Obama most certainly has no clue about our economy, that much is certain from some of the things that he does. Granted, one does not have to be an economic genius to run for president, but I have to question the people that he has chosen to advise him on economic matters, the so-called experts in the field. If effects be something to judge by (and I cannot fathom anything better to judge by), then these "experts" are failing spectacularly.
There is a particular author that I would like to address and consider some. He operates a blog titled "The Pragmatic Capitalist" and posts those articles on Seeking Alpha also. I will agree that he is somewhat of a financial sage, having spent many years working for Merrill Lynch Global Wealth Management. Although I tend to agree with ninety percent of what he has to say, he is a "modern monetary theorist", sometimes referred to as Chartalism, which is a theory that I fear does not reflect reality, particularly in this unique time.
What is modern monetary theory? Well, as best I understand it presently, it is the idea that money is issued by a state and is offered legitimacy and demand only by the taxation of the government in that specific currency. In extraordinary situations, they then enforce the use of said currency with domestic force (e.g. military and police). "The resulting fiat money [or currency] has no intrinsic worth. Rather, fiat money draws its value because it is the only unit accepted for payment by the government of taxes." -1
Below is one of the simplest descriptions of the modern monetary theory that I have gotten thus far:
The govt is not a household or a state. They do not finance spending via revenues. The US govt, as a monopoly supplier of currency in a floating exchange rate system simply spends. Think of the US govt as an alchemist. The alchemist can create as much gold as he please in order to buy up productivity, but he has to be very careful not to debase his gold. Hence, there is no solvency risk for the alchemist. Only a pseudo form of default via currency collapse (hyperinflation).My issue with this whole system is the value of money. Who decides that a currency is valuable? According to modern monetary theory (MMT), the value is effectively assigned by the government via taxation and enforcement thereof. This system works fine when people are content and happy, but when times are uncertain and people are severely displeased with the government, then the possibility of MMT breaking down becomes more evident. This entire theory is founded on the government being able to suppress the people, with force if necessary. I believe this is a faulty assumption, because if enough people revolt and refuse to use the currency issued by the government (particularly in a democratic republic), the government will lose that fight. So, if the MMT breaks down when people are discontent and unhappy, did it ever have the correct view in the first place? I tend to think it did not. This has enormous ramifications for not only Federal Reserve policy, but also for average Joe investors like you and I.
We do not finance our spending via the bond market. Taxes do not finance spending either. We issue bonds as a form of controlling the Fed Funds rate. It’s a pure monetary operation. Not a fiscal financing operation. We issue bonds to maintain the money supply by controlling the overnight rate and control excess reserves. People think this is govt debt because Congress mandates the issuance of bonds and that’s how the system works in Europe and under the gold standard. This thinking has never changed despite the dramatic changes in the monetary system after the Nixon shock. I am quite certain that Bernanke understands this (or at least partially), but I am also quite certain that most other people in power do not (otherwise we would never have made all the policy mistakes I have been pointing out over the last few years).
Let’s understand a few things first:
1. foreigners do not fund our spending. That is a fact.
2. The bond market is a monetary tool. NOT a fiscal financing tool.
3. We tax in order to create demand for the currency. In addition, it controls aggregate demand or effectively, the money supply.
I’ll use the example I often use. Please excuse the simplicity, but this can be a mind bending concept if you are textbook taught (trust me, I know the feeling) so I will keep it simple:
I start a productive economy/country and invite my 5 friends to become citizens. Rather than forcing all of us to trade with heavy gold I issue TPC notes. Now, in order to create real demand for these notes I create a tax. This makes you beholden to me via the TPC notes. You MUST have them in your account on April 15th of every year. I’ve created instant demand. This is what the US government does. In return, they spend money on public works, create jobs, supposedly spend money on furthering our nations prosperity (in theory at least) and protection of the nation (a military).
How do I enforce your use of the TPC notes? I create jobs via a military and a police force and pay them well. Don’t want to pay your taxes? Say hello to officer Joe. A group doesn’t want to pay their taxes? You can protest, but if you get out of control I will introduce you to 500 men wearing body armor holding M4 carbines. In other words, don’t question the currency or else….As long an economy is productive, the sovereign nation can enforce the use of said currency, and as long as we don’t issue excessive currency there should always be demand for it. In other words, trust in the national currency is safe as long as the rule of law is maintained, corporations are productive and I maintain my ability to tax you.
I do not borrow from governments or tax to spend as I would if my currency were backed by gold. Interestingly, I can’t TAX you until I’ve credited your accounts with TPC notes. There is no money to be taxed otherwise. So, in effect, I have to SPEND in order to TAX (counter-intuitive to what you have been taught). Taxing debits your accounts (saps liquidity) and crediting is government spending. On my island, I am never revenue constrained. If you don’t pay your taxes I will throw you in jail and confiscate your money. But that doesn’t mean I can spend more when I tax. What do I care if you send me your TPC notes? I can just press a button and credit my “spending” account right after I shred your tattered looking cash. This is what the government actually does. Taxation is essentially a form of maintaining control of private sector spending. Pay your taxes in cold hard cash. The IRS will shred those dollar. They don’t put them in a bag and mail them to the Treasury so they can’t go “spend” it. The only reason they might keep the dollars is if they are pretty and in good condition so they can go back out into circulation.
So what’s the bogey here? What’s the catch? The bogey here is inflation which is constantly moving up and down with the amount of money in the system based on my tax rate, spending, etc. Thus, govt cannot just spend and spend and spend or the extra dollars in the system will chase too few goods and drive up prices. Thus, it’s important to understand that govt cannot just spend recklessly. This is important so I’ll say it again. This does not give the govt the ability to spend and spend and spend.
In terms of the bond market, the issuance of bonds does not serve the same purpose it did under the gold standard. We actually issued bonds because we were revenue constrained (not enough gold reserves at all times to fund spending without creating massive inflation). Today, we effectively control the value of money in the banking system via bond issuance (a pure monetary operation to control the Fed Funds Target Rate). It can also be thought of as another form of government spending because a treasury bond is basically a savings account. Contrary to popular opinion, QE is actually a deflationary event because it takes an interest bearing instrument out of the private sector’s hands and replaces it with a non-interest bearing deposit. QE is a term that used by people who want to scare you into thinking that the govt is being reckless with their money. The reality is that QE is just an asset swap. Nothing more. Debt monetization is another tool of the fear mongerers who don’t understand that debt monetization is actually impossible so long as the Fed has a target rate. It’s operationally impossible.
The US government is never revenue constrained. They are not like a household or state government. We don’t need China to buy our bonds in order to spend. China gets pieces of paper with old dead white men on them in exchange for real goods and services. They can either hold that money in a checking account at the Fed OR they can do what they wisely do and invest those pieces of paper in what is actually a savings account at the Fed. We also don’t need taxes to spend. The budget deficit is in direct inverse correlation to private sector savings. To be more precise: net household financial income = current account surplus + government deficit + business non-financial assets.
This by no means says that the government can just recklessly spend. But it’s imperative that the government spend SOME money otherwise they are simply debiting the system each year via taxation without ever crediting accounts. Just ask yourself what would happen if the govt imposed a one time 100% asset tax? The private sector would instantaneously be without money. How would they spend? How would they invest?
Many financial theorists actually believe the Great Recession (and the Great Depression) was caused by account SURPLUS. You’ll notice that both events were preceded by great periods of “fiscal competence”, ie, budget surpluses. In reality, the govt had debited too many accounts and forced the private sector into deficit. This results in the private sector borrowing what it can’t actually get its hands on. The risk is full blown debt deflation due to excessive debt levels (because you borrow what you can’t actually get your hands on). I think the cause is a bit more complex than that but the fact that we are grossly overtaxed and the govt spends very inefficiently is a large contributing factor. -2
I will repeat the question that I had before: who decides that a currency is valuable? I would have to say that it is the "market". What is the market, you ask? You are the market, and I am, and anyone who has to capacity and desire to use a government-issued currency. I believe that this includes foreign countries as well. Countries like China may not "fund" our spending in the strictest sense of the word, but I believe very firmly that they play an enormous role (although less so now) as a holder of US government currency. What about the citizens of the US? Surely, they are required to use this currency. Any modern investor should know that this is most assuredly false. I have a whole host of things to put my money into, none of which involve US dollars. I could just as easily open a bank account in Australia or Canada or any other country than the US and transfer all of my money into this account, thereby removing my faith in the currency issued by my own country. So, to say that even US citizens are beholden to the US government is not fully true. There is significantly increased resistance to us doing this, but it is still an option to us.
It seems to me that globalization is the death of modern monetary theory.
1 - Chartalism - Wikipedia article - from the Principles section.
2 - The Myth of the Great Bond "Bubble" - The Pragmatic Capitalist - TPC author Cullen Roche comment reply to gumshoe2020
"Capitalism without losers is like Catholicism without hell."
-- Cullen Roche
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