–Deficits and interest rates: Another myth

An alternative to popular faith

11/15/09 (AFP): “The US government announced last month that it had closed its 2009 fiscal year with a record budget deficit of 1.417 trillion dollars, up 962 billion dollars from the prior year. The huge gap stemmed from declining revenues and a massive boost to spending in a 787-billion-dollar stimulus plan designed to jolt the world’s largest economy from its prolonged recession. Concerns over the deficit underscore a fundamental tension undercutting Obama’s presidency in its first year — the extent to which he is attempting sweeping political change at a moment of historic financial peril.

“Many economists say high deficits during economic crises are acceptable to fuel government spending to stimulate growth. But long-term deficits can result in high interest rates, making it much harder for consumers to finance outlays such as new homes and cars.”

Yet another myth in the pantheon of economic myths circulating the globe. Look at the following chart and tell me whether you can see a relationship between deficits — even large deficits — and interest rates.

Debt vs Interest Rates

Contrary to popular faith, deficits are not the cause of inflation or high interest rates. Browse through the posts on this site, and you will see why.

–Deficits: The Possible vs. the Certain

An alternative to popular faith

Human beings have difficulty distinguishing threat levels. Despite the absolute fact that airline travel is safer per mile than auto travel, some people drive, even long distances, because they fear the safer air travel more than the dangerous auto travel.

Then think of the people who won’t vaccinate their children against the H1N1 flue, because they fear any unknown, possible adverse effects of vaccination more than they fear the known, deadly effects of the flue.

I was reminded of this human failing when I read an article in which the author claimed the economic recovery was not “real,” because it relied on government funding rather than on private funding. The author seemed to feel government funding was, in some way, artificial – as though we were using saccharine, rather than sugar, to sweeten our coffee.

Of course, money is money, and federal money is indistinguishable in effect from private money. But I suspect the author had something more than artificiality in the back of his mind. He probably understands that the federal government has the unique and unlimited ability to create money from thin air, and repeatedly has proved it never can run out of money. So, what is his concern? He must fear two things: Federal deficit spending might cause inflation and our grandchildren might have to pay for deficits.

As for inflation: Despite current, massive deficit spending we do not now experience an unacceptable level of inflation, and are unlikely to soon. Moreover, in the thirty-five years since we went off the gold standard, large deficits never have caused inflation. Clearly, something is askew with the deficits-cause-inflation hypothesis.

Even if deficits did cause inflation, private spending is identical with public spending; both add money to the economy. So the author should fear the supposed inflationary effects of private and public spending, equally.

As for grandchildren, I am a grandchild of the adults who saw the gigantic deficits of WWII and of President Reagan. Yet, because tax rates have gone down, I never have paid one penny toward those monster deficits. Similarly, if tax rates continue to stay level or decline, as they should, my grandchildren will not pay a penny toward today’s deficits.

What has this to do with the human difficulty distinguishing threat levels? The debt hawks know with certainty, that many millions of people now suffer the devastating effects of unemployment and loss of homes and lifestyle. People are dying, financially, emotionally and yes, even physically.

These same debt hawks believe that at some unknown time in the future, their children, grandchildren or great grandchildren may have to pay some unknown amount toward today’s debt. Yet they fear unknown future damage more than the certainty of today’s. That is why you see people rail against deficits. In essence, they are so afraid they one day may run short of water, they will let a home burn to the ground rather than allowing the fire fighters to save it.

The shame is that many professional economists, who should know better, foster these misguided fears, leading to misguided actions.

Rodger Malcolm Mitchell

-Debt hawks — Economics’ Chicken Littles

An alternative to popular faith

Are you too young (or too old) to remember the fable about Chicken Little, who believed the sky was falling down when an acorn fell on her head? She ran around in a panic, screaming “The sky is falling,” a now common idiom denoting an hysterical or mistaken belief that disaster is imminent.

Thus, have the debt hawks, aka Chicken Littles, been telling us for 30 years that the sky is falling, and that federal deficits will create disaster. Neither has occurred, or is likely soon, but failure of prediction neither embarrasses nor educates debt hawks.

We have arrived at a deficit of $1.4 trillion. In the past 30 years, the gross federal debt has grown an astounding 1,400%. The economy has grown, inflation has not been a problem, federal borrowing has not replaced private borrowing, countries have not refused to lend to us and because federal tax rates actually have gone down, no one’s grandchildren have paid for the $12 trillion gross debt.

The problem with debt hawks is they don’t understand money. They think of money as a scarce physical substance. It may be scarce to you and to me, but it no longer is scarce to the federal government, which since 1971, has created money at will, simply by creating T-securities from thin air, then exchanging them for the dollars it created earlier — also from thin air.

Visualize this. You go to a football game and the scoreboard reads 14 – 7. You might say one team “has” 14 points and the other team “has” 7 points. But in reality, the scoreboard merely has credited one team with 14 points and the other team with 7 points. The points are not physical things. No one “has” them.

Why is this important? Because in the economy, you and I are the teams and the government is the scoreboard. Points are not a real substance. Teams are merely credited with points. Money no longer (after we went off the gold standard) is a real substance. You and I, or more specifically, our bank accounts, merely are credited with money.

The scoreboard (government) never runs out of points. The government never runs out of the ability to credit you with dollars. The scoreboard does not need to ask either team to return some points so it can credit more points. Crediting a team with points does not reduce the scoreboard’s ability to credit more points. Crediting people or companies with money does not reduce the government’s ability to credit more money.

The scoreboard does not need to borrow points. The government does not need to borrow dollars. It as easily, safely and prudently can create dollars directly, rather than by creating and selling T-securities.

Imagine you decide to start a country from scratch. What is the first thing you will do? The people in your country need money, so you, as the government, will credit them with money. How? Perhaps by buying things from them. The people will give you material things and services; you will credit their bank accounts.

Debt hawks will call this exchange “deficit spending,” and they will demand that the people credit you, the government, back with some of the money. That’s called “taxation.” It is identical with giving the scoreboard back some points.

The scoreboard neither has nor needs points. The federal government neither has nor needs money. It never needs to be credited with money. It never needs to borrow money. It is the scoreboard. It can credit, endlessly.

The debt hawks continue to use obsolete, gold-standard thinking, from when money was a substance and was scarce to the government. Today, if the government wanted to give you $1 trillion, it simply would credit your bank account for $1 trillion, and debit its own balance sheets. Nothing physical would happen except the movement of a few electrons. The government can do this endlessly. In fact, last fiscal year, it did.

The government does not have a stash of money from which it spends. The government has no money at all. It merely credits bank accounts — yours, mine, foreign governments’.

Some may fear this can cause inflation, but the government now has absolute control over the value of its money through its control over both the supply and the demand (interest rates) for money.

The world changed in 1971, and the debt hawks have not yet understood that. Perhaps “hawk” is the wrong bird. More appropriate might be “Chicken Little.”

Rodger Malcolm Mitchell

-Peter Schiff and the money-supply myth

The debt hawks are to economics as the creationists are to biology. Those, who do not understand Monetary Sovereignty, do not understand economics. If you understand the following, simple statement, you are ahead of most economists, politicians and media writers in America: Our government, being Monetarily Sovereign, has the unlimited ability to create the dollars to pay its bills.

         Peter Schiff, who is running for one of Connecticut’s Senate seats and is president of Euro Pacific Capital, writes: “Almost every dictionary defines inflation as an expansion of the money supply, not rising prices.”
         Untrue. I have no idea what dictionary this guy is using, but he probably is using the libertarian “inflation is monetary inflation,” meaning supply = inflation.

        Money is a commodity. It is a surrogate in what otherwise would be a barter transaction.
         Inflation is the loss of money’s value compared with the value of goods and services. Like all commodities, the value of money is based on supply and demand. Increasing the supply does not cause inflation if the demand (interest rates) increases proportionately.

        [Note: Schiff may be influenced by the widely discredited and essentially worthless Austrian school of economics definition for inflation, a definition that has no real-world value, in that it does not include actual price changes.]
         Schiff also says, “Although more money may not immediately translate into rising prices, over time the correlation is extremely reliable.”

monetary sovereignty

        There is no historical relationship between M3 (green) or M2 (red) growth and inflation (blue). The reason: Money supply is only half the demand/supply story.
        When the Fed gets a whiff of inflation it raises interest rates, which by increasing the demand for money, increases the value of money (i.e. prevents/cures inflation).

Rodger Malcolm Mitchell

No nation can tax itself into prosperity, nor grow without money growth. It’s been 40 years since the U.S. became Monetary Sovereign, , and neither Congress, nor the President, nor the Fed, nor the vast majority of economists and economics bloggers, nor the preponderance of the media, nor the most famous educational institutions, nor the Nobel committee, nor the International Monetary Fund have yet acquired even the slightest notion of what that means.

Remember that the next time you’re tempted to ask a dopey teenager, “What were you thinking?” He’s liable to respond, “Pretty much what your generation was thinking when it screwed up my future.”