How to prevent and cure inflation. (It’s not what the “experts” tell you.)

Two related philosophies about federal finances are MMT (Modern Monetary Theory) and MS (Monetary Sovereignty). You now are reading an MS blog.

MMT and MS agree on the following principle that was expressed by MMT’s L. Randall Wray in his paper “WHAT ARE TAXES FOR? THE MMT APPROACH” 

“Taxes are not needed to ‘pay for’ (federal) government spending. The logic is reversed: government must spend (or lend) the currency into the economy before taxpayers can pay taxes in the form of the currency. Spend first, tax later is the logical sequence.”

U.S. federal taxes are not needed. The U.S. government, being Monetarily Sovereign, has the unlimited ability to create its own sovereign currency, the U.S. dollar.

The U.S. government never unintentionally can run short of dollars. Even if all federal tax collections totaled $0, the federal government could continue spending, forever.

The articles you read about the “unsustainable” federal debt are, very simply, wrong. There is no level of U.S. dollar obligations the federal government cannot easily sustain.

Ben Bernanke: “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”

Alan Greenspan: “Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit. A government cannot become insolvent with respect to obligations in its own currency.”

St. Louis Federal Reserve: “As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets (borrowing) to remain operational.

Professor Wray’s paper continues:

Some who hear this for the first time jump to the question: “Well, why not just eliminate taxes altogether?” There are several reasons.

First, it is the tax that “drives” the currency. If we eliminated the tax, people probably would not immediately abandon use of the currency, but the main driver for its use would be gone.

We disagree with the “taxes drive the currency” notion. Contrary examples abound. Professor Wray’s own “Roobucks” are not “driven” by taxes. They are driven by the discounts they provide. Bitcoin is not “driven” by taxes.

However, the real point is contained in the following paragraphs from Wray’s paper:

Further, the second reason to have taxes is to reduce aggregate demand. If we look at the United States today, the federal government spending is somewhat over 20% of GDP, while tax revenue is somewhat less—say 17%.

The net injection coming from the federal government is thus about 3% of GDP. If we eliminated taxes (and held all else constant) the net injection might rise toward 20% of GDP.

That is a huge increase of aggregate demand, and could cause inflation.

Ideally, it is best if tax revenue moves countercyclically—increasing in expansion and falling in recession.

That helps to make the government’s net contribution to the economy countercyclical, which helps to stabilize aggregate demand.

The implicit assumption of the above paragraphs is that the private sector’s money supply drives inflation, and the way to control inflation is to reduce the private sector’s money supply.

In a similar vein:

A Wikipedia article says, “Low or moderate inflation may be attributed to fluctuations in the real demand for goods and services, or changes in available supplies such as during scarcities. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.”

We disagree with Wray and with the Wikipedia author. A “long sustained period” of money supply growth cannot exceed a “long sustained period” of economic growth.

The money supply cannot grow faster than economic growth. The two are interdependent in the formula for GDP:

Real GDP = Real Federal Spending + Real Non-federal Spending + Real Net Exports

A decrease in taxes would increase the “Non-federal Spending” factor and GDP by the same amount. By formula, tax decreases increase GDP.

Inflation usually is defined as a general increase in prices. Another way to say it is, “Inflation reduces the purchasing power of each unit of currency.”

There are two levels of inflation: Intentional and unintentional. The intentional form is the amount that the central bank believes is helpful for a growing economy. The U.S. Federal Reserve has as its target rate, 2% inflation.

When annual inflation drifts above or below the 2% target, the Fed quickly raises and lowers interest rates, i.e. raises to rates combat inflation; lowers rates to stimulate inflation.

(The Fed also lowers interest rates to stimulate economic growth, which follows the common myth that stimulating growth and stimulating inflation require the same actions.)

The Fed’s target rate of inflation is maintained by interest rate control, which controls the demand for, and purchasing power of, U.S. dollars. Increasing the demand for dollars reduces inflation; decreasing the demand for dollars encourages inflation.

But what about high inflation, say of 50% or 50,000% annually or more. Such hyperinflations always are caused by shortages of food and/or energy (oil).

The famous Zimbabwe hyperinflation is a typical example. The government took farmland from white farmers and gave it to blacks who did not know how to farm. The inevitable food shortage caused hyperinflation.

In response, rather than trying to cure the food shortage, the Zimbabwe government began printing more currency.

This provided the illusion that currency printing caused the hyperinflation, when in fact, the hyperinflation caused the currency printing.

Think of a typical scenario this way: The inflation-adjusted money supply goes up. Where does the additional real money go? The vast majority goes to spending, which by definition, increases real GDP.

One might argue that some is saved, but since saved dollars are not spent, they cannot contribute to aggregate demand.

All increases in the real money supply increase real GDP.

Further, and most importantly, all decreases in the real money supply (because of taxes) decrease real GDP. Thus taxes, rather than being effective moderators of inflation, actually are recessive.

Recession is not the opposite of inflation. The two can occur simultaneously. The opposite of inflation is deflation. Taxes do not cause deflation. Deflation, i.e. price decreases, is caused by excess supplies of goods and services.

Thus, removing currency (via taxes) from the economy would have done nothing to cure the inflation, though it would have reduced real (inflation-adjusted) GDP economic growth, while it impoverished the populace.

There are several ways to prevent or cure inflation, but taxation is not one of them. Taxation merely takes dollars from the private sector and delivers them to the federal government, where your tax dollars are destroyed.

Taxation does nothing to address the fundamental cause of inflation: Shortages.

Imagine an inflation caused by a food shortage, and the automatic response is an increase in taxes. How would leaving fewer inflation dollars in the pockets of the people eliminate the food shortage?

It wouldn’t, of course.

Consider again, Zimbabwe: Rather than taxing, designed to reduce the currency supply (while impoverishing the people), or printing currency to increase the currency supply (thereby reducing the already diminished value of Zimbabe’s money), the Zimbabwe government should have taken steps to increase the food supply.

This might have included paying to educate Zimbabwe’s farmers and/or paying experienced farmers to manage farms or paying to import food from other nations.

These steps would have required the Zimbabwean government to spend more money to correct inflation — a counterintuitive response, but the only one based on financial reality.

In Summary
Any time a nation experiences an unwanted level of inflation, the correct early step is to increase interest rates, thus increasing the demand for, and the value of, the nation’s currency.

If the inflation has grown beyond interest rate increases as a sole solution, additional steps are needed:

1. Determine what exactly is causing the inflation
2. If the cause is a shortage of food or energy the government must either import the needed food or energy, or fund ways to increase the domestic production of food or energy.
3. If the government is monetarily non-sovereign (a euro nation, for instance), and cannot afford to fund imports or fund domestic production of the scarce commodities, it immediately should begin the process of issuing its own sovereign currency, i.e. it should make itself Monetarily Sovereign.

Raising taxes is exactly the wrong step since that will worsen the inflation problem, while adding recession to the burden.

Rodger Malcolm Mitchell
Monetary Sovereignty
Twitter: @rodgermitchell
Search #monetarysovereignty Facebook: Rodger Malcolm Mitchell

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The most important problems in economics involve:

1. Monetary Sovereignty describes money creation and destruction.
2. Gap Psychology describes the common desire to distance oneself from those “below” in any socio-economic ranking, and to come nearer those “above.” The socio-economic distance is referred to as “The Gap.”

Wide Gaps negatively affect poverty, health and longevity, education, housing, law and crime, war, leadership, ownership, bigotry, supply and demand, taxation, GDP, international relations, scientific advancement, the environment, human motivation and well-being, and virtually every other issue in economics.

Implementation of Monetary Sovereignty and The Ten Steps To Prosperity can grow the economy and narrow the Gaps:

Ten Steps To Prosperity:

1. Eliminate FICA

2. Federally funded Medicare — parts a, b & d, plus long-term care — for everyone

3. Provide a monthly economic bonus to every man, woman and child in America (similar to social security for all)

4. Free education (including post-grad) for everyone

5. Salary for attending school

6. Eliminate federal taxes on business

7. Increase the standard income tax deduction, annually. 

8. Tax the very rich (the “.1%”) more, with higher progressive tax rates on all forms of income.

9. Federal ownership of all banks

10. Increase federal spending on the myriad initiatives that benefit America’s 99.9% 

The Ten Steps will grow the economy and narrow the income/wealth/power Gap between the rich and the rest.

MONETARY SOVEREIGNTY