(originally published on May 2, 2023) <\/p>\n\n\n\n
So here we go again: budget talks in connection with a looming debt ceiling. As the narrative unfolds, we find ourselves journeying through a mythical tale of budget deficits and consequent debt, which threatens our children who will pay exorbitant tax rates in order to pay for their parents’ profligate ways. And, it may end up this way.<\/p>\n\n\n\n
The tale, however, is based on the false premise that a government budget is like a household budget. A household which spends more than it takes in, will either need to draw down savings or borrow to fund their deficit ways. A government, however, with its own free floating currency is not like a household. It has the ability, and authority, to create all the money it needs. Not that this is advisable: excessive money creation, without an appropriate level of money destruction, is inflationary. Borrowing and taxation are the money destruction tools necessary to maintain an appropriate sized money supply. We could walk through the accounting to prove the accuracy of the latter statement, but this will unnecessarily complicate matters and common sense already tells us that taxation and borrowing by the government removes purchasing power from the goods, services, and asset markets.<\/p>\n\n\n\n
To be clear, the U.S. federal government’s practice of “funding” deficit spending with debt is a policy choice indoctrinated into law. To fund public sector federal deficits with debt, is not, however, a natural law, inherent to a financial system in which the governing body has the authority to create its own money.<\/p>\n\n\n\n
If an entity has the ability to create something, it does not have to go into the marketplace to get it. The U.S. government does not need to tax or borrow to fund its operations; it can create money to do this. It does need to tax and\/or borrow to reduce the circulation of money in order to control inflation in the goods, services, and asset markets. The key is to control the flow of funds in a productive but non-inflationary manner, but it does not require an equality between spending on one side of the equation, and taxation and borrowing on the other side of the equation.<\/p>\n\n\n\n
All of this roughly coincides with Modern Monetary Theory (MMT). I hesitate to mention this, however, as MMT has been badly misrepresented in the press; you will rarely, if ever, hear an accurate description of MMT in the corporate press. What you will hear in the establishment press is that MMTers claim that the federal government can spend as much as it wants, without inflationary consequences–which has never been their position–quite the opposite.<\/p>\n\n\n\n
The system is currently set-up to force the government to act like a household. This is likely done to impose discipline on the federal government. If the federal government accumulates massive debt, pressure mounts for the government to rein-in spending, which, given any level of productive capacity, will free-up space for the profit making private sector to operate without inflationary consequences.<\/p>\n\n\n\n
There is no intent here to tell a story of a bunch of greedy dudes who are trying to screw the public, although those types might exist. Most people, including U.S. Congressional representatives, have not thought beyond the household analogy. Others, understand the above, but do not like the public sector so they happily play along in the mythical land where governments must act like households, where expenditures must equal taxation and borrowing. But understanding the possibilities in a sovereign monetary system, such as exist in the U.S., is important.<\/p>\n\n\n\n
If, for some reason, we conclude that we prefer to match federal deficit spending with federal debt issuance because, perhaps, the accounting is neat, but then prefer to not pay interest on the debt, the Treasury Department could bypass the private sector, and simply sell the debt directly to the Federal Reserve (FED). Earnings at the Federal Reserve are returned to the Treasury Department so that any interest paid to the FED from Treasury earnings would be returned to the Treasury Department; in effect, the Treasury would pay interest to itself, consequently the Treasury would incur little interest expense. What little interest expense it would incur would be to fund FED operations. Current law, however, prohibits the direct sale of U.S. securities from the Treasury Department to the Federal Reserve. Hmmm.<\/p>\n\n\n\n
A direct sale of Treasury securities from the Treasury Department to the FED would, of course, cut-out the private sector. This is, perhaps, where part of the problem lies. Currently, the Treasury sells U.S. debt to a group of roughly two dozen very large banks. This network of primary dealers then distributes the debt to others who wish to hold U.S. securities, pocketing the spread between the original purchase price and price earned during the subsequent sale.<\/p>\n\n\n\n
Furthermore, the sale and purchase of U.S. securities by the Federal Reserve is central to its monetary operations. When the FED wishes to reduce the money supply it sells Treasury securities to the primary dealers which are paid-for from deposits, i.e., reserves, held by these banks at the Federal Reserve. When the FED wishes to increase the money supply, it purchases securities from the primary dealers which increases the banks’ deposits (reserves) at the Federal Reserve. Through the subsequent sales and purchases of Treasuries to private sector actors, reserves are shuffled throughout the system. Reserves are the basis for further lending and money creation by the commercial banking sector. Commercial banks create new money when they lend, all that is required is that they hold in reserve 10% on deposit at the Federal Reserve, hence, the importance of reserves in the system.<\/p>\n\n\n\n
Treasury securities within an investment portfolio are also an excellent tool which enables investment managers to calibrate risk within private investment portfolios.<\/p>\n\n\n\n
While all of this is convenient to the operations of the U.S. financial system, there is absolutely no reason that the working classes should bear the burden of excessive debt loads: first, because debt need not equal deficit spending, or even exist at all, this is a policy choice; second, because to the extent U.S. debt is deemed necessary to the proper functioning of the U.S. capital markets, the burden for repayment of the debt should be shifted to those groups who most benefit from this set-up, the higher income groups, through higher progressive tax rates\u2013 in effect, forcing the holders of the debt, to pay for the debt, otherwise the debt amounts to a massive transfer of income and wealth from the working classes to the capital owning classes.<\/p>\n\n\n\n
So, in the charade of budget and debt ceiling talks, it is important to bear in mind that it need not be this way; that high debt levels are a policy choice and are not required to fund deficit spending; but Treasury debt might be a good tool to absorb money out of the asset markets to avoid inflation in these markets. All of this could more easily be avoided through higher progressive tax rates, both to pay down debt, or to avoid the accumulation of debt in the first place.<\/p>\n","protected":false},"excerpt":{"rendered":"
(originally published on May 2, 2023) So here we go again: budget talks in connection with a looming debt ceiling. As the narrative unfolds, we find ourselves journeying through a mythical tale of budget deficits and consequent debt, which threatens<\/p>\n