Tuesday, July 29, 2014

Why this recovery isn't "working"

The exerpt below from Warren Mosler provides a brief comparison on the last few "bubbles" to this one. Note the importance of understanding the sector balances, the effect of our collective savings on the economy, and how debt/credit expansion (incl. government) is so critical to "recovery". 

So where do we go from here to avoid stagnation/recession? It's either learn to use deficits properly to make up for the savings "leakages" or we need a massive effort from the business community and investors to move money into the real economy. 

Yes, we really do need to address the banking sector and excessive credit expansion but this is not the same as saying we need to eliminate credit in general or move to a "gold standard" or "100% reserve banking".

So why does housing matter?Can’t spending simply go elsewhere? 
The problem is the oldest of all macro constraints-If any agent spends less than his income, another must spend more than his income for all of the output to get sold. 
It’s also been expressed as ‘the paradox of thrift’- decisions to not spend income and to instead ‘save’ cause sales and income to fall with no increase in net savings. 
And it shows up in this discussion- ‘if the banks charge interest, where does the economy get the money to pay it?’ With the response ‘the banks spend the interest income’. 
And if the banks don’t spend their income it’s the same unspent income problem as with any unspent income. 
Unspent income is also known as a demand leakage. 
And in the normal course of business, the US has all kinds of demand leakages going on, many due to tax advantages, including pension contributions (and pension fund earnings), additions to IRA’s, insurance reserves, bank reserves, foreign central bank dollar reserves, etc. etc. etc. 
This means that much output won’t get sold unless other agents spend more than their incomes. This includes the US govt spending more than its income (the dreaded deficit), as well as corporations spending more than their earnings, and consumers borrowing to spend more than their incomes.Which is where housing comes in. Historically it’s been the engine of ‘borrowing to spend’ to offset the demand leakages, driving the economy even as the automatic fiscal stabilizers work to bring down the govt’s deficit spending. This includes the borrowing to spend that turned into the sub prime fiasco, the Clinton housing boom that combined with the .com and y2k borrowing to spend, and the $1 trillion+ S and L financing/fraud that drove the Reagan years back when that was a lot of money. 
Yes, the business sector can materially borrow to spend to close the output gap. It falls under ‘investment’, including construction, and many would argue it’s the preferred way to go. And this would include new equity issues as well as borrowings ‘further up the credit stack’, as long as it’s ‘borrowing to spend’ on real goods and services- the output- GDP. So yes, there’s some of that going on, which is encouraging, but not nearly enough to overcome the demand leakages they way it did in the late 90′s. 
So again, historically, it’s been new housing that has been the prime channel for private sector agents to spend more than their incomes.Yes, they can spend on other things, but it’s highly problematic for that spending to result in anything near the mortgage debt of prior cycles. 
That is, instead of a 200,000 mortgage on a house, the same family would have to borrow 200,000 to spend elsewhere to similarly support the economy/accommodate the savings desires of those wishing to spend less then their incomes. Buying a car does some of that, and maybe a few appliances, or a student loan.
But overall, seems to me that kind of thing can’t ever be enough to ‘close the output gap.’ 
And with the politicians measuring success by their deficit reduction efforts, the macro constraint of unspent income only gets worse. 
So housing matters a lot as it looks to be the only available avenue for the economy to spend more than its income in sufficient quantities to overcome the demand leakages.

Read the full article here

Saturday, July 26, 2014

Do conservatives actually create socialism?

It is a double irony: Conservatives’ and Libertarians’ deadly fear of socialism and the resulting obsession with anti-government policies, (especially deregulation and its cousin, de-supervision), results over time in the very society and economic situation most feared; and at the same time the deliberate, persistent resistance to all effective uses of government money in the economy, and any legitimate reigning in of the financial industry’s excesses, prevents the bulk of the private sector from having the kind of robust growth they (and in fact all) desire.

The tragedy is that this obsession over the evils of socialism has created a massive blind spot to the real causes of economic devastation so prevalent over the past few decades. Rather than addressing the real causes of economic crises, extreme wealth disparity, declining real wages, and systemic unemployment, these very problems have been exacerbated via a flawed economic framework that creates and sustains this destructive environment.

How does this happen? There is a clear progression that stems from a fatal misunderstanding of monetary systems and the role of government money in a healthy capitalist economy. 

An important note before we begin: this is not a promotion of "socialism" as it is commonly understood (or misunderstood). I am addressing the understanding of money, not how we should or shouldn't use it once properly understood, although I do believe most need to rethink what the best uses are once they gain a proper understanding of its operations. Our political parties give us mostly all the wrong choices. 

The destructive cycle

It starts a meme along these lines: “socialism is the greatest threat to our liberty!” which then leads to the following three beliefs:

  1. the government does nothing well (exceptions are always made for the military which somehow isn’t viewed as “the government”?);
  2. the private sector does everything better (this is a rather dishonest assessment – another myth that’s been debunked, but never mind that for now);
  3. regulation holds back the private sector from otherwise good growth that benefits everyone. (I.e. if we can just get the government off our backs we would all prosper again.)

From this set of beliefs, a sequence of events unfolds as follows (you can trace this repeatedly in history if you study the past 100 years alone). 

  • The nation elects representatives who share this view, and these officials proceed to pass legislation to remove or weaken regulations (look up the repeal of the Glass-Steagall Act for a stunning example that is directly tied to our last three financial crises).
  • As “pro-business”, anti-government, anti-regulation fervor grows, mounting pressure is placed on the remaining regulators and agencies to stop “harassing” businesses (i.e. stop the supervising that is their job) and rather trust in the "self-regulation" of industry (i.e. industry has all the right incentives to do the right thing...BP? JP Morgan?...hmmm…)
  • With less oversight, many large financial institutions and corporations can and do take on more risk, driven by the short-term financial incentives provided to their CEOs.
  • Financial sector, corporate and other private wealth at the top grows rapidly. With the increased wealth and influence, control of the political process increases.
  • Unethical and immoral (and in many cases corrupt and fraudulent) behavior begins to increase. Regulators are given favors; insiders are placed in oversight positions; opposition voices are out-lawyer'd and out-lobbied.
  • A form of Gresham’s Law takes effect where bad morals drive out good business practices. Those who don’t play the game are replaced by those who do, driven by short-term greed and a reckless disregard for the longer-term consequences.
  • Supporting business practices and compensation structures become normative through self-reference to each other (e.g. the “market” has determined we have to give CEOs enormous wealth based on short term results, and they keep it all even if shareholders lose big shortly afterward).
  • With political influence, laws are changed to further legitimize wealth extraction & decriminalize previously immoral or fraudulent behavior.
  • Private sector excesses and abuses have now become virtuous (Gordon Gekko’s “Greed, for lack of a better word, is good” is gospel). Fraud goes un-prosecuted. Government intervention is frowned on. Regulators who identify problems are demonized, discredited and sidelined.
  • Excessive credit expansion and risk taking reach their pinnacle in a financial asset bubble (e.g. stock market, real estate, commodities speculation). By now there is typically a large unsustainable debt burden underlying everything – people investing with borrowed funds and without capital. Minsky calls this the Ponzi stage – where more debt is needed just to pay the interest on the maturing debt.
  • Then comes the inevitable economic bust where the first domino falls in the “non-payable debt chain” ("debts that can't be paid, won't be"). Usually there’s a trigger such as a large bankruptcy, rising default rates, a foreign debt crisis, or a ponzi scheme exposed.
  • The economy, nation, and more often the world is plunged into recession, economic crisis, job losses and unemployment, falling or stagnant wages…millions fall into the government safety net (food stamps, unemployment, disability). 
  • The banking system is in disarray as no one trusts anyone else and so inter-bank lending freezes, requiring the Central Bank to step in as lender of last resort. (Priority is always given to rescue the banking system first as it is viewed as the necessary heart of the whole economy - in reality, there are ways to address liquidity and extend credit to going-concern business needs without bank "bailouts" - but politicians get scared and look for the bankers for how to deal with the very problems they often created in the first place).
  • Businesses and consumers retrench. Efforts to “tighten the belt” exacerbate the crisis, and as it drags on, social problems increase (businesses cut more jobs, systemic unemployment, depression, lost medical benefits, general anxiety, …)
  • Deficit spending increases without any Congressional action simply due to the “automatic stabilizers” of social protection programs and falling tax receipts.
  • Misplaced fears of rising deficits and national debt lead to calls for "austerity" and "shared sacrifice" to reign in government spending, reducing what helpful inflows to the private sector were helping offset the private sector collapse. 
  • Dependence upon the government social net increases, and the number of people relying on "socialism" grows. Deficits keep growing naturally. 
  • In the next election cycle, many more voters are dependent and, not seeing any alternative, continue to seek government solutions to their dire economic and social challenges.

As the political groups fight over stimulus "funded by taxing the rich" versus tax and spending cuts, the economy struggles, unemployment stays high, growth stalls, investment slows, and the cycle continues. This undesirable outcome was not the result of deliberate policies promoting socialism but rather the destruction of a healthy private sector by bad economics and the policies they promote. 

Meanwhile, the banks and the very wealthy sweep in on the misfortunes of the populace to pick up assets inexpensively – most of whom will have liquidated their stocks before the crash since they have the knowledge of what is happening with the troubled assets well before and in greater detail that the retail investor. 

In summary

The economic framework held by so many today and the political strategies that accompany them have directly led to an increased dependence upon government (in the kind of ways we all would prefer were less if possible) and a steady destruction of the private sector through the concentration of wealth and political power in the hands of a handful of powerful financial institutions, large corporations and the individuals behind them.

While I have focused on the political “right” above, both major parties have contributed to this deadly cycle over the past 30+ years, and both are greatly misguided in their approach to macro-economic policy. Both hold the country back. 

There is a different way

I am convinced that most Americans, (despite the faux left-right political debate), love their country, seek justice, care about people, and want a good future for their children. This tide will turn soon, as one by one we walk away from the side-show of politics, talk radio, social media hysteria and all the other clamoring voices sowing fear and discord with their illusory economic views.

As we choose a more hopeful path forward, looking for solutions and guided by a proper framework of how things work, this generation will lead the nation forward to a prosperous and equitable future. To get there, we need a new approach:

  • Government money (through tax policy and budgets/spending) can and should play an important role in providing for the full employment of its citizens, and also in ensuring the nation is investing in the capital development desired to provide for a prosperous future and strong economy. More on this in future blogs, but this surely involves leading edge infrastructure in transportation, sustainable & affordable energy, world-class education, knowledge development, research & development, health, and provision for the elderly and needy. This does NOT necessarily mean government does all these things but it has a role to finance them.  
  • Appropriate regulation of the privileged banking industry is essential for the long-term health of the economy. Banks have a special role to play in providing the finance needed for the real economy, especially for productive capital. They have an exclusive privilege to create money for this purpose. Their services of underwriting and due diligence are valuable and necessary. Government backing of the banking industry for depositors is a good thing. Banking activity that extends beyond the arenas that serve the public good (speculation, exotic financial instruments, etc.) should be at the full risk of the investors and not backed by the government or central bank. 
  • These are two of the "biggies" - we can discuss others and more specifics going forward.

Full credit goes to Bill Black for his insightful exposition of the deregulation cycle. Read more herehere, here.

Thursday, July 24, 2014

The myth of loanable funds

This one is a biggie! It has been referenced a number of times in previous posts but it warrants further explanation as it underlies many of the misplaced fears about government spending and debt. 

The "loanable funds market" does not exist in the real world, and yet remarkably, the belief in it is held by most economists and almost all politicians. And that means it drives policy decisions - in a wrong direction on both sides! This is one deadly myth!

The idea is this: 

  • savings create deposits (see this myth exposed here); 
  • the pool of savings is available for lending by banks etc.; 
  • to the extent the government increases deficits, a greater share of the "pool of loanable funds" gets used up by government debt (bonds); 
  • this takes away from (or "crowds out") private sector investment.

Look at this quote from the Congressional Budget Office (CBO):

Large federal budget deficits over the long term would reduce investment, resulting in lower national income and higher interest rates than would otherwise occur. Increased government borrowing would cause a larger share of the savings potentially available for investment to be used for purchasing government securities, such as Treasury bonds. Those purchases would crowd out investment in capital goods—factories and computers, for example—which makes workers more productive.

Here we have a classic example of how pervasive is the complete misunderstanding of how modern money functions. Our policy-makers are guided by this kind of economic nonsense into foolish decisions that constrain use of government fiscal activity to address critical issues and desirable outcomes. 

Scott Fullwiler has an excellent piece explaining how the CBO is still following an outdated paradigm - read it here. It's quite shocking to see how perilously wrong they are about such an important topic. 

As explained previously, banks are NEVER constrained in their lending by the amount of deposits they have. If they find a good lending opportunity, they will write the loan. The creation of the loan creates a new deposit (literally new bank money created by computer entries). They can either obtain the required reserves from another bank or the Central Bank will always provide reserves if there is a shortfall in order to keep their target interest rate. 

Some might say we should have a 100% reserve requirement for banks so they don't create so much debt. The concern is valid as irresponsible lending/speculation by banks is a real problem. However, having a 100% reserve requirement doesn't change anything. Banks are not constrained by reserves (or deposits). They can still create loans at will, so the key to limiting the inappropriate lending is to change and enforce the rule - i.e. proper regulation and criminal prosecutions for fraud etc.  

So let's turn back to the government. Does the government debt take away anything from the private sector? No! No business suffers from an inability to obtain financing for a good investment because there are too many government bonds for sale. In fact, the so-called "debt" is actually the only "net" financial savings in an economy. For every dollar saved by one person, another person must become indebted a dollar (all money is debt) - there's no net monetary savings in the economy except for government injections of money which get turned into what we call the national debt. 

Wars can be very helpful to illustrate monetary operations (unfortunately we don't learn from then and apply the same approach in peacetime for national interests!) How did the US fund WWII? It created new money in large quantities and spent it into the economy. Since the economy reached a level of almost full productivity and employment, tax increases were needed to avoid inflation (we are a long way from that problem today!) Did the US need to collect from a pool of savings before it spent? No. It spent, and then taxed/sold bonds in order to drain excess dollars from the economy.

Look at the combination of the GW Bush tax cuts and wars. How was it paid for? New money created and spent. So why are we happy to do this when it's for the wrong reasons but we don't do it for what we really need to take our economy into the next century and meet the needs of its citizens?

What do you think we should use the people's money for? 

How about a national high-speed electric train system to reduce dependence on flights between major metro areas and reduce oil usage and pollution?

How about taking care of our growing elderly population with leading edge housing designs and care?

How about improving the care for our veterans and their families?

What about a job guarantee so that everyone who wants to work can work and provide for their families so everyone can contribute to society and productivity?

How about both parties getting together to create medical care for everyone while still using the best of the private sector's capabilities and lowering medical costs for businesses?

Why wouldn't we accelerate the move to a clean and sustainable energy  

It is ALL affordable. There is NO constraint in terms of "savings" - in fact such initiatives would increase the net financial wealth of the country since government funding ends up in private sector bank accounts.

Share the positive news and let's end the deadly myths that hold back our nation. We need a congress that understands this stuff, and it will take all of us spreading the word to get there.

Monday, July 21, 2014

The myth of redistribution

Taking from the rich to give to the poor. The idea once overly romanticized by Robin Hood is now more often demonized with cries of "class warfare". The link between government taxes on the wealthy and spending for the needy is taken for granted by all across the political spectrum. And it's a myth!

It does appear that many on the left would dearly like to tax the rich more since they view their wealth accumulation as a problem that hurts the lower and middle class (and there's some truth in the wealth inequality gap problem, as we've discussed). Many see increased taxes as a legitimate redistribution of often ill-gotten wealth from the greedy to the needy. While their angst may be mostly directed at the uber-rich and "banksters", the tax proposals coming from the left usually sweep up the many small businesses and even upper middle class workers. This becomes an easy target for the opposition.

The right quickly responds with examples of the millions of small business "job creators" who would be punished by these measures and how jobs will be lost and investment/expansion reduced (and there's truth to this also). The idea of taking "what is rightfully mine" to give to someone else "who may not have worked as hard" (as is often the view) is greatly resisted. The very idea of it is often portrayed as unethical and a "moral hazard" that prevents people from working hard to get their own American dream.

During the Obama-Romney campaign, President Obama made a very awkward attempt to make the point that even businesses benefit from government funded resources such as education and infrastructure ("If you have a business...you didn't build that"). The reaction was swift and effective and the intended message drowned out. The idea of the so-called "self-made" man/woman/business is alive and well in America. 

During that same campaign the President described income inequality as the defining issue of our generation. Tackling this problem would be a key part of his second term agenda. It fizzled immediately after the election. 

The left simply can't or won't touch the class warfare issue and yet we do have a real crisis developing related to declining real incomes, wealth inequality, and persistent unemployment. The right won't raise taxes and won't support any increase in non-military government spending without an offsetting "pay for" cut elsewhere. The left insists on tax increases for "the rich" to pay for government deficit spending. We're stuck.

What choice is left?

Once again, it is economic myths that guide our policy-makers and the voting public. The good news is that there's another and better alternative for currency-issuing nations. 

Taxes NEVER pay for government spending. Really, they don't. The link is a fiction. It is a self-imposed constraint to say X tax is needed to pay for Y spending. We have unnecessarily limited our options by insisting that the only way to provide income to the poor it to take it from the rich. Robin Hood can retire (or go fight other battles) - this isn't one of them. In fact, as described above, it is political stalemate to link the two. DON'T DO IT! It is not necessary to pick a fight with the powerful in order to address unemployment and poverty. And in the same manner, there is no fiscal reason to cut welfare programs or privatize social security in order to make a case for tax cuts. 

How does this work? All government spending is simply crediting bank accounts. Any spending we authorize is done simply by increasing account balances on computers. The government doesn't need our tax money and actually can't "use" it to spend. Taxes remove excess money already spent by the government, and the amount and type of taxes imposed is an entirely separate government operation. And remember that inflation is never an issue when we're so far below full employment and economic output. Yes, this means more deficits and "debt" - which when properly understood is to our benefit.

So if the left wants to make a case for increasing employment and incomes at the bottom, just make the case for it. Affordability is NOT the issue. No tax increases are needed. In fact, tax cuts (e.g. for the lower/middle class) could be part of the solution. For those on the right, there are way to fund beneficial growth programs without raising taxes and without government agencies taking over. Get creative. Fund more R&D. Support entrepreneurship programs. Educate and train unemployed persons in needed skills... 

Understand how we can use our own monetary system, educate yourself and your friends, and start asking your congresspersons to support solutions that build up people and the economy.

One place to start is to implement a job guarantee - a living wage job for anyone who is willing and able to work but is not currently employed in the private sector. 

Redistribution doesn't work politically, and it isn't how taxes and spending work either. Decisions on what, how, and how much to tax are entirely different than decisions on spending. We invented money exactly for this reason - let's use it wisely.

Sunday, July 20, 2014

$250 billion - that's how the banks value fraud versus the AG's $7 billion wrist-slap fine

Separation of powers - a concept that's at the core of the American ideal. Yet somehow it's been simplified down to "government" (big vs small), and the people herded into two tidy political camps - Team R & Team D.

Yet there are certainly other "powers" that must also be restrained so a people can live in liberty (military, religion, courts, oligarchs, banks, etc.) It is the banks that are the focus of my writing as they are perhaps the most powerful and misunderstood power, especially by those herded into the R camp who for some reason see only Gov as a power to restrain. And it is the large banks who most clearly grasp how our monetary system works and who use it most effectively for their own ends. 

Money can be confusing, and so it's very easy to stay with our "team" and blame the "other team" for all problems, as though everything is ultimately political and comes down to who is in the White House. But in recent decades, little has rivaled the damage done to society and the economy by the financial sector (really it's the big global banks not all/local banking that is the "power" referenced). 

The good news is that the light appears to be shining in their dark corner and perhaps this will lead to much needed reforms.

See here for the latest - a $250 Billion inter-bank lawsuit arising from the 2008 fraud and criminal activity in mortgage banking - are the wheels about to come off?

Bill Black provides the critical details that blew the top off the case - all of which is "strangely missing" from the AG announcements and media coverage:

  • Richard Bowen was the Citicorp chief underwriter and the whistle blower that deserves more credit and to encourage others to step forward.
  • Regulators did their job which should be publicized and encouraged, not hindered or hidden. 
  • This was a criminal indictment which should have resulted in prosecutions and jail-time, not a fine and wrist slap. 
There is a reason certain banking activity is regulated and certain actions are fraudulent and criminal. Until senior executives are jailed as they were after the Savings & Loan crisis, fines will remain a good investment for continuing the destructive behavior until the next financial crisis. 

Saturday, July 19, 2014

A tale of two currencies

Since I'm traveling in Greece on vacation I have been reflecting on the momentus decision made by European countries to abandon their national currencies for the Euro. I understand the geopolitical rationale behind the move, and yet it is hard to see how this is a good thing for most of these nations (Germany aside) - at least as constructed in its current form. 

The Euro is a currency union with a central monetary system (central bank) but no fiscal union (every country taxes and manages its own spending). This is very much like the 50 US states giving up the right to have their own currencies, only they must also be responsible for their own social security, medicare, military and all other costs of government functions. They must raise sufficient taxes to pay for all this since they have no ability to simply issue currency to pay for these things. They must now balance their budgets (or borrow to cover deficits). Virtually all of Europe gave up the standard monetary system of all nation-states for the hope of a stronger currency (Germany likely hoped for a weaker currency so they could export more - which they have), and a lasting peace on the continent. 

In 2011, S&P downgraded the US dollar and around the same time there was much handwringing about the US becoming the next Greece. Afterall, our debt is now over $17 trillion, an astronomical number that just sounds really scary and irresponsible, and even our president had made statements about the debt being unsustainable. 

But is it? 

Remember that a currency-issuing nation with a floating exchange rate has no constraint on its ability to create its currency. And just as importantly, the "sector balance equation" tells us that this so-called debt is actually a reflection of the private and foreign sector's desire to save that currency. We really have $17 trillion in savings account balances. 

It appears S&P, after completely failing in their credit rating business and being complicit in the mortgage-backed security fiasco that cost the US economy trillions of dollars (and therefore added to our debt), has further shown their inability to understand simple monetary operations. The US is not Greece (or France or Spain or...)

So what has Greece done?

By abandoning their own national currency, Greece must earn foreign currency in order to pay for things that it used to be able to pay for by issuing Drachma. It can do this by a balanced budget, or if wants to spend more than its private sector earns in a given year, it must go more into debt or become a net exporter. Afterall, this has worked great for Germany, right?

Can everyone net export? Of course not! 

For every exporter there must be an importer. Germany needs Greece to be a net importer so it can keep selling Mercedes cars to their taxi drivers. So Germany wants to drive Greece's wages and standard of living into the third world so Greece can become a low-cost producer and earn more Euros from abroad. That's not going to happen for a host of reasons, so Greece lives with devastating depression-level unemployment. And this is obviously counterproductive. 

And what does lower wages in Greece mean for Germany - less disposable income and therefore less purchasing power. Europe is only now beginning to wake up to the fact that they need to increase demand (people buying things) in order to increase sales and therefore growth and therefore help pay their debts. Why is this so difficult to grasp? Weimar casts a long shadow over the German fiscal psyche but they learned all the wrong lessons from that tragedy. 

Greece could try to borrow more, but unlike the US (and UK, Canada, Japan etc.), their debt is in a currency they do not issue. They must earn the Euros to pay back the debt, so we're back to square one. 

Now many simply view the Greeks as the classic lazy, irresponsible, corrupt southern Mediterranean population, living beyond their means. And certainly, there has been corruption. But does every nation need to become their world's laborers to have quality of life? Can the fruits of productivity be enjoyed by a people? Do we all have to become slaves to debt and ever-more expensive things so that the gains of productivity are always elusive, while the world's wealth accumulates in the accounts of the financial sector like Smaug's lair? 

There is a way forward for Europe but it must involve restoring use of currency for the good of people. Allowing the central bank to issue currency to certain levels for each nation would be a good start, and other reforms would allow the currency union to operate more like the US-states model. A job guarantee should be a priority, given the criminal unemployment levels that the EU leaders have forced on the Eurozone.

Let's hope Europe's population can see the right path forward and push their leadership for the change that will restore hope. The road they are on now has been trodden before and its path often leads to social disorder or war. It's not too late to make the turn.

Sunday, July 13, 2014

Money Myth 11: We must save more to restore our economy

It seems so right doesn't it? Fiscal responsibility. Working hard. Saving. If only everyone would do it then they would all prosper and our economy would get back on it's feet. (Some even go so far as saying that reason the poor are poor is that they simply lack these qualities). 

Like so many of our money myths, the basis of this viewpoint hearkens back to the gold standard days. The general idea is as follows:

  • productivity creates an excess (e.g. the farmer/business sells more than is needed to pay bills and satisfy wants/needs);
  • this excess leads to savings (i.e. in money/gold);
  • these savings create a pool of funds which can be drawn upon for investment;
  • investment in capital goods increases productivity again (e.g. farmer buys new combine harvester; business upgrades to robotic assembly).

Now don't misunderstand the point - of course saving, hard work, and fiscal responsibility are good things for the individual or business. However, looking for them to save our economy is a problem. There are two flaws with this understanding:

  1. We don’t need savings in order to invest: in modern economies, most investment is done via credit, not savings;
  2. When everyone saves, the economy suffers: for every person that spends less than their income (saves) someone else has to spend more than their income to make up the difference (dis-save, add debt, government runs deficits), otherwise the economy contracts.

FACT 1: Investment creates savings, not the other way around.

How? When a bank finances an investment, the bank takes the promise of repayment as its asset and simultaneously credits a bank account with newly created money (literally numbers in a computer). No savings or existing deposits were needed to fund this investment.

Credit is based on the ability to pay (banks call this underwriting). If creditworthiness exists, loans are granted. When a loan is granted the bank makes a deposit in the borrower’s bank account (or the borrower may directly purchase something so the credit is to the seller’s bank account).

There is NO pool of savings needed to fund most investments (although some savings are needed for down payments or to maintain equity ratios). However, when investment occurs, a new financial asset has been created out of thin air and a new real asset has been purchased or constructed.

Why does this matter?
Loans create deposits. Contrary to popular belief, lending is never constrained by deposits or pools of money saved (or bank reserves). Banks can and will always lend if there is an ability to pay and an opportunity for profit. Businesses borrow and invest when they see a forecast of increasing demand for their goods and services. Consumers borrow when they are confident their income will be sustained long term so they can make their loan payments.

Lowering interest rates when there is no spending/demand (i.e. insufficient employment & incomes) doesn’t lead to investment nor does it stimulate the economy, yet this is what the central bank keeps trying to do. This was the lesson of the Great Depression and it is a lesson for central banks today. Both then and now we have low interest rates but low investment and high unemployment. Monetary policy (managing interest rates and buying/selling government bonds) can’t do the trick.

As long as our collective desire to save is high, fiscal policy is needed to fill the gap in demand (lowering taxes and/or increasing spending so the private sector has more capacity to spend while also saving). Perhaps one day we will also see significant dis-saving (households and businesses investing/spending their stores on money) which could also help restore growth, but we shouldn’t shrink back from using fiscal policy when it is needed.

FACT 2: Saving money is a classic example of the “fallacy of composition”: what may be good at the individual level isn’t necessarily good at the aggregate level. 

The only way everyone can save is if the government runs deficits or the balance of trade is positive.

Here’s why. All income is someone else’s expense. In order to make a profit, businesses must sell what they make for more than it costs to produce. If one person saves money, someone else has to “dis-save” or increase debt. If everyone seeks to save more, businesses (if you add them all up) will be collectively spending more money on wages than they receive from customers buying their goods and services. What will businesses do in this situation? Reduce production, cut costs, and lay off workers. The economy will contract.

Keynes called this the “paradox of thrift”. Collectively trying to save money will probably result is less overall saving because it will cause the economy to shrink, incomes to fall (or go away via unemployment!), and reduced savings.

Is there any way we can all save? Yes! The government can run persistent and sufficient deficits to match the level of our collective savings desires so that the economy as a whole can save money without triggering a recession. And if such deficits were so directed as to increase employment and incomes then the resulting savings and benefits would be more broadly distributed rather than concentrate at the top.

If you’ve been paying attention, you will recognize that we just explained a critical shift in how we should understand government deficits and “debt”. They are exactly equal to the private sector net financial savings! The so-called national debt is actually a record of the amount of money we all desire to save … and that’s nothing to be afraid of.

Tuesday, July 8, 2014

The job guarantee

It is apparent that more work is needed to crack the hard shell of misinformation regarding how money works that pervades both sides of the political spectrum, media, and the general public. However, a number of readers have begun to get it and are now looking for some practical application. I’ll return to some more “educating” soon, but first, what follows is a basic framework for the job guarantee so that those who are running ahead have something to build upon.

Why a job guarantee?

As we have discussed, there is NO natural rate of unemployment. Unemployment is completely unnatural. It is a direct result of the way modern monetary and capitalist market systems function, as evidenced by the fact that there was no unemployment in traditional or agrarian societies. Money causes unemployment since people must earn it to survive and pay taxes.

Modern capitalist economies never have and never will attain full employment. I won’t go over the reasons again here, but the evidence is all around us and today and throughout history.

There is no valid and just economic, social or political reason for a nation to leave productive labor unemployed. Please let me know if you can find one. Aside from the loss of real tangible value to society and the economy (how many lives, including their own, would be made better if the tens of millions of willing workers were able to contribute productively to society and the economy), unemployment has also been linked to crime rates, drug addiction, family breakdowns, mental health problems, and a host of other social ills.

So what’s the alternative? A job guarantee would solve a host of social and economic problems, increase the real wealth of a nation, and bring greater price and economic stability. It can most certainly be afforded – in fact it costs us in all kinds of ways NOT to implement such a system. Aside from the fact that affordability simply isn’t an issue for currency-issuing nations, the program’s nominal costs are actually very minimal when one accounts for the offsetting savings from taxes received and reduced government welfare spending; and they are net positive for the overall economy when one accounts for fiscal stimulus plus the multiplier effect on the private sector economy and the mitigation of productivity losses from recessions. Recent estimates of a simulated job guarantee in the US indicate that GDP would increase by over one trillion dollars. That's real enough!

So what is the job guarantee?

Simply a guarantee of a job to all who are ready, willing, and able to work.
When the economy is in a downturn and the private sector lays off workers, the program will expand. When the economy recovers, the private sector will hire them back and the program contracts. It functions as a buffer stock of labor (today we have a buffer stock of unemployed people). In the interim, everyone has a job and ideally receives on-the-job training and skill development.

The job guarantee recognizes that full employment should be the goal of monetary and fiscal policy, and ensures that the nation’s productive workforce does not suffer decline and loss of human capital/productive skills during business cycle downturns.

There is also a recognition that the government can afford anything for sale in its own currency (simply by crediting bank accounts as it does with most spending), and that “buying” the nation’s unused labor is non-inflationary since these are resources not otherwise being “used” – in the same way that buying surplus inventory isn’t inflationary.

Yes, it’s really quite simple, but of course there are important details to consider. Let’s dispel a few of the common concerns by outlining how the program could work.

The basic framework

The job guarantee approach that is often advocated goes something along these lines:

  • The job guarantee is for people the private sector does not want to hire at any given time. If the private sector desires and can afford to hire them again, they can simply offer them a better job. It is not about the government hiring away workers in competition with the private sector.
  • The government would pay for the program costs and wages, but workers would still be taxed as other workers and the government would see a significant offset in spending from other programs.
  • Those in the job guarantee program would not be government employees. Charities, not-for-profit organizations, and other local organizations – possibly municipalities, counties, etc. – would offer job opportunities through the program. The pool of previously unemployed workers would now be able to help serve the community in a host of practical ways that enhance the overall quality of life.
  • All employment opportunities would be managed locally throughout the country. Local organizations and leaders know what is needed most in their communities and who can best qualify to provide the work and training needed. They also have a vested interest in seeing successful outcomes.
  • The job guarantee would provide a basic living wage and benefits to all participants. This would effectively eliminate the minimum wage and create a floor for private sector compensation, benefits and work conditions.
  • While there would likely be a modest one-time impact to costs from the implementation, the program would not be inflationary (i.e. there is no wage-price spiral effect). The degree of price changes would be a result of where the wage/benefit level is set, which can be debated.
  • Employees would be given on-the-job training. The fact that they remain employed and even may improve their skills helps keep them more employable for the private sector as it recovers.
  • Employees would have performance reviews and can still be fired. They would be given several opportunities to succeed but must meet normal employment requirements to stay in the program.

Only a failure of imagination would prevent all employable workers from being productive. Build houses for the low income, improve or add city parks and public spaces, provide after school and child care services, staff libraries and museums, offer free music and art lessons and other educational opportunities to underserved areas, build community gardens, develop community makers spaces, provide personal visits and care for the elderly, restore historic sites, install solar panels on public property, …

So let’s get creative. What does your community need most? What skills are available amongst the pool? How can community and organizational leaders collaborate to achieve the most benefit?

What would a job guarantee do?

Provide the basis for broad-based social and economic justice.
  • Create a buffer stock of employable labor for the economy.
  • Bring price stability (lessens downturns and anchors prices during upswings), while maintaining stable economic growth.
  • Eliminate the minimum wage.
  • Remove hundreds of billions from unemployment insurance payments, food and nutrition assistance programs, incarceration costs, and many other welfare programs.
  • Significantly increase GDP and overall demand for goods & services due to the additional spending from a fully hired population (note that those at the lower end of the wage spectrum spend a higher proportion of their income and so have a higher multiplier effect on the economy).
  • Enhance the lives of millions of currently unemployed and underemployed workers, providing them with an opportunity to provide for their families and improve their skills and lives.
  • And so much more…

When something makes this much sense, it’s worth sharing! Spread the word!

For those who wish to dive into the literature on the subject there are different names given to various different proposals along these lines. The most common terms are the Employer of Last Resort or ELR (Minsky), Right to Employment (Harvey), and the Job Guarantee (Mosler, Wray, Forstater, Murray, and others).

Sunday, July 6, 2014

He who governs least, governs ... least?

I intend to turn shortly to some further elaboration on full employment and the job guarantee. 

However, before I move on from the topic of my last post, I thought a recent interaction would further illustrate the point that our biases are holding us back. I emphasized in that blog the fact that in a modern monetary system such as we have, there is a critical role for government money to enable the private sector to meet its desired savings level and to achieve full employment. Trying to avoid this results in sometimes severe self-inflicted economic and social harm. 

Yet despite this fact, many people refuse to accept this reality and simply don't want the government to be involved. To quote from that piece: 

"Many people are more afraid of what the government will do with this knowledge than they are concerned with the pain inflicted on so many by ignoring the truth and refusing to allow the monetary system to be optimized for the benefit of all."
So I was not surprised when I received a comment from a friend insisting that "he who governs best, governs least". That is his guiding principle, period. Now the origins of this quote are a bit uncertain, but it certainly can be associated with the history of liberal (in the old sense of the word) thought seeking a government "of the people and for the people" rather than oppressive rule. I wholeheartedly agree. 

But what is really meant by these words? Is it a dictum for resisting any and all increased involvement of government? With all due respect to whoever coined the phrase, I find the term "least" very unhelpful. How can we define good government this way?

I assume we all want a military that can protect our nation from harm. Is an army best that fights least? Perhaps in peacetime that is highly appropriate, but when an invader is at our shores, then "least" is a problem. I prefer "effectively"!

What about veteran's medical services? Are doctors best who care least? What about our law enforcement and court system? Are judges best who judge least? Are police best who police least? These are all representations of our government.

How about regulators. Are regulators best who regulate least? Many argue "yes", but again, that depends on the situation. If our rivers are poisoned and our medicines are untested and harmful, and our banks are taking excessive risks and creating massive economic turmoil, then I suggest we want highly effective and empowered regulators. Of course we also don't want regulations for regulations sake either. Sure, there are plenty of outdated, worthless, and counterproductive regulations that should be removed or updated. We need right and appropriate regulation to have a safe and healthy society and rules for businesses to operate within.

"Least" isn't a criteria; it's a quantity - an artificial and undefined limit.

We could go on - border patrol, highway construction and maintenance, air traffic control, ... we want efficient and effective government that serves the public purpose that we collectively choose as a nation. Creating a subjective barrier of "least" serves no constructive purpose in defining what we want government to do. Rather, it generally undermines appropriate government at every turn, and in many respects, likely leads to much of the poor laws and regulations we have since too few are engaged in constructive definition of them at the outset.

Perhaps what we are really talking about is enumerated powers. Government should only be doing what we grant government the power to do. Governments do have a tendency to stretch those boundaries, and we need to reign them in. That's why we designed our system the way it is. But this is not a reason to exclude from those powers the very things that can most help us, the people. Just because we see some excess in one area, we shouldn't refuse to empower government to work on our behalf in areas that are critical to our well-being. And yet this is exactly what we're doing with our currency and monetary system.  

In closing, I feel the need to qualify this again since those like my friend above will likely take these comments to mean I believe 100% in what our government is doing...sigh ;-)

No, there is much to reform and restore in order to have our government truly be "of" and "for" the people. If you've been paying attention, that's been the point of this blog all along, not cheer leading for the status quo. But we need believe that the system we created can be used for our good. 

And what can that system do if we understand and use it?

  • End unemployment
  • Reduce inequality
  • Reduce reliance on ineffective Gov spending on "war on poverty" programs to tackle many social issues
  • Restore prosperity and a strong economy
  • Leave the next generation with a better country (cleaner air & water, restored land, better food, modern infrastructure, abundant energy, superior education, ... )
And with that, I promise we'll be back to just economics on the next post!

Thursday, July 3, 2014

Happy July 4th - Having hope in our government again!

I have had numerous interactions with friends – conservative, liberal, and other – over the matters on which I have been writing (how our monetary system actually works and how to best use it). Some of these friends are well versed in economic issues, banking and finance, trading, and business. 

I have noticed a common theme.

  • None of them can find fault in the technical arguments about how the monetary system actually works.
  • They agree with the facts I have laid out such as how sectors must balance, how central banks function, how governments spend money into existence and tax some of it back, that there is no financial limit on the issuance of national currency, etc.
  • Note that so far we’re strictly talking about how things work – one can apply this knowledge from either a right or left political persuasion.
  • Once we reach that point, there is often a resistance to the logical implication...that it is economically damaging NOT to use the system properly, such as allowing increased deficits when the private sector seeks to save more.
  • Finally, many will even agree that solving critical economic issues such as unemployment is technically doable and would be great "if it worked", but they again resist actually supporting such a position.

I find this curious. 
What’s going on? 

The reason that most often arises is that they simply don’t like the fact that government money plays a key role in the success of the private sector economy. In essence, they don’t want the government’s involvement, despite conclusive evidence that it is essential to the success of our capitalist system and the prosperity of society as a whole, and that this can even be done without expansion of the government itself in terms of more hired bureaucrats. 

It seems that many people are more afraid of what the government will do with this knowledge than they are concerned with the pain inflicted on so many by ignoring the truth and refusing to allow the monetary system to be optimized for the benefit of all. This is simply tragic, as anyone following the news since the 2008 crisis can see. 

Unfortunately, this isn’t new. There are a select few who do understand how things work and they appear to want to keep it a secret. For example, Nobel economist Paul Samuelson was once quoted:
“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say “uh, oh what you have done” and James Buchanan argues in those terms. I have to say that I see merit in that view.” 

Now this is quite remarkable, no? He is essentially saying that there is merit to the view that we should use fear to deceive people about how money actually works (i.e. we don’t actually have to balance the budget, and generally we shouldn't) because if they had true knowledge it might be used irresponsibly. Now such a fear might have grounds, but I am of the view that openness is better than deceit when it comes to democratic principles and the maintenance of liberty. There are surely other ways to control reckless government spending. In fact, hiding the truth has likely just given control of the purse strings to those who understand how to use it for their benefit, often to the detriment of the citizenry. (Have you ever seen a war or a bank bailout we couldn’t afford?) 

For my conservative and Libertarian friends who seem to fear most this thing called “government” (in the USA, this is ourselves acting collectively through our representatives), my appeal is that you don’t let your mistrust get in the way of using the very system we designed for our collective benefit (and I especially mean benefit to the private sector economy). 

It seems many are not afraid to support and use the nation’s powerful military to its full potential despite the very real threat to democracy such large permanent standing forces have been throughout history. How much more should we use the powerful monetary system we have created to ensure the economy is strong, our resources are productive, and the well-being of our people is maximized! Imagine if we allowed a state to be invaded but we didn't send in troops out of fear that our government would be irresponsible deploying its power for such ends - instead we'll have them stationed at the border to care for refugees. Yet we have sidelined our powerful monetary system while leaving millions unemployed. We have the solution standing ready but we don’t want to use it. 

I may not persuade you with a brief post like this, but if I can at least pry open the minds of a few to begin your own journey of understanding money, perhaps we can get somewhere. I’ve walked in your shoes. Until I delved into the real workings of modern money systems, I held many faulty beliefs about “balanced budgets”, “fiscal responsibility”. I have read my fill of the great Libertarians such as Hayek and Bastiat who warned us of government tyranny. But there is a wide chasm between Hayek's dire predictions of Stalinism or Nazism and the typical representative government, and there are other very real threats from non-government powers such as oligarchs and banking giants that are also grave threats to liberty. I’m hoping you’ll be willing to hope again in what we've built, even if it means taking a road less traveled and saying goodbye to some old ideas. 

So allow me to press on a little further. Despite the constant rhetoric from both sides, our government simply isn’t as bad (when our party isn’t in power) or as good (when our party is in power) as we often like to believe. And just as importantly, for all the government bashing going on, the private sector isn’t without similar flaws and ills either! Let’s just be pragmatic here. Big institutions of all kinds can get pretty inefficient and even corrupt. If you want to point out the evils of power, you really have to look at both sides - government and non-government alike. 

It is so often claimed that the government is just inefficient and wasteful, bureaucratic, lacks creativity and innovation, and stands in the way of the private sector with its excessive regulations. Whereas the “free market economy” (I’m still trying to find one of these) is what creates and innovates, is efficient and self-regulating, and if just left alone will bring the prosperity we all desire. 

But is this really accurate? 

Let’s just take a few examples to the contrary.

Innovation and creativity: 

Government departments, and funded organizations, universities, research labs, and the hard working individuals working in all these institutions have invented a huge array of advanced technologies and scientific discoveries we take for granted every day. GPS, the Internet, Google, baby formula, microchips, vaccines, bar codes, aerodynamic semi-trucks, … the list could go on and on.

And is the private sector without its fair share of lackluster firms? How many companies can you point to that stopped innovating, lacked the creativity to see technological change, and were made obsolete? The industry I work in is full of them. Certainly plenty of innovation has come from entrepreneurs, but one can also say that much successful commercialization of innovation has come after government funded the initial inventions. Venture capital is all too ready to jump in after the hard work has been done, but let’s not discount what the public sector has accomplished on our behalf. It is quite remarkable and deserves more recognition.

Hard working and efficient: 

We can all find a few examples to the contrary, but take an honest look at our educators (I’m married to one), those in the military and our first responders, those regulators who work tirelessly pursuing perpetrators of fraud, corruption, pollution, and poor quality, the scientists in research labs, the judges and public defenders, etc. Most of these people are serving us in some way and work hard every day to make a difference. Perhaps if they all wore fatigues we would stop and appreciate them more often. Maybe if we told dedicated teachers we appreciate their service as often as we did the courageous military personnel, the latter might be deployed less often!

So what about the private sector? Name a large corporation that isn’t prone to waste, excess, has some lazy workers, and suffers from inefficiency throughout its large bureaucratic organization. The Dilbert cartoon was popular for a reason! Again, let's be objective. 


I won’t defend the sophomoric and often dysfunctional behavior in our nation’s capital. We need good leaders who will be true selfless public servants, fathers and mothers (we need more women in politics for sure!), and states-persons for our nation. 

And I certainly won’t disparage the millions of great businesses, farms, and community banks that are heart of our economy. However, let’s be honest with where many of our problems lie. Are we so quick to forget the fraud and corruption of Enron and MCI? What about the Exxon and BP oil disasters? What has been the cause of the tremendous global economic crises that have wreaked havoc with tens of millions of lives to this day? The global financial institutions have settled numerous investigations with multi-billion dollar fines in order to avoid facing up to the alleged fraud and criminal activity. And they say we just need less government oversight and it will all be okay? When has the government last caused as much economic hardship and personal pain to millions of individuals as the large financial sector has in the past decade?

In conclusion:

Why am I saying all this? Because the disproportionate sense of anti-government sentiment is paralyzing us from acting on knowledge that could transform our economy and bring real prosperity. And it likely won’t get better until we recognize this.  

Now lest I be misunderstood, I am not at all advocating for government running everything, nor am I an anti-capitalist. I have been a successful entrepreneur for the past twenty years and a strong believer in business and market-based solutions. 

I’m also not arguing for one political approach or another -- I would love to see conservatives and liberals and every other flavor grasp the working of money and debate how best to use it from their perspectives (there's plenty left to debate!) But I am saying that it is intellectually dishonest and collectively self-defeating to think of “government” as the main obstacle and the private sector as the best solution to everything

Our monetary system requires government fiscal policy to work well – it’s a fact we can’t ignore even if we don’t like it. 

In reality, if we understood it, we would grow to like it a lot. It doesn't change the fact that government must be constrained and limited; that we need budgets and accountability; that transparency is essential to good public policy. Let's debate the right uses and approaches, but do so with everyone at the table around an accurate framework of how government money works in our economy.

So as we celebrate the founding of this remarkable nation with its constitution and form of government that our founding fathers and mothers fought so hard for, let's honor them by respecting the essential role that government can play in our collective lives, while working to redeem it from any corruption, greed, and ignorance that deprives we, the people, from the full enjoyment of life, liberty and pursuit of happiness. 

Our monetary system, like all else the constitution established, is of the people and for the people. Understand it. Use it. Have hope again in ourselves and our government system!