foreign country or bond vigilante can win a bet against a Central Bank since the Central Bank has an unlimited ability to buy or sell, and hence an interest-rate induced crisis is a phantom. There is really no need for long term government bonds since they can always be renewed at term.

There is zero risk that interest rates will rise beyond where the central bank wants them to rise. Now admittedly, the central bank board of directors are all human and they can sometimes get crazy ideas (Paul Volcker infamously allowed rates to reach 20% in the early 1980s, thinking the Fed should try to control the money supply and not the rate of interest!) But these are hopefully aberrations of history and we can learn and move forward. 

Our danger is not from bond vigilantes, but from ourselves. Our greatest danger is a population that believes a set of myths and elects politicians the enact fiscal reforms such as balanced budget amendments that would set our nation spiraling into depression. 

As a currency issuer, our government can always make any interest payment now and in the future, and can always choose the rate of interest we pay to those who hold onto our currency. We are never dependent upon them for money: they are dependent upon us!

Now that's more hopeful news, isn't it! Let's spread confidence in our monetary system to the upcoming generation of leaders and rescue the doom & gloom folks from their misguided despair!

Sunday, April 6, 2014

Money Myth 7: Social Security and Medicare are unfunded liabilities that we cannot afford.

FACT: A currency-issuing nation can always afford any obligation denominated in its own currency.

Many of us have grown up hearing politicians and pundits telling us repeatedly that these future obligations to seniors and the sick are huge burdens that we cannot possibly bear.

They love to use terms such as "unfunded liabilities"; they reference "trust funds" as though that's all the money we've got; they delight in scaring people with sound bites like "social security is going broke" or "our trust fund is running out". 

These alarming proclamations lead us to believe that we haven't collectively saved enough money or that our politicians have squandered away the savings, leaving us unable to pay for the future obligations to our senior citizens without massive new tax hikes and austere living for our children.

Who are these people that make such outrageous claims and mislead whole generations? Let me suggest that when people are mostly sowing fear, and not hope, start looking for their agenda and seek other perspectives. 

Once again, let's get beneath the rhetoric and look at the facts in light of how modern money works. 

Social Security doesn't need to be saved, it needs to be funded.

What is the essence of Social Security? As a nation, we have made a promise to our elderly that once they stop working we will credit their bank accounts with an adequate income stream so they can provide for their needs for the rest of their lives. We care for our own. We're not going to leave our parents and grandparents to live in poverty. 

Now as a sovereign currency-issuing nation, can we ever run out of keystrokes that add numbers into bank accounts? Of course not! 

Do we need to take more money from working people before our government can afford to meet the needs of the elderly or sick? Never. Federal government spending is all done via the creation of new money. 100%. Taxes never add to the government's bank account. Spending never diminishes what they have left to spend. 

Remember, we are not a currency-using government that must obtain its currency before it can spend. We are a currency-issuing sovereign. We invented the concept of currency-issuance precisely so that we can direct our government to credit bank accounts for those things we deem in the public interest. We don't have to choose between providing adequate income for the elderly or paying our troops.

Now of course we can decide foolishly to tie our hands behind our backs and pretend that we don't have any money. We can decide to self-impose limits on the amount of money being issued and subsequently saved by the private sector. We can choose to impose meaningless budget rules that hurt the economy and the lives of our citizens. We can choose to stop investing in the things that ensure our children's future is better than our own by pretending we can't afford it. These are political choices, not driven by economic necessity. 

We can always afford Social Security because we can always direct our government to credit bank accounts with new money. How about a constitutional amendment to permanently fund a social security income for all at a living wage, adjusted as necessary for inflation? The same applies to Medicare, Veteran's care, funding our roads and bridges, and all other important financial obligations we have made together that benefit society. We simply need a commitment to fund. 

What about the Trust Fund? Shouldn't the government save for the future? 

Some would have us taxing more today so that our government can put that money away in a lock box to be drawn upon only by future generations. They want the government's savings account to get a really big balance today so that it has enough for all the future needs. 

Really? So we want to put a high tax burden on the economy today - removing money from people and savers - for what? So our currency-issuing government won't have to issue money later? 

As a point of logic, an IOU-issuer can't "save" its own IOUs. It has no need for them (aside from printing costs) since it can always create new ones. When governments try to do so by running budget surpluses, they are being counterproductive in economic terms and short-sighted in terms of the real needs of their country. They can always issue money later but they can't instantaneously issue infrastructure or education or health. Saving reserves of scarce real goods such as food & oil may make sense for emergencies and national security, but when currency-issuing sovereign governments save money for future needs they are simply overtaxing the population

Our real social security is found in real things.  

If we, the people, decide we want to provide a living income for our senior citizens, we simply direct our government to issue them the necessary digits in their bank accounts. No new taxes are needed to fund anything. 

The bigger question is whether we have invested in the actual resources they need to live well: things like good food, safe and affordable housing, transportation, a healthy environment. Is the remaining working population equipped to be productive enough and is it fully employed to meet their own needs and those of the rest of society when the future is here. Have we trained enough care workers? Do we have a good food supply? Have we build livable cities and neighborhoods where people of all ages can get around safely? Are we in tune with our climate and environment in how we consume resources, grow food, and rely on clean water?

Do we really think we can't take care of our elderly? The greatest threat is our gross misunderstanding of our monetary system that prevents us from maintaining and strengthening policies that provide essential benefits to those in need, and investing today for the needs of tomorrow.

Similarly, if we decide that essential health care is something everyone should be able to benefit from, we can always "afford" to credit the bank account of doctors and nurses and hospitals when they provide care for the sick. We shouldn't be passing laws that burden workers or businesses with these costs. In fact, I would argue that removing health costs as a business expense (and hence cost of production) will increase our national competitiveness while lowering the cost of goods to consumers. 

The health care debate should be over what approach we take to ensuring everyone has access to and can afford essential health services. 

More reading

Warren Mosler has suggested an appealing alternative to our current confused and convoluted health care system. 

Friday, April 4, 2014

Money Myth 6: The Fed is printing money

FACT: QE is not an inflationary expansion of money in the economy - it's a tax on private savers. 

There has been much fear mongering over the Federal Reserve's (the Fed) recent open market operations. The fear is that this activity is inflating the money supply and will fuel massive inflation by injecting trillions of dollars into the economy. It simply isn't so. 

It doesn't help that the Fed uses obtuse terms such as Quantitative Easing (QE) to describe what is simply the Feb buying Treasury Bonds from willing sellers.

What is this all about?

Dual Mandate

The Fed has two main mandates beyond its role in keeping the banking system healthy: low inflation and ensuring full employment (note, the Fed is not actually well equipped to do either: see Kelton's Dual mandate -- right goals, wrong agency). 

The Fed believes that it has a significant influence over the economy's growth rate through its ability to manage interest rates (i.e. it believes economic activity rises and falls based on the interest rate it sets - a somewhat dubious assumption). It manages the short term interest rate by buying or selling government bonds whenever the inter-bank interest rates moves off its target rate. 

What is QE all about?

QE is an attempt to affect the longer term rates in the hope that by bringing down long term interest rates it will stimulate more lending and help kick-start the economy.

Despite the hysteria on many web sites, QE actually has no effect on the money supply. The central bank "buys" a longer term bond (e.g. 10 Year Treasury Bills) from a willing seller. The market for such bonds is immense and no one knows when the Fed is the buyer of someone else. The seller (e.g. a bank) had invested in an interest-earning bond, and now they receive a non-interest earning reserve account balance. There's the same amount of "money" in the system. It just changed from one kind of asset to another. 

What does happen when the Fed buys bonds is that banks end up with more reserves than they can do anything with. Banks are never limited by reserves when they lend: it is the availability of credit-worth borrowers, not by the quantity of reserves (nor even the interest rate), that determines whether banks will increase lending. So what happens? The extra reserves sit in the banking system and the inter-bank interest rate (Fed Funds Rate) falls below the Fed target toward zero percent. 

What does the Fed do now? It has to start paying interest on the excess reserves or the banks lose income they were depending upon from the bonds they were holding. This is what happened in 2008 in the US. 

QE is a tax!

Economist Warren Mosler describes QE as a tax - it removes interest income from the private sector. Think about that. Rather than the stimulus it intends, QE is actually taking money out of the private sector! Any by lowering the long term interest rates, it also reduces the amount if interest income being earned by those holding long term bonds, further removing income from the private sector. 

So rather than a reckless printer of money, QE is probably better described as an anemic phantom "stimulus". 

If we want to stimulate economic activity, we need to do so via fiscal policy (more spending, less taxes), not monetary policy (interest rate targeting).

Congressional delusions

Ironically, the Fed pays most of the interest in earns to the Treasury (it's really just the Government paying itself with new money that it creates). Congress, not understanding that they could simply have the Treasury issue money for all their spending needs, got very excited when this extra interest came flowing in from the Fed to fund their budgets. Strangely, the Republicans were silent on this new tax increase... Sigh!

The Fed doesn't print money

The Fed is in some sense a currency scorekeeper, crediting and debiting accounts in response to government, private sector, and foreign financial activity. It responds to the lending activity of banks, the spending & taxing of the Treasury, and the activity of foreign account holders (mostly central banks). It can buy and sell financial assets to manage interest rates and help the banking system recover from crises. It isn't printing money. 

Money that doesn't end up in the economy buying goods and services does nothing. Reserves do nothing. Savings do nothing. It is money that is spent that creates growth in a capitalist system, and the entity that can increase spending when the economy is lacking is the Treasury. 

The Jeckyll Island creature

A few final words are worth mentioning here for those who believe the Fed is a disastrous monster created by banks to destroy America. I won't get into the history here, assuming that those who have read this far are somewhat familiar, but the conspiracy theories and anti-Fed rhetoric don't provide anything of value to a true understanding of the banking system.

In short, my view is that there are many things we can do to improve our banking system, but eliminating the Fed is not one of them. We have many vestiges of the gold standard that can, and arguably should, be done away with (like selling long term government bonds), and there needs to be much more regulation of the large private banks, but these kinds of changes are in the hands of Congress, not the Fed.

  • Yes, the Fed was created in secrecy, but for good reason as it would have been difficult to form in the open (note, the Declaration of Independence was also formed in secret for good reasons!)
  • Banking without a central bank to act as lender of last resort has proven to be very unstable with frequent and messy bank failures. 
  • The Fed is really part of the consolidated government financial sector (with the Treasury) and operates under the oversight of Congress: we could probably merge their functions in many ways and save ourselves much public confusion (and maybe then end the silly arguments that the Fed isn't a government entity, even though it has private owners). 
  • The separation of Treasury & Fed functions are largely optics. The idea was that the Treasury had to have bank balances at the Fed before it could spend and the Fed has to buy bonds in the open market to avoid the government from funding its own spending without any "market discipline". In reality, there is no market discipline and there cannot be in a system like this since i) the Fed sets interest rates, ii) there are always buyers of bonds since spending precedes bond issuance, and iii) the Treasury therefore can always ensure it has adequate funds in its Fed account - we could eliminate all these fictitious "controls". 
  • Innovations such as Federal FDIC insurance to protect depositors are good things and have gone a long was to provide confidence in our banking system. I would recommend expanding such protections on deposits while increasing regulatory scrutiny of bank lending and other activities. 
  • As mentioned above, the Fed is really the wrong institution to be managing inflation & employment since these are far more directly controlled by fiscal policy.
  • Interest rates on government securities could (should) be set permanently low since they are risk-free assets. Let the markets set interest rates on their other investments based on sound underwriting, but the Fed should mostly get out of the interest rate game.
  • Essentially, the problems in the financial sector are mostly the result of the activities of private bank risk-taking, not the presence of the Fed. We need to focus our attention on restoring oversight of banks and prosecuting criminal and fraudulent activity to bring the financial sector back to the business and serving the needs of the productive sector of the economy.

Additional reading

For more a view on what's wrong with the Fed and its response to the Great Financial Crisis, see It's Time To Reign In The Fed.

Warren Mosler's Proposals for the Treasury, the Federal Reserve, the FDIC, and the Banking System

We're overdue for a shift from deregulation to appropriate regulation.

When conservatives finally wake up to the fact that financial sector deregulation (not government spending) is at the heart of our nation's economic issues (along with money in politics), we can begin the path to a real recovery and a prosperous future.

The history and lessons learned here are essential to grasp:

Thursday, April 3, 2014

Money Myth 5: Fiat money isn't backed by anything - it's all based solely on trust.

FACT: The money of sovereign currency-issuing nations derives its value from the imposition of taxes, not blind trust. Taxes "drive" modern money (but never fund government spending), and that's a good thing!  

The blogosphere is rampant with fear-filled predictions of the collapse of the US Dollar. These authors tend to decry the concept of "unbacked" fiat currency and pine for the days of "sound" money backed by gold. Their dire warnings about government "money printing" leading to a calamitous economic collapse are usually accompanied with exhortations to buy gold (presumably they make money from the gold and silver exchanges that advertise on their sites). It's easy to sell doom & gloom. It's surprisingly difficult to convince people that there is hope and prosperity within our grasp. Yet there really is when we understand modern money!

So this is how modern State money really works:
  1. Let's start at the beginning: a new nation is formed or reconstituted.
  2. The new State creates its monetary unit (dollar, yen, franc, etc.)
  3. At the same time the State is granted the right to impose taxes on the population and the power to enforce collection of those taxes.
  4. The State decrees (i.e. by "fiat") that its new money is the only thing it will accept in payment for the taxes owed. 
  5. The money now has value to everyone who owes taxes - in fact everyone needs to find a way to earn them - we have just created the concept of unemployment!
  6. The population now needs to obtain the government money in order to pay their taxes and so it is willing to work or sell goods to the government in exchange for this new currency.
  7. The State can now issue new money into the economy (today this is done mostly via computer entries crediting bank accounts) to provision whatever labor or products or services it it authorized to do for the people. 
  8. The private sector happily accepts this money in payment for wages, goods, etc. since they need the units for their taxes, or because they know others will need them.
  9. In a very short time, the State money replaces other forms of money in that domestic economy since it is more practical for everyone to use the State money for accounting, issuing loans, determining prices, paying wages, taxes, and the exchange of goods & services.
  10. The private sector will also try to save some of this money for future needs which means the government usually must issue more than it taxes away just to keep up with demand for its money.
  11. A national currency has been created. It is not based on "trust" but upon the establishment of a government that has power to tax.

We gave our government a monopoly on the issuance of money for a very important reason - so that it can issue that money as needed for public purpose. Why did we leave the gold standard? Because it put shackles on our nation's ability to issue money as needed for public purpose! 

It is pointless to debate economic ideas and approaches to government spending that are not based around this understanding. There's no such thing as a private sector economy without State money and a functioning government sector. Much folly has resulted from economic theories and political policies that ignore or diminish this reality.

What does this mean practically?
  • Our government has no real limits on its ability to spend and cannot run out of its own money (but of course this doesn't mean it should spend without accountability). However, it definitely IS limited by the availability of the real resources that it wants to procure and the willingness of labor to perform its work.
  • Government can now “afford” to buy/build/fund anything for sale in its own currency. Of course, consideration is still given to the impact of its spending on the economy, prices, output, foreign trade, etc., but there is never a shortage of money unless it is self-imposed
  • Any constraints such as balanced budget requirements and deficit ceilings are self-imposed and usually counterproductive to the proper functioning of the monetary system and the health of society and the economy.
  • The amount the government taxes has nothing to do with its ability to issue money or spend. The level of taxation ideally should be used as a means of keeping the economy at full employment.

So-called budget “deficits” are completely normal, indeed essential, in such a system: they are exactly what we made the system to do

If every dollar that has been spent into existence is subsequently taxed out of existence, we would be quite foolish. Why would we hurt the economy this way? (In fact in the US we have tried to do this seven times in our history and each time, predictably, we sent the economy into depression). 

Why do we need constant deficits? 

Firstly, many nations import more than they export and so we have a net outflow of money from the domestic economy. This functions much the same way as savings and taxes; both of which remove spending from the private sector. Secondly, people always want to save some of the national currency. By removing all the government money from the economy we are also removing all our savings, and also causing the amount of spending to fall precipitously. When spending falls, businesses can't pay their bills and so they downsize the workforce, and loans can't be repaid and so default rates rise and banks fail.

State money's purpose is to direct resources (labor and goods) to public needs and desires. It could be to establish a national park, build a highway system, fight a war, educate our children, provision medical services for those that need them, or care for our elderly. 100% of this is accomplished by issuing new money. The government simply must tax enough of it back to create continual demand for the money that is being spent and to maintain balance in the economy (too little tax and we get inflation; too much and we get unemployment). 

State money (fiat money) is sound money. It is far more powerful and provides much more policy space than linking a nation's currency to gold or fixing exchange rates between nations ("Exhibit A" - see the Euro!) The question is whether we will fully use this invention for the purpose for which it was created - to ensure the safety, prosperity, and happiness of all citizens.

Hope is completely within our hands. Let's grasp it! 

More reading

Monopoly Money: The State as a Price Setter,
Taxes Drive Money,
Tax-Driven Money: The evidence from history

J.D. Alt has produced an excellent visual explanation of how money functions, called Diagrams & Dollars. See links and video below.



YouTube Video: