There has been a raging, centuries old, debate on the proper role of government in society. Conservatives’ rail against the excesses of big government. Liberals believe that government can solve all of society’s problems. There is now a new economic philosophy, Modern Monetary Theory, which postulates that federal budget deficits don’t matter because (1) the federal debt will realistically never be paid off, or even paid down; (2) that because governments issue “fiat money” currency, they can never become insolvent (they are simply able to increase their debt and print more money to pay creditors); and (3) there will always be a market for new U.S. debt. Further, they can show a historical relationship between deficits and savings rates in the private sector (higher federal deficits mean higher savings rates).
This concept is especially appealing to liberals who favor a plethora of new government spending programs. They already have Keynesian justification for federal deficits designed to stimulate private sector economic activity (See my book Greed Power and Politics the Dismal History of Economics and the Forgotten Path to Prosperity). If MMT can be believed, they no longer need worry about raising tax rates to pay for huge spending programs — again, simply print more money.
So, is MMT sound economic theory or simply too good to be true?
Is Money Wealth?
Let’s take a hypothetical example and pretend that the U.S. government accidentally sends me a fifty-million-dollar check. I deposit twenty-million in a bank, purchase a thirty-million-dollar yacht and sail around the world. The fifty-million-dollars represented real wealth that I immediately spent. However, it only had value because the bank accepted my deposit at its face value and the seller of the yacht also accepted my money at face value. The intrinsic value of the check was zero; the full faith and credit of the United States was worth fifty-million-dollars. Now let’s “MMT” the scenario and pretend that U.S. government debt is limitless. Therefore, the government attempts to create an enormous amount of wealth by sending every U.S. citizen a fifty-million-dollar check, and then goes further by sending every resident of the United States a fifty-million-dollar check. Question: as a result of this program Is the United States of America, and everyone in it, fabulously wealthy?
Before answering that question, I am going to back up for a minute and look at another example: A couple walks into their local bank; then they sign papers for a home mortgage. Their banker subsequently prepares a check made payable to the seller of the couple’s new home. Let’s assume that the total cost of the house is $250,000, and our new borrowers finance the full $250,000. The formula for a simple balance sheet is Assets minus Liabilities equals Net Worth. It’s pretty easy to see that their new asset (house) is worth $250,000, their liability (mortgage) is $250,000 and their net worth related to the purchase is zero.
Back to the question: Is the United States of America, and everyone in it, fabulously wealthy? The answer is no and I’ll tell you why. The U.S. government sends out checks totaling (I have no idea so I will throw out a figure) $1 quadrillion. The United States has taken on debt in the amount of $1 quadrillion and has distributed $1 quadrillion to its population. The net effect is that zero wealth was created.
Value Based Free Trade
Money is not the goose that lays golden eggs. Value based free trade is the goose that lays golden eggs. True wealth is not money. It is goods and services that constitute true wealth. If we couldn’t trade money for goods and services, then money would be worthless. There is no intrinsic value in money it is merely a claim ticket to what we want – goods and services.
The $250,000 mortgage in our previous example was only possible because bank customers took their hard-earned money (from value based free trade – labor) and deposited it in the bank. The new home owners could only afford their new mortgage payment because they were willing to transact their labor for money and their money for a new home (again, value based free trade). Money, as in all forms of private property, can be viewed as an extension of, and a return on, a person’s investment in labor. In other words, In the free-enterprise system, a worker is willing to commit to your company a certain number of hours per day of her time, energy and talent (labor) to further your company’s goals. In exchange, you will pay her an agreed upon amount of money that can be used to further her goals. The more perceived value a person has to her employer, the higher her wage. Of course, however, this is relative to the supply of comparable labor in a given market. If the money that results from this wage is invested wisely, wealth (private property) will increase. This can be compared to a product, in that the more perceived value a product has to a consumer, the higher the price (again relative to supply); and the higher the price relative to the costs of production, the higher the profits. If the profits are invested wisely, the company becomes wealthier (more private property). And if you replace the word society with the words company and employee, then you can begin to see that all of the combined work and productive processes only benefit the worker and employer because society has placed a higher value on the services and products than their costs to society.
The fifty-million-dollar per capita windfall was, of course, a ridiculous example because (1) there is a limit to the amount of money that the United States is able to raise relative to new debt. (2) Nothing of value was provided by the population to the federal government to justify $1 quadrillion. It was simply a gift from Uncle Sam. And (3) no new real wealth was created.
To clarify, I will use the current holders of our federal debt as an example (the percentages are approximate):
The U.S. Federal Debt: $21 Trillion
30% Federal government agencies such as the Social Security Trust Fund.
Derived from payroll taxes on labor (value based free trade)
15% Federal Reserve
Derived from the customers of member banks, who deposited their hard-earned money. (value based free trade)
05% State and local governments.
Derived from state and local income taxes — on labor and profits (value based free trade)
Derived from the international trade of goods, services and commodities (value based free trade)
10% Pension funds
Derived from the retirement funds that were set aside from the wages of workers (value based free trade)
10% U.S. banks, pension funds, insurance companies, savings bonds.
Derived from — you get the idea (value based free trade)
There is a relative equilibrium of public and private capital flows throughout the world. For example, the more goods and services that the United States imports from other countries, the more U.S. debt those countries will be able to purchase. Today, the world‘s economic systems are able to absorb all international debt (not just the United States). My hypothetical $1 quadrillion in new debt would crush that equilibrium and leave a huge percentage of the new U.S. debt unfunded.
It is only true to a certain extent that because of fiat money, countries can never become insolvent. There are numerous examples of countries who have, to one extent or another, been in default on their loans. In other words, unable to meet the contractual obligations of their bonds. Typically, because they don’t have enough income from taxes or exports to pay the interest on their loans making both existing and potential creditors unwilling to extend further credit — at least without conditions. In the case of Greece, the European Union forced austerity measures on the country to reduce its public outlays in an effort to reduce its budget deficits. Many countries have devalued their currencies to make their exports cheaper on world markets, often creating unsustainable inflation rates.
As for savings rates: there may be a relationship between deficits and private savings rates, but I doubt that there is any proof that acceptable private savings rates are dependent on high federal budget deficits.
A legitimate concern expressed by conservatives is a tendency by some politicians to spend money as zero-sum gain (game) transactions. A zero-sum gain results when one person or entity’s gain is exactly equivalent to another’s loss. Some zero-sum examples from our federal government include:
- Loan guarantees: $535 million went to the bankrupt Solyndra Corporation.
- Crop subsidies: The 2014 farm bill budgeted subsidies to be $90 billion over ten years.
- Most foreign aid projects: the Obama Administration spent $20 million to help Indonesian students obtain masters degrees.
- Federal grants: $615,000 to digitize memorabilia from the drug-obsessed, counterculture band, Grateful Dead; and $103,000 to find out if sunfish that drink tequila are more aggressive than sunfish that drink gin.
- Military cost overruns: The F-35 Joint Strike Fighter Jet is $163 billion over-budget.
- Every omnibus spending bill that is burdened with billions of dollars in congressional pork barrel spending.
This is not to imply that all loan guarantees, foreign aid projects, or federal grants are bad, however, these are all specific examples of direct costs to United States taxpayers that benefit politically-connected individuals, organizations, corporations, and nations, which result in a net gain to our economy and society of zero.
To further illustrate the point: if you hand over a $100 bill to a thief at gunpoint, then you are $100 poorer and the thief is $100 richer, the net gain in wealth is zero. On the other hand, if you purchase $100 worth of groceries at the supermarket, then in aggregate, the items in your shopping cart are more valuable to you than the $100 that you give to the cashier. The economy and society gain from the excess value over cost because, not only did you gain from the transaction, but so did the growers, the manufacturers, the distributors, and the retail store.
The Good News
The good news for liberals is that value based free trade is not exclusively the domain of the private sector. Taxes, when properly used represent value based free trade. The automobile would be worthless without public roads, cities would be cesspools without civil engineering. Floods would cause far more damage without levees. The list of value based public projects, both existing and potential, is only limited by your imagination. A few federal projects that I believe would add more value to society than their costs are Universal Health Care, infrastructure, a coordinated federal program to update traffic lights using current technology, internet security, and the conversion of electricity from oil and natural gas to nuclear.