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Modern Monetary Theory - Fraud 1 - Government Spending
This is the first part of a critique of some of the thoughts expressed by Warren Mosler in his booklet "Seven Deadly Innocent Frauds of Economic Policy"
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"Deadly Innocent Fraud #1 - The federal government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow. Fact: Federal government spending is in no case operationally constrained by revenues, meaning that there is no “solvency risk.” In other words, the federal government can always make any and all payments in its own currency, no matter how large the deficit is, or how few taxes it collects."
Political rhetoric aside, I'm not sure who actually questions whether the federal government is "operationally constrained" in this way - after all, there are lots of people who voice concern about the federal government propensity to print money. I could point out that the Federal Reserve Bank is the organization that ends up doing the accounting tricks in the current scheme, not congress, but of course the Fed is subservient to political forces so that quibble is "operationally" moot. As it relates to to making up any difference between spending and borrowing and taxes, the "operational" question is not whether we can, but whether we should increase currency accounts in this way, and if so by how much. For by this logic taken to the limit, there is no reason for any taxes or borrowing - the government need only increase the number of units in the accounts of those it wants to pay.
As for whether we should, the problem with doing so is that simply increasing the number of currency units (CU) in account does not increase the supply of goods and services, so it does not make the community better off. In addition there are serious problems that arise as a result of the CU distribution. The first recipients of these new CU are able to use them to bid up prices, which effect on the rest of the community is higher prices as the value of existing CU are diluted. Those who are more downstream in the new CU distribution pay the higher prices with CU that are worth less. In addition, the steadily decreasing CU value discourages savings, encourages taking on debt, rewards the people who are savvy enough to recognize these connections rather than those who produce things that people value, and seriously damages the welfare of people on fixed incomes.
At least Mosler acknowledges that there's a down side - that increasing the accounts may "cause prices to go up" (p.17) , but his car example (p. 34) is a rare acknowledgement of the damaging effects of sustained inflation at even relatively moderate levels. Other than this, his discussion mostly fails to consider those consequences. He even states that high inflation is "something I’ve never seen in the U.S. in my 60-year lifetime" (p. 113), which makes me wonder what he was doing in the 1970's, from when even I recall the futility of Gerald Ford's "Whip Inflation Now" buttons.
I should acknowledge that there is not wholesale agreement on the best definition for inflation, whether it be the wholesale increase in price levels (and here) or the increase in money supply that drives those price increases. One particular commodity or another may from time to time experience large or small shocks to the relative supply or demand, which in the cases of increasing demand or decreasing supply can cause those commodity prices to increase - oil during the 1970's embargo (for which subsequent US price controls was exactly the wrong response), and the occasional bad year in agricultural commodities are typical examples. Such changes can flow into price changes in other goods and services, causing a spike in such prices as the effects of the shock are experienced and then mitigated by people making substitutions or economizing or finding new sources of supply. However, such commodity- or industry-driven price level changes cannot explain the economy-wide long term price increases that typify inflation. In an economy with increasing production - an increasing amount of consumer goods and services, a fixed amount of money can only result in steadily decreasing prices; increasing the money supply is then the cause of inflation. The later definition is also the historical one, linking to the debasement by the king of coined money.
I will have to treat separately the tragedies of faster than general inflation increases in the cost of education and health care. The fact that these are two very highly regulated segments of our economy is a correlation that ought to at least allow consideration of a causal connection. I have written on this before and will do so again.
Looking deeper into Mosler's family currency analogy (p.18) also exposes the problems with his notion that money should have no commodity value and that the government should just credit accounts as payments. The root of the problem is that it fails to recognize what makes people better off, represented by the availability of goods and services that people actually value. If the purpose of these coupons is only to pay taxes, then the exchange is simply a trick to get the "children" to perform work for the "adults". If the coupons are to have any other usefulness, then they must be exchangeable for other goods and services that the "children" desire - toys or snacks or baseball games or whatever - after a time the coupons will be traded on that basis.
The coupons have no original value except to avoid being punished for not paying a fraction of them back in taxes. If the "adults" then double the number of coupons in circulation, or even in their recorded accounts, that has done nothing to the quantity or quality of available goods and services. The children, now having more spendable coupons and assuming their value scale has not changed, will bid up the prices of those toys and snacks and ball games so that the result is all those things now cost twice as many coupons to obtain. The children are not any better off in their material well-being, but are worse off for the wasted effort expended on finding out what the new exchange rate should be. If the "adults" preferentially bestow additional coupons on one of the children, that child has the advantage of more spendable coupons and can bid up prices beyond what the other children can sustain, clearly benefiting the one over the others. Any non-uniform distribution of coupons leads to a transfer of wealth to the people who get the coupons first from those that get them later.
Increasing account balances do not make things better in the community at large, nor do the problems with account manipulation go away if the new CU are distributed equally. Aside from the operational challenge of actually managing such a distribution, the new account levels cause people to waste energy trying to figure out what the new price levels should be. That uniform distribution has been called the "helicopter drop", made famous recently by Ben Bernake, but earlier expressed by Milton Friedman.
In the real world, the process has the same outcome whether or not the factors of production are all working to capacity. In the first place, inflation represents the relative valuation on the part of consumers of the currency unit with respect to goods and services; if there are more currency units with the same amount of goods and services then prices are going to rise (it even happens in gold-based money, as seen in gold mine communities during a gold rush). In the second place, the ultimate aim of production is consumer goods, so to achieve sustainable economic growth the overall structure of the factors of production must expand in a more or less compatible way that increases production for consumers. Even if a given factor has unused capacity, it does no good to create twice as many nails or blue tarps or tomato plants or carburetors (for example) if the consumer demand for those goods doesn't reach those levels, or if those products do not fit into the production structure leading to other consumer goods.
Mosler imagines a new country that creates a currency from scratch (p. 19), but ignores what it was that the people previously used to conduct trade, i.e. that which was separate from the requirement to pay the taxes that the government of this new country suddenly proclaims as necessary. Money started in trade as recognizable, divisible, durable, scarce, and useful; the value in exchange was because people placed independent value on the underlying commodity. Even now, gold continues to have industrial and aesthetic value. Based on this long history, the United States once had specie money, defined as a weight of gold or silver, so one could obtain specie for those dollars on demand. In an instant, the state under FDR in 1933 effectively confiscated personally held gold and compelled all debts previously denominated in gold to be payable in terms of paper, which constituted a wholesale theft from everyone in the community. Consequently, it is misleading to claim that "We need the federal government’s spending to get the funds we need to pay our taxes" (p. 21) - legal tender laws, a relatively recent development, compel us to pay taxes and make all other monetary exchange using the sanctioned monetary unit. The funds did not appear because of government spending; they appeared by the forced conversion of gold-denominated contracts.
The British "hut tax" story is revealing (p.26); the people in Africa were evidently satisfied with their way of life when the British started to tax them - no doubt it was the white man's burden to compel this servitude.
The explanation of taxes as a limit on aggregate demand (p. 27) might be more plausible if the federal government simply reduced the size of the currency accounts in accordance with the tax receipts, but that is not what happens. All those taxed dollars (and more) are immediately spent by the government to purchase goods and services. The aggregate does not change in magnitude, only in direction - away from things that might be desired by the people individually and towards things that are desired by the people with political power.
The question of direction is that of the structure of production and consumption, a point often overlooked by analyses of economic aggregates. Distortions in the structure of production is part of the explanation for the current and previous recessions, which Mosler expresses as when "total spending isn’t enough to make sure everything in the store gets sold" (p.27).What is really happening is that some things are not getting sold at the price levels the current owners might wish, while they would be sold if those owners chose to lower those prices to the market clearing level. The owners might realize a loss in that circumstance, or they might instead think that prices will rise in the near future and so they can afford to withhold goods from the market at their current prices.
An alternative explanation for the recession starts with looking at the causes of the preceding boom, to explain why it is that there might be more in the store than can be profitably sold. In other words, we have to explain why has the entrepreneur paid for factors of production at prices above which she can profitably sell the end product. This requires investigation of credit and interest rates, corruption of which (e.g. making more available through mechanisms such as fractional reserve banking and subsidized interest rates) causes false signals to spread through savers and investors about the actual demand and availability of financial capital, which leads the one to spend more and the other to invest more than is sustainable. More discussion of this in the section on deadly innocent fraud number 6.
Meanwhile, this discussion says nothing about how prices are always in fluctuation to clear the market, and how the attempts by government policy to hold up prices contributes to lengthening the duration of the inevitable correction after a boom.
Mosler does get it right when he says "The real “costs” of running the government are the real goods and services it consumes" (p. 28) - in all cases the cost of something is most accurately expressed as what it is we renounce in order to claim whatever is our choice - the foregone opportunity of the next best thing we could have done instead. The dollars in the exchange serve as a means of calculating that cost, but we should not confuse the dollars for what it is we give up.
But I don't think that Mosler sees this connection. Nor does he see how this relates to the question of changing the number of CU in circulation (which, again, does nothing to change the amount or quality of goods and services, and therefore does not make the community any better off).
Mosler further falls short when he asserts that the size of government can be set to the right level based on the real costs and benefits (p 28). The problem with this statement is not the importance of understanding what are those costs and benefits, but rather the fundamental impossibility of objectively determining those costs and benefits as an aggregate for the society, particularly for conditions where the price system has been completely subverted by political machinations. This is impossible because we can not equate the costs and benefits among the various people in the community, a point which can be seen by looking at the basis of any trade made between consenting adults - both exchange something they like less for something they prefer. The things in exchange are necessarily of unequal value in the views of the parties involved - in fact their perception of costs and benefits are in opposition. In the political domain, the costs and benefits are impossible to ascertain because the people involved have no real choice over what costs shall be incurred and what benefits are to be sought.
As for the recent flurry of attention to the US debt ceiling, the historical developments have been ones that set two forces in opposition - the people who think the government should be able to spend any amount of money, and those that do not but who don't have the political will to actually restrict the spending (especially on behalf of their own favored interests). It is indeed a farce, but one for which I am happier that the conflict at least causes the issue to be discussed.
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For more of this discussion, see the following posts concerning the other frauds
1 comment
I discovered that this series sparked a comment on MikeNormanEconomics, where Matt Franko said…
OK I’ve read enough, right in his chapter one: “In an instant, the state under FDR in 1933 effectively confiscated personally held gold and compelled all debts previously denominated in gold to be payable in terms of paper, which constituted a wholesale theft from everyone in the community. ” That’s all I need to see at this point…
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Mr. Franko evidently takes exception to my reference, which the original points here in Wikipedia, for: 1) the clause regarding gold confiscation, and here for 2) the clause about debt repayment in paper. The implication is that he finds the references not credible or not relevant.
Credibility: Here are a few more references to the points that these acts “revoked gold as universal legal tender for debts, and banned private ownership of significant amounts of gold coin". To be clear, some of these propagate some other fallacies about the causes and cures of that depression, but the conditions of gold ownership are pretty explicit in the public record.
http://en.wikipedia.org/wiki/History_of_the_United_States_dollar#The_Gold_Reserve_Act
http://www.answers.com/topic/gold-clause-cases
http://www.enotes.com/gold-reserve-act-1934-reference/gold-reserve-act-1934
http://www.presidency.ucsb.edu/ws/index.php?pid=14610&st=&st1=#axzz1rCgtKLGV
To be sure, I did not have to dig into the Google results to find these references, so I think they fall beyond the threshold of cherry-picking
Relevance: Mr. Franko gives no other indication of his objection, so I can not determine where my point was lost. Absent specific criticism, I will raise one point that I did not make explicit in the original writing. In the subject fraud, Mosler is making the point that a government which imposes a new currency on the population can not expect to receive any of that currency returned in taxes unless some of it is first distributed to the people who will later have to pay up. Of course this is true, almost by definition.
However, the government does not just distribute the currency free and clear - such a process would be nugatory. The plan that Mosler has in mind is that first the government compels people to give up their time or property, and hands over the currency in exchange; in any other circumstance such a process would be condemned as a blatant act of thievery upon the entire population.
So in addition to the other problems previously highlighted about the MMT frauds, I question why we should not have a similar reaction of condemnation to the Mosler plan to create a new currency?
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