-Smoot-Hawley revisited

An alternative to popular faith

Just a quick thought: President Barack Obama’s decision to impose trade penalties on Chinese tires has infuriated Beijing. This is eerily reminiscent of Smoot-Hawley. Continued political cave-ins to unions could take us to a depression. At a time like this, the world needs the freest possible trade, not protectionism.

Rodger Malcolm Mitchell
For more information, see http://www.rodgermitchell.com

–The low interest rate/GDP growth fallacy

The debt hawks are to economics as the creationists are to biology. Those, who do not understand monetary sovereignty, do not understand economics. Cutting the federal deficit is the most ignorant and damaging step the federal government could take. It ranks ahead of the Hawley-Smoot Tariff.


       The Fed raises interest rates to fight inflation. To fight recession, the Fed does the opposite. It cuts interest rates.

This may sound logical except for one, very small detail. The opposite of inflation is not recession. The opposite of inflation is deflation. So doing the opposite of what you would do to counter inflation makes no sense when trying to counter a recession.

We could have a recession with deflation. We could have a recession with inflation, which is called “stagflation.” The history of Fed rate cuts, as a way to stimulate the economy, is not a good one. The Fed, under Chairman Greenspan, instituted numerous rate cuts. The result: A recession that President Bush’s tax cuts cured.

The Fed, under Chairman Bernanke, instituted numerous rate cuts. The result: The 2008 recession.

Why does popular faith hold that cutting interest rates stimulates the economy? Because popular faith views only one side of the equation. But, for each dollar borrowed a dollar is lent. $B = $L.

Cutting interest rates does cost borrowers less. A business needing $100 million might be more likely to borrow if interest rates are low than when they are high. Further, consumers are more likely to spend when borrowing is less costly. So making borrowing less costly stimulates business growth and consumer buying. At least, that is the theory.

What seems to be ignored is the lending side of the equation. When interest rates are low, lenders receive less money. And who are the lenders? Businesses and consumers.

You are a lender when you buy a CD or a bond, or put money into your savings account. When interest rates are low, you receive less money, which means you have less money to spend on goods and service — which means less stimulus for the economy.

In short, interest rates flow through the economy, with some people and businesses paying and some receiving. Domestically, it’s a zero-sum game — except for the federal government.*

A growing economy requires a growing supply of money. Cutting interest rates does not add money to the economy. That is why there is no historical correlation between interest rates and economic growth. During periods of high rates, GDP growth is not inhibited. During periods of low rates, GDP growth is not stimulated.

Please review the following graph:

monetary sovereignty

Blue is interest rates. Red is GDP growth. Not only are low interest rates not associated with high economic growth, but the opposite seems to be true. There seems to be a correlation between high interest rates and high GDP growth. How can this be?

*When interest rates are high, the federal government pays more interest on T-securities, which pumps more money into the economy. This additional money stimulates the economy.

This shows why the Fed’s repeated rate cuts do not seem to stimulate the economy. The action has been shown, time and again, to be counter-productive. Cutting interest rates to stimulate the economy is like pouring water on a drowning man.

Do you remember these headlines: “Employers slashed 80,000 jobs in March.” “The U.S. central bank has lowered rates by 3 percentage points since mid-September” “The loss of jobs signals another interest rate cut by the Federal Reserve later this month.” “Federal Reserve Chairman Ben Bernanke acknowledged Wednesday that the country could be heading toward a recession, saying federal policymakers are ‘fighting against the wind’ in combating it.”

Rate cut after rate cut did nothing. So what was the Fed’s plan? More rate cuts. During the previous recession, the Fed also attempted rate cut after rate cut, also to no avail. The recession, finally ended with the Bush tax cuts. The Fed has not learned from experience, but stubbornly adheres to the popular faith that interest rate cuts stimulate the economy.

Rate cuts do not stimulate the economy. They never have. They never will.

“Stimulating” an economy means making it larger. A large economy requires more money than does a smaller economy. Therefore, the only thing that stimulates the economy is the addition of money.

Rate cuts, by reducing the amount of interest the federal government pays, actually reduce growth of the money supply. We are on the edge of a recession, because the economy is starved for money. The coming “stimulus” checks will help, but they are too little and too late. This should have been done months ago, and the amounts should be far larger.

The only way to prevent or cure a recession: Federal deficit spending. There is no excuse for recession or inflation. These problems are not economic failures. They are leadership failures.

Rodger Malcolm Mitchell

For more information, see http://www.rodgermitchell.com

–To understand economics, you must understand Monetary Sovereignty. Most economists and politicians don’t.

Mitchell’s laws: The more budgets are cut and taxes inceased, the weaker an economy becomes. To survive long term, a monetarily non-sovereign government must have a positive balance of payments. Austerity = poverty and leads to civil disorder. Those, who do not understand the differences between Monetary Sovereignty and monetary non-sovereignty, do not understand economics.

Kermit the frog famously said, “It isn’t easy being green.”  It also isn’t easy convincing people that traditional economics not only is hypothetically wrong, not only is factually wrong, but is wrong to such a degree it is extremely harmful to our economy. 

The more extreme debt-hawks believe the U.S. federal government should run a balanced budget or even have no debt at all. The more moderate debt hawks feel some debt may be necessary at times, but to them, federal debt is like bitter medicine you take only when absolutely necessary.

All debt hawks, whether extreme or moderate, are long on facts, but short on evidence.

Their “facts” inevitably include federal deficit and debt measures, projections to the future, debt/GDP ratios and spending for Medicare and Social Security.

But when they interpret the facts, they provide no evidence that their interpretations reflect reality.

By contrast, here are facts, and a few opinions, which you may choose to interpret for yourself.

1. Fact: Money is the way modern economies are measured. By definition, a large economy has a larger money supply than does a small economy. Therefore, a growing economy requires a growing supply of money. QED

The graph below shows the essentially parallel paths of GDP vs. perhaps the most comprehensive measure of the money supply, Domestic Non-Financial Debt:

One could argue that money begets production or that production begets money, and both would be correct. The point is that money supply (i.e. debt) and GDP go hand-in-hand. Reduced debt growth results in reduced economic growth.

2. Fact: All money is debt and all financial debt is money.  In addition to being state-sponsored, legal tender, there are four criteria for modern money:

Monetarily Sovereign money must be defined in a standard unit of currency.

MS money has no, or limited, intrinsic value.

The demand for money is determined by its risk (danger of default or devaluation, i.e., inflation) and its reward (interest rates).

Money must be owned by an entity other than the entity that created it.

The above criteria describe many forms of money including currency, bank accounts, T-securities, corporate bonds, and money markets. There is no form of money that is not debt. A growing economy requires a growing supply of debt/money.

2.a. Fact: Federal “deficit” is a statement of the net amount of money the federal government has created in one year.
Opinion: The word “deficit” is pejorative. A more neutral description would be money “created” or “added,” as in, “The government has created $1 trillion,” or “The government has added $1 trillion to the economy.” Compare the psychological meaning of those statements with the current phrasing, “The government has run a $1 trillion deficit.”

3. Fact: 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.

4. Fact: Recessions tend to come on the heels of reductions in federal debt/money growth (See graph, below), while debt/money growth has increased when recessions were resolving. Taxes reduce debt/money growth. No government can tax itself into prosperity, but many government’s tax themselves into recession.

Reductions in federal debt growth lead to inflation

Recessions repeatedly come on the heels of deficit growth reductions, and are cured with deficit growth increases.

5. Fact: The federal government gave itself the unlimited ability to create debt/money on August 15, 1971, when it went completely off the gold standard. This ability is called Monetary Sovereignty.

Because the federal government now has the unlimited ability to create dollars, it neither taxes or borrows in order to obtain dollars. It simply creates them. Tax dollars are destroyed upon receipt.

6. Fact: Federal “debt” is the total of outstanding Treasury Securities. Here is how the federal (not state or local) government supposedly “borrows.” If you “lend” to the federal government, first you must put dollars into your checking account.

Then you tell the government to debit your checking account and credit your Treasury security account by the same amount. The process is similar to transferring money from your checking account to your savings account.

Then, to “pay off” the “debt,” the government simply debits your T-security account and credits your checking account. Thus, the government could pay off all its debt tomorrow, simply by debiting all T-security accounts and crediting the “lenders'” checking accounts.

The entire process neither adds nor subtracts money from the economy (but for interest paid).

Our Monetarily Sovereign government does not borrow the money it already has created, but rather exchanges one form of U.S. money (T-securities) for another (dollars). The entire “borrowing” process actually is nothing more than an asset exchange.

Federal borrowing of the money it previously created, is a relic of the gold standard, when the federal government did not have the unlimited ability to create dollars.

But do T-securities have any benefit? Yes, federal interest payments add to the money supply, a stimulative event. Federal control over interest levels adds to the government’s ability to control the value of the dollar.

T-securities (debt) are not functionally related to the difference between taxes and spending (deficits). They are related only by laws requiring the Treasury to create T-securities in the amount of the deficit.

The Treasury has the ability to create T-securities (debt) without there being any deficit, and the government can run a deficit without creating T-securities. Federal debt is not functionally the total of federal deficits.

7. Fact: Federal taxes, as a money-raising tool, are unnecessary, harmful and futile — unnecessary because since 1971 (when the U.S. government became Monetarily Sovereign) the government has had the unlimited ability to create money without taxes, harmful because taxes reduce the money supply, which reduction leads to recessions and depressions, and futile because tax money sent to the government is destroyed as a balance sheet credit.

Our Monetarily Sovereign government does not store dollars for future use. It creates dollars, ad hoc, by paying bills.

The so called “debt” merely is an accounting of the total outstanding T-securities created out of thin air, by the federal government. The government is legally required to create T-securities in an amount equal to the deficit, but this requirement became obsolete when we went off the gold standard and became Monetarily Sovereign, in 1971.

Today, the federal government creates money by spending, i.e. it credits checking accounts to pay its bills. This crediting of checking accounts adds dollars to the economy.

The federal “deficit” is the net money created in one year and the federal “surplus” is the net money destroyed in one year. In short, deficit spending creates money and taxing destroys money. If taxes fell to $0 or rose to $100 trillion, this would not affect by even one dollar, the federal government’s ability to spend.

Further, (opinion)all tax (money-destroying) systems are unfair. See: http://rodgermitchell.com/FairTaxes.html. For a country with the unlimited power to create money, spending is not related in any way to taxing.

8. Fact: Contrary to popular myth, there is no post-gold standard relationship between federal debt and inflation. (See graph, below)

There also has been no relationship between inflation and the overall money supply, best indicated by “Total Debt Securities for All Issuers.”

Opinion: While dramatically increased the money supply can reduce money value (aka “inflation”), factors affecting demand seem to have been more important.

Inflation seems to have been more closely related to oil prices than to any other single element. (See the graph, below)

inflation vs oil

A brief discussion of oil prices and inflation is at https://rodgermmitchell.wordpress.com/2009/09/24/is-inflation-too-much-money-chasing-too-few-goods/

In this regard, hyperinflations are not caused by “money-printing,” but rather by shortages, most often shortages of food. So-called “money printing” (ala Zimabwe and Germany), were the governments’ response to hyperinflation, not the cause.

9. Fact: There is no post-gold standard relationship between federal debt and tax rates, which have remained level through massive deficits. (See graph, below) Fact: You and I, who are the children and grandchildren of the ’80’s, have not paid the massive Roosevelt and Reagan debts.

Taxes do not pay for federal spending. Federal spending creates dollars.

9.a. Fact: Federal deficit spending does not use “taxpayers’ money.” Federal spending creates money ad hoc.

When the government spends it credits bank accounts. No taxes involved. By definition, deficit spending means taxes do not equal this year’s spending let alone previous year’s spending. Only surpluses use taxpayers’ money, by causing recessions.

For the above reasons, our children and grandchildren will not pay for today’s money creation, but they will benefit from today’s deficit spending — better infrastructure, army, education, R&D, safety, security, health and retirement.

10. Fact: There is no post-gold standard relationship between low interest rates and high GDP growth.
Opinion: The opposite seems true:

Why do high interest rates seem to stimulate?
Opinion: High rates force the federal government to pay more interest, pumping more money into the economy.

11. Fact: The Federal debt/GDP ratio is a meaningless fraction, because it measures two, mathematically incompatible pieces of data. It’s an apples/oranges comparison. GDP is a one-year measure of output; federal debt is the net outstanding T-securities created since the nation’s birth.

The T-securities created years ago affect this year’s debt in the debt/GDP ratio, while even last year’s GDP does not affect this ratio. See: Debt/GDP

Because federal debt is the total of T-securities, and the federal government has the functional ability to stop creating T-securities at any time, the Debt/GDP ratio easily could fall to 0, depending on federal law.

11.a. Fact: The debt/GDP ratio does not measure the federal government’s ability to pay its bills. The government does not pay bills with GDP; it creates the money ad hoc to pay its bills.

Were GDP to be $0, the government still could pay bills of any size, simply by crediting the bank accounts of its creditors.

12. Facts: In 1979, gross federal debt was $800 billion. In 2009 it reached $12 trillion, a 1400% increase in 30 years. During that period, GPD rose 440% (annual rate of 5.5%>) with acceptable inflation. The same 1400% increase would put the debt at $180 trillion in 2039, a mean annual deficit of $5+ trillion.

This calculates to a 9.5% annual debt increase for the past 30 years. Repeating that growth rate would put the 2010 deficit at about $1.14 trillion, and the 2011 deficit at about $1.25 trillion. The deficit for year 2039 would be about $15.8 trillion.

Opinion: I know of no reason why the results would not be the same as they have been in the past 30 years. However, increasing the debt growth rate above 9.5% might show even better results:

In the 10 year period, 1980 – 1989, federal debt grew 210%, from $900 billion to $2.8 trillion (a 12% annual debt increase), while GDP grew .96% from $2.8 trillion to $5.5 trillion (a 7% annual increase). During that same period, inflation fell from 14.5% in 1980 to 5.2% in 1989. See graph, below.

Monetary Sovereignty

Facts: In summary, large deficits have coincided with GDP growth, while not causing unacceptable levels of inflation.

Opinion: Federal money creation is constrained only by inflation, not by supply, debt, deficits, GDP, debt repayments or any other factor — only inflation. History indicates: a) We never have reached that point and b) Such inflation could be prevented and cured by raising interest rates (for minimal inflation) and/or by federal purchase and distribution of the scarce items causing the inflation.

(While raising interest rates does increase production costs and also adds to the money supply by forcing greater government interest payments, higher rates increase the demand for money, which is anti-inflationary. The graph below may indicate that CPI decreases follow interest rate increases by about a year.

13. Facts: Any health insurance proposal that covers more people will cost more money. Extracting that money from doctors, hospitals, pharmaceutical companies, by necessity, would reduce the availability of health care.

Increasing taxes on any individuals (even the wealthy) or on businesses, will depress the economy by removing money from the economy. Only the federal government can supply additional money while stimulating the economy.

14. Fact: Social Security is supported neither by FICA nor by a trust fund. Were FICA eliminated, and benefits doubled, Social Security still would not go bankrupt unless Congress decided to make this happen.

In June, 2001, Paul O’Neill, Secretary of the Treasury said, “I come to you as a managing trustee of Social Security. Today we have no assets in the trust fund. We have promises of the good faith and credit of the United States government that benefits will flow.

Yet, SS continues to pay benefits. Your Social Security check comes from a mythical trust fund that contains no money and receives no money.

Social Security (and Medicare) benefits are paid ad hoc by the U.S. government, not from a trust fund, and are not dependent on FICA taxes. which (opinion:) can and should be eliminated. See: FICA

15. Fact: The finances of the federal government are different from yours and mine and businesses’ and state, county and city government finances.

Unlike the federal government, which is Monetarily Sovereign, we cannot create unlimited amounts of money to pay our bills. We first need to acquire money, either by borrowing or by saving, to spend.

The federal government does not acquire money. It creates money by spending. As an accounting principle, the tax money you send to the government is destroyed upon receipt. Then the federal government creates new money to pay its bills. The government has no fund from which it pays bills.

Fact: Were taxes to decrease to zero, this would not change by even one penny, the federal government’s ability to spend.

Opinion: The failure to recognize the difference between the Monetarily Sovereign federal government and all other entities, which are monetarily non-sovereign, is the primary reason for recessions and depressions.

16. Fact: The federal government has the unlimited ability to create the dollars to pay any bill of any size. It never can run short of dollars; it never can go broke.

Opinion: The federal government should distribute dollars to each monetarily non-sovereign state, on a per capita basis.

The states would determine how they distribute the dollars (to counties, cities and/or taxpayers). I suggest a distribution of $5,000 per person or a total of $1.5 trillion.

17. To understand economics you must understand Monetary Sovereignty.

Fact: In 1971, the U.S. went off the gold standard, thereby becoming a Monetarily Sovereign nation, and at that moment, all economics textbooks became obsolete. Sadly, mainstream economists, the politicians and the media have not yet caught up.


Summary: So there you have a list of facts, plus a few opinions, which I have noted. Read the facts and draw your own inferences.

You can find a great number of debt-hawk sites (i.e. Concord Coalition, Committee for a Responsible Federal Budget), which in essence are privately funded think tanks, paid to influence popular belief, with propaganda masquerading as data.

There, you will see data showing the size of the federal debt. These data are presented in a way designed to imply that the debt (money created) is too large.

But you will find no proof of these ideas. You will see no historical graphs equating debt with any negative economic outcome, simply because such graphs do not exist. Debt hawks believe federal deficits are so obviously bad, no proof is needed.

Yet, despite lacking proof, debt-hawks have foisted their opinions on the media, the politicians, weak-minded economists and the public, much to the detriment of our economy.

Rodger Malcolm Mitchell

No nation can tax itself into prosperity, nor grow without money growth. Monetary Sovereignty: Cutting federal deficits to grow the economy is like applying leeches to cure anemia. Two key equations in economics:
Federal Deficits – Net Imports = Net Private Savings
Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports