- Dog Ear Publishing, LLC (March 4, 2015)
Edward J. Delzio
THE NATIONAL DEBIT
How the Post-Gold-Standard
Modern Monetary System Really Works
1 POINTS ON A SCOREBOARD
2 WHAT IS A TREASURY BOND?
3 MODERN MONETARY THEORY
4 THE ISSUER AND THE USERS OF DOLLARS
5 OUR ECONOMIC ECOLOGY
6 THE TRAINING WHEELS COME OFF
7 QUANTITATIVE EASING
8 PRINTING MONEY
9 THE DEBT CEILING
10 THE NATIONAL DEBIT
11 FULL FAITH AND CREDIT
There is an innocent false impression of our present day economic ecology that widely exists today. This collective misunderstanding mostly arises from a failure to distinguish the completely separate monetary functions of the United States federal government, from the monetary functions of everyone else. Since the gold-standard era ended, the federal government operates under a new paradigm, different from what we were taught long ago, and different from what we are still told today. Certain idiosyncratic relics from that bygone-gold-standard era, like the formality of needing to raise a debt ceiling to increase federal government deficit spending, or the tradition of selling Treasury bonds to finance that spending, still clumsily coexist with today’s post-gold-standard reality. As a result, the important needs of the rest of us, to balance our individual budgets, are routinely confused and often commingled with the more important needs of the federal government, to balance their entire economy.
In the gold-standard era, the U.S. federal government, then a user of dollars backed by gold, needed to finance deficit spending by raising revenue via taxation, or by selling debt in the form of bonds, which are today called U.S. Treasury bonds. When it left the gold standard, however, the federal government completely changed, from being a user of dollars (backed by gold), to becoming the issuer of dollars (that are not backed by gold). Today, in the post-gold-standard era, the function of financing federal government deficit spending has also completely changed, and Treasury bonds now play a new multifunctional role in our modern monetary system.
All U.S. Treasury securities (short-term bills, medium-term notes, and long-term bonds) are a safe investment for all users of dollars because all U.S. Treasury securities are risk-free, interest-bearing, time deposits in the Securities, or savings account, at the U.S. central bank, the Federal Reserve. Treasury bonds are actively traded in a liquid global Treasury bond market which serves as a safe harbor for dollars taking flights to quality away from risky assets, into risk-free assets like Treasury bonds, during global market turbulence. Treasury bonds are used in monetary policy to set the ‘price’ of dollars, or, the interest rate of money, and to keep the economy growing smoothly by accommodating or tightening economic conditions to achieve full employment and price stability. Treasury bonds are used in fiscal policy to help grow the economy whenever increased federal-government deficit spending is needed to stimulate aggregate demand. Furthermore, Treasury bond issuance today serves to neutralize the inflationary bias of newly printed, freshly created, fiat dollars that now finance federal government deficit spending. Note that’s only an inflationary ‘bias’, because unlike being able to determine the EXACT dilution of outstanding shares of company stock when creating new shares; when it comes to inflation, there are way too many moving pieces at play for anyone, to reach any conclusions, with any specific formulas (like the now debunked ‘Quantity Theory of Money’), about any direct relationship between newly-created dollars and the dilution—if any—of purchasing power.
The federal government is the issuer of dollars, and everyone else—you, me, all households, all businesses, any U.S. local cities, U.S. states, or foreign governments (all together, this book will refer to these as the “nonfederal government”), are the users of dollars. In today’s modern monetary system, dollars are added by federal-government deficit spending, and they multiply from nonfederal-government deficit spending. All dollars are ‘printed’, or keyboard-created, by both federal-government and nonfederal-government deficit spending, and far from being a problem, this is how the economy grows. Injections of newly created dollars from both federal-government deficit spending and nonfederal-government deficit spending kick that flywheel, a yin-yang of supply and demand, to keep it spinning in a steady balance along with all other existing dollars in the economy. Post gold-standard, the federal government, the issuer of dollars, doesn’t need to borrow dollars to deficit-spend anymore, but the nonfederal government, the users of dollars, still does.
We should all rethink the concept of federal government debt, or more specifically, not let ourselves be intimidated by it, because there is no such thing as the issuer of dollars needing to borrow its own dollars, as long as those dollars are no longer fixed, nor convertible to anything. The issuer of dollars can always issue more dollars, so it never has debt in dollars (a liability, yes; an actual debt, no). Therefore, since leaving the gold standard, Treasury bonds, and all other Treasury securities which are all denominated in dollars, are more like ‘bondholder’s equity’ rather than debt. The issuer of dollars can always return the dollars to holders of maturing Treasury bonds, and the issuer of dollars can always pay the dollars in interest income due from those Treasury bonds, so Treasury bonds will never default for a lack of dollars. Treasury bonds could default if poor choices are made by policymakers; however, the insight is that the issuer of dollars will never default for ‘running out of dollars’ like a user of dollars. Today, instead of being actual debt, Treasury bonds are merely debits (from the issuer of dollars) offsetting equal and opposite credits (to the users of dollars).
Since leaving the gold standard, Treasury bond sales and federal tax collections are not needed to finance spending because the ‘financing function’ of Treasury bonds and federal taxes have taken the back seat to other functions, like maintaining the ‘political constraint’ to federal spending, maintaining price stability in the economy and maintaining the demand for fiat dollars. Post-gold standard, the issuer of fiat dollars spends first and then collects dollars—not the other way around. Because federal taxes must be paid in dollars, federal taxes serve to make us need dollars, to go out and earn the dollars needed to pay federal taxes; thus, in the post-gold-standard era, federal taxes generate the initial velocity of dollars. Rather than see those Treasury bonds as debt, better to think of them as financial ‘products’ like bank Certificates of Deposit sold to ‘customers’ seeking investments paying risk-free fixed income (sold to fulfill the savings desire of Main Street consumers).
The federal government has full monopoly control over dollars. The U.S. central bank, our Federal Reserve Bank, operates independently yet is part of, or within, the federal government, the issuer of dollars. The Fed facilitates everyone in both the federal government and the nonfederal government to deficit spend (to ‘print’ money). The Fed routinely swaps dollars for assets, or transfers dollars between its Reserve and Securities accounts, on a daily basis to provide liquidity for the proper functioning of markets. Acting as the banking agent for the federal government, the Fed, via monetary policy, mainly adds or drains existing dollars to and from the monetary base to attempt to influence interest rates. As mandated by Congress, the Fed does this to try to achieve suitable conditions that will accommodate steady economic growth, full employment, and price stability. Extraordinary monetary policy and even an emergency ‘printing’ of dollars (a creation of dollars intentionally designed to enter money-supply circulation) on the part of the Federal Reserve Bank or any other central bank is only needed to contain a financial panic—as a last resort to counterbalance political fiscal policies if they are pro-cyclical (if they are unintentionally magnifying) poor economic conditions.
The nonfederal government, the users of dollars, has a desire to save dollars. Federal-government deficit spending fulfills this savings desire. Far from being a problem, federal-government deficit spending increases the nonfederal-government savings surplus by exactly the same amount. Without federal-deficit spending, all of us in the nonfederal government would have a harder time fulfilling our savings desires, which would lead to excess hoarding, and cause deflation. During the gold standard, if too much gold was saved, or hoarded, usually in response to a financial panic, the federal government could not issue more gold, which resulted in depressions. Since leaving the gold standard, however, the federal government, the issuer of dollars, can now always meet nonfederal-government savings desires by simply lowering federal taxes, or increasing deficit spending (issuing more dollars) without worrying about having enough gold to back those dollars. As a result, since leaving the gold standard, the United States has avoided depressions.
The traditional formality of using the outstanding amount of all Treasury bonds as the running count of all federal government deficit spending remains, because federal government deficit spending should never be arbitrary. As per the U.S. Constitution’s Appropriations Clause (Article 1, Section 9, Clause 7), our country’s cornerstone of the “power of the purse”, federal government deficit spending is controlled, or limited, by Congress. This running total, the so-called “national debt”, is not actual federal debt anymore, but is still a useful measure, an important vital sign of the economy. The amount of federal government deficit spending tells us precisely at any given moment what amount would not be needed if aggregate demand in the economy were strong enough, healthy enough, to not depend on federal-government stimulus. Those legs of mass production and mass consumption, along with those arms of Congress and the president, if in sync, should keep us moving without too much federal-government deficit spending, without excess federal-government stimulus. The amount of federal-government deficit spending the economy needs to keep growing tells us by how much our economy has strayed away from being in balance; however, not from a balanced federal budget standpoint, but from a balanced national economy standpoint. In other words, how much the federal government deficit-spends should not be focused on balancing a gold-standard-era federal government budget, but instead on balancing the entire post-gold-standard national economy. For example, in the modern monetary system, if total aggregate demand is too strong, (if mass consumption is overpowering mass production), the federal government must decrease deficit spending to get an economy in balance, not to get a budget in balance.
Congress should use the debt ceiling as an opportunity to improve the economy and create results for constituents, instead of as a weapon to bludgeon other policymakers, because the debt ceiling is an anachronism from a previous era of dollar convertibility to gold. In the post-gold-standard, modern monetary system, dollars should be spent by a proactive federal government according to present economic conditions, not past self-imposed constraints. Adjustments in federal government deficit or surplus spending should counterbalance slowing or accelerating nonfederal government spending. For example, if aggregate demand is too weak, increased federal government deficit spending is needed; if aggregate demand is too strong, decreased federal government deficit spending is needed. People who fear raising the debt ceiling because it would cause more federal-government deficit spending and lead to long-term weakness and instability fail to see that precisely because of federal-government deficit spending, this country has had many years, and will continue to have many more, of economic strength and stability.
Today, our federal government, now the issuer of dollars, is no longer a business, and the federal government does not have a profit motive like the users of dollars. The federal government, now the largest economy, and the world’s sole superpower, has a higher calling, a greater purpose, to promote democracy and expand freedom across the globe. In the post-gold-standard modern monetary system, the federal government, the issuer of dollars, should always strive to have a balanced economy, which widens prosperity. Conversely, the nonfederal government, the user of dollars, just as during the gold-standard era, remains a business, still has a profit motive, should spend within its means, and should always strive to have a balanced budget, which maintains that prosperity.
POINTS ON A SCOREBOARD
Imagine you are sitting in a packed stadium, watching your favorite team at a home game for the championship title. Both teams are making tremendous plays; the score is very close, and then suddenly your team gets hot and starts scoring again and again. Soon, it becomes a blowout and your team is absolutely sure to win, but instead of the crowd going wild with joy, they go suddenly quiet, then start getting worried and frightened. Why? Because everyone watching the game has been led to believe that if their team keeps scoring, the stadium might run out of points. The crowd gets concerned that continuing to put so many of these points on the scoreboard may be unsustainable, so they wonder if the stadium should slow down, or maybe even stop putting any more points on the scoreboard. Even worse, if the stadium isn’t able to pay for all these points put up, then the balance due will create a debt that will affect future games. All of the spectators are getting disgusted at the thought of this reckless, out-of-control point-giving by the stadium and upset at the thought that this stadium will be dumping the burden of paying for all that debt of points into the future onto the backs of the crowd’s children. The fans get so terrified at the thought of all this crushing indebtedness of points that the leaders in charge decide to stop play and the stadium is shut down.
This is what is going on in our federal government today because of the present collective fiction on many issues related to our monetary system, federal deficits, and the national debt. People look up at a sinister-looking U.S. National Debt clock in midtown Manhattan ticking away at around 18 trillion dollars, and they are told that it represents some unsustainable, catastrophic doom.
Instead, they should be imagining another clock, with a less negative outlook, perhaps one called the U.S. Household Net Worth clock (which ticked over 80 trillion dollars in 2014). They should imagine a U.S. Standard of Living clock ticking away even faster, with even more impressive amounts, decade after decade, generation after generation. Yet instead of the crowd being ecstatic that their home team is beating the competition, that their players are the best in the world, playing in the greatest stadium in history, they just keep worrying themselves sick over an imminent default or other nonexistent threat to the financial security of the country.
WHAT IS A TREASURY BOND?
In late summer of 1983, about a month after starting entry-level work at RMJ Securities, a U.S. Treasury bond brokerage shop in the financial district of New York, I finally got the nerve to ask coworkers: “What is a Treasury bond?” I kept getting wildly different answers—mostly that they were IOUs on our country, or that they were debt of the government from world wars, or, whatever they were, because of them, America would soon go bankrupt. This was also the first time I ever heard the word ‘trillion’, after one coworker read out loud from that day’s Wall Street Journal that the national debt was now over that amount, meaning our country owed over A TRILLION DOLLARS, the amount of outstanding Treasury bonds. Fast forward thirty years later to 2013, the Japanese public debt exceeded A QUADRILLION YEN—that sounds scary, doesn’t it? You bet it does and why in 1983 my coworkers and I wondered nervously if each of us had to pay a proportionate share of all that U.S. gov’t debt back. The conversation quickly turned gloomy; all of us were soon resigned to an impending disaster, a financial reckoning no doubt in store for all of us because of these Treasury bonds. Were Treasury bonds really debt that would soon crush our country? Was that why banks and investors were desperate to sell them, and the reason why our company brokered these bonds like mad? It sure seemed so where I worked, in a room full of desks of brokers screaming and barking at the top of their lungs like they were escaping a fire in a crowded theater for eight hours straight every day.
Anyway, the only definitive thing I found out about Treasury bonds right then was that nobody really knew for sure what they were. Not satisfied and now concerned, I picked up the phone, dialed information, and, without a clue of who, what, or where I would get my answers from, asked the operator at directory assistance for ‘the Treasury.’ I didn’t realize until later that the area code I was given was for Washington, DC, so I had probably called the United States Treasury Department right across the street from the White House. Naturally, I got transferred all over, and each time I got someone, I just kept asking whoever picked up to please tell me exactly what Treasury bonds were. Eventually, I got someone honest enough to admit that they couldn’t explain exactly what Treasury bonds were; however, they did know for sure that I could buy one myself, almost like any major bank (primary dealer), or institution (direct bidder by a non-primary dealer), or foreign central bank (indirect bidder) does every week. I was told I could do this personally right at the Federal Reserve Bank of New York located on Maiden Lane in New York City, which was just two blocks away from where I worked, so I found out when the next Treasury auction was and walked over to the Federal Reserve Bank before one o’clock in the afternoon that day (the deadline for applications, or bids, for the bonds called tenders). I submitted the application form called a noncompetitive tender (the big players submit a competitive tender), and made out a check to the Federal Reserve Bank for the minimum bond purchase of $1,000 (the big players’ checks have more zeroes). A week later, after the bond was issued, I received it in the mail (they were still physically delivered to individual buyers back then). It was a $1,000 par, or face-value, ten-year Treasury note, an 11 ¾% Nov ’93, meaning it paid me, the Treasury bond buyer, exactly $58.75 every six months until maturity in November 1993, when I would receive the last interest payment plus my entire principal, the original investment, back. The semiannual interest payments were also city- and state tax free. Everyone I showed this Treasury note to at the office was impressed—especially the RMJ brokers that lived locally and paid ‘triple tax’ (paid federal, NY state and NY city taxes). At the next auction, I passed out tender forms to half the trading floor.
That was more than thirty years ago. Today, Treasury bonds are no longer physically delivered—they are all electronically registered—and you no longer have to go to a Federal Reserve Bank to buy them. Instead, you can go online to purchase them. The website where you can purchase the bonds, which is called Treasury Direct, refers to Treasury bonds as debt. Furthermore, it explains that the reason Treasury bonds are sold is “to borrow money to raise cash needed to keep the government operating”—so even today, the federal government, which is the issuer of dollars, is sticking to an outdated, gold standard era narrative that it needs dollars from us in order to function. No wonder then, when one listens to most of our politicians; watches popular hosts and guests of high-rated TV, cable, and radio programs; or reads articles in newspapers written by the world’s smartest reporters, the conventional wisdom that Treasury bonds are debt holds. Furthermore, it is widely believed that because the Federal Reserve Bank is printing money, it is enabling the government to dangerously overspend.
I understand why everyone feels this way. I felt this way for a long time as well, until I recently found out what, exactly, Treasury bonds are, and what they are not. What I learned is that so many things that we are constantly being told about Treasury bonds, the national debt, quantitative easing, printing money, debt monetization, the debt ceiling, an inflation threat, and our dollars becoming worthless is false. There is even less understanding of how and why the Federal Reserve Bank uses Treasury bonds at the operational level. Worse, our belief in these untruths causes alarm and misunderstanding most likely leading to more self-inflicted uncertainty, denial of investment spending needed to spur our economy, and unnecessary government shutdowns.
MODERN MONETARY THEORY
Just like that scene in ‘The Wizard of Oz’, Americans today are in front of that curtain at the end of the yellow brick road (at the end of the gold-standard era). We stand there, shivering in fear, as that constant bellowing, from scary-sounding talking heads, projected on that curtain (that facade), warns us about our ‘out-of-control’ U.S. federal spending, our ‘imminent default’ of U.S. Treasury bonds, our ‘soon-to-be worthless’ U.S. dollars and our ‘inevitable collapse’ of the U.S. economy—all because of the national ‘debt’. Just like Toto the dog, Modern Monetary Theory (MMT) pulls back that curtain.
In 1992, I supported Ross Perot in that year’s presidential election. Even though I had been living and working in Tokyo for several years, I was still a proud card-carrying member of Ross Perot’s Reform Party because I firmly believed that reducing our huge federal deficit, which he campaigned on, was the most important issue. I was absolutely wrong. I was letting all the noise and the fear mongering misinform me. I was just as clueless about Treasury bonds and federal-deficit spending until recently. I even wrote an op-ed in a local Honolulu newspaper while my wife and I lived there during 2010. I criticized conservatives complaining about all the spending under President Obama. I asked where all their rage had been when President George W. Bush had vaporized the Clinton administration’s surplus, eliminated pay-as-you-go, put everything on a Bank of China credit card, and doubled the debt.
Although that paper thought my letter was good enough to print, the truth is that I was again dead wrong. What I would soon learn is that the Clinton surpluses were not actually good, unless you intentionally wanted to cause a recession, which was exactly what happened. I would also learn that dollars to finance federal government deficit spending under President George W. Bush or any other president since Richard Nixon have not been charged on a credit card, or, more specifically, have not been borrowed at all. I figured after a long career as a Treasury bond broker, I was an expert on the subject, but not so. I was making the same mistakes about our monetary system as most people. Then finally, I had my awakening, my economic epiphany. A couple of years ago, I discovered modern monetary theory (MMT), and the truth, shall I say, set me free. I first got wind of MMT after watching economist Mike Norman on YouTube. Then I learned about economist Warren Mosler, champion of MMT, by reading his book, The 7 Deadly Innocent Frauds of Economic Policy. Professors Stephanie Kelton and L. Randall Wray at the University of Missouri-Kansas City are also prominent proponents of MMT. MMT for me has been like those art pictures, those 3D stereogram images: You stare at the center of the picture cross-eyed for a while, then, eureka, that hidden image inside that was right in front of you the whole time…suddenly, you see it. It turns out I was staring at the Wall Street Journal every morning, staring at all those Treasury bond trading screens for thirty years, until I finally saw it: that hidden component needed to fully see and truly understand our modern monetary system. I consider that fast, too, because if it weren’t for MMT, I never would have seen the simple truth about Treasury bonds in the post-gold-standard era that was always right before my eyes. Warren Mosler’s blog, The Center of the Universe, inspired the cover of this book, and the analogy of points on a scoreboard (Chapter 1) comes from Mr. Mosler’s speeches.
Until I started understanding what Warren Mosler was writing and talking about, I was making the same mistake that most people make today, which is still thinking of Treasury bonds as they used to be in a bygone era—an era when the dollar was fixed, or convertible to gold. An era when our federal government could not just issue or ‘print’ gold out of thin air, so to pay back the debts incurred, the federal government needed to raise money through tax revenues or borrowing. All of us, even the federal government, were in the same boat; we were all users of gold. Since 1971, however, the dollar has not been tied to gold; therefore, the federal government no longer needs to dig up gold to put in vaults to guarantee, to back up, our dollars—or even worry about having enough gold stored in case anyone wants to redeem their dollars. Our economy, and by extension, the global economy, is no longer limited, no longer fixed, or tethered to gold. The entire dynamic, our monetary system, completely changed. Our federal government, the issuer of dollars, became the origin source of all dollars, and the nonfederal government, the users of dollars, all rotate around the federal government, which sits at the center of universal finance.
The basic concept of modern monetary theory is that the lifeblood of our economic ecology today is no longer gold, a hard currency, with only a finite amount available; it is now a soft currency, created by fiat, and is of infinite amount. Our dollars no longer come from a mine in the ground but can enter circulation directly from federal government deficit spending, in amounts accounted for and facilitated by Treasury bonds. The precise amount of deficit spending, through fiscal policy, aside from provisioning the federal government, also plays an important role as a policy tool that strives to influence aggregate economic demand and foster productive economic activity. In short, productivity now backs the dollar (and confidence now backs all fiat systems). For example, because federal government taxes must be paid in dollars, one purpose of federal government taxes now is to create demand for dollars, to give those dollars issued by the federal government their needed initial velocity and not needed to finance federal government spending. In other words, the modern monetary theory begins (the ‘modern money story’ starts) with the federal government—desiring to provision itself—imposing a tax liability that can only be settled in dollars, creating a nonfederal gov’t need (creating a nonfederal gov’t velocity) of dollars. Another purpose of federal government taxes is to raise them if needed to ‘drain’ dollars from incomes, out of the hands of consumers, to prevent inflation; or to lower them to ‘add’ dollars back to incomes, back into the hands of consumers, to prevent deflation. The federal government has monopoly power over dollars. It wields that power through its central bank, the Federal Reserve Bank. The Fed uses Treasury bonds, which also now play a very important role as tools, through monetary policy, to influence (to manipulate), the interest rate (the ‘price’), of dollars.
If any of this sounds familiar, it’s because you’ve played the Monopoly game. There is absolutely no mention in the rules about the Monopoly Bank going into ‘debt’ when creating more Monopoly Money; nor is there any mention whatsoever in the rules about the Monopoly Bank having to ‘borrow’ Monopoly Money from anyone. The Monopoly game rules were written around the same time when President Franklin Delano Roosevelt initiated our country’s phase-out from the gold standard—our switch from dollars that were convertible to gold, to dollars that were not. As per the Monopoly game rules, “The Monopoly Bank never goes broke, if the Monopoly Bank runs out of money, the Monopoly Bank may issue as much as needed by writing on any ordinary paper.” In short, as long as the Monopoly Banker approves the creation of Monopoly money, then ‘let it be done’—the translation of the Latin word ‘fiat’. Which is just like our federal gov’t today. The federal gov’t, the issuer of fiat dollars, plays by similar rules as the Monopoly Bank. After Congress approves any proposal for deficit spending (after the ‘political constraint’ is satisfied), the federal gov’t taps dollars into electronic existence with a keyboard—the modern equivalent of the Monopoly bank simply printing $1, $5, $10, $20, $50 and $100 on ordinary pieces of paper. Which is the same as any monetary sovereign (like Japan, the U.K., Canada, Australia, etc.) issuing their own non-convertible, free-floating, fiat currency. Anyone today saying otherwise probably never fully-understood the Monopoly Game rules. Anyone today who did understand those Monopoly Game rules (that does understand the ‘currency analysis’ of the Monopoly money), easily grasps the paradigm difference (the MMT insight) of the federal government’s switch from spending in gold-backed dollars to spending in their own fiat-currency. We, along with our policymakers, should all be thinking like Charles Darrow—who wrote those Monopoly Game rules in 1933—when it comes to the question of ‘How are we going to pay for’ federal-government deficit spending on the public purpose for the common good. We all should be using ‘modern monetary thought’, rather than using gold-standard-era mentality (rather than thinking in the past). In the post-gold standard, modern monetary system, the federal government, the issuer of fiat dollars (the issuer of a STRONG ‘World Reserve’ currency in an era of LOW inflation and even lower interest rates), HAS MUCH MORE flexibility to deficit spend. Under the guise of ‘borrowing’ and going into ‘debt’—a formality of a bygone era that mainly still exists only to make certain that the ‘Power of the Purse’ of Congress is not usurped—the federal gov’t/the issuer of dollars (The Bank) is merely ‘debiting’ (is simply supplying) the users of dollars (The Players) with more needed currency (with more needed liquidity) to keep the economy in balance (to keep The Game functioning properly); so that We The People can be given the same opportunity to pursue happiness (so that The Players can be given the same opportunity to be winners).
THE ISSUER AND THE USERS OF DOLLARS
The federal government, the issuer of dollars, is the center of the U.S. economic universe and the origin source of all dollars in the world economy. The nonfederal government, the users of dollars, is the rest of us—you, me, all households, all businesses, local governments, state governments, even foreign governments, everybody else—everybody except the federal government: any person or institution that cannot issue dollars and is instead a user of dollars. Federal government spending for provisioning itself, for entitlements, for defense, for our infrastructure—all spending, any spending, spending beyond what the federal government takes in from federal taxes, Social Security taxes, Medicare contributions, etc.—is deficit spending, or when the federal government ‘prints’ money. Deficit spending by the federal government is the federal government crediting dollars to us, the nonfederal government. We, the nonfederal government, the users of dollars, we also deficit spend, we also ‘print’ money; we print money when we use credit cards, get student loans, get mortgage loans, borrow to start businesses or expand businesses, and so on. Federal government deficit spending adding dollars and nonfederal government deficit spending multiplying those dollars is the optimal environment for a growing, expanding, and stronger economy.
The key to understanding modern monetary theory is to look at our present economic structure as a ledger with the issuer of dollars on one side, and the users of dollars on the other. Similar to Newton’s laws of motion, every debit causes an equal and opposite credit on a ledger, and vice versa. The main ledger of a soft currency like dollars has the issuer, the federal government, on one side, and the users, the nonfederal government, on the other. The issuer and the users interact together in one vast and holistic economic ecology. Today, any amount of federal government spending that goes beyond federal government income is simply debited, or, more specifically, created by keyboard, and spent into the economy to the nonfederal government (users of dollars), which simultaneously triggers a credit, or, an addition in the same amount that was deficit spent, to the outstanding balance of Treasury bonds of the federal government (issuer of dollars). Since leaving the gold standard, the federal government’s ability to create dollars is now unlimited, no longer constrained, no longer fixed to some kind of backing to gold or anything else. In the post-gold-standard modern monetary system, the federal government should spend as much or as little as needed to help the national economy in response to the country’s prevailing economic condition, to promote long-term growth prospects, and should not be constrained by arbitrary debt ceilings, political agendas, or short-term special interests.
As mentioned previously, the nonfederal government is absolutely everybody except the federal government, or those that do not issue dollars and thus are users of dollars—that is, all of us who need to budget ourselves, to budget our dollars, and to prevent ourselves getting into too much debt of dollars. Furthermore, because the nonfederal government does not issue dollars, it will always need to ‘get’ dollars the old-fashioned, gold-standard way—through borrowing—meaning go into debt, to finance deficit spending. The federal government does issue dollars, so it does not go into debt, to finance deficit spending.
If the issuer of dollars (federal government) is spending in deficit, then the other side of that ledger, the users of dollars (nonfederal government) are saving in surplus, by the same amount to the penny. Conversely, if the issuer (federal government) is saving in surplus, then the users (nonfederal government) are not saving and are forced to spend in deficit also by that same amount to the penny. Since it is eventually unsustainable and problematic for the nonfederal government to deficit-spend for any prolonged period, the federal government should not save in surplus unless intentional to purposely put the brakes on an overheating economy. A federal government surplus is the economic equivalent of a reverse thruster on a commercial jet airplane. You should only go into federal government surplus, turn that reverse thruster on, to reverse the flow of dollars if you are going too fast at that moment and want to immediately slow the economy, slow that plane down. The Clinton surplus actually triggered the Bush recession. Just like that reverse thruster, a federal government surplus should be used only a little bit, not too much—just enough to balance the economy back to slow and steady growth, not with the explicit need of balancing a federal budget. In the post-gold-standard modern monetary system, only the nonfederal government needs to balance their budgets.
Outdated gold-standard mentality is the reason why most people today think it is unsustainable for the federal government to spend in deficit. Actually, it is unsustainable if the federal government spends in surplus for any prolonged period because in economic reality it is unsustainable if the nonfederal government spends in deficit for any prolonged period. All six major depressions in United States history were preceded by prolonged federal government surpluses. The depressions of 1819, 1837, 1857, 1873, 1893, and 1929 all had that same thing in common. During the gold standard, the federal government and the nonfederal government were both users of gold (users of gold-backed dollars), so both the federal government and the nonfederal government needed to balance a budget. Those six times in history, with the good intention of a balanced budget, the federal government had overdone the amount of surplus (left that reverse thruster on too long) which resulted in the unintended consequence of an unbalanced economy. To understand why those depressions occurred, why federal government surpluses triggered them, all you have to do is look at the credits and debits of dollars flowing between the federal government and the nonfederal government as a bookkeeper. If the federal government, on one side of the ledger, is saving in surplus, then the nonfederal government, on the other side of the ledger, must be, in equal and opposite amounts, spending in deficit, meaning it is borrowing heavily or depleting savings for all spending, which eventually ends badly. Most people have this backward today; they think it is unsustainable for the federal government to spend in deficit, as if the federal government was still in the gold standard era and needed to acquire gold or borrow gold-backed dollars before spending those dollars. What is true, however, is that it is unsustainable for the federal government to not spend in deficit for a prolonged period of time. For example, the federal government also ran budget surpluses in 1920, 1921, 1922, 1923, 1924, 1925, 1926, 1927, 1928, and 1929—so for ten years straight, on one side of the ledger, the federal government was saving in surplus, and on the other side of the ledger, the nonfederal government was spending in deficit, either depleting savings or going further into debt to finance spending. The result was the Great Depression. Ben Bernanke’s key area of scholarship was the Great Depression, and he puts the blame for that depression on the federal government because it prevented inflows of gold (gold-backed dollars) from entering the money supply. In other words, the nonfederal government had suffocated.
Another important concept of modern monetary theory is that the federal government does not need to issue Treasury bonds to finance its spending, not anymore. In our post-gold-standard modern monetary system, the federal government issues Treasury bonds to be used by its agent, the Federal Reserve Bank, to achieve a dual mandate, or goal of full employment and price stability through its monetary policy. The federal government also issues Treasury bonds to be used as tools by the Federal Reserve Bank to maintain monopoly power over the dollar and to manipulate the price, or interest rate, of the dollar as it sees fit to attempt to regulate aggregate demand. Furthermore, as the issuer of dollars, the world’s reserve currency, the federal government issues Treasury bonds to serve as a safe haven for global dollar deposits. Treasury securities may be marketable, meaning some Treasury bonds, notes, and bills trade in a huge and highly liquid Treasury bond market, thus adding to the dollar’s worldwide appeal. When countries buy our Treasury bonds, they are not lending us dollars but are simply depositing their dollars into an interest-bearing account, just like you do, but on a bigger scale at a bigger bank. Central banks of other countries—all our global trading partners—desire to park their reserves of dollars in Treasury bonds, for safekeeping. One controversial reason is to sterilize their dollars to maintain competitive trade advantages, known as strategic devaluation, another example of complete monopoly power that all federal government central banks have over their currencies.
OUR ECONOMIC ECOLOGY
Perhaps the greatest misconception about U.S. Treasury bonds today is that they are debt of the federal government. They aren’t. Treasury bonds used to be debt, but not anymore. If the United States owed China its yuan, or owed Japan its yen, then the United States would be in debt. If the United States owes these countries nonconvertible U.S. dollars, a currency that the U.S. federal government creates, that’s not debt. It’s liabilities to make interest payments and obligations to pay principals at maturity, yes; an actual debt, no. We still do use that retro terminology, however, just like we still say how much horsepower your car engine has. You don’t have to worry about driving your car too fast so as to not tire the horses out, yet that is the same thinking you hear and read today concerning our federal government debt, as if we might somehow run out of dollars, or tire them out. Remember, this applies only to the federal government. The federal government, because it is the issuer of dollars, dollars no longer convertible nor fixed to anything, is never in debt of dollars, just like IBM is never in debt of IBM stock because IBM can always issue more IBM shares. However, if you, me, any household, any business, any U.S. local city, any U.S. state, or any foreign government borrows dollars, gets a mortgage in dollars, takes out a loan in dollars, issues a municipal or dollar-denominated sovereign bond, then yes, that is debt. That is debt because we cannot issue dollars, we are users of dollars, when we deficit-spend we are on the hook for those dollars, and we have to get those dollars back from somewhere to return them. Let’s take a closer look at dollars and Treasury bonds.
Most of us keep some of our dollars in accounts at banks, and at those banks, we have checking accounts and savings accounts. We transfer our dollars back and forth between our checking accounts and savings accounts. We transfer dollars from checking into savings, because savings accounts earn interest over time, and we also transfer dollars that we instead need to be liquid from savings back into checking. Most people today aren’t familiar with the actual workings of our U.S. monetary system on this same operational level. A big source of many myths and collective angst comes from all those mysterious machinations of Treasury bonds behind the scenes over at the Federal Reserve Bank. Let’s pull the curtain at the Fed back a little bit.
The Federal Reserve Bank is set up almost exactly the same as any private bank, with one notable exception—the Fed has complete monopoly power over dollars. The Fed, our central bank, where all the banks do their banking, has a similar account setup as any other bank does, but instead of a checking account, the Fed calls it the Reserve account, and instead of a savings account, the Fed calls it the Securities account. All banks with outstanding deposit liabilities are required to keep a certain percentage, called a reserve requirement, in the Reserve account at the Fed, because that reserve requirement, like any emergency money, needs to be liquid, like a checking account at any other bank. In addition, any bank, plus anybody else who wants to, may deposit its dollars in the Securities account at the Fed, because the Securities account earns interest, like a savings account at any other bank. Making a deposit in the Securities account at the Fed is also known as buying a U.S. Treasury bond.
All marketable U.S. Treasury securities (Treasury bonds, notes, bills, and also Treasury inflation-protected securities, or TIPS), are nothing but interest-earning time deposits in the Securities, or savings, account at the Federal Reserve Bank. When anyone buys a Treasury bond, he or she is opening a term deposit in the savings account at the Fed, just like opening a deposit in a savings account at any bank. Whether you are a widowed senior citizen or a foreign central bank, buying a Treasury bond is like getting a CD at any bank, except a Federal Reserve Bank CD is called a Treasury bond. So what exactly happens when anyone buys an existing or newly issued U.S. Treasury bond?
The dollars used to buy Treasury bonds usually originate from checking accounts at private banks and, because these dollars are excess dollars, were transferred overnight to the checking, or Reserve, account at the Fed. On the settlement date of the Treasury bond purchase, those dollars are then transferred from the Reserve, or checking, account at the Fed, over to the savings, or Securities, account at the Fed, and registered in the buyer’s name. That’s it; that’s buying a Treasury bond. Buying a long-term Treasury bond, a medium-term Treasury note, or a short-term Treasury bill is nothing but a simple transfer of dollars from the Fed’s checking account to the Fed’s savings account, just like you do at your own private bank, and for the very same reason—to transfer liquid, demand deposit of dollars over into an interest-earning time deposit of dollars.
Conversely, what, exactly, happens when someone sells a Treasury bond, or when a Treasury bond matures? Those dollars are transferred from the savings, or Securities, account at the Fed back to the checking, or Reserve, account at the Fed, just like you do for the same reason—to transfer your interest-earning time deposit of dollars over into a liquid, demand deposit of dollars. The same thing happens for quantitative easing (QE), or large-scale asset purchase (LSAP), when the Federal Reserve Bank forces the sale of marketable Treasury bonds out from the Treasury bond market to manipulate the price, or interest rate, of dollars lower. The Fed is not permanently printing money, just temporarily transferring the dollars of the holders, or sellers, of those Treasury bonds from their Securities account at the Fed over to the Reserve account at the Fed. The dollars of those Treasury bond owners were transferred at the Fed, purposely by the Fed, in an exercise of monopoly control of the Fed.
Again, the exact same thing would happen if China or Russia or Japan ever decided to sell its U.S. Treasury bonds, dump them, even all at once. That would certainly cause turbulence on the airwaves and in the markets, but after all the selling on the rumors and all the buying on the news, at the end of the day, what would have happened was simply more transfers of dollars, with extra noise. There is nothing to worry about if any country sells its Treasury bonds, because China, or anybody else who owns Treasury bonds, paid for them with dollars. Dollars are our free-floating currency that is no longer backed, or convertible, or fixed to gold, and which our federal government, the issuer of dollars, creates. In this scenario, the Fed would merely transfer China’s dollars from the Fed’s Securities account to the Fed’s Reserve account. Click. Enter. Blink. Done. No burden on your children. No unsustainable debt. No out-of-control borrowing, and no danger to the financial stability of the country. In our post-gold-standard modern monetary system, the buying and selling of Treasury bonds is just ebb and flow inside our very own economic ecology, nothing but routine transfers of dollars back and forth between checking and savings accounts in one holistic U.S.-dollar dominion.
It is crucial to understand that there is a huge difference when the federal government deficit-spends and when the nonfederal government deficit-spends. The nonfederal government, the users of dollars, incurs a debt when it prints money, or deficit spends, so it needs to spend within its means and balance its budget. The federal government, however, since leaving the gold-standard era, is now the issuer of dollars and is not in debt when it prints money, or deficit spends; it has bigger problems to deal with now: It needs to spend according to need, to balance its economy. In other words, all of us in the nonfederal government are in our very own balancing acts, but the federal government is balancing all of us in one gigantic balancing act. The federal government balances the economy by attempting to regulate aggregate demand with fiscal policy and also with monetary policy. Fiscal policy is executed by the legislative and executive branches, Congress and the president, and monetary policy is executed by an agent of the federal government, the Federal Reserve Bank. Fiscal policy is administered by adjusting amounts of federal government deficit spending and federal income taxes; and monetary policy is administered by adjusting the price, or interest rate of dollars. Whether the federal government chooses to adjust federal deficit spending and/or adjust federal income taxes is a political decision. All that is important is that adjustments to spending and adjustments to taxation be countercyclical, that they reverse economic conditions for the better, like the tax cuts and spending increases did in the year 2001. Fiscal policy should never be pro-cyclical—that is, continue to be a drag on already anemic economic growth—like the tax hikes and spending sequestration did in 2013. Federal deficit spending and federal income taxes should be adjusted in opposite directions to be effective. For example, if both federal deficit spending and federal income taxes are increased, the net effect is minimal because accommodative and non-accommodative actions are being taken at the same time. The same thing happens if both are decreased. If federal deficit spending is decreased, which is non-accommodative, and federal income taxes are decreased at the same time, which is accommodative, the result is again minimal. Fiscal policy is effective only when your actions are in sync with what you want to accomplish. For example, you increase federal deficit spending and lower federal income taxes like in the year 2001 if you want to speed up the economy (which was what most politicians were trying to do). You do the opposite, decrease federal deficit spending and increase federal income taxes like in 2013, only if you want to slow the economy (which wasn’t what most politicians were trying to do). The key is that everyone should understand the difference between adjustments in federal deficit spending and federal income taxes of fiscal policy in a modern monetary context.
Along with fiscal policy there is monetary policy. Monetary policy is administered by the federal government, the issuer of dollars, through its agent, the Federal Reserve Bank. The Fed controls monetary policy independently of the federal government but understand that the Fed is part of the federal government. More precisely, the Fed is independent within the federal government, not independent of the federal government. Monetary policy by the Fed is attempted mainly by adjustments to the price, or interest rate, of dollars. Monetary policy and fiscal policy together make up our economic ecology, a spectacular masterpiece that is our modern monetary system.
Our Fed can easily determine the proper balance of interest rates by the rate of unemployment and the stability of prices. For example, if unemployment and prices are stable, the interest-rate yield curve is normal, or positively ascending, then the economy is balanced, the economic environment is perfect, and the Fed has achieved its “dual mandate.” If unemployment is very low, and wages and consumer prices are rising too quickly, the Fed needs to increase interest rates for less liquidity. By draining liquidity, the Fed tightens economic conditions and prevents inflation. The opposite, if unemployment is very high, and wages and consumer prices are not rising at all, means the Fed needs to decrease interest rates for more liquidity. By adding liquidity, the Fed eases economic conditions and prevents deflation.
If and when the Fed chooses to adjust interest rates is not a political decision, and the Fed is independent so it can make decisions on monetary policy without interference or influence from any outside forces. All that is important is that the Fed’s actions help balance the economy, not help special interests or win elections. Fed actions sometimes are made not only because of prevailing economic conditions but also to counter prevailing political inaction, to buy time so that politicians can make needed economic reforms. The extraordinary quantitative easing from 2008 to 2014 was needed because of the extraordinary dysfunction of the political process that resulted in bickering, downgrades, and shutdowns. Such an environment does not create confidence; nor is it in any way conducive for stronger economic growth. We all know that political parties are competing with each other, and we get that they don’t like each other. The question is, can they work with each other? Look at Japan. Japan’s “Lost Decade”, that ten plus years of economic contraction and deflation, wasn’t caused by the Japanese citizens. The Japanese are well-educated, hardworking, and diligent savers. The Japanese politicians, on the other hand, are a different story. The average term of Japan’s prime ministers is just two years. From 2006 to 2011, four out of five prime ministers did not stay in power for more than twelve months. Frequent political changes and the uncertainty they create were the major reasons for Japan’s prolonged economic stagnation, a situation that Japanese policymakers are still trying to fully escape from today. The Japanese, who invented quantitative easing in the mid-1990s, know all too well that extraordinary monetary policy can help buffer political inaction but cannot cure it. Chairman of the Federal Reserve Bank, Ben Bernanke frequently expressed concern about a drag from Washington and included the phrase “Fiscal policy was restraining economic growth” in thirteen straight Federal Open Market Committee (FOMC) policy statements from March 20, 2013, until his successor, Fed Chair Janet Yellen, ended QE on October 29, 2014. This is why the Fed or any central bank is independent—so its monetary policy can also counter, or negate, political dysfunction and pro-cyclical fiscal policies that amplify, or make worse, bad economic conditions.
THE TRAINING WHEELS COME OFF
In 1971, President Nixon closed the gold window, meaning from then on, the United States would not convert dollars and, by extension, Treasury bonds held by foreign central banks, to gold. That day, because the federal government then became the issuer of fiat—non-convertible dollars—no longer backed by gold, Treasury bonds went from being debts payable in dollars backed by gold (something that the federal government needs to get), to just savings accounts in dollars (something that the federal government doesn’t need to get) . The training wheels of our early economic structure, which the gold standard was, were taken off.
From the infancy days of our economy up until 1933, the dollar was technically convertible to metals, mostly to gold, meaning it was perceived that all dollars floating out there, or our money supply, was physically backed by gold. This gave our currency credibility and helped our initial economic growth, but it also constrained, or limited, it. We could issue only as many dollars, extend as much credit, as we had gold in our Treasury vault. Furthermore, whenever users of our gold-backed dollars for some reason decided to suddenly not spend so freely, if there was any hoarding of gold, this would create shortages, reduce the ‘velocity’ of spending—money velocity throughout the economy—and cause panics. In worse cases, it caused bank runs, deflationary spirals, and even severe depressions.
In 1913, seeing that these gold shortages were causing these panics, and realizing that the lack of gold was the same thing as lack of credit, Congress created the Federal Reserve Bank. In 1933, in the depths of another depression, the Great Depression, the worst deflation in history, an Executive Order by President Franklin Delano Roosevelt declared that a serious emergency existed, that any further hoarding of gold and silver posed a grave threat to the U.S. economy, and criminalized its possession. The days of gold’s relevance were then numbered. The creation of the Federal Reserve Bank was the solution to the problem caused by a lack of gold. Lack of gold was like a short leash that kept our economy constrained because gold cannot be issued, a gold supply is always limited. If gold was limited, then our dollar was limited, and by extension, our economic potential was limited.
The Federal Reserve Bank began an undertaking that replaced gold with credit, which is unlimited yet can be controlled. The Federal Reserve could add credit to ease conditions to stimulate spending and investment to prevent deflation. Conversely, the Fed would also have the power to do the exact opposite: to intentionally drain or remove credit, or tighten it, to intentionally slow the economy if necessary to halt inflation. The Federal Reserve would use credit, via Treasury bonds, to harness the forces of liquidity to attempt to influence aggregate demand and the direction of the economy.
This was a monumental evolution of monetary development in our country. This was an entirely new concept, going forward, that the Fed would now step in as a “lender of last resort” to provide credit and increase liquidity, to keep the velocity of spending, or money velocity, going strong, and prevent panics. By smoothing out the booms and busts, the Federal Reserve Bank would provide an environment in which everyone felt confident and certain about the future of the economy. Our dollar, our Treasury bonds, and our monetary system would transform. Ours would soon become the greatest economy in world history, backed not by gold but by something even more valuable, with even greater potential, and, best of all, in unlimited supply. Our dollars, our Treasury bonds, our post-gold-standard modern monetary system would be backed by the “full faith and credit” of the United States.
Many people today still clamor for the United States to go back to a gold standard. My guess is that these people have lots of gold, or they are betting on gold. Perhaps they are seeking political power and are using fear to get it, or maybe they just miss the good ole days and want to go back in time. Putting America back on a gold standard would be like putting the training wheels back on a teenaged child’s bicycle. For the same reason one wouldn’t do that, America should not go back on a gold standard; it is a bad idea, because the gold standard was our young country’s early economic and monetary system’s ‘golden’ training wheels.
For centuries, the economic universe revolved around gold, silver, or currency backed by these or other metals. Convertible, or fixed to these metals, these currencies were considered ‘hard’ currencies. All businesses, all economies, all monetary systems, were therefore also fixed, constrained, or tethered to a limited amount of gold, silver, or other metals because no one could issue, create, or print them. Before any issuance of more currency, these metals needed to be mined, shipped, and stored in vaults to back up the currency. The amount of gold was always limited, so economic growth under a gold standard was also always limited to the amount of gold that could be dug up from the ground or plundered from elsewhere. This was rudimentary, inefficient, and one of two major disadvantages of gold as a currency or a backing of a currency. The second disadvantage of gold as a currency or a backing of a currency is that gold, a precious metal, is an excellent store of value. Gold retains value, will always be even more valuable over time, and that is a major disadvantage for a currency in a modern monetary system because it encourages hoarding. People can take their gold, or gold-backed dollars, leave it in a safe deposit box in a bank, or place it in a chest and bury it, and know that it will forever be more valuable because there is only a limited amount of gold. This feature of gold makes it great for the few who have it, but not so great for the population at large, limits the ability for an economy to grow and stunts wider prosperity. Under a gold standard, with a limited amount of gold, our economy, and, by extension, all economies, were playing in a zero-sum game. Furthermore, the ability to respond to hoarding, savings gluts, or any other shortages of gold was also limited, which resulted in financial panics and economic depressions.
Dollars, or, more specifically, unconvertible dollars, which are fixed to nothing and are issued by fiat, serve better as a currency in a modern monetary system because they are perishable, they have an ‘expiration date.’ Unlike gold’s, the dollar’s purchasing power is always shrinking; therefore, instead of encouraging hoarding, dollars encourage spending. A shrinking purchasing power of idle cash dollars encourages investment. The more that the federal government can encourage the spending of dollars, the more that the federal government accommodates the investment of dollars, the more the economy grows. Dollars have an embedded ‘use it or lose it’ functionality (dollars have a ‘planned obsolescence’), which is when a product is purposely designed to slowly break down after a certain time to encourage turnover. The issuer of currency needs this slow disintegration built into the currency to discourage hoarding (to encourage spending)—to influence an increase in the velocity of money. Dollars are intentionally manipulated to deteriorate about 2% per year, and the price, or interest rate, of dollars is in firm monopoly control by the federal government, the issuer of dollars, through its agent, the Federal Reserve Bank. Unlike gold or any other ‘hard’ currency, ‘soft’ dollars are much more efficient because they can always and easily be made available to the population at large by swapping an IOU, a note payable, or indebtedness for dollars with financial intermediaries within the banking system, aka credit extension. Credit facilitates all of us, gives us all access to money when we wish to deficit-spend, to ‘print’ money, which multiplies dollars previously added to the economy by federal government deficit spending.
Instead of being limited or constrained by a fixed amount of gold bars needed in a Treasury vault to back the currency, in our post-gold-standard modern monetary system we have dollars that are unconvertible, fixed to nothing, which allows the economy to be limited only by a nation’s imagination and reach of innovation. As a result, the U.S. economy is the strongest, our U.S. dollar is the world’s reserve currency, and our U.S. Treasury securities are the safe haven of choice in global flights to quality when markets are volatile. Our federal government, the issuer of dollars, in complete monopoly control of those dollars, sits firmly at the center of the economic universe since leaving the gold standard. Once an economy has grown, matured, and proven it can ride on its own, no more training wheels are needed. Then all that is needed to back its currency is the “full faith and credit” of the government and its people. Nothing more or less.
Since leaving the gold standard, the purpose of U.S. Treasury bond issuance in our modern monetary system has morphed. What once was a simple task that used old handheld tools needed to finance federal-deficit spending dollars is now a complex modern electronic masterpiece used to neutralize the inflationary bias of federal deficit-spending dollars. Neutralizing these dollars means offsetting newly-printed, potentially inflation-stoking dollars, fresh from the federal government’s keyboard, that are funding federal deficit spending, entering INTO money-supply circulation, by neutering already-existing dollars—of the same exact amount to the penny—OUT FROM money-supply circulation. During the gold-standard era, existing gold-backed dollars were borrowed, or received from investors buying Treasury bonds, so there was no addition of dollars, no inflationary bias caused solely by federal-deficit spending. Post-gold standard, keeping the same formalities of Treasury bond issuance in place serves this purpose. In addition, Treasury-bond issuance today makes sure that—even post-gold standard—we continue to embrace the ‘Power of the Purse’ of Congress. In other words, unlike users of dollars, even though there is no longer a ‘financial constraint’ for the issuer when spending its own fiat dollars, there still remains that ‘political constraint’—spending still has to be approved by policymakers.
In normal economic conditions, federal-government deficit spending is funded with newly-printed dollars and offset by a removal in the same amount of existing dollars from the money supply via Treasury-bond sales. This is done to prevent too many dollars from chasing too few goods—aka, inflation. For example, the United States, while provisioning itself and making other outlays, usually needs to deficit-spend a certain amount in any given month. The federal government goes about deficit spending, and vendors are paid with newly printed dollars deposited into their bank accounts. To neutralize these dollars entering money-supply circulation, Congress authorizes the debt ceiling to be increased so the Treasury department can issue Treasury bonds. The amount of issuance is added to the running total, or our national ‘debt.’ The Federal Reserve Bank, acting as the financial agent of the federal government, assists the Treasury in selling the Treasury bonds. These new Treasury bonds, denominated in dollars, are sold to U.S. citizens, U.S. banks, nonbank institutional investment firms, or foreign central banks; thus, the Treasury bonds are paid for with dollars already existing in the money supply throughout the economy. Treasury bonds issued and sold are always in the same amount of federal deficit spending so that the same amount of newly printed dollars used to fund federal-deficit spending entering into the money supply is at the very same time coming out of the economy elsewhere and getting parked in the Securities account at the Fed when the Treasury bonds are bought. In other words, newly-printed dollars come in (deficit spending), and the same amount of older, existing dollars, comes out (pays for the Treasury bond). This offset, or neutralization, prevents these newly-printed U.S. dollars from being possibly being inflationary (potentially harming the economy).
Large-scale asset purchases (LSAP), or so-called ‘quantitative easing’ (QE), is the Fed simply switching off this neutralization. Operationally, QE, or LSAP, means the Federal Reserve Bank is buying Treasury bonds every month. The Fed does this for the same reason a company buys back its own stock: to make the price go up. QE is just Treasury bond buybacks. ‘Buyback’ is exactly how the back-office trade settlement people of any Treasury bond trading desk at the banks, during QE, referred to QE whenever I confirmed Treasury trades done with clients. When the price of bonds goes up, their yield (the effective yield in dollar amount that is ultimately paid in interest income to the buyer of the bond) goes down, so by keeping the yields of Treasury bonds low, the Fed is further manipulating interest rates, or the ‘price’ of money, down, to accommodate the economy—more specifically, to help borrowers at the expense of savers. In a slow economy, with inflation that is far too low, or in a very weak economy threatened by deflation, neutralization of newly printed dollars created for deficit spending is not needed because the economy lacks inflation. The economy needs inflation. Whatever amount of Treasury bonds the Fed buys during LSAP has the same effect as if those Treasury bonds had not been issued in the first place. One arm of the federal government has sold Treasury bonds, and another arm of the federal government is buying them back. This reverses the neutralization, so from then on, freshly created, newly printed, inflation stoking, fiat dollars are entering the economy without any offset. In other words, the Fed has stopped the neutralization of federal-deficit spending dollars entering the economy that is normally done to prevent inflation, in this case to intentionally try to cause inflation. The key word here is try. This is the tricky part. The cliché “You can lead a horse to water but you can’t make him drink” is very applicable here and is the very reason so many people got wrong what effect the Fed’s actions would have on our economy in the LSAP years that started in November 2008 and ended in October 2014. You can drain a trough (decrease liquidity) and make a horse stop drinking (slow the economy), but the opposite is not automatically true. The Fed can push the economy into recession, like Chairman Paul Volcker did successfully in 1981 to slow the economy to stop runaway inflation, but the Fed alone cannot pull the economy out from a recession to stop deflation. Only aggregate demand (the horse) can pull the economy out of recession. Increased reserves don’t automatically mean increased aggregate demand. The Fed can fill the trough (add lower-costing liquidity) but can’t make the horse drink. The Fed needs help. Only if the politicians are eliciting confidence by implementing sound fiscal policies, making growth-inhibiting reforms, creating an environment for a stronger economy and a better future, can they convince the horse to drink. Most people got this wrong; they thought QE would automatically cause hyperinflation, interest rates to rise, and Treasury bond prices to tumble—things that would happen only if and when aggregate demand were to increase dramatically. What many hedge fund ‘stars’ and bond ‘kings’ learned from Professor Bernanke was that, other than manipulating interest rates lower, QE does not automatically cause anything, period. The threat of deflation, however, will automatically cause QE.
QE, or LSAP, begun in December 2008, lowered the price, or interest rate, of dollars to ease credit, to accommodate the economy by attempting to stimulate growth with regularly scheduled forced sales of selected Treasury and mortgage bonds. The Fed took extraordinary LSAP measures for several reasons: Mass production (supply) was overpowering mass consumption (demand). Disinflation was and still is the world economy’s main threat. Demographic forces continue to cause structural unemployment, which has piled on to cyclical unemployment, resulting in labor-force slack and stunted labor-wage growth. Strategic devaluations overseas are weakening currencies against the dollar, which imports more disinflation. Fiscal policy (raising federal income taxes for upper-income earners in January 2013 and sequestering federal spending in March 2013) restrained U.S. economic growth. QE should stimulate the economy and spur growth, but the result is not automatic. Even less of a guarantee is that any growth caused by QE would be so strong that it would spark high inflation. The Japanese know this all too well; those many years of zero economic growth and falling prices during their “Lost Decade” is proof. Misunderstanding of Treasury bond buybacks, or QE, that began in 2008 is why so many traders and other investors lost money putting on positions, or placing bets, that it would cause immediate inflation. Inflation hurts owners of any bonds because the fixed interest income (set coupon payments) received from those bonds has less purchasing power, so if you expect inflation, you sell bonds. Realization that QE wasn’t going to cause inflation or cause Treasury bond prices to collapse reversed those bets, and the Treasury bond market reflected that capitulation on July 25, 2012. The buying of Treasury securities that day was so strong that the Treasury note (ten-year maturity) yield touched an all-time record low of 1.38%, meaning this “flight to quality”, or demand for those bonds was the highest ever. Two days later, and wanting to stop panic selling of Eurozone sovereign bonds of the stressed member states, European Central Bank (ECB) President Mario Draghi pledged to do “whatever it takes” to encourage traders, and to convince the markets, to buy those bonds, and also force yields down, to accommodate the Eurozone economy. Meanwhile, in the U.S., bond vigilantes (traders that still had no confidence in the Fed’s handling of the credit crisis) wisely chose to stop fighting the Fed until the following year, when Chairman Bernanke hinted that “tapering”, or the beginning of ending QE, was being considered, and that process eventually begun in December 2013.
During LSAP or QE, selected Treasury and mortgage bonds are impounded, or somewhat exist, in suspension from the bond market, and are temporarily placed in the Fed’s portfolio (the Fed’s balance sheet), without owners, until the economic crisis has passed. Because these bonds no longer have registered owners, interest payments on them while they are in the Fed’s portfolio are given back to the Treasury. According to minutes of the Federal Open Market Committee, if any of these bonds mature while economic conditions still warrant no change to Fed policy, the Fed will reinvest the bonds. By reinvest, this means the Fed will use any maturing mortgage bond principal payments for the purchase of more mortgage bonds; or in the case of Treasury bonds, the Treasury department will roll over any maturing bonds into new issues and the Fed will repurchase those Treasury securities at auction. This keeps the same notional (original principal or ‘par’ value) amount of both mortgage and Treasury bonds right where they are, in the Fed’s portfolio, to maintain accommodative monetary conditions. If at any time the Fed deems it appropriate to no longer maintain accommodative monetary conditions because the economy is improving, the Fed will not reinvest, meaning it will outright sell these bonds back into the bond market, assigning the bonds once again to owners. This action will unwind, or reverse all that has been done, and this is why LSAP is not a permanent creation of money by the Fed. Next is the timing of the Fed’s “lift off” or normalization to higher interest rates. As per FOMC statements, when the Fed decides to begin “lift off,” depends on the Fed’s assessment of actual and expected progress toward its objectives of maximum employment and two percent inflation.
Lowering interest rates by buying bonds during LSAP increased reserves, our monetary base. Increasing monetary base does not automatically mean increased money supply, increased consumer loan activity, weaker dollars, or inflation, however. Again, any new money in reserves enters the money supply not by being pushed by the Fed but only if pulled by outside forces of that horse, aggregate demand, which then could expand the money supply, stoke consumer borrowing, dilute existing dollars, and cause mild inflation. Although the situation was not necessarily ‘mission accomplished,’ on October 29, 2014, the U.S. economy, still the world’s strongest economy by far, had enough strength to end LSAP. Any mortgage or Treasury bonds remaining on the Fed’s balance sheet are nothing more than central bank fire extinguishers to be used in the very low-odds chance that the economy kicks into high gear and we suddenly suffer from massive hyperinflation. The odds of that are slim, but with another $3 trillion of cash earning around 0.00% burning holes in the pockets of money market account holders, it is good to know there is at least that much on the Fed’s balance sheet at their disposal.
When asked in December 2010 on 60 Minutes if he felt confident that he could prevent inflation from getting out of control, Chairman Bernanke answered that he was 100% confident that he could raise rates in fifteen minutes to slow down the economy and stop inflation from becoming a problem. Everyone should not doubt this, except for the “fifteen minutes” part. If the Fed sprayed $4 trillion in notional value of bonds from those fire extinguishers onto the open market, interest rates would skyrocket and put the flames of an economy burning too hot out in fifteen milliseconds! For the record, I should note that the modern monetary theory (MMT) community is not a big fan of quantitative easing (QE), or large-scale asset purchases (LSAP). MMTers would prefer that the Fed simply leave short-term overnight Fed Fund rates (which influence all interest rates throughout the economy) permanently at zero, then leave it to Congress and the President to deploy fiscal policy measures to stimulate the economy and to increase aggregate demand. MMTers argue that the Fed buying Treasury bonds to lower interest rates and provide economic accommodation is a wash at best because the drastic reduction of interest income payments to holders of all bonds acts like a tax, another drag against spending. QE causes lost interest income that would have been spent into the economy, thus negating any monetary easing effects, or may even worsen an already existing deflationary bias. In contrast, the Federal Reserve Bank sees fixing a weak economy as the domestic side of U.S. national defense, and LSAP as a crucial mobilization very similar to any war effort—an economic battle that calls for a sacrifice, of savers’ dollars, which are enlisted and put in uniform as dollars of spenders. If all goes according to the Fed’s plan, those dollars will be deployed as consumption and investment, and rally other dollars of savers to also become dollars of spenders. Hopefully, policymakers will stop bickering with each other, get out of their foxholes, and join the war effort. Victory is achieved when the allied forces of spending-dollars have marched forward in a combined offensive with enough velocity and increased aggregate demand to defeat the debilitating deflation that threatened the country before those savings-dollars were deployed.
When attempting to describe LSAP or QE by the Federal Reserve Bank, the pundits and financial mythologists frequently use the words “debt monetization” on the airwaves and in the newspapers. Some critics go even further and accuse the Fed of engaging in “debt monetization to finance federal deficit spending.” LSAP is often confused with yesteryear’s monetizing of the debt. During the gold standard era, ‘debt monetization’ meant a permanent funding of Treasury bonds forced upon the Fed by the Treasury department during an inflationary time when the economy was suffering from an excess of dollars. LSAP means a temporary funding of Treasury bonds at the Fed’s discretion, and done only in the event of disinflation, or weak aggregate demand suffering from a shortage of dollars. Monetizing the debt, or permanently using newly printed dollars to fund deficit spending in a strong economy that didn’t need them, was pro-cyclical, making economic conditions worse. LSAP, temporarily using newly printed dollars to fund deficit spending in a weak economy, is countercyclical, or makes economic conditions better. Monetizing the debt refers to the bygone gold-standard era when the federal government issued Treasury bonds with low rates pegged by the Treasury Department, with the goal (with their goal) of balancing the budget by financing the debt as cheaply as possible. Quickly after WWII, when inflation was rising dangerously, the Fed, with the goal (with their goal) of balancing the economy, was not pleased at being forced to buy Treasury bonds, or more precisely, funding these Treasury bonds, or monetizing the debt, with newly created ‘high-powered’ printed money and at low interest rates unsuitable for the prevailing economy. Prior to the Korean War, the Fed chairman at the time, Marriner Eccles (who designed the blueprint of President Franklin Delano Roosevelt’s New Deal), argued that investor dollars, or dollars that were previously printed and that already existed in the money supply, should buy these Treasury bonds instead. Rather than a dollar ‘add’ of high-powered, newly-printed, freshly-created dollars, Chairman Eccles (correctly) argued to ‘drain’ dollars out from the economy to prevent inflation. As explained in Chairman Eccles’s recollections, Beckoning Frontiers, this rift was resolved, and the Federal Reserve Bank was given independence from the Treasury Department in the game changing Fed-Treasury Accord of 1951. Two things you can conclude for sure whenever a critic says that the Fed is monetizing the debt: (1) The person saying that isn’t quite sure what ‘monetizing the debt’ really means, but (2) no matter what it is, the speaker’s ignorance has made him or her fearful of and biased against all that federal-gov’t ‘money printing.’
The words ‘printing money’ have different meanings for different people. For this chapter, ‘printing money’ simply means what most people (correctly) think it means: federal government deficit spending. More specifically, it is any money creation that enters money-supply circulation. Meaning that the nonfederal gov’t (as well as the federal gov’t) ‘prints money’ too—which is what American economist Hyman Minsky meant when saying “Everyone can create money, the problem is to get it accepted.” The only difference between the two is that when the federal government creates money, they can take a little longer than the nonfederal gov’t paying it back. In fact, the last time that the federal gov’t paid back any money (the last time that the national ‘debt’ went down), was in 1957. Yes, you read that right, the national debt DID NOT go down during the budget surplus years of President Clinton—another difference between quote unquote ‘debt’ of the federal gov’t and actual debt of the nonfederal gov’t (actual debt of households). households).
An easy way to think about ‘printing money’ (money creation) is to forget about the money being created and instead think about the BOND being created. Just like the federal gov’t that creates a Treasury bond in order to create money (in order to deficit spend); the rest of us, the nonfederal gov’t, also creates an IOU, a promise, a ‘bond’ to pay back the newly-created money with interest over a set period of time. That newly-created bond—conjured out of thin air—is the starting point. If there is any takeaway that readers should get from this chapter, let it be this: It’s better to think of all money creation (deficit spending) as being the newly-created bond—not the newly-created money. Whether the federal gov’t is deficit spending (creating a bond) to put a rover on Mars; or you are deficit spending (creating a bond) to drink a cup of Starbucks, that newly-created bond is first and foremost. It’s been that way for a long time—since a damsel named Faith first hooked up with a stud called Creditworthy—way before we started ‘printing money.’
What is money printing—or, more specifically, who is printing money? Money is printed by both federal-government deficit spending and nonfederal-government deficit spending. Everybody is printing money. The Federal Reserve Bank, along with other financial intermediaries in the business of credit extension, facilitate the printing of money by everybody else. Your VISA card company doesn’t call you and say it just printed money into your account so go out to eat somewhere nice. Just like when the federal gov’t approves ‘printing money’ (approves any deficit spending); when we, the nonfederal gov’t authorizes it; the Fed and the banks (and the credit card company) acting as financial intermediaries (as middlemen), assist us. The point being that we shouldn’t point our fingers at the Federal Reserve for ‘printing money’. For example, to help contain the credit crisis in 2008, Congress actually printed all that money for the Troubled Asset Relief Program (TARP); the Fed tapped the keyboard and recapitalized the troubled institutions only after Congress authorized it. Congress printed that money, not the Fed. The U.S. bailouts turned out to be a good political decision. The dollars printed by Congress for targeted rescues were very successful, albeit despised by the general American public. By December 2014, every penny ($426 billion) that was ‘printed’ by Congress for TARP to rescue firms needing bailouts actually turned a profit.
The Fed really only monitors, or regulates, money already printed by everybody else until one of two corrective actions is needed. The Federal Reserve Bank is like a box that is connected to all the tubes that all the dollars in the world flow through. On top of that box are two light bulbs. If the money is circulating too fast, meaning too many dollars are chasing too few goods and services, one of those light bulbs turns on. That means that the Federal Reserve needs to flick a switch that decreases, tightens, or ‘drains,’ money from the monetary base, (from the Fed’s Reserve account to the Fed’s Securities account), to raise interest rates and prevent the economy from overheating and causing inflation. Conversely, if money is circulating too slowly, meaning too few dollars are chasing too many goods and services, the other light bulb turns on. That means the Federal Reserve needs to flick the other switch that increases, eases, or ‘adds,’ money to the monetary base, (to the Fed’s Reserve account from the Fed’s Securities account), to lower interest rates and prevent the economy from stalling and causing deflation. Most of the time, the Federal Reserve Bank is not printing money (is not intentionally trying to add newly-created dollars to the money supply) but simply regulating the flow of all the money already printed by everybody else. If unemployment is low, and prices are rising at the Fed’s desired pace of about 2% per year, then neither of the light bulbs is on and the Fed is achieving its dual mandate
Much of the criticism regarding money printing comes from a fear that the more money is printed by federal-government deficit spending, the more it devalues the dollar. This is absolutely true, but rather than fear the devaluation, or debasement, or dilution of dollars, we should try to understand it better. Since the United States left the gold standard, instead of being a user of dollars similar to using a credit card whenever deficit spending, try to think of it as if the federal government, now as the issuer of dollars, is now using a debit card. Every time the federal government deficit-spends and prints dollars, the purchasing power of all outstanding dollars decreases, just like the float of all stock shares of one company dilutes every time that company issues more shares. If diluting the outstanding float of a particular company’s shares was bad, a company would never issue more shares. However, a company issues more shares routinely and intentionally, with the explicit goal of growing the company. For example, a company may issue more shares to be used to purchase more factory equipment, acquire another company, or incentivize executives to improve results, so that hopefully, in the long term, the company increases profits, successfully grows, which benefits all shareholders. Any shareholder would much rather have a smaller percentage ownership of a company that routinely issues more shares to grow that company, than a bigger percentage ownership of a company that was not issuing more shares, not making an effort to expand, and not growing at all. The same goes for any user of dollars. A user of dollars should be glad that the issuer of dollars is printing more dollars, which grows the economy and widens prosperity. There is no doubt that the American quality of life keeps getting better, our standard of living is constantly improving, and our per capita wealth remains higher than most people around the world, a direct result of U.S. economic growth, that in large part is made possible by the intentional devaluation of dollars by the Fed.
For example, since the United States left the gold standard, the spending, or purchasing, power of one U.S. dollar in 1971 is now less than 20 cents. Here’s another way to look at this: An 80% devaluation in about 40 years means that since then, your money lost roughly 2% per year. The Fed calls this 2% per year shrinkage of your dollar mild inflation, but far from being a problem, this is actually intentional, the secret sauce that makes our economy so dynamic since it left the gold standard. The federal government as issuer of dollars has monopoly power over dollars, and this shrinkage is part of its design embedded in dollars. The Federal Reserve and the other major central banks around the world are all targeting a mild 2% inflation rate. 2% inflation is a desired rate for any central bank because it gives consumers the most purchasing power while still staying a safe distance from a dangerously low zero or negative inflation rate (deflation). As mentioned previously, modest inflation is that ‘use it or lose it’ functionality purposely built into dollars to prevent savings gluts, to promote risk taking and investing, which grow the economy. The federal government needs you to spend your dollars, not sit on them. When it comes to dollars, the federal government, the issuer of dollars, the creator of dollars, is just like your creator, your parents, chasing you out of the house so you don’t sit around all day. The federal government reminds us all that our dollars on account, just like our time on earth, are disintegrating, so get busy.
For example, the reason that required minimum distributions (RMDs) exist in traditional individual retirement accounts (IRAs) is not that the federal government needs to confiscate the taxes from that money to finance itself. The federal government needs you to spend all that money and to help stimulate demand, not die with a pile of cash that you could have enjoyed during your life and deployed sooner into the economy. Another example, in June 2014, ECB President Mario Draghi adopted a –0.1% interest on the deposit rate, a first for such a large central bank. This meant that commercial banks would have to pay to leave reserves at the ECB instead of lending them out. This could be a test drive that may portend what new tools central banks are planning to use to arrest deflationary forces in future monetary policy. If, let’s say, federal governments were to eliminate all cash currency and coins (some costing more to make than they are worth) to streamline the drag of counting out change during everyday transactions or to perhaps try to reduce off-the-book, underground economic activity, you would not be able to withdraw cash out from your bank to escape a negative interest rate. To avoid this devaluation, this ‘tax,’ you would have no choice but to put your dollars to work—exactly what every central bank wants. Therefore, despite what you hear, dollar devaluation, deficit spending, and money printing, when used and understood correctly, actually play important roles in growing our economy.
An example of out-of-control money printing is the credit crisis of 2008. Access to credit was overextended to non-qualified home buyers. Mortgage lending standards evaporated. We all drank the Kool-Aid. Everyone was convinced that home prices would keep going up: the home buyers, the real estate brokers, the mortgage loan companies, the politicians, the Fed, the banks, the traders, the rating agencies, and the buyers of collateralized debt obligations (CDOs) infected with toxic sub-prime loans—everyone except the home sellers and the people who bet on a mortgage market meltdown using those synthetically created CDOs intentionally designed to pay off when the mortgage market crashed.
An example of controlled money printing that grows our economy goes something like this: Someone borrows money from a bank to buy a home. He signs an IOU over to the bank and gets the money. That is how the nonfederal government monetizes debt. Nonfederal-government debt monetization occurs the moment anyone borrows, or sells his indebtedness for money. Next, the bank sells that IOU, now a mortgage loan, to the Government National Mortgage Association (Ginnie Mae), a direct arm of the federal government. Ginnie Mae buys mortgage loans from all the banks and mortgage loan companies to expand the mortgage bond market, to provide greater liquidity for more mortgage loans and achieve its goal of promoting increased home ownership. Ginnie Mae takes that mortgage loan and other mortgage loans purchased from other banks and, through a process called securitization, creates a mortgage bond known as a Ginnie Mae bond. Ginnie Mae bonds are ultra-safe and liquid because they have an explicit guarantee, or backing of the federal government. Unlike a Treasury bond, this Ginnie Mae bond is actual debt of users of dollars, the nonfederal government. That Ginnie Mae bond is sold to individual investors through mutual funds, or through banks and broker dealers, to institutional investors like pension funds. Other investors may also buy and sell those bonds during the normal course of daily Wall Street bond trading, and all of this is a normal part of growing our economy.
The part that is not normal is the credit crisis of 2008, which the Fed responded to by starting LSAP. That Ginnie Mae bond and other mortgage bonds known as Fannie Mae or Freddie Mac agencies or mortgage-backed securities (MBS), were all eligible for monthly purchase by the Federal Reserve Bank’s LSAP program. The Fed bought all these bonds back to manipulate the price of money—this time in the form of mortgage loan rates—downward, to attempt to specifically stimulate the housing market. Most people in general again confused this with debt monetization, but it’s more like debt monopolization. Those mortgage bond holders forced to sell their bonds to the Fed would much rather have those bonds back rather than have all those cash dollars in a low-interest-rate environment, but they had no choice—another example of the complete monopoly control of dollars that the federal government, the issuer of dollars, and its fiscal agent, the Federal Reserve Bank, holds.
At the end of the day, what has really happened? Instead of the federal government just providing liquidity to banks and mortgage loan companies to promote home ownership, the federal government has taken the banks and the mortgage loan companies out of the picture. The federal government is now directly involved in the mortgage loan business, directly providing credit to those seeking to finance spending on homes. If any criticism or complaint is made that the federal government is ‘monetizing debt’ or ‘printing money’ to finance spending on homes, is that true?
The answer is no. The answer is no because the nonfederal government, the home buyer is the one who monetized debt and printed money. The home buyer monetized debt at the moment he received the money in exchange for signing a mortgage, at the moment he was approved for the loan. This nonfederal-government deficit spending is how the economy grows, the way the money supply increases. The Fed can keep filling that trough with low-interest money and lead the horse to that water, but only aggregate demand—like someone borrowing to own a home—only that horse, can drink the water.
Another key to understanding modern monetary theory (MMT) is to also see how the nonfederal government in our modern monetary system prints money, or creates deposits on the operational level. Using the above example of getting a mortgage loan, on the operational level, money was given (debited) from the mortgage lending bank to the home buyer, and that loan amount was posted (credited) on the books of the lending bank as an account receivable (equal and opposite). The bank that lent the money to the home buyer then created reserves—or, more specifically, created a deposit in the Reserve account at the Federal Reserve Bank—to cover a necessary reserve requirement that is always done for any bank liability like a new loan obligation. Note that the loan (the home buyer) created (printed) the deposit (money). That is how the entire nonfederal government, the users of dollars, prints money—by borrowing it. The home buyer, or anybody else in the nonfederal government, prints money—or, more specifically, creates deposits—by borrowing money, by taking out loans, a necessity anytime the nonfederal government deficit-spends. This is why the Fed increasing reserves during LSAP does not automatically result in increased borrowing, or more printing of money by people. The Fed wants people to increase borrowing, the Fed is trying to encourage the people to print money, but increased borrowing is not automatic. This is a crucial concept of MMT: Loans create deposits, not the other way around; and as explained above, your newly-created ‘bond’ create loans create deposits. You don’t borrow a million dollars from a bank because the bank has a million dollars; the bank has a million dollars in loan receivable assets because you borrowed that amount. You didn’t take out a mortgage because the Fed printed money; a reserve requirement on deposit was printed at the Fed because you took out a mortgage.
The federal government, the issuer of dollars, also prints money by spending more than it receives, by deficit spending. For example, the federal government prints money when it orders up and pays for an aircraft carrier. Federal-government deficit spending and nonfederal-government deficit spending together interact in an economic ebb and flow of demand between the issuer of dollars and the user of dollars. Money is created, or printed, by an initial demand by either the federal government or the nonfederal government. The Fed watches over all this money printed by everyone else, studies the effect that all this money is having on the prevailing economy, and through monetary policy, attempts to regulate future demand.
That demand from both the federal government and the nonfederal government, or total aggregate demand, is crucial for money to keep being created, for the velocity of dollars to keep going, ensuring that our economy keeps growing. If the demand from us, the nonfederal government, starts to leak, then the federal government needs to take up that slack, to recover that demand leakage. It is much better, though, if demand from us—that is, nonfederal government demand—is strong enough to not need federal government demand, to not need the federal government to ‘prime the pump.’ That home buyer may have decided to borrow, or to print, the money to buy that home because his job is going well, or because he feels confident about the future and maybe even plans on borrowing more in the future. This represents healthy demand and is why nonfederal government borrowing is so important for a growing economy: Nonfederal government deficit spending prints money from, or is pulled by, real demand; whereas federal government deficit spending tends to print money for, or is pushed by, artificial demand. For example, money printed into the economy from federal-government pork-barrel deficit spending may not have as much velocity as money printed into the economy from real demand from nonfederal-government deficit spending. Just like a rope, money printing works better when it is pulled, not pushed, so conditions need to be created that provide an environment that encourages money printing by the nonfederal government. If an environment is created that encourages money printing by the nonfederal government, then the economy is growing organically, and won’t have to rely so much on ‘money printing’ by the federal government.
THE DEBT CEILING
The debt ceiling is an anachronism of a bygone era when the U.S. dollar was backed by gold, when the federal government needed to acquire that gold, an era when both the federal and nonfederal government were users of gold. An era when the federal government, like everyone else, had to exchange something to get dollars. Created in 1917, the debt ceiling replaced a previous policy in which each spending appropriation had to be approved, so to avoid having to legislate each and every single bond issue, Congress gave a limit, like with a credit card.
Today, however, a credit card for the federal government, the issuer of dollars, is no longer like a credit card for you and me, the users of dollars. Both the nonfederal government and the federal government print money. The big difference is that when the nonfederal government prints money, those users of dollars are in debt, but when the federal government prints money, it isn’t in debt. We dollar users have to get dollars to pay a credit card balance back because we cannot issue dollars to pay the balance like the federal government can. A credit card limit is a constraint on all of us, the nonfederal government, because we all need to get the money to pay back our debts. The federal government, the issuer of dollars, will never run out of dollars; therefore the debt ceiling today is an arbitrary and unnecessary vestige from the past. The federal government creates dollars, so it always has the ability to make dollar interest payments on Treasury bonds. The United States will never default on its Treasury bonds unless intentionally because of suicidal politicians. There should be no fear of the federal government spending beyond a ceiling, nor even the mention of a default. Until the debt ceiling stops being used to threaten a default, the theatrical fights over it that caused the 1995, 2011, and 2013 debt-ceiling crises (and that will cause future crises) to come were (and will be) nothing more than dangerous power grabs.
The key to understanding why the debt ceiling and the debt-ceiling fights are meaningless is knowing that since leaving the gold standard, the nonfederal government and the federal government are playing the same game but by different rules. The nonfederal government prints money but has to finance it because it doesn’t issue dollars, while the federal government prints money but doesn’t have to finance it because it does issue dollars. Our credit cards have credit limits that are real because we can’t issue dollars, whereas the federal government credit limit called the debt ceiling is not real because the federal government can issue dollars. We dollar users have to get dollars to pay our credit cards, which is a problem, but the federal government can issue dollars to pay its credit card, which is not a problem.
To be fair, an important point of view in the debt-ceiling debate is the concern held by many that every time the government raises the debt ceiling—every time more Treasury bonds are issued—the federal government is mindlessly spending money. That depends. If an economy is growing rapidly, inflation expectations are increasing, interest rates are ticking up, and everyone who wants a job can find a job, then the federal government would be foolishly spending money by raising the debt ceiling. In that scenario, the federal government would be recklessly fueling inflation, when too many dollars are chasing too few goods, and causing prices to increase too quickly. That should instead be the time to drastically decrease federal-government deficit spending, and even to also consider raising federal taxes if necessary, to hit the brakes on growth as prudent fiscal policy in the interest of balancing the economy, (rather than the interest of balancing a budget), would call for.
At this writing, seven years after the 2008 credit crisis, however, the world economy is facing the exact opposite problem: The aggregate demand for goods and services is simply not strong enough; we are still suffering from a dangerous and threatening worldwide disinflation. We may not think the economy will get worse, but it may. We may not see people standing outside in bread lines like during the Great Depression, but they are—only out of eyesight, because the unfortunate masses today get assistance electronically. Too many people have given up hope of finding work and have dropped out of the labor force for good, which sugarcoats the unemployment rate. We are now in a generational demographic shift that started in January 2011 when 10,000 baby boomers began turning sixty-five every day, half of them with inadequate savings, dependent on family, on government, and on Social Security to survive, and that continues, another 10,000 each and every day, until the year 2029.
That was the bad news. Now here is the good news: In October 2014, the Fed ended the LSAP program, which breathed a sense of relief to everybody, especially because all other major developed economies across the globe still needed aggressive monetary policy. In the November 2014 U.S. midterm elections, the Republican Party scored decisive victories and won full control of the Congress, so with that and the Democratic Party in the White House, everybody in America now at least has something to like in Washington, DC. With all uncertainty removed for the next two years, both political parties can focus on actually governing and effectively legislating for positive results to show their constituents for the next national election. Add to this equation recent plunging oil prices, meaning less money required to fill up our gas tanks and heat our homes, and you have the perfect environment for a potential economic breakout.
Meanwhile, more federal-government deficit spending (stimulus spending on infrastructure for example) will still be needed to help attempt to make up for the massive slack in aggregate demand, to help get the unemployed back to work, to help increase skills, which helps increase wages, to help keep our economy, and the global economy, from stalling or even possibly slipping into a perilous deflationary spiral. Increased federal government stimulus spending, lower federal taxes, (fiscal policy) and low interest rates (monetary policy) play only a part in getting our economy back to full strength. Broader solutions and comprehensive reforms to boost competitiveness are needed to get us, the people spending more. Putting more purchasing power back into the hands of consumers, with fiscal and monetary policy rowing in the same direction, plus a surge in confidence throughout the country from a true belief that the federal government is working well to improve our lives, is the only way to get a weak economy back to being strong again. Let’s hope our politicians engage in that debate.
THE NATIONAL DEBIT
The concept of U.S. national debt is a fossilized, American antiquity, a vestige of our gold-standard era. Since the gold standard era ended, the federal government operates under a new paradigm, different from when it was a user of gold or gold-backed dollars like everybody else. The U.S. national debt was the total, or the accumulated amount, of all the federal-government deficit spending ever done to date—that is, the amount of money our federal-government deficit spent from its very first year as an independent nation since funding the Revolutionary War, plus all the years of deficit spending in the years that followed. Each of those years of federal-government deficit spending, added up, that grand total, even to today in the twenty-first century, is still called the U.S. national debt, because even to this day, it is thought by most people that our federal government is still in debt, just as if it were still a user of gold. Since the federal government changed from being a user of gold or gold-backed dollars into the issuer of dollars, dollars that are neither convertible nor fixed to anything, however, the national debt is no longer a debt at all. If that clock in midtown Manhattan weren’t there only to create a sensation, it would correctly say the national debt is $0.00 instead of ticking ominously ever higher. Better yet, let’s start calling our national ‘debt’ and that $18-odd trillion on that clock the national debit.
There is no federal-government national debt, nothing to worry about, no burden on your children, and no danger to the financial stability of the country, because all Treasury bonds are denominated in dollars. The federal government can always issue dollars backed not by gold, which is limited, but instead by our full faith and credit, which is unlimited. Contrary to a user of dollars like a local or state government, the federal government cannot run out of dollars. The economic fact of life today is that our federal government, the issuer of dollars, never, ever, lacks the means to finance itself.
On August 15, 1971, when President Nixon ended both the Bretton Woods system and the convertibility of our Treasury bonds to gold, our country’s cumulative national debt changed from being a historical debt of gold, gold-backed currency, or gold-backed Treasury bonds to just an accounting entry, a ledger posting, a debit of dollars by the federal government, the issuer of dollars. Today, in the post-gold-standard era, in our modern monetary system, when the federal government deficit-spends, or ‘prints,’ money, because it is no longer a user of gold or a user of dollars like everybody else but is instead now the issuer of dollars, the federal government no longer needs to borrow to finance spending. Buyers of Treasury bonds are not financing the federal government anymore. Nobody is lending our federal government anything. Our federal government, the issuer of dollars, doesn’t need to get dollars from anyone. Congress authorizes spending, the count is kept by an accounting credit entry, or addition, in outstanding Treasury bond issuance, and these new issues of Treasury bonds are auctioned, sold, and assigned to new owners in book entry (electronic) form. Simultaneously, the Fed, as the agent of the federal government, by fiat, by computer keystroke, simply debits dollars. These newly created, freshly printed deficit-spending dollars are distributed from the issuer of dollars to the users of dollars. Each year’s deficit spending by the federal government equals the amount of net savings to the nonfederal government to the penny. (That is not conjecture, it is an accounting identity like assets equal liabilities plus capital). Far from being a problem, deficit spending by the federal government, the center of our economic universe, is the true source of dollars in the global economy and is therefore crucial to balancing total aggregate demand.
Besides provisioning itself and making national expenditures, our federal-government’s deficit spending balances the economy by kicking that flywheel, a yin-yang of mass production and mass consumption (supply and demand). When the U.S. economy is strong and that wheel has balanced spin, then less kicking, less—or even no—federal deficit spending is needed. If the economy were too strong, growing too quickly, and dangerously close to a spike in inflation, or even a drastic hyperinflation, would decreased federal government spending that creates a surplus be prudent, as long as that surplus were short term and simply slowed, not totally stopped the wheel. Conversely, if the economy were too slow, if amounts of federal spending, or federal purchasing power (fiscal policy) is insufficient— political decisions made between the president and Congress—then it would be up to the Fed, independent yet within our federal government, to counterbalance with needed action (monetary policy) that accommodates the economy until it recovers needed spin from strong consumer purchasing power.
Today, the broad market for all bonds, all debt issuance, is known as the credit markets. This is another example of gold standard mentality, because today all bonds are not debt. Only the users of dollars are in debt when they deficit spend, because users of dollars cannot issue dollars and they must still borrow dollars to finance that deficit spending. The issuer of dollars is not in debt when they deficit spend, because they can issue dollars to finance that deficit spending. Since leaving the gold standard, whenever the issuer of dollars spends in deficit, instead of increasing a debt balance like any user of dollars, the issuer of dollars increases a debit balance. Because U.S. Treasury bonds issued by the issuer of dollars are now debits instead of debt, instead of calling the marketplace where Treasury bonds trade the credit markets, it would be more accurate to call the marketplace where Treasury bonds trade the debit markets.
All bonds other than Treasury bonds are in the credit markets because there is a credit risk, or a chance that the bond issuer may fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Treasury bonds should not be thought of as being in the credit markets. Treasury bonds are issued by the issuer of dollars, and because the issuer of dollars can always issue more dollars to make interest and principal payments in dollars, Treasury bonds will never fail. There is no credit worthiness to consider because Treasury bonds will never default. The issuer of dollars can never go bankrupt, only a user of dollars can go bankrupt. All bonds issued by the users of dollars, however, may default. Because the users of dollars may not always be able to make those bond interest and principal payments, all these bonds other than Treasury bonds may fail, so that is why these bonds of the users of dollars are in the credit markets. Credit rating agencies would most likely not agree with any of this, in fact, Standard & Poor’s reduced the credit rating of U.S. Treasury securities, to AA+, four days after the Budget Control Act of 2011. Keep in mind, however, that credit rating agencies are the same folks that prior to the 2008 credit crisis, had rated many toxic mortgage-related securities, AAA, or ‘Outstanding’.
The debit markets should include not only all U.S. Treasury securities, but all other worldwide federal or national government bonds denominated in a floating, non-fixed, nonconvertible currency like JGBs, and UK Gilts as well. A debit markets designation would clearly separate the cost of capital between the debits of the issuers of currency and the debts of the users of currency. All investors around the globe would be able to distinguish the difference between what are essentially only debits, of the issuers of currency in the debit markets (subject to central-bank manipulation and cannot default), from the actual debts of users of currency in the credit markets (subject to market forces and can default).
In the post-gold-standard modern monetary system, it is crucial for federal policymakers, across the world, to help their users of currency, by balancing the economy, rather than obsess over balancing a gold-standard-era federal budget. In other words, it is no longer a problem for a national budget to be out of balance, it is only now a problem for a national economy to be out of balance. In the post-gold-standard modern monetary system, the only way to get your federal budget moving back towards balance is to first get your federal economy moving back towards balance. On the website of economist Warren Mosler, The Center of The Universe, it states “Mosler’s Law”: “There is no financial crisis so deep that a sufficiently large tax cut or increase in public spending cannot deal with it”. Countries across the world struggling with unbalanced economies should heed this advice.
In Japan, instead of considering a large tax cut to deal with a weak economy, struggling for decades now to fully escape the deflationary forces of contraction, Japanese policymakers increased taxes! In April 2014, because those Japanese policymakers were more concerned with balancing the federal budget, the Japanese government raised the national sales tax, called the Consumption Tax, from 5% to 8%, and with an additional increase to 10% planned for the following year. The result of this nonsensical gold-standard mentality was a recession. As is standard operating procedure with any large tax hike, the Japanese economy promptly contracted both quarters immediately after that tax hike.
Like any country that needs more economic growth, Japan simply needs less taxes, more public spending, and meaningful reforms to get the economy back in balance. Japan should not be worrying about balancing a federal budget. Japan has over one quadrillion yen in outstanding Japanese government bonds (JGBs), double the size of the economy, but so what? Those JGBs are denominated in yen. Yen is a non-convertible, free-floating currency. Yen is not backed by gold, nor fixed to the U.S. dollar anymore, so the issuer of yen will never, ever, have a problem ‘paying back’ anything denominated in yen. Just like a U.S. Treasury bond, a JGB is not actual federal debt anymore, not in the modern monetary system. Today, just like U.S. Treasury bonds, JGBs are not a national debt anymore, Treasury bonds and JGBs are just a national debit. Today, the Japanese government, the issuer of yen, creates yen, deficit-spends that yen, pays that yen, into the economy, to the users of yen, and then those users of yen put it all back, right back into the Japanese government, into JGBs. That is not debt. That is ebb and flow, tidal gravity, ecological transfers, all within one vast and immense, intertwined, interacting, multivariate, multinational, Japanese yen dominion. Japan rose from the rubble of the Second World War to become a free, wealthy, industrialized, modern paradise, the third largest economy in the world, because of all the federal government deficit spending, not despite of it. Getting a federal budget back into balance is not Japan’s problem, getting a national economy back into balance is Japan’s problem. The issuer of yen, with an economy out of balance, simply needs to get more yen, more purchasing power, into the hands of Japanese consumers to buy more goods and services, not just more yen into the hands of central bankers at the BOJ to buy more bonds.
Furthermore, over in the Eurozone, since the 2008 credit crisis, many citizens of the weaker Eurozone countries that did not cause the crisis have been subjected to austerity. This cutting back by some Eurozone citizens makes most others cut back, which creates a so-called paradox of thrift, making overall economic conditions even worse. Meanwhile, Eurozone politicians, with 12% of the Eurozone labor force unemployed, are not making the immediate reforms desperately needed for both immediate-term and long-term economic growth. The ECB wants Germany, the largest economy of all member states in the Eurozone, to consider increasing stimulus spending (demand-side fiscal policies) while Germany wants the ECB to consider pushing for more reforms like labor reforms in weaker countries, like Spain (supply-side fiscal policies). Until Germany and the ECB can come to a solid agreement on ways to help long-term growth prospects throughout the Eurozone, and implement them, the ECB has no choice but to kick the can down the road and increase bond buying.
In a confluence of events in late October 2014, at the same time the U.S. Federal Reserve Bank ended its QE program, the Bank of Japan, with an economy that had just fallen into yet another recession, announced its own expansion of quantitative qualitative easing (QQE). This QQE program included $250 billion, yen equivalent, of more in purchases of Japanese government bonds by the BOJ than previously announced, plus a tripling of purchases of both Nikkei 400 stock index exchange-traded funds (ETFs) and real estate investment trusts (J-REITS) by the BOJ. In addition, sensing an urgency to “do what it must” to lift inflation, ECB President Draghi said he would also like to start another asset purchase program called “public” QE, meaning the start of Eurozone sovereign debt purchases by the ECB.
Only bold politicians making unpopular, but desperately needed tax cuts, shovel-ready stimulus, and real reforms that kick-start consumption will create an environment for long-term economic growth, not just the BUY button of a central bank keyboard.
FULL FAITH AND CREDIT
Investment in Treasury bonds, like any other investment, is generally done for one of three reasons: to simply buy and hold, to hedge against other investment positions, or for speculation (taking the other side of the first two). With the rise of day traders, hedge funds, and full-scale high-frequency trading, the share of speculative activity in the investment realm has also risen dramatically. That space once dominated solely by investment banks is now shared by all kinds of financial-products-and-services firms. This is not because Wall Street has gotten greedier; it is because, as the saying goes, that’s where the money is.
Of course, Wall Street, like any street, has its share of bad actors, but working in tandem with the Federal Reserve, Wall Street has powered capitalism and our country. State-of-the-art technologies with microsecond market price formation enables buyers and sellers to continue coming together here in the financial capital of the world. To know just how much money Wall Street firms are competing for, look at our national debt—or, as I would prefer it be called, the national debit. Nearly $18 trillion at this writing has been debited from the federal government, which issues those dollars, and credited to the nonfederal government, which uses those dollars to grow the economy. Thanks to our fine-tuned, man-made, post-gold-standard modern monetary system, today, the United States of America has the strongest economy on earth.
Full faith and credit in the U.S. federal government, which confers risk-free status in our U.S. Treasury bonds and other securities, is really a full faith and credit in ourselves. It is not just our Treasury bonds and our dollars giving strength (and backing) to our economic system; it is us, we the people. What truly backs our monetary system is us. We are all backed by nothing but the full faith and credit we have in each other. It is a backing, a commitment amongst ourselves, to abide by our laws, to help others, to pursue happiness, and to make the world a better place for our children. The gold standard was replaced by the golden rule.
Most people think of a crystal ball as some kind of magical sphere with which one can perform an act of clairvoyance or pretend to see the future. Actually, the crystal ball is more like a reflection glass. The proper way to read the crystal ball is not to look into the middle of it but to look at the side of it, to see the reflections of the past. What goes around usually comes around, so you can have a lot of success in the future by watching the reflections on the crystal ball, by looking at the past and studying the past, because the past usually repeats. As that saying goes, you yourself should study the past or be condemned to repeat it. Keeping your eye on the reflections will also let you recognize the past if it does go around and reappear on the other side of that crystal ball.
In a June 2012 policy study called Global Aging and the Future of Emerging Markets, Richard Jackson, senior fellow for the Center for Strategic and International Studies (CSIS), warned that “Japan may be on the edge of a new economic era, an era of secular economic stagnation, which certain other fast-aging developed countries will soon enter.” At that same time in 2012, the Unicharm Corporation, Japan’s largest diaper maker, reported that in Tokyo, sales of diapers for the elderly had begun outstripping sales of baby diapers. You can safely assume that you will be seeing a similar statistic about diapers coming around that other side of the crystal ball here in the United States and other countries in the not too distant future.
Studying Japan’s past is an easy way of guessing what will appear on that crystal ball next, and perhaps the easiest way to have guessed what would happen here in the U.S. is to have lived in Japan about twenty five years ago. In October 1987, I had the amazing opportunity to transfer to my company’s Tokyo branch, where I met my wife, Yukiko, and I eventually spent fourteen years living in Japan. My coworkers and I saw several strange phenomena in Japan during the 1990s that came across as very odd to any other recently arrived American expat. For example, twenty five years ago in Japan, during the nineties, there was a lot of concern among the Japanese about their “graying of society.” There was an unusual spike in suicide rates. Many Japanese started losing faith in their government. Young adult Japanese, even though they were employed in good jobs paying well, were having fewer children or none at all, and preferred to live in “rabbit hutch” apartments. Other Japanese, that recently graduated college, were having trouble finding full-time employment, and called “freeters” from the English word freelancers, had no choice but to accept low-paying part-time jobs. Some of these part-timers couldn’t afford rent in Tokyo and, known as “parasite singles,” moved back in with their parents. Many Japanese gave up on ever finding jobs again, some never left their bedrooms, and became known as “the reclusive people.” The Japanese media focused on the shrinking middle class and referred to those increasingly marginalized from the elite as the “gap society.” The Bank of Japan (BOJ) introduced a novel monetary policy invention that became known in the press as quantitative easing, with the explicit purpose of manipulating interest rates down to almost zero to accommodate the Japanese economy and pull it out from deflationary forces that had lasted many years. Pundits ridiculed this dangerous “experiment”, and many opportunistic Japanese policymakers constantly criticized this reckless expansion of the central bank balance sheet. Sound familiar?
My coworkers and I could never imagine that these eerily bizarre events taking place in Japan back then, in the nineties, would ever reappear on the other side of the crystal ball in the U.S. or in other countries, ever again, yet today, a variation of these same themes routinely appears. Since the credit crisis of 2008, here in the U.S., there has been plenty of criticism leveled against the Federal Reserve Bank’s extraordinary monetary policy actions. The war of words excoriating central bank bond buying is now flaring up in the Eurozone, as the ECB contemplates beginning a “public QE”, or an expansion of purchases that will include member state sovereign bonds. Lost in all this criticism, finger pointing, and fear mongering, is who is also to blame for endless worldwide central bank intervention in the markets. Instead of doing nothing, and trying to turn the public against competing parties of the federal government and all the central bankers, policymakers can simply to their jobs, get to work, improve the economy, and that will stop the central banks, that alone will end all the QE. Nobody said that extraordinary monetary policy of central bankers is the cure-all for an economy in crisis. Extraordinary monetary policy just buys time so policymakers can do what actually needs to be done to cure an economy in crisis. One the patient is put under sedation, that’s the time for the surgeons to operate, not start bickering with the anesthesiologists. Just as in normal economic conditions, you have to first balance your economy in order to balance the federal budget; policymakers need to first make the extraordinary fiscal policy changes that will grow the economy out of crisis, in order to end the extraordinary monetary policy.
Most of the fear propagated by politicians, pundits, and market gurus has a purpose. They repeat inaccurate myths to exploit your fear and use it to gain power, ratings, or your wealth. Some politicians are uncomfortable with the immense power that the Federal Reserve Bank wields, especially because the less effective those politicians are in their fiscal policies, the more aggressive the Fed has to get with its monetary policies. These politicians despise the Fed’s independence and that the Fed does not take orders from them. Some pundits on the airwaves need to keep scaring you constantly so you keep watching their commercials. Some investment gurus will frighten you into thinking the worst—that Social Security is a Ponzi scheme, for example—to goad you into letting them handle your finances. A dubious salesman will insist that the dollar will soon be worthless, to convince you to buy gold or to bet against the country by using his products. Anyone with a trade position against the American economy getting stronger will commonly ‘talk his book’ and predict financial Armageddon to make those bets pay off. Supporters of a special interest may invent a fake or simulated problem caused by some nonexistent threat to gain power, or it is possible, that they just aren’t sure what they are talking about. People spreading fear may just not understand our modern economic ecology and may cling to the old understandings, the old instruments of the past, as if our economy leaving gold was just like a rocket in initial flight, still pulled by the forces of gravity; that rocket, however, had a booster separation and left those forces of gravity (gold) and entered outer space as a capsule. Thus, we have many people today struggling with the controls, with that instrument panel, not understanding zero gravity, and thinking like old-school pilots instead of space-age astronauts
Do not fear of a default of our Treasury bonds, or of our dollars becoming worthless, or of our monetary system ever collapsing, but only of a weakening of that full faith and credit that we have in each other. As long as we continue to believe in each other, our country’s achievements, like our dollars, are truly unlimited. The next time you hear or read someone once again trying to scare you about the national debt or our country going broke, just remember that one of two things is happening: (1) The speaker knows that what he or she is saying is not true, but the speaker needs you to believe it to advance some agenda, or (2) the speaker has no idea what he or she is talking about. Ask yourself which is worse. Then sit back, tune out the noise, and have full faith that the use of fear to weaken your full faith, will, like many other things in this life, reappear on the other side of that crystal ball again.
Marine mammals that live in the sea must surface to take gulps of air. These mammals are always conscious of how much oxygen they still have left, because this fixed amount determines when they need to resurface for more. This is how our monetary system worked in the gold-standard era. The dollars in our national economy, like oxygen inside those lungs underwater, was constantly limited. The range, or potential, of our economy was constantly limited. Then, just like a mammal that evolves from the sea, our monetary system evolved. Our federal government, the issuer of dollars, like that evolved mammal, is no longer limited by a fixed amount of air, unlike those other mammals, the users of dollars, which were left behind and remain in the sea. Like that evolved mammal, with newer powers, that now roams the land, no longer needing to be concerned about its source of oxygen or of running out of oxygen, our post-gold-standard modern monetary system has many other, much more important, things to worry about.
Let’s circle back to the beginning of the book and the analogy of points on a scorebook, but now I want you to imagine that you are walking home from that stadium after the game. To sustain a leisurely stroll, you breathe at a natural, steady pace. Every fresh breath of oxygen going right into your lungs is like fresh deficit-spending dollars going right into our economy. If you then start walking up a steep hill, you naturally need to breathe more heavily, you need to breathe more of that oxygen; and just like an economy currently in a more difficult position, the economy would need more dollars, more economic oxygen. Just an increase in oxygen isn’t enough, however. You need much more help to get up this hill; you must have more effort from the rest of the body. Just standing there, taking huge gulps of air won’t get you up that hill, just like QE adding reserves alone will not automatically cause the economy to move to a better position. The national economy needs the two legs, mass consumption and mass production, to work together, striding powerfully to make that climb. The national economy also needs the two arms, Congress and the president, working in sync, not just hanging there, unmoving. Afterwards, once you resume walking in a balanced pace on level ground again, that would be the appropriate time to breathe more easily; and likewise, for the economy, only then should federal deficit spending to be restored back towards balance as well. Once back to a ‘normalized’ walk on level ground, you should just let the rest of the body do the work, resume normal breathing, without having to heavily gulp oxygen anymore. Understanding the concepts of modern monetary theory will help you enjoy that walk, and not worry about being in debt for how many breaths you took when climbing that hill or having to pay back that oxygen. Just like you do not pay back the air you breathe to supply your body with that air, the issuer of dollars also does not pay back the dollars it creates to supply their economy with those dollars (nor do we have to put all that gold that we dug up back underground).
To help understand modern monetary theory (MMT), one must have an open mind, and may need to unlearn many mainstream beliefs regarding the monetary system. Common understanding about financing the federal government or our monetary system inaccurately pertains to how it worked in a now outdated gold standard era. The further away that our monetary system moves beyond that gold standard era, the less understanding there is about our monetary system, which only increases the frustration many people have with Washington. Before you even begin to understand MMT, however, you need to check your political bias, as well as any gold standard mentality, at the door. Be willing to consider an opposing viewpoint, and try as hard as possible to think independently. The Federal Reserve is independent. The Fed has no political bias. To truly understand the Fed and our modern monetary system, neither should you.
The more that the concepts of modern monetary theory begin to make sense, the more that the concepts of political theory may begin to make sense as well. For example, in MMT, all of the users of dollars, the households, the businesses, the local and state governments, all must live within their means, balance their budgets, and avoid getting into too much debt. Traditionally, this is the purview of the Republican Party. Fiscal conservatism is a core pillar of the Republican Party’s principles, and the most to benefit from fiscal conservatism are the users of dollars. No doubt a good reason why, at this writing in 2015, Republicans have full control of both houses of Congress, (54% Republican Senators, 57% Republican Representatives), and 62% of U.S. states have Republican governors. On the other hand, the federal government, the issuer of dollars, since leaving the gold standard, should be more concerned with balancing the national economy than balancing a federal budget. In the post-gold-standard modern monetary system, the President of the United States should also be thinking beyond balanced budgets, greater profits, or healthy balance sheets; the federal government, the issuer of dollars, should also be thinking about a balanced economy, greater prosperity, and healthier citizens. Traditionally, this is the strong suit of the Democratic Party. Liberal thought tends to concentrate on those needs that are of higher importance for the issuer of dollars, like more equality, greater tolerance, and the expansion of opportunities, for all. Therefore, both the issuer of dollars and the users of dollars need and depend on both political parties. The better both political parties work together, the better off both the issuer and users of dollars are.
Just try to not let yourself be led to believe from others constantly telling us how to think that one political party is good and the other is bad. That is not rational. Politics is not sports. On any given Sunday, you should watch both teams through an independent prism and cheer for the team, the political party, which has the best idea. A spirited clash on the field of ideals, between competing political parties, always going head to head, will usually result in a moderate compromise, and a huge win for all Americans. Being a free country, free to disagree, which encourages constant debate, and constant improvement, may not always be so pretty, but is definitely the quickest, most efficient way to become a stronger nation.
Our economy is no longer financially constrained, nor quantified by chests of gold as in our past or in the pasts of others. Our economy, just like our dollar, is now held back only by a limit of imagination and reach of innovation. Today, our monetary system is untethered. Issuers and users of dollars are backed by nothing more than the full faith and credit in our federal government and in each other. This alone is enough to make our dollar the world’s reserve currency, the payment of choice across countries, and the money supply of Earth’s greatest economy—an economy kept resilient to external shock by expert handling by the Federal Reserve Bank. Many critics try to convince us otherwise, that instead the Fed’s actions are a threat to the financial security of the country. For example, critics of the Fed will try to convince you that the Fed’s actions will cause some calamity such as hyperinflation, or a collapse as in the German Weimar Republic. The truth, however, is that the currencies of Weimar or Bolivia or any other country that collapsed were fixed or convertible to something. There is no example in history of any government collapsing from hyperinflation with a floating, nonconvertible currency like the U.S. dollar. Instead of listening to misinformation and standing too close to the gold-standard-mentality picture, we should all step back, understand modern monetary theory, and marvel at the totality of the masterpiece that is our post-gold-standard, modern monetary system.
U.S. Treasury bonds play a crucial part in the function of capitalism which powers the largest economy in the world, and the greatest nation in history. Treasury bonds serve as electronic postings, or debit entries of money printed by the federal government, to equally offset all deficit spending (to equally offset all those credit entries made to the nonfederal government). All money printed, or all dollars issued by the federal government and spent into our economy adds to the national debit balance—the total amount of outstanding U.S. Treasury bonds. During the gold standard era, when dollars were convertible, or fixed, that balance of the national debt was an actual debt to the federal government—because it was denominated in gold-backed dollars and the federal gov’t could not create gold by fiat. Post-gold-standard however, dollars are no longer convertible to gold, dollars are free floating, and so today, that national debit balance is no longer a ‘debt’ to the federal government—because it’s denominated in dollars that the federal gov’t can create by fiat. Take a dollar bill out of your wallet. You are looking at a perpetual ‘bond’ with a 0% coupon. Treasury bonds are just dollars with a maturity date and a coupon (and since the national ‘debt’ hasn’t gone down since 1957, now in the post-gold-standard era you could consider them all ‘perpetual’ as well). Think about that, the federal government is exchanging their ‘dollars’ (which they have an unlimited amount of) for your blood, sweat and tears (which you only have a limited amount of)—and the federal gov’t will do that trade All.Day.Long. So rather than think of it as a ‘debt’, that national debit balance is better thought of as an asset of the nonfederal government (on the left side of their balance sheet); and, as a rolling, or perpetual, ‘bondholder’s equity’ of the federal government (on the right side of their balance sheet). Every penny of that public-held national debit balance is saved in U.S. Treasury bonds by the nonfederal government, and it always remains within the U.S. dollar dominion of the sole issuer—the U.S. federal government’s banking system. That national debit balance of Treasury bonds represents the total amount that was needed ever since the founding of our nation to keep the promise of democracy to all Americans. Today, that national debit balance equals the confidence that all users of dollars around the globe currently have in the United States. The higher the amount of that national debit balance, the fuller the faith and credit the world has in our nation. That national debit balance will grow and will continue to underwrite freedom and prosperity to all humanity. That balance, the national debit, credited out to us, to We The People, benefiting all mankind, is a true treasure and “if it is not excessive will be to us a national blessing”. Alexander Hamilton (the guy on the ten-dollar bill) was right.