Sunday, December 24, 2017

Is Washington tacitly operating under a new monetary theory?

In 2002 when soon-to-be-dismissed U.S. Treasury Secretary Paul O'Neill warned then Vice President Dick Cheney that the Bush administration's tax cuts would drive up deficits and threaten the health of the economy, Cheney famously answered: "You know, Paul, Reagan proved deficits don’t matter."

In the wake of the recently approved federal tax cut,voices concerned about the damage that deficits will do are rising again.

What's curious is that since Cheney's rebuke of O'Neill, growing federal government deficits seem not to have mattered. In fact, the largest deficits ever boosted the economy after the 2008-09 recession, exceeding $1 trillion annually for four years.

All of this suggests that the federal government has for a long time been operating under an unspoken monetary theory, namely, that government spending does not need to be backed by revenues and that the debt issued to fill the gap between spending and revenues will have little effect now or in the future.

But isn't there some level of federal debt which would cripple the federal government and the U.S. economy?  A common metric for measuring this debt is the ratio of federal debt to annual gross domestic product (GDP). When one looks at a graph of this, the growth in debt seems perilous, rising from a low of around 30 percent of GDP in the early 1980s to more than 100 percent of GDP today.

Seemingly more perilous is the rapid growth in Japanese government debt. That debt has soared from a low of around 40 percent of GDP in 1990 to almost 200 percent of GDP now. Yet, the oft-prophesied demise of Japanese government finance has not occurred.

What the United States and Japan share in this regard is that each issues its own sovereign currency. That means both could theoretically retire their entire government debt in one day by issuing sufficient currency to buy up all the outstanding bonds. (A smarter way would be to do this very gradually without announcing it. In the alternative, the legislature could pass a law requiring government bondholders to sell their bonds back to government at a pre-determined price—something bondholders would certainly dislike since the price is likely to favor the government.)

What this tells us is that any government that issues its own currency will never run out of money to pay back bondholders. That's, in part, why there is no panic among Japanese and American owners of government debt. What the above further tells us is a bit more shocking: Such governments don't even need to issue debt to finance their operations.

And, so long as a government doesn't issue more currency than the economy can produce goods and services for, it won't create price inflation (defined as too much money chasing too few goods).*

The only reason for governments which control their own currency to levy taxes then is to create demand for that currency. If someone has to pay taxes in the government-issued currency, he or she will want to receive at least some payment in that currency. As it turns out, so will everyone else. As a result it becomes simply more convenient if everyone adopts the country's sovereign currency as their unit of account and medium of exchange.

All of what I've just described fits neatly into what is called Modern Monetary Theory (MMT), the premises of which are so deceptively simple that it is hard for people to believe them. But Japan and the United States seem already to be operating under that theory save for one act—the act of issuing copious amounts of government debt, something that is entirely unnecessary under MMT.

The idea that governments which issue their own sovereign currency must rely on private credit—mostly from wealthy citizens—to finance themselves is an illusion. But it's an illusion that the monied class hopes no one will see through. For if the public does see through it, government debt—which is used like a weapon to promote cuts in social spending—would cease to frighten anyone (and may be gradually eliminated). That means spending policy would become much more flexible than previously imagined.

So, it turns out that Dick Cheney was right—but not for reasons which he and the new rentier class would ever be willing to admit, namely, that the government doesn't need loans from rich people or loans of any kind. Bondholders therefore can't really hold the government hostage. Realizing this and acting on it would seriously diminish the influence of the rich in the halls of power and make a realignment of spending priorities possible.


*This is an important check on the creation of money. A complete discussion of this would require a separate piece covering the physical limits the economy faces with regard to resources (especially energy), climate and infrastructure.

Kurt Cobb is a freelance writer and communications consultant who writes frequently about energy and environment. His work has appeared in The Christian Science Monitor, Resilience, Common Dreams, Le Monde Diplomatique,, OilVoice, TalkMarkets,, Business Insider and many other places. He is the author of an oil-themed novel entitled Prelude and has a widely followed blog called Resource Insights. He is currently a fellow of the Arthur Morgan Institute for Community Solutions. He can be contacted at


Yvan Roy said...

MMT seems closer to reality than most would think. It also shows how dysfunctional the EU is as shown by Greece for example.

Shawn B said...

Hello Kurt

Always enjoy reading your essays.

You have noted above that MMT theory says you can print all of your sovereign currency you want, with certain checks – printing too much money creates inflation, for example. (Of course, that could be the objective….). There are real world physical constraints also, as you cite in the footnote. In a related vain, if memory serves, Alan Greenspan, Paul Krugman, among others, have said in so many words, that the U.S. can print, and deficits don’t matter.

I am way out of my depth in discussing MMT theory, but I wonder, is anything ever really free, or without costs?

It seems like another check on “free” currency creation, whether that currency is issued by a central bank, or directly by a government, is other currencies (and their underlying physical systems), traded in the global system. If you (Country A) print too much currency, the value of your currency goes down, relative to other currencies. Therefore Country A’s cost of imported resources and finished products goes up.

(Yes, this is above paragraph is a gross simplification of the system. Most “money” in circulation is in fact digital and created by banks through debt issuance. And then there is the whole process of government bond sales, domestically and internationally, all tied into a massive bond market. How MMT shortcuts all this I have not studied.)

Of course, the U.S. dollar holds status as the world’s reserve currency, and there is a whole discussion one can have about the advantages and disadvantages of that, and the need for the U.S. to be a debtor nation. (Triffin dilemma , etc.)

Playing out now, may be the “costs” of this reserve currency arrangement, along with excessive debt/money printing. China, Russia, others, are now seem determined to leave this global system dominated by the U.S. dollar linked backed by oil trading in dollars. They have multiple reasons for these actions for sure, but one reason at least is their reaction to the (eventual?) devaluation of the U.S. dollar denominated debt. My guess is that the recent budget passed by the Republican majority adds fuel to this fire.

There are some who are skeptical that these countries can establish their currencies for global trading use, and so think the U.S. can continue to borrow (though bond issuances) , or print, with impunity. Time will tell. But if these countries are successful, or in some other way take down the current global financial system, U.S. citizens could see dramatic rises in the costs of living, and shortages of resources.

Nothing is for free, there is always a cost somewhere, at some point in time.

Anonymous said...

“Such governments don't even need to issue debt to finance their operations.”

Which means that government could then, theoretically, finance any kind of government services (such as universal free health care), without putting any kind of a burden upon the citizenry.

“The only reason for governments which control their own currency to levy taxes then is to create demand for that currency.”

How so? Why can’t issuing bonds create the demand for “government currency”?

“The idea that governments which issue their own sovereign currency must rely on private credit—mostly from wealthy citizens—to finance themselves is an illusion.”

Well then, therefore it is also an illusion that anyone should be required to pay any taxes. Ever. There is no need. So why can't bonds then be used - for everything?

Steve said...

I find it difficult to believe that there are no negative consequences to infinite government debt in an age of fiat paper currency (backed by nothing by government 'promises'). Certainly there are plenty of negative repercussions from a world that seeks infinite growth of an economy (which is what governments tend to use much of their debt to try and deliver, at least if you listen to their 'promises') with all the concomitant resource requirements (especially energy) when you exist upon a finite planet. I suppose the theory could be correct and the experiment we are all caught up in could just keep on keeping on. But if the monetary wizards are wrong, it could be we just haven't hit the tipping point yet and the bouquet of consequences are just ahead beyond the horizon...only time will tell.