Our false view of deficits and money
In political debates throughout the developed world, the most prominent divide today is almost certainly that between the needs of society for unemployment safety nets, retirement and pension programs, health care spending, and desired public services versus the demands of the bond market to slash spending in order to reduce budget deficits. The issue is sometimes presented in terms of morality as in “it’s wrong to spend what you don’t have” or “it’s only right that governments, like individuals, manage their finances soundly”. It’s also sometimes presented in a particularly grating parental tone as politicians site a need to have an “adult conversation” with their presumably childlike constituents.
There are two things about this debate that literally scream out for attention. The first is that it’s a completely contrived and false issue having absolutely no bearing on the true nature of money and debt. Individuals can be in debt to others but it’s utter nonsense to think of societies as somehow capable of being in debt to themselves. Societies are not individuals. The second thing is that a very tiny number of elites along with their political and intellectual supporters derive enormous benefits and power from the view that deficits are important. They’re the monied titans that comprise what we call the “bond market” and we’re repeatedly reminded we must change our ways and appease this apparent force of nature. Obama’s former Director of the Office of Management and Budget Peter Orszag, now lucratively sitting as vice-chairman of global banking at Citigroup, instructs us in today’s Financial Times: “it is … difficult to see the political system embracing that reality (of deficit reduction) without being forced to do so by the bond market”. Another article right along side it, entitled “Only tough reforms can save the land of the rising debt”, warns us “… if Japan does not switch course voluntarily (reduce deficits), it may soon find that financial markets will force changes upon it.” We’ve virtually ceded democracy to those with extreme wealth who, motivated only by private greed, claim a right to decide the limits of possible prosperity within societies. Politicians from “center-left” through the right support them and in turn are supported by them.
In this post, I seek to make the argument that there’s no sound justification for this transfer of power and there’s every reason to reject the entire discourse and move to a democratically based monetary regime which permits maximum prosperity for all. It’s not too great an overstatement that the key to overcoming most of our problems is a changed monetary system. For is it not clear the technology exists today for widespread prosperity and the only thing holding it back is a lack of purchasing power (i.e. money)? Monetary policy is not mainly an economic issue, it’s political in the deepest sense of the word. It cannot be left in the hands of economists or those in high finance.
Let’s jump to the central point: we have what is known as a fiat currency. It’s not backed by gold or any other commodity and we, i.e. the government, can issue it without cost by simply crediting a bank account. This immediately should seem strange – is it not the height of lunacy for a government to feel the need to borrow something which it can in fact produce at will? Or to adjust its policies to induce others to lend it back its own fiat currency? The whole thing appears absurd. Is it not equally ludicrous to think we, i.e. the government, must rely on tax receipts in order to obtain this currency? We should pause for a moment and ponder this. If we can create our currency without cost, then clearly we don’t need to rely on taxes or borrowings to generate it. This is counter to all normally accepted intuitions but with only a little thought it must be admitted this is unarguably true.
This being the case, what is the purpose of borrowing and taxes? The reality is they are not means of generating funds for government spending but are, rather, only monetary tools that serve no purpose other than reducing the money supply. Both taxes and borrowing do the same essential thing – they drain money from the economy. The Federal Reserve, in fact, routinely manages interest rates with this understanding of money and adjusts its borrowing levels on a daily basis to meet its monetary targets.
Those who claim government spending should be limited to the sum of tax receipts and a low level of borrowing are in fact favoring a policy of austerity that limits societal spending regardless of need. They base their views on an unfounded conception that any monetary spending must be offset by either of the two monetary tools of contraction, i.e. taxes or borrowing. Why should that be? If the economy is suffering from unemployment and underutilized resources, what possible reason exists to think monetary creation needs to be offset by monetary contraction? Yet that is precisely the standard orthodox view of finance. Monetary creation beyond the limits of the economy is certainly unwise and would be inflationary. But why would monetary creation limited to the productive capacity of the economy be so? All past periods of prosperity involved the “printing of money” through private bank credit. The boom in the late 90’s and the recent mortgage boom involved massive private money creation through debt and yet there was virtually no inflation. Why should economists condemn the government printing of money yet not object to the private? Can anyone seriously believe that expanding purchasing power in today’s environment could possibly be inflationary?
To sum up my argument. The government should create sufficient purchasing power directly through monetary creation in order to provide full employment and utilization of resources. It should only use borrowing and taxes to reduce purchasing power when capacity is being reached and the economy is in need of contraction. Borrowings over an extended term would likely be level as they would decline when the economy was doing poorly and would rise when contraction was needed. Since borrowings are only monetary, interest rates on debt could be maintained at zero percent and so interest on debt would not be an issue. Going further, one can see that borrowings are almost identical to reserves held by banks at the Fed. The government could establish reserve requirements for those with great wealth that would fluctuate depending on monetary policy. This is not the time to expand further on the many options for treating monetary contractionary tools. The critical point is to recognize the monetary nature of it all and the truly democratic opportunities for prosperity that a change in view entails.
There’s a great deal of theoretical support for this line of thinking. Abba Lerner was an early Keynesian economist who coined the term Functional Finance in the early 1940’s. This key article clearly expresses the monetary nature of debt and the need then (as now) to drop the false notions of financial orthodoxy. The guru of right wing monetarism, Milton Friedman, penned this article in 1948. He recognized the same reality and I would think the article should make those who reject this argument take pause. Friedman argues for eliminating the private banking power to create money and supports “as the chief function of the monetary authorities, the creation of money to meet government deficits or the retirement of money when the government has a surplus”. He concludes that “…government expenditures should be financed entirely by either tax revenues or the creation of money”. By today’s standards his proposal is radical but its general thrust is not too different than what is argued here. There are economists who are making the same points today, including Jamie Galbraith and L. Randall Wray (see here and here). But these perceptive scholars are either ignored or even portrayed as near lunatic. The false undemocratic consensus is that strong.
It’s well past time we on the left, those who passionately seek a better and more democratic world, recognize the monetary nature of much of our problems and demand our leaders stop creating artificial barriers to our prosperity.
(I’ve written other posts on this issue which are filed under the Monetary/Fiscal tab.)