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• You want coherence and political courage from Barack Obama? HAA!!!!!!!!!!!! Fat bl**dy chance!!!

  Posted by catlady | December 4th, 2009 at 11:43 am

• Marshall, this post may not have been the best place to put it, but I’d really like to see you address the arguments of the theoclassical economists to your position. Would you please write a new post, or point me toward something you’ve written in the past, that addresses the concerns of the orthodoxy that increased government spending would lead to runaway inflation, or bond investors would demand higher interest rates thereby increasing the cost of borrowing.

  As I understand it, you are absolutely right about there being no real constraints to government spending other than causing inflation. We would need to find a way to avoid this outcome: the rich who own real property and physical plant do fine since their wealth grows along with inflation, while the middle class’ savings get wiped out. Would you please go in to this issue in depth?

  Thanks in advance…

  Posted by Josephus P. Franks | December 4th, 2009 at 12:23 pm

• I’d also be very interested in that post, but, isn’t the logical counterstatement that the middle class has debt, not savings? At our current point in history, that is…

  Posted by James Call | December 4th, 2009 at 12:34 pm

• Well, I am working on precisely some form of critique that both James and Josephus have asked for, but I am still aiming to do this in a language which everybody can understand, rather than deploying too much jargon. You’re right that many of these blog posts have implied critiques of neoclassical economic theory, but I am going to work on something along the lines that you both have suggested.

  Posted by Marshall Auerback | December 4th, 2009 at 3:59 pm

• Your analysis using aggregates and accounting identities obfuscates the real issue involved in government spending - what is the QUALITY of that spending. Government and bureaucratic spending is almost by definition wasteful, creates new entitlements, misallocates resources and creates enlarged vested interests that will wish to continue to live off government spending.

  What has some of the current stimulus achieved - more jobs in teaching, health care and other state sectors. Do you really imagine that is what the US economy needs in its present parlous state - more teachers and health care workers? It needs thousands more people who can produce tradeable goods not state-related jobs with all the attendant add-ons - pensions, benefits, expense allowances etc.

  The analysis of what government spending does in DETAIL calls for very rigorous intellectual discipline (not differential equations). That is why it is never done. So many economists prefer to talk in terms of the Big Levers to argue that government spending is a Good Thing; it gives them the sense of a broad sweep in solving problems.

  Posted by Donald Last | December 5th, 2009 at 4:44 am

• It’s true that government spending should be directed toward productive assets rather than, say, bailing out insolvent banks. I have long called for this. On the other hand, Donald, I completely disagree with your implied assertion that teachers or health care workers are any less important for an economy than people engaged in manufacturing. Is a manufacturing base required to sustain high wages and high productivity and therefore high standards of living. I think not!

  Further, do you need to produce things to maintain high employment levels? I think not!

  If you can only maintain a strong manufacturing sector through protection who wins out of that? Clearly there are many losers within the nation? Who are they?

  A beggar-thy-neighbour approach to world economic interactions is also likely to backfire – who wins and loses out of that? Are these characters really wanting the US to become autarkic?

  Further, what is the role of the public sector? Do progressives really want the government to be giving out corporate welfare to manufacturers who are unable to pay sufficient wages given the technology and working conditions expected to compete against low wage nations?

  What is the responsibility of post industrial nations to allow the poorer nations to develop in the same way that they did – via industrialisation?

  The worry I have is that this so-called progressiveness is not what I call progressive at all. It is still grounded – you pick this up by reading some of the literature supporting the agenda – in a macroeconomics – that is, in my view, at the heart of the problem – they seek to redress.

  Further, this so-called progressiveness thinks that selective government handouts to private industry will bring back the glory days of manufacturing. That’s precisely the kind of inefficient government spending that you rightly decry.

  Posted by Marshall Auerback | December 5th, 2009 at 7:17 am

• Marshall, nice article, but your point about teachers and healthcare workers is a bit absurd. If so we can all be teachers or healthcare workers, but we would be homeless and starve. Plus government spending tends to concentrate wealth into the hands of the politically gifted, not to those who can actually invent/create things that make our life better and more productive (think the Kleptocrats in Russia).

  Also regarding creating money out of thin air only works if we can produce those dollars and not create a “Federal Reserve” debt instrument. We are on a exponential debt repayment curve that is outrunning our ability to service it. so every dollar comes with a long tail interest that can not be paid back.

  If this was so easy Zimbabwe would be the wealthiest country on earth.

  Posted by Bob Kudla | December 5th, 2009 at 8:28 am

• ” . . . a government which issues its own sovereign currency cannot go broke . . .”

  Really? I’m pretty sure Zimbabwe issues its own currency. I have One Trilllion Zimbabwe Dollar bill to prove it.

  Posted by Michael Baker | December 5th, 2009 at 8:40 am

• It is an interesting point about manufacturing. Couldn’t the development of a new energy grid, algae-growth facilities and panels used to reduce carbon in the air be developed in the same concentrated way that the automobile and aircraft industries once were? Certainly that’s not a waste, manufacturing-wise? I’m not a economic but I am often perplexed by the notion that the world’s leading market can subsist on service industries alone.

  This is not meant as a criticism, but a genuine inquiry.

  Posted by James Call | December 5th, 2009 at 9:30 am

• “…a government which issues its own sovereign currency cannot go broke…”
  We need a little “ceterus paribus” here. The above statement is true, to the extent that the currency requires no EXTERNAL consent to its’ value - in other words, no trade involving that fiat
  currency is required. This situation can persist in a society whose
  economic requirements are fully satisfied by resources within its
  borders. It can even be true when a society is NOT self sufficient in everything, but can exchange some surplus commodity or product for what it lacks. Where it breaks down is precisely at the point that requires a persistent shortfall in
  trading balances, requiring an external partner to hold currency. Even THIS situation is not in and of itself unstable,
  if the currency can be converted by the holder to secure rights to valuable assets within the “deficit society”. The key word here is “secure”. In Zimbabwe, a kleptocratic thug dictatorship,
  nothing was secure. I am not an expert on the quality of assets which exist in Zimbabwe, but when it was Rhodesia, its’
  owners were reluctant to part with it. As a former colony, one
  can understand the reluctance to exchange deficits for sovereign control of assets, just as we in the US blocked the
  sale of Unocal to China. It is only when holders of your currency are allowed to hold nothing of value except the right to get a few per cent more of it every year, that the risk of
  flight can occur.

  Posted by Robert KAHN | December 5th, 2009 at 10:00 am

• The idea that inflation is prevented in the Chartalist approach when the government steps in and raises taxes is fine as an abstraction, but as a political reality it is nonsense. When the boom is going strong the US Congress is going to suddenly raise taxes to put towards the national debt? Does that sound to anyone like a credible way to regulate inflation?

  Posted by JeffC | December 5th, 2009 at 10:26 am

• Sir,

  There are other problems, apart from “not going broke”, associated with your proposed remedy of limitless government spending (LGS)… they generally fall into the category of unforeseen consequences (UC).

  Other readers have listed some of the more foreseeable consequences, the most telling being that there is no multiplier attached to LGS … not only that but I am reading that the results are negative, … this is the distortions of LGS at work.

  As I see it LGS invariably supports the (failing) status quo … it does not seek out college drop-outs with start-up business ideas in the garages of Seattle … the painful but healthy transition from old industries to new is hampered by LGS, aided substantially by the lobbying of embedded interests … this is an unfortunate brake on much needed social change.

  The latest UC is the mercantilist policies of China … notably the Remnimbi/Yuan peg to USD … and the effect this is having on, first, Asia and now, Europe.

  The Chinese are not budging … so there is the limit to your proposed LGS… how much pain you can inflict on the rest of the world.

  We are watching a pivital moment in history.

  Posted by Nicholas Arno | December 5th, 2009 at 10:48 am

• I don’t see how China’s mercantilism is a UC of our LGS… seems like China was on a mercantalist path long before it became a major investor in our debt. Isn’t China’s mercantilism linked more to the fact that it was an underdeveloped country, and mercantalism has a fairly proven track record of development for such countries?

  Posted by James Call | December 5th, 2009 at 12:14 pm

• Well, there’s a limit to the extent that if more people wanted to hold dollars, than yuan and the Chinese wanted to defend the level, they would eventually run out. But that’s $2.2 trillion of forex reserves they could use to defend the peg. China’s consumption is growing rapidly, but investment as a percentage of GDP is rising even faster. Their approach has worked for them, but they’ll eventually move to a more domestic oriented economy. But the notion that we have to worry about this again reflects a misunderstanding of the monetary system. let’s start by looking a how we got where we are today with China.

  It all started when China wanted to sell things to us and we wanted to buy them.

  For example, let’s suppose the US Army wanted to buy 1 million T shirts from China for $1 each, and China wanted to sell 1 million T shirts to the US Army at that price.

  So the Army buys 1 million T shirts at $1 each.

  First, understand both parties are happy. There is no ‘imbalance.’ China would rather have the $1 million than the T shirts or they wouldn’t have sold them, and the US army would rather have the T shirts than the money or it wouldn’t have bought them. The transactions are all voluntary.

  But back to our point- how does China get paid?

  China has a ‘reserve account’ at the Federal Reserve Bank. A reserve account is nothing more than a fancy name for a checking account. It’s the Federal RESERVE Bank so they call it a RESERVE account instead of a checking account.

  So to pay China, the Fed adds $1 million to China’s checking account at the Fed. It does this by changing the numbers in China’s checking account up by $1 million.

  So China has some choices. They can do nothing and keep the $1 million in their checking account at the Fed, or they can buy a US Treasury security.

  A US Treasury security is, functionally, nothing more than a fancy name for a savings account at the Fed. The buyer gives the Fed money, and gets it back later with interest. That’s what a savings account is- you give a bank money and you get it back later with interest.

  So let’s say China buys a one year Treasury security.

  All that happens is that the Fed subtracts $1 million from China’s checking account at the Fed, and adds $1 million to China’s savings account at the Fed.

  And all that happens a year later when China’s one year Treasury bill comes due is the Fed takes that money out of China’s savings account at the Fed and puts it in China’s checking account at the Fed.

  Right now China is holding some $2 trillion US Treasury securities. So what do we do when they mature and it’s time to pay China back? We move the money from their savings account at the Fed to their checking account at the Fed and wait for them to say what, if anything they might want to do next.

  This is what happens when all US govt debt comes due, which happens continuously. The Fed moves money from savings accounts to checking accounts on its books. And when people buy tsy secs, the Fed moves money from their checking accounts to their savings accounts. So what’s all the fuss?

  It’s all a tragic misunderstanding.

  China knows we don’t need them for anything and is playing us for fools. They know all we owe them to ‘pay them back’ is a bank statement from the Fed.
  When a Treasury bill, note, or bond is purchased by a bank, for example, the government makes two entries on its spreadsheet we call the ‘monetary system.’

  First, it debits (subtracts from) the buyer’s reserve account (checking account) at the Fed.

  Then it increases (credits) the buyer’s securities account (savings account) at the Fed.

  As before, the government simply changes numbers on its own spread sheet - one number gets changed down and another gets changed up.

  And when the dreaded day arrives, and the Treasury securities Chinas holds come due and need to be repaid, the Fed again simply changes two numbers on its own spread sheet.

  The Fed debits (subtracts from) China’s securities account at the Fed.

  And they credit (add to) China’s reserve (checking) account at the Fed.

  That’s all- debt paid!

  China now has its money back. It has a (very large) dollar balance in its checking account at the Fed. If it wants anything else- cars, boats, real estate, other currencies- it has to buy them at market prices from a willing seller who wants dollar deposits in return. And if China does buy something the Fed will subtract that amount from China’s checking account and add that amount to the checking account of whoever China bought it all from.

  Notice too, that ‘paying off China’ doesn’t change China’s stated $ wealth. They simply have dollars in a checking account rather than US Treasury securities of equal dollars. And if they want more Treasury securities instead, no problem, the Fed just moves their dollars from their checking accout to their savings account again, buy appropriately changing the numbers.

  Paying off the entire US national debt is but a matter of subtracting the value of the maturing securities from one account at the Fed, and entering adding that valued to another account at the Fed. These transfers are non events for the real economy, and not the source of dire stress presumed by the mainstream economists, the politicians, business people, and the media.

  Posted by Marshall Auerback | December 5th, 2009 at 3:43 pm

• If the government printed money, and did nothing else, then the statement is true. Computer accounts will balance.

  If the government attempt to buy constrained resources with the paper, then the private sector would buy less. That is the key. Money printers assume surplus resources in the short run. Even the stimulus liberals have to assume unused resources for their scheme to work.

  Posted by Mattyoung | December 5th, 2009 at 3:50 pm

• How’s that working out for Japan. How’d I end up on the this backwoods Keynesian site.

  Posted by Anon | December 5th, 2009 at 4:22 pm

• In addition to addressing criticisms of these ideas, it would be enlightening to explore who benefits from adherence to the old paradigms.

  Posted by Jeff65 | December 5th, 2009 at 5:05 pm

• You say capacity utilization is low so let’s have government spend some money to keep people employed. What’s not clear is: who will buy the output? Should we just dump it in the sea?

  At the moment nobody wants paper goods(books, newspapers, magazines) so paper mills, publishers and bookstores are closing. What’s the point of keeping them open with government money? It’s not a rhetorical question. Is there a point?

  If it’s ok for government to take real resources from people to keep them open, it should be OK for *YOU* to pay to keep them open. How many debt-ridden paper company shares do you hold?

  Posted by molecule | December 5th, 2009 at 5:10 pm

• “If the government attempt to buy constrained resources with the paper, then the private sector would buy less. That is the key. Money printers assume surplus resources in the short run. Even the stimulus liberals have to assume unused resources for their scheme to work.”

  But we don’t face this situation. We face oversupply, not overdemand. The government isn’t “crowding out” anything; it’s picking up the slack. If demand was voracious, then perhaps we could speak of this issue, but as it is, supply is flat, and government is driving demand in lieu of the private sector, which is, in essence, not shopping at this time.

  Posted by James Call | December 5th, 2009 at 6:24 pm

• Modern monetary theory is not complicated and it is pretty easy to grasp if one takes the time and invests the energy required to do some reading. Obviously, reading an isolated blog post or two if insufficient. There is a petty large literature by professional economics available at http://www.levy.org/publications.aspx. Bill Mitchell has addressed a number of these issues at his blog, too. Here’s the sitemap. http://bilbo.economicoutlook.net/blog/?page_id=1667

  I recommend reading Randy Wray’s, Understanding Modern Money: The Key to Full Employment and Price Stability (1998). It’s available online at Google Books.

  Things like inflation have been addressed in these places. Here’s a start from a post by Bill Mitchell. http://bilbo.economicoutlook.net/blog/?p=6205

  Posted by Tom Hickey | December 5th, 2009 at 6:39 pm

• For the inflationista’s, Steve Randy Waldman (not an MMT’er) makes an important point about inflation that is usually missed, in Asset inflation, price inflation, [wage inflation] and the great moderation.

  Posted by Tom Hickey | December 5th, 2009 at 9:05 pm

• Tom Hickey is correct. Randy Wray and Bill Mitchell are two of my mentors and are great sources for understanding modern monetary theory.

  James, on the question of the world’s leading market subsisting on service industries alone, let me ask you the following? Do you think we should all go back to working the land? At the turn of the 20th century, more than half of all Americans were in agricultural related industries. Now around 1% of the population produces even more food output.
  There is a presumption that only manufacturing provides good quality, high paying jobs. I’m not sure that’s true. Working in an automobile plant or a steel factory is tough work (I worked in a steel plant one summer, I know!). Just because it’s high paying doesn’t mean it’s a good job or necessarily sustainable. Shouldn’t society value the work of a health care worker or teacher as much as someone employed in manufacturing? There’s nothing wrong with developing good paying service jobs.

  Jeff C and Robert K, on the question of Zimbabwe and taxation. To assert that the government faces no OPERATIONAL constraint in terms of creating net financial assets is not to suggest that we should have the government spend until we get to a state akin to Weimar Germany or Zimbabwe. I did say inflation is the constraint. If the government continues to spend too much, then it can create inflation and should be reduced. Of course, much of this will occur in any event via the automatic stabilisers working in reverse: tax revenues will rise and social welfare expenditures will go down. But if inflation continues to be a problem, the government can resort to higher taxation. You suggest that this is not politically possible. I would argue that it’s more politically feasible when it is started from the perspective of full employment. Much harder to enforce tax increases or spending cuts when we’re in recession which in any case will exacerbate our current problems. And why would you want to do that in any event? Because of some vague notion of “retaining market credibility”? I don’t even know what that means.

  I concede there are circumstances in which I could envisage a Weimar or Zimbabwe scenario. If we had complete political dysfunction and a corresponding loss of taxing authority, a la Zimbabwe (or the Confederacy during the Civil War). If the tax system breaks down, the government’s fiat money can indeed become worthless - which is manifested as hyperinflation. The government in that situation can print ever increasing quantities of money, but find little for sale, even as resources sit idle. This does not require full employment or high capacity utilization. In fact, quite the opposite because once the value of money collapses in the manner I described above, it becomes virtually impossible to undertake ‘money now for money later’ transactions, and the economy degenerates into barter, or the private sector contracts with alternative money with a relatively more stable value. The point is that that the hyperinflation is not caused by the “printing of money” per se. Rather, running the printing presses at full speed captures only the effect, not the cause of the problem. It is usually the breakdown of the tax system, indeed the political system as a whole, that creates the hyperinflation.

  That is still an outlier in the US in my opinion, although watching our current government in action, I do not discount it as a possibility.

  Posted by Marshall Auerback | December 5th, 2009 at 11:37 pm

• Thank you, you are right to correct me.

  I meant to convey that it is my view that the latest effects of China’s established mercantilist policies, (the latest being the peg to USD), are now causing unbearable hardship to Asian and European countries and that this is an unintended consequence of the US government monetizing its debt. ie, the peg was the Chinese response last year when they foresaw the only plausible US exit strategy.

  I note your brief lesson on the monetary system however I believe you will regret expressing the view so simply that US government debt can be resolved by the click of a mouse. This reminds me of Dick Cheney’s unfortunate comment that deficits don’t matter. The market has a view.

  I expect you are about to find out what tmarket credibility means as the USD gyrates and this is felt first in equity markets world-wide and from there to the real economy. Gold is sending a clear message.

  In respect to political dysfunction a truly troubling aspect to the events of the last twelve months is the looting of the US economy by those in a position to do so. BoA’s intention to repay TARP and the price action just prior to the announcement of the failure of Amtrust being two examples in the last week.

  At the other end of the spectrum “strategic default” on underwater home mortgages shows that many, many people are abandoning the system and taking what they can on the way out.

  The failure to pursue fraud across the entire spectrum might well be an equivalent to the “loss of taxing authority” indicator that you mention. It is hard to see the present team being in a position to turn the tide.

  Posted by Nicholas Arno | December 6th, 2009 at 12:32 am

• Note that Bernanke is still creating US dollars left and right to buy up the toxic assets of his banker buddies on Wall Street. Interesting how the only time we have to watch our spending is when it helps common folks, but when it is time to decide whether to help out Goldman Sachs, the sky is the limit.

  Posted by dlr | December 6th, 2009 at 1:48 am

• Nicholas, the market might have a view, but market rates are set exogenously by the central bank, not endogenously by the the “markets”. This is a fundamental misconception that lies at the heart of neo-classical economics. See my piece on America and China.
  I don’t think gold is sending any message. It simply reflects a portfolio preference shift, a bunch of funds chasing a bandwagon trade (the corollary of the US dollar bear bet, which I personally think is running its course). I would be wary of reading much more into that.
  I also think you mischaracterise my position: I do not say (unlike Dick Cheney) that deficits do not matter. What I have said repeatedly is that we face no operational constraint here. We have a political constraint which is inflation.
  What you describe as a simplistic view is based on my 30 years’ work in the financial markets. Does the government actually get anything real to give to someone else? No, it’s not like they get a gold coin to spend.

  You can actually watch this happen with online banking. You can see the balance in your bank account on your computer screen.

  Suppose the balance in your account is $5,000 and you write a check to the govt. for $2,000.

  When that checks clears, what happens? The 5 turns into a 3, and your new balance is now down to $3,000. All before your very eyes!

  And all they did was change a number in your bank account. The government didn’t actually ‘get’ anything to give to someone else. No gold coin dropped into a bucket at the Fed. All they did was change numbers in bank accounts. Nothing ‘went’ anywhere.

  (Can you now see why it makes no sense at all to say the government has to get money by taxing in order to spend?)

  So if govt. doesn’t actually get anything when it taxes, how does it spend?

  Imagine you are expecting your $2,000 social security payment to hit your bank account which already has $3,000 in it, and you are watching your account on your computer screen. You are about to see how government spends without having anything to spend.

  Presto!

  Suddenly your account statement that read $3,000 now reads $5,000. What did the government do to give you that money?

  It simply changed the number in your bank account from 3,000 to 5,000. It changed the 3 into a 5. That’s all. It didn’t take a gold coin and hammer it into a computer. All it did was change a number in your bank account by making data entries into its own spread sheet which is linked to other spread sheets in the banking system.

  Government spending is all done by data entry on its own spread sheet we can call ‘The US dollar monetary system.’

  And even if the government paid you with actual cash, that cash is nothing more than the same data, but written on a piece of paper rather than entered into a spread sheet.
  Now you might say that if that’s all there is then Zimbabwe awaits us.
  So let’s go through the causation. You get an extra $2000 via a computer entry. So do a bunch of other people as a consequence of government electronically crediting accounts with new net financial assets. The recipients of these financial assets then go out and spend the dollars. Now, this new mass expenditure might well increase economic activity in the real economy, which is precisely the role of fiscal policy.
  Does it invariably follow that significant inflation would follow? Only if the government continued to do this after we had reached full output and employment.
  But the government has this unique power that you and I don’t have - namely, they can tax to drain aggregate demand. That’s the other side of the equation.

  On your last point, yes, if the government continues to pursue these deficit myths that I have decried, but somehow still manages to find additional financial guarantees for insolvent and fraudulent banks (which I have also criticised), then this does pose the legitimate threat of widespread debt repudiation amongst ordinary Americans and increasing political dysfunction. I have also written about this. I hope it doesn’t come to this, but it could do if Obama continues to take the line that we are running out of money. I’m trying to suggest a way to avoid this outcome and you haven’t persuaded me that what I have suggested would lead to the Zimbabwe scenario that you describe, if you go through the operational aspects of this carefully. Thanks for the thoughtful comments, however, Nicholas.

  Posted by Marshall Auerback | December 6th, 2009 at 1:51 am

• There is a disconnect here; one based on philosophical underpinnings of how to measure an increased standard of living.

  Using the analogy above, with the gov’t being the casino chip issuer, it’s important to understand human behaviour when the gov’t “issues new chips”, ie currency. The problem is that the folks who have been earning and risking their hard earned chips effectively become diluted. so they stop playing, investing and generating the needed effort to move the economy along. they go to another casino. in other words, if you constantly dilute the rewards, the free market incentives are removed.

  Why is this important? because the TRUE output of an economy is measured in value creation and earnings growth. Today, we measure this in currency flow through the economy (GDP) which is a direct consequence of currency issuance, but it says nothing about the true earnings growth and potential value creation. It’s like saying everyone in the casino is getting richer because the casino is issuing more chips, even without anyone adding any value. The problem is the casino down the street might have better odds and the chips might be holding their value better AND the economy is not efficiently allocating credit to value creating activities.

  the other major problem is the assumption that a “government which issues its own sovereign currency cannot go broke”; this is true if the currency is held by the people of the country. This is not the case today. Japan has made it through 20years this way, due to a large private saving rate, but now they are looking down the barrel of outside borrowing and a catastrophe.

  Look at what the chinese have gained throught their “investment in the US”: they have lent the US $2T dollars and generated economic output of >$4T dollars. How is this possible? Mainly because we are willing to sell our know how to finance the fantasy of an increased standard of living. This is made possible through currency issuance, debt issuance, and the false believe in chronic credit generation.

  i would recommend everyone who would like a counterpoint to the above article, read Niall Ferguson’s recent cover article in Newsweek. it points out many of the problems with the modern, convenient distortions to Keynes’s original work.

  at the end of the day, if currency is issued without an equivalent value or earnings power improvement in the economy, it is a dilutive event. Period. it doesn’t matter how it’s book kept, the average standard of living goes down.

  Posted by Pete | December 6th, 2009 at 9:09 am

• Niall Ferguson’s analysis is based on completely flawed analogies. See Bill Mitchell’s excellent analysis at http://bilbo.economicoutlook.net/blog/?p=6449#more-6449

  Your understanding of the casino analogy is flawed as well. There is no “dilution” because you’re not dealing with a static pie. The new net financial assets can be used to expand real economic activity, so there is no “dilution” effect. But the standard of living will go down if we proceed with these nonsensical ideas that we have no means to fill the hole left by the private output gap. And unfortunately, this type of thinking is spreading across the globe. Now the UK is saying that they have “run out of money”. If they are serious, watch what happens to their economy next year.
  Japan has done enough to prevent depression, but their government spending has been characterised by continuous stop starts in fiscal policy for the past 2 decades, along with a TAX INCREASE (presumably, because they too felt they were “running out of money”). That the savings were domestic is irrelevant. The government’s spending isn’t “funded” out of a savings pool. Since government is the only issuer of currency, like any monopoly government can set the terms on which it is willing to supply it. If you have something to sell that the government would like to have—an hour of labor, a bomb, a vote—government offers a price that you can accept or refuse. Your power to refuse, however, is not that great. When you are dying of thirst, the monopoly water supplier has substantial pricing power. The government that imposes a head tax can set the price of whatever it is you will sell to government to obtain the means of tax payment so that you can keep your head on your shoulders. Since government is the only source of the currency required to pay taxes, and at least some people do have to pay taxes, government has pricing power.
  A currency backed by something with “equivalent value” (whatever that means) is not a panacea. We had a gold standard in the 19th and had about 5 depressions. Money has no “intrinsic” value. It’s value is totally extrinsic. Adopting a gold standard, or a foreign currency standard (“dollarization”), or a Friedmanian money growth rule, or an inflation target is a political act that serves the interests of some privileged group. There is no “natural” separation of a government from its money. The gold standard was legislated, just as the Federal Reserve Act of 1913 legislated the separation of Treasury and Central Bank functions, and the Balanced Budget Act of 1987 legislated the ex ante matching of federal government spending and revenue over a period determined by the celestial movement of a heavenly object. Ditto the myth of the supposed independence of the modern central bank—this is but a smokescreen to protect policy-makers should they choose to operate monetary policy for the benefit of Wall Street rather than in the public interest (a charge often made and now with good reason).

  Posted by Marshall Auerback | December 6th, 2009 at 2:36 pm

• i agree with the technical aspects of your arguments but, again, i think you are overlooking a key concept. you said it well:

  “The new net financial assets can be used to expand real economic activity, so there is no “dilution” effect.”

  absolutely true; the issue is how to measure “real economic activity” and is it positive or negative. my contention is that it is not positive, and probably negative.

  reissuing the chips does not necessarily lead to real economic activity; in fact i think we’ve proven that over the last 10+ years. and wow, we even got a minor debt service crisis! “real earnings” of an economy must always match debt service over the long haul, assuming a moderately stable currency and sovereign debt rating. otherwise the Fed has to step in and pay the bills and the value of the people’s currency is impacted.

  current financial policy in the US and the basket case that is britain are covering over a very deep earnings power deficit (industrial, human capital, etc). the solution has been to paper over this with a fiat money system, in the end facilitating the transfer of power and wealth to competitors, especially in the east, as they have focused on “real economic activity” .

  what we have in the US is a sale by the gov’t of the US economic power to fund “bread and circuses” at home to win elections without any underlying investment in “real earnings power”. this will come to it’s natural conclusion as it always has. maybe Ferguson doesn’t have the financial manifestations correct, but it seems he does have the basic cause correct. the idea that Fiat money systems are a modern invention and resilient to the above is laughable. history has proven over and over again that 2+2 always equals 4 in the long run.

  the consequences of this misjudgement will show up at some point, maybe as a debt crisis, as the true value of our “real economic activity”, (independent of monetary theory), will show itself at some point and using technocratic arguments about money flows overlooks this basic outcome.

  What Obama said then is that the borrowing and money issuance is too high for the amount of “real economic activity” in the near future.

  BTW, your comments on the Federal Reserve act and independence are excellent…

  Also, i appreciate you getting this discussion going; it’s an excellent piece and i hope you keep writing them.

  Posted by Pete | December 7th, 2009 at 8:00 am

• Marshall, what you say is true, what is also true is the sovereign will run out of credibility far sooner than it runs out of (borrowed) cash. I presume you are an economist, one who does not appear to understand money at all. You fail to detect its current purpose against the backdrop of massive finance- generated credit. You also refuse to recognize money as a derivative, as a claim and nothing else.

  The argument can only be made as a fragment of credit and money creation against the entirety of it. First of all, the new credit that you desire must add to immense mass of legacy debt that already exists. Your argument ignores scale. According to the Bank of International Settlements, the totality of credit, finance’s claims against the production of the world is over 600 trillion- with- a- T dollars! The expansion of finance credit is serviced by the expansion of finance’s balance sheet, the addition of more credit. $600 trillion becomes $1200 trillion which becomes $2400 trillion … becoming asinine long before that lofty total is reached.

  The danger of rounded- off amounts of imbalanced derivative positions falls greater than the GDP of the entire world! What results is the increasing irrelevance of the credit system as a whole, rather than the value of its claims. Finance is the new Zimbabwe.

  Also avoided is the entire issue of the cost of servicing increased sovereign debt. You don’t dig into credit creation deeply enough, ignoring the trap that is created by extensive sovereign borrowing. Government borrowing by way of supply and demand in credit markets keeps interest rates or the discounted cost of money … very low. The more governments borrow, the lower the money cost falls: the world becomes overstuffed with redundant claims in markets where claims are not in demand. His argument - identical to those of the other faux- Keynesians who populate the real economist profession - consigns the sovereigns to endless and increasing borrowing: running ever- faster to remain in place. Otherwise, reducing the flow of borrowing allows for the increase in interest costs - again due to supply and demand in the marketplace - which rapidly overwhelms the ability of the governments to service existing loans through additional borrowing.

  I learned all this from my mother; never borrow to pay off other loans. Never use capital for operating expenses. I learned this when I was - uh - twelve!

  At the same time, the increase in credit represents a shift from less credit- worthy appearing private finance toward sovereigns which appear more credit worthy. The burdens of default jump from private to public borrowers. The Citigroup/HSBC/Deutche Bank defaults are now appearing in Dubai, China, Saudi Arabia, and are becoming more likely in Greece, Spain, Venezuela and elsewhere. Adding more debt is simply dandy … up to a point where it becomes a self- reinforcing disaster.

  By borrowing more, governments manipulate the credit market, which makes it hard to measure the ‘true’ cost of money by that market. Governments can borrow at decreasing cost until they cannot any more. What is that inflection point?

  At the deepest level this article misrepresents reality. The argument is intellectually dishonest. Governments as well as finance and banks can create representations of goods or claims against goods but not the goods themselves. Government can print more money but cannot print jobs.

  It also cannot print oil which is where our jobless problem originates. Workers have been too expensive for ten years against the backdrop of uncertain fuel availability or rinsing trend fuel prices. Marshall cannot formulate a correct solution to a problem he misrepresents to himself and his readers.

  The question to sovereigns is when will interest costs rise.

  Without going into charts and graphs, the efforts of the past sixteen months in the United States and for far longer in Japan and elsewhere has been to hold money costs as low as possible, so that institutions that the current crisis have mired in extremis can ‘earn their way back into profitability’ by pocketing the spread between the low money cost and the returns on money they themselves lend. The reason these companies need to do so is the large and expanding portfolios of uncollectable legacy loans on (or off) these companies’ books.

  Since the employed cannot profit on the borrowing spread, the costs of extending credit to them - by employing them - cannot be recovered, except by the means that put them into unemployment in the first place. At the same time, their continued borrowing is becoming a desperate necessity to the companies themselves … even more so than to employees; without more loans extended and then repaid at high interest, the companies cannot hope to earn their way back into solvency.

  As the subsidy lending continues, a paradox emerges. On one hand the failing loans expand at a rate equal to the increase in subsidy, which renders the entire effort futile. On the other hand, the appearance of institutions without obvious public distress suggests that the worst aspects of the crisis are past and that subsidy lending can be ended soon. Reducing the subsidy lending would remove significant political and monetary/fiscal stress from the government. This is the center of Obama’s remark about not being able to afford to lend jobs into existence.

  I would suggest that what the credit market is tending to measure is less the money- cost of money but ‘full faith and credit’, itself. At some level of lending faith becomes skepticism, then revulsion. Problem is … nobody can tell in advance what the level of lending is. Certainly, increasing the level shortens the odds of its appearing sooner rather than later.

  What is needed is an entirely different approach that does not simply bandage a part of the problem but addresses the whole. We live beyond our means, both money means and energy means. The first step is to start figuring out what the optimum means might be and figure out how to make them work for the greatest number.

  Anything else is just more self- serving lies, IMO.

  Posted by steve from virginia | December 7th, 2009 at 5:07 pm

• Steve, I think you’re missing the main point: the government doesn’t borrow money, it creates it out of thin air. Period. Or at least, the Fed does (and the govt. should have that role).

  Posted by Zach P | December 7th, 2009 at 10:19 pm

• …
  For the millionth time, Mr. President, a government which issues its own sovereign currency cannot go broke. It cannot “run out of d
  ..
  US goverment intake about 2.2 trln $$, it spends about 3.8-4 trln$$.. thus almost 100% deficit.. how long can you live spending 2 $$ and making 1 $$ same time..

  what a moron…
  hey stupid, here’s solution right here.
  why dont goverment just give away each each citizen cool 1 million bucks and call it day..

  good luck,
  alex

  Posted by alex west | December 8th, 2009 at 1:10 am

• Well, Alex, I could well be stupid, but then again, I didn’t create double entry bookkeeping which is clearly the concept with which you have difficulty. Government spending and taxation receipts are flows between the government sector and the non-government sector.

  A budget deficit arises when the flows into the non-government sector arising from government spending are greater than the flows from out of the non-government sector arising from taxation payments. The “drain” thus has to be open at all times and just the relative flows altered if you want the net outflow to be reduced.My economics training tells me that anything that reduces aggregate demand in this environment will further damage employment. If people have less purchasing power then employment falls. Increasing taxation, specifically, will reduce aggregate demand. Your idea of giving away $1m to each citizen is certainly interesting, but it probably would be inflationary, which is why I wouldn’t advocate it. But in spite of yourself, you are thinking of the right way to deal with the problem, although something tells me that your proposal was not a serious one.

  Posted by Marshall Auerback | December 8th, 2009 at 3:32 pm

• hi Marshall,
  nice reading your comments,..
  sorry for bad words, it was to start up the conversion..:)

  still you don’t get it… Everybody must live within ones means…
  government, people, corporations..

  how long can you borrow 100,000 $ at bank, and spend 200,000 $… how long corporation can do the same???
  not long.. one is going to be in bankruptcy, corporation is in chapter 10..
  that same w/ government.. its not their money.. its’ other people money…

  YOU DON’T DEAL W/ ROOT OF THE PROBLEM…
  AMERICANS ARE POOR and getting poorer and have LIVED for LAST 10 YEARS BEYOND THEIR MEANS..
  its that simple..
  and government must not spend borrow and away money
  but tell the truth… STOP SPENDING AND START TO SAVE.. STOP BUYING ALL THE STUFF..
  yes.. its going to be painful, more unemployment, but in the end that’s only solution…

  if you’re smart’ as you claim to be, you must understand that US government cant spend 2 $ for 1 $ dollar in taxes..
  that’s impossible.. the end will be painfully… more taxes. more pain
  or printing money and Weimar.. that’s it.. no way around..

  good luck
  nice talking to you
  alex

  ps
  as for spending.. once world ‘JAPAN’… 20 years,, still NIKKEI 70 percent below top.. at least JAPS had savings back in 90x

  Posted by alex west | December 9th, 2009 at 2:48 am

• Marshall,

  Thank you for trying to educate me to your point of view.

  I beilieve that an increased standard of living that was funded, not by wage growth over the last decade but by credit growth, should be allowed to go down to a sustainable level. Standards of living do fluctuate. The pricing power of labor has to be increased or prices must be allowed to decline. Note also that as the credit growth kept hitting (previous) limits to growth over the last decade, those limits were dealt with by reducing lending standards with the inevitable results.

  I believe the government’s power to increase tax receipts is limited to a much greater extent than you are allowing for.

  You argue that government should bankrupt itself by taking over private obligations, which is essentially the case except that you claim this government alone cannot bankrupt itself. A first….

  If you will indulge me a quotation ….

  “The national budget must be balanced. The public debt must be reduced; the arrogance of the authorities must be moderated and controlled. Payments to foreign governments must be reduced, if the nation doesn’t want to go bankrupt. People must again learn to work, instead of living on public assistance”

  Cicero. 55BC

  I am betting on Steve from Virginia’s mum and the Niall Ferguson’s of this world.

  Thank you for a thoughful and respectful discussion.

  Good luck to all.

  Posted by Nicholas Arno | December 9th, 2009 at 3:35 am

• Well, Nicholas, I don’t know whether Cicero operated under a gold standard or some other external constraint, so unsure how relevant his views are in the current economic context, but thanks for the inputs.

  Posted by Marshall Auerback | December 9th, 2009 at 2:03 pm

• Alex,

  Your conceptual confusion starts from the premise that a government is just like a household, which of course is patently false. First, the government’s interest is the public interest. The government is there to provide for the general welfare, and there is no correlation between this interest and a position of surplus or deficit, nor of indebtedness, in the government’s books.

  Second, the government is sovereign. This fact gives to government authority that households and firms do not have. In particular, government has the power to tax and to issue money. The power to tax means that government does not need to sell products, and the power to issue currency means that it can make purchases by emitting IOUs. No private firm can require that markets buy its products or its debt. Indeed taxation creates a demand for public spending, in order to make available the currency required to pay the taxes. No private firm can generate demand for its output in this way. Neither of these statements is controversial; both are matters of fact. Nor should they be construed to imply that government should raise taxes or spend without limit. However, they do imply that federal budgeting is different from private budgeting, and should be considered in its proper, public context.

  While it is common to regard government tax revenue as income, this income is not comparable to that of firms or households. Government can choose to exact greater tax revenues by imposing new taxes or raising tax rates. No firm can do this; even firms with market power know that consumers will find substitutes if prices are raised too much. Moreover firms, households, and even state and local governments require income or borrowings in order to spend. The federal government’s spending is not constrained by revenues or borrowing. This is, again, a fact, completely non-controversial, but very poorly understood.

  The federal government spends by cutting checks – or, what is functionally the same thing, by directly crediting private bank accounts. This is a matter of typing numbers into a machine. That is all federal spending is. Unlike private firms, the federal government maintains no stock of cash-on-hand and no credit balance at the bank. It doesn’t need to do so. There are surely limits of wisdom and prudence on federal spending, as well as numerous checks, balances, and self-imposed constraints, but there is no operational limit. The federal government can, and does, spend what it wants.

  Tax receipts debit bank accounts. So does borrowing from the public. These are operationally distinct from spending. There is no operational procedure through which federal government “uses” tax receipts or borrowings for its spending. If, perchance, one chooses to pay taxes in cash, the Treasury simply issues a receipt and shreds the cash. It has no need for the income in order to spend. This is why it is a mistake to look at federal tax receipts as an equivalent concept to income of households or firms.

  Posted by Marshall Auerback | December 9th, 2009 at 2:05 pm

• Alex West (and most Republican Senators) might understand the point that that Marhshall is making if they read about how Marshall’s point applies to an ultra simple economy. There is a very nice illustration of this ultra simple economy point here: http://www.slate.com/id/1937/

  Posted by Ralph Musgrave | December 16th, 2009 at 1:52 pm

• To be sure, as we MMTers have emphasized many times, too much government spending can be inflationary.

  But the measure of “too much” cannot be found by looking at the size of the deficit (or, equivalently, at the shortfall of tax revenue), or at the ratio of government spending to GDP, or at the outstanding debt stock. Rather, government spending will approach an inflation barrier as the economy approaches full employment of resources, including labor resources. Yet, we are no where near to full employment. Any fear that current levels of spending, or even much larger amounts of federal spending, might be inflationary are premature. With 12 to 25 million jobless workers remaining, inflation is not a legitimate worry.

  In one respect, government money is like any other money: an IOU. IOUs must always be accepted by their issuers. It is different in several respects: the only thing a sovereign government promises is to accept its IOU in payments to government. (there is no promise of conversion) Government can impose on citizens/subjects a liability–taxes, fees fines, tithes, whatever. (that is sovereign power) And name what is accepted in payment (its own IOU). Finally, government’s IOU is often promised in “redemption” of the IOUs of other issuers: a bank deposit can be “withdrawn” into cash on demand. Government does not have to impose this–private issuers of IOUs will voluntarily promise such a redemption to make their own IOUs more desirable.

  This is what makes government unique. Those who refer to household budgets are mistaken. No household can issue “that which is necessary to pay taxes”; no household can impose a tax liability on citizens/subjects; no household can issue IOUs that the banking system promises to deliver on demand in redemption.

  Yes there are real resource constraints. Yes there are political constraints (as we are finding out right now with regard to health care “reform”). Yes Congress can tie both of its hands behind its back on the belief that government is “finance constrained”.

  For more on the possibility of inflation and dollar depreciation, see: http://neweconomicperspectives.blogspot.com/2009/12/is-it-time-to-reduce-ease-to-prevent.html

  Posted by L. Randall Wray | December 19th, 2009 at 11:16 pm

• Marshall or Randall

  I accept what you are saying here and what Warren Mosler is saying on Facebook at his Center of the Universe Site (looks the same in many instances) but like Jeff Inmelt I just don’t understand how the service economy can sustain America. Does the World want our dollars and our military so badly that we can just keep consuming without producing anything. Are we George Bush’s dedicated shoppers whose only role in the world is to keep shopping and buying what others produce?

  Please I am not trying to be sarcastic, I just don’t understand that part of what your saying.

  The corollary to my question involves our skill levels. It took a long time for the US to develop the skills to build autos,planes,ships and semi conductors is it in our best interest as a country to allow those skills to atrophy and replace those jobs with clerk and cashier jobs at Wallmart and hamburger slingers at McDonalds”?

  Can you provide an answer or direct me to where I can find one that isn’t technical?

  Posted by Charles Yaker | January 12th, 2010 at 10:33 am

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