Debating debt

I still worry about the mounting national debt. But a reader named Jimbo has argued (in comments, here) that my fears are groundless, because the rules in a fiat currency system are fundamentally different from the rules under a gold standard. This point of view is called Modern Monetary Theory. I would like to believe MMT, because then I could stop worrying.

Today I came across a brief explanation of MMT. It's sufficiently dumbed down that even I could grasp it.

Is MMT correct? I don't know. I lack the economic expertise to pass judgment. Two things make me wary: first, it seems to be promising a free lunch, and second, it appears to serve as a justification for "progressive" policies, i.e., bigger and more intrusive government.

As a pessimist, I'm doubtful of free lunches, and as a conservative, I'm not sold on big government as the solution to all ills.

Still, the MMT people may have a point. Maybe when the US went off the gold standard, the rules of the game changed. Maybe when we obsess about deficits and a balanced budget, we are stuck in an outdated paradigm.

As one commenter at the above-linked site argues,

Being the sovereign provider of a non-convertible floating rate (fx) currency of issue, the US government is not financially constrained. This means that the federal government does not need to tax or borrow to finance its deficit spending. To say that the government will go bankrupt, become insolvent, run out of money or default on its debt is like saying that a scoreboard will run out of points.

Are we scaring ourselves silly for no good reason? Or are the MMT people singing a pollyannish siren song?

Discuss.

Comments

[Tom Hickey]

Check out Ezra Klein's 5.12.10 interview of James K. Galbraith if you want reassurance from a top economist that the sky is not falling.

Galbraith: The danger posed by the deficit ‘is zero’

MMT aka Neo Chartalism is neither liberal nor conservative. It describes how the currency monetary system works. This knowledge can be used to formulate reality-based policy that is either liberal (favors government spending) or conservative (favors tax reduction).

Both expenditure and tax reduction increase deficits, and it turns out that Dick Cheney was correct when he said that deficits don't matter. In fact, they are necessary because government deficits translate into nongovernment surpluses, and government surpluses translate in to nongovernment deficits (private debt). This is a matter of national accounting and sectoral balances, not hypothesis.

The government as monopoly currency issuer has the sole prerogative and corresponding sole responsibility to provide the correct amount of currency to balance spending power (nominal aggregate demand) and goods for sale (real output capacity). If the government issues currency in excess of capacity, demand will rise relative to the goods and services available, and inflation will occur due to a glut of money. If the government falls short in maintaining this balance, recession and unemployment result, due to a glut of goods and services. The government attempts to achieve the correct balance through fiscal policy (currency issuance and taxation) and monetary policy (interest rates), based on data and its analysis in terms of sectoral balances.

Presently, both deficit hawks and deficit doves are getting in the way of this process. The result is contraction lasting much longer than necessary with the consequent losses accruing from foregone opportunity, not to mention the waste and degradation of human capital. The opportunity cost of pursuing so-called fiscal responsibility when it is a myth is huge and foolhardy. It is based on gold standard thinking that has been obsolete since Nixon shut the gold window on August 15, 1971.

[Michael Prescott]

Thanks, Tom Hickey, for that interesting and illuminating comment. I'm starting to come around to this point of view, but I'll need to read further -- if I can find sufficiently simplified presentations of MMT. I'm not kidding when I say that this stuff has to be dumbed down for me!

[Matthew]

The money is, of course, being printed and shovelled hand-over-fist to those people who showed themselves to be absolutely the worst possible judges of profitable investments, but are politically well-connected.

The end game is tears. . .

[Spirit]

So, Tom, do you think the UK could apply the same policy? The new government elected this week evidently doesn't.

[realpc]

MMT sounds like a perpetual motion machine. It sounds like plain old wishful thinking and self-deception. Remember when everyone was saying that real estate is the perfect investment because prices only go up, never down? Well MMT is probably something like that.

There is no free lunch, and what goes up must come down. It's real simple. Of course, some people are too smart to believe anything simple.

[Matt Rouge]

To throw another wrench in the gears here:

http://www.moneyasdebt.net/

Videos available free on YouTube:

http://www.youtube.com/watch?v=_doYllBk5No

If you look on Wikipedia, this stuff seems to get some respect (instead of being dismissed as crankery), and it makes sense to me, too. There's more at work than just whether the government will go bankrupt or not. It's also who or what accumulates over time. This video says it's the banks, who will inevitably have to default based on how interest works.

YMMV, and I really don't think anyone has firm answers on how the economy works these days. There's only pretending to know.

[realpc]

Galbraith doesn't make sense. He doesn't have to, because he's a smart expert and he "knows." If you want to believe him you will, even though he provides no evidence, because he just knows. He is describing some kind of magic well where you can take out as much as you like and it will never run dry. You can give money and jobs to everyone without limit and without end.

When someone tries to sell you something that cures all diseases and solves all problems, what do you think? Haven't we learned to be skeptical?

Galbraith is your typical leftist academic. He can spin any nonsensical ideas he likes because they don't have to apply to the real world.

[realpc]

Galbraith doesn't make sense. He doesn't have to, because he's a smart expert and he "knows." If you want to believe him you will, even though he provides no evidence, because he just knows. He is describing some kind of magic well where you can take out as much as you like and it will never run dry. You can give money and jobs to everyone without limit and without end.

When someone tries to sell you something that cures all diseases and solves all problems, what do you think? Haven't we learned to be skeptical?

Galbraith is your typical leftist academic. He can spin any nonsensical ideas he likes because they don't have to apply to the real world.

[Matt Rouge]

@realpc

I hear you. To what degree are the proclamations of a Galbraith or Greenspan or anybody falsifiable, scientifically speaking?

If the economy goes to heck, as it did in 2008 and various times in the past, it seems that the basic approach is never questions; rather, another round of tuning, regulating, adjusting, etc., is required.

FWIW, I am far left politically, but I think neither the left nor the right is happy with the status quo at this point.

[Michael Prescott]

It seems to me that Galbraith did provide evidence. He said that long-term interest rates in the US are low even in the face of high deficits; that in every period where the US has not run a deficit, a recession has followed; and that Japan has run huge deficits for 20 years and their interest rates remain near zero.

[Matt Rouge]

Michael,

How many times has the US not run a deficit since going off the gold standard? It would seem to be a pretty small sample size.

Japan (where I lived for 8 years) should not be held up as an example of big deficits working, as the economy has been in pretty poor shape since 1989 (when the bubble burst) and has had various deflationary crises.

I wish economists could admit that we just don't know how to run the economy. We don't know what causes will produce what effects. If we did, the chaos of 2008 would never have happened, as the wise potentates of the economy could have averted it.

[Matthew]

Michael,

Japan is about to blow sky high because of their demographics, and their interest rates will go through the roof.

Trees do not grow to the sky. . .

[Jeff R]

Well I'm not an economist either, but perhaps the most confusing issue here is that the U.S. government doesn't technically issue its own currency -- the Federal Reserve does. The Federal Reserve is more or less a private institution, or, it may be more accurately described as a public/private hybrid institution. Congress called for the creation of a new central bank back in 1913, but the central bank that was created, the Federal Reserve, was created by private bankers. Frankly, it's hard to really even describe what the Fed is, it's a rather unique institution. As far as I know, the Federal Reserve has not been publicly audited before and its meetings are not public either. Essentially, the Fed kind of has the best of both the public and private sector...some of the priviliges of a government institution with the benefit of being private organization.

So if the institution issuing currency isn't technically a government institution...would MMT still apply? I don't really know...but I figured I would throw that out there.

[realpc]

"It seems to me that Galbraith did provide evidence. He said that long-term interest rates in the US are low even in the face of high deficits; that in every period where the US has not run a deficit, a recession has followed; and that Japan has run huge deficits for 20 years and their interest rates remain near zero."

Ok, he provided evidence, but not meaningful evidence. Economists can take any fact and use it as evidence for any theory. The same fact could just as easily be used as evidence for a different theory.

Please don't be convinced by his authoritative expert tone.

[dmduncan]

I'm not buying any of it and I think it's sheer foolhardiness to think that things are peachy. The hour is late and there is knocking at the door.

Don't listen to the lullabye.

[Zerdini]

From the Independent newspaper today:

Lingering concerns about the European sovereign debt crisis, coupled with the threat of inflation, underpinned demand for gold yesterday, with prices hitting record highs in euro and sterling terms.

Spot gold hit a record of $1,248.15 amid worries that EU moves to stem the crisis in Greece and allay fears about Portugal and Spain may not succeed. In sterling terms, the yellow metal, which is viewed as a safe-haven investment, rose to a record high around £841 an ounce.

"Gold is the ultimate store of value and the best hedge against sovereign or inflation risks," VTB Capital said. "The rush of investors into gold is unlikely to abate anytime soon, especially now that traditionally hawkish eurozone central bankers may have to engage in quantitative easing."

[Zerdini]

Gold is all the rage here:

http://www.gold-dubai.net/

[MickeyD]

MMT is just a living example of JM Keynes's aphorism "Markets Can Remain Illogical Far Longer Than You Or I Can Remain Solvent" The reincarnation of the Weimar Republic looms IMO.

[Paul]

Don't start them off on reincarnation again.

[Michael Prescott]

I don't think Weimar is a relevant example. The Germans were paying off war debts in foreign currency. They kept devaluing the mark so they could afford to make the payments. As soon as they finished paying off the debt, hyperinflation abated.

[Michael Prescott]

By the way, I'm typing these comments on an iPad.

[Zerdini]

Is your iPad one of these Michael?:

Artisan and designer, Stuart Hughes, of UK-based company Goldstriker International has released an Apple iPad that is made up of solid gold and comes with encrusted diamonds and costs a cool £129,995.

The iPad, also called Supreme Edition, comes with 53 diamonds with 22ct solid gold enclosure. Only 10 such iPads will be available globally and you'd probably need an assistant (or your bodyguard) to carry it anyway; it weighs a whopping 2.1Kg, more than three times the weight of the regular iPad.

[Hjortron]

I read your post, but I haven't read all the replies thoroughly. I am also not an economist. But I do have a talent (or so I believe) for knowing when someone is spot on, even if I'm not an expert on the subject.

This guy is in this case undoubtedly Peter Schiff.

I encourage all of you to listen to all he has to say. Here are some examples:

http://www.youtube.com/watch?v=U9Mo3WcCgPg (3 parts)
http://www.youtube.com/watch?v=A0Uk3hKnQQ8
http://www.youtube.com/watch?v=XW3jFfVtYSs
And this series I seriously recommend: http://www.youtube.com/watch?v=3puyy6UqkwY (9 parts)

He predicted the dot-com-bubble, and the housing bubble, and was very vocal about it. He was completely right. Now he is predicting that within 2 years, you will have an currency crisis, where the dollar starts losing value, BECAUSE of the bailouts, etc. Just listen to him. Any questions are welcome.

And here is a documentary released a day ago about the current state of the economy:

http://www.youtube.com/watch?v=eb1n1X0Oqdw

I suggest you buy gold, silver, food and shelter, or to simply leave the country. Hyperinflation is going to happen in all likelihood, and high inflation, that is, much higher than in the '70s, is going to happen no matter what.

But that is just my rudimentary understanding of what these guys are saying. I believe them because they have been right so far, and they make compelling arguments.

I'd love to hear your opinions on the matter.

[realpc]

Common sense tells us that Krugman and Galbraith are wrong. Just as common sense told us that Greenspan was wrong about housing.

[Michael Prescott]

But is common sense applicable in this case? We rely on our experience as a consumer in determining what is "sensible." But the government, as an issuer of currency, operates according to different rules than a household, so our personal experiences may not apply.

It is, at the very least, interesting that Japan's interest rates have not risen, and they have experienced no inflation, despite decades of high deficits. Yes, their economy remains very weak because of ingrained structural problems and a lack of flexibility in addressing them, but even so, standard monetary theory would have predicted high inflation and interest rates by now, wouldn't it?

If the standard theory is wrong, maybe MMT is right.

[realpc]

"the government, as an issuer of currency, operates according to different rules than a household, so our personal experiences may not apply."

That's what Galbraith wants us to think, and he wants us to doubt our common sense and our experience. But look at what he is asking us to believe -- that you can spend without limit with no consequences. It isn't possible. Even though our money is imaginary. it is real in the sense that it is information. It has symbolic reality, and it exists in relation to the rest of the world.

If the US government creates as much money as it needs at any time, without regard for consequences, then the informational value of our money would be lost. The informational, symbolic, value of money depends entirely on the idea that it is limited, not infinite. As soon as money becomes infinite, it becomes meaningless.

What I'm saying should be perfectly obvious to anyone, even academic economists. The value of a dollar depends entirely on the number of dollars in the world, and its value relative to other currencies.

You simply look at Japan and say their economy still exists in spite of high deficits, and therefore so can we. But there could be many differences between us and Japan. And we don't know how Japan's high deficits might eventually cause damage.

America refuses to accept any pain, as a whole or as individuals. It resembles a heroin addict.

[Gary Grimes]

I'm no economist but MMT sounds like Bernie Madoff on steroids.

As for gold and silver watch how many people get broadsided when their values start to decline.

[realpc]

"MMT sounds like Bernie Madoff on steroids."

Exactly. There is no perpetual motion machine and there never will be. Don't be fooled by whether someone won the Nobel prize or who their father is or where they teach. When they ask you to suspend your common sense and trust their theories remember that none of them saw what was happening with real estate and mortgage derivatives.

And why not? Because they believe in perpetual motion machines and infinite pyramids. They don't think money grows on trees -- they think it materializes out of thin air.

[Michael Prescott]

Money does materialize out of thin air when the government is a sovereign currency issuer. The Fed can create new money simply by adjusting figures in a spreadsheet.

The value of money is determined by how much money is in circulation relative to the total supply of goods and services. We hear so much about inflation, yet after two years of record deficits, inflation and interest rates are near zero. Maybe that's because the extra money pumped into the economy by the Fed is mostly not in circulation, but being held in reserve.

I really think these issues are more complex and subtle than some commenters are acknowledging. MMT may be right or wrong, but the people who developed it are not stupid, and you can bet they've already thought of all the obvious objections.

[dmduncan]

"I really think these issues are more complex and subtle than some commenters are acknowledging. MMT may be right or wrong, but the people who developed it are not stupid, and you can bet they've already thought of all the obvious objections."

Not stupid but willfully blinded by what they want to believe.

Look at those Schiff videos. So many of those experts who are indeed smart people failed to see what Schiff clearly saw. Occasion after occasion they laugh at him like he's nuts.

They were all wrong and Schiff was right, and he was right years before his time.

So when one guy gets it right when so many others get it wrong, you wonder what he sees for the future and it seems to me you then take it seriously, and you take the laughing experts less so.

Schiff was right not on something small but on something HUGE, and they laughed at him for what he was saying.

Schiff sits there calmly enduring their laughs explaining exactly why we were heading for disaster and all those experts listen and laugh like he's speaking Martian.

Why? It's not because they are stupid men that they don't see what Schiff sees, and I doubt if Schiff reads this post that he will be persuaded by it or hasn't heard it before.

[dmduncan]

"Two things make me wary: first, it seems to be promising a free lunch, and second, it appears to serve as a justification for 'progressive' policies, i.e., bigger and more intrusive government."

Whatever else you do, I think you should hold on to these suspicions like a life preserver while doing it.

I don't think we should consider monetary policy in isolation from the socio-political objectives of the people pushing it.

[dmduncan]

Liberals have actively sought to change their moniker to "progressives."

This is also a corporate tactic. When they screw up a brand name they switch to another to create the illusion that a different company has taken its place.

But "progressives" is even more interesting.

Attack "progressivism" and you might be labeled as hostile to "progress" which far too many people unwittingly assume is always good.

Of course, to have progress there must be some goal to progress toward, so if the liberal now wants to be seen as making progress, we should inquire about the final destination to see if it's some place we really want to be.

[Chris]

Another very good source of information for seeing through MSM nonsense in regards to all the financial fraud and spend us to prosperity ponzi schemes is Karl Denninger's blog market ticker:

http://market-ticker.denninger.net/

[realpc]

"after two years of record deficits, inflation and interest rates are near zero. Maybe that's because the extra money pumped into the economy by the Fed is mostly not in circulation, but being held in reserve."

So, doesn't that look to you like a lurking disaster?

"I really think these issues are more complex and subtle than some commenters are acknowledging. MMT may be right or wrong, but the people who developed it are not stupid, and you can bet they've already thought of all the obvious objections."

Yes, yes of course. We are objecting because we are ignorant and stupid and don't have Nbbel prizes. So trust the folks that didn't foresee the financial crisis and "fixed" it with bailouts.

You know, it is possible that we commenters aren't stupid either. The smart experts might ignore the obvious objections. Didn't they ignore all the obvious objections to complex derivatives built from sub-prime loans?

[realpc]

There is something that MP might not recognize, and this is the fact that there are things that no one knows. It doesn't matter how intelligent and educated and knowledgeable a person might be, they still cannot know what is not know by humanity. Such as the future, for example.

The unknown is infinite, while the known is finite. So when it comes to the things that are unknown, a nobel-prize winning economist and I are on the same level. We don't know. But the expert pretends to know, or fools himself into thinking he knows.

When experts claim to know things that are unknown and/or unknowable, and when they ask us to ignore our common sense, then their expertise has absolutely no value. Worse, it is dangerous because they may cause us to ignore an imminent crisis, such as the real estate crash.

[Mark Alexander (the other Mark)]

Amazing that so many people buy into MMT, but governments have been conning citizens for thousands of years, and citizens continue to be suckered.

There are always consequences to printing money. If not, then nothing would stop the govt from making us all millionaires and calling it a day.

Government cannot create wealth for itself. If it could, it would have no need for taxes.

I outline what goes on in something I wrote about 5 years ago in Evil Dictionaries and Money. Here's the link to Part 2, which tells a little Fairy Tale.

http://www.witnit.org/archives/2005/02/evil_dictionari_2.php

By the way, when governments go into massive debt owned by other countries, those other countries begin dictating our policies toward them...Thank you, China and Saudi Arabia.

[Michael Prescott]

"There are always consequences to printing money. If not, then nothing would stop the govt from making us all millionaires and calling it a day."

What would stop them, according to MMT, is that the total amount of money in circulation cannot exceed the total value of available goods and services without bringing about inflation.

"By the way, when governments go into massive debt owned by other countries, those other countries begin dictating our policies toward them...Thank you, China and Saudi Arabia."

This assumes there would be dire consequences if China stopped buying US debt. What would those consequences be? The only consequence I can see is that the US might have to raise interest rates slightly to entice other investors to buy the debt.

I'm not completely sold on MMT myself, but better arguments than these are needed to refute it.

[dmduncan]

What does MMT say about the FED? Isn't it odd that of all the conspiracy/thriller movies we get, there never seems to be one centered around the role of the FED?

Opening lines of Henry Hazlitt's Economics in One Lesson:

"Economics is haunted by more fallacies than any other study known to man. This is no accident."

[Jimbo]

Micheal, glad to see you're coming around a bit. It is a bit "Alice in Wonderland", isn't it? Of course, if you already beleive in a lot of weird stuff like telepathy and life after death (like we both do), I guess it's easier to accept that most "experts" don't know what they're talking about.

But look at what he is asking us to believe -- that you can spend without limit with no consequences.

Neither Galbraith (nor any MMT advocate I've ever heard of) has said that. What he is saying is that the constraints a currency issuer is under are not the same as the constraints you or I (or the state of California or GM) are. A currency issuer can't magically make the economy create more goods and services than it is capable of producing. But it can buy anything that is offered for sale in it's currency of issue, simply by crediting the bank account of the seller. It doesn't have to get the money from anywhere, or convince anyone to lend it to it.

What does MMT say about the FED?

It says that the functions it performs are necessary, although many proponents believe it should be folded into the Treasury. Despite what various conspiracy-minded sites would have you believe, the Fed is an arm of the Federal government, that acts in concert with the Treasury to both enable the operations of the government and regulate the financial system. I have a lot of problems with the way it's run, but ultimately a central bank of some kind is necessary.

[Jimbo]

By the way, when governments go into massive debt owned by other countries, those other countries begin dictating our policies toward them...Thank you, China and Saudi Arabia.

For a currency issuer in a floating exchange rate regime, there is no functional difference between "cash" and "bonds". Both simply exist as entries on the Fed's computers.

Think of it this way: say you have $10,000 in a savings account at your bank. You decide you would rather have it in your checking account. You go to your bank's web site, login, and order the transfer. Did the bank have to scare up money to "pay you off"? No - it just changed some numbers, debiting one account and crediting another.

Of course, if you actually go and demand cash, they have to give you some, and they have to get it from the Fed. But this is the key - for a central bank, there is nowhere else. The quantities on it;s books are not convertible into anything else (like the money in your account at the bank is, to Federal Reserve Notes), so the only thing you can demand in exchange for Fed money is... more Fed money.

[Jimbo]

Oh, and one more thing, about MMT serving to justify "progressive" policies.

There is nothing inherent to MMT that is "progressive", "liberal", "conservative", or any other political point of view. It is simply a description of how the system works. What policy prescriptions you make given this knowledge are based on your own political point of view.

I myself tend toward conservatism. I think the bias should be toward lower taxes to achieve the necessary deficit, rather than increased spending (which tends to result in ll-conceived projects and political payoffs). Make sure supply and demand roughly match, and then step back and let the private sector do the rest.

And if you think about it, an economy where everybody can easily get a job will be a much more conservative one. A large mass of unemployed workers are going to look for the government to take care of them, one way or another. If you make it possible for them to take care of themselves, they will naturally want the government out of their way.

[realpc]

"A large mass of unemployed workers are going to look for the government to take care of them, one way or another."

I think that is a common misconception. Unemployed workers, in general, would rather get a job than a measly welfare payment. Most probably understand that most jobs are created by private companies, not by the government. Therefore unemployed workers are just as likely to be libertarian as socialist.

You always hear progressives complaining that workers vote against their own interests when they vote for conservatives. But they are making the unwarranted assumption that progressives known how to improve the economy so everyone can get a job.

Of course, that is what progressives believe, but it isn't true, and most workers probably know that.

[dmduncan]

"I have a lot of problems with the way it's run, but ultimately a central bank of some kind is necessary."

Why is it necessary?

[Jimbo]

dmduncan-

I believe that because I believe that a government issued flexible exchange "fiat" currency, properly managed, is the only way to run a modern economy that doesn't doom it to either cycles of boom and bust or chronic economic underperformance. (whether such currencies have ever been properly managed is another issue entirely, but even with our current mismanagement they prevent another calamity on the order of the Great Depression, which is no mean feat.) Such a currency requires at least the basic clearing functions of a central bank. As I said, though, that doens't require a separate policy arm called "the Federal Reserve" - actually, I see most of the policy setting functions of the FEd are completely unnecessary and counterproductive.

Here are my friend Warren Mosler's proposals for the Treasury, Fed, FDIC, and banking system, which I agree with:

http://mosler2012.com/wp-content/uploads/2009/03/toronto.pdf

[dmduncan]

Well there are conspiracies, and if anything deserves to be called one it's the planning of the FED at Jekyll Island.

[Michael Prescott]

Think how much worse it would be if they'd planned it at Hyde Island!

[Mark Alexander]

"I'm not completely sold on MMT myself, but better arguments than these are needed to refute it."

Well, to be fair, I wasn't making arguments, I was making assertions. :-)

Arguments can be made only when foundations and assumptions are established in common. My posts on money are a starting point for that.

[dmduncan]

"Think how much worse it would be if they'd planned it at Hyde Island!"

The Mr. Hyde part is where the ugly transformation occurs. It's a global experiment, so it takes time.

[Zerdini]

Today's news:

In the US there was a surprise 25,000 increase in jobless claims to 471,000 in the week ending May 15. The deterioration in the employment picture, coming hard on the heels of Wednesday's drop in inflation, underlined worries that the US is exposed to a possible global double-dip recession.

Mr Gross said investors were now being frightened off by worldwide "fiscal tightening momentum", adding that markets were facing "a mini-relapse of a flight to liquidity as hedge funds and other leveraged positions are liquidated to preserve capital".

One worry is that European leaders are not sufficiently behind the $1 trillion bail-out fund they announced, in collaboration with the International Monetary Fund, last week. A second fear is that other indebted countries could soon be exposed.

One rumour abounding on Thursday was that a major rating agency will soon have to downgrade Japan's credit score, potentially bringing the world's second-biggest economy into the spotlight.

[Roger Knights]

Galbraith sounds like the emperor's tailor. If enough indebtedness (nakedness) is taken on, and eventually someone will notice that the clothing (creditworthiness) is illusory and start laughing (no longer buying government bonds at a low interest rate).

Here's a nice semi-absurdist article, "On Our Token Economy System":

http://seekingalpha.com/article/205908