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While Labor Unions celebrate Anti-Austerity Day in Europe, European Neoliberals raise the ante: Governments must Lower Wages or Suffer Financial Blackmail

Posted on September 30, 2010 by | 7 comments

By Michael Hudson

Most of the press has described Europe’s labor demonstrations and strikes on Wednesday in terms of the familiar exercise by transport employees irritating travelers with work slowdowns, and large throngs letting off steam by setting fires. But the story goes much deeper than merely a reaction against unemployment and economic recession. At issue are proposals to drastically change the laws and structure of how European society will function for the next generation. If the anti-labor forces succeed, they will break up Europe, destroy the internal market, and render that continent a backwater. This is how serious the financial coup d’etat has become. And it is going to get much worse – quickly. As John Monks, head of the European Trade Union Confederation, put it: “This is the start of the fight, not the end.”
Spain has received most of the attention, thanks to its ten-million strong turnout – reportedly half the entire labor force. Holding its first general strike since 2002, Spanish labor protested against its socialist government using the bank crisis (stemming from bad real estate loans and negative mortgage equity, not high labor costs) as an opportunity to change the laws to enable companies and government bodies to fire workers at will, and to scale back their pensions and public social spending in order to pay the banks more. Portugal is doing the same, and it looks like Ireland will follow suit – all this in the countries whose banks have been the most irresponsible lenders. The bankers are demanding that they rebuild their loan reserves at labor’s expense, just as in President Obama’s program here in the United States but without the sanctimonious pretenses.
The problem is Europe-wide and indeed centered in the European Union capital in Brussels, where fifty to a hundred thousand workers gathered to protest the proposed transformation of social rules. Yet on the same day, the European Commission (EC) outlined a full-fledged war against labor. It is the most anti-labor campaign since the 1930s – even more extreme than the Third World austerity plans imposed by the IMF and World Bank in times past.

The EC is using the mortgage banking crisis – and the needless prohibition against central banks monetizing public budget deficits – as an opportunity to fine governments and even drive them bankrupt if they do not agree roll back salaries. Governments are told to borrow at interest from the banks, rather than raising revenue by taxing them as they did for half a century following the end of World War II. Governments unable to raise the money to pay the interest must close down their social programs. And if this shrinks the economy – and hence, government tax revenues – even more, the government must reduce social spending yet further.
From Brussels to Latvia, neoliberal planners have expressed the hope that lower public-sector salaries will spread to the private sector. The aim is to roll back wage levels by 30 percent or more, to depression levels, on the pretense that this will “leave more surplus” available to pay in debt service. It will do no such thing, of course. It is a purely vicious attempt to reverse Europe’s Progressive Era social democratic reforms achieved over the past century. Europe is to be turned into a banana republic by taxing labor – not finance, insurance or real estate (FIRE). Governments are to impose heavier employment and sales taxes while cutting back pensions and other public spending.
“Join the fight against labor, or we will destroy you,” the EC is telling governments. This requires dictatorship, and the European Central Bank (ECB) has taken over this power from elected government. Its “independence” from political control is celebrated as the “hallmark of democracy” by today’s new financial oligarchy. This deceptive newspeak evokes Plato’s view that oligarchy is simply the political stage following democracy. The new power elite’s next step in this eternal political triangle is to make itself hereditary – by abolishing estate taxes, for starters – so as to turn itself into an aristocracy.
It is a very old game indeed. So it is time to put aside the economics of Adam Smith, John Stuart Mill and the Progressive Era, to forget Marx and even Keynes. Europe is ushering in an era of totalitarian neoliberal rule. This is what Wednesday’s strikes and demonstrations were about. Europe’s class war is back in business – with a vengeance!
This is economic suicide, but the EU is demanding that Euro-zone governments keep their budget deficits below 3% of GDP, and their total debt below 60%. On Wednesday the EU passed a law to fine governments up to 0.2% of GDP for not “fixing” their budget deficits by imposing such fiscal austerity. Nations that borrow to engage in countercyclical “Keynesian-style” spending that raises their public debt beyond 60% of GDP will have to reduce the excess by 5% each year, or suffer harsh punishment.[1] The European Commission (EC) will fine euro-area states that do not obey its neoliberal recommendations – ostensibly to “correct” budget imbalances.
The reality is that every neoliberal “cure” only makes matters worse. But rather than seeing rising wage levels and living standards as being a precondition for higher labor productivity, the EU commission will “monitor” labor costs on the assumption that rising wages impair competitiveness rather than raise it. If euro members cannot depreciate their currencies, then they must fight labor – but not tax real estate, finance or other rentier sectors, not regulate monopolies, and not provide public services that can be privatized at much higher costs. Privatization is not deemed to impair competitiveness – only rising wages, regardless of productivity considerations.
The financial privatization and credit-creation monopoly that governments have relinquished to banks is now to really pay off – at the price of breaking up Europe. Unlike central banks elsewhere in the world, the charter of the European Central Bank (ECB, independent from democratic politics, not from control by its commercial bank members) forbids it to monetize government debt. Governments must borrow from banks, which are create interest-bearing debt on their own keyboards rather than having their national bank do it without cost.
The unelected members of the European Central Bank have taken over planning power from elected governments. Beholden to its financial constituency, the ECB has convinced the EU commission to back the new oligarchic power grab. This destructive policy has been tested above all in the Baltics, using them as guinea pigs to see how far labor can be depressed before it fights back. Latvia gave free reign to neoliberal policies by imposing flat taxes of 51% and higher on labor, while real estate is virtually untaxed. Public-sector wages have been reduced by 30%, prompting labor of working age (20 to 35 year-olds) to emigrate in droves. This of course is contributing to the plunge in real estate prices and tax revenue. Lifespans for men are shortening, disease rates are rising, and the internal market is shrinking, and so is Europe’s population – as it did in the 1930s, when the “population problem” was a plunge in fertility and birth rates (above all in France). That is what happens in a depression.
Iceland’s looting by its bankers came first, but the big news was Greece. When that nation entered its current fiscal crisis as a result of not collecting taxes on the wealthy, European Union officials recommended that it emulate Latvia, which remains the poster child for neoliberal devastation. The basic theory is that inasmuch as members of the euro cannot devalue their currency, they must resort to “internal devaluation”: slashing wages, pensions and social spending. So as Europe enters recession it is following precisely the opposite of Keynesian policy. It is reducing wages, ostensibly to “free” more income available to pay the enormous debts that Europeans have taken on to buy their homes and pay for schooling (hitherto provided freely in many countries such as Latvia’s Stockholm School of Economics), transportation and other public services. Manly such services have been privatized and subsequently raised their rates drastically. The privatizers justify this by pointing to the enormously bloated financial fees they had to pay their bankers and underwriters in order to get the credit to buy the infrastructure that was being sold off by governments.
So Europe is committing economic, demographic and fiscal suicide. Trying to “solve” the problem neoliberal style only makes things worse. Latvia’s public-sector workers, for example, have seen their wages cut by 30 percent over the past year, and its central bankers have told me that they are seeking further cuts, in the hope that this will lower wages in the private sector as well, just as neoliberals in other European countries hope, as noted above.
About 10,000 Latvians attended protest meetings in the small town of Daugavilpils alone as part of the “Journey into the Crisis.” In Latvia’s capital city, Riga, yesterday’s Action Day saw the usual stoppage of transportation and an accompanying honk concert for 10 minutes at 1 PM to let the public know that something was happening. Six independent trade unions and the Harmony Center organized a protest meeting in Riga’s Esplanade Park that drew 700 to 800 demonstrators, relatively large for so small a city. Another union protest saw about half that number gather at the Cabinet of Ministers where Latvia’s austerity program has been planned and carried out.
What is happening most importantly is the national parliamentary elections this Saturday (October 2). The leading coalition, Harmony Center, is pledged to enact an alternative tax and economic policy to the neoliberal policies that have reduced labor’s wages and workplace standards so sharply over the past decade. A few days earlier a bus tour drove journalists to the most visible victims – schools and hospitals that had been closed down, government buildings whose employees had seen their salaries slashed and the workforce downsized.
These demonstrations seem to have gained voter sympathy for the more militant unions, headed by the hundred individual unions belonging to the Independent Trade Union Association. The other union group – the Free Trade Unions (LBAS) lost face by acquiescing in June 2009 to the government’s proposed 10% pension cuts (and indeed, 70% for working pensioners). Latvia’s constitutional court was sufficiently independent to overrule these drastic cuts last December. And if the government does indeed change this Saturday, the conflict between the Neoliberal Revolution and the past few centuries of classical progressive reform will be made clear.
In sum, the Neoliberal Revolution seeks to achieve in Europe what the United States has achieved since real wages stopped rising in 1979: doubling the share of wealth enjoyed by the richest 1%. This involves reducing the middle class to poverty, breaking union power, and destroying the internal market as a precondition.
All this is being blamed on “Mr. Market” – presumably inexorable forces beyond politics, purely “objective,” a political power grab. But is not really “the market” that is promoting this destructive economic austerity. Latvia’s Harmony Center program shows that there is a much easier way to cut the cost of labor in half than by reducing its wages: Simply shift the tax burden off labor onto real estate and monopolies (especially privatized infrastructure). This will leave less of the economic surplus to be capitalized into bank loans, lowering the price of housing accordingly (the major factor in labor’s cost of living), as well as the price of public services. (Owners of monopoly utility services would be prevented from factoring interest charges into their cost of doing business. The idea is to encourage them to take returns on equity. Whether or not they borrow is a business decision of theirs, not one that governments should subsidize.) The tax deductibility of interest will be repealed – there is nothing intrinsically “market dictated” by this fiscal subsidy for debt leveraging. This program may be reviewed at rtfl.lv, the Renew Task Force Latvia website.
No doubt many post-Soviet economies will find themselves obliged to withdraw from the euro area rather than see a flight of labor and capital. They remain the most extreme example of the Neoliberal Experiment to see how far a population can have its living standards slashed before it rebels.
But so far the neoliberals are fully in control of the bureaucracy, and they are reviving Margaret Thatcher’s slogan, TINA: There Is No Alternative. But there is an alternative, of course. In the small Baltic economies, pro-labor parties are pressing for the government to shift the tax burden off employees and consumers back onto property and financial wealth. Bad debts beyond the reasonable ability to pay must be scaled back. It may be necessary to let the banks go under (they are mainly Swedish), even if this means withdrawing from the Euro. The choice is between who will be destroyed: the banks, or labor?
European politicians now view this as being truly a fight to the death. This is the ideology that has replaced social democracy.

[1] Matthew Dalton, “EU Proposes Fines for Budget Breaches,” Wall Street Journal, September 29, 2010.

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Posted in Michael Hudson, Policy and Reform, Taxes, Uncategorized, Unemployment

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“Fed Chairman Ruml got it right in 1946”

Posted on April 19, 2010 by | 3 comments

Hat tip Warren Mosler’s blog (http://www.moslereconomics.com/)

On his recent piece “Taxes For Revenue Are Obsolete ” that appeared on the Huffington Post he notes:

April 15th has come and gone, but the issue of taxation remains the course de jour. I was recently forwarded an article entitled Taxes For Revenue Are Obsolete, written in 1946 by Beardsley Ruml, the former Chairman of the Federal Reserve Bank of New York and published in a periodical named American Affairs. While Ruml was writing about the merits of corporate taxes, it is his discussion about how the function of taxes changed after the nation exited the gold standard that make this a must read. As Ruml’s stated, with an “…inconvertible currency, a sovereign national government is finally free of money worries and need no longer levy taxes for the purpose of providing itself with revenue… It follows that our Federal Government has final freedom from the money market in meeting its financial requirements… All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue.” He goes on to explain how, with Federal spending not revenue constrained, the first function of taxation is to regulate the value of the dollar, which we know as regulating inflation. The notion of the Federal government ‘running out of money’ and ‘dependence on foreign borrowing’ as well as ‘sustainability’ is categorically inapplicable. The operative CBO ‘scoring’ is the inflationary effect, rather than simply a revenue forecast. And while Social Security and Medicare may turn out to be inflationary, they are not ‘bankrupting the nation’ as most believe, including a Democratic Congress that cut Medicare spending with the recent health care bill and has all entitlements ‘on the table.’

See also here.

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Posted in Taxes, The Federal Government Deficit, The National Debt, Uncategorized

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A Plea to the President: Tear Up That Speech

Posted on January 27, 2010 by | 1 comment

By Stephanie Kelton

My colleague and fellow blogger, Randy Wray, has just argued that President Obama should scrap the speech he’s planning to deliver tonight and surprise the American people with something entirely different. I couldn’t agree more. And while I agree that job creation must be JOB ONE in the months (and years) ahead, I would encourage the President to make massive tax relief the cornerstone of tonight’s speech.
Specifically, the President should call on Congress to support a full and immediate payroll tax holiday. Right now, the government takes away about 15% of our incomes in the form of payroll taxes. With a full payroll tax holiday, a married couple earning $60,000 a year would see their take-home pay increase by about $750 each month. In the aggregate, this will help millions of Americans pay their mortgages, student loans, credit card bills, and so on, while at the same time reducing business expenses (remember that employers contribute to the payroll tax too). All told, a full payroll tax holiday would allow Americans to keep about $1 trillion this year.
So stand before us, Mr. President, and tell us that you want to stop taking this income away from us until we, as a nation, have clawed back every job that has been lost since the start of the recession. Tell us that you intend to take bold steps to protect jobs, keep families intact and provide relief for millions of American businesses. Tell us that you have done all you intend to do to help the banks and the automakers and that you will not accept a jobless recovery — that an increase in economic activity is meaningless without rising employment in good jobs.
And, most importantly, tell us that you refuse to adopt a timeline for cutting the deficit. Tell us that you will not take one dime of payroll taxes away from us until your Administration can declare “Mission Accomplished” on the job front.
Finally, tell the American people that anyone who opposes a payroll tax holiday wants to keep taking hundreds, perhaps thousands, of dollars from them every month. Then watch what happens in 2012.

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Posted in Policy and Reform, Stephanie Kelton, Taxes, The Federal Government Deficit, Uncategorized, Unemployment

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What If the Government Just Prints Money?

Posted on November 22, 2009 by | 46 comments

By Scott Fullwiler

As Congress gets set in the near future to consider raising the debt ceiling yet again, my fellow blogger L. Randall Wray creatively suggests not raising the debt ceiling but instead having the Treasury continue spending as it always does: by simply crediting bank accounts. As he puts it:

The anti-deficit mania in Washington is getting crazier by the day. So here is what I propose: let’s support Senator Bayh’s proposal to “just say no” to raising the debt ceiling. Once the federal debt reaches $12.1 trillion, the Treasury would be prohibited from selling any more bonds. Treasury would continue to spend by crediting bank accounts of recipients, and reserve accounts of their banks. Banks would offer excess reserves in overnight markets, but would find no takers—hence would have to be content holding reserves and earning whatever rate the Fed wants to pay. But as Chairman Bernanke told Congress, this is no problem because the Fed spends simply by crediting bank accounts.
This would allow Senator Bayh and other deficit warriors to stop worrying about Treasury debt and move on to something important like the loss of millions of jobs.

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Memo to Congress: Don’t Increase the Government’s Debt Limit!

Posted on November 19, 2009 by | 19 comments
By L. Randall Wray

In a piece written for CNN, Senator Evan Bayh rails against the growing federal government budget deficit. He warns that next month the Treasury will ask Congress to raise the debt limit from its current $12.1 trillion, and promises that he will vote “no”. It is time, he argues, for Congress to stand up for our nation’s future by creating a bi-partisan debt commission that would finally put an end to “unsustainable” deficit spending.

The Senator goes on:

When President George W. Bush took office in 2001, our public debt amounted to 33 percent of our economy. Today, it is 60 percent of our gross domestic product. If we do nothing, our debt is projected to swell to over 70 percent by 2019. To put those numbers in perspective: If you divided the debt equally among all Americans, every man, woman and child living in the United States today would owe more than $39,000.

I presume the Senator has got his math correct, but there is a glaring error in his English that can be corrected by substituting an “n” for an “e”: If you divided the debt equally among all Americans, every man, woman and child living in the United States today would own more than $39,000. Government debt is a private asset. You and I do not owe government debt, we own it. Indeed, the only source of net dollar-denominated financial wealth is federal government debt.

The good Senator continues, comparing his proposed debt commission with an earlier successful bi-partisan effort:

There is precedent to create this type of commission with real teeth. President Ronald Reagan created a commission, chaired by Alan Greenspan, to shore up Social Security in the early 1980s.

That commission hiked payroll taxes to transform Social Security from a “pay-as-you-go” system (payroll taxes collected were matched to current year spending) to an “advanced funded” system that accumulated “Trust Fund assets”. In truth the Trust Fund is nothing but an accounting gimmick in which one arm of government (the Treasury) owes another arm of government (Social Security), with workers and their firms saddled with payroll taxes that are a third larger than Social Security spending. Like almost everything else Alan Greenspan did, the Social Security commission was a monumental failure and its actions were completely unnecessary. All Social Security payments can be made as they come due whether the Trust Fund holds Treasury debt or not, and no matter how much “revenue” the payroll tax collects. Like the bowling alley that credits points when pins are knocked down, the Treasury cannot run out of “points” credited to the accounts of pensioners.

The anti-deficit mania in Washington is getting crazier by the day. So here is what I propose: let’s support Senator Bayh’s proposal to “just say no” to raising the debt ceiling. Once the federal debt reaches $12.1 trillion, the Treasury would be prohibited from selling any more bonds. Treasury would continue to spend by crediting bank accounts of recipients, and reserve accounts of their banks. Banks would offer excess reserves in overnight markets, but would find no takers—hence would have to be content holding reserves and earning whatever rate the Fed wants to pay. But as Chairman Bernanke told Congress, this is no problem because the Fed spends simply by crediting bank accounts.

This would allow Senator Bayh and other deficit warriors to stop worrying about Treasury debt and move on to something important like the loss of millions of jobs.

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Posted in L. Randall Wray, Taxes, The Federal Government Deficit, The National Debt, Uncategorized

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Should America Kowtow to China?

Posted on November 17, 2009 by | 3 comments
By Marshall Auerback
First Published on New Deal 2.0.

Do the Chinese really fund our deficit? Or is this more Neo-classical money mythology?

Another Presidential junket to Asia and another one of the usual lectures from China, decrying our “profligate ways”. Today’s Wall Street Journal reports:, “China’s top banking regulator issued a sharp critique of U.S. financial management only hours before President Barack Obama commenced his first visit to the Asian giant, highlighting economic and trade tensions that threaten to overshadow the trip.”

According to Liu Mingkang, chairman of the China Banking Regulatory Commission, a weak U.S. dollar and low U.S. interest rates had led to “massive speculation” that was inflating asset bubbles around the world. It has created “unavoidable risks for the recovery of the global economy, especially emerging economies,” Mr. Liu said. The situation is “seriously impacting global asset prices and encouraging speculation in stock and property markets.”

Well, “them’s fightin’ words”, as we say over here. And of course, the President and his advisors are supposed to accept this criticism mildly because in the words of the NY Times, the US has assumed “the role of profligate spender coming to pay his respects to his banker.”

The Times actually does believe this to be true. They refer to China’s role as America’s largest “creditor” as a “stark fact”. They do not seem to understand that simply because a country issuing debt which it creates, it does not depend on bond holders to “fund” anything. Bonds are simply a savings alternative to cash offered by the monetary authorities, as we shall seek to illustrate below.

It is less clear to us whether the Chinese actually believe this guff, or simply articulate it for public consumption. China has made a choice: for a variety of reasons, it has adopted an export-oriented growth strategy, and largely achieved this through closely managing its currency, the remnimbi, against the dollar.

One can query the choice, as many would argue that it is more economically and socially desirable for China to consume its own economic output. According to Professor Bill Mitchell, for example, “once the Chinese citizens rise up and demand more access to their own resources instead of flogging them off to the rest of the world…then the game will be up. They will stop accumulating financial assets in our currencies and we will find it harder to run [current account deficits] against them.”

But there have undoubtedly been certain benefits that have accrued to the Chinese as a consequence of this strategy. The export prices obtained by Chinese manufacturers are about 10 times as high as the prices obtained in the more competitive domestic markets, and the challenge of competing in global markets has forced Chinese manufacturers to adhere to higher quality standards. This, in turn, has improved the overall quality of Chinese products. In the words of James Galbraith:

“Is there a way for the Chinese manufacturing firm to turn a profit? Yes: the alternative to selling on the domestic market is to export. And export prices, even those paid at wholesale, must be multiples of those obtained at home. But the export market, however vast, is not unlimited, and it demands standards of quality that are not easily obtained by neophyte producers and would not ordinarily be demanded by Chinese consumers. Only a small fraction of Chinese firms can actually meet the standards. These standards must be learned and acquired by practice.” (”The Predator State, Ch. 6, “There is no such thing as free trade”, pg. 84).

What about the US government? What should it do? Should it actually respond to China’s complaints by trying to “defend the dollar”?

I hear this recommendation all of the time in the chatterplace of the financial markets, but seldom do those who fret about the dollar’s declining level actually suggest a concrete strategy to achieve the objective. In fact, it is unclear to me that there is any measure the Fed or Treasury could adopt which might support the dollar’s external value.

And why should they? Given the horrendous unemployment data, and 65% capacity utilization, it is hard to view imported inflationary pressures via a weaker dollar actually becoming a serious threat.

But wait? Don’t the Chinese (and other external creditors) “fund” our deficit? And won’t they demand a higher equilibrating interest rate in order to offset the declining value of their Treasury hoard?

Again, this displays a seriously lagging understanding of how much modern money has changed since Nixon changed finance forever by closing the Gold window in 1973. Now that we’re off the gold standard, the Chinese, and other Treasury buyers, do not “fund” anything, contrary to the completely false & misguided scare stories one reads almost daily in the press.

This claim is seldom challenged, but our friend, Warren Mosler, recently gave an excellent illustration of this fact in an interview with Mike Norman. Mosler provides a hypothetical example in which China decides to sell us a billion dollars’ worth of T-shirts. We buy a billion dollars’ worth of T-shirts from China:

“And the way we pay them is somebody pays China. And the money goes into their checking account at the Federal Reserve. Now, it’s called a reserve account because it’s the Federal Reserve, and they give it a fancy name. But it’s a checking account. So we get the T-shirts, and China gets $1 billion in their checking account. And that’s just a data entry. That’s just a one and some zeroes.

Whoever bought them gets a debit. You know, it might have been Disneyland or something. So we debit Disney’s account and then we credit China’s account.

In this situation, we’ve increased our trade deficit by $1 billion. But it’s not an imbalance. China would rather have the money than the T-shirts, or they wouldn’t have sent them. It’s voluntary. We’d rather have the T-shirts than the money, or we wouldn’t have bought them. It’s voluntary. So, when you just look at the numbers and say there’s a trade deficit, and it’s an imbalance, that’s not correct. That’s imbalance. It’s markets. That’s where all market participants are happy. Markets are cleared at that price.

Okay, so now China has two choices with what they can do with the money in their checking account. They could spend it, in which case we wouldn’t have a trade deficit, or they can put it in another account at the Federal Reserve called a Treasury security, which is nothing more than a savings account. You give them money, you get it back with interest. If it’s a bank, you give them money, you get it back with interest. That’s what a savings account is.”

The example here clearly illustrates that bonds are a savings alternative which we offer to the Chinese manufacturer, not something which actually “funds” our government’s spending choices. It demonstrates that rates are exogenously determined by our central bank, not endogenously determined by the Chinese manufacturer who chooses to park his dollars in treasuries (credit demand, by contrast, is endogenous).

Here is how the mechanics actually work: government spending and lending adds reserves to the banking system because when the government spends, it electronically credits bank accounts.

By contrast, government taxing and security sales (i.e. sales of bonds) drain (subtract) reserves from the banking system. So when the government realizes a budget deficit (as is the case today), there is a net reserve add to the banking system, WHICH BRINGS RATES LOWER (not higher). That is, government deficit spending results in net credits to member bank reserves accounts. If these net credits lead to excess reserve positions, overnight interest rates will be bid down by the member banks with excess reserves to the interest rate paid on reserves by the central bank (currently .25% in the case of the US since the Fed started to pay interest on these reserves). If the central bank has a positive target for the overnight lending rate, either the central bank must pay interest on reserves or otherwise provide an interest bearing alternative to non interest bearing reserve accounts. But this is a choice determined by our central bank, not an external creditor.

Yet we are constantly being told by the financial press that the dollar’s weakness was supposed be the factor that would “force” the Fed to raise rates, since the Chinese supposedly “fund” our deficits.

So far, that thesis hasn’t been borne out. And it won’t be, because this isn’t how things operate in a post gold-standard world.

And a second and equally salient point: what would those who fret about the dollar, have the Fed do? Should they raise rates to defend it? It is unclear that this would work. The relationship between a given level of interest rates offered by the central bank and the external value of a currency is tenuous. Consider Japan as Exhibit A. The BOJ has been offering virtually free money for 15 years and yet the yen today remains a strong currency (much to the chagrin of the likes of Toyota or Sony).

Of course, higher rates can have an offsetting beneficial income impact (what Bernanke calls the “fiscal channel”), but it does not follow that a decision to raise rates would actually elevate the value of the dollar (and the benefits of higher rates from an income perspective could just as easily be achieved via lower taxation).

The reality is that private market participants could well view the move as something akin to a panicked response by the Fed, and the decision could well trigger additional capital flight, which could weaken the value of the dollar.

So it is unclear to me what the Tsy or Fed should be doing about the dollar. My view is that this is a private portfolio preference shift and I don’t think central banks should be responding to every vicissitude of changing market preferences. The US government should simply ignore the market chatter and idle threats from the Chinese and do nothing.

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Posted in Marshall Auerback, Taxes, The Federal Government Deficit, The National Debt, Uncategorized

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Money as a Public Monopoly

Posted on August 26, 2009 by | 25 comments
By L. Randall Wray

What I want to do in this blog is to argue that the reason both theory and policy get money “wrong” is because economists and policymakers fail to recognize that money is a public monopoly*. Conventional wisdom holds that money is a private invention of some clever Robinson Crusoe who tired of the inconveniencies of bartering fish with a short shelf-life for desired coconuts hoarded by Friday. Self-seeking globules of desire continually reduced transactions costs, guided by an invisible hand that selected the commodity with the best characteristics to function as the most efficient medium of exchange. Self-regulating markets maintained a perpetually maximum state of bliss, producing an equilibrium vector of relative prices for all tradables, including the money commodity that serves as a veiling numeraire.

All was fine and dandy until the evil government interfered, first by reaping seigniorage from monopolized coinage, next by printing too much money to chase the too few goods extant, and finally by efficiency-killing regulation of private financial institutions. Especially in the US, misguided laws and regulations simultaneously led to far too many financial intermediaries but far too little financial intermediation. Chairman Volcker delivered the first blow to restore efficiency by throwing the entire Savings and Loan sector into insolvency, and then freeing thrifts to do anything they damn well pleased. Deregulation, which actually dates to the Nixon years and even before, morphed into a self-regulation movement in the 1990s on the unassailable logic that rational self-interest would restrain financial institutions from doing anything foolish. This was all codified in the Basle II agreement that spread Anglo-Saxon anything goes financial practices around the globe. The final nail in the government’s coffin would be to preserve the value of money by tying monetary policy-maker’s hands to inflation targeting, and fiscal policy-maker’s hands to balanced budgets. All of this would lead to the era of the “great moderation”, with financial stability and rising wealth to create the “ownership society” in which all worthy individuals could share in the bounty of self-regulated, small government, capitalism.

We know how that story turned out. In all important respects we managed to recreate the exact same conditions of 1929 and history repeated itself with the exact same results. Take John Kenneth Galbraith’s The Great Crash, change the dates and some of the names of the guilty and you’ve got the post mortem for our current calamity.

What is the Keynesian-institutionalist alternative? Money is not a commodity or a thing. It is an institution, perhaps the most important institution of the capitalist economy. The money of account is social, the unit in which social obligations are denominated. I won’t go into pre-history, but I trace money to the wergild tradition—that is to say, money came out of the penal system rather than from markets, which is why the words for monetary debts or liabilities are associated with transgressions against individuals and society. To conclude, money predates markets, and so does government. As Karl Polanyi argued, markets never sprang from the minds of higglers and hagglers, but rather were created by government.

The monetary system, itself, was invented to mobilize resources to serve what government perceived to be the public purpose. Of course, it is only in a democracy that the public’s purpose and the government’s purpose have much chance of alignment. In any case, the point is that we cannot imagine a separation of the economic from the political—and any attempt to separate money from politics is, itself, political. Adopting a gold standard, or a foreign currency standard (“dollarization”), or a Friedmanian money growth rule, or an inflation target is a political act that serves the interests of some privileged group. There is no “natural” separation of a government from its money. The gold standard was legislated, just as the Federal Reserve Act of 1913 legislated the separation of Treasury and Central Bank functions, and the Balanced Budget Act of 1987 legislated the ex ante matching of federal government spending and revenue over a period determined by the celestial movement of a heavenly object. Ditto the myth of the supposed independence of the modern central bank—this is but a smokescreen to protect policy-makers should they choose to operate monetary policy for the benefit of Wall Street rather than in the public interest (a charge often made and now with good reason).

So money was created to give government command over socially created resources. Skip forward ten thousand years to the present. We can think of money as the currency of taxation, with the money of account denominating one’s social liability. Often, it is the tax that monetizes an activity—that puts a money value on it for the purpose of determining the share to render unto Caesar. The sovereign government names what money-denominated thing can be delivered in redemption against one’s social obligation or duty to pay taxes. It can then issue the money thing in its own payments. That government money thing is, like all money things, a liability denominated in the state’s money of account. And like all money things, it must be redeemed, that is, accepted by its issuer. As Hyman Minsky always said, anyone can create money (things), the problem lies in getting them accepted. Only the sovereign can impose tax liabilities to ensure its money things will be accepted. But power is always a continuum and we should not imagine that acceptance of non-sovereign money things is necessarily voluntary. We are admonished to be neither a creditor nor a debtor, but try as we might all of us are always simultaneously both. Maybe that is what makes us Human—or at least Chimpanzees, who apparently keep careful mental records of liabilities, and refuse to cooperate with those who don’t pay off debts—what is called reciprocal altruism: if I help you to beat the stuffing out of Chimp A, you had better repay your debt when Chimp B attacks me.

OK I have used up two-thirds of my allotment and you all are wondering what this has to do with regulation of monopolies. The dollar is our state money of account and high powered money (HPM or coins, green paper money, and bank reserves) is our state monopolized currency. Let me make that just a bit broader because US Treasuries (bills and bonds) are just HPM that pays interest (indeed, Treasuries are effectively reserve deposits at the Fed that pay higher interest than regular reserves), so we will include HPM plus Treasuries as the government currency monopoly—and these are delivered in payment of federal taxes, which destroys currency. If government emits more in its payments than it redeems in taxes, currency is accumulated by the nongovernment sector as financial wealth. We need not go into all the reasons (rational, irrational, productive, fetishistic) that one would want to hoard currency, except to note that a lot of the nonsovereign dollar denominated liabilities are made convertible (on demand or under specified circumstances) to currency.

Since government is the only issuer of currency, like any monopoly government can set the terms on which it is willing to supply it. If you have something to sell that the government would like to have—an hour of labor, a bomb, a vote—government offers a price that you can accept or refuse. Your power to refuse, however, is not that great. When you are dying of thirst, the monopoly water supplier has substantial pricing power. The government that imposes a head tax can set the price of whatever it is you will sell to government to obtain the means of tax payment so that you can keep your head on your shoulders. Since government is the only source of the currency required to pay taxes, and at least some people do have to pay taxes, government has pricing power.

Of course, it usually does not recognize this, believing that it must pay “market determined” prices—whatever that might mean. Just as a water monopolist cannot let the market determine an equilibrium price for water, the money monopolist cannot really let the market determine the conditions on which money is supplied. Rather, the best way to operate a money monopoly is to set the “price” and let the “quantity” float—just like the water monopolist does. My favorite example is a universal employer of last resort program in which the federal government offers to pay a basic wage and benefit package (say $10 per hour plus usual benefits), and then hires all who are ready and willing to work for that compensation. The “price” (labor compensation) is fixed, and the “quantity” (number employed) floats in a countercyclical manner. With ELR, we achieve full employment (as normally defined) with greater stability of wages, and as government spending on the program moves countercyclically, we also get greater stability of income (and thus of consumption and production)—a truly great moderation.

I have said anyone can create money (things). I can issue IOUs denominated in the dollar, and perhaps I can make my IOUs acceptable by agreeing to redeem them on demand for US government currency. The conventional fear is that I will issue so much money that it will cause inflation, hence orthodox economists advocate a money growth rate rule. But it is far more likely that if I issue too many IOUs they will be presented for redemption. Soon I run out of currency and am forced to default on my promise, ruining my creditors. That is the nutshell history of most private money (things) creation.

But we have always anointed some institutions—called banks—with special public/private partnerships, allowing them to act as intermediaries between the government and the nongovernment. Most importantly, government makes and receives payments through them. Hence, when you receive your Social Security payment it takes the form of a credit to your bank account; you pay taxes through a debit to that account. Banks, in turn, clear accounts with the government and with each other using reserve accounts (currency) at the Fed, which was specifically created in 1913 to ensure such clearing at par. To strengthen that promise, we introduced deposit insurance so that for most purposes, bank money (deposits) functions like government currency.

Here’s the rub. Bank money is privately created when a bank buys an asset—which could be your mortgage IOU backed by your home, or a firm’s IOU backed by commercial real estate, or a local government’s IOU backed by prospective tax revenues. But it can also be one of those complex sliced and diced and securitized toxic waste assets you’ve been reading about. A clever and ethically challenged banker will buy completely fictitious “assets” and pay himself huge bonuses for nonexistent profits while making uncollectible “loans” to all of his deadbeat relatives. (I use a male example because I do not know of any female frauds, which is probably why the scales of justice are always held by a woman.) The bank money he creates while running the bank into the ground is as good as the government currency the Treasury creates serving the public interest. And he will happily pay outrageous prices for assets, or lend to his family, friends and fellow frauds so that they can pay outrageous prices, fueling asset price inflation. This generates nice virtuous cycles in the form of bubbles that attract more purchases until the inevitable bust. I won’t go into output price inflation except to note that asset price bubbles can fuel spending on consumption and investment goods, spilling-over into commodities prices, so on some conditions there can be a link between asset and output price inflations.

The amazing thing is that the free marketeers want to “free” the private financial institutions to licentious behavior, but advocate reigning-in government on the argument that excessive issue of money is inflationary. Yet we have effectively given banks the power to issue government money (in the form of government insured deposits), and if we do not constrain what they purchase they will fuel speculative bubbles. By removing government regulation and supervision, we invite private banks to use the public monetary system to pursue private interests. Again, we know how that story ends, and it ain’t pretty. Unfortunately, we now have what appears to be a government of Goldman, by Goldman, and for Goldman that is trying to resurrect the financial system as it existed in 2006—a self-regulated, self-rewarding, bubble-seeking, fraud-loving juggernaut.

To come to a conclusion: the primary purpose of the monetary monopoly is to mobilize resources for the public purpose. There is no reason why private, for-profit institutions cannot play a role in this endeavor. But there is also no reason to believe that self-regulated private undertakers will pursue the public purpose. Indeed, as institutionalists we probably would go farther and assert that both theory and experience tell us precisely the opposite: the best strategy for a profit-seeking firm with market power never coincides with the best policy from the public interest perspective. And in the case of money, it is even worse because private financial institutions compete with one another in a manner that is financially destabilizing: by increasing leverage, lowering underwriting standards, increasing risk, and driving asset price bubbles. Unlike my ELR example above, private spending and lending will be strongly pro-cyclical. All of that is in addition to the usual arguments about the characteristics of public goods that make it difficult for the profit-seeker to capture external benefits. For this reason, we need to analyze money and banking from the perspective of regulating a monopoly—and not just any monopoly but rather the monopoly of the most important institution of our society.

* Much confusion is generated by using the term “money” to indicate a money “thing” used to satisfy one of the functions of money. I will be careful to use the term “money” to refer to the unit of account or money as an institution, and “money thing” to refer to something denominated in the money of account—whether that is currency, a bank deposit, or other money-denominated liability

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‘Monetization’ of Budget Deficits

Posted on August 25, 2009 by | 9 comments
By L. Randall Wray [via CFEPS]

It is commonly believed that government faces a budget constraint according to which its spending must be “financed” by taxes, borrowing (bond sales), or “money creation”. Since many modern economies actually prohibit direct “money creation” by the government’s treasury, it is supposed that the last option is possible only through complicity of the central bank—which could buy the government’s bonds, and hence finance deficit spending by “printing money”.

Actually, in a floating rate regime, the government that issues the currency spends by crediting bank accounts. Tax payments result in debits to bank accounts. Deficit spending by government takes the form of net credits to bank accounts. Operationally, the entities receiving net payments from government hold banking system liabilities while banks hold reserves in the form of central bank liabilities (we can ignore leakages from deposits—and reserves—into cash held by the non-bank public as a simple complication that changes nothing of substance). While many economists find the coordinating activities between the central bank and the treasury quite confusing. I want to leave those issues mostly to the side and simply proceed from the logical point that deficit spending by the treasury results in net credits to banking system reserves, and that these fiscal operations can be huge. (See Bell 2000, Bell and Wray 2003, and Wray 2003/4)


If these net credits lead to excess reserve positions, overnight interest rates will be bid down by banks offering the excess in the overnight interbank lending market. Unless the central bank is operating with a zero interest rate target, declining overnight rates trigger open market bond sales to drain excess reserves. Hence, on a day-to-day basis, the central bank intervenes to offset undesired impacts of fiscal policy on reserves when they cause the overnight rate to move away from target. The process operates in reverse if the treasury runs a surplus, which results in net debits of reserves from the banking system and puts upward pressure on overnight rates—relieved by open market purchases. If fiscal policy were biased to run deficits (or surpluses) on a sustained basis, the central bank would run out of bonds to sell (or would accumulate too many bonds, offset on its balance sheet by a treasury deposit exceeding operating limits). Hence, policy is coordinated between the central bank and the treasury to ensure that the treasury will begin to issue new securities as it runs deficits (or retire old issues in the case of a budget surplus). Again, these coordinating activities can be varied and complicated, but they are not important to our analysis here. When all is said and done, a budget deficit that creates excess reserves leads to bond sales by the central bank (open market) and the treasury (new issues) to drain all excess reserves; a budget surplus causes the reverse to take place when the banking system is short of reserves.

Bond sales (or purchases) by the treasury and central bank are, then, ultimately triggered by deviation of reserves from the position desired (or required) by the banking system, which causes the overnight rate to move away from target (if the target is above zero). Bond sales by either the central bank or the treasury are properly seen as part of monetary policy designed to allow the central bank to hit its target. This target is exogenously “administered” by the central bank. Obviously, the central bank sets its target as a result of its belief about the impact of this rate on a range of economic variables that are included in its policy objectives. In other words, setting of this rate “exogenously” does not imply that the central bank is oblivious to economic and political constraints it believes to reign (whether these constraints and relationships actually exist is a different matter).

In conclusion, the notion of a “government budget constraint” only applies ex post, as a statement of an identity that has no significance as an economic constraint. When all is said and done, it is certainly true that any increase of government spending will be matched by an increase of taxes, an increase of high powered money (reserves and cash), and/or an increase of sovereign debt held. But this does not mean that taxes or bonds actually “financed” the government spending. Government might well enact provisions that dictate relations between changes to spending and changes to taxes revenues (a balanced budget, for example); it might require that bonds are issued before deficit spending actually takes place; it might require that the treasury have “money in the bank” (deposits at the central bank) before it can cut a check; and so on. These provisions might constrain government’s ability to spend at the desired level. Belief that these provisions are “right” and “just” and even “necessary” can make them politically popular and difficult to overturn. However, economic analysis shows that they are self-imposed and are not economically necessary—although they may well be politically necessary. From the vantage point of economic analysis, government can spend by crediting accounts in private banks, creating banking system reserves. Any number of operating procedures can be adopted to allow this to occur even in a system in which responsibilities are sharply divided between a central bank and a treasury. For example, in the US, complex procedures have been adopted to ensure that treasury can spend by cutting checks; that treasury checks never “bounce”; that deficit spending by treasury leads to net credits to banking system reserves; and that excess reserves are drained through new issues by treasury and open market sales by the Fed. That this all operates exceedingly smoothly is evidenced by a relatively stable overnight interbank interest rate—even with rather wild fluctuations of the Treasury’s budget positions. If there were significant hitches in these operations, the fed funds rate would be unstable.

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The Endogenous Money Approach

Posted on August 17, 2009 by | 3 comments
By L. Randall Wray [via CFEPS]

In Neoclassical theory, money is really added as an after thought to a model that is based on a barter paradigm. In the long run, at least, money is neutral, playing no role except to determine unimportant nominal prices. Money is taken to be an exogenous variable-whose quantity is determined either by the supply of a scarce commodity (for example, gold), or by the government in the case of a “fiat” money. In the money and banking textbooks, the central bank controls the money supply through its provision of required reserves, to which a deposit multiplier is applied to determine the quantity of privately-supplied bank deposits.

The evolving Post Keynesian endogenous approach to money offers a clear alternative to the orthodox, neoclassical approach. With regard to monetary theory, early Post Keynesian work emphasized the role played by uncertainty and was generally most concerned with money hoards held to reduce “disquietude”, rather than with money “on the wing” (the relation between money and spending). However, Post Keynesians always recognized the important role played by money in the “monetary theory of production” that Keynes adopted from Marx. Circuit theory, mostly developed in France, provided a nice counterpoint to early Post Keynesian preoccupation with money hoards, focusing on the role money plays in financing spending. The next major development came in the 1970s, with Basil Moore’s horizontalism (somewhat anticipated by Kaldor), which emphasized that central banks cannot control bank reserves in a discretionary manner. Reserves must be “horizontal”, supplied on demand at the overnight bank rate (or fed funds rate) administered by the central bank. This also turns the textbook deposit multiplier on its head as causation must run from loans to deposits and then to reserves.

This led directly to development of the “endogenous money” approach that was already apparent in the Circuit literature. When the demand for loans increases, banks normally make more loans and create more banking deposits, without worrying about the quantity of reserves on hand. Privately created credit money can thus be thought of as a horizontal “leveraging” of reserves (or, better, High Powered Money), although there is no fixed leverage ratio. In recent years, some Post Keynesians have returned to Keynes’s Treatise and the State Theory of Money advanced by Knapp and adopted by Keynes therein. Rather than imagining a barter economy that discovers a lubricating medium of exchange, this neo-Chartalist approach emphasizes the role played by the state in designating the unit of account, and in naming exactly what thing answers to that description. Taxes (or any other monetary obligations imposed by authorities) then generate a demand for that money thing. In this way, Post Keynesians need not fall into the “free market” approach of orthodoxy, which imagines some pre-existing monetized utopia free from the evil hands of government. The neo-Chartalist approach also leads quite nicely to Abba Lerner’s functional finance approach, which refuses to make a fine separation of fiscal from monetary policy. Money, government spending, and taxes are thus intricately interrelated. This approach rejects Mundell’s “optimal currency area” as well as the monetary approach to the balance of payments. It is not possible to separate fiscal policy from currency sovereignty-which explains why the “one nation, one currency” rule is so rarely violated, and when it is violated it typically leads to disaster (as in the current case of Argentina, and-perhaps-in the future case of the European Union!).

Like Keynes, Post Keynesians have long emphasized that unemployment in capitalist economies has to do with the fact that these are monetary economies. Keynes had argued that the “fetish” for liquidity (the desire to hoard) causes unemployment because it keeps the relevant interest rates at too high a level to permit sufficient investment to raise aggregate demand to the full employment level. While it would appear that monetary policy could eliminate unemployment either by reducing overnight interest rates, or by expanding the quantity of reserves, neither avenue will actually work. When liquidity preference is high, there may be no rate of interest that will induce investment in illiquid capital-and even if the overnight interest rate falls, this does not mean that the long term rate will. Further, as the horizontalists make clear, the central bank cannot simply increase reserves in a discretionary manner as this would only result in excess reserve holdings and push the overnight interest rate to zero without actually increasing the money supply. Indeed, when liquidity preference is high, the demand for, as well as the supply of, loans collapses. Hence, there is no way for the central bank to simply “increase the supply of money” to raise aggregate demand. This is why those who adopt the endogenous money approach reject ISLM-type analysis in which the authorities can eliminate recession simply by expanding the money supply and shifting the LM curve out.

Furthermore, unlike orthodox economists, Post Keynesians reject a simple NAIRU or Phillips Curve trade-off according to which some unemployment must be accepted as “natural” or as the cost of fighting inflation. Earlier, some Post Keynesians had argued for “incomes policy” as an alternative way of fighting inflation, however, that rarely proved to be politically feasible. Lately, at least some Post Keynesians have argued that not only is the inflation-unemployment “trade-off” unnecessary, but that full employment can be a complement to enhanced price stability. This is accomplished through creation of a “buffer stock” of labor, according to which the government offers to hire anyone ready, willing, and able to work at some pre-announced and fixed wage. The size of the buffer stock moves counter-cyclically, such that government spending on the program will act as an “automatic stabilizer”. At the same time, the fixed wage and benefit package helps to moderate fluctuation of “market” wages. Finally, it is emphasized that the “functional finance” approach to money and fiscal policy advanced by Lerner explains why any nation that operates with a sovereign currency will be able to “afford” full employment. In this way, it is recognized that while unemployment exists only in monetary economies, unemployment does not have to be tolerated even in monetary economies. When aggregate demand is low, fiscal policy-not monetary policy-can raise demand and provide the needed jobs. The problem is not that money is “neutral”, but that when demand is low, the private sector will not create money endogenously, hence, the government must expand the supply of HPM through fiscal policy. If a deficit results, this will increase reserves held by the banking system, which must be drained through sale of government bonds in order to prevent a situation of excess reserve holdings from pushing overnight interest rates to zero. Therefore, bond sales by the treasury are seen as an “interest rate maintenance operation” and not as a “borrowing” operation. Indeed, no sovereign issuer of the currency needs to borrow its own currency from its population in order to spend.

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FOR FURTHER READING

Brunner, Karl. 1968. “The Role of Money and Monetary Policy”, Federal Reserve Bank of St. Louis Review, vol 50, no. 7, July, p. 9.

Cook, R.M. 1958. “Speculation on the Origins of Coinage”, Historia, 7, pp. 257-62.

Davidson, Paul. Money and the Real World, London, Macmillan, 1978.

Deleplace, Ghislain and Edward J. Nell, editors. Money in Motion: the Post Keynesian and Circulation Approaches, New York, St. Martin’s Press, Inc., 1996.

Dow, Alexander and Schiela C. Dow 1989. “Endogenous Money Creation and Idle Balances”, in Pheby, John, ed, New Directions in Post Keynesian Economics, Aldershot, Edward Elgar, p. 147.

Friedman, Milton. 1969. The Optimal Quantity of Money and Other Essays, Aldine, Chicago.

Grierson, Philip (1979), Dark Age Numismatics, Variorum Reprints, London.

—–. 1977. The Origins of Money, London: Athlone Press.

Hahn, F. 1983. Money and Inflation, Cambridge, MA: MIT Press.

Innes, A. M. 1913, “What is Money?“, Banking Law Journal, May p. 377-408.

Kaldor, N. The Scourge of Monetarism, London, Oxford University Press, 1985.

Keynes, John Maynard. The General Theory, New York, Harcourt-Brace-Jovanovich, 1964.

—–. A Treatise on Money: Volume 1: The Pure Theory of Money, New York, Harcourt-Brace-Jovanovich, 1976 [1930].

Knapp, Georg Friedrich. The State Theory of Money, Clifton, Augustus M. Kelley 1973 [1924].

Lerner, Abba P. “Money as a Creature of the State”, American Economic Review, vol. 37, no. 2, May 1947, pp. 312-317.

Marx, Karl. Capital, Volume III, Chicago, Charles H. Kerr and Company, 1909.

Moore, Basil. Horizontalists and Verticalists: The Macroeconomics of Credit Money, Cambridge, Cambridge University Press, 1988.

Mosler, Warren, Soft Currency Economics, third edition, 1995.

Parguez, Alain.1996. “Beyond Scarcity: A Reappraisal of the Theory of the Monetary Circuit”, in E. nell and G. Deleplace (eds) Money in Motion: The Post-Keynesian and Circulation Approaches, London: Macmillan.

Rousseas, Stephen. Post Keynesian Monetary Economics, Armonk, New York, M.E. Sharpe, 1986.

Wray, L. Randall. Understanding Modern Money: The Key to Full Employment and Price Stability, Edward Elgar: Cheltenham, 1998.

—–. Money and Credit in Capitalist Economies: The Endogenous Money Approach, Aldershot, Edward Elgar, 1990.

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A Primer on Government Surpluses

Posted on August 15, 2009 by | 6 comments
What is a federal government surplus?

When the federal government’s revenue exceeds its spending over the course of a year, it is running a budget surplus and outstanding Treasury securities will be reduced by the same amount over the year. In 1999, the federal government’s surplus was $99 billion and it is projected to grow to $142 billion for fiscal year 2000. This means that US taxpayers will pay $142 billion more in taxes this year than the government spends. More concretely, taxpayers will write checks to the Internal Revenue Service in the amount of $1.914 trillion, while the US Treasury will write checks received by Americans in the amount of only $1.772 trillion—a difference of $142 billion. The only way that taxpayers can write checks to the IRS that exceed the amount of checks received from the Treasury is to surrender $142 billion of Treasury securities to the government. In other words, running a surplus necessarily means that the Treasury is reducing nominal wealth of the non-government sector. This is why federal budget surpluses reduce outstanding Treasury debt and non-government sector net nominal worth.


What is the long-term effect of running perpetual government surpluses?

On current projections, the federal government will run surpluses over this decade that will total more than $2.9 trillion, leading to an equivalent reduction of non-government sector net nominal wealth—of $2.9 trillion. This wipes out almost 80% all of the publicly-held US Treasury debt, including that now held by foreigners. No one can accurately predict how the economy will react to such an unprecedented reduction of its nominal wealth—especially when the most liquid assets will be removed from private portfolios. However, throughout our history, the US has experienced exactly six periods of substantial reduction of federal government debt, achieved through persistent budget surpluses, and each of those periods ended in one of our nation’s six depressions. Our last period of substantial surpluses occurred between 1920 and 1930, when Treasury debt was reduced by 36%; the Great Depression began in 1929. For a more recent example, Japan began to run government surpluses in 1987, which reduced non-governmental nominal wealth and generated a deep recession that has already lasted a decade. Note, however, that neither the US in the 1920s nor Japan in the late 1980s came close to draining $2.9 trillion worth of wealth from the economy, even after adjusting for higher prices today.

Doesn’t a budget surplus allow us to save for the future?

Those who believe that a surplus can be “saved” for the future, or “used” to finance tax cuts or spending increases simply do not understand the nature of a surplus. Does anyone really believe that we can “save for the future” by burning $3 trillion worth of private sector wealth? During any period, the government can always choose to spend more (or less), in which case the surplus over the period may be lower (or higher); similarly, it can increase (decrease) taxes and thereby may increase (decrease) the surplus. But, as Gertrude Stein said, “there is no there there”-a surplus exists only as a deduction from private sector income. The negative household saving that some commentators are finally noticing is merely the accountant’s flip-side to the budget surplus. A government surplus necessarily reduces private sector savings and cannot be “saved for the future”.

How do budget surpluses impact non-government sector financial balances?

There is another, less transparent, impact of government surpluses on the non-government sector. At the level of the economy as a whole, when one sector spends more than its income, another necessarily spends less for the simple reason that in the aggregate, total spending equals total income. Let us, then, disaggregate the economy into three sectors to determine the implications of government surpluses for the other sectors. First, we can consolidate all levels of government into a public (or, government) sector, and likewise consolidate households and firms into a domestic, non-government (or, private) sector. For completion, we must add a foreign (“rest-of-the-world”) sector. At the aggregate level, the spending of all three sectors combined must equal the income received by the three sectors. It is clear that if the public sector is spending less than its income—that is, it is running a surplus—this must imply that at least one other sector is spending more than its income (in other words, is running a deficit). Mathematically, the sum of the balances of the three sectors must equal zero. It is convenient for our purposes to write this as:

{Public Sector Surplus} + {Foreign Sector Surplus} = {Private Sector Deficit},

which merely moves the private sector balance to the right-hand-side and reverses the sign (in other words, writes the balance as a deficit rather than a surplus, since a negative surplus is the same thing as a deficit).

Because the US has been running a balance of payments deficit in recent years, this means that the foreign sector is in surplus (the rest-of-the-world receives more US dollars than it spends). A few years ago, our public sector ran a sufficiently large deficit to more than offset the foreign sector surplus, so that our domestic non-government sector was able to run surpluses. However, in the past two years, the US public sector’s balance has turned toward surplus. When combined with our balance of payments deficit (or foreign sector surplus), this means that the domestic private sector’s balance (that is, its savings) has turned sharply negative—toward large and growing deficits. The non-government sector deficit is now approximately equal to 5.5 percent of GDP—far and away the largest private sector deficit the US has seen in the post-war period.

Will the federal government really run surpluses for the next decade?

It is very difficult to take seriously any analyses that begin with the projection that our government will run surpluses for the next decade. Part of our skepticism comes from the inherent difficulty in making projections. More importantly, it is difficult to believe that our economy can continue to grow robustly as the government sucks disposable income and wealth from the private sector by running surpluses. When the economy slows, the surplus will eventually disappear—automatically—as unemployment compensation rises and tax revenue falls due to the slowdown. As the government spends more and taxes less, the surplus will vanish.

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