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Modern Monetary Theory - Fraud 3 - Budget deficits
This is the third 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 #3: Federal Government budget deficits take away savings. Fact: Federal Government budget deficits ADD to savings."
My first complaint with this section is the characterization that the deficit equals increased monetary savings (p. 42). I grant that when people purchase such securities they are putting aside those resources, so those purchases represent savings, but it is a mistake to conclude that there is an increase in savings because of this. The dollars put into US government securities would have been put elsewhere if the government had not been selling low-risk bonds (full faith and credit and all that, guaranteed by taxes and inflation) - elsewhere such as investment into productive enterprises, or spending on consumer goods and services.
I offer a few challenges to the discussion surrounding the numbered points (p 43-44):
a) firstly is the failure to acknowledge that the same sort of money flow arrangement does not also happen with private lending, which comes back to my prior objection that Mosler ignores the unseen - that which would have been done with those same resources had the government not entered the market. It is obvious that any money that is loaned out is eventually spent by the recipient, which of course becomes income and possible savings or further spending. However it is a mistake to mix up the originating circumstances - there can be no original loan except of what has been previously saved, i.e. held back from consumption (more on this point in my post on Fraud 6)
b) next is failure to account for winners and losers in this situation. Time and again it is the politically connected banks who benefit from these arrangements, illustrated recently by the sweetheart deals that allow the likes of Goldman-Sachs to buy those financial instruments at next to nothing and sell them immediately at a profit (here is a January 2011 description in the NYT). National Affairs (Jason Thomas, Fall 2010) put it this way:
The banks had an additional motive for buying federal debt. As a result of the credit crisis and the flagging economy, the rate at which banks lend to one another hovered near 0.25% for much of 2009, while ten-year Treasury notes yielded 3.5%. This meant that banks could borrow from other banks cheaply, and then use that money to buy Treasury securities, which would earn them more than 3% in net interest income. The ability to obtain such wide margins without the assumption of much credit risk obviously increased the appeal of Treasury securities.
[Here is a related article found in econbrowser that describes more recent plans in the Fed for further manipulations of the credit markets, in which they buy long term debt with newly created money - i.e. they make loans, and borrow an equivalent amount back at short term rates. This might keep the wheels from falling off for a bit longer, but it is playing with fire to risk those rates flipping like they have for all sorts of other lending institutions.]
An inflationary effect of Federal government borrowing can be seen by how it actually works in practice. The Treasury issues debt obligations, private parties purchase those securities, then the Federal Reserve banks repurchase the securities from those parties, thereby "monetizing the debt" - increasing the number of dollars in the system as a direct result of the debt securities created by the Treasury. A similar mechanism is when the banks that originally purchase those Treasury securities use them as collateral when borrowing from the Fed. These processes have been going on since the years leading up to the 1929 crash, if not also since the inception of the Fed.
c) then there's the topic of "the usual things government spends its money on" - so often foreign and domestic wars, there is no reason to encourage it.
d) Mosler makes a similar error, but in reverse, in reference to a budget surplus, suggesting that the only way for private savings is through government securities. Of course a surplus either goes to paying down the debt or lowered taxes; both return dollars to the checking accounts of the community, where they can be spent, saved, or invested as people see fit.
e) and finally there is a fundamental error to not differentiate between demand deposits (savings accounts) and the purchase of debt instruments such as Treasury securities - the funds are not available in the latter until the term is up (which could occur gradually if the loan is amortizing). The buyer of those securities can not treat them as a savings account, to be withdrawn at any time.
The Al Gore story (p 45-6) falls to the error (d) above, by implying that the only thing to buy with personal savings is Treasury securities. If a surplus were monetized by tax reductions, does Mosler really think that people would not find their own ways to save or invest or spend the difference? And if the surplus went to buy down the debt, would not the sellers of those securities now have the proceeds to spend in other ways? In what way does this "drain our savings", except by the incorrect equating of debt obligations with demand deposits?
The Robert Rubin story (p 46-7) falls to the error (e) above.
For a comprehensive analysis of US money and banking history, see Murray Rothbard's History of Money and Banking in the United States (available in different forms through Mises.org)
There is quite a bit more to the national debt than the fact that normal accounting equates it in magnitude to the non-government accounts at the Federal Reserve Bank. In addition to the point (e) above, the debt does not treat all citizens equally, as purchasers of those securities take the advantage of very low risk investments, made possible by the future taxes or inflation to be paid by everyone else [covered in (b) above].
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For more of this discussion, see the following posts concerning the other frauds
3 comments
“tommy belesis” links to the NYT article describing how brokers at John Thomas Financial spent one lunch time in a “rally” in support of Wall Street. If the point is that Wall Street financial concerns are often beneficiaries of budget deficits, then I agree.
NOTE: I doubt whether the author of that comment is the same person as the President and CEO of JTF, but appreciate the irony of the attribution.
There are a couple parts in answer to the remark by Mr. Mulaik.
Fed purchase of Treasury obligations, doing so with money that comes “out of thin air", starts the inflationary cycle. Those funds did not previously exist; now they do, and their recipients can spend them on goods and services, diluting the value of other dollars in the economy as they bid up prices in the market.
Forcing taxpayers to redeem the Treasury debt obligations, even after they have been purchased by another division in the same government entity, sucks some of those additional dollars back out of the system, thereby mitigating the inflationary effect of the earlier purchase by the Fed.
However, that the dollars are withdrawn in this way does not eliminate the problem. It is not a value-neutral operation, because the people giving and taking are completely different, and circumstances have changed between the two times. These aspects make the effect a wholesale transfer of wealth from one part of the population to another, from the general taxpayers to the bankers who buy and sell those securities.
If the Fed creates money out of nothing, ad infinitum, the value of the currency will collapse; that it has not yet happened is I think a consequence of the growth in productivity that our economy has sustained in the intervening years.
Finally, while the Fed is in some ways independent of the rest of the US Government, it could not exist without explicit government support. Fed policy is not formally tied to Administration policy, but politics drive it towards typically more expansionist monetary policy, which not coincidentally is what the Administration usually wants. The separation between Treasury and Fed is a product of history, not rational design, and I won’t try to defend it.
Why is it that we must assume that when the Fed buys the Treasury securities issued to finance deficit spending, that the Treasury owes both the principal and the interest to the Fed to redeem those securities. Is not the debt between government and private citizens, but once a government agency buys the securities from a private citizen the debt has been redeemed. The Fed, by it current admission, is a government agency. Government is one entity, not multiple entities. Once a government agency redeems a debt on a security, no other agency of the same government should be obliged to pay the same amount to the Fed by raising tax revenues from the private citizens to finance the purchase. That amounts to government’s paying twice for the same securities.
Perhaps when the United States backed its money with gold, the Fed used its money backed by its gold, and it needed to replace that with gold backed money from elsewhere. But once we went onto a fiat money system, where the Fed simply creates its money out of nothing, out of thin air, there is nothing that the Fed has lost when it created the money to purchase the securities. Any entity that can create money out of thin air is different from entities that must get their money from elsewhere. Any debt obligations to entities that create money out of thin air are absurd. The whole idea of redeeming a person for expenditures he/she has made presumes that the person gave up something he initially possessed in making the expenditures. If a person can create the money out of thin air, ad infinitum, he/she has not lost any money he expends, that he/she cannot immediately recreate.