Jamie Galbaith's “Foreword” To Modern Money: A Commentary
Warren Mosler has an important forthcoming book called The Seven Deadly Innocent Frauds, which is, fortunately, available right now in a pre-publication version for reading and commenting from Warren's site.
Jamie Galbraith, Warren's friend and occasional co-author has recently written a Foreword to the book, which also can serve as a Foreword to the Modern Money (or Monetary) approach to economics. I think the foreword is important enough in itself that I decided to comment on it. That commentary is the subject of this blog post. I've arranged the post as a series of quotes and additional, hopefully, value-added, comments on what Jamie said.
Warren Mosler is a rare bird. A self-taught economist who is not a crank. A successful investor who is not a blowhard. A business person with a talent for teaching. A financier with a true commitment to the public good.
We have co-authored testimony and the occasional article, and I attest firmly that his contributions to those efforts exceeded mine.
Many economists value complexity for its own sake. A glance at any modern economics journal confirms this. A truly incomprehensible argument can bring a lot of prestige! The problem, though, is that when an argument appears incomprehensible, that often means the person making it doesn't understand it either.
(I was just at a meeting of European central bankers and international monetary economists in Helsinki, Finland. After one paper, I asked a very distinguished economist from Sweden how many people he thought had followed the math. He said, "Zero.")
I really laughed at this. How many of us have had the experience of encountering someone who offered an incomprehensible argument, and then questioning that person, and finding that no matter how hard they tried, they really couldn't explain what they meant. Leading to the conclusion that they really don't understand their own view well enough to explain it to someone else. This observation is true all too often, and reminds me of one of the themes of John Kenneth Galbraith's work, which always emphasized graceful expression and arguments that were very easy to understand and which avoided formal models based on the economic theory of markets, but instead focused on analysis of the relations between components of the economy governed by markets and other components that were not subject to them, but could manipulate them instead.
Warren's gift is transparent lucidity. He thinks things through as simply as he can. (And he puts a lot of work into this – true simplicity is hard.) He favors the familiar metaphor, and the homely example. You can explain his reasoning to most children (at least, to mine), to any college student, and to any player in the financial markets. Only economists, with their powerful loyalty to fixed ideas, have trouble with it. Politicians, of course, often do understand, but rarely feel free to speak their own minds.
Simplicity is the distinguishing feature of Warren's work. Other, MMT practitioners, Jamie himself, Randy Wray, Bill Mitchell, Marshall Auerback, Stephanie Kelton, and Pavlina Tcherneva all write very well and are cultivating the art of communicating ideas to people who aren't economists. They're remarkable in that way, and any one of them can exhibit extraordinary simplicity in anything they write. But for putting things simply on topic after topic in a book length presentation, Warren is unequaled in his success in doing that, and this whole book reflects that success. It's a beautifully simple and painless introduction to a difficult subject.
Now comes Warren Mosler with a small book, setting out his reasoning on seven key issues. These relate to government deficits and debt, to the relation between public deficits and private savings, to that between savings and investment, to Social Security and to the trade deficit. Warren calls them "Seven Deadly Innocent Frauds" – taking up a phrase coined by my father as the title of his last book. Galbraith-the-elder would have been pleased.
The common thread tying these themes together is simplicity itself. It's that modern money is a spreadsheet! It works by computer! When government spends or lends, it does so by adding numbers to private bank accounts. When it taxes, it marks those same accounts down. When it borrows, it shifts funds from a demand deposit (called a reserve account) to savings (called a securities account). And that for practical purposes is all there is. The money government spends doesn't come from anywhere, and it doesn't cost anything to produce. The government therefore cannot run out.
This is a beautifully simple and brief summary of Warren's view of money exchanges involving the Government by Jamie. It reflects Warren's analogy that in the Modern Money system, the Government is like the scorekeeper in a game. Its job is not to have or not have money. It is to mark up or mark down non-Government sector accounts according to its operating rules and procedures. And it tells us to think about Government taxing and spending in terms of the Government marking up or down non-Government sector bank accounts. Since the Government is like a scorekeeper, it's easy to understand, that, like other scorekeepers, it doesn't have or not have points. Instead, it has the authority to give or take away the points (USD) of others. Therefore, it can't run out of points, unless a political decision is made by the Congress or the Executive to limit its authority, i.e. the number of points (dollars) it can create/spend.
This simple point, that the Government can't run out of “points” (money), is of enormous political significance, because it means that arguments against policy proposals that are based on the idea that their cost is too great for the Government to shoulder because “we are running out of money,” are frauds, perhaps innocent, perhaps not, but certainly, they are literally deadly, since as in the cases of health care reform, infrastructure reconstitution, environmental protection, climate control, alternative sources, and other areas, refusing to legislate effective solutions because “we are running out of money,” costs lives every day.
Money is created by government spending (or by bank loans, which create deposits). Taxes serve to make us want that money – we need it in order to pay the taxes. And they help regulate total spending, so that we don't have more total spending than we have goods available at current prices – something that would force up prices and cause inflation. But taxes aren't needed in advance of spending -- and could hardly be, since before the government spends there is no money to tax.
This paragraph of Jamie's is truly an amazing one because it is pregnant with so many important aspects of the MMT point of view, all packed into a very short and very simply stated paragraph. The idea that money is created by Government spending is, I think, at variance with the image most people have in mind. The common view is that money, if created by the Government, is “printed,” and then spent by the Government. But that most often money is not created, but is gathered through taxes or borrowing and then is spent by Government. However the MMT view Warren and Jamie present, is that when Government spends, it both spends and creates money in a single electronic process, and that, specifically, it spends money by marking up a non-Government sector bank account, and that this act “creates” money that did not exist before in that account. Now, that little point about operations is revolutionary because it suggests that Government doesn't spend any tax or borrowed money it may have, as other entities spend money they possess; but rather just creates new money every time it spends.
The next sentence in that quote contains the MMT answer to the question: Why is that fiat money, unbacked by any commodity, valuable to us? And the answer, simply, is that it is valuable because the Government is requiring us to pay taxes using that money, and that is the real basis for its use as a medium of exchange. The sentence also answers another frequently asked question: If Government can always create money, then why do we need taxes? And the answer, of course, is to make its fiat money valuable, so that it will be used as a medium of exchange
Then Jamie makes the further point that taxes are also important, because they regulate the overall level of spending and can prevent spending from exceeding the available supply of goods, and causing inflation.
And then the final very important point in that dense paragraph of Jamie's: namely, that the Government doesn't acquire the capability to spend first by taxing or borrowing, and then spend, second. But rather it spends first, and its spending places enough money (USD) in the hands of the non-Government sector, so that people and businesses can pay taxes and also engage in commerce using the currency that Government has issued through spending, including lending the Government back some of the money it created. This is one of the central principles of MMT's view of Modern Money systems. The spending comes first, and the taxing and borrowing later. As Warren emphasizes many times in his book, this is a matter of logic, because there would be nothing to tax and nothing to borrow if money had not been first created by the Government.
A government borrowing in its own currency need never default on its debts; paying them is simply a matter of adding the interest to the bank accounts of the bond holders. A government can only decide to default – an act of financial suicide – or (in the case of a government borrowing in a currency it doesn't control) be forced to default by its bankers. But a US bank will always cash a check issued by the US Government, whatever happens.
So, from the previous paragraph, this one directly follows. Since the Government always has the authority to spend to pay its debts, and since in the spending it creates new money, that Government, as long as it has not incurred debt in foreign currencies making it subject to its bankers, can never default on its debts, because it has “run out of money” (become insolvent). It can voluntarily decide to default, i.e. refuse to spend to fulfill its obligations, for various political reasons. But if it has an understanding of its real monetary powers and the will to persist, it can never be forced to default because of decisions made by banks, other nations which hold its debts, or international credit agencies which either foolishly or malevolently, downgrade its credit even though it cannot default.
This last point is of great importance politically, because people advocating deficit reduction rely on the argument that if Government debt gets too high, the interest burden on that debt can become so great that it places the Government in danger of having to default on its debts. But as we've seen, there is never any way that a Government like the United States can be forced to default, because there is no way to drive it into insolvency.
Notice also, that US banks will always cash Government checks. Why? Because Government checks are a form of Government currency, legal tender, that US banks must accept as cash equivalents. Accepting Government checks is not voluntary.
Nor is the public debt a burden on the future. How could it be? Everything produced in the future will be consumed in the future. How much will be produced depends on how productive the economy is at that time. This has nothing to do with the public debt today; a higher public debt today does not reduce future production -- and if it motivates wise use of resources today, it may increase the productivity of the economy in the future.
That's a very short statement of the essentials of Warren's view on this issue, and of his way of refuting the idea that deficits and debt will put result in heavy burdens on our children and grandchildren. But there is a way in which the public debt could be a burden on the future, and that way is if the Government decides to pay the previously incurred debt back by consistently running surpluses over a number of years. If the Government were to do that, its actions would create a net withdrawal of savings from the non-government sector of the economy, plunging the economy into recession or depression, and preventing the creation of valued economic outcomes (wealth) for our children and grandchildren to build upon.
I hope the irony associated with the political significance of this last point is not escaping you. One of the primary points of today's deficit terrorists is to warn us that running high deficits and increasing the national debt and the public debt-to-GDP ratios, will hurt our children and grandchildren, and that if we care for them, we must discipline ourselves by reducing Government spending and ceasing to live beyond our means. However, the real truth made clear by Warren's argument, summarized so clearly by Jamie, is that the only way to really hurt our children and grandchildren is to follow the very advice the deficit terrorists are offering; because it is precisely that advice that will lead to the double-dip recession or perhaps even Great Depression II that will destroy the real wealth we and our children can build upon to create the foundation we need for our grandchildren.
Public deficits increase financial private savings -- as a matter of accounting, dollar for dollar. Imports are a benefit, exports a cost. We do not borrow from China to finance our consumption: the borrowing that finances an import from China is done by a US consumer at a US bank. Social Security privatization would just reshuffle the ownership of stocks and bonds in the economy – transferring risky assets to seniors and safer ones to the wealthy – without having any other economic effects. The Federal Reserve sets interest rates where it wants.
All these are among the simple principles set out in this small book.
And all are of the first importance too. That public deficits increase non-government savings dollar for dollar. For example, means, as warren points out in the book, that the famous US National Debt Clock that everyone gets so uptight about is actually a US non-Government sector National Savings Clock. It also implies that every time we run a Government surplus it make the Government sector poorer, not richer. That imports are a benefit and not a cost, is a principle that is very significant for the hysteria we often see expressed about the US balance of payments “problem.” Is it really a problem? Not if you want to get more goods from other nations, in return for electronic paper, than they get from you. As for borrowing from China to finance our consumption, how may times have you heard commentators complain about our profligate ways that can only be maintained if we borrow from the Chinese? Warren's book dispels both that nonsense, and also the nonsense that our Government spending is financed by debt instruments sold to the Chinese.
Warren's argument showing that privatization of Social Security would accomplish nothing but place greater risks on the retirement funds of seniors is important, but also important is his additional argument showing that Social Security isn't broken and has no problems of solvency. Both arguments are particularly relevant now that many are claiming that Social Security “reform” is needed because we can't afford to continue the present system, much less extend it. They show that if there is a need for reform it is only to extend Social Security to younger people and to stop its financing through regressive taxation on working Americans.
Finally, Warren's point, highlighted by Jamie, that the Federal Reserve sets interest rates where it wants, is another enormously important one in today's political context. The deficit terrorists talk continuously about interest rates being driven up by the high deficits and excessive Government spending. However, if the Federal Reserve can set interest rates where it wants, then it's clear that this argument of the deficit terrorists also falls by the wayside.
Also included here are an engaging account of the education of a financier, and an action program for saving the American economy from the crisis of high unemployment. Warren would do this by suspending the payroll tax – giving every working American a raise of over 8 percent, after tax; by a per capita grant to state and local governments, to cure their fiscal crises; and by a public employment program offering a job at a modest wage to anyone who wanted one. This would eliminate the dangerous forms of unemployment and allow us to put our young people, especially, to useful work.
This is Warren's version of the MMT reply to deficit terrorism. It is his way out of the Great Recession, and its economic cost in both the short and the long run is far less than the costs of recession we are paying now, and are very likely to pay in the future if deficit terrorism wins the day this Fall.
Warren's heroes, among economists and apart from my father, are Wynne Godley and Abba Lerner. Godley – a wonderful man who just passed away – prefigured much of this work with his stock-flow consistent macroeconomic models, which have proved to be among the best forecasting tools in the business. Lerner championed "functional finance" – meaning that public policy should be judged by its results in the real world – employment, productivity and price stability – and not by whatever may be happening to budget and debt numbers. Warren also likes to invoke Lerner's Law – the principle that, in economics, one should never compromise principles, no matter how much trouble other people have in understanding them. I wish I were as a good at observing that principle as he is.
The message of MMT for fiscal sustainability is that the real results pointed to by Lerner, and also by Galbraith, the elder, summarized in his phrase “the public purpose,” are the object of public policy in fiat money systems. Budget and debt numbers have no importance in themselves, because what they measure is the stress placed on government solvency in systems that can become insolvent because the value of their currency is dependent on externally held creditors, foreign currencies, or commodities that back their currency. But these numbers do not measure solvency stress or fiscal sustainability in systems whose governments are sovereign in their own currency. So, for these systems (including the US) these numbers are irrelevant, and all that counts is the impact of Government spending on real economic, social, and environmental outcomes outcomes.
To MMT, “fiscal sustainability” in nations sovereign in their own currency, doesn't mean sustaining the ability of Government to spend. Since there is no solvency risk, no matter how much it spends, it can always spend if it chooses. But rather, fiscal sustainability is about maintaining the Government's capability to spend as it needs to, to help people create real value from economic activity. And, it is exactly that kind of fiscal sustainability, that is undermined by deficit terrorism and its focus on maintaining arbitrary levels of meaningless numbers and prioritizing them ahead of real value, results, and the public purpose. The deficit terrorists propose to have our Government self-impose constraints that will prevent it from solving our many, many problems, for the sake of meeting certain arbitrary deficit and number targets. From the MMT point of view reflected in Warren's 7 Deadly Innocent Frauds, this proposal isn't about maintaining fiscal sustainability and responsibility. It is instead about undermining real fiscal sustainability and acting in the most fiscally irresponsible manner one can imagine, because it divorces policy from its impact on real valued outcomes, and ties its measure of success instead, to abstract and arbitrary numbers having no direct connection to people and their lives.