“Are There Spending Constraints on Governments Sovereign in their Currency?”
Stephanie Kelton, Associate Professor of Macroeconomics, Finance, and Money and Banking, Senior Scholar at The Center for Full Employment and Price Stability (CFEPS), University of Missouri – Kansas City, Research Associate at The Levy Economics Institute of Bard College, and blogger at New Economics Perspectives
Session 2 — 1st Fiscal Sustainability Teach-In and Counter-Conference
George Washington University, Washington DC, April 28, 2010
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TRANSCRIPT (Thanks to the Volunteer Transcription Team):
Stephanie Kelton: Well, I think we have the same crowd we had before, which is very nice to see. We haven’t put anyone off too terribly yet. My name is Stephanie Kelton and I’m very happy to have an opportunity to come and elaborate on some of the things that we’ve started talking about this morning. The title of the talk that I was asked to give is ‘Are there spending constraints on governments sovereign in their own currency’, and Professor Mitchell answered that question in the previous session and everyone was here for that. So, if you’d like to break for lunch… [laughter] Just kidding! [00:00:39]
I’m going to go ahead and say something anyway about this, and what I’m going to say is based on what was described this morning as something called Modern Money Theory. This is not a term that we came up with. I think that others who began to follow our work branded us with this title and started referring to us as the Modern Money School and to our ideas as Modern Money Theory and in many ways I think it’s kind of unfortunate, but this is the brand that we now, or the cross that we now bear, because it is something of a misnomer. What we’re doing is actually not modern at all. The ideas are not theoretical, and they aren’t particularly modern. What we’re doing is simply describing, operationally, the way government finance works. It’s not a theory; we do not make assumptions, although we are economists. What we’ve been describing to you today is not dependent upon any ceteris parabis condition or any set of assumptions about perfect competition or rational agents or anything else that you get exposed to when you study economics, but rather an attempt to simply describe the way in which the institutional arrangements are set up, and the accounting identities and what happens in a balance sheet framework; when one side of the equation moves, what happens on the other side of the equation? That’s really all we’re up to, so don’t be afraid. [00:02:09]
As I said, the ideas aren’t particularly modern. I could have filled the page with names of folks who’ve come before us, espousing exactly the same kinds of things that we’re talking about here today. One of the earliest was a German economist by the name of Georg Friedrich Knapp, who wrote a book called ‘The State Theory of Money’. Many of the same ideas that you’re hearing from us today can be found in the work of Knapp. They can be found in Keynes, most specifically in his ‘Treatise on Money’ published in 1930, and they can most surely be found in the work of Abba Lerner, who wrote extensively on this kind of thing, publishing papers with titles like ‘Money as a Creature of the State’. So, they are neither modern nor are they theoretical, but we like them. [00:02:58]
What we didn’t do, I guess, a lot of this morning is really to talk about money, and what is money. And, while there were some references to accounting, and blips on a screen and button pushing and so forth, we didn’t really distinguish what we’re talking about in Modern Money Theory from what most of the textbooks describe and what our students end up getting taught in most economics programs across the globe. [00:03:27]
When you open up an economics textbook, and you turn to the page that begins to talk about money, inevitably you find a story that begins with something about barter; and ‘once upon a time’ man trucked his wares to the local trading venue because he’s preprogrammed to truck barter in exchange, as Adam Smith told us, and there was no currency around. So you had to lug your clay pots and your shoes and your fish and whatever else you may have specialized in the production of, down to some local trading venue, where the only way the exchange could take place is if you happen to come upon the person who not only had what you wanted, but wanted what you had. [00:04:10]
Economists refer to that as the double coincidence of wants. And so, barter is this clumsy system for conducting exchange and, so the story goes, man suddenly decided – hey there must be a better way to organize – we should really think about finding some Thing that would be universally accepted. And, lo and behold, they hit on money, primitive forms of money first. The textbooks tell stories of things like pebbles and shells and feathers and beads and all of that, and later discovering money things like precious metals, which had nice properties that fish and other commodity monies didn’t have, in that they would serve as a good store of value, they were easily divisible, they were portable – you put your coins in your pocket and go conduct your exchange. [00:04:58]
But, the story is always told that this somehow happened spontaneously. The private sector figures out that there’s a more efficient way to conduct exchange. They choose to use money. They decide what money is. And this all happens without imposition from any authority, no state, nothing like that. So the money is stateless. And, then of course, over time, money evolves (I’m still in the textbook story) from things like primitive money to gold and then to paper with gold backing. People take paper in exchange for real goods and services and the argument is – well, but at the end of the day, it’s as good as gold. So they continue to accept the paper. [00:05:42]
Then the story gets more difficult to explain, for this group. Sometimes we call them the Metalists because, when you have a pure fiat money system, why do people accept currency, that is intrinsically worthless, backed by nothing of value, and yet people will beg, borrow, steal, toil away the day, in order to get these otherwise worthless pieces of paper? [00:06:05]
And so, what we like, what we prefer, is the story that’s been dubbed, or the approach that’s been dubbed Modern Money Theory, which traces the nature and origin of money to the early authorities. Randy has written a lot about this in his, ‘Understanding Modern Money’ book, from the early temples and later to the nation states and we could go on and on about this, but that’s not what I want to do. But, it does trace the origin and nature of money to some power authority; that is, the money does not emerge spontaneously by the will of the people, but it is imposed on them. [00:06:43]
How is it imposed on them? It is dictated by the authority. It is chosen. The authority establishes that you all must pay something to me. I define the unit of account. In the United States, the unit of account is the dollar. So I say in what unit you must pay obligations to me and then I tell you what you have to do to eliminate those debts. And so, I impose a tax liability on you. I make you indebted to me. Now you need to do something to eliminate your obligation to me. And I tell you how you can do that. In the United States, you can earn dollars. You pay your tax obligation to the state in U.S. dollars. That gives value to the government’s otherwise worthless pieces of paper, and allows them to move real resources from the private to the public domain. [00:07:34]
So we have a very clear way to answer the question ‘Why is fiat money accepted?’, whereas our textbook counterparts have some difficulty with that. If you push them too hard, they say, ‘Well, Pavlina accepts dollars from me when I go into her shop because she knows that she can pay Warren her rent with those dollars’. And then you say, ’Well, why does Warren take them?’ ‘Well, Warren knows that he can pay Marshall when he rents a car from him’. ‘Well, why does Marshall take them?’ ‘Well, Marshall knows that Randy will take them.’ And you get into this infinite regress problem. They really have no answer, is the problem in that theory. [00:08:08]
So the Modern Money approach accepts that the currency derives its value from the state’s willingness to accept it in payment to the state, to eliminate obligations to the state. Now there are lots of things that obviously circulate as money things. The government’s money is not the only thing out there. And there is some ordering, or hierarchy of money things. Some are more generally accepted than others. [00:08:39]
And so here I have a quote from James Tobin just to give this some credibility because we pull out the Nobel Prize winner when we want to convince you that these ideas are not crazy and fringe, and James Tobin said in a book in 1998, “In advanced societies the central government is in a strong position to make certain assets generally acceptable media by its willingness to accept a designated asset in settlement of taxes and other obligations. The government makes that asset acceptable to any who have such obligations and in turn to them and to others and so on.” [00:09:14]
So Pavlina takes it because she has obligations to the state. If she herself doesn’t, she knows she can find someone who does. That’s why this thing is special and that’s why the government’s IOU is special and those of us that have done some work in this area, in talking about a hierarchy of money would argue that the reason that the state’s IOU, the state’s money sits at the top of the hierarchy is because it is the most generally accepted and it gains its acceptability by virtue of the state’s proclamation that we all need it in order to eliminate our tax liability. [00:09:48]
So, Modern Money Theory stresses the relationship between the government’s ability to make and enforce tax laws on the one hand, and its power to create or destroy money by fiat on the other. I would define as a sovereign government, a government that retains these powers, that they are sovereign in their own currencies. Among others, examples of governments with sovereign currency, the United States, Canada, UK, Japan and Australia, all sovereign in this regard, by this definition. [00:10:21]
So the question then becomes, for a sovereign government, how much can it spend? Can it afford Social Security? Medicare? Tax cuts? Is the current path sustainable? Isn’t inflation going to be a problem? Will we bankrupt our children and grandchildren? What if the foreigners decide they don’t want to hold our bonds? I am only going to answer a couple of those questions in this talk because many of those are designed to be answered by other panelists later today. [00:10:51]
So, here we have the analogy. This is what most students who study economics are taught, and Ross Perot, I think, deserves a lot of credit for the fact that people think in these terms today, or blame, as the case may be. Ross Perot told us early on, just like the government, every American has to live within his means, and President Obama has told us that the government is out of money. So, what is the basis for this household government analogy? The household clearly has a budget constraint. And we also teach that in our economics classes. Micro economics teaches students how to maximize utilities subject to some constraint, face a budget constraint. How much money can you spend? You can spend everything you receive, either working or unearned in some capacity – gifts, interest earnings, whatever it is – after taxes, plus everything you can borrow. That’s what you can spend. And when it comes to buying things in the United States there’s really only one way to make final payment. When you purchase something, at the end of the day, the only way to pay for it is with the government’s money. There is no other way. [00:12:05]
How does that work? And so here’s an example. Suppose that you go out to dinner and you purchase your meal with your Visa card. Is that the final payment? No. You get a bill in the mail from Visa, and what do you do? You write them a check. Is that the final payment? Well, maybe the last time you see anything happen, but it’s not the final payment. At the end of the day, Visa doesn’t want your check. It doesn’t want what you’ve written down. What it wants is a credit to its bank account and that happens as that check goes through a clearing process and Visa’s bank account is credited with reserves. What are bank reserves? Government IOUs. Federal Reserve money. government money. Only the government’s money can discharge a payment as final means of payment. We are the users of the government’s currency. [00:12:59]
In contrast, the government is the issuer of its currency. It is not like a household. It doesn’t have to raise money by borrowing or collecting taxes in order to spend. Those of us in the private sector have to earn or borrow dollars before we can spend. The government must spend first. And we say this, and sometimes people have a hard time understanding that. How can the government spend first? How can it not spend first? How could the government collect taxes, in dollars, first? It first had to have spent those dollars into existence. The spending has to come before the payment or the collection of taxes. The government must spend first. Government spending is not (we use this term a lot) operationally constrained by revenues. It doesn’t need tax payments and bond sales in order to fund itself. It is not operationally constrained. The only relevant constraints are self-imposed constraints. We talked a little bit about this earlier, things like debt ceilings. That’s a self-imposed constraint. Rules that prevent the Treasury from running an overdraft in its account at the Fed. That’s a self-imposed constraint. It is a constraint that is imposed by Congress. Rules that prevent the Fed from buying Treasury bonds directly from the Treasury, so-called monetizing the debt, is a self-imposed constraint. [00:14.36]
How does the government actually spend? It spends by writing checks on its account at the Federal Reserve Bank. What we see, and what we hear all the time is that the government is spending a hundred, taxes are ninety and it sells bonds equal to ten. So, what we see is an attempt to coordinate the government’s spending with taxes and bond sales and it creates the illusion that what’s happening is that the government is taking money from us and using it to pay for the things that it purchases. But that’s not really what’s going on. As Warren likes to say, the government neither has nor does not have any money at any point in time. It is simply the scorekeeper. So what happens when the government spends? [00:15:24]
Let’s suppose that the U.S. Treasury issues a check for a hundred million dollars to Halliburton. What happens? The Fed marks down the Treasury’s balance. It subtracts one hundred million from the Treasury’s account at the Fed. Halliburton takes the check and deposits it wherever Halliburton happens to bank. I chose Bank of America. So Bank of America marks up Halliburton’s balance by a hundred million dollars. The Fed marks up the size of Bank of America’s reserve account (this is some reserve accounting, hang in there; it’s a little dry). The Fed, in the clearing process, credits Bank of America with a hundred million dollars in its reserve account. [00:16:08]
So what’s happened at the end of the day? What are the effects of government spending? The monetary base increases. We call that ‘high powered money’. Those are the bank reserves. The monetary base increases by a hundred million. The money supply increases by a hundred million. The money supply is all the checking accounts and traveler’s checks and a couple other things, but by and large, those are the deposits, ordinary everyday checking accounts. So the money supply increases. So what is the lesson from this? The lesson is that government spending creates new money, both high-powered money, bank reserves, and the more narrow definition of money, M1. They both increase as a consequence of government spending. [00:16:50]
How about when the government collects taxes? What happens there? Say you write a check for five thousand dollars to the IRS on your personal checking account, and you bank at Wells Fargo. Wells Fargo marks down the balance in your account, minus five thousand. The check gets sent from the IRS to the Treasury’s bank. The Treasury banks at the Fed. The Fed marks up the Treasury’s balance by five thousand, and the Fed marks down Wells Fargo’s balance by five thousand. What happens at the end of the day? The effects of paying taxes (See, when you pay taxes, there’s nothing there. Everything just disappears.) The monetary base decreases. Bank reserves go down by five thousand, so the base goes down. The money supply also goes down because you drew on your checking account. So, the money supply goes down by five thousand, the narrow measure, M1, and the monetary base goes down as well. Paying taxes destroys money. It doesn’t give the government anything. It doesn’t get anything. It eliminates those liabilities. They are, for all intents and purposes, destroyed. [00:18:06]
That’s if you pay with a check. What would happen if you actually sent the government your cash? Every once it awhile it seems like you hear about some crazy person who does this in protest. They get a huge sack, usually of coins just to make it really offensive and difficult on some poor bean counter. Let’s say you have a tax liability and it’s a hundred dollars and you just mail in a one hundred dollar bill. Apart from the shock of opening the envelope, what are they going to do with this? What do we do with this? Send it to the Fed. That’s where the Treasury banks. Goes to the Fed, and what do they do with it? They shred it. They shred it. Why would they shred it, I mean literally shred it, if they needed it to buy things, if they could use it to spend? Because they don’t use it to spend and they don’t need it to buy things. [00:19:06]
So why bother collecting taxes at all, if the government doesn’t need our money, and this came up earlier. Lynn raised this question. Why bother collecting taxes? When we pay our taxes, whether by cash or by check, all we’re doing at the end of the day, is returning to the government its own liabilities. That’s all we’re doing. And they say, ‘Thank you very much’, and the transaction is done. They don’t get anything that they can turn around and spend. They get their own IOU back from us. That’s the end of the transaction. [00:19:40]
So, why do it? Two reasons. One is, and this goes back to the Modern Money Theory that I began with, one is that taxes give value to the government’s money. If they were just to say, ‘We don’t need taxes in order to spend, so let’s suspend all collection of taxes’, that would undermine the value of the currency. It would take away the need that we have to acquire the government’s money. Why would we work and produce things for the government? Why would the government be able to move resources from the private sector to the public domain if it can’t get us to do that by virtue of the fact that we are willing to work and provide things to get the government’s liabilities? So, taxes maintain a demand for the government’s currency – that’s important – and the other thing they do, is they allow the government to regulate aggregate demand. Too much spending power can be inflationary, too little causes unemployment and recessions. [00:20:42]
All right, well then, why does it sell bonds? What are bond sales all about? It’s not selling bonds to cover a shortfall because it needs to borrow money from us. A lot of people have argued, and Bill talked about this a little bit earlier with the Rogoff-Reinhart piece, that there’s a tipping point out there. Won’t we sell too many bonds? Won’t the debt get too large? Isn’t there some point of no return beyond which the whole system collapses? What if the interest payments become too large? What if the rest of the world decides they don’t want to buy the bonds? [00:21:21]
Bonds are nothing more than a savings account at the Fed. We give up dollars today and we receive dollars plus interest at a future date. So if the government sells bonds today, funds get moved from checking accounts. People who have money buy the bonds. Funds move from the checking account into what’s effectively a savings account. It’s the interest earning asset, IOU of the government. So, that’s what we hold now. When the bonds mature, the government credits our account, principal plus all of the remaining interest, and the funds are converted back into checking accounts; they move from saving back into checking accounts. [00:22:04]
I couldn’t get the twelve trillion. I wanted the actual number, 12.4, wherever we are today, but this is as recent as I could find. This is the national debt clock, the sum total of all of the outstanding bonds that the Treasury has issued. And, what we would argue is we shouldn’t call that the national debt clock; we should just rename it. It’s the national world dollar savings account. All it does is keep a record of the total amount that’s invested in savings as opposed to checking accounts at the Fed. It’s nothing more than that. [00:22:44]
Something about the issue of solvency, the tipping point problem. Can the government run out of money? The U.S. government can’t run out of money any more than the Washington Nationals Baseball team stadium can run out of points. Every time a ball game is played at Washington National Stadium, some team scores some points and they appear on the screen and then the other team scores and some more points appear on the screen. And there’s nobody behind the screen going, ‘Hey Johnny, we’re running out of points here’, you know, right? Look in the trust fund. That’s not the way it happens. You just add the points. [00:23:30]
Same exact thing with the way the government operates. And this is the quote that Marshall brought up earlier and the one that Warren likes to use a lot, and I like it too. So here it is in writing so that you know we didn’t make it up. This is Ben Bernanke in an interview on Sixty Minutes just last year when Pelley asked him, “Is that tax money the Fed is spending?” And Bernanke says, “It’s not tax money. The banks have accounts at the Fed much the way that you do, have an account at a commercial bank. So when we want to lend to a bank, we simply use the computer to mark up the size of the account they have with the Fed.” [00:24:00]
It’s exactly like putting points on the screen at the baseball game. Just mark up the balance. Can you run out of points? Can the government run out of money? No. There is no solvency issue when you are the issuer of the currency. OK, this is a quote from Alan Greenspan saying largely the same thing. “A government cannot become insolvent with respect to obligations in its own currency. A fiat money system like the ones we have today can produce such claims without limit.” [00:24:34]
My parents told me money didn’t grow on trees. It didn’t for us. Then, why, if this is true, why are the PIIGS in trouble? Why are Portugal and Greece and Ireland and Spain and Italy; why is there all of this talk about them not being able to fund themselves? I mean, they have a fiat currency. [computer glitch] Why are they in trouble? [00:25:07]
And the reason they’re in trouble, and this was discussed some this morning, is that all sixteen nations that adopted the Euro, gave up their sovereign currencies in favor of a stateless currency. The Euro is a stateless currency. It is a fiat currency in that it is non-convertible. You don’t get to take it in and ask for gold at the end of the day, or any other commodity. But, it is not a sovereign currency in the way that the U.S. currency is sovereign, and that imposes certain constraints on the governments that use this currency. [00:25:41]
It means the default risk, solvency, is a legitimate problem for the governments that use this currency. Every one of them, not just Greece and Portugal, but Germany and France as well – every one of them could default on their debts if they’re unable to raise enough money by either taxing or borrowing from those who already have Euros. They must borrow or raise taxes; they must collect money before they can spend. It’s the only way they can do it. They are all users of their own currency. They are the users of their currency, much like California, Illinois, New York, New Jersey – they’re just like states in the United States. They’re in the same relationship relative to the currency as are individual states in this country. [00:26:31]
This is the hierarchy of money. So the entire thing in Euroland is denominated in Euros. For any particular government, look at the hierarchy of money. What is it that sits at the top of the hierarchy? It’s the Euro. What is the relationship between the currency at the top of the hierarchy and the government? In this example, the government does not control the currency that sits at the top of the hierarchy. And that turns out to be a huge problem for Greece. [00:27:03]
And we’ve seen problems with other currencies, not just the Euro, but we saw problems with Mexico, 1995; we saw problems with Russia in 1998, Southeast Asian currency crisis in ’97. They all issued paper currencies. But why did they have problems? Why did Russia default? Why were there currency crises? Isn’t that inconsistent with everything I’ve said? No, because I said that the currency needed to be a fiat currency, non-convertible, floating exchange rate. Non-convertible. Every one of these countries had fixed exchange rates. And, as a result, every one of their governments became the users rather than the issuers of their currency. [00:27:45]
I don’t know of a single example of a currency crisis or a debt default by a sovereign government that has issued obligations in its own currency when it has flexible exchange rates in a non-convertible currency. I don’t know of one. The U.S. can control its currency and therefore, by implication, its economic destiny. [28:11]
There is a relationship between the power the state has in the monetary sphere and the power that it can exert in the political policy sphere. There is no revenue constraint for governments that control the money that sits at the top of the hierarchy. Does that mean that we should spend without limit? No. No. Emphatically no. As the economy recovers, spending will need to be regulated to prevent inflation. But I would argue, and I think what we’re all here to argue today is that it’s time to stop allowing the monetary system to limit our range of policy options. It is causing unnecessary human suffering and it’s time for us to begin to recognize the advantages of a Modern Monetary System. Thank you.[29:00]
Session 2: Q&A [00:29:15]
Unidentified: I have one question, can you explain the difference between what happened in Argentina and what happened in Russia? Because Russia defaulted voluntarily on its domestic debt versus Argentina had a problem with US dollar debt. [00:29:35]
Warren Mosler: So… If any of you have been to the Fed, you know you start everything off with “So.” So what happened in Russia [he laughs] was that they had a fixed exchange rate, the ruble was fixed at 645 to 1, and they were borrowing dollars in order to keep it going because people were— would rather have their dollars than a ruble. When you have a fixed exchange rate, the dynamic is, if you get paid in rubles, you have three choices: You can do nothing, you can buy ruble securities, or you can cash them in for the reserve currency, which was dollars. So with a fixed exchange rate the treasury competes with the option to convert, and you see that all the time, and so with fixed exchange rates, the interest rates are actually controlled by the market. And so what happened in Russia is as the treasury competed with the option to convert, interest rates went up and up and up, and finally they were paying 200 percent and there was no interest rate where people would rather have the rubles than the dollars and they ran out of reserves, couldn’t borrow any, and defaulted on their conversion obligation. Now, at that point in time, what most countries would do would be just to float the currency and say, Okay, look, there are no more dollars for now and the ruble’s floating and just keep the money— the central bank operational. What they did in Russia, when they ran out of dollars, they just turned out the lights and went home, shut off the computers, didn’t open for up four months later. When they did open up, they went in through the hard drives, and sure enough, the ruble balances were still there, and they were — they basically honored them. There was a little bit of restructuring, but nothing particularly serious on the interest-rate side. And so it was a fixed-exchange-rate collapse, or blowup, and they just shut everything down.
Now in Mexico they had the same kind of blowup and they just — what was it, three to one, three and a half to one, or something like that? Was it three? Three to one back in about ’95, they were supposed to honor these tesobono obligations, where you were able to turn these in, they were at an index to U.S. dollars, where you could turn in and get— and they were guaranteed you could get enough pesos where you could convert those instantaneously into 40 billion dollars. Well, there was no amount of pesos that could be converted into 40 billion dollars, so the whole thing collapsed, and they wound up dishonoring their promises, rolling some into Brady Bonds, and they let the currency float, they just— and so the peso went to nine to the dollar or somewhere around there. And they kept business as usual with the— as a floating exchange rate. Okay, so I don’t know if that answers your question or not, but that’s what happened. [00:32:25]
Unidentified: I was asking about Argentina…
Warren Mosler: Argentina. Yeah. Argentina was fixed one-to-one to the U.S. dollar. Same type of thing: Interest rates went up because of the option to convert, they ran out of dollars, and one night in a deflationary mess that followed with after thirty-two dead in the street one night Buenos Aires they reopened with the floating exchange rate, they let the peso float. Okay, Russia, the difference was, when it blew up they just turned the lights off and went home. They could have kept it going if they wanted to, they didn’t know what buttons to push at the central bank, or they were afraid for their lives, the central bankers, and just left, okay, which is the story I’ve heard also.[00:33:06]
[male] Just one corollary follow up question. Can you explain how this relates to the Rogoff Reinhart book? That is the debt in foreign currency versus in on your own currency and what these magic numbers, 90% debt-to-GDP means. [00:33:24]
Stephanie Kelton: Yeah, I think the lesson to be drawn from the arguments that I made are that the debt-to-GDP ratio is largely irrelevant so long as the debts have been written in a currency that you have a monopoly over the issue of. So the U.S. Government can always meet, on time and in full, any payment that comes due in U.S. dollars, *period*. Okay? If you’re borrowing in a currency that you do not control, you cannot create, like Greece cannot create the Euro. It is prohibited by the master criteria, Article 104, you can’t print money. So they can’t always, necessarily, serve as on-time and in-full obligations that come due; it’s not a sovereign currency.[00:34:16]
Warren Mosler: Let me just add to that, if you look at Italy back in the eighties, they had one of the best economies in the world with debt-to-GDP ratios well over 100 percent and inflation rates in double digits. So the problem with inflation is not that there’s any real economic problem, it’s a political problem. People don’t like it, and you will get thrown out of office if you allow inflation. Not because it’s not good for employment and output, it’s just considered immoral. It’s the government robbing us of our savings, and hidden taxes and all these types of things. And it has to be respected, and democracy reflects the will of the people. [00:34:15]
Stephanie Kelton: Keep in mind also that Japan’s debt-to-GDP ratio is roughly 200 percent, but as long as the borrowing is done in yen, it’s not a problem. [00:35:01]
Bill Mitchell: If you read their book carefully — have you read their book?
Bill Mitchell: If you read their book carefully, you’ll see — and you go through each case and trace the currency systems being run, the circumstances surrounding the default, you’ll only find one example of a sovereign, truly sovereign government in modern history that has defaulted, and that was Japan, and it was during the war, and the reason they defaulted was because they said they weren’t going to pay back debts to their enemies, and it had nothing at all to do with the question of solvency, it was a political decision. And so, you know, I think the book is being used very frequently now by commentators as, See, this is the definitive piece of research, and in actual fact it’s highly limited research and applies to a very small number of circumstances that we don’t find in very many countries. [00:36:14]
Warren Mosler: Look, I’ve had very strong conversations with David Leibowitz of Standard & Poor’s about this, separating the difference between ability to pay and willingness to pay, and the last time on that last go-around I sent you a copy of that, but they have stopped downgrading on ability to pay, I believe, they are now downgrading on willingness to pay, which is what happened with Japan. So what we’re saying is, there’s always the ability to pay; there may not be the willingness to pay. Very different things. [00:36:44]
Pavlina Tcherneva: Just to add on to the Argentina story, it’s instructive for another reason. Argentina actually is a very good case study of how you launch a currency. When the state was bankrupt, the provinces were bankrupt, what they did is they actually issued their own IOUs. They issued [patacornes?? lecops?? foreign terms], the varieties of local currencies. Now, our states are prohibited from doing that, but in Argentina they could, and so you get back to Stephanie’s point, Why do you trust the currency you didn’t have before, you didn’t use before, the vast majority of people are not using, you know, there’s no trust that was built in the system, and the reason was because the states taxed the population in these LECOPs and they negotiated that you could pay your utility bills in patacones. And so, although everybody was up in arms and saying, you know, You can’t be using this system, and, granted, it didn’t last very long, you go to Argentina and you see every store says “Aceptavos patacones.” It is very effective to launch this currency. Once they floated, they had no need for them anymore. [00:37:45]
Warren Mosler: In Russia, after the central bank shut down, they traded what they called arrears, which is I thought a fantastic word for what things are. So the states with the— whole corporations would trade arrears with each other. [00:38:15]
John Lutz: From the great state of New Jersey, or infamous, as it currently may stand. I want to thank Stephanie very much for her very clear presentation. I did want to ask you a specific question, though. When you’re talking about countries, everybody believes you but you see that lurking look in their eyes and they say, Well, what happened to Germany after World War I or the latest case, Zimbabwe? Could you explain that in clear terms? [00:38:36]
Stephanie Kelton: No, but I hope Marshall can. [Laughter]
Marshall Auerback: I’ll be doing a full presentation
Stephanie Kelton: That is the topic of Marshall’s presentation. Will you be staying for the full day? . . . Okay. Well, then. I was going— Okay. [00:38:52]
Roger Erickson: Another question about getting back to treasury bonds. We’ve all heard, most of us have heard now that we went off the gold standard under Nixon in 1971. The question that rarely gets asked is, “Why does anybody bother selling Treasury bonds anymore, at least very many of them,” and a follow-up is, “Is there any country in the world that doesn’t bother doing that to any extent?” [00:39:21]
Marshall Auerback: It’s the law. That’s the short answer.
Warren Mosler: What happens is that when new countries start, they just have what they call central bank credits, but then when they become real countries, then they start using treasury securities, so then they become real countries like everybody else. And even Russia was like that. For years they were just central bank credits, so they had it right to begin with and then moved on to be like everybody else. I have seen that happen many times.[00:39:44]
Roger Erickson: But that doesn’t answer the question. Marshall, can you elaborate on why?
Marshall Auerback: Yeah, it’s a legacy of — As you say, Nixon closed the gold window in ’71, Bretton Woods was completely eliminated in ’73, but we didn’t sever the legal connections to that system at the time, so that the laws that were enacted in Congress are predicated on the old gold standard thinking, so that by law you have to issue debt dollar for dollar to “fund” the spending. So it’s simply a legal legacy. There is no operational reason for it. And I think one of the things we have to do at times, and that we don’t do well enough at times, is we tend to conflate the descriptive with the normative, and I think we have to make clear to people that, and I think Bill’s been very good at this, especially recently, I think the blog from a couple of days ago, that there are certain theoretical aspects which are impeded from happening in an operational sense because of these silly legal constraints, and that happens to be one of them. One of the things that we’ve talked about is that just let the Treasury run an overdraft facility with the Fed as opposed to issuing bonds, but there’s no real reason for that other than the legal legacy. [00:41:12]
L. Randall Wray: Yes. One other thing, this is the interest-earning alternative to holding reserves, which in the United States until a year ago didn’t pay interest, so what we needed to do was to put in place the alternative that doesn’t require selling treasury bonds, and that is to pay interest on bank reserves, so Canada had done this ten years before, so Canada no longer had any operational reason to sell treasuries, although they may not understand this and they’re still selling treasuries and there could be a legacy of law also. Now we’re in the same situation, now we’re paying interest on reserves, and so we don’t need to sell the treasuries anymore for operational purposes, but we still have the law.[00:41:57]
Warren Mosler: From a function point of view, the reason to sell term securities would be to raise the interest rates for the term structure, and clearly that’s not what they want, what they’re trying to do. [00:42:07]
Roger Erickson: But you’ve pointed out many times that that only requires very-short-term bonds. [00:42:10]
Warren Mosler: But if you want thirty-year rates to be higher, if you want mortgage rates to be higher, you could go sell ten-year securities to drive up rates, if that was the public purpose. That would be the only reason you would sell ten-year securities would be some public purpose behind having higher ten-year rates. Now I don’t think anybody thinks there is, they’re doing it for other reasons. [00:42:30]
Roger Erickson: So I know Bill’s going to comment. Could you also just slip in is there any country in the world that’s just forgone selling treasury bonds? [00:42:38]
Bill Mitchell: The example that I’m going to tell you about is Australia, because I know it very well. And the traditional system under the convertible currency was what was called a tap system of issuing date, and what the government would do in that system would be, they’d decide on what yields they were going to offer, and let’s say they’d say 4 percent or whatever it was, and then they would announce the tap was turned on, and if people took up— if the private investors took up, wanted to hold the paper at that yield, then they would, they’d buy it. And if there was a shortfall, the central banker would buy — strike forward. After convertibility collapsed, the end, it was soon after that that we started to worry about budget deficits and the monetarist surge occurred, I’m talking about mid-’70s onwards, there was a constant public debate among the sort of characters that I hang out with, as a professional economist, about the dangers of the tap system and the dangers of allowing there to be any shortfall at all that the central bank might take up. And there was a really grand debate and what happened in the early ’70s they decided that the tap system was dangerous and they realized that — they decided to change the system, and they turned to an auction system that was purely available to the private sector. And the auction system then allowed the private sector to determine the yield of the issue. Obviously, the last unit of debt sold would be the highest yield that was being prepared to be paid by the private investor, and they prohibited the central bank from buying any of the issue, other than small amounts infrequently for operational reasons, and they soon solved that anyway by creating a support rate, so they minimized the use of that, they minimized the need for that. And you read the literature on this, the government papers, they separated the debt issuance from treasury into a separate unit, and if you read all of their papers, they talk about the reason they’re issuing debt and structuring it in this auction system, why, was to maintain fiscal discipline. They knew damn well that the central bank could buy it all, they know damn well. I know the reserve bankers very well, I talk to them regularly, they know the central bank could control the whole yield curve if they wanted to. But they won’t, it’s voluntary, but they won’t because they want to maintain what they call fiscal sustainability, which is the antithesis to what I call fiscal sustainability. As to whether there’s any country that doesn’t, my understanding is, No. But they’re all caught up, we’re all caught up in the same ideological tangle. [00:46:19]
Warren Mosler: Even worse. A few months ago I was at, one of the guys in debt management at Treasury and they’re extending the maturity of the treasury, more 30 years, more 10 years, it’s like why are you doing that?, don’t you guys want mortgage rates to be lower, why are you doing that. He says, Well, we’re worried about downgrades, the ratings agencies have come in and told us if we don’t extend the debt we risk being downgraded. Okay, so the deeper you look, the worse it gets. [00:46:44]
Roger Erickson: Well then, as a final comment and I’ll be quiet, many people have blamed this area, I mean the last thirty years in the deregulation of financial markets, on the mania for deregulating everything — Thatcher and Reagan and people like them — but, based on everything we’ve heard today, it seems that everything else was deregulated at the same time we were hyper-regulating our monetary systems, which is inexplicable. [00:47:14]
Bill Mitchell: No, it’s not inexplicable at all, because they wanted to — the whole paradigm and the whole ideology was to create freedom, so-called freedom, for the private sector and hamper the government sector from having any freedom, ’cause you can’t trust the public sector, you can only trust the private sector, because the rhetoric is that the private sector is market-disciplined and the public sector isn’t. It’s entirely consistent. [00:47:41]
L. Randall Wray: Can I just add one thing, because I think Edward, Lynn, and Roger all have raised a similar point, you know. Do they actually understand the way things work? And so the possibility is, Yes, they do, and so we create these myths or frauds because this is how we’ll constrain the government because otherwise the politicians will run away and start growing the size of government. But actually it is we don’t trust the voters. We don’t trust the populace, we don’t trust democracy, that is what it really is all about, because ultimately that is what’s going to constrain the politicians, it’s democracy. [00:48:24]
Unidentified: This may be a digression, but I stumbled on to looking at the Fed balance sheets, which I guess come out weekly or monthly. Why is their goal — They do have treasuries they list as assets or liabilities — why do they have gold on the Fed balance sheet, and what is it there for? [00:48:40]
Warren Mosler: Because they had it there before and they don’t want to sell it. It’s like the national forests or any other asset. But there’s no monetary use for it.
You know they do lend it also, and there’s some talk they’ve been using their— they haven’t been transparent about what they’ve been doing on the lending side. I don’t know what’s going to come of that. [00:49:04]
Teresa Sobenko: I’m not an economist, I’m an investigative journalist, that’s why many things are probably pretty new to me, but I listened to the president of the European parliament yesterday. He was just mentioning a few things. But what I learned today, I wanted to ask the panelists if this currency, the Euro, is a problem right now, because that’s the way it is, because there’s no state connected to that. Wasn’t there enough knowledge that they did that, or was it something on purpose again that is being created right now? Where to look for the remedy for this, because they are right now talking about introducing a common language, which the president is fighting. I mean, is it a scheme or is it just the lack of information? [00:50:20]
Marshall Auerback: No, there is an awareness of the problems. In fact, no less than Otmar Issing from Germany, who’s one of the hard-liners on — he’s one of the practitioners on strong money, good-as-gold, etc., etc., he readily conceded that a European monetary union in the absence of a political union longer term is not viable. And I think that — But they also realize that politically the nations, the individual nation-states within the Eurozone, were not able to create this new entity called the United States of Europe. And the hope was that the use of a common, of a monetary union would ultimately lead to a political union.
So there have been these institutional constraints, they’ve been recognized right from the start. You know, Randy has written about this since the mid-1990s, so has Jan Kregel and other colleagues of Randy’s, I’ve written about it since early 2000, Bill’s written about it as well. So there is an awareness, but there was a political restriction that I think kept it going.
And, you know, the question often then arises, Well, why didn’t they just keep it as a narrow bloc, why did they create these problems by allowing countries like Italy and Portugal to come in in the first place? And that’s a much longer story, but basically you’ve got three Germanies: You’ve got the Germany of the Bundesbank, you’ve got the Germany represented by people like Helmut Kohl who believe that you want to bind Germany within a broader Europe within these European structures and to make it as wide as possible, so there was a political impetus from him, and then you have Germany number three, industrial Germany, the Germany of BMW, Siemens, you know, and the like, and they rather like the idea of keeping countries like Italy and Spain in there as well, because they thought, Wow, we can lock them in at these exchange rates, they won’t be able to competitively devalue against us, and so it will help to sustain our competitiveness.
So there were a lot of unique political circumstances that drove this, and there was also the problem that you had a country like Belgium, which is essentially part of, in many respects, you’ve got the Benelux countries—Belgium, Luxembourg, and the Netherlands. The Netherlands and Luxembourg fulfilled the original Maastricht criteria. Belgium didn’t; I think Belgium had one of the worst debt-to-GDP ratios, it was over a hundred percent, but you couldn’t really well have a Eurozone where you allowed the Netherlands and Luxembourg to come in but you didn’t allow Belgium to come in, and once Belgium was allowed it, then the Italians were going to put up their hands and say, Well, if they’re going to be let in then we should be let in, and likewise with Spain and Portugal. So it became politically unsustainable to pick and choose.
Although if you ask the Germans, I think, hand over heart, they would have preferred a much narrower core Eurozone and it would have been much probably much more workable. Although ultimately you would still have the same problems but it’s deferred the moment of reckoning, that’s been the main issue. [00:53:31]
L. Randall Wray: I’m glad you asked that question because I actually jotted down a little note. Something that we probably should talk about, which is that, see, the Euro is still a tax-driven currency, so it fits that part of the story, it’s tax-driven. The problem is that we don’t have the fiscal authority to issue that currency, we have individual nation-states, so these are much more like U.S. states.
So sometimes I’ll get the question, people ask, Well, hold it a second, it sounds like there’s nothing backing up the Euro according to our scheme, and why is it so strong then? Well, it’s a tax-driven currency. Okay, you have to pay your taxes in Euros, and it actually doesn’t matter, it’s sort of a bizarre situation, it doesn’t matter whether the governments default on their debts, the Euro can remain strong.
Greece can go down, and, who knows, the Euro might go up. People will be glad Greece has defaulted and is now kicked out of the union so the Euro could be a very strong currency even while all of the member nations deteriorate and collapse. [00:54:43]
Teresa Sobenko: Thank you.
Edward Harrison: Here’s my question. It’s about the operational necessity for having treasury bonds. Because my understanding is that treasuries are used in order to target a Fed funds rate, that you need the treasuries in order to keep the interest rate at a certain level. My question about this is that if you prefer using monetary policy over fiscal policy as a driver of government action, don’t you need a constant flow of treasury securities in order to keep on the run securities constantly coming in order to keep a liquid market in that vehicle. [00:54:44]
Warren Mosler: Let me bypass the question this way: If the Fed wanted a 2 percent Fed funds target, it could just trade Fed funds. It could say I’m two bid two offered; banks, do whatever you want all day, we’ll add it up at the end. So, you know, from that point of view, that would be sufficient to target interest rates. [00:56:02]
Edward Harrison: But that’s a political nonstarter, they’d never be able to get away with that, they wouldn’t do that. From a political perspective, that would never fly.
Warren Mosler: Right. I’m just saying, from an operational perspective, all the Fed has to do is set the overnight rate in terms of a bid and an offer, which is what they do in Canada and Australia, where they have a corridor which does that. But from an operational point of view, you don’t need treasuries for that. Now, based on the way we’ve got our institutional structure, where the Fed has to use a repo market where they’re doing overnight loans back and forth where they’re required to use treasury securities as collateral, then you’re correct in that sense, but again, that’s a self-imposed constraint, and what we saw after the middle of ’08 was they started expanding that collateral base because using treasury securities was ineffective, and so you saw them overcome this self-imposed constraint through a variety of things, always missing the point that all they really had to do was trade in Fed funds, and you’re right, politically they never got there. [00:57:08]
Bill Mitchell: Just two points on that. In ’90–’96 we elected in Australia a conservative government — Warren will know this story I’m about to tell I think — and for the next ten out of eleven years they ran surpluses increasing, and they sold it to the public as rail bridges started to crumble, public education started to crumble, hospital waiting lists started to increase, they sold it to the public as getting the debt monkey off their backs, and because they were now obviously retiring debt as it became due, and by 2001 the bond markets were so thin that there was a huge outcry. Now who did the outcry come from? Well, it came from the Sydney futures exchange at the beginning, and all of the other traders that were using the government debt as what I call corporate welfare, basically as a guaranteed annuity in which they could price their risk off, and this led to the government having an official inquiry —remember that Warren? — they had an official inquiry onto what the size of the bond market should be, and they were blithely running surpluses all the time, and they agreed, they caved into the pressure particularly from the Sydney futures exchange, they caved into the pressure and announced that they would continue to issue debt at an agreed amount, they came up with an agreed amount of millions per quarter, even though they were running surpluses, they continued to issue debt. I thought that was a really… Do you remember that, Warren? [00:59:01]
Warren Mosler: We put a paper—
Bill Mitchell: Yes, that was the official, the Commonwealth government inquiry into the optimal level of debt when you’re running a surplus.
Warren Mosler: Yeah, that was a good paper if anybody wants to see it. [00:59:12]
Bill Mitchell: You can download it off my research center, off CofFEE’s website [here - selise], go back to about 2002, December 2002, and you’ll see all of the documents and all of the special pleading from the top end of town on why the government had to issue debt even though they were running surpluses, despite two facts. One is that at the same time the recipients of the corporate welfare were leading the charge to deregulate the welfare state for the workers and deregulate the wage system and get rid of social security, and secondly, despite the fact that the top end of town were the ones that were leading the myths about the onerous debt burdens the deficits they used to run were causing. The second brief story is it’s very interesting now with Basel 3 about to emerge which will change some of the rules relating to the quality of assets having to be held by banks under the capital adequacy regulations, the banks are starting now to suggest that the deficits aren’t going to be high enough to produce enough debt for them to satisfy their requirements, and they’re starting to pressure the Basel process to allow commercial paper to count as high-quality assets in the capital-adequacy calculations. I think that’s very ironic. [laughter][01:00:45]
Warren Mosler: Plus the idea that you need international bank standards makes no sense. You set your own.
Jeff Baum: I’m actually an investment manager, so I come from a bit of an operational side. I kind of get the general idea of what you’re saying here, and it’s all very new to me, so I’m trying to get my head around it, but it sounds like basically you’re saying that the government, or, in my mind, the Fed, can create currency, therefore they can spend as much as they need to — I get that. There’s an inflation consequence because of this, but I haven’t heard too much about what that consequence can lead to. There’s obviously some sort of distributional question, and I guess that’s the political question, I haven’t heard that addressed, I don’t know if you guys do that or if that’s for the politicians. But then it just changes the question from: “But we can’t afford this” to “What are we going to spend it on?” and maybe there is a big question there, as Randall was saying, that once the voters figure that out it turns into a big political fight. I don’t know if you guys heard, there’s some quote somewhere that says democracy can only last until the voters realize they can vote to the purse strings of the treasury. So I guess my question is: Do you have any kind of summary about how this turns into a political question, and what are the distributional consequences of that?[01:02:20]
L. Randall Wray: I’m sure several people will comment, but I think that what the public needs to understand is if you’re saying you want the government to do this, you want the government to spend on this, that means we’re going to devote real resources to this. Do you really want the government to devote our nation’s capacity to supply you with this, and if you do, then democracy wins and we do it. But you got to realize that means less resources here, okay, so to get it out of the deficit hysteria, the affordability, and so on, it’s a real issue. Do we want to devote an ever-rising share of our nation’s output to be put to taking care of aged people? Put it that way, and let the population vote on it. They might vote yes, they might vote no . . . okay? That’s democracy. [01:03:19]
Marshall Auerback: Two points I’ll make. One is that if we get the debate along the lines that you’ve suggested, then we’ve effectively won the argument, because we’ve always said ultimately it’s a political argument. You know, I’ve had exchanges with people and I’ve written on blogs and often get these debates, and it ultimately comes down to saying, “Look, you are making a political argument. You and I might happen to disagree on the best ways that the government can use the money here, but that’s okay, I respect that, this is a pluralistic society and we can have differences of views, but let’s at least get past the operational issue.” And the other point I would make is that even the notion of affordability, it’s applied in a very, very selective way, as I’m sure you’ve noticed. I mean, when we declare war, we don’t sort of say, “Well, we’re running a budget surplus and can we afford to go to war?”, we just do it. Or we don’t say, “Well, we’re going to buy this aircraft carrier, so we’d better check with our bankers in China as to whether we can afford it or give them a line item and see if they want to red-line anything.” Nobody actually ever does that, but that’s the logic of their position, if you follow it through to the conclusion. But somehow when we get onto a subject like health care or Medicare or Social Security, it’s like, Oh, well, affordability becomes an issue, so I think it’s more a reflection on our skewed value system than anything else, actually. [01:04:55]
Stephanie Kelton: Just one point on the distributional issue, one of the things that you hear a lot about now is the growing size of the national debt and the growing interest burden, and we really need to make that a distributional topic, because it goes directly to this argument that we’re passing this on to the next generation and the generation after that, becomes a generational argument, which it absolutely is not, okay? All of the interest payments will be made by the people who are alive at the time the interest payments come due, and what we’re talking about is a shift of income from those paying taxes to those receiving payments because they’re bondholders. And so the bigger the share of the interest, relative to the size of the economy, the bigger the command of the goods and services the bondholders can wield against the rest of us. And so that becomes a discussion that we definitely would want to have. [01:05:51]
Continue to Session 3…..