Once upon a time, you could pop open the front hood of a car and when looking inside, it was not so intimidating, it was easy to understand how everything about that engine worked. If you were lucky enough to have a ‘muscle car’, you even knew how to adjust the choke, to increase the amount of gasoline going into that gas / air mix, to get that beast started when it got really cold outside…
The economy works with a similar principle. During an economic cold snap, the federal gov’t needs to add more gasoline, more potency, to that combustible mixture of public sector demand / private sector demand, to get that engine to turn over and started again…
Our economy has been in a winter freeze for too long. Our fiscal policymakers could offer a hand by simply adjusting the choke to add more federal gov’t spending (more federal gov’t demand) to that mix (total aggregate demand). Instead, we only have our monetary policymakers just giving the car more gas (with an improper mix), trying over and over again to start the engine, and the more they try, the more gas they give it, so rather than starting the engine, they have flooded it. The pistons are not in sync because the policymakers are not in sync.
Perhaps this is because of ideological differences, but my guess is that our fiscal policymakers are out of sync with our monetary policymakers because when most fiscal policymakers open that federal gov’t hood and look inside, they’re afraid to admit that they really don’t understand how the modern model works.
First the ideological differences: Some of your policymakers today are ‘Keynesian’ deficit doves and some are ‘Austrian’ deficit hawks. The Keynesian says that we shouldn’t worry about federal gov’t deficit spending because creating money ‘doesn’t cause inflation’, and the Austrian says that we should worry about federal gov’t deficit spending because ‘printing money’ will cause inflation.
Both are mistaken. In 1971, President Nixon unilaterally cancelled the direct international convertibility of the US dollar to gold, meaning from that day on, our US dollar was a pure, fiat currency, and the US officially entered the post-gold standard, modern monetary system. Since then, the US economy has had only one deflationary year (a negative print on the historical charts), so the Keynesian is wrong about the ‘creating money doesn’t cause inflation’ thing. In fact, a 1971 dollar today is worth about 18 cents, but that decrease in purchasing power is the secret sauce. Newly-printed dollars are the engine lubricant that keeps the economic moving parts running smoothly, and a big advantage is that since 1971, the federal gov’t uses its own motor oil instead of borrowed motor oil. Since 1971, the federal gov’t is the monopoly issuer of their very own ‘fiat brand’ of motor oil that the post-gold-standard era engine takes. Just like motor oil for any engine, more newly-issued dollars needs to be routinely added to our economy. Constant additions of newly-issued dollars, like motor oil, keeps our economy from seizing up and going into depressions (which the economy did six times before 1971 and also has never happened since). Furthermore, the United States is the largest economy in history, the dollar is the world’s reserve currency and our Treasury bonds are one of the safest investments on earth today. Meaning that there is no ‘capital flight’ and there is no desperate urgency to convert out of US dollars into another currency, so the Austrian is wrong about the ‘printing money will cause inflation’ thing as well. That said, both the Keynesian and the Austrian don’t need to fight an endless ideological battle between each other; because today, in this modern monetary system, hawks AND doves are needed very much at crucial times by the users of dollars (that seeks to maintain prosperity) and ALSO by the issuer of dollars (that seeks to widen prosperity). So instead, the Keynesian (with a fear of deflation) and the Austrian (with a fear of inflation) should make an effort to see both perspectives and work together with each other.
Let’s get back to what is really happening under that hood. During the gold standard era, the federal gov’t could not just ‘print’ gold out of thin air. Federal gov’t deficit spending was being financed by borrowing gold-backed dollars. For whatever amount of debt that was incurred, it meant that the federal gov’t was on the hook in gold-backed dollars. Back then, Step 1 was for the federal gov’t to get authorization from Congress to deficit spend. Step 2 was to issue bonds to borrow the gold-backed dollars. Step 3 was to pay the vendors. After officially replacing gold-backed dollars with pure-fiat dollars, federal gov’t deficit spending became a different paradigm. Now, the federal gov’t, the issuer of fiat dollars, can just issue fiat dollars out of thin air. Post-gold standard, Step 1 is still the same, the federal gov’t gets authorization to deficit spend. Step 2 is the federal gov’t prints new fiat dollars by clicking on a computer keyboard. Step 3 is to ‘credit’ the vendor’s bank account with that computer keyboard. Step 4 is to issue bonds in the same exact amount that was newly-printed, however, not to borrow that amount, but only as an accounting entry, a ledger posting, a ‘debit’, of that same amount of fiat dollars, to consolidate the federal gov’t balance sheet. So before, federal gov’t deficit spending added to an actual outstanding debt of gold-backed dollars (similar to a household borrowing more and causing indebtedness); now federal gov’t deficit spending subtracts from the purchasing power of all outstanding fiat dollars (similar to a company issuing more stock and causing dilution). A gold-standard era credit card that ‘monetized debts’ with gold-backed dollars was cut in half and replaced by a post-gold-standard-era debit card that ‘monetizes deficits’ with fiat dollars. What causes the puzzled look on most fiscal policymakers whenever looking under the hood these days is understandable, because the US Treasury and the central bank are still using an outdated, gold-standard-era driver’s manual. Those bygone instructions, that were taught to all of us long ago and still told to us today, stick to the narrative that the federal gov’t, the issuer of fiat dollars, needs to ‘borrow’ fiat dollars, however, what is actually going on under that hood is quite different. In the post-gold standard, modern monetary system, federal gov’t deficit spending has been ‘money’ (debit) financed for decades, yet still to this day, takes place behind what is only an archaic facade of being ‘bond’ (debt) financed. The national debt, what was once an actual debt of gold-backed dollars before 1971, is now nothing more than a national debit of fiat dollars.
For the non-federal gov’t, nothing much changed in 1971. You, me, all households, all businesses, state & local gov’t, we are not issuers of dollars, we are still just users of dollars. For the non-federal gov’t, the users of dollars, it’s simple: We can deficit spend more if our personal debts are low, and we shouldn’t deficit spend more if our personal debts are high. For the non-federal gov’t, the users of dollars, the dashboard indicator is the same one that we have always used, and is easy to understand:
USER OF DOLLARS dashboard ‘indicator’:
No Debt————X————–Too Much Debt
This is the best scenario. The needle is balanced perfectly between ‘No debt’ and ‘Too Much Debt’. Servicing your debt is manageable, and the amount of your deficit spending is not too high, nor not too low:
= FINANCIAL SITUATION IS WELL UNDER CONTROL (No need to be a deficit hawk or a deficit dove, nor take any counter-measures, because the budget is in balance)...
USER OF DOLLARS dashboard ‘indicator’:
No Debt—X————————Too Much Debt
You have no debt, no deficit spending, so the needle is all the way left. Not a bad problem to have, but not really a preferable scenario either:
= NEED TO TAKE ON MORE RISK…ADD INVESTMENTS USING LEVERAGE (Here is the time to be a deficit dove, because if the budget of any user of dollars is in balance, if not under any threat whatsoever of ‘running out of dollars’, users of dollars should take that opportunity to increase spending on investments to accumulate wealth).
USER OF DOLLARS dashboard ‘indicator’:
No Debt————————X—Too Much Debt
This is the worse scenario because it is the hardest to resolve. The needle has gone all the way to the right, meaning that the amount of your deficit spending has made servicing your debts unmanageable:
= NEED TO DELEVERAGE AND BALANCE YOUR BUDGET (Here is the time to be a deficit hawk, because if deficits of any user of dollars gets too high, they may ‘run out of dollars’, so any user of dollars must reduce spending in order to get their budget in balance).
The issuer of dollars is a completely separate paradigm from the user of dollars. The federal gov’t, the issuer of dollars, should use a different dashboard indicator, but sadly, because too many fiscal policymakers suffer from a federal-gov’t-is-the-same-as-a-household delusion, they don’t use it, despite also being very easy to understand:
ISSUER OF DOLLARS dashboard ‘indicator’:
This is the best scenario, where the newly-created dollars that finance federal gov’t deficit spending & entering the money supply is closely matched by the newly-created goods & services entering the expanding economy. Those newly-created dollars are neither causing more than 2% inflation (dangerously subtracting too much purchasing power from all dollars) nor any deflation (dangerously adding too much purchasing power to all dollars). In this optimum ‘not-too-hot-not-too-cold-Goldilocks’ economic environment, the decrease of purchasing power of all dollars is contained to a desired level of inflation, just under 2%, the perfect margin of safety away from 0%:
= STRONG GROWTH SUSTAINED, MONETARY POLICYMAKER MANDATE OF PRICE STABILITY ACHIEVED…No need for the deficit hawks nor the deficit doves to prod their fiscal policymakers to take any counter-measures, because the economy is balanced. However, fiscal policymakers could still strive to correct remaining social imbalances, by addressing wealth inequality, and creating opportunities for all those that are not benefiting from the growing economy, like the underemployed, the unemployed, or the non-participating (Collateral damage from that ugly, yet just-as-important, other blade side on the sword of capitalism).
ISSUER OF DOLLARS dashboard ‘indicator’:
Not a good scenario, but an easy problem for both monetary & fiscal policymakers to solve. In this scenario, newly-created dollars that finance federal gov’t deficit spending & entering the money supply is overpowering the newly-created goods & services entering the economy. Too many dollars chasing too few goods has resulted in inflation over 2%:
= INFLATION WARNING: MONETARY POLICYMAKERS SHOULD REDUCE ACCOMMODATING MEASURES (RAISE INTEREST RATES), WHILE FISCAL POLICYMAKERS SHOULD REDUCE STIMULUS MEASURES (LESS FEDERAL SPENDING AND/OR RAISE FEDERAL TAX RATES) TO GET THE ECONOMY BACK IN BALANCE…(Here is the time for the deficit hawks, taking the cue from their monetary policymakers, to prod their fiscal policymakers to act, but note, it’s a separate paradigm, the issuer of dollars is reducing spending to get the economy that is running too hot in balance, NOT to get ‘the budget’ in balance).
ISSUER OF DOLLARS dashboard ‘indicator’:
In this scenario, the newly-created dollars that finance federal gov’t deficit spending & entering the money supply is getting overpowered by the newly-created goods & services entering the economy. Too many goods and services chasing too few dollars has resulted in disinflation to levels near zero which is threatening to worsen into a full-blown deflationary spiral. This is the worst scenario, the situation that many countries are stuck in today, and not an easy problem to solve, especially if fiscal policymakers fail to act because they think like users of dollars (they think like households):
= DEFLATION WARNING: MONETARY POLICYMAKERS SHOULD INITIATE ACCOMMODATING MEASURES (LOWER INTEREST RATES), WHILE FISCAL POLICYMAKERS SHOULD INITIATE STIMULUS MEASURES (MORE FEDERAL SPENDING AND/OR LOWER FEDERAL TAX RATES) TO GET THE ECONOMY BACK IN BALANCE…Here is the time for the deficit doves, taking the cue from their monetary policymakers, to prod their fiscal policymakers to act, but again note, it’s a separate paradigm. Unlike a household (the user of dollars), the federal gov’t (the issuer of dollars) is not as concerned with getting a budget in balance; the federal gov’t is increasing spending to get an economy, that is running too slow, back in balance.
In conclusion, unlike the users of dollars, the dashboard indicator for the issuer of dollars is the current rate of inflation, not the current amount of debt. The perfect inflation rate, one that provides a margin of safety, is just under 2% per year. This 2% annual decrease in the purchasing power of all outstanding dollars, this slight level of inflation, is much more preferable to the alternative, which would be dangerously low inflation, or worse, outright destructive deflation. What determines how much the federal gov’t, the issuer of dollars, should deficit spend, is ALWAYS to keep inflation balanced, to keep the economy in balance, and NEVER to keep a budget balanced.
The questions that fiscal policymakers need to ask themselves while looking under the hood: Is that newly-created demand entering the economy from that federal govt deficit spending increasing aggregate demand (?) Are the newly-created dollars entering the economy from that federal govt deficit spending stoking inflation (?)
OR, is the stimulative effect of that newly-created demand and the inflationary bias of those newly-created dollars vaporizing on impact (?)
If so, then please give your monetary policymakers a hand, and adjust that choke.
Also special thanks to @netbacker for his suggestions that inspired this post (Follow @netbacker on Twitter for more about the economy).
Using this ‘Inflation Indicator’ should be the US federal gov’t policymaker’s guide; but ONLY in the event of an economic crisis should it be THE guide. For example, similar to a badly-injured patient losing blood, the federal gov’t should perform an immediate transfusion of increased spending (s/b priority one in that triage situation).
However, when the economy has recovered, for the issuer of dollars, other ‘indicators’ should also be the guide when deciding on spending policies. Indicators such as productivity gains (are you seeing increased wage gains along with increased federal spending?); wealth inequality (are you only seeing stock & bond price gains?); price gains (are you only seeing currency-induced stagflation?); etc., must be considered by federal policymakers (taking cues from monetary policymakers) when making spending plans.
“MMT needs a more detailed explanation as to the limits of federal government spending and understanding of how we prioritize spending besides the catch-all inflation. Inflation is not as useful guide as it is more difficult to create in more developed countries than in the past. Inflation is not as relevant nowadays, because world-wide productive capacity has increased, and the ‘Savings Bubble’ liquidity trap takes money out of the consumer [functional] economy and puts it on ice.”—CHARLES ‘Kondy’ KONDAK, co-contributor to the Pure MMT for the 100% page.
Kondy next dives deeper into why the ‘inflation indicator’ (even though it is way better than using the ‘budget indicator’), still isn’t the only indicator to look at when making federal spending plans—even in a weak economy:
“Introducing money into the economy without increasing the percentage of people that can save, without improving productivity, or without producing a tangible asset for the public purpose, now or in the future, runs a much greater risk of just being ‘inflationary’. Yes, increased production wherever it occurs is beneficial; but increasing the ‘Savings Bubble’ [nonfunctional economy] without a healthy flow back into the productive [functional economy]?—NO! Further, even if none of these things are accomplished with deficit spending money creation [even if the spending plans were ‘paid for’ by taxes], it would still be a waste of money as it creates nothing of real value. We may run into having to make political decisions to prioritize spending, as we cannot do it all. This said there is a time and place during recessions for solely propping up aggregate demand. In the meantime, instead of using the ‘inflation indicator’, the gold-standard ‘federal-gov’t-is-the-same-as-a-household’ mentality of using the ‘budget indicator’ with federal spending decisions, continues (today in 2018). You have the Republicans, cutting taxes while increasing spending. Then, while we wait for those tax cuts ‘to pay for themselves’ (through increased economic growth), that’s when the Republicans next get busy and demagogue budget deficits and drumbeat the need to cut spending on other functions of government (except the military of course). The Democrats, not so much, but similar to the Republicans (some things never change), the exception to their spending plans is that they almost always come with ‘the pay for’ (with increased taxes upfront).”—Charles ‘Kondy” Kondak
Another dashboard ‘indicator’ that the federal gov’t, the issuer of dollars (spending in its own fiat dollars), must also watch is Debt to GDP; because, even if you achieve your desired ‘level’ of inflation, it still might not be a desired ‘type’ of inflation.
“If deficits are creating increases in productivity, then the Debt to GDP ratio should be falling; so if the economy is at the desired level of inflation, the Debt to GDP ratio should not be rising. If the Debt to GDP is rising, either we are stuffing the top 5% with just more dollars, with no production (inflation of asset bubbles / dollars stuck in the nonfunctional economy / wider wealth inequality), at best; or, at worst, we could be heading for a crisis.”—MINETHIS1
I agree…I think that MineThis1 is absolutely right. My understanding, when then-Vice President Dick Cheney said “Reagan proved that deficits don’t matter” in January 2004, he meant that what matters is GDP. As long as your GDP (your productive output) is rising at the same pace of deficits (federal ‘debt’), then you’re fine (and it’s even better if your GDP is rising faster than your rising ‘debt’).
H/T Jim ‘MINETHIS1’ Boukis
“I’m not a fan of MMT — not at all.”—Warren Buffett
In a telephone interview today (Fri 3/15/19) the Berkshire Hathaway Inc. chief executive officer said that the deficit spending that’s part of the theory could risk inflation, perhaps even—in his words— a “spiraling” inflation. “It would be unwise to have the ratio of debt to gross domestic product grow consistently,” he added.
Note: If MMTers understand that ‘Their Deficits (Their Debt) = Our Savings (Our Money), then MMTers need to heed what Buffett & Minethis1 are saying. If Our Money (DEBT) is growing faster than Our Productivity (GDP), then you are heading for danger and as per Buffett “We don’t need to get near danger zones because we don’t know precisely where they are.”
“MMT persuaded me that deficits are ¯\_(ツ)_/¯, but I am still cautious about debt as a % of GDP (which is currently ~105% in the US).”—JLP (@JLouisPitcock on Twitter)
“Recently, Kelton (2019) has slipped in another long-standing Keynesian argument that stability of the debt-GDP ratio requires that the nominal interest rate be less than the nominal rate of growth (i < g). In doing so, she tacitly admits another financial constraint on government and continues the walking back process. On one hand, the walking back process is reasonable; on the other hand, it undermines MMT’s claims regarding government being financially unconstrained.”—Thomas Palley, ‘WHAT’S WRONG WITH MODERN MONEY THEORY (MMT): A CRITICAL PRIMER’, March 2019
Bingo…In addition to inflation, federal ‘debt’ / gdp is an important dashboard ‘indicator’ to keep an eye on. Look at Japan—the MMT ‘poster child’. In 1991, Japan’s ‘debt’/gdp was 50%. That was the start of their ‘lost decade’ (the first of more to come). While Japan’s ‘debt’/gdp ratio kept rising, Japan dropped from the world’s second largest economy to the third largest economy. In 2018, Japan’s GDP was $5.17T. That’s less than it was in the nineties (Japan’s GDP was $5.45T in 1995). MMTers should think twice before regurgitating that yarn about Japan being the ‘poster child’ since, as per Dr. Steve Keen in his 2017 book, “Japan now features in popular culture as a cautionary tale about fading stars rather than rising suns.”
“This is why it is so important to distinguish between productive spending and unproductive spending. Productive spending adds to the real wealth of the real economy. Unproductive spending does not. The specific problem with an unproductive-debt boom is that it will further increase the total amount of credit flows WITHOUT a corresponding increase in the real wealth of the economy [it will further increase Debt/GDP, or in other words, it increases the ratio of ‘Our’ Savings v. output ]. Of course, just where inflation shows up varies from case to case. Sometimes the results of an unproductive-debt boom can show up as pure, unadulterated asset inflation. This is the heroin and cocaine of Wall Street—when all those extra flows push up the value of stocks, real estate, junk bonds et cetera while leaving the Fed’s traditional inflation-warning gauges untouched. Party! Paper-asset inflation can be just as destructive as any other kind of inflation. When the government malinvests, i.e. borrows or spends unproductively, it does not help things. In fact it only makes matters worse.”—Jack Litle aka ‘Jack Sparrow’, CEO of Mercenary Trader
It’s good to see that more folks are going beyond the political ‘prescription’ memes and are picking up on this:
“Some MMT advocates – including Stephanie Kelton, an economic adviser to Sanders – point to Japan as proof that the approach works. Despite high public debt, its economy is steadily recovering, and standards of living are high. It is not true that Japan’s experience proves that Modern Monetary Theory works, as some have argued. Though Japan’s gross debt-to-GDP ratio, at 240%, is the highest in the developed world, what really matters – for the government, just like for private firms – is the net debt-to-GDP ratio, which accounts for real and financial assets. And Japan’s public companies have very large real assets. In fact, by this measure, Japan is about on par with the US, and doing much better than France and Germany, according to the International Monetary Fund’s October 2018 Fiscal Monitor report ‘Managing Public Wealth’. Further challenging Kelton’s assessment, Japan’s primary balance has improved under Abenomics, thanks to its economic recovery.—Koichi Hamada, ‘Does Japan Vindicate Modern Monetary Theory?
Which is what MineThis1 has (correctly) been saying all along, which is that Japan is a ‘poster child’ not because the MMT approach works; but simply because Japan—good for her—is a wealthy nation. Meaning Japan or any other rich monetary sovereign with a rising ‘Debt’/GDP will be fine…UNTIL IT ISN’T.
Japan’s government Debt/GDP ratio reached 253% in 2017—but is it an *actual* ratio of 253%?
In a post-gold standard, post-QE world, if Japan has a 253% Debt/GDP ratio BUT their central bank bought back 40% of their bonds, perhaps it’s more like a net 152% Debt/GDP (60% of 253).
In other words, don’t count the bonds at the federal government’s own central bank (nor the newly-created reserves that replaced them) as part of the Debt/GDP ratio. Don’t take my word for it, ask someone in finance that’s worth their salt if bonds that are ‘called’ back from bondholders, by the bond issuer, are still a debt to that issuer?
What I’m getting at is that in Japan’s private sector, the public-held debt in that 253% Debt/GDP was broken up. 101% of it (40% of 253) went to the BOJ—leaving a net 152% Debt/ GDP (60% of 253) in the private sector.
That 101% became newly-created reserves that the BOJ paid (for the bonds that replaced that 101% of that 253% Debt/GDP out from the private sector).
Meaning that (not including the 101% of JGBs that left the private sector and went to the central bank’s balance sheet) the 253% Debt/GDP is actually 152% Debt + 101% reserves / GDP in the private sector.
Furthermore, why count those reserves as debt (why include those reserves in the Debt/GDP ratio) if after all, those reserves are not debt. They are liabilities, yes; debt, no.
So that 253% Japan Debt/GDP ratio (that Godzilla) is more like 152%…and that’s even if you consider it a ‘debt’ (if you consider it a real monster).
So rather than thinking that Debt/GDP is actually a ‘debt’…or if that ‘debt’ is even actually that high…if it’s RISING is the real warning indicator.
“The nation is selling out its national wealth as ‘Debt’ to GDP rises (as ‘Debt’ to Assets rise). If ‘Debt’ / GDP only keeps rising, that means federal-gov’t money creation is continuously outpacing its economy’s growth. In other words, the increase in private-sector production is not keeping up with the increase in public-sector printing. At some point, more people start losing faith in that currency and sooner or later, less people want it.”—MineThis1
“One could argue that Japan is a classic example of when federal-gov’t deficit spending (more ‘keystrokes’ instead of needed ‘pen-strokes’) has the effect of diminishing marginal returns on the productive economy.”—Charles Kondak