An MMT View of the Twin Deficits Debate

Invited Presentation by L. Randall Wray at the UBS European Conference, London, Tuesday 13 November 2018

Q: These questions about deficits are usually cast as problems to be solved. You come from a different way of framing the issue, often referred to as MMT, which—at the risk of oversimplifying—says that we worry far too much about debt issuance. Can you help us understand where fears may be misplaced?

Wray: First let me say that I think the twin deficits argument is based on flawed logic.

It runs something like this: the government decides to spend too much, causing a budget deficit that competes with private borrowers, driving interest rates up. That appreciates the currency and causes a trade deficit.

The budget and trade deficits are unsustainable as both the private sector and the government sector rely on the supply of dollars lent by foreigners. At some point the Chinese and others will demand payment and/or sell out of dollars causing US rates to rise and the dollar to crash.

While that’s a simplified summary, I think it captures the main arguments.

Here’s the way I see it:

  1. Overnight rates are set by the central bank; deficits raise them only if the central bank reacts to deficits by raising them.
  2. Budget deficits result in net credits to bank reserves and hence put downward (not upward) pressure on overnight rates that is relieved by bond sales by the Fed and Treasury—or by paying interest on reserves. In other words, there’s no crowding out effect on rates. (Inaction lets rates fall.)
  3. Budget deficits result from the nongovernment sector’s desire to net save government liabilities. So long as the nongovernment sector wants to net save government debt, the deficit is sustainable.
  4. Current account deficits result from the ROW’s desire to net save US dollar assets. So long as the ROW wants to accumulate dollars, the US trade deficit is sustainable. So there is a symmetry to the two deficits, but not the one usually supposed.
  5. The US government does not borrow dollars from China. China’s net exports lead to accumulation of dollar reserves that are exchanged for higher earning Treasuries. If China did not run current account surpluses, she would not accumulate many Treasuries. All the dollars China has came from the US.
  6. If the US did not run current account deficits, the Chinese and other foreigners would not accumulate many Treasuries. This shows that accumulation of Treasuries abroad has more to do with the trade deficit than with Uncle Sam’s borrowing. (Compare the US with Japan—where virtually all the treasuries are held domestically.)
  7. A sovereign government cannot run out of its own liabilities. All modern governments make and receive payments through their central banks. Government spending takes the form of a credit by the central bank to a private bank’s reserves, and a credit by the receiving bank to the account of the recipient. You cannot run out of balance sheet entries.
  8. Affordability is not the question. The problem with too much government spending is that it diverts too many of the nation’s resources to the public sector—which causes inflation and leaves the private sector with too few resources.
  9. So, no, I don’t worry about sovereign government debt if it is issued in domestic currency—although I do worry about inflation and as well about excessive private sector debt as well as nonsovereign government debt.
  10. To conclude: We’ve reversed the twin deficit logic and emphasized quantity adjustments. The twin deficits are the residuals that accommodate the desired net saving of the domestic private sector and the ROW, respectively.
  11. Usually the domestic non-government sectors want to accumulate dollars so the only sector left to inject dollars is the US government. This means Uncle Sam runs a deficit because others want to accumulate dollars. The government also accommodates the portfolio desires of the non- government by swapping dollar reserves and bonds on demand.
  12. Finally if the ROW does not want dollars anymore, it can buy goods and services in the US. That will reduce the external deficit, stimulate domestic demand, and thereby reduce the fiscal deficit.

20 responses to “An MMT View of the Twin Deficits Debate

  1. Andrew Hartman

    What if the foreign holders of very large quantities of dollars want to buy all our defense contractors, Alphabet/Microsoft/Apple type companies, or very large tracts of farmland? In what ways is it a strategic disadvantage that a rival owns trillions of our currency? what could go wrong?

    • Hello Andrew, foreign buyers of US assets, property and equipment have to follow US laws, and the Justice department has the authority to block foreign purchases. For example, earlier in the year, the Justice Department blocked the sale of the Chicago Stock Exchange to a Chinese company. Congress has, and always can, set limits and restrictions as to how foreign firms can operate in the States.

  2. What about the price of tea in China? Huh? We should stop buying it so the competitor states can’t buy or strategic assets. Oh, on another note, thanks for the article clarifying MMT view on deficits.

  3. Hartman: I can remember back when everyone was so, so worried that the Japanese would buy up our country and take over. Never happened. And they got stuck with overpriced real estate. Note: foreign buyers are subject to our laws. We can pass whatever laws we want to govern who can own what, and what they can do with it. You are raising strawmen when you talk about defense contractors–we have already refused in some cases to allow Chinese ownership of strategic firms and officials are deep into investigations of supply chains of sensitive inputs to those. And ownership of Apple is already global. If foreign companies buy our farmland (ie pig farms–already happened) they are subject to our laws; if they are abusing us it is because our laws are lax. We should of course tighten up regs on use of farmland, how animals are treated in feedlots, what is done with animal waste–and so on–no matter who owns the factory farms.

    • If Amazon tells me I can only buy from the cosmetics section then I’m not going to shop at Amazon. While the US can pass whatever laws they want those laws come with consequences. As more of these restrictions are placed it is less likely that the “ROW will want to accumulate dollars” and your fears of inflation will be realized.

    • Thursday, 10 May 2012
      Fed Approves First Communist Chinese Takeover of U.S. Bank
      Written by Alex Newman :
      The increasingly controversial Federal Reserve offered a green light on Wednesday for banks controlled by the Communist Chinese dictatorship to gobble up American financial institutions and enter the U.S. banking market despite national security concerns, sparking warnings among critics about the rapid spread of the brutal regime’s influence within America. Analysts, meanwhile, called the unprecedented approval a “landmark step” for regulators that could have global implications.
      Under the U.S. central bank’s decision, the Industrial and Commercial Bank of China (ICBC), the largest bank in the Communist Party-run country with assets estimated at some $2.5 trillion, will be allowed to become a holding company and acquire the Bank of East Asia in New York. It marks the first time that a Communist Chinese bank — ICBC is more than 70 percent owned by the regime — has been permitted to take over an American bank. All 13 branches of the U.S. institution will be taken over.

      As part of the deal, U.S. authorities also granted bank holding company status to the regime’s sovereign wealth fund, China Investment Corp, which participated in the deal. Central Huijin Investment, which holds the regime’s shares in ICBC, was approved for the classification as well. And according to analysts, Wednesday’s decision by the Fed is just the beginning. …
      “In a footnote on its order approving the deals, the U.S. central bank also noted that national security objections about the scheme had been raised. It was not immediately clear what the concerns were or how they were addressed — if at all — but the Fed said reviewing such issues was the responsibility of government agencies, not the privately owned central bank.”

      N.B., FED, ‘privately owned bank.’
      So much for ‘legislation’- when discovered it does not work for “Real Power” It is changed.

  4. Andrew Hartman

    Hi Willy, my questions were serious, not snark. To successfully communicate MMT ideas to people who are brainwashed to fear USA federal deficit spending and foreign trade deficits, I want to be able to answer all the possible objections. My question, touching on dollar foreign reserves, T-bills, and trade deficits, is the one that I don’t quite have a good answer for. Will you restate your answer assuming a good faith question from a person that you want to convince? Perhaps you don’t have a steel-manned answer at hand, but give it a try it is good practice. AH

  5. Bottom line. Treasuries owned by any foreign gov. are real debt. “Current account deficits result from the ROW’s desire to net save US dollar assets. So long as the ROW wants to accumulate dollars, the US trade deficit is sustainable. ” Read; IF the ROW wants to NO LONGER accumulate US dollars; that debt must be redeemed.

    Now enter the ‘fatal flaw’. This debt is not sustainable if this is interest attached. Interest is a mandatory increase they will exponentially grow the debt that will create ‘systemic failure’.
    Noble Laureate for Physics.(Excerpt from
    “In four books written from 1921 to 1934, Soddy carried on a “quixotic campaign for a radical restructuring of global monetary relationships”[this quote needs a citation], offering a perspective on economics rooted in physics—the laws of thermodynamics, in particular—and was “roundly dismissed as a crank”[this quote needs a citation]. While most of his proposals – “to abandon the gold standard, let international exchange rates float, use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort” – are now conventional practice, his critique of fractional-reserve banking still “remains outside the bounds of conventional wisdom”[this quote needs a citation]. Soddy wrote that financial debts grew exponentially at compound interest…”

    • Carmen, wow, I really gotta read this Soddy guy, he seems to have anticipated a lot of stuff we now believe about money. And he’s absolutely right that financial debts will grow exponentially due to the magic of compound interest, but that applies to private debt (as Michael Hudson tells us again and again) not public debt. I’ll be interested to see if he made that distinction.

      • A FREE DOWNLOAD; “The Role Of Money” by Noble Laureate Frederick Soddy (1934).

        “So elaborately has the real nature of
        this ridiculous proceeding been surrounded with
        confusion by some of the cleverest and most
        skillful advocates the world has ever known, that
        it still is something of a mystery to ordinary
        people, who hold their heads and confess they
        are ” unable to understand finance “. It is not
        intended that they should.” Frederick Soddy (The Role Of Money)

      • All debt that has compounded interest attached is subject to “The Rule of 72”
        As for Soddy, what irony, his valuable book is a FREE download-

      • Hello CG,
        If debt increase exponentially, to where are all these dollars flowing?

        As the Treasury increases interest payments, they instruct the Fed to credit the bank accounts of the bond holders. The bond holders will spend some of the interest payments back into the real economy. The additional spending increases backlogs at companies, who then buy new plant, equipment, and hire workers to work through the backlog and maintain market share. The government taxes the new income of companies and workers, which moves the financial position of the government towards (or into) surplus. The new financial position of the government requires fewer (or if in surplus, no) bonds, and the interest payments of the government will slow or reverse. Wouldn’t you agree?
        Thanks, Joel

      • Aaand, not really. I think Soddy is more a predecessor of the Positive Money philosophy.

    • Hello Carmen,
      If the rest of the world no longer wants to hold US dollars, then they will have to sell those dollars in exchange for their local currency. Consider China. if they no longer wanted to hold USD, they would take the ones that they receive from business sales, and sell the USD for yuan. As they sell, they increase the supply of USD and increase the demand for yuan, causing the USD to depreciate relative to the local currency. The greater the volume of dollars sold, the more the USD will depreciate.

      This will make Chinese products more expensive for American firms and workers, and also make US products less expensive for Chinese firms and workers. So sales volume to the States declines in China, forcing Chinese companies to layoff workers and shutter factories.

      Why would the Chinese harm their economy with such a policy?

      Thanks, Joel

      • Joel, “Why would the Chinese harm their economy with such a policy?”
        Answer; “they wouldn’t sell their dollars, for that reason plus the lost of interest.
        Their real option is to redeem for ‘goods and services’

  6. Robert Lavergne

    What/Who are ROW’s?

  7. Herman van Beek

    Some of you seem to forget the difference between stocks and flows.

  8. @Carmen

    “The debt must be redeemed.”

    So? The only promise made is to redeem it in the fiat currency over which the issuing sovereign exercises a monopoly and for whom the supply is inexhaustable.

    Where is the problem for the sovereign issuer? Nowhere.

    The problem is for the holder of those instruments, not the issuer, given that it’s the former that no longer wants the currency which happens to be the only thing on offer upon redemption.

  9. Herman van Beek

    Hello Creigh,
    Maybe the Economics paragraph in the Wikipedia article on Soddy put you on the wrong track. It is very much not state of the art economics stating that Soddy’s critique of fractional wisdom remains outside the bounds of conventional wisdom and that after a plethora of articles from well-known economists criticising fractional reserve banking, to begin with L Randall Wray and Bill Mitchell. Then referring to the IMF-article on the Chicago Plan as only source for the idea that there might be something in that idea of Soddy is to say it politely, somewhat odd.
    Soddies ideas, judging from what’s in the Wikipedia article are close to Keynes’ and to modern Keynesians’. The idea of energy as quintessential for an economy is at the core of ecological economics but also of James Galbraith’s view on the future of economic growth as argued in The End of Normal (2014). Exponential growth of financial debts refers to the stock of debts and only in the private sector and is as such at the heart of the economic and financial crises of 2008/2010 (I am European)