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Fiscal Solvency, Sustainability, and Confusion

letsgetitdone's picture

Professor Pavlina Tcherneva, one of the speakers at the recent Fiscal Sustainability Teach-In Counter-Conference, in a striking post entitled “Do Not Confuse Solvency with Sustainability,” says this about solvency and sustainability:

”Mad obsession with debt- and deficit-to-GDP ratios, divorced from any consideration to what is happening to the real economy, boggles the mind. Remember government deficits always create non-government surpluses--to the penny. When the government spends more than it collects, the private sector earns more than it pays in taxes to the government. That is, the private sector accumulates these government liabilities, again, in the form of electronic dollar reserves. The government does not run out of ‘electronic reserves’.These deficits go somewhere! They create income and profits for someone. The real question is “for whom?” and did those earners produce anything of value to society in exchange for getting this money? This is not a matter of financially bankrupting the nation. It’s a matter of bankrupting the economy in real terms. It’s about filling the coffers of a financial sector which has hired 7% of total U.S. employees in increasingly dubious services and who take almost 40% of total corporate profits (half of which are rents and serve no economic purpose). It’s about starving grandma, leaving our kids without world- class education, allowing the sick to get sicker, and the unemployed to become unemployable. And all because we refuse to build the real resources which we all need in order to maintain a decent standard of living. Now I would prefer not just a decent standard of living, but an excellent one—one to boast about, one that the richest country in the world can offer its citizens. Stop confusing solvency with sustainability. Start measuring sustainability in terms of the real goods, services, and jobs government spending creates for the public purpose.”

I was really happy to see Pavlina raise the deficits “for whom” question. The military-industrial complex clearly doesn't object to deficits for them, and the banksters and corporatists are strangely silent when it comes to deficits for them. But when it comes to deficits for Grandma, the unemployed, and others who need help, all of a sudden we have a case of fiscal irresponsibility and unsustainability. And then comes the real message: “stop confusing solvency with sustainability.” But, the question is: will a deficit hawk agree that she or he is confusing solvency with sustainability? Probably not.

The reason why is because of the way they look at government spending. They believe, apparently, that the Government cannot spend unless it first either funds itself through taxation or borrowing. So, if raising taxes is not feasible, and borrowing through issuing debt instruments is either increasingly difficult, or much more expensive than in the past, or both, the issue of solvency will be front and center for them since they will be projecting that at some point the Government will not be able to get money to spend either through taxation or borrowing.

Let's define “fiscal sustainability” as the extent to which patterns of Government spending do not undermine the capability of the Government to continue to spend to achieve its public purposes. Then fiscal solvency, the present ability to spend to achieve public purposes, and fiscal sustainability, while still not the same, are very closely associated for people who believe that the government must either tax or borrow before it can spend. As government deficits and national debts get higher, people who believe that governments must either tax or borrow to maintain solvency will begin to fear that borrowing costs will get out of control and consume too much of the government budget, or even worse that the Government may decide to tax them more heavily to maintain solvency.

This approach to insolvency scenario, and the close association of degree of fiscal solvency with degree of fiscal sustainability makes sense for Governments that have commodity money systems (e.g. the gold standard); or for Governments that don't have control over their currency, either because they have given up currency control to super-ordinate political systems (such as the Eurozone nations, or the American states), or because they incurred debts in currencies they cannot issue, and don't control.

For systems like the above, debts, deficits, and debt-GDP-ratios may legitimately be used as measures of both degree of fiscal solvency and degree of fiscal sustainability, simply because as debts increase, solvency lessens, and fiscal sustainability, once again, the extent to which patterns of Government spending do not undermine the capability of the Government to continue to spend to achieve its public purposes also becomes less and less.

The problem with the assumption of a close association between fiscal sustainability and fiscal solvency is that it's only reasonable when we're looking at economic systems whose governments are not sovereign in their own currency. Once a government has that sovereignty and takes care to keep it, the association, assumed by the Administration, the Peterson Foundation, and the deficit hawks, simply breaks down and deficits, debts, and debt-to-GDP ratios cease to be useful measures of either fiscal solvency or fiscal sustainability.

In such systems, the Government can literally never run out of money and therefore become insolvent, since it can always create more as the need arises. Nor does it have to fund its spending either by borrowing or taxing. It can spend without doing either, simply by using its monopoly power as the agency with the sole authority to issue currency. So, for nations like the United States, Japan, Canada, Australia, and many others there is no possibility of insolvency unless a political decision is made to default on debts, even though a Government sovereign in its own currency can never be forced to do that. And that's why deficits, debts, and debt-to-GDP ratios are invalid measures of fiscal solvency. In fact, in these kinds of systems, there are no measures of degree of fiscal solvency, simply because solvency is never an issue. The degree of solvency is constant, so long as the Government retains it authority to spend and repay debts with the money it creates.

For these types of systems there is never an issue of involuntary insolvency, and since this is not a possibility, literal lack of a government's own currency can never undermine the capability of that government to continue to spend money to achieve its public purposes. However, even though solvency, barring misunderstandings by authority, need never be an issue, inflation can become an issue, as can Government spending on things that don't fulfill public purpose.

About government spending, inflation, and the need to produce value, Pavlina says:

”Just because the government pays by issuing liabilities, does not mean that it can spend willy-nilly on whatever it chooses! Absolutely not! The constraint to government spending is inflation (not the ability to ‘pay’), which is why you always have to fix government spending to something of value. When government spending injects bank reserves into the private sector it must do so by producing something for society.”

And here, I think, is where the real problem of fiscal sustainability comes in for fiat money systems. In such systems, fiscal solvency is not a problem. But what if the Government spends so much that aggregate demand becomes greater than the capacity to produce, and government also spends on the wrong things, i.e. on things that don't fulfill public purposes in the sense that they create value for very few people in society, don't renew and extend the education, energy, environmental and infrastructural foundations of the economic system and also don't produce full employment?

Then one result will be rising prices and also a weakening of both the foundations of the economy and its labor force, resulting in the destruction of productive capacity, real wealth and real value in the economy over time. Eventually, this will make such a fiat currency less valuable in international currency markets, and will cause the price of imports to rise, contributing further to inflation. Also, the strengthening of inflationary trends will force the Government, if it wants to control inflation, to tax those who are the source of over-heated aggregate demand; not to raise funds since it still cannot run out of its own money, but to cool aggregate demand and ensure that it doesn't exceed productive capacity.

Can inflation in nations whose governments retain control over their currency undermine the fiscal sustainability of those governments? I think the answer to this question is “no.” Inflation may be very harmful to segments of the population that can be hurt seriously by it, and if patterns of Government spending push demand further while concentrating it in a small segment of the population, then further decline in the currency may feed back into an accelerating inflationary cycle. But since the Government will always be solvent, it's continuing ability to spend to achieve its public purposes, is not in doubt.

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

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sisterkenney's picture
Submitted by sisterkenney on

Been laid up and had to take a little time off (not nearly as much as I need, but the draconian rules will kill you), but this article roused me to write to the Editor and the author:

My response:
Rather than repeat the talking points of a billionaire reactionary who has made it a goal to strip Social Security and Medicare from the poor, elderly, and disabled, (for decades!) it would behoove a responsible reporter to do some diligent investigation into the history and philosophy, not to mention the economic "theories" that Mr. Peterson and his ilk subscribe to. Isn't it curious that "deficits" and "national debt" are never an issue until a Democratic majority or President exists? And if "everything is on the table", why doesn't this commission START with our bloated military budget and our ill-begotten wars and myriad military bases? Why is there ALWAYS money to bail out bankers, contract out government jobs to the private sector at horrific mark-ups, give corporations and agribusiness huge tax breaks and government subsidies (at the cost of supporting American jobs and small businesses), Why is the cap on SS taxes $100,000? Why do people who make money from shuffling paper pay less income tax than their secretary? And why doesn't the average reporter of financial issues not know/understand that "deficit hawkism" isn't a "truth", it's a THEORY of governmental spending brought to you by the SAME idiots that cause our economy to crash and burn every 5-7 years (this isn't a bug of our system, it's a FEATURE). And the meme that our government should be run like a household, with a balanced budget, or even a surplus,during a depression, runs counter to the history of WHAT WORKS to help bring increased/full employment to this country. If nothing else, let's give another, more rational and humane system a try, since the one we've been using has surely destroyed many lives and jobs and businesses recently. Do a little research, read, study, then describe what raiding our "entitlements" will do to/for this country.

I did offer some "links for learning" in my postscript, but I would welcome any and all comments and suggestions to make this type of response better, and hopefully increase my chances for reaching hearts and minds, in addition to getting published.

letsgetitdone's picture
Submitted by letsgetitdone on

Win the war first. Worry about the "household" later.

letsgetitdone's picture
Submitted by letsgetitdone on

Make this one a blog post and make each of these questions a bullet point.

Submitted by hipparchia on

that's an awesome letter, sisterk, and would make a very good post.