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Fairy Tales of the Coming State of the Union: The Government Is Running Out Of Money

letsgetitdone's picture

In "All Together Now: There Is No Deficit/Debt Problem,” I warned against the message calling for deficit reduction that the President will probably deliver in his State of the Union Address next month. I argued that there was no deficit/debt problem and that it is essential to reject the President's framing of the issue and move on cope with the real problems of the economy and American Society. That piece stands alone. But I also think it would be useful to examine each of the specific fairy tales the President is likely to tell in making his case justifying austerity measures which are certain to be counter-productive. This post focuses on one these fairy tales; the narrative that the Government is running out of money.

We first heard that from the President on May 23, 2009 in a C-SPAN interview with Steve Scully There he said:

SCULLY: You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?

OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we've made on health care so far. This is a consequence of the crisis that we've seen and in fact our failure to make some good decisions on health care over the last several decades.

Since then, the President has reinforced his view that the Government is short of money, especially when he created the National Commission on Fiscal Responsibility and Reform. But, in addition, he's always acted as if he believes the Government has a Government Budget Constraint (GBC), and he's never acted as if he believed that the Government is in a unique position because it is the issuer and not just the user of its own currency.

What’s really behind this angst is, ostensibly, the mistaken idea that the Government can run out of money and so go broke, and that it is doing so. But this fear, if it is real, is due to a misunderstanding, a throwback to the days before 1971, when the currency had to be backed by some finite amount of a commodity such as gold.

We live in a different time. All the money issued by the Government today is backed by nothing except the full faith and credit of the United States of America, and that means that our Government can always use its constitutional authority to create money to pay its previous debts at any point in time, as long as it chooses to spend to meet its obligations. There’s no solvency issue and no solvency risk. America can’t go broke. The Government doesn’t finance its expenditures, either through taxing or borrowing. So even if it has a temporary inability to tax or to borrow it can't go broke, unless its political authorities (including Congress) fail to honor its obligations in violation of the provisions of Section 4 of the 14th Amendment to the US Constitution. To get a better understanding of why this is true, take a look at this passage from the transcript of the presentation of Professor Stephanie Kelton given at the Fiscal Sustainability teach-In Counter-Conference (held at George Washington University on April 28th 2010).

” . . . the government is the issuer of its currency. It is not like a household. It doesn’t have to raise money by borrowing or collecting taxes in order to spend. Those of us in the private sector have to earn or borrow dollars before we can spend. The government must spend first. And we say this, and sometimes people have a hard time understanding that. How can the government spend first? How can it not spend first? How could the government collect taxes, in dollars, first? It first had to have spent those dollars into existence. The spending has to come before the payment or the collection of taxes. The government must spend first. Government spending is not (we use this term a lot) operationally constrained by revenues. It doesn’t need tax payments and bond sales in order to fund itself. It is not operationally constrained. The only relevant constraints are self-imposed constraints. We talked a little bit about this earlier, things like debt ceilings. That’s a self-imposed constraint. Rules that prevent the Treasury from running an overdraft in its account at the Fed. That’s a self-imposed constraint. It is a constraint that is imposed by Congress. Rules that prevent the Fed from buying Treasury bonds directly from the Treasury, so-called monetizing the debt, is a self-imposed constraint. [00:14.36]

How does the government actually spend? It spends by writing checks on its account at the Federal Reserve Bank. What we see, and what we hear all the time is that the government is spending a hundred, taxes are ninety and it sells bonds equal to ten. So, what we see is an attempt to coordinate the government’s spending with taxes and bond sales and it creates the illusion that what’s happening is that the government is taking money from us and using it to pay for the things that it purchases. But that’s not really what’s going on. As Warren likes to say, the government neither has nor does not have any money at any point in time. It is simply the scorekeeper. So what happens when the government spends? [00:15:24]

Let’s suppose that the U.S. Treasury issues a check for a hundred million dollars to Halliburton. What happens? The Fed marks down the Treasury’s balance. It subtracts one hundred million from the Treasury’s account at the Fed. Halliburton takes the check and deposits it wherever Halliburton happens to bank. I chose Bank of America. So Bank of America marks up Halliburton’s balance by a hundred million dollars. The Fed marks up the size of Bank of America’s reserve account (this is some reserve accounting, hang in there; it’s a little dry). The Fed, in the clearing process, credits Bank of America with a hundred million dollars in its reserve account. [00:16:08]

So what’s happened at the end of the day? What are the effects of government spending? The monetary base increases. We call that ‘high powered money’. Those are the bank reserves. The monetary base increases by a hundred million. The money supply increases by a hundred million. The money supply is all the checking accounts and traveler’s checks and a couple other things, but by and large, those are the deposits, ordinary everyday checking accounts. So the money supply increases. So what is the lesson from this? The lesson is that government spending creates new money, both high-powered money, bank reserves, and the more narrow definition of money, M1. They both increase as a consequence of government spending. [00:16:50]

How about when the government collects taxes? What happens there? Say you write a check for five thousand dollars to the IRS on your personal checking account, and you bank at Wells Fargo. Wells Fargo marks down the balance in your account, minus five thousand. The check gets sent from the IRS to the Treasury’s bank. The Treasury banks at the Fed. The Fed marks up the Treasury’s balance by five thousand, and the Fed marks down Wells Fargo’s balance by five thousand. What happens at the end of the day? The effects of paying taxes (See, when you pay taxes, there’s nothing there. Everything just disappears.) The monetary base decreases. Bank reserves go down by five thousand, so the base goes down. The money supply also goes down because you drew on your checking account. So, the money supply goes down by five thousand, the narrow measure, M1, and the monetary base goes down as well. Paying taxes destroys money. It doesn’t give the government anything. It doesn’t get anything. It eliminates those liabilities. They are, for all intents and purposes, destroyed. [00:18:06]

That’s if you pay with a check. What would happen if you actually sent the government your cash? Every once it awhile it seems like you hear about some crazy person who does this in protest. They get a huge sack, usually of coins just to make it really offensive and difficult on some poor bean counter. Let’s say you have a tax liability and it’s a hundred dollars and you just mail in a one hundred dollar bill. Apart from the shock of opening the envelope, what are they going to do with this? What do we do with this? Send it to the Fed. That’s where the Treasury banks. Goes to the Fed, and what do they do with it? They shred it. They shred it. Why would they shred it, I mean literally shred it, if they needed it to buy things, if they could use it to spend? Because they don’t use it to spend and they don’t need it to buy things. [00:19:06]”

So, as Stephanie Kelton indicates, the Government spends by marking up private sector accounts. The Warren she refers to in the transcript is Warren B. Mosler, another Conference participant, and a pioneer in clarifying the operational facts of how the Government actually spends. Warren's analogy, which you'll also find described in his book The 7 Deadly Innocent Frauds, characterizing the Government as a scorekeeper at an athletic event, leads him to ask whether it makes sense to look at the scorekeeper (the Government) as either having or not having points so that it makes sense to ask whether it can run out of points. Of course, it doesn't make sense to see the scorekeeper that way. It only makes sense to view the scorekeeper (the Government) as having an unlimited authority to create points (US Dollars) to serve its purposes. So, of course, the Government cannot run out of US Dollars except due to its own self-constraints.

There are a number important self-constraints, imposed by Congress, that are hamstringing this scorekeeper beyond the constitutionally envisioned constraint of the Executive Branch spending only what Congress authorizes and appropriates. 1) The Congress prevents the Treasury from running a negative balance in its Federal Reserve accounts as a result of its spending. 2) The Congress also mandates that the Treasury issue debt to prevent such negative balances. 3) It also imposes a debt limit on the amount of debt that can be issued at any time.

None of these self-constraints are necessary. Potentially, they can interfere with the ability of the Government to pay its legitimate obligations including repaying its debts, and since section 4 of the 14th Amendment clearly says that the validity of the debts of the United States cannot be questioned, this raises of the question of the constitutionality of these constraints. A very important question currently, since many Republicans in the House are looking forward to refusing to raise the debt limit when the issue comes up in March -- a voluntary act on the part of the US Government that calls our debt repayments into question.

Why doesn't President Obama appear to know these facts about the impossibility of the US running out of US Dollars to pay its debts and buy things with? Well, perhaps he does know about it. Certainly, Alan Greenspan knows that “A government cannot become insolvent with respect to obligations in its own currency.” And Ben Bernanke knows that the US hasn't used tax money to bail out the banks. So, it's reasonable to assume that the President must know that we can never run out of money. So, why, pray tell, does he tell us that we've already run out of it?

We have to stop believing in the myth that the Government can’t do things because its money is limited, and start believing in the idea that the Government is us acting together to solve serious American problems that can’t wait. The Government belongs to all of us. It is ours, and we shouldn’t let the President or anybody else, talk us into the fairy tale that we shouldn’t use its unlimited authority to issue money to help us to act together to solve our serious and long-standing problems. That way lies the decline and fall of the United States. It is national suicide.

There are more Fairy Tales that are likely to appear in the President's State of the Union Message. I'll cover them in upcoming posts..

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

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Submitted by Hugh on

Kleptonomics parallels MMT in the sense that the government can never run out of money as long as there is something left to steal. Money just provides the tokens or account entries to actualize the theft.

Submitted by lambert on

... should serve the public purpose. That's moral point that MMT makes. Kleptocracy, by definition, doesn't serve the public purpose. The right verb is not "parallel" but "prevert."

Submitted by Hugh on

Well, pervert then, but it has always interested me how our elites finance their own projects (i.e. looting), as per MMT, while they treat spending for us as if we were still back on the gold standard.

letsgetitdone's picture
Submitted by letsgetitdone on

interested me too. But if we can spread MMT maybe they won't find it so easy to do that anymore.

Submitted by Sufferin Succotash on

...and start living within our means! How this is supposed to work with a 70-percent consumption-driven economy is something of a mystery. But I trust our statesmanlike leaders and our disinterested economists to get it right!


letsgetitdone's picture
Submitted by letsgetitdone on

The banksters, and the fraudsters and the drugsters need to tighten their belts. Most of the rest of us need money to get off junk food and start taking care of our families properly.

Submitted by Sufferin Succotash on

Whenever anyone starts pontificating about how we should start "tightening our belts" and "living within our means" it's time to reach for your revolver.

Submitted by lambert on

That's a lot more clear.

"MMT for me but not for thee!"

letsgetitdone's picture
Submitted by letsgetitdone on

is the key. That's what makes it Galbraithian economics.

letsgetitdone's picture
Submitted by letsgetitdone on

demand is great enough, the economy will have to be cooled down, at that point we can fight them about re-introducing progressive taxation.

CMike's picture
Submitted by CMike on

and both Social Security and Medicare* are wrecked, why not join the fight to re-introduce progressive taxation now? I guess you think "Festivus and Quantitative Easing for the rest of us" is an easier sell at this time. Makes sense, once we control the commanding heights at the Treasury and the Fed we'll have more leverage to work with when it comes to changing tax rates.
*Lets says:

What we should not do is to directly defend specific social safety net programs such as Social Security and Medicare against cuts in these programs. The effect of even a successful defense of these programs without first destroying the idea that deficit reduction is needed will be to cause even heavier cuts and burdens in other areas that we have not chosen to defend.

letsgetitdone's picture
Submitted by letsgetitdone on

They need to change the freakin' menu.

letsgetitdone's picture
Submitted by letsgetitdone on

are good to fight for. But if someone asked me what I'd most like to see passed right now. It would be Warren Mosler's full employment economic program, not more progressive taxation. That is to say I'm all for going hard on progressive taxation, getting everyone to support that and then using it to get a full employment program.

beowulf's picture
Submitted by beowulf on

1. Variable tax rates, that is taxes that'd go up as economy improves, and go down if it weakes. Politically it makes sense to set the tax rate sufficient to balance the budget, then grant a partial payroll tax holiday in inverse relationship to the unemployment rate. For example, for each point of U3 unemployment, cut taxes by 10 points (9.5%---95% tax holiday, 6.3%--- 63% tax holiday, etc), adjust monthly or quarterly based on DOL unemployment numbers. Instead of "taxes going up to record highs" every month,, you'd take the hit for raising taxes once, and thereafter, even at 4% unemployment, everyone is still getting a tax cut. Payroll taxes, being so regressive, would be the best tax to make variable. If you want to go full-on Henry George, give a federal income tax credit on the same schedule for state and local property taxes ON LAND. States would be crazy not to put as much of their tax burden on land as possible, otherwise their citizens are paying federal taxes they don't have to.

2. Warren Buffett import certificate (IC) market. I think Wynne Godley was right to focus on trade imbalances. Either by a cap and trade market or by the Levy Institute suggestion that Tsy auction off ICs and use revenue to cut taxes, cutting trade deficit would plug $500 billion in demand leakage.

3. Lerner/Vickrey market anti-inflation market. If the govt is doing its job managing the economy, it has to deal with the inflationary pressure that is a consequence of strong economic growth (on the other head, it won't be dealing with 10% unemployment). On the principle, 'don't wait till you're thirsty to dig a well,' it'd be prudent to set up an anti-inflation warrants market before there's inflationary pressure.

4. Martin Feldstein's Tradeable Gasoline Rights. Reagan's CEA chairman came out with a "free market" gasoline rationing plan a few years ago that's pretty clever. If we don't cap gasoline consumption, high gas prices are going to kneecap any future economic boom. Since there is no political will to raise gas taxes sufficient to do the job, Feldstein's TGR market would be an easier sell (residents of each state that drive more than average pay those who drive less for their gas rights, can be handled automatically at the pump by the oil companies).

Ironically, the import certificate, anti-inflation and gas rights markets would all give the federal govt tools it lacks now to tackle serious macroeconomic issues not in spite of but because all of the money stays off-budget and in the private sector. Tsy could make regulatory changes that boost or lower market prices that'd have the same macroeconomic effect as a tax hike or tax cut... without Congress having to pass a new tax law (which can take months, assuming it ever happens).

letsgetitdone's picture
Submitted by letsgetitdone on

beowulf, I always look forward to your very original comments and policy proposals. Please keep 'em coming.

Francis O MY's picture
Submitted by Francis O MY on

During the 1920’s Henry Ford and Thomas Edison teamed up to express their views on the monetary system. One particular proposal was that the government should issue currency rather than bonds to finance the huge Muscle Shoals nitrate plant in the Tennessee River Valley. Among quotes attributable to Ford are:

“The function of money is not to make money but to move goods.”

“The youth who can solve the money question will do more for the world than all the professional soldiers of history.”

“It is well that the people of the Nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

Thomas Edison captured the matter with such masterly good sense that he is quoted below at some length:

“If our nation can issue dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good, also. The difference between the bond and the bill is that the bond lets the money broker collect . . . whereas the currency pays nobody but those who contribute . . . in some useful way.”

“If the Government issues a bond, it simply induces the money brokers to draw $30,000,000 out of the other channels of trade . . . if the Government issues currency, it provides itself with enough money to increase the national wealth . . . without disturbing the business of the rest of the country. And in doing this it increases its income without adding a penny to its debt.”

“. . . it is the people who constitute the basis of government credit. Why then cannot the people have the benefit of their own guilt-edged credit by receiving non-interest-bearing currency . . . instead of bankers receiving the benefit of the people’s credit in interest-bearing bonds?”

“If the United States Government will adopt this policy of increasing its national wealth without contributing to the interest collector – for the whole national debt is made up of interest charges – then you will see an era of progress and prosperity in this country such as would never have come otherwise.”

“And it is the control of money that constitutes the money question.

letsgetitdone's picture
Submitted by letsgetitdone on

But the nation was on the gold standard back then, so there were budgetary constraints on how much we could spend and still remain solvent. Since 1971, we cannot run out of money.

Submitted by Hugh on

Oil is trading at $92/bbl today. There are a couple of things to say about that. First, it should be trading in the $35 range minus financial speculation. So there already is a major de facto tax on oil products, such as gasoline. It is just that the proceeds of that tax are going to pay for bonuses at places like Goldman's and to float the economies of oil producers. Second, oil above $90/bbl will push the economy into overt, as in cannot hide, recession. If you want to affect gas prices, you need to do it at this level. Third, I said at the time that any tax cuts that made it to the middle class would not result in increased buying power but would be soaked up by commodity price inflation. Looks like I was right on that.

letsgetitdone's picture
Submitted by letsgetitdone on

Another instance of this Administration's failure to use its investigation and enforcement powers to put an end to fraudster activity. This is perhaps the biggest factor now preventing recovery. You can't go forward if you don't look backward first.

Rangoon78's picture
Submitted by Rangoon78 on

"Meanwhile, capitalism seemed to have an extremely difficult time reforming itself in any meaningful way. When anyone suggested that maybe six-year-old workers shouldn't be forced to actually stand in the vat of benzene, the robber barons should have said: "That's a great idea! Any money I'll lose on the vat thing I'll more than make back by not having to constantly train new six-year-olds after the previous ones drop dead!" But they didn't. Instead, they took the person who made the suggestion out behind the factory and shot them."
Rather than understanding that the problem of the 20th Century was the refusal of capitalism to compromise with human beings, they think the problem of the 20th Century was the few compromises capitalism did make. In fact, even the European upper classes seem to have now forgotten what their grandparents learned via the most direct experience possible.
So they're getting rid of the compromises as quickly as they can. Their goal is apparently to rewind the clock to 1900 and see if history turns out differently this time.

-Jonathan Schwarz
Read him:

coyotecreek's picture
Submitted by coyotecreek on

I linked this post on FB this AM and actually heard back from three people who live in my community. (None of them agreed with anything this post said, but I expected that.)

I would like to start a dialogue on these topics with them. One guy offered this as an alternate view. you know anything about this site?

letsgetitdone's picture
Submitted by letsgetitdone on

Haven't run across he/she before. Took a quick look at the notion of money, Martenson appears to believe in commodity-backed money, the mark of an Austerian site. How would you like to handle the dialogue?

coyotecreek's picture
Submitted by coyotecreek on

and articles to read as background - and then a non-political discussion. I plan to try and snag as much as possible form your postings to use as the basis of what I supply.

I have always appreciate how you have dealt with these issues and trust that you will make sense to them - on some level - if I can get them to open up their minds. There are two Obama Dems and a Libertarian involved. Should be interesting!

Any other thoughts you have would, as always, be valued.

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Submitted by letsgetitdone on

Plug me in if the exchange starts.

Submitted by hipparchia on

he's just another gold bug - ie, another ron paul, but with better social skills and a more polished demeanor.

yes, he takes a lot of true stuff - wealth inequality, various forms of debt [public and private] and the trillions of $$$$ they add up to, the bank bailouts, etc - and combines them in the scariest ways possible, some of which may even be true, but all of which are designed to scare you into going out and buying gold nownownow!.

then for just $300/yr you can join his membership list and get, among other tips, information to help you preserve and grow your wealth. he adds in peak oil and environmental stuff into his crash course, so maybe his tips for growing your wealth include investing in alternative energy startups, but gold bugs, besides telling you to buybuybuy goldgoldgold, also then want to sell you shares in gold mining companies.

you could spend a lot of time and effort [and a lot of posts!] picking apart the various half-truths and misdirections and disnformation in those 3+ hours in his crash course, and the transcripts from the teach-in would provide with you some useful material if you want to take on such a project, but it's probably easier to just point your goldbug acquaintances to various posts here with a "yeah but, stephanie kelton says..." or "bill mitchell says..."

Submitted by lambert on

In fact, it does not; that's a self-imposed constraint from Congress.

The compounding enters in only because we are paying the banks interest to lend us our own money. It's a sweet deal for them, but why are we doing it?

UPDATE To expand, the thesis of the post might work for the larger economy; but the equation of the deficit with debt is a matter for political economy....