A fundamental truth of economics: A Monetarily Sovereign nation never unintentionally can run short of its own sovereign currency.
The nation does not need to tax and does not need to borrow. It creates its sovereign currency at will.
To not understand that fact is to not understand economics, for it is the absolute foundation of economics.
THEWEEK Magazine recently published the article, “The big question about Modern Monetary Theory everyone is missing,” by Ryan Cooper.
Modern Monetary Theory (MMT) and Monetary Sovereignty (MS) share many characteristics regarding money in today’s economies.
Here are a few excerpts from the article, together with my comments.
Economists are in the midst of one of the periodic debate flare-ups over Modern Monetary Theory.
On the pro-MMT side we have economists like Stephanie Kelton and Randall Wray, while on the other we have the odd bedfellows of The New York Times’ Paul Krugman and the People’s Policy Project’s Matt Bruenig.
Professor Kelton has been a “pen pal” of mine for several years. I met Professor Wray years ago, when I gave a talk to his class at UMKC.
This intricate debate is about the main merits of MMT, an economic school of thought which has received wide attention for its dismissal of the need for taxes to pay for new spending.
Both MMT and MS agree that unlike state and local taxes, which do pay for state and local government spending, federal taxes do not pay for federal spending.
The reason is that the U.S. federal government is Monetarily Sovereign. It is sovereign over U.S. dollars, which it creates ad hoc, every time it pays a creditor.
Even if the U.S. government collected zero taxes, it could continue spending, forever.
However, there is an important question which has to this point not been raised. The MMT advocates say that inflation should be controlled through fiscal policy, instead of monetary policy conducted by the central bank as is current practice.
In other words, if prices start rising, we can keep them in line by raising taxes.
But does that actually work?
No, it doesn’t work, cannot work and never will work.
Raising taxes is too slow and too political (waiting for Congress), too undirected (which taxes?), not incremental enough (raise taxes how much?), and too damaging to economic growth (taxes reduce the money supply).
Unfortunately, MMT takes incompatible positions. It says correctly, that federal taxes do not fund federal spending, but incorrectly that federal taxes are necessary to cause demand for U.S. dollars.
During times of recession and economic slack, a state borrowing in its own currency has unlimited capacity to spend, because printing money or borrowing to spend on public works and so on will not cause inflation so long as there are unemployed workers and idle capital stock.
Think, Mr. Cooper. If a state has the unlimited capacity to spend and to “print” money, why would it need to, or even want to, borrow? Think.
Contrary to popular wisdom, the U.S. does not borrow dollars. Instead, it accepts deposits into T-security accounts, the purpose of which are:
- To provide the world with a safe place to park unused dollars. This helps stabilize the dollar.
- To assist the Fed in controlling interest rates, which control inflation.
But if there is full employment, taxes are needed for new programs — to fund them for the former, or to stave off inflation for the latter.
Here, Cooper reveals he doesn’t understand the differences between monetarily non-sovereign state and local government financing (where borrowing is necessary), vs. Monetarily Sovereign federal financing (that requires no borrowing).
The federal government levies taxes, but not to obtain dollars. It freely produces all the dollars it needs.
The purpose of federal taxes is to control the economy by discouraging certain activities with higher taxes and by encouraging others with tax reductions.
The effect of federal taxes (as opposed to the purpose), is to reduce federal deficit spending which reduces the money supply.
All federal taxes do this — income taxes, FICA, sales taxes, import duties, etc. They all reduce the money supply. Just as tax cuts are economically stimulative, tax increases are recessionary.
And just as increased federal deficit spending helps cure recessions, decreased federal deficit spending causes recessions, and worst case, depressions.
U.S. depressions tend to come on the heels of federal surpluses.
1804-1812: U. S. Federal Debt reduced 48%. Depression began 1807.
1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.
1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.
1997-2001: U. S. Federal Debt reduced 15%. Recession began 2001.
Now, it should be noted that MMT’s style of argumentation seems to have dented the brainless pro-austerity mindset that dominates much of elite discourse, which is very much to its credit.
Remember the above comment, because later in his article, Cooper unknowingly supports the very austerity he calls “brainless.”
He discusses the key objection to MMT (and MS), inflation:
The way tax-side inflation control is supposed to work is through supply and demand.
Since taxation will leave buyers with less money in their pockets to spend, market competition will force suppliers to cut prices and workers to accept lower wages.
But if markets have become dominated by a few big firms, then business can resist this pressure, because buyers have nowhere else to go.
Taxation reduces the supply of money. Though taxation can support the demand for money, it is not necessary for that purpose.
Interest is a more effective device for supporting the demand for money. While taxes depress an economy, interest stimulates the economy by increasing federal dollar interest input.
Money growth grows an economy.
A good test of this prediction came in the late 1970s, when inflation was at its postwar peak.
Economist John Kenneth Galbraith argued for price controls, but conservative “monetarists” like Milton Friedman argued that (with) a steep hike in interest rates, inflation would come down quickly and easily.
The Fed tried Friedman’s policy, but it turned out Galbraith was right.
The Fed hiked interest rates to an eyewatering 20 percent, creating the worst recession since the Great Depression up to that time.
But inflation only came down very slowly — partly through Keynesian-style spending effects, but partly by badly damaging the labor movement, which cut unionization.
In the past 50 years, since President Nixon took the U.S. off a gold standard, inflation has not been caused by America’s massive federal deficit spending. See: Inflation has been caused by the price of oil.
The Fed wisely has not recommended controlling the price of oil, an action that would lead to an oil shortage, and a recession, if not a depression. That is what price controls do: Lead to shortages.
And what do shortages lead to? Hyperinflations.
So, Cooper writes that Galbraith was right about price controls?? Where did that come from? He provides no evidence.
The true effect of price controls is to reduce economic growth by reducing supply and profits — the economic necessities for growth.
Price control is a feature of the “brainless, pro-austerity mindset” that Cooper properly criticized a few paragraphs ago.
And do increased interest rates really lead to recessions? Or is it simply that recessions lead to decreased interest rates?
The above graph shows that sometimes interest rates peak at the start of recessions, sometimes they peak in the midst of economic growth, and sometimes they decline at the start of recessions.
One cannot say that increased interest rates historically have caused recessions.
The real pattern is that decreased deficit spending causes recessions and increased deficit spending cures recessions.
Why? Because a growing economy requires a growing supply of dollars, and deficit spending adds stimulus dollars to the economy.
Most inflations and nearly all hyperinflations are caused by shortages, usually shortages of food, and often shortages of oil.
For instance, Zimbabwe, an oft-mentioned hyperinflation victim, had its hyperinflation begin with a food shortage. (Farmland was stolen from farmers and given to non-farmers.)
One reason inflation control is delegated to the central bank is that it can work quickly, adjusting interest rates in response to economic conditions several times per year.
Congress works extremely slowly at the best of times, and control is usually split between the two parties.
The Fed may have performed poorly over the last decade, but do we really want Mitch McConnell having to sign off on inflation policy?
Exactly. Now that Cooper belatedly has confirmed why price controls and tax increases don’t work and can’t work, we come to the:
Modern Monetary Theory (MMT) and Monetary Sovereignty MS) describe the realities of economics similarly.
They agree that a Monetarily Sovereign nation, such as the U.S., cannot run short of its own sovereign currency, and neither needs nor uses tax dollars to fund spending.
They differ in many other areas however, one of which has to do with controlling inflation:
Three inflation controls were discussed, only one of which is effective:
- Price controls which cut profits and thus cut economic growth, lead to recessions and ultimately cause inflations by causing shortages. They don’t work, and neither MMT nor MS supports this approach.
- Tax increases, which are too slow, too political, not incremental, and cause recessions by decreasing the money supply. They don’t work, though MMT supports this approach.
- Interest rate increases, which actually increase the money supply (by causing the federal government to pay more interest into the economy, and work by increasing the value of dollars (by increasing the demand for dollars). Works, and has been working since the end of WWII. MS supports this approach.
Rodger Malcolm Mitchell
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