Money is No Object:Accounting for Deficits, Taxes and Trust in the 21st

Century

Stephanie Kelton, Associate Professor, University of Missouri-Kansas City Financial Planning Association Annual Retreat Conference, May 5-8, 2012

What is Money?

“Money is the most powerful and pervasive secular force on the planet. Yet for most, it’s a source of mysticism and mystery.”

- Dick Wagner, JD, CFP®

Barter Theory

• Dominant within Economics

• Metallist/Monetarist

• Spontaneously Originates in Private Sector

• Replaces Clumsy Barter

• Eliminates “double-coincidence of wants”

• Reduces Transactions Costs

“Truck, Barter and Exchange” ~Adam Smith

The Evolution of Money (textbook story)

• Primitive monies

• stones, beads, shells, feathers, fish, cattle, etc.

• Precious metals

• Paper with metal backing

• Fiat money -- Trust?

Textbook Conclusion

• Money is what money does

• A veil over the real economy

• Not important in its own right

• Money, debt and finance don’t even fit into many economic models

Credit and State Theories• Chartalist/Cartalist

• Anthropologists, Sociologists, Numismatists

• Find origin of money in credit/debt relations

• Precedes markets and exchange

• Separate currencies not a coincidence

• State plays central role Roman tally sticks, British Museum

Regardless of Origin, Today

• All money exists as an IOU

• The “I” is the debtor

• The “U” is the creditor

• IOUs are recorded in a money of account

• The Australian dollar

• The US dollar

• The Japanese Yen

• The British pound

• The _____ Euro???

Money is Not an Object

• The money of account is abstract

• Like an “inch,” a “foot” or a “yard”

• It cannot be seen or felt

• It is represents a social debt relation

• In any modern nation, the money of account is chosen by the national government

The Power of the State

• Recognized as far back as Aristotle, through Adam Smith and into the modern era

• John Maynard Keynes told us: “The age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-of-account...To-day all civilised money is, beyond the possibility of dispute, chartalist.”

A Sovereign Government

• Defines the money of account

• Imposes taxes, fees and other obligations

• Decides what it will accept in payment to itself

• Chooses how it will make its payments

Sovereign Money

• Most governments choose their own unique money of account and issue their own unique currency

• “One Nation, One Money”

• Most governments also require that taxes be paid in a currency that the state has the exclusive power to issue

• These currencies are “sovereign money”

Taxes Drive Money

• As long as the state has the power to enforce its tax laws, the people will need the government’s money

• The currency will have value, and people will sell things to the government in order to get the government’s money

• Whatever the government accepts in payment to itself will become the “definite” money in the system

• The final means of settlement

The Hierarchy of Money

• The private sector “leverages” the government’s money

• Layering of IOUs with differing degrees of acceptability

• But private sector cannot create net financial assets

• Only one final means of payment

Government

Banks

Non-financial Business

Households

Most acceptable

Least acceptable

The US Hierarchy

$

United States Government

Issues the currency at the top

of the pyramid

Non-convertible fiat money

Taxes and spends in dollars

The Benefits of Sovereign Money

• The government can never “go broke” or “run out” of money

• It can afford anything for sale in the domestic unit of account

• It does not need to borrow its own currency

• It can set the policy interest rate at any level

• It has an expanded policy space

Pre-1973, Bretton Woods

$

GoldPromised to convert US$ into gold at a

fixed price

Had to limit spending to protect gold

reserves

Dollars were subordinate

United States Government

Post-1973 Fixed Exchange Rates

US$

Ruble, Peso, etc.

Did not issue the currency at the top of the pyramid

Heavily dependent on trade surpluses

Had to limit spending to protect reserves

Sacrificed control of interest rates

Russia, Argentina, Southeast Asia and Mexico

What about the Euro?

• EMU is an exceptional case

• The currency is divorced from the nation

• “One Market, One Money”

• The euro is effectively a foreign currency from the perspective of the individual nations

• The EUR-17 are USERS of the currency

• They lack the powers of a sovereign ISSUER

The Eurozone

Does not issue the currency that sits at the

top of the pyramid

Heavily dependent on trade surpluses

Governments can “run out” of euros

Must pay marketinterest rates

Any EMU Country

Euro

Money Matters

• Governments should be in control of the currency that sits at the top of the pyramid

• Otherwise, they lack the power to keep their domestic economies on track

“By virtue of its power to create or destroy money by fiat and its power to take money away from people by taxation, [the State] is in a position to keep the rate of spending in the economy at the level required to [maintain full employment].”

~Abba P. Lerner

How does a Currency Issuer Spend?

• By directing its bank (usually the central bank) to credit someone’s account

• Frequently happens without even writing a check

• In the “modern money” era, government spending is accomplished through electronic keystrokes (Bernanke)

• The monopoly issuer of the currency can always meet its obligations (Greenspan)

“We’re out of

money.”

“The government, just like every American household, has

to live within its means.”

Is the Government Like a Household?

• No - not anymore

• We abandoned the gold standard

• We ended Bretton Woods

• We have “modern money” created by keystrokes on a computer

• But we act as if we are still stuck in a fixed exchange rate world

Afraid of Becoming Greece

Why is the Eurozone a Train Wreck?

• The EUR-17 gave up their keyboards!

• Became users of the currency, much like individual US States

• Italy is like Indiana. Greece is like Georgia.

• Transferred spending authority to the financial markets

• Forced to accept job-killing austerity or risk defaulting on euro-denominated debt

The US Still Has its Keyboard

• The US Government cannot “go broke”

• It cannot “run out” of money

• It is the monopoly issuer of the currency

• It cannot run out of keystrokes anymore than a scorekeeper can run out of points

Money is No Object

• As Chairman Bernanke explained on 60 Minutes in 2009: (PELLEY): Is that tax money that the Fed is spending? (BERNANKE): It’s not tax money. [W]e simply use the computer to mark up the size of the account.

The Issuer of the Currency Can’t Go Broke

“[A] government cannot become insolvent with respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such claims without limit”

~Alan Greenspan, 1997

Then Why the Weak Recovery?

• Policymakers (and most economists) don’t understand how the monetary system works

• They think the government faces the same kinds of constraints that users of the currency (i.e. households, businesses and state/local governments) face

• They warn that our fiscal path is unsustainable

• And they ask for “shared sacrifice”

The Hawks Want Immediate Cuts

• A deficit hawk opposes deficit spending on principle

• Often favors “sound money” (e.g. gold standard or 100% reserve backing)

• Would legislate rules to mandate balanced budgets

The Doves Want Eventual Cuts

• A deficit dove supports limited deficit spending in tough economic times

• Want the budget balanced over the business cycle

• Support rules to limit the size of the deficit (e.g. Europe’s Fiscal Pact)

• Prefer to wait until after the economy begins to recover before imposing austerity

A New Bird in Town: The Deficit Owl

http://animalsexplaineconomics.tumblr.com/

Owls Doves Hawks

A New Brand of Macro

• Discovering an emerging school of economic theory

• Modern Monetary Theory (MMT)

• Exposes the fallacies in conventional economic theories

• Views unemployment as socially harmful and economically inefficient

• Supports a full employment economy

“Academically, that school has not been challenged. And from

what I study on it, they’re right!”

~Bernard Lietaer

The MMT Deficit Owl

• Assigns no arbitrary limit to the size or duration of the deficit

• Relates government’s balance sheet to the rest of the economy

• Uses sectoral balance sheet approach

Government Surplus = Non-government Deficit Government Deficit = Non-government Surplus

Government Non-Government

$$$

$$$

A Simple and Fundamental Accounting Truth

G>T

T>G

What They Show

• In any given period, the sectoral balances show whether a particular part of the economy is:

• Spending more than its income

• Running a deficit

• Spending less than its income

• Running a surplus

• Spending just equal to its income

• Balancing its budget

Deficit

Surplus

The Whole Enchilada

Internal: Government Sector

Internal: Domestic Private Sector

External: Foreign Sector

One Rule• The laws of double-entry

bookkeeping apply

• All sectors cannot take in more than they spend (i.e. be in surplus)

• All sectors cannot spend more than they take in (i.e. be in deficit)

• At least one sector will be in deficit

Beware Swings in Private Sector Balance

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The Private Sector Balance

• As a general rule, the private sector needs to be in surplus

• Households and firms cannot continually borrow more than their income

• At some point, lenders will run out of creditworthy borrowers who are willing to spend

• Private debt levels may become unsustainable (Minsky)

• When an expansion driven by private sector debt reaches an end, sales soften, jobless claims trend higher, and economic activity falters

• Government revenues soon fall short of expenditures and the government’s budget eases

Achieving a Private Sector Surplus

• There are only three ways to put the private sector in surplus:

• 1.) Run a government deficit and a current account surplus

• 2.) Run a government deficit > current account deficit

• 3.) Run a government surplus < current account surplus

• Only countries with trade surpluses can avoid running government deficits

• But not everyone can be a net exporter!

• As long as our current account is in deficit, the US government needs to frequently be in deficit

But We’re Terrified of Deficits • What if people lose

trust in the dollar?

• What if China refuses to buy our bonds?

• What if interest rates skyrocket?

• What if we set off hyperinflation?

So We Live Well Below Our Means

Output gap estimated at $9.8 billion per day in

lost income

25 million Americans unable to find full-time work

$2.3 trillion infrastructure deficitOne in four children

in poverty

There Is An Alternative to Shared Sacrifice and Economic Stagnation

Twitter: @deficitowl