by Robert Coutinho
Some of you may remember my previous articles on Modern Monetary Theory (MMT). I believe it is time for a refresher, and also another rant about Congressional misdeeds. Thus, I will attempt to put some of the catastrophe that we are facing (and will face soon) into understandable language.
First the shutdown: Congress (mostly the House of Representatives, aka Republican representatives, since the Democratic ones were opposed to the inclusion of a delay of the ACA) failed to pass a budget and failed to pass a Continuing Resolution (CR; those who have seen the CR acronym will now know what it stands for). A Continuing Resolution is a bill to allow the government to keep going as it was currently running (or at least before any shutdown). The reason that Congress failed to pass legislation is that all appropriation bills MUST (by Constitution) start in the House of Representatives. The House kept on attaching either destroying or delaying legislation for the ACA (Affordable Health Care Act), which the Senate and President Obama had already stated were non-starters.
So, in other words, rather than pass resolutions or (gasp!) an actual budget that could even have a chance of passing in the Senate and not getting vetoed by the President, the House decided that they would rather pass nothing and let most of the Federal Government programs shut down. The shutdown includes National Parks (as mentioned in many other articles), Head Start programs, Women Infant Children aid (WIC), all sorts of things in U.S. possessions including Guam, Virgin Islands, Puerto Rico, Washington D.C. and some other places, if you would like a complete list, just use any internet search engine and you will get more information than you likely would want. Perversely, this will not stop the legislators from receiving their own paychecks or health care. I’m not sure about their aids…some of them may have also been furloughed.
The Republican Party’s claim is that the ACA is a horrible, terrible, yucky, no-good, bad law for the people of the United States. Keep in mind that they are (in effect) stating that virtually every aspect of the law needs to be repealed. Their proxies in the media (mostly radio talk-show and Fox News analysts) have been scaring many under-informed (or uninformed) people about what the ACA will actually do. This has been essentially shown through numerous public opinion polls where the questions about support or opposition to ACA show many people having unfavorable opinions, yet when asked about the specific laws that the ACA actually enacts, well then the same people are all for the stuff. When you make a bogeyman out of a law that most people support the contents of, you are operating on dangerous ground.
As I stated in a comment on one of Dr. Estes posts:
“The GOP legislators were (are) scared to death that “Obamacare” would go into effect. They have lied their way into a corner, like a house painter getting trapped by his own work. Starting tomorrow (today?), people will be able to access the insurance pools that ACA created. All of the people who already have health insurance (the vast majority of Americans) will be completely unaffected.
“The previous sentence is the part that the Republican congressmen fear the most. They created a bogeyman and will be shown for the pathological liars that they are. The reason that the Democratic legislators (and president) did not feel the need to negotiate (over and above the fact that “negotiating” how someone kills you is not negotiation, neither is “How to dismantle Obamacare” a starting point) is because the insurance pools take effect whether the government is shut down or not. Thus, people will discover that ACA is not the Godzilla/Megatron/Terrorist that they have been led to believe.”
Now I do not mean to imply that the President or the Democratic legislators actually wanted a shut-down—quite the opposite. I am only pointing out that “Obamacare” is not likely to upset many voters. Thus, the extra expense (yes it will cost more to shut down the government than it would have cost to keep it going) is both unnecessary and detrimental to the deficit that the Republican legislators have so recently (ever since Obama became President) become aghast about.
However, the shutdown is a miniscule problem in comparison to what the United States may face in a few short weeks. With any luck and with good parental supervision, Congress and the President may solve that problem and the one I am about to discuss BEFORE catastrophe strikes.
“Okay Rob, what other catastrophe do we face?”
Oh, just the end of civilization as we know it.
“What? How?”
Well, okay, it would most likely send the world into another recession—if, and only if, Congress got its act together before the end of the year. Not paying the bills on time is something the federal government has never done. It is what the economic community calls a black swan event. The longer Congress takes to begin paying the bills again (after Oct. 13th assuming that they don’t raise the debt ceiling) the worse the consequences are likely to be.
Time for another lesson in Modern Monetary Theory (theory being of the scientific term, not the uncertainty type—thus similar to the Theory of Gravity, Theory of Relativity, Theory of Evolution, Theory of [insert many other scientific principles that have been accepted due to reproducible experiments performed thousands to billions of times]). Yes, a scientific theory of this nature is synonymous with a scientific law (Newton’s laws of motion, for example). Thus, what I am going to present to you is not some possibility, it is what the reality of the monetary system encompasses.
The U.S. dollar is backed by the Treasury as legal tender for all debts, public and private, in the United States (including possessions). By public debts, the statement on your paper money is referring to taxes, liens, fines and other such obligations you may incur that you have to pay to the Treasury (or the IRS, etc.) In other words, no matter how much you beg a federal worker (when they have not been furloughed of course), that worker is not authorized to accept a bale of hay in order to cancel your debt (or mark it as payed in full) to the Federal Government. In addition, they may not accept foreign currency, jewelry, gold, silver, uranium, or any other commodity. You MUST pay the U.S. in dollars. Keep this in mind, it is a very important part of MMT.
Back in 1971 President Nixon took the U.S. off of the gold standard. Up until that time gold was valued at $35 per troy ounce—by law. Not only that, but other countries could exchange excess dollars for gold. Under Franklin Delano Roosevelt, the price had been set (thus setting the value of the dollar). Roosevelt had also made the hoarding of gold a felony. That went out the same as the set value for the commodity. So, in 1971, one of the most profound changes in U.S. currency was enacted with virtually no fan-fare, no marker in history books of such a drastic change, nothing. It was mostly greeted as a “Ho hum” event. It was nothing of the sort.
When the U.S. stopped exchanging gold for dollars, most of the other countries followed suit. Even the English Pound was no longer exchangeable for one pound of silver (which is where the name of the currency came from in the first place!) This meant that money was backed by…by… many people simply did not know. Some economists and financiers thought that it was backed by loans (mortgages mostly), but that was not actually the case. Banks do not “create” money when they lend it. They create both a debit AND a credit. Thus, although more money will go into circulation when a bank loans money, it also creates the promissory note. Since the two balance each other out, no net money is created. By the way, banks do not lend the money they have (such as from deposits); they lend the money that they believe they can continue to support based on the amount of reserves the Federal Reserve Bank requires of them. Again: banks do not only lend from the savings accounts of their clients—they lend money and create it at the same time!
Some very smart people starting with Minsky and including Wynne Godley, Warren Mosler and many more, began looking into the situation and discovered that the reality was almost stranger than Monopoly money. The money is of value because all of the debts owed to the U.S. must be paid in dollars. Similarly, the English pound is the only currency accepted for debts due to the British government. Since all federal taxes must be paid in dollars (and all state taxes, although that is not actually required by federal law, but instead required by each state individually), anyone who needs to pay taxes (or fees, etc.) needs to get some of that stuff. That is why the stuff is of value.
Take a while to let that sink in; I’ll wait.
Okay, now try to understand something: the Congress has the sole responsibility of deciding how the money gets created. In other words, all people who need to pay the federal government must pay it in something that the federal government has the sole power to create (unless they designate that some other entity can also make the stuff, but they are still technically in control). In actual practice, Congress has delegated the task of deciding how much to create to the Federal Reserve (the Fed). The Fed sends instructions to the Department of Treasury which runs the printing presses and coin mints which actually produce the physical currency.
For a quick synopsis of the different ways one can tally the total money supply I looked up the wikipedia description
M0: The total of all physical currency including coinage. M0 = Federal Reserve Notes + US Notes + Coins. It is not relevant whether the currency is held inside or outside of the private banking system as reserves.
MB: The total of all physical currency plus Federal Reserve Deposits (special deposits that only banks can have at the Fed). MB = Coins + US Notes + Federal Reserve Notes + Federal Reserve Deposits
M1: The total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits
M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).
MZM: ‘Money Zero Maturity’ is one of the most popular aggregates in use by the Fed because its velocity has historically been the most accurate predictor of inflation. It is M2 – time deposits + money market funds
M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.
M4-: M3 + Commercial Paper
M4: M4- + T-Bills (or M3 + Commercial Paper + T-Bills)
L: The broadest measure of liquidity that the Federal Reserve no longer tracks. Pretty much M4 + Bankers’ Acceptance
Now I realize that a lot of that may be difficult to understand, but basically a whole lot of the actual supply of U.S. dollars is NOT in print form (even if one considers bonds as being in print form). In fact, most of the money is kept in cyberspace. Computers are really good at doing arithmetic, and banks love to use computers for exactly that reason. So, going back to what I mentioned before about banks creating money and loans: when you get a mortgage the money created is (usually) deposited in banks somewhere and the loaning institution also holds a promissory note. Thus there is a debit and a credit which cancel each other out.
Where, then, does the excess money come from? If everyone paid back all their loans, would we have no money supply? Some bankers used to think so; some still do. The reality is that the federal government must create money so that we can pay it to them. Back when the east coast of much of N. America was delineated into British colonies, the colonials had a need for some public works. They needed roads, bridges, canals, and other such items in order to have a smoothly running society. They obtained the labor by issuing script which basically said, “This person has done some work for the colony and is entitled to x amount of resources for his labor.” The script took on a valuable role in enriching and acting as the driving engine for commerce in the colonies. The Bank of England found out about this and threw a tantrum. After changing their diapers and washing their faces, the trustees of the BOE went to Parliament and told them that the colonies were taking all the power away from Parliament regarding rule in the colonies. It was mostly a sham, but the bankers wanted their cut of all the work that the colonists were doing, so they tried to bamboozle the law makers. Parliament believed the sham and outlawed script—insisting that only official British currency could be used. Since there was almost none of the stuff in the colonies, the colonials were forced to borrow the money from BOE.
The consequences for the British Empire would eventually prove semi-catastrophic. The colonies immediately went into an economic depression. The wealthy (and educated) folks in the colonies resented having to pay BOE for, basically, nothing. This led to something that we in America call the American Revolution. The fact that Parliament also wanted the colonists to pay taxes to the British treasury (in BOE issued currency, of course) also contributed to the outrage; basically rubbing salt in an already festering wound.
I would like you to think about the colonial script for a bit. Why would merchants, farmers, inn keepers and others honor the script? Well, to put it bluntly, because the colonial governments insisted that they do so. They also began taxing their citizens to pay for the running of the governmental expenditures. Script was accepted as a payment for such taxes. BOE gold coins would have also sufficed, but there was very little of those in the colonies (as I mentioned above).
Thus, the first time that N. America saw a currency that was based on the need to pay taxes was when the British colonies found that they needed roads, court houses, etc.
U.S. currency today is based on the same need as colonial script was: you have to pay taxes with it. If there were no taxes, U.S. dollars would (likely) lose their value and be nothing more than pictures of dead founding fathers and dead presidents. No one can ask the federal government to exchange dollars for gold, silver or any other commodity. The money is backed by the full faith and credit of the United States (just as are U.S. bonds—we’ll get to those in just a bit). The only problem with this is that unless someone else is willing to trade you goods and services for the stuff, it is really only useful for paying taxes and fees.
Now please don’t get me wrong here, the money is exchangeable for all sorts of things all over the world! In fact, most of the commodities that are sold globally are sold in dollar denominations. Some countries actually use U.S. currency as their own official currency—even though they don’t have the right (or capacity, for that matter) to print the stuff! The reason that the dollar is the world reserve currency is because after World War II the only wealthy country left standing (without significant physical and economic damage) was the U.S. That made it easy to get the other countries to accept the dollar as the reserve currency.
The interesting part about our currency being the world reserve currency is that we have no mandated restrictions on how much of the stuff we want to produce. The other countries of the world are (at least to some extent) dependent upon us being fiscally responsible and ethical. Never the less, we do not guarantee any backing for the money other than that it may be used for all debts public and private in the U.S.
NOW THE SCARY PART
In a few weeks, congress and the president will need to do something about the debt ceiling. The House Republicans may use this issue to destroy the world economy and end civilization as we know it. They almost did that a year ago, and they have such a pathological hatred of Obamacare (ACA) that they appear ready to default on the payment of U.S. Treasury certificates. If the debt ceiling is not raised then interest payments on bonds will still get paid, but other bills will have to be stuffed into drawers, under mattresses or hidden somewhere else out of sight. Ask really poor people what they do with bills they can not pay and apply that to the Treasury Department. This has not happened since the Revolutionary War.
The spectacularly weird part of all of this is that there are very few good reasons for U.S. Treasury certificates (we’ll call them U.S. bonds) to exist in the first place. Back when dollars could be exchanged for gold, if the government ran a deficit, it needed to borrow the money in order to have enough gold in Fort Knox to pay off nations that might accrue an excess of our money. Today, however, the only thing that one can get when turning in a U.S. bond is…dollars. In other words, the bond is simply a savings account for the holder—with the U.S. government paying interest on the quantity. All the bonds are issued in U.S. dollars. We did not borrow yen, reminbi, marks, euro’s, pounds or any other currency. We “borrowed” the stuff that we create.
One of the greatest falsehoods that most of our governmental personnel hold is that expenditures of the federal government must be covered by either taxes or loans (bonds). The actual reality is that the federal government is the creator of the money and does not need it. If you take a bunch of money (in 1’s, 5’s, 10’s, 20’s, 50’s and 100’s) to the IRS in Andover, MA to pay your taxes, the agent receiving the cash will give you a receipt, possibly thank you for being a responsible citizen and then shred the money.
Wait! What?
The Treasury Department does not ask the IRS if money has been collected. The IRS does not notify the Treasury Department when it gets money. Most of the transactions are actually done in a computer located in one of the Federal Reserve buildings. You see, money is created by the federal government in order for you to pay your taxes. When you pay your taxes, that money is taken out of circulation. When the Treasury issues checks (or more likely has computers debit the accounts in banks across America and other parts of the world), they create the money. Thus, if the federal government did not create the money first then there would be no money with which to pay your taxes.
The implications of this fact are rather profound.
1. There is no need for the federal government to have debts. In fact, we do not “owe” anything to China, Japan, Germany and other bond holders. When the Treasury Department holds a bond sale they already have the necessary banks and other entities lined up to “buy” the stuff. No one goes overseas and begs other countries to lend the U.S. some of its own money. If a Chinese firm wants to bid on the bond, well, that just lowers the interest rate at which that bond matures—along with all the other ones sold during that auction. When, and if, the Chinese decide to “cash in” their U.S. bonds, the Federal Reserve will simply make a few data entries in their computer—moving the value from savings to checking. Then the Chinese may use their checking account to purchase any goods and services that they find are listed as for sale in U.S. dollars.
2. There is no reason whatsoever for the U.S. to default on bonds. Since the government has the sole power to create the money, it need only create it to pay off the bonds. We would not even have to fire up the printing presses since most transactions are done in cyberspace. As mentioned in #1, there is actually virtually no reason to even issue bonds.
3. The only reason for the federal government to have a balanced budget or a surplus is to curb inflation. Doomsayers back in 2009 insisted that the fiscal deficit would destroy the economy and the country. At absolute minimum it would cause hyperinflation similar to what happened in Germany back in the 1920’s. I’m still waiting for it (or more correctly, I said at that time that it would not happen, since the money supply in M2 and beyond had been severely reduced, thus threatening deflation—a much worse situation, by the way, than inflation). The only way that the federal government can become insolvent is if Congress somehow passes laws that force it to be insolvent. They have done this with the U.S. Postal Service and are heading for the same with the rest of the country’s finances.
4. Congress should ignore how much they are taking in for taxes and fees when considering how much to spend. Since they create the money in the first place, they only need to determine how much they need to spend, not how much they can afford. After they have figured out how much they need to spend, they should then determine how much needs to be taxed back out of existence to keep inflation at an acceptable level. Usually 2% per year is considered acceptable—and we have not even had that much from 2009 to 2013!
5. Somebody needs to set a law, rule, suggestion, something to wit: all elected federal officials and all cabinet members (along with the president and vice president) need to be taught what money is. They are arguing over stupid stuff that has not existed as a real problem since 1971.
6. The vast majority of American voters should not be well-educated on MMT—then they would insist on more expenditures than would be wise or necessary. That would lead to out-of-control inflation.
7. There is no need for issuing U.S Treasury Certificates (other than to give wealthy people a tax haven). Since the federal government can create the money it needs in order to pay its bills, issuing bonds is simply a very inefficient means of ensuring that some of the money is not spendable. Sometimes we may not want so much money to be spendable, but there are much better ways to accomplish that objective.
Probably the U.S. Constitution should be amended to set up an independent agency that would set the quantity of taxes that need to be collected in order to keep inflation at acceptable levels. Congress would be permitted to spend as they found necessary and to delineate what PERCENTAGE of the taxes and fees are to come from which sources (really only taxes since fees are going to be paid only when accrued). Thus, if they want corporations and businesses to pay 10% of the tax revenue, income tax to pay for 80% of the tax revenue and other taxes to pay for the last 10% of the tax revenue, that is up to them. What the tax VALUES would come to would be set by the new agency. The agency’s only job would be to see to it that inflation stays in check and that deflation is avoided whenever possible (since deflation usually leads to economic depressions).
Items 1 through 3 above are facts. The other stuff is opinion, but opinion based on the realities we face in this country (and the actual reality of how money is created, put into circulation, and then taken out of circulation).
I hope that I did not bore you too much. I hope that adults (or maybe altruistic space aliens) will replace the babies that are throwing tantrums in the Capitol building. I hope that Congress will see the error of its ways and stop scaring the rest of the world to death. I am not terribly optimistic about any of these possibilities, however.
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. He has written a fictional novel, Their Last Best Hope, which is currently available at Tate Publishing, Amazon and book stores.