Latest Grand Bargain is (mostly) a Grand Waste of Time

It’s so frustrating to know how the economy works(MMT), and then watch a bunch of men who don’t, try and improve the national economy. Here is a one line sentence explaining how to grow an economy.

People need to spend more money so that there will be the increased demand for new jobs and new business.

That’s it.  But let’s look at Obama’s latest Grand Bargain proposal from a critical MMT perspective.  Obama’s plan has 3 parts.

  1. Simplify the corporate tax code
  2. Try to coax companies to “repatriate” their foreign money holdings
  3. Use the tax increase to fund infrastructure jobs.

The firsObama_and_Mitch_McConnell[1]t plan is to simplify the corporate tax code in 2 steps.  First, it’s going to eliminate several deductions and so-called “special interest” loop holes.  That will increase the amount of taxes the government collects.  The second step is to lower the tax rate to the point where the money gained by closing loopholes is roughly equivalent to what’s lost by lowering the tax rate from 35% to 28%.  Overall this is “revenue” neutral.  Will this help the economy grow?  Hell no!  At best it might make the economy run more efficiently(always a good thing!), but it won’t grow.   It won’t grow because all they’re doing is changing who pays what, and not the total amount taxed.  No growth.

The second part is to get companies with foreign money holdings to bring the money into the country.  Normally, there is, apparently, a tax on doing that.  Therefore, companies leave their earnings overseas.  This estimate says there are over a trillion dollars out there.  Obama’s proposal is to try and get those companies to bring in the money by offering a one time, low tax, to do so.  From an MMT perspective this would be bad for the overall economy because it’s taking money out of the economy.

The third and final part of the Obama plan is to start funding infrastructure and job training programs.  From an MMT perspective, increasing government spending will be good for the overall economy because it will increase demand for jobs and business.  Hooray!

The reason I call this plan a waste of time is because, the first part offsets itself and the good in the third part is offset by the harm of the second part.  Making these plans revenue neutral will never give the economy the boost it needs.  Infrastructure jobs that aren’t offset with tax increases will.  Tax cuts that aren’t offset by tax decreases will also do the trick.

If there is any redeeming part of the proposed ‘grand bargain’ is the possibility that money will be shifted from those who are letting it sit, to those who will spend it.  That’s why I added the qualifier(mostly) into the title.  If that money is truly just sitting in a foreign bank, collecting low interest dust, then shifting the money to infrastructure and creating jobs for the unemployed will help some.  My guess is that only some of that money is “just sitting there”, the rest is being reinvested into other enterprises and will only end up moving around who gets it.

The thing that Obama, along with the GOP that’s already dismissed the whole thing, don’t understand is that the government doesn’t need that money to spend on infrastructure.  The government can’t run out of money anymore than a stadium can run out of points on a scoreboard.  Therefore, we can grow this economy until unemployment is back to a non-embarrassing level.

Recognizing who\what Really Controls Interest Rates

Just in case there was any doubt about what really controls interest rates, the past couple of months should dispel any lingering doubts.  The Federal Reserve(The Fed) is without a doubt in full control of interest rates going up or down.Money Graph

Back in spring, the Fed hinted that it was going to ease up on “Quantitative Easing” or QE3.  Quantitative easing, for those who don’t know, is the Fed trying to flood the market with dollars by buying stocks and bonds(*True Story)  They call it Quantitative Easing to make themselves sound smarter than you(*Not a true story).

So guess what happened?  Interest rates have been steadily rising this summer.  Despite that, many people mistakenly believe that interest rates are determined by a “Free Market” or by “bond vigilantes”.  The only time “the market” really gets involved is when they start trying to guess at what the Fed is going to do.  That was demonstrated last Wednesday.  The Fed said nothing, the market reacted as if that meant interest rates were going to go up.

The policy implications for this are immense.  I won’t get into all of them on this little post.  But let’s just start at the bottom.  The Fed sets interest rates.  That is a fact, once that cannot be denied.  Whether or not that is desirable is a different argument.  But, right now, the only thing standing between a 0% interest rate, or a 40% interest rate is a whole bunch of wealth, well-connected bankers.

No amount of budget deficits or surpluses can change that fact.  Granted, the bankers may make their decisions based on federal budgets or the health of the economy.  But the decision is still in the hands of a small number of people, not “the market”.

The Farce That is Sequestration

Brace yourselves, The effects of the so-called “Budget Sequestration” are about to hit.  The two parties aren’t going to compromise so the automatic budget cuts are going to hit and hurt the economy.  The media will probably ultimately blame the two political parties for not coming together to fix something that EVERYONE knows is going to be bad for the economy.

The actual economic damage is compounded by the other deficit-reduction measures that have already slowed growth, including a 2 percent payroll tax increase. All told, economists expect the sequestration plus last month’s fiscal-cliff deal to slow the pace of GDP growth by 1.5 percentage points. That’s no small change for an economy growing about 2 percent a year, particularly one that appears to have lost steam in the fourth quarter of 2012.

<snip>

The reality is that they are equally at fault: Both sides accepted the across-the-board cuts if they couldn’t agree to more sensible ones.

I don’t blame the two parties for this mess.  I blame bad economics.  John T. Harvey has a good write-up of why this is going to be bad and why it’s all unnecessary in his article Suicide by Sequestration.

As suggested above, many others have already gone into detail on where cuts will hit and how bad it will be. But, the overwhelming majority of this has been written based on the assumption that we do, in fact, need to cut the debt and deficit, just not this way. I therefore want to do what I’ve done so many times before in this blog: explain why this is a false and terribly dangerous premise. ANY reductions in the deficit are a mistake, not just those forced by sequestration. Below, I attack a number of the fallacies on which these contrary opinions are based (many of these have appeared before in this column–I’ll keep repeating it until President Obama listens!):

<snip>

For God’s sake, we have so many difficult problems facing us today. Why add to that by shooting ourselves in the foot–no, the head–by purposely reducing economic activity even more? To see how well this brilliant economic-recovery strategy works, just look at Greece, Spain, and the UK. Better yet, look at the US in fourth quarter of 2012. That negative growth, correlated as it was with a big drop in government spending, is a precursor of things to come.

I highly recommend reading the rest.  John explains better than I could so I won’t repeat his points.  Instead, I’ll try to answer his question of Why do we keep trying to do this to ourselves?.

The economists that our leaders listen to keep telling them that budget deficits are always bad.  It’s always bad to have debt for a household or business, so in theory, it should be bad for a national government.  It’s a very powerful and emotionally convincing theory backed up by the metaphor of a household or business budget.  The people who keep pointing out that The Federal Budget is not Like Your Budget keep getting drowned out.

How powerful is this theory?  It’s so powerful it drowns out common sense.  Let’s take a different situation.  Let’s say someone at the pet store tells you your fish tank should have no more than 3 snails for every 5 fish.  But your fish tank has 4 snails and 5 fish.  So you take away one snail.  But you notice that a week later your fish starting looking sickly and the water gets dirty.  You add back a snail and everything starts slowly recovering.  When you tell this to the pet store owner, he assures you “no no, you gotta take that snail away.  Your tank will get ‘too clean’.  The 3 snails will eventually learn to clean more.”.  So you go home and take the snail away again, but sure enough your tank gets dirty and the fish sickly.  How many times would you keep trying to take a snail away before you conclude that the pet store owner doesn’t know what the hell he’s talking about?  Well, if you’re a congressman, at least more than 5 years!

We have experienced nearly 5 years of a trillion plus dollar budget deficit.  The entire time our economy has been slowly recovering.  The only times it has faltered is when congress has another budget or debt ceiling fight to cut the budget.  How long can this go one until more people start realizing that the economy is recovering and falters when we prematurely try to balance the budget?  If we were scientists and observed this many countervailing examples of our theory, we’d throw it out in a heartbeat.

But, we don’t throw out the theory that “Budget Deficits are always bad”.  Why?  Because the metaphor of the federal budget being like a household budget is just too strong.  We’ll just keep telling ourselves that we “cut the ‘wrong’ things”.  Apparently, they’ll never conclude that it’s the cutting itself that is ‘wrong’.

MMT Has a Long Way to Go

At the recent VP debate, I watched two gentlemen blame each other’s “spending” for causing the recession.  This does not bode well for MMT or reality entering our politics.  Up until now, I thought there was hope for Democrats.  But after watching the VP debate, if they all start following Biden’s lead it’ll mean they are moving further away from the reality instead of closer.

As you or anyone who has read an MMT book like the Seven Deadly Innocent Frauds knows, budget deficits and debt are not real problems.  Recessions cause deficits, not the other way around.  But, listen look at this art of the exchange (courtesy of abcnews)  that illustrates what  I’m talking about:

BIDEN: And, by the way, they talk about this Great Recession if it fell out of the sky, like, “Oh, my goodness, where did it come from?” It came from this man voting to put two wars on a credit card, to at the same time put a prescription drug benefit on the credit card, a trillion-dollar tax cut for the very wealthy. I was there. I voted against them. I said, no, we can’t afford that.

And now, all of a sudden, these guys are so seized with the concern about the debt that they created.

RADDATZ: Congressman Ryan?

RYAN: Let’s not forget that they came in with one-party control. When Barack Obama was elected, his party controlled everything. They had the ability to do everything of their choosing. And look at where we are right now.

They passed the stimulus. The idea that we could borrow $831 billion, spend it on all of these special interest groups, and that it would work out just fine, that unemployment would never get to 8 percent — it went up above 8 percent for 43 months. They said that, right now, if we just passed this stimulus, the economy would grow at 4 percent. It’s growing at 1.3.

For that last 4 years Republicans would attack Democrats and the Administration for debt and deficits. Democrats would counter with two wars, and the other things republicans deficit spent money on before the recession.  The implication was that Republicans were hypocrites for only caring about deficits when Democrats were spending on things Republicans didn’t like.  From a MMT perspective it wasn’t a harmful counter-argument.

Unfortunately, the above statement by Biden implies that the Republican spending was the cause of the current recession.  That is a very destructive narrative.  First of all, the absurdity for implying that I am out of a job now, because the government bought a tank 10 years ago.  The second is that it reinforces the conventional wisdom that budged deficits are bad in of themselves.  Also, it reinforces the false idea that debt denominated in a Sovereign currency can cause any crisis.

I was hoping to convince Democrats of the truth.  That debt and deficits don’t really matter(at least not in the way they think).  Instead they appear to be moving closer to the Austrian school and the idea that sovereign debt causes recessions – instead of the other way around.  I hope Biden’s logic doesn’t catch on with the rest of the party.

All that Bunk About Deficits and Skyrocketing Interest Rates

It is astounding how long experts can keep repeating the conventional wisdom in the face of -what SHOULD be – overwhelming reality.  The way things work today, the Federal Reserve sets the interest rate.  Additionally, inflation is determined primarily by aggregate demand.  We have nearly 5 years of data backing this stuff up.  Yet, the conventional wisdom marches on.

The federal reserve very plainly sets the (short-term) interest rate.  That is what they do.  It’s called an Open Market Operation. When they want interests to go down they buy U.S. bonds.  That puts cash in the system and lowers interest rates.  When the Fed wants interest rates to go up, they sell their stock of U.S. bonds and remove cash from the system.  In this way the federal reserve sets the interest rate on U.S. bonds which then in turn influence other interest rates(like mortgages and car loans).  This isn’t a secret.  They explain it on their website.

Despite this, we have deficit terrorists running around telling us that we need to cut social security and gut medicare right now! This very instant!  Because if we don’t, interest rates will spike.  We’ll have to start paying 150 bazillian% (Note:  not a real number) on the federal debt and our mortgages.  Pete Peterson, the stereotypical deficit terrorist, states the conventional wisdom very plainly.

I see two potential crises in the future: a near-term financial crisis rooted in declining investor confidence that leads to sharp rises in interest rates and forces sudden, draconian changes in the federal budget; and a longer-term economic crisis that would result from diverting more and more of our national resources to servicing debt instead of investing in areas that are essential to long-term growth. These crises are made all the more likely by the fact that growing debts aren’t just an American problem. Projections show that, by 2035, the world’s advanced economies could face debts approaching 200% of their GDP. With countries competing for scarce capital, interest rates are almost sure to rise steeply.

(emphasis added)

We are now on fiscal year 5 of approx trillion-dollar budget deficits.  I’m still waiting on those mythical bond vigilantes to spike our interest rates.

With that in mind, I found two news stories that are oh-so interesting.  The first is that Mortgage rates hit a new record low last week.  So much for worrying about skyrocketing interest rates…  But what about U.S. bonds?   Maybe those are skyrocketing?  They are still insanely low.  On top of that, there was a bond auction this week where, for every 1$ in U.S. treasuries being sold, 3.16$ was bidding to buy them.  That is a record high amount of bids.  So despite low interest rates and high budget deficits, bond holders are not only sticking with U.S. bonds, but are flocking towards them in record numbers.

In both cases, it is because the federal reserve is purposely keeping the interest rates low.  They always keep it low when they want it low and always keep it high when they want it high.  At this point, I expect someone who is well-versed in the conventional wisdom to grab his or her hair and shout, “Fed keeping interest rates low?  zOMG!  Hyperinflation!  Weimer!  Printing Press!”, and then their head explodes(Note:  I cannot be held liable for exploding heads).  All I have to say is that I am still waiting on that hyperinflation.

The small, but growing community of Modern Monetary Theory(MMT) economists can explain this phenomenon better than conventional economists.  They understand how Modern money works.  How Inflation an interest rates are really set.  Unfortunately, the conventional wisdom doesn’t want to hear it.  Instead, we continue to have both presidential nominees talk about budget deficits without anyone asking to explain the supposed problem.

Reframing Money

You probably all know about the story of Copernicus.  In the 1500s he spread the idea that the Sun – and not the Earth – was at the center of our solar system.  Despite fierce resistance from the Church, the idea caught on and changed the way scientists think about our place in the Universe.  One part of the story you may not know is that there was such a thing as a pre-copernican astronomy.  It involved complex theories to explain the movement of planets that involved things like “epicycles” and “coils”.  Believe it or not, they did a fairly decent job of predicting the movement of planets and forecasting eclipses.  However, as accurate as those models may have been, Copernicus’s model was much simpler to understand and ended up being even more accurate.  When Copernicus changed the frame of reference from the Earth to the Sun, suddenly everything else fell into place and was much easier to understand.  To understand modern economics, we need a similar change of perspective from the old.

Most of us have a 19th century view of money.  That is, the view that money and dollars are nothing more than a unit of exchange that is representative of something concrete like gold or silver.  Granted, most people know that the gold standard has been over for over 40 years now.  However, when talking about money, we still carry the thinking and language of money as gold.  We think of dollars in terms of being physically limited, like gold.  Also like gold, we think of in terms of supply and demand – if there is more of it, it is automatically less valuable and vice verse.  We think of the government “saving” dollars like it saves gold in a vault.  We think of the government needing to hoard dollars today so that they can be used tomorrow.  This view of money comes with a (unsubstantiated) story of money that goes like this:  A long time ago humans used barter to exchange goods.  This was inconvenient so they decided to find a common unit of exchange.  Gold and Silver were settled on because they were rare and one piece of gold(or silver) was just as good as another.

An increasing number of economists are taking a different approach to understanding money and that is called Modern Monetary Theory or MMT that I’ve been writing about for almost a year.  Rather than thinking of money as purely a unit of exchange created spontaneously, MMT economists take a different approach. The approach was proposed, most famously, by Knapp.  He viewed Money as “a creature of the state”.  MMT economists view is that money is how the government of a capitalist country brings resources to the government.  Here’s how the story goes:

Say you are the head of your own country.  You want to build a new highway for your people.  To do so, you must convince people to work for you and sell you the concrete and tools you’ll need to build your road.  You therefore decide to create a new currency and give it a name… say iCoin.  You offer your iCoins to people to work for you or to sell you construction equipment, but nobody accepts your offer because nobody wants an iCoin.  Therefore, as head of the government, you impose a tax on all your people of 10 iCoins that must be paid by next April 15th or be faced with jail time.  Suddenly, people need iCoins and are willing to work or sell the government equipment in exchange for iCoins that they will eventually give back to the government.  (A by product of this is that people start exchanging it with each other.)

The take away from the story is that taxes are what gives a currency value and the purpose of the currency is to make private resource public.  These concepts give us a new approach to understanding money in a modern economy.  Just like when Copernicus put the Sun at the center of the solar system, this new approach simplifies our understanding and reveals once obscure truths that now seem obvious.  I’ll briefly go over a few of them, although each deserves their own blog post.

What gives Fiat money value.

As far as I’m concerned, there has never been a really good explanation of why fiat money(money with no gold backing) has value.  The traditional approaches have been less than satisfactory.  The one traditional explanation is that all fiat money grew out of gold or silver certificates and that even when the exchange was closed, people keep accepting the certificates out of habit.  The second traditional explanation – the one still taught at places like Harvard – is even less concrete.  It goes something like this “As a hair stylist, I accept dollars from my customers because I know that I can use them to buy a hamburger at my favorite restaurant which accepts my dollars because they can use it to pay their waiters who also accept dollars because they know they can use them to get a hair cut at my salon.”  Both of the traditional explanation requires a leap of faith by currency users every time they accept dollars.  In the MMT approach, it is real simple why people accept dollars as a payment: “I need dollars to pay my taxes.”

Extended Recessions

There are several possible causes for temporary, short-lived recessions that no economic understanding can always prevent.  However, the MMT approach provides a simple understanding of extended recessions like the one we’re in now, or the ones in the early 80s and 90s.  A long term recession is caused by the government not providing enough dollars for everyone to meet their tax requirements and dollar savings desire.  Where-as the traditional approach requires understanding everything from sticky prices and wages, IS-LM charts, and Phillips curves.

Currency Value and Inflation

The traditional approach to understanding how a government can control the value of a currency is based on interest rates – The idea being that if you raise interest rates the currency becomes more valuable-, “quantity theory” if the amount of money in the system goes up then the value of the currency must (eventually) go down, and reserve levels(the amount of money banks must keep in their vaults).  The MMT approach views it differently.  MMT views that the only way a government can control the value of their currency is by the level of taxation and spending level(i.e. fiscal policy).

New Insights

In the previous 3 examples comparing the different approaches one can see that neither approach is definitively wrong or right.  Just like the ancient astronomers vs. Copernicus,  MMT just offers a different approach that makes things easier to understand.  MMT also makes a few things obvious that aren’t obvious in more traditional approaches.

The first is the limits on federal spending.  Those trapped in the traditional approach believe that a government can only spend what money it gets (or will get) from taxes.  The MMT approach suggests that tax level isn’t the limitation – the ability of the economy to create the resources the government wants to buy is the only limitation.  If the government deficit spends too much it’ll hit resource limitations which manifests itself as inflation.  Therefore, inflation is the only limitation on government spending – not tax revenue or even borrowing.

Recessions and Inflation

Another thing MMT shows is an explanation of why governments can spend more during a recession without raising taxes.  In the traditional approach, a large budget deficit is thought to automatically cause inflation based on the “quantity theory of money”.  Therefore, even during a recession when tax revenue drops and unemployment rises, it is recommended to cut spending so as not to cause inflation.

However, the MMT approach shows why that is wrong.  During a recession, people are out of work.  If the whole point of money is to bring resources to the government… then people being out-of-work means that the government has MORE room to spend because there are more resources available.  In fact, the government should not only spend more, but even tax less.  As long as the unemployed resources are available, the government has no reason to cut back during a recession.  That’s why we can have 3 years of trillion dollar plus deficits and still have very low inflation.

Final Remarks

There are of course numerous other things that your understanding of is changed once money ise viewed as how the government of a capitalist country brings resources to the government.  There are too many to cover in a single post.  Not the least of which is the relationship (or lack there of) between inflation and unemployment, trade deficits, interest rates, and many more.  All these topics need their own posting to due them any justice.  I won’t get into it now, but the point of this is to acknowledge that MMT completely reframes the role of money and that the reframing makes it easier to understand the real world mechanics of modern economies.

You don’t have to accept MMTs reframing of money to understand all these concepts mentioned above, but just like with reframing the Earth moving around the Sun helps to understand astronomy, so does MMTs reframing of money.  Otherwise, to explain everything that we’ve seen just in the last 3 years we have to accept things like sticky prices, an ever-changing Phillips curve, and maybe even Ricardian equivalence.

Sen. Sanders showing MMT some love while reforming Fed

Back in October, Senator Bernie Sanders put together a panel of economists and other public policy experts to come up with a plan to “reform” the Federal Reserve structure.  As his news release makes clear, there is a lot of room for improvement.

Sanders announced formation of his expert advisory panel in the wake of a damning report that faulted apparent conflicts of interest by bank-picked board members at the 12 regional Fed banks.

Top executives from Goldman Sachs, J.P. Morgan Chase, General Electric and other firms sat on the boards of regional Federal Reserve banks while their firms benefited from the central bank’s policies during the financial crisis, the Government Accountability Office investigation found. The dual roles created an appearance of a conflict of interest, according to the GAO.

The surprising part was that the panel had a significant number of MMT economists.  People like L. Randall Wray, William Black, James Galbraith, and Stephanie Kelton.  With all that MMT on the council and the strong showing from the UMKC economics department, I’m optimistic about the reforms they’ll come up with.  Wray has been writing about the Fed since being on the panel.  I think it gives a little hint of the kind of things he and other MMT economists are recommending.  Here’s links to his articles:

Time to abolish the Fed?  Maybe Andrew Jackson was Right.

MORE SECRETS OF THE TEMPLE: Time to Demand Transparency and Accountability of Our Public Stewards

BERNANKE’S OBFUSCATION CONTINUES: The Fed’s $29 Trillion Bail-out of Wall Street

BERNANKE’S OBFUSCATION ON THE 29 TRILLION DOLLAR BAILOUT: RESPONSE TO CRITICS

The $29 Trillion Bail-Out: A Resolution and Conclusion

The title’s alone are encouraging and give you an idea of what he’s writing about.  I highly encourage reading all of them.  It (hopefully) is a preview of the final recommendations the panel will deliver to the good Senator.

Still waiting on that hyperinflation.

In 2009, there was a crazy, wild-eyed passion spreading among conservatives and the Teabagger.  Here are some choice quotes from prominent conservatives and teabagger favorites.

Glenn Beck and Ron Paul

Ron Paul:  [snip] So the bailout is a disease, it’s contagious, it’s ongoing, and the result of this will be the destruction of the dollar, which to me means runaway inflation, and political chaos. It’s very, very dangerous.

Glenn Beck: OK, hang on, because you are saying “runaway inflation”. You’re meaning Weimar Republic, wheelbarrow full of money type of stuff to buy a loaf of bread. Is that the kind of inflation you are talking about?

Eric Cantor

Finally, we must ensure that vast government spending doesn’t lead to rampant inflation in the future. At $825 billion, this Democrat stimulus proposal causes us great concern. While the Fed remains rightfully concentrated on fighting deflation, uncontrolled spending and borrowing will most ultimately lead to inflation if the spigot is not turned off in time. That could trigger a flight of foreign capital and a steep drop in the purchasing power of the dollar for the American consumer. As interests rates rise to keep foreigners financing our debt, the pain dealt to businesses and families alike promises to be sharp.

Michele Bachman

Make no mistake. This stimulus bill has very little to do with stimulating the economy and helping the average American . This is a bailout for big government. And let’s get ready. We are looking at massive tax increases and we are looking at massive inflation or both. In fact, we could be looking at hyperinflation.

Arthur Laffer (The “Father of supply-side economics” or Reaganomics)

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

We are a couple of months away from the close of the third year of the Obama Administration.  Before that we will mark the 4 year anniversary of the start of the Great Recession(Dec 2007).  And, most importantly we’ve just finished our third fiscal year in a row of having more than a trillion-dollar budget deficit.

So based on all the hyperbole of conservatives, and the fact we’ve had such huge budget deficits, one might think we were facing huge bouts of inflation.  So let’s take a look at the inflation rate for the last three years.
fredgraph3YearInflation
As you can see, since the stimulus and other government spending brought us out of a recession, month to month changes bounced around between .4 and negative .2 and only briefly went higher than .5 percent.  However, is that a lot?  Let’s compare it to the previous years.  Let’s take at the data since January 2001.

 

fredgraph2001ToPresentInflation

 

As you can see, after officially exiting the recession, inflation has actually been consistently lower than in the earlier, non-recession ,years.  The only spike you see was from earlier this year and was almost entirely driven by energy costs.  How do I know?  Let’s lay over the cost of energy in general and gasoline into the graphs.

 

fredgraph3YearInflationAndEnergy

 

Remember these are month-to-month changes.  As you can see, the energy costs went up so much higher and faster that I had to adjust the scale of the graph to show the increase.  General Prices(blue line) barely looks like a bump while Gas Prices(Red) and general energy costs(Green) went up about 10 times as fast.  So those price increases weren’t driven by general inflation, they were driven by an increase in energy costs.

So in spite of these billion and trillion-dollar budget deficits, how has there been such low inflation?  Didn’t Weimer Germany prove that always happens?  The assumption that a large budget deficits will automatically lead to high inflation is deeply ingrained in our politics.  Based on the last 3 years, you would think that this belief would be re-examined.   And yet, republicans and conservative allies are still warning that the sky is falling inflation is coming.  The whole theory of oncoming inflation is based on the flawed quantity theory of money.  A theory rendered even less relevant since it was developed when we were still on a gold standard.

So what is an alternative explanation?  Does this mean that government can spend and spend without consequence?  MMT (which evolved from keynesian economics) provides an alternative economic framework for understanding why a government can have a trillion dollar deficit 3 years running and still have inflation that is lower than it was when deficits were less than 400 billion.  First of all, inflation comes from spending money, not creating it.

As long as all spending is matched by an equal increase in the amount of goods and services produced by an economy, that spending won’t be inflationary.  Here’s the macro economic implications:  During a recession dollar savings tends to increase – i.e. people tend not to spend their money.  People are afraid of losing their job, and businesses are afraid to expand, leading to reinforcing recessionary effects. One thing that doesn’t change right away is the capacity in the economy. Therefore, when people save dollars, they open up room for the federal government to deficit spend money that won’t be inflationary.  In fact, if the government doesn’t spend it’ll cause deflation which is really bad for an economy.

To better understand the macro economics, let’s take a look at a micro economic example:  Presumably, even during a recession, a factory that produced 100 cars yesterday, can still produce 100 today.  If all the people in the economy bought 100 cars yesterday, but only bought 99 today, then that means that the government can come in and buy an extra car and it won’t be inflationary because the factory can produce it.  Now, of course I’m not suggesting that the government start asking factories how much it can produce and directly buy what it doesn’t sell.  Instead, I’m just trying to give a micro example of what is happening across an entire economy.  The economy has excess capacity that the people producing the items aren’t buying because they are saving their dollars.

The take away is that the federal government has the ability to have deficits until the economy can no longer increase the amount of goods the economy is capable of producing, then inflation happens.  The size the budget deficit can be depends on many things.  One of the things as explained above is the rate of private savings which tends to be higher during recessions.  That is why the federal government can run a trillion dollar plus deficit 3 years running and the economy can still have a lower inflation rate than when it was running sub 400 billion dollar deficit.

Euro Zone Debt Crisis Was Going to Happen Eventually

The European Union was set up in a manner that guaranteed that eventually, one of its members was going to have a debt crisis.  What makes the Euro so unique is that it was setup almost like a gold standard.   Each nation does in the Eurozone does not issue it’s own money.  It must be borrowed.  That borrowing must come from someone who has Euros.  This is very different from most other modern countries like the U.K., United States, Canada, or Japan.  The reason this becomes important is not during economic booms, but during the busts.

During an economic bust – or recession – people are out of work and pay less taxes.  Therefore the nation brings in less tax money.  Additionally, the increasing unemployed add to the costs of the social safety net.  Therefore as the recession goes on, countries bring in less tax dollars, but are obliged to pay out more benefits.  This becomes a problem when you cannot have a budget deficit.  The U.S. states are having that problem right now.  Greece and other Euro zone nations aren’t supposed to have budget deficits greater than 3% of GDP.  That is impossible during a deep enough recession.

During a deep recession, a Sovereign nation like Japan or the United States could run a large budget deficit to counter-act the recession.  Eurozone nations cannot do that.  They must cut back along with the rest of their private sector.  Well, when a recession is caused by people cutting back, and then the government cuts back… it’s only going to make the recession worse!

Even if Greece perfectly managed their finances and economy, this would’ve just happened to another euro zone country.  Greece just happened to be first.  MMT economists predicted this would happen several times over the years(See here, here, and here and again here).

Governments must be able to counter act recessions.  The Euro was designed without thinking about recessions.

The Dilemma Faced by Greek Citizens: How to Vote?

Last week it appeared that a bailout deal between Greece and the rest of the EU was going to go through.   However, it seems that the prime minister of Greece is going to quite literally, “let the people decide“.  Now, the Greek people must decide if they want to vote for the bailout – which requires them to raise taxes and cut government services, or against the bailout which would cause them to default on their loans.  If the default on their loans, they won’t be able to deficit spend Euros anymore and will have to, in response… raise taxes and cut government services.  That is quite a dilemma for Greek Citizens.

If I were a Greek Citizen, I would vote ‘No’.  The reason is that there are other options.  If the Greek government cared more about their citizens then about foreign and domestic bankers, they would research those alternatives.  Those alternatives would give Greeks what they seem to want.  A more leisurely lifestyle – even if it’s ‘poorer’.  There is nothing wrong with wanting that and no reason they can’t have it.

One of the alternatives is the so-called Mosler bond.

turn the bonds it buys into Mosler bonds, by requiring the govt of issue to legally state that in the case of non payment, the bearer on demand can use those bonds for payment of taxes to the govt of issue.

That would allow Greece to continue borrowing and spending on demand and at will.

Another alternatives is one that, for some reason, seems to be way outside the policy discussion.  Greece could just drop out of the EU, and convert all debts back to a Sovereign currency like their original drachma.  Once they’re monetarily sovereign they will never again have to worry about government default.  They will be like most of the world in that the only limit on spending will be inflation.  If Greeks want a leisurely lifestyle and don’t mind having a week currency, they could go back to full employment for those who want employment.

Unfortunately, neither of these options seem to be seriously discussed even though it would give Greek citizens what they desire.  That is why I would vote no against this deal.  Vote it down, and force the government to seek alternatives.

Some, like Warren Mosler himself, would encourage Greece to vote yes.  His reasoning is very logical.  If you vote for the bailout, you can continue borrowing and only have to accept some cuts and small tax rise.  If the vote is no and you default and cannot continue borrowing, then you will have to cut even more spending and raise taxes even more.

In the end, it comes down to politics.  Mosler’s position is very pragmatic.  Vote for the bailout because it’s not as bad as default.  My position is very political.  Vote it down and force the Greek government to find an alternative solution.