Daily Archives: April 30, 2010



By L. Randall Wray

On Wednesday April 28 several New Economic Perspective bloggers participated in a 1960s style “teach-in” in Washington DC to explode some of the myths about Federal Government deficits. Our event was timed to counter the Pete Peterson-funded extravaganza that promoted all of the fallacies used to stoke hysteria and fear of deficits. You can find more information about our event, as well as our power point presentations (here).

Right before the event, we also issued a joint piece examining the nine worst myths, posted at both New Deal 2.0 (here) and at the Huffington Post (here). The flurry and fury of comments to our piece was amazing, nay, shocking. I think these comments demonstrate just how successful the billions of dollars spent in Peterson’s campaign have been at promulgating dangerous falsehoods over the past two decades. Indeed, the level of commentary is notable both for the vitriol and for its sheer ignorance. One wonders whether civil and informed discussion on the topic of money is even possible.

I was reminded of a conversation I once had with the late and great Robert Heilbroner about my book, “Understanding Modern Money”. He warned me that the book was going to scare the living daylights out of readers (actually he used more colorful language—but it was a private conversation, not a public blog fit for family viewing). He went on to explain that money is the scariest thing for most people, sure to result in heated and angry discussion. It is also complex, something everyone talks about but few understand. Hence, it is a topic that must be carefully addressed, and with plenty of reassurances that one is not propounding anything too unsettling. It is also a subject that accumulates more than its fair share of cranks—indeed, “monetary cranks” actually earned an entry in the New Palgrave dictionary of economics. (By the way, most of the “cranks” discussed in that entry actually were less “cranky” than someone like Milton Friedman or Friedrich von Hayek—but that is a topic for another time.) For that reason, new ways of looking at money will (rightly, sometimes) be suspiciously treated.

The reaction to our post on the nine myths also reminded me of an interview Nobel winner Paul Samuelson gave to Mark Blaug (in his film on Keynes, “John Maynard Keynes: Life/Ideas/Legacy 1995”). There Samuelson said:

“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say “uh, oh what you have done” and James Buchanan argues in those terms. I have to say that I see merit in that view.”
In other words, the need to balance the budget over some time period determined by the movements of celestial objects, or over the course of a business cycle is a myth, an old-fashioned religion. But that superstition is seen as necessary because if everyone realizes that government is not actually constrained by the necessity of balanced budgets, then it might spend “out of control”, taking too large a percent of the nation’s resources. Samuelson sees merit in that view.

It is difficult not to agree with him. But what if the religious belief in budget balance makes it impossible to spend on the necessary scale to achieve the public purpose? In the same film James Buchanan argues that the budget ought to be balanced except in wartime—and while he does not explicitly endorse Samuelson’s argument that this is nothing but a useful myth, he does imply that there is no financial/economic/solvency reason for balancing the budget. Rather, it is to keep government in check, to ensure it does not grow and absorb too many of the nation’s resources. Ironically, Buchanan’s willingness to deficit-spend in wartime seems to imply that the US ought to almost always run deficits since we are almost always at war with someone. Hence, he seems to advocate nearly permanent budget deficits—no doubt unintentionally. Many might question that position on the argument that if it is OK to run deficits to destroy one’s enemy then it surely makes sense to run deficits to build a strong nation. Indeed, older readers of this blog will remember that our nation got interstate hiways on the argument that this is good for national defense, and that many of us got through college on “national defense student loans”. But that is not really the point I am driving at in this blog.

What I am arguing is that discussion of money and budget deficits has simply reached a state in which it has become impossible to address real world problems. I have always thought that honesty is the best policy—even if the truth is scary—but I am in the education business, not in politics or marketing or religion. But even if we concede Samuelson’s point, that old-time deficit religion is not now useful—even if it might have served a useful purpose in the past.

Yes, government must be constrained. That is what elections and budgeting and accounting and accountability are all about. We need more democracy, more understanding, and more transparency. Politicians need to listen to Main Street—not just Wall Street—before deciding where and how much to spend. They need to be controlled by a budgeting process—whose purpose is not to balance the budget, ensuring tax revenues match spending outgo, but rather to give us some idea of the size of the programs (hence, what percent of our nation’s resources will be devoted to their projects) and, equally important, to hold our leaders and project managers accountable. When managers run over budget, it does not threaten our government’s solvency but it should threaten its credibility. Fraud and over-reach are always a threat where government’s spending is unconstrained. And, yes, too much government spending generates competition over resources, bottle-necks, and even excessive aggregate demand, all of which can generate inflation.
We don’t need myths. We need more democracy, more understanding, and more transparency. We do need to constrain our leaders—but not through dysfunctional superstitions.

Greece CAN Go it Alone

By Marshall Auerback and Warren Mosler

Greece can successfully issue and place new debt at low interest rates. The trick is to insert a provision stating that in the event of default, the bearer on demand can use those defaulted securities to pay Greek government taxes. This makes it immediately obvious to investors that those new securities are ‘money good’ and will ultimately redeem for face value for as long as the Greek government levies and enforces taxes. This would not only allow Greece to fund itself at low interest rates, but it would also serve as an example for the rest of the euro zone, and thereby ease the funding pressures on the entire region.  

We recognize, of course, that this proposal would also introduce a ‘moral hazard’ issue. This newly found funding freedom, if abused, could be highly inflationary and further weaken the euro.  In fact, the reason the ECB is prohibited from buying national government debt is to allow ‘market discipline’ to limit member nation fiscal expansion by the threat of default. When that threat is removed, bad behavior is rewarded, as the country that deficit spends the most wins, in an accelerating and inflationary race to the bottom.

It is comparable to a situation where a nation like the US, for example, did not have national insurance regulation.  In this kind of circumstance, the individual states got into a race to the bottom, where the state with the laxest standards stood to attract the most insurance companies, forcing each State to either lower standards or see its tax base flee. And it tends to end badly with AIG style collapses.

Additionally, the ECB or the Economic Council of Finance Ministers (ECOFIN) effectively loses the means to enforce their austerity demands and keep them from being reversed once it’s known they’ve taken the position that it’s too risky to let any one nation fail.   

What Europe’s policy makers would like to do is find a way to isolate Greece and mitigate the contagion effect, while maintaining the market discipline that comes from the member nations being the credit sensitive entities they are today; hence, the mooted “shock and awe” proposals now being leaked, which did engender an 8% jump in the Greek stock market on Thursday.

But these proposals don’t really get to the nub of the problem. Any major package weakens the others who have to fund it in the market place, because the other member nations are also revenue dependent, credit sensitive entities. Much like the US States, they do not control central bank operations, and must have good funds in their accounts or their checks will bounce.

The euro zone nations are all still in a bind, and their mandated austerity measures mean they don’t keep up with a world recovery. And Greek financial restructuring that reduces outstanding debt reduces outstanding euro financial assets, strengthening the euro, and further weakening output and employment, while at the same time the legitimization of restructuring risk weakens the credit worthiness of all the member nations. 

It does not appear that the markets have fully discounted the ramifications of a Greek default.  If you use a Chapter 11 bankruptcy analogy, large parts of the country would be shut down and the “company” (i.e. Greece Inc) could spend only its tax revenues.  But the implied spending cuts represent a further substantial cut in aggregate demand and decreased revenues, in a most un-virtuous spiral that ends only with an increase in exports or privation driven revolt. 

The ability of Greece to use the funds from the rescue package as a means to extinguish Greek state liabilities would improve their financial ratios and stave off financial collapse, at least on a short term basis, with the side effect of a downward spiral in output and employment, while the sovereign risk concerns are concurrently transmitted to Spain, Portugal, Ireland, Italy, and beyond. Those sovereign difficulties also morph into a full-scale private banking crisis which can quickly extend to bank runs at the branch level.

Our suggestion will rescue Greece and the entire euro zone from the dangers of national government insolvencies, and turn the euro zone policy maker’s attention 180 degrees, back to their traditional role of containing the potential moral hazard issue of excessive deficit spending by the national governments through the Stability and Growth Pact. If the member states ultimately decide that the Stability and Growth Pact ratios need to be changed, that’s their decision. But the SGP represents the euro zone’s “national budget”, precisely designed to prevent the hyperinflationary outcome that the “race to the bottom” could potentially create. At the very least, our proposal will mitigate the deflationary impact of markets disciplining credit sensitive national governments and halting the potential spread of global financial contagion, without being inflationary. 

Do Not Confuse Solvency with Sustainability

By Pavlina R. Tcherneva

The Peter G. Peterson foundation held its ‘fiscal summit’ yesterday to address the looming government debt and deficit ‘problem’. According to a TRNN journalist who attended the summit, the conference began with “we know what the problem is, the federal government debt and deficits have become unsustainably large, we need to make hard choices, cut government spending, including on Social Security and Medicare…”
Any sensible person should be scandalized by this purely ideological stance. When it is necessary to go into war, the deficit is never a problem; when we bail out the financial sector, deficit spending is a ‘requirement’, when we build prisons and pack more people in our jails, oh well… But when it comes to paying for the retired and the sick, surely the government can’t afford to do that! Grandma better pull herself by her bootstraps and take responsibility for her retirement or healthcare needs. But even if we get past the propaganda, Peterson and all the deficit hawks are making one fundamental mistake: they are confusing sustainability with solvency.