More thoughts on out of control deficit spending
About a year ago I wrote a post called "Out of control US deficit spending". The purpose of the post was to begin a series of posts presenting the modern monetary theory (MMT) framework from a deficit hawk’s perspective, what I later dubbed MMT for Autrians.
I just want to reiterate a few themes from that post and some other MMT-themed posts in light of Stephanie Kelton’s guest post where she asked Can The US. Afford Its Present Deficit Spending?. While I am not an MMT-er, I do use the MMT framework for discussing a lot of economic issues because it is a more accurate depiction of the mechanics of our fiat money monetary system. Bookmark this page if you want a post to review and come back to which highlights the major economic themes addressed by MMT.
- Like it or not, we live in a fiat money world. No major currency now traded on foreign-exchange markets is linked to gold or other precious metals. Wikipedia says, "Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree." This fiat money system is quite different from a gold standard. Many economic pundits are trapped in a gold-standard mentality and make arguments that are irrelevant in a fiat money world. (See Misunderstanding Modern Monetary Theory for an example).
- Most importantly, fiat money makes sovereign default less relevant but currency depreciation and inflation more relevant. And, no, a weaker currency and inflation do not equal default even if it feels like theft. Government can default on a fiat currency obligation. Doing so is a political decision not an economic one. The government can always make good on a claim in the money it has created if it chooses to do so. (See Russia, sovereign debt defaults, and fiat currency).
- From the government’s perspective, there is no functional difference between any of its obligations like bank notes, electronic credits, or treasury bills and bonds. As a ten pound note says, “I promise to pay the bearer on demand the sum of [fill in the blank sum][fill in the blank fiat currency].” The fact that the U.S. issues bonds to cover its deficit is an artificial constraint that is a legacy of the gold standard. I assume we still have this policy as a political decision to prevent government from just printing money to cover spending. (See If the U.S. stopped issuing treasuries, would it go broke?)
- The question then is about political choices, resource allocation, currency depreciation and inflation. For example, in the U.S. there has been a lot of discussion about ‘starving the beast’ by shutting down the government until spending is brought to heel. This is an entirely political debate based on choices about the size of government and resource allocation in the economy. It has nothing to do with affordability. I think this kind of brinkmanship is reckless and deeply irresponsible. This is not the way you would see these issues debated in Switzerland or Germany for example. For bondholders, the political risk of potential default in the U.S. is real in a way they are not in those other two countries. There is a real possibility the U.S. could default. For that reason alone, the U.S. doesn’t deserve a AAA bond rating. (See Bill Gross: Deficit Hawk, Bond Vigilante).
- In regards to resource allocation, we must always keep in mind the accounting identity which shows that government deficits are exactly equal to non-government sector surpluses. That is to say, in an open economy like the U.S., the private sector balance plus the current account balance is exactly offset by the government sector’s balance. Any movement in one balance necessarily moves the others. As I indicated in my post labelled "Out of control deficit spending", we need to separate the accounting from the ideology. The economics and accounting of budget deficits is clear. It is the policy prescriptions where ideology and political choice are key. (See Economics 101 on government budget deficits).
- MMT demonstrates that budget deficits are the result of an ex-post accounting identity. In plain English that means the policy prescriptions are the economic input and the deficit is the output. Focus on the policy and policy goals, not deficits. Stephanie Kelton correctly stated, "debates about "affordability" become inapplicable. As this becomes more widely understood, we can begin to have a completely different — and vastly more important — debate about the size and role of government." This is where MMT’ers and I differ. We both recognize that the policy prescription debate is about resource allocation and the size of government. However, MMT’ers are principally concerned with full employment and using government to help achieve that goal. I am also concerned with full employment but have a more negative view of government’s ability to achieve full employment without cronyism or resource misallocation. It is important to remember that one doesn’t have to agree with MMT’er policy prescriptions to use the MMT framework (See Does focusing on deficit reduction reduce deficits?)
- The U.S. dollar’s role as a reserve currency creates pressure on the capital account, causing a capital account surplus and a current account deficit. Combined with the private sector’s desire to net save, this entrenches federal government deficits (See How To Reduce Government Budget Deficits)
There are a few other points I want to highlight related to deficits and debt.
- The national debt is a government liability. The national debt is the debt holder’s asset. See Money the government owes us
- The BIS, the central banks’ central bank, has issued a report warning that malinvestment is likely to continue in a world of excess monetary stimulus. How do you deal with that problem? See Why Stimulus Is No Panacea
- The Europeans are in a fundamentally different situation to the U.S. or Britain because of the currency issue. Spain does not have a sovereign currency. Ireland does not have a sovereign currency. This makes them users of currency and beholden to market liquidity. See On Creators of Currency and the Sovereign Debt Crisis.
- QE2 is not good economic policy because it is just an asset swap and has no direct effect on the real economy except via private portfolio preferences. As a result, it encourages leverage and speculation and opens the Fed up to charges of recklessness. See QE2 Is Equivalent to Issuing Treasury Bills and Does Ben Bernanke Believe The Stuff He Writes?
I think I will leave it there. What should be clear is that if you can’t even agree about the mechanics of the issue, you’re not going to have a good debate about the substance. Some of the points I have outlined above are incontrovertible. The accounting identity of government deficits and non-government surpluses is one. You should view people arguing for cuts in deficit spending who do not also point to this identity in a dubious light. Assume they don’t even realize the identity exists. How are they going to be able to have an enlightened view about deficits if they don’t understand that government deficits are the mirror image of non-government surpluses?