Modern Monetary Theory – An Introduction: Part 3

By Dale Pierce

III. Taxing and Spending

MMT 101

The state’s money is a good store of value and a reliable medium of exchange because absolutely everybody needs at least a little of it. Even off-the-grid survivalists and doomsday preppers need it. Because when they pay for their hollow-point ammunition at Dick’s, or for their freeze-dried mashed potatoes at Costco, they not only pay for the goods – they also pay the sales tax. Now, Dick’s and Costco only take dollars or dollar-denominated credit anyway, but what makes the state’s money valuable is that every company has to collect the tax piece in dollars and cents – and pay dollars to the government at the close of each week or month or other accounting period. Between sales taxes, property taxes, income taxes and all other taxes, everyone knows that there will be a stable, long-term demand for the currency which the state alone can issue. If this currency is reasonably well-managed by the country’s monetary authorities, it will remain everyone’s preferred legal tender – unless a person really is a survivalist or some other kind of crank.

The federal government spends by crediting private bank accounts, creating U.S. dollars in real time, by fiat, when it does so. Almost every single dollar the U.S. government has spent since a day back in mid-1971 has been created in exactly this way. (Exceptions include those famous went-missing-in-Iraq pallets of hundred-dollar bills we learned about later. The oddness of the example makes the main point that much stronger). The federal government doesn’t have or need a hoard of dollars stored away somewhere. Money is almost entirely a set of spreadsheets now. Such money is just electrons. Just zeros and ones stored in the computer databases of banks and central banks.

Since its spending is by fiat, the U.S. government doesn’t have to collect taxes or borrow from the Chinese to get money to spend. The function and true effect of taxation in a fiat money economy is to regulate aggregate demand. (the bonds are for interest-rate management). Taxes destroy some of the fiat dollars the federal government creates when it spends. They don’t “go” anywhere. They just disappear from private bank accounts. When we pay our taxes, there are a few fewer zeros and a few fewer ones in our particular spreadsheet cell in our bank’s computer. That’s all. The rest – the receipt, essentially – is a formality. The U.S. government is not more able to spend another dollar after we have been debited a dollar. It is not less able to spend after someone is credited one. And this account of the matter is not theoretical or, to the operatives who actually run the banks, in any way controversial. This is just the way the banking and central banking system works every day. Completely routine.

One of the big frustrations felt by advocates of Modern Monetary Theory is that so many completely routine and non-controversial truths about fiat money are so persistently distorted and falsified by the political pundits and media personalities who have replaced real journalists in almost all venues of news and information – especially in America. So, to be clear, no one is saying that this is the result of some conspiracy. People *start out* confused. Because the whole thing is very confusing. People remain confused, in part, because the political utility of keeping them both insecure and confused is so great. But it’s also much deeper than that. For money is not just an economic category. Money and ideas about money are woven deeply into everyone’s cultural D.N.A.

From the ancient Greek myth of King Midas to the Walt Disney version of the grasshopper and the ant, everyone grows up listening to proverbs and parables about money. And these stories aren’t about zero-coupon bonds or the London inter-bank lending rate. They’re morality tales. They’re about selling the family cow for a bag of magic beans, or selling one’s birthright for a mess of potage. They blend together bible stories, folk tales, Aesop’s fables, quotes from Poor Richard’s Almanac – they come from more sources we could ever remember or count. Taken as a whole, they form a large portion of every person’s world view. And the important point about all of this, for our purposes, is that one hundred percent of this entire body of folk wisdom and common sense is premised, utterly, on gold-standard thinking. All of it. Every pithy Shakespearean quote. Every humorous Benjamin Franklin anecdote. Every word to the wise.

Modern Monetary Theory calls attention the biggest change to the global monetary system that has ever happened in recorded human history. And yet it affirms that this change was, ultimately, for the purpose of preserving and improving upon something that was there all along. Modern Monetary Theory, and much of the rest of post-Keynesian Economics generally, summons educated people to form a true and accurate understanding of the relationship between the state and its money – and the way this money therefore relates to everything else. And this clarity is not just for its own sake. It leads to both economic and political conclusions. 

MMT sets forth a straightforward program of middle-class tax cuts, federal revenue sharing to support the states, and a full-employment policy anchored, ultimately, in a program that would make a federally-funded, entry-level job available to every person who wants work but can’t find any. MMT is able to demonstrate that all of these goals are achievable without excessive or abnormal levels of consumer price inflation, without creating artificial economic “bubbles”, and without recourse to the most effective jobs program of the 19th and 20th Centuries – namely, wars and world wars. We want to give peace, and a genuinely moral “equivalent” of war, a real fighting chance.

Money is a Tax Credit

The thing modern fiat money preserves and improves upon is simple to say, but a little complicated to explain. It doesn’t yield easily to the gold-standard version of common sense. But it’s something anyone can understand if they try: one way of unlocking the mystery of money is to think of it as really just being a tax credit. Easy to say, but needs some unpacking.

This starts with understanding that the state, clearly, has no use for its own money – for its own I.O.U., one might even say. The things a government needs in order to be a government are mostly the same kinds of real goods and services the private sector needs – and produces. From jet planes to ink-jet printers to new printing presses for the national mint, the things government needs differ in only quite minor ways from the things individuals and firms sell to, and buy from, each other. But when the government buys them, it is a quite special case.

When the federal government buys something (or a state government does, spending federal dollars) the transaction has a completely different character than when an individual or a company buys something. In the latter case, existing dollars change hands – dollars which were previously spent into existence by the state. These dollars have been saved – set aside by someone in anticipation of some expected future need. But when the government spends, it creates new  dollars by fiat, ex nihilo or “from nothing”. It doesn’t draw them from some hoard or store. It never needs one. And these transactions are completely voluntary. Companies and other private-sector entities compete with the same energy and determination for sales to government entities as they do for any other category of sales. If anything, governments are even more desirable as customers – because they can always pay, and they virtually always do.

The conundrum of fiat money is why anyone takes it in return for their real goods and services. The economist Hyman Minsky once, somewhat famously, remarked that, “Anyone can print their own money. The trick is getting someone to accept it”. But if we think of the government’s I.O.U. as a tax credit – as a ready means of eliminating any private party’s obligation to pay a tax imposed by government, the mystery disappears. We could just as easily think of the tax – the real tax – as having been “paid” when we surrendered our goods or rendered a service to our government – *in the first place*. The fiat-dollars we receive in return can just as easily be thought of as records – recording the fact and magnitude of our real-goods transfers for future recognition by the government at tax time.

At the end of the fiscal year, we bring our records to H&R Block, or to our networked tax ap and settle up. Zeros and ones change polarity. Our e-mail in-trays deliver us the news, good or bad, and we’re done. Our government thus acknowledges that we have supplied our designated share of the things it has needed in the prior year to pave roads, hire teachers, and manufacture Reaper drones and other advanced weapons systems for the military. In the process, some of our dollars disappear into the nothingness from whence they came. Exactly that many of the government’s tax-credit I.O.U.s are simultaneously cancelled – and then we all start over.

The fact that only a relatively small number of all the transactions that take place are public-private interactions doesn’t change the essential character of fiat, tax-credit money. Almost all persons and economically relevant private-sector entities are taxed in multiple ways. All need to accumulate tax-credits in the course of a given period, or else obtain them from day to day in the case of something like a sales tax. We trade the government’s outstanding I.O.U.s amongst ourselves as the medium of exchanging goods and services. We save them up in anticipation of future needs, secure in the knowledge that their value is determined, from day to day, by the most liquid, transparent and reliable currency-exchange markets in the world. The value of our dollars does vary, but it does not vary randomly or arbitrarily. And while a small annual dose of price inflation is built into the fiat-money system, it no longer comes as a surprise. Everyone anticipates it and can adjust their plans accordingly.

What to Wish For

In the next chapter, we will examine inflation in as much detail as necessary for us to understand the way it helps us to ward off and protect ourselves from the monster that really haunts capitalism. The one that has haunted it from its inception, and which has wrought more human misery upon the nations of the earth than any other single condition except war. Deflation is inflation’s evil twin. Deflation is the economic plight Japan has languished in these twenty years now, and still counting. It has lain at the root of every depression capitalism has ever suffered through, and it is the thing all sane people should be most afraid of now.

A little more inflation would be a very good thing right now, because it would make holding onto cash a little more costly. This brings us to the “paradox of thrift” Keynes talked about in the 1930s, also known as a “fallacy of composition”: if everyone does the prudent thing and stops spending (at the same time), demand collapses and the economy, potentially, just implodes. That’s how we might still get into a full-blown depression. And even if not many people still remember the adage, it is as true as it ever was: the only good way to get out of one is not to get into one in the first place. We are playing a very dangerous game. Or rather, our plutocrats and politicians are playing it on our behalf. The result of a highly successful, generation-long campaign to demonize government-in-the-abstract has left us with a real government which, in many very important respects, simply can’t do its job anymore.

It is critical that we understanding the necessary role Big Government plays in a modern, stable capitalist economy. Government has to be big enough to protect capitalism from its own inherent excesses. Capitalism can be, and often is, quite mindlessly destructive. Waving this off with a quip about “creative” destruction or an airy “look it up in Schumpeter” is a pretty insulting stance for a neo-clacissist to take. Especially when we contemplate the blasted, ruined economic landscape this attitude has landed us all in since 2008.

Keynesian theory and policy were designed around a true understanding of capitalism’s profound destructiveness. They were forged in one of world history’s darkest hours of economic and political crisis. The timely deployment of Keynes’ policy ideas saved democratic civilization, *and capitalism*, from the rise of a terrifying new barbarism in the 1930s, and was the real deliverer of managed capitalism from the failed experiment of totalitarian communism. The Gipper had nothing to do with it. That’s just the mythology of the Right. But American liberals have no one to blame but themselves if they did not stand up for this truth when it mattered most.

John Maynard Keynes almost single-handedly *saved* capitalism from the twin dangers of “revolution” and “orthodoxy”. (By which he meant the economic disaster that was nourishing fascist movements everywhere in the 1930s). Revisionist history has tried, but must ultimately fail to erase the truth of this. The fog of ideology may persist a while longer, but it will eventually lift. It is an insult to the intelligence of any serious student of economic history to place Keynes’ world-historical works of economic and philosophical genius next to the ponderous, self-referential mathematizing of the neo-classical school. Much less the failed, useless meanderings of Whatchamacallit Economics. Granting the validity of such a comparison would be like taking the time to weigh Ayn Rand’s view of the history of philosophy – which was that the only two philosophers worth reading were herself and Aristotle. It is breathtaking to think that people as influential as Allen Greenspan and Paul Ryan are adherents of this cultic caricature of a “philosophy”.

Big Government – government big enough to be immune to the influence of Wall Street, and those whom William Jennings Bryan referred to as “the Lords of Money” – is necessary, in order to reign in the tendency of capitalism to polarize society itself. If the diverse classes that make up a capitalist society become so unequal, economically, that they also become unequal socially and politically, then democracy itself becomes an illusion. We are perilously close to that point already. It is becoming more and more clear that the troubles we are living through today are merely a prelude – to something much, much better or to something much, much worse. Things cannot continue as they are. But while our case is difficult, we should take some comfort from the fact that it is not really new. We are recapitulating the tragic history of the depression years. Characters like Paul Ryan and Rand Paul are reminders that the old maxim still holds true – when tragic history repeats itself, the second round is farce.

Keynesianism is struggling to make a comeback, both as theory and as policy. Its advocates are becoming bolder as the uselessness and fecklessness of the “neo-classical” order become, daily, more apparent. But it will take much more than a bit of academic jousting to turn this tide. It will take movements – mass movements. We can only hope that the Occupy Wall Street uprising will turn out to have been just the first American stirring of this impulse. It is encouraging to know that Arab Springs can still happen. It is encouraging that Russians can still be passionate about a Democracy Movement that was botched and corrupted about as badly as one can imagine. It is immensely encouraging to know that a self-consciously anti-I.M.F. and anti-Washington-Consensus sentiment has arisen very powerfully in many of the countries of Latin America. It will be a test for American reformers to cut through the media propaganda that equates these countries’ economic anti-imperialism with anti-Americanism.

The American Right are not a majority – not even close. They just talk a lot louder than other people and have a lot more rich friends. And they use their clout, both as donors and as advertisers, to inordinately sway the media’s coverage of just about everything. Intimidating liberals and demanding equal time for both “sides” of such issues as evolution and global warming is almost a job description in Washington now. The result is a very distorted picture of what Americans really believe and are really in favor of. But we can’t afford to kid ourselves about how deeply imbued this country, and both political parties are with the ideology and senseless confusion that trades under the brand name of “deficit-hawking”. This subject is so important, it had to be saved for last.

The Virtue of Deficits

As noted earlier, Government budget deficits are normal and necessary. Since the founding of the United States in 1780, there have been only six short periods when the federal government ran surpluses. And, every time, it was a mistake. Every such period in American history immediately preceded, and helped precipitate, either a depression or a significant recession. This very much includes the Clinton surpluses of the late 1990s, of which Democrats are so inordinately and inappropriately proud. For the only thing those surpluses did was add to the shock of the collapsing dot-com bubble – which then rapidly propelled the U.S. economy into the “Bush” recession of 2000-2002. Bush, of course, promptly and correctly resorted to Keynesian stimulus policy, mainly via tax rebates. (We may only wish, nostalgically, that some remnant still survived of what used to be a bi-partisan Keynesian policy reflex for fighting recessions).

Deficits are normal and necessary for two main reasons. The first is simply that the U.S. economy, like all capitalist economies, has a secular tendency to grow. More and larger transactions require more liquidity and a larger stock of money held in private hands. And, secondly, people and firms have a persistent tendency to save – to store up dollars and other net financial assets. Which, obviously, means that these dollars are being systematically withdrawn from the flow of purchases and sales – i.e., that flow of which our economic activity fundamentally consists. 

At the highest level, the economy is a place where everyone works at making things, and where all of the things that get made then need to be bought – and sold. One person’s spending is another person’s income. One person’s purchase is another person’s sale. If we make the realistic assumption that goods and services are, on average, sold for about what they cost to produce, it is clear that the economy can’t afford the “leakage” represented by the private sector’s desire to spend less than its income (what economists call the the desire of households and firms to “net save”). Other leakages include taxes and,potentially at least, trade surpluses. If money is surrendered to the state or sent abroad, it is not available to purchase domestic goods or services.

This aggregate-demand shortfall is a chronic problem for capitalist economies which can only be solved, even in normal times, by government deficits. If private demand is not supplemented by a sufficient amount of public-sector spending, the economy falls into recession. If there has also been some massive shock, such as a burst housing bubble or a stock-market crash, a deep recession can even settle into the protracted kind of deflationary slump for which we reserve the term “depression”.

These economic dynamics were explained by Keynes seventy-odd years ago and his theories have been refined by others in the years since. It should not even be controversial that capitalist economies have a strong, secular tendency to “leak” aggregate demand. It should be common knowledge that this tendency – for aggregate demand to be too low to support full employment – lies at the heart of capitalism’s marked tendency to fall into periodic recessionary and even deppressionary states. This isn’t the whole story, but it’s the part that classical economics couldn’t ever quite get right – which was why governments that followed the advice of classical economists in the 1930s couldn’t find their way out of the Great Depression.

People and firms want to hold onto money – “net-save”. And the only possible source of the private sector’s net financial assets is the government’s deficit spending. This is a prime source of confusion about where money comes from and even what, exactly, money is. Because of the role money plays in our own day-to-day lives, we all have an instinctual tendency to think of money as just another valuable thing or commodity. That’s how we all have to relate to money as individuals and as members of households. And, in capitalist economies, valuable things and valued services are produced by the private sector.

There are a few exceptions – public utilities, subway trains, etc. But as a rule, and in the vast majority of actual cases, useful and valuable *stuff* exists because the labor of workers has added value to already-valuable physical and natural resources. In capitalist economies, this is done almost entirely by firms and small businesses. So whenever we make the naturalistic mistake of lumping money in with things that money can buy, like emeralds, or motorcycles, we are making a very fundamental mistake about money. Including our own money. Even though we know that every last dollar that exits was originally issued by the federal government, we think of the dollars we and other people have in our wallets as having been “made” in the private sector.

Even language reinforces this error: we say, “He made all his money in plastics”. Or, “How much did you make last year”? Because of its role as a universal medium of exchange, and because of both the real and the later (ersatz) economic history of metal money, this naturalistic fallacy has to be brought to consciousness before its unreality can even be discussed. And even trained, Ph.D. economists (the neo-classical kind) very commonly use language and design models that only make even a particle of sense in a gold-standard world. It is the “loanable funds” thesis, for example, which drives much of the deficit hysteria we hear so frequently, and undergirds the argument that austerity generates economic growth.

Neo-classicists represent borrowing as a contrast between “patient” individual agents, who are willing to wait for the things they want, and “impatient” ones, who want immediate gratification. (Or who want to finance a new entrepreneurial venture). Interest is the price of impatience and the reward that patient agents are entitled to receive in return for waiting. Patient agents, (who are probably sentient humans) save money and deposit it in a bank. These savings are, thus, the “loanable funds” available to be borrowed at any given time. Even Paul Krugman talks like this (he’s a “neo-Keynesian” – i.e. a neo-classicist with a conscience, who therefore gives a damn whether the “agents” he studies live or die). Since our available “loanable funds” are limited – are a function of the patience supply – governments must take great care not to borrow too much of the patient agents’ savings, lest their borrowing come to “crowd out” impatient entrepreneurs seeking capital for new or expanded ventures.

Now, since it is a certified, bi-partisan Truth that “governments can’t create jobs – only the private sector can”, it follows that the one and only way for a country’s government to help employment and growth recover from a recession is to leave as many of the banks’ “loanable funds” un-borrowed as it possibly can. And the only politically viable way to do that is to spend less money. From this point of view, it doesn’t make much difference what part of the budget you cut (if this sounds like the Sequester, that’s because it sounds exactly like the Sequester). If the only cuts that are politically possible are random cuts, that’s still O.K. All you’re trying to do is leave more zeros and ones in the banks’ spreadsheets so that all those hordes of salivating, animal-spirited, would-be entrepreneurs will find enough of them waiting there to launch their piece of the Next Big Thing and thereby, finally, Create Jobs.

Unfortunately, the Last Big Thing was bank fraud – and on a continental scale. Unfortunately, the housing frenzy at the center of the scam crushed the real economy when everything unwound chaotically in 2008-2009. Unfortunately, not even well-established, highly profitable, existing companies want to expand in the face of today’s low aggregate demand. Existing plant and equipment are under-utilized anyway. Nobody has any real use for the banks’ zeros and ones right now – except those same predatory, too-big-to-fail banks themselves. They are eating a free lunch served by the Fed in the form of interest-free loans and a willingness to still treat worthless, blown-to-bits mortgage bonds as triple-A paper for meeting collateral requirements. These banks don’t care how long the real U.S. economy continues to stagnate – they’re making money all over the world, speculating on fun stuff like the Brazilian Real and next year’s cocoa crop. And when their whales lose humongous bets on Euro-bonds or Cypriot banks, it’s no big deal. They know that even the most embarassing Congressional hearing is still just one news-cycle long, and that U.S. regulators will still be all tea-and-sympathy no matter what.

“Loanable Funds” is bunk, just like the Quantity of Money and all the rest of Whatchamacallit Economics. Deposits don’t create loans – loans create deposits. Banks don’t lend out deposits, and they obviously don’t lend out reserves. Their loans just confer purchasing power on borrowers, along with debt. Modern Monetary Theory calls this bank-created credit “horizontal” money-creation [Primer Link] to distinguish it from the “vertical” money-creation only the state can engage in. Private debt and credit “net to zero” – they cancel each other out, so to speak. But looking at the way banks and central banks actually operate renders the entire framework of “loanable funds” absurd. This justification for austerity in a recession is – or should be – laughable.

The U.S. budget deficit has not “crowded out” any private borrowing, because that’s not how money, banking and credit work in the real world. And since nothing was crowded out – since their was no bidding war for access to the patient peoples’ limited stash of dough – U.S. interest rates went down, not up, in the years that saw the biggest deficits. And Zimbabwe? Core consumer price inflation remains all-but-undetectable as we continue to flirt with an austerity-induced second-dip recession eerily like the one Franklin D. Roosevelt induced in 1937. By following exactly the same kind of bad, deficit-hawking advice we are getting from “moderates” and “centrists” today.


This introduction to Modern Monetary Theory is not an attempt to convince or win over large numbers of regular people – significant numbers of average American voters or citizens. Not many average voters are smart enough, patient enough or open-minded enough to be convinced by mere arguments at this stage. So not very many are likely to become “MMT-aware”, as I’ve been putting it. At least not soon. There has been too much debt-scare propaganda over too long a period, and far too little informed push-back from people who many be very progressive in their outlook and world-view, but who are determined to “pay for” everything by taxing the rich. That argument feels morally just. It is morally just, and progressives are very attached to it – but it misses the real point. By conceding the neo-liberal framing of political economy it falls into a predictable slot in the conventional American media narrative. It’s a dead end.

MMT needs to win its academic battle and then go on to become the theoretical lynch-pin of a new Keynesian political program. What we need, to sufficiently shake up the orthodoxy and force them to engage on principled terms, is a sea change in *educated* public opinion. We will know we are getting somewhere when significant numbers of name-brand progressive journalists, documentarians and other influential public intellectuals begin to really “get” MMT and start talking about it. This is the movement’s most urgent need right now, and this introduction is a swing at meeting that need. It started as an attempt to answer the “Just say what you have to say” question. Clearly, it has evolved into something a bit more involved, and an attempt has also been made to put some necessary historical context around some of these things. But it is still, essentially, just an invitation to learn more.

There are a number of very-accessible accounts of MMT basics online. None is easier or more enjoyable to follow than Warren Mosler’s instant classic, “The Seven Deadly Innocent Frauds of Economic Policy”. (The reference is to a book on a related subject which happens to be the final book written by John Kenneth Galbraith). The role of essays like mine is to make a more succinct, more polemical argument – to try to motivate people who are already progressive (or who are, at minimum, very independent-minded) to give MMT a much closer look. At the same time, it is an opportunity to give a systematic, all-around account of what the contemporary MMT movement is about and where we’re coming from.

In the next chapter, we will build on the basics presented here to get into some necessarily more complex and technical subjects – initially, the details of how and why various kinds of inflation sometimes get so out of hand and, specifically, what makes hyper-inflation events like Weimar-1923 and modern-day Zimbabwe happen. The mythology of hyper-inflation is so prevalent today, this subject calls for a very complete treatment.  

But, beyond this, we need to take an even closer look at deflation. For this is the grave and completely gratuitous danger our political leaders are playing games with in Washington today. They are flirting with the very worst kind of economic disaster. The main thing preventing it right now is Gridlock Itself. But the Sequester alone may be contractionary enough to tip us into a recession-inside-of-a-moderate-depression. And that has the potential to destabilize things in ways that may be very volatile and dangerous. As Warren Mosler often puts it, we are letting the irrational fear that we might turn into the next Greece spook us into policies that are all too likely to turn us into the next Japan. To have a fighting chance of avoiding this, MMT needs to attract a much larger following among the progressive “intelligentsia”. And this will need to happen pretty fast.

Good things are happening. Chris Hedges is listening to Michael Hudson. Chris Hayes is listening to Stephanie Kelton.  Lots of people are taking an interest in the Platinum Coin meme that Joe Firestone is mining and writing about. And these are just examples – MMT is perceptibly gaining traction in countries all around the world. Students in Finland called their country a “hotbed of MMT” at yet another packed seminar – chaired, this time, by MMT pioneer Randall Wray. There’s a trend in all of this, and it’s a very encouraging trend. So we’ve got to keep pushing. Now is the time for everyone to do whatever they can. 


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