How I Learned to Stop Worrying and Love MMT (Guest Voice)

How I Learned to Stop Worrying and Love MMT
by Robert Coutinho

Modern Monetary Theory (MMT) is an explanation of how the current system of money works. It is somewhat counter-intuitive and is a very refreshing and assuring piece of knowledge. Let me see if I can share it with you. For those who want in depth explanations, please go to one of the references cited at the end.

The federal government issues its own currency. Since 1971, the currency has ceased to be exchangeable for anything (it used to be exchangeable for gold, but Richard Nixon stopped all that nonsense). The reality of US dollars, Canadian dollars, Australian dollars, British pounds and many other fiat currencies is that they are required in order to pay taxes in those sovereign nations. That is it. That seems stupid, but it is reality. It is also profoundly important to economic policy at the federal level and virtually all of our politicians get it wrong!

The reason that this is so profound is that the implications are mind-bogglingly counter-intuitive. If the government issues its own currency, then it has no possibility of default. The government can not run out of money, nor can any program of the government do so. To quote Warren Mosler, “Yes, that means that the government has to spend first, to ultimately provide us with the funds we need to pay our taxes.” Wait, what? To reiterate, we need the government to spend first so that we can have funds with which to pay our taxes. Mr. Mosler gave a great description by suggesting an example of a household. I’ll paraphrase the example here.

You have two parents who want their children to do chores. They decide to issue coupons for chores done. Each child must pay ten coupons per week to avoid punishment. Where do the kids get the coupons? From the parents. Thus, the parents must first ‘spend’ the coupons (thus getting them into circulation) before the children can pay their weekly taxes. This may sound simplistic, but it is actually how things are done.

For instance, if you go to the IRS and pay your taxes in cash, they will thank you for being a good citizen, give you a receipt and then shred the money. The Treasury folks do not have a direct line to the IRS nor vice versa. The Treasury does not need to know if taxes were collected. When they need to spend, they make entries in a computer that change entries in other computers. That is it. So, if our above parents wanted to, they could simply keep track of each child’s quantity of coupons on the home computer. The parents don’t ‘own’ coupons. They don’t need coupons in order to ‘pay’ the children to do chores. They create the coupons when needed. That is what the Treasury folks do as well (note: the Federal Reserve has some hand in all of this as well, but, for most purposes it is irrelevant which one is doing the data entry).

It sounds like I’m suggesting that the Federal Government does not need to collect taxes! Actually, in a very real sense, they don’t. They always have an infinite supply of data entry numbers. Computers are fun like that. They will handle any number you want to enter. However, if there are no taxes then dollars (or whatever) could become worthless due to a lack of absolute demand.

If this is the case, then why tax anyone at all? The answer is one of those counter-intuitive parts I mentioned. “1. Federal taxes serve to regulate aggregate demand, not to raise revenue per se. 2. Federal borrowing serves to regulate the term structure of interest rates, and not to fund expenditures.” Thus, taxes are to regulate demand and bonds are used to set the interest rate. Neither of these sounds normal, but both are what happen when one has a fiat currency that is based on issuance. This does not mean that the government can spend without consequence. It means only that the federal government can spend without fear of a check bouncing. The only way that a federal check can bounce is if the Federal Reserve (the government) chooses to bounce its own check.

In addition, it also means that there is no pressing reason why the Treasury would need to borrow money in order to spend it. Congress can simply tell the Fed to credit the Treasury’s account by $500 billion and spend it. There is no need to borrow the money, since the Treasury is the ones who make the money in the first place.

What, then, is the consequence for the federal government spending too much? The answer is inflation. Yes, that is it. If the government spends too much then there will be an excess of dollars in circulation competing for a finite amount of resources. The cost of the resources will go up. Thus, the Fed and the Treasury are working out systems to make sure that inflation does not get out of hand. Meanwhile, taxes serve to take money out of the system, thus are one of the primary methods of trying to keep inflation low.

A common misconception is that if the federal government ‘borrows’ too much money that there will be none available for businesses. It is actually almost irrelevant how much the government borrows because they don’t need to borrow at all. It is an accounting method that helps to set the interest rates. The reason the Fed wants to set interest rates is so that banks will not keep lowering their own rates in competition for loans. If the Fed sets an interest rate (overnight rate for reserves) of 2%, the banks will be unwilling to offer less than that to borrowers since they would have to pay that much to settle reserve accounts if they had to purchase from the ‘lender of last resort’. This gets into another entire economic situation about how banks create money, but that will have to wait for another day.

What about China, Japan and others lending to us? Well, it turns out that what they are basically doing, when they buy T-bills, is changing their reserves at the Fed from a checking account to a savings account. When they cash in the T-bills they are moving their money at the Fed back to the checking account. The only thing, ultimately, that foreign governments can do with excess dollars is exchange them for goods on the open market that are also denominated in dollars (this is not automatically goods made by us since many different items and commodities are bought and sold in US dollars internationally). Never the less, if China wanted to ‘cash in’ all of its bonds, the Fed would just reduce the data entry for China’s savings account and increase it for their checking account. They would not even have the Treasury Department create the actual dollar bills since most financial transactions are now done by computer.

The important thing to remember is that it is inflation, not insolvency, that would result from deficits (and overall debt) getting too high. Inflation is watched very closely by the Fed and they would immediately raise interest rates if the rate of inflation got out of hand. Meanwhile, during bad economic times, it makes a lot of sense to have deficit spending because it helps to employ more people. Ultimately, we would like most people to be employed. In case you think that deficit spending will always lead to inflation, consider the past three years. We have had huge deficits and yet the interest rates are nearly zero. That’s because unemployment is so high. It is possible to have both inflation and high unemployment, but at the moment we do not.

Meanwhile, the claim that Social Security (or any other government funded program) is running out of money is bunk. Why? Because we print our own money! Greece does not print its own money. Neither do Spain, Portugal, Ireland, Italy, France, Germany nor any other country in the Euro Zone. They use the Euro. So when you hear about USA following in the footsteps of Greece, ask the claimant if he believes that California is the same as the United States. Yes, our individual states (and households) are similar to Greece (and thus the reason that most states have a balanced budget mandate).

If we print too much money, other countries will not value it as much and will raise their costs. Our dollar would lower in comparison to the other currencies, thus making our goods and services more competitive compared to other countries. Meanwhile, our own salaries and such would still remain about the same (all other things being equal). So, while it might cost more to buy a bottle of French wine, a California vintage would still be the same.

Then why did we have stagflation in the 70′s? Because OPEC decided to keep raising the cost of oil. This caused all the other costs to raise (thus the costs that OPEC countries had to pay for stuff they wanted as well). Eventually, many electric companies began switching to natural gas causing OPEC to reduce its output by fifteen million barrels. That still was not enough and the price of oil dropped. So, to sum up with inflation, most of the high inflationary periods are actually due to the price of oil increasing—and we really don’t have any control over that!

So, for those who read my article describing how colonial script had created a thriving economy, consider: where did the script come from? The colonial governments spent it (contracting people to perform services). Then others used it as currency—since they did not really have a currency. Then the Bank of England realized that they were not getting a cut and got script outlawed. But, before it was outlawed, script allowed a thriving economy. The various colonial governments did not have to worry about ‘getting’ enough script. They created it in the first place. The same happens now with the federal government. Meanwhile, you and I and the states DO have to worry about getting money before we spend it, because it is illegal for us to manufacture our own money.

SOME SOURCES:

http://hir.harvard.edu/debt-deficits-and-modern-monetary-theory

http://www.huffingtonpost.com/warren-mosler/modern-monetary-theory-th_b_872449.html

http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

http://pragcap.com/resources/understanding-modern-monetary-system

Robert Coutinho is a disabled pharmaceutical chemist living in Massachusetts. He has been learning about life, the universe, and everything since he was born in 1963. He has had little else to do since his disability began in 1997.

  

Author: Guest Voice

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12 Comments

  1. and inflation is a big deal…

    that is unless we want to wheel barrel money to our favorite cash only vendors.

  2. @SL: actually that would be hyperinflation (a subset of inflation). It requires a sustained 40%/year inflation to be in hyperinflation. We do want to ‘worry’ about inflation (it is not pretty and can impoverish a nation). What we do NOT want to worry about is what the vast majority of politicians tell us we must worry about.

    We can not leave a national debt to our children. Why not? Because they can not send us their goods and services. We can not send our goods and services to those fighting WWII. Goods and services are used by the people at the time they are produced.

    Thus: if we are worried about, “how the baby-boomers can retire,” we need to consider not whether or not there will be enough money, but rather if there will be enough goods and services. Mosler gave an excellent example in one of the above-referenced articles.

    If, 50 years from now, we had 300,000,000 people retired and one worker, he would be a busy little guy. He would need all sorts of new technologies in order to produce all the food, medicine, housing, etc. that everyone needed. One problem we would not have is whether or not we could pay him.

  3. geez cant a person be a little hyperbolic around here?? :)

  4. There is one more purpose to taxation that is not mentioned here. That is redistribution.

    In any society, wealth and income tend to accumulate in pockets. That is the nature of markets. The accumulation takes place by two mechanisms – The first one is via zero sum games – that result in the Boltzmann Gibbs type distribution for both wealth and income. The second is by income from accumulated wealth (primarily interest income) resulting in a Pareto Distribution. The first distribution applies to the 99% while the second is operative for the 1% (Actually a little bit different but metaphorically correct)

    Taxation policy can either reduce income and welath disparities, or exacerbate them. Current tax policies appear to result in increasing the disparities rather than reducing them.

  5. Meanwhile, the claim that Social Security (or any other government funded program) is running out of money is bunk.

    This point is true but misleading. Social Security is in demographic rather than fiscal trouble. It’s not cash that ultimately takes care of retirees, it’s young people. The government can’t print more of those.

  6. Actually, the taxes on wealthy individuals does not, per se, redistribute wealth. The government pays some people, it also takes money away from some people. The redistribution is a function of government policies that lower the capacity of a wealthy person (in this case) to obtain as many goods and services and increase the capacity of those it pays.

    In effect, a Social Security recipient is not much different (from the gov’t’s point of view) than any one of its employees (at least when it comes to pay day).

    Yes, Dr. J., the problem with Social Security will be how many people are available to provide goods and services to the retired people. Thus, retirement accounts are likely to be used as means to get more goods/services than one’s fellow retirees (as opposed to some mythical need to have to save up one’s labor).

    As a consequence, it behooves us to sink and much resources as we can in to education and research & development. Those are the only ways that we are going to be able to increase the per-person output of our children and grandchildren. Thus: cutting education budgets is most likely to ensure that we cut our comfort during retirement.

  7. Why do I get the feeling Grover Norquist and all who have signed his pledge don’t know this? Judging by the tax policies of FDR through Nixon, this information seems to have been something that politicians used to know. And now, since Reagan, they have been pandering facts and assumptions such as “lower taxes create jobs” and other hookum to get votes at the expense of the general economy. I’ve said this countless times before and I’ll say it again. If we let the GOP run the henhouse and enact their fiscal policies AGAIN, we are really screwed. If we don’t get a president and a Congress that undoes the Bush tax cuts we are screwed. Will the voters allow that considering how intentionally misinformed we have become as a result of political messaging?

  8. Yes, RC. The retirement age also matters.

  9. Slamfu: actually, until Nixon got rid of the gold standard, we did not have a currency that was nonconvertible (it was convertible to gold). Also: the taxes on the wealthy will not be needed unless we face rampant inflation (and thus need to reduce the money supply). I am not advocating a continuance of the Bush tax cuts, I’m only pointing out that if we simply did not bother to create bonds, we would have no national debt (just extra dollars in the system–and not really even that, since savings bonds are, by definition, money in the system).

    I think you may have completely missed the point of the article.

  10. Rcoutme, really interesting essay. Thanks!

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