In my last post I introduced Warren Mosler's notion of “deadly innocent frauds,” (difs) and discussed the idea of fiat monetary systems and its implications for the first dif: “in order to spend money, the Government must first raise it through taxation, or borrow it.” In fiat monetary systems, that idea is false, which is why it is a dif. The true principle instead is: “Government Spending is NOT operationally limited or in any way constrained by taxing or borrowing.” In the course of discussing the first dif, I emphasized its role as a belief underlying the current orientation of the Obama Administration toward planning for deficit reduction and deficit neutrality. Concerns that are wholly inappropriate, foolhardy, and even suicidal, in view of all we need to do to reinvent America, and the fact that we have a fiat monetary system. In this installment I'll move on to Mosler's other difs and discuss their political and economic implications.

Mosler's second dif is: “With Government Deficits we are leaving our debt burden to our children.” This, of course, has been a scary common sense belief that those who don't want to solve social problems have used forever to persuade people not to implement progressive solutions to their problems. The problem is that in fiat money systems the meaning of deficits is entirely different than in commodity money systems. The deficit is just the annual difference between Government income from transactions with non-Governmental entities and Government spending in such transactions. Most Government income comes from tax collections, so generally speaking there is little or no deficit when tax collections match Government expenditures. In commodity money systems, when income falls short of expenditures, we have a deficit tied to a commodity, and when the deficit accumulates year after year we have a national debt also tied to a commodity. To finance the debt, Governments in such systems must raise taxes to increase income, or borrow money to finance expenditures through debt. If they borrow money, however, the debt can only be paid back through increased revenue collections at some future time, or by more borrowing to pay debt obligations. But, in fiat monetary systems, the situation is different. When Government expenditures exceed revenues in those systems, a deficit doesn't have to be reduced by increased tax revenues, or other transactional income, nor does it have to financed by borrowing. Instead, since money isn't limited by its relationship to a material commodity, the money necessary to make Government expenditures can just be created at will by the Government. It need not be the product of either increased taxes or debt financing, as it must be in commodity systems.

The significance of this idea, which is just the counterpoint to the first dif, that “Government Spending is NOT operationally limited or in any way constrained by taxing or borrowing,” is that whatever Government deficits we leave to our children also need not be repaid by them through either further borrowing, or increased taxation. These deficits, just like our own can be financed by our children and grandchildren by creating whatever money they need to finance them. Of course, if they want to reduce their well-being, they can raise taxes or borrow money to handle those deficits. But what they do, and the precise size the burden they choose to assume is up to them and has nothing to do with us, so long they retain our fiat monetary system.

Warren Mosler expresses the counterpoint to the second dif in this way:

"Collectively, in real terms, there is no such burden. Debt or no debt, our children get to consume whatever they can produce."

That is, unless they choose not to produce it, because they raise taxes and cripple economic productivity, in a vain and misguided attempt to pay down a fiat debt with money they might otherwise use for investment.

As Mosler points out: it is impossible for our children and Grandchildren to send any of the goods and services they produce back into the past to pay down the deficits we incur today. And he also points out that paying off the national debt in a fiat monetary system is merely a matter of accounting. As he says:

"Even briefer - to pay off the national debt the government changes two entries in its own spreadsheet - a number that says how many securities are owned by the private sector is changed down, and another number that says how many $US are being kept at the Fed is changed up. . . ."

In short, folks, there is no debt burden for our children and grandchildren. That there is, is a myth, a fairy tale, a dif, as Mosler terms it. It is not reality, and we ought not to make it reality by believing it and acting accordingly.

The third Mosler dif is: “Government budget deficits take away savings.” And the counterpoint to it is: “Government budget deficits ADD to savings.” Mosler points out that this is just Economics 101, when the Government spends dollars it transfers dollar credits to non-governmental sector entities. That is the nature of such transactions. So it is just an accounting identity, true by definition, that an increase in the Government deficit, increases the dollars in the non-governmental accounts that have received the Government transfer. So, “Government deficits = increased 'monetary savings' for the rest of us. To the penny. This is accounting fact, not theory. . . .” It's also equally true, that Government surpluses = decreased monetary savings for the rest of us. This too, is accounting fact, and not theory.

The relationships between increased deficits and increased savings, and increased surpluses and decreased savings, are important because misunderstanding them, and accepting this third dif, is widespread, and very harmful. Because people believe that Government deficits take away from non-governmental savings and also investment, they also believe that Government deficits must be avoided and that Government surpluses are good. So, this dif reinforces the doctrine that Government programs should be revenue neutral or even produce Governmental savings, a doctrine that if implemented will actually immediately result in reduced non-governmental savings and investment, a deadly effect in recessionary times, when non-governmental savings that may be used for investment are sorely needed. Surpluses, because they detract from nongovernmental savings and investment, can even cause recessions. Our most recent experience of this is with the Clinton surpluses which were followed by the recession in the waning days of the Clinton Administration that greeted George W. Bush when he took office.

Mosler's fourth dif is one that is much in the News right now. It is that “Social Security is broken” and will, one day in the foreseeable future, run out of funding. This claim is used to persuade people to consider the idea that Social Security must be reformed, before the “trust fund” runs out of money. However, the truth is that there is no trust fund. There are only social security accounts and entitlements accompanying these accounts guaranteed by the Federal Government. Whether, or not the “trust fund” runs out of money or not, the Federal Government will still have make payments to those entitled to receive Social Security payments and since Government money is, at bottom, “fiat money,” the counterpoint to this dif is that “Government checks don't bounce,” and that includes Social Security checks.

So, why is everyone so excited about the plight of Social Security? Why are they so sure that we need Social Security and, more broadly, entitlement reform? I think the answer, for people of good will, is their failure to understand the fiat monetary system, how it works, and what really makes money more or less valuable in such a system. The source of value is not money itself. It is the valuable goods and services that are produced by the economy. As long as the economy keeps producing valued goods and services, the fiat money used as a medium of exchange will have value. And as long as it has value, the Government can keep making and spending it to increase economic activity when it flags, and its taxing power and control over interest rates to dampen activity in case demand outstrips supply, and inflation occurs.

The function of Government in an economy with a fiat money system is to maintain economic activity at a level sufficient to produce the valued goods and services citizens want. When the Government doesn't spend enough to do that, it is failing to prevent or end economic downturns. When it spends so much that its spending exceeds the productive capacity of the economy, it is failing to prevent or end inflation. Social Security and other safety net entitlements are one way of ensuring that demand will be high enough to maintain productive capacity. In recession and depression, they have a counter-cyclical function. They benefit the economy much more than they cost it. Entitlement reform that undermines the function of the safety net in keeping demand at a high level, for the sake of cutting Government spending, on the assumption that Government money is somehow limited, is dangerous to the health of the economy. It is a fool's path. It undermines the very mechanisms that help to protect us against depressions. And it does so based on a misunderstanding of our fiat monetary system, and the false belief that the Government can run out of money if we don't reform social security and other entitlements.

The ideas that Government deficits create a debt burden for future generations, take away non-governmental sector saving, and that socials security is broken are all “deadly innocent frauds,” supporting the idea that deficits must be avoided, even if we have to suffer through extreme economic downturns to avoid them. These frauds, like the idea that Government spending is operationally limited by the need to tax and borrow, all serve to reinforce the idea that Government can't do anything about a bad economy without doing more harm than good. The contrapuntal ideas that Government can create money, and is not operationally limited by the need to tax and borrow, there is no debt burden on future generations that limits production or consumption, deficits don't subtract from, but add to non-governmental savings, and Government checks including Social Security checks don't bounce, all reinforce the idea that Government deficit spending is not to be avoided, but, on the contrary is something we can and need to do to avoid the economic and human waste of unnecessary economic recessions and depressions.

Some years ago now, Democrats tried to make the Government the guarantor of full employment. But the drive to do this was blunted by the decline of Keynesian macroeconomics, the new ascendancy of free market ideology, and the call for deficit neutrality. We now see however, that at least four of the arguments against deficit spending are based on deadly innocent frauds whose application is damaging to our economy. In Part Three of this series I'll continue the discussion of Mosler's 7 difs and their implications

(Also posted at the Alllifeisproblemsolving blog where there may be more comments)