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The Deficit Myth According To MMT – The Role Of Currency

At the center of frustrations with today’s economic policies, one term seems to boil to the top more than any other: Modern Monetary Theory (MMT).

Today we’ll discuss government taxes, spending, annual budgets, and budget deficits — and how none of them are relevant under MMT for the reasons you likely believe.

Thatcher’s Backward Dictum: (TAB)S

In a now-famous speech from 1983, British prime minister Margaret Thatcher declared that “the state has no source of money, other than the money people earn themselves. If the state wishes to spend more it can only do so by borrowing your savings or by taxing you more.” This was Thatcher’s way of saying that the government’s finances were constrained in the same way our personal finances are constrained. In order to spend more, the government would need to raise money. “We know that there is no such thing as public money,” she added. “There is only taxpayer money.”

Basically, if the British people wanted more from their government, they would have to foot the bill.

Was it an innocent mistake or a carefully crafted statement designed to discourage the British people from demanding more from their government? I’m not sure. Regardless of her motives, Thatcher’s remarks concealed the currency-issuing power of the state. More than three decades later, political leaders in currency-issuing nations like the UK and the US still talk as though we, the taxpayers, are the ultimate source of the government’s money.

This notion is also leftover from the days before fiat currency when the gold standard was the ultimate source of the government’s money.

As former British prime minister Theresa May put it more recently, the government doesn’t have a “magic money tree.” Unless they take more of our money, we’re told, the government can’t afford to top up spending on existing programs much less fund ambitious new projects.

To most of us, the idea that the government must tax more to spend more probably sounds reasonable. And our politicians know it. They also know that most of us don’t want to see our taxes go up, so they twist themselves into knots, trying to figure out how to win votes by vowing to do big things without asking the majority of us to pay more. For example, Donald Trump promised the American people that Mexico would pay for his border wall, while Democrats have insisted that billionaires and Wall Street banks can foot the bill for many of their ambitious programs. The money has to come from somewhere, right?

Actually, we’ve got it backward. But before we get to that, let’s walk through the conventional understanding so it will be easier to contrast this backward thinking with the way things actually work.

Recall that the finances we understand best are our own, and we know that we need to come up with money before we can spend. So, the idea that the federal government must collect funds in order to spend seems intuitively correct, right? Extrapolating from our own experiences, we know that we can’t walk out of the department store with a new pair of shoes or drive away from the car dealership in a sporty new vehicle unless we come up with the financing first.

According to conventional thinking, the government relies on two sources of funding: it can raise your taxes, or it can borrow your savings.

Taxes allow the government to collect money from people who have it, which means taxes are looked upon as a way to transfer money to the federal government.

Tax is Surgery, Not Virtue, Not Theft, Not Slavery – Alvarism ...

If the government wants to spend more than it collects by taxing, it can raise additional funds by borrowing from savers. In either case, the idea is that the government must come up with the money before it can spend. That’s how most of us have been taught to understand the government’s fiscal operations.

Taxing and borrowing come first. Spending comes last.

A handy mnemonic for the conventional way of thinking is

(TAB)S:

taxing and borrowing precede spending.

Because we’ve been trained to believe that, like each of us, the government must “find the money” before it can spend, everyone becomes obsessed with the question: How are you going to pay for it? 

You see these questions bleated over and over on the 24/7 news cycle: “How are you going to pay for the wall, President Trump?” “How are you going to pay for socialized healthcare, President Obama?” “How are you going to pay for free college tuition, Senator Sanders?”

We’ve been conditioned to expect our elected officials to offer a blueprint that maps out the source of every new dollar they wish to spend. Even the most progressive candidates fear that they’ll be eaten alive if their proposals add to the deficit, so borrowing is almost never an option. To show that their policies won’t add to the deficit, they hunt for ways to squeeze more tax revenue out of the economy, usually targeting those who can most easily afford to pay more.

But, in the view of MMT advocates, there’s often room to fund new programs without the need for higher taxes. Adding to the deficit shouldn’t be looked upon as a taboo. Here’s why: Taxes are critically important, but there’s no reason to assume the government must raise taxes whenever it wants to invest in our economy.

After all, the federal government almost never collects enough taxes to offset all of its spending — Deficit spending is the norm!

Everyone in Washington, DC, knows it. And so do voters.

So let’s cover how the government actually spends:

How the Currency Issuer Spends: S(TAB)

Because it’s the dominant way of thinking, most of us probably carry a version of the (TAB)S model in our minds. Even if we have never spent a moment of our time thinking about the inner workings of the federal budget, we probably believe that the government needs our money to help pay the bills.

We might even feel a bit patriotic about the check we send off to the Internal Revenue Service (IRS) every April, proud to have done our small part in building low-income housing, paying our men and women in uniform, and supporting our farmers with generous subsidies. I hate to be the bearer of uncomfortable news, but that’s not what’s actually happening. If you’re not already doing so, you should probably sit down. Are you ready?

Your taxes don’t actually pay for anything, at least not at the federal level.

The government doesn’t need our money. We need their money. We’ve got the whole thing backward! The government spends first and then taxes or borrows.

That sequencing turns Thatcher’s dictum completely around, reordering the mnemonic to give us

S(TAB):

spending before taxing and borrowing.

The government doesn’t go around looking for someone else to pick up the TAB, it just spends its currency into existence. Warren saw things that most economists were missing. To many of us, his ideas initially sounded completely original, but most weren’t. They were only new to us. It turns out they could be found in canonical texts, like Adam Smith’s Wealth of Nations or in John Maynard Keynes’s two-volume classic, A Treatise on Money. Anthropologists, sociologists, philosophers, and others had long ago arrived at similar conclusions about the nature of money and the role of taxes, but the economics profession had largely lagged behind.

Taxes are there to create a demand for government currency. The government can define the currency in terms of its own unique unit of account—a dollar, a yen, a pound, a peso—and then give value to its own otherwise worthless paper by requiring it in payment of taxes or other obligations. “Taxes turn litter into currency.” At the end of the day, a currency-issuing government wants something real, not something monetary. It’s not our tax money the government wants. It’s our time. To get us to produce things for the state, the government invents taxes or other kinds of payment obligations. This isn’t the explanation you’ll find in most economics textbooks, where a superficial story about money being invented to overcome the inefficiencies associated with bartering—trading goods without the use of money—is preferred. In that story, money is just a convenient device that sprang up organically as a way to make trade more efficient. Although students are taught that barter was once omnipresent, a sort of natural state of being, scholars of the ancient world have found little evidence that societies were ever organized around barter exchange.

MMT rejects the ahistorical barter narrative, drawing instead on an extensive body of scholarship known as chartalism, which shows that taxes were the vehicle that allowed ancient rulers and early nation-states to introduce their own currencies, which only later circulated as a medium of exchange among private individuals. From inception, the tax liability creates people looking for paid work (aka unemployment) in the government’s currency. The government (or other authority) then spends its currency into existence, giving people access to the tokens they need to settle their obligations to the state. Obviously, no one can pay the tax until the government first supplies its tokens. Most of us simply have the sequencing wrong: Taxpayers weren’t funding the government, the government was funding the taxpayers.

Just as the Federal Reserve describes itself as “the issuing authority for all Federal Reserve notes,” the US Mint describes itself as “the nation’s sole manufacturer of legal tender coinage.” Finally, the Federal Reserve issues digital dollars, known as bank reserves. These are created exclusively via keystrokes on a computer-controlled by the government’s fiscal agent, the Federal Reserve. When the Wall Street banks needed trillions of dollars to survive the 2008 financial crisis, the Fed effortlessly conjured them into existence using nothing more than a keyboard at the New York Federal Reserve Bank.

To the average person, it might seem as though the government literally takes the bills rolling off its printing press or coins tumbling from its minting machines to pay its bills. Cable news shows certainly love the imagery of the mass production of money. They’ll often air a story about government spending while running a video of newly manufactured dollars spewing from the printing press. But Federal Reserve notes and coins are mostly there for our convenience. It would be way too clunky for the federal government to pay Boeing for a fleet of new fighter jets with an enormous stockpile of physical currency. That’s just not how it works.

Instead of handing over fistfuls of cash, as in Monopoly, the federal government makes most of its payments the way a scorekeeper assigns points in a game of bridge. Except, instead of writing the points on a scorecard, payments simply get typed into a keyboard by someone at the Federal Reserve.

For one thing, you and I need dollars to pay our taxes. And because taxes (and death) are an inescapable fact of life, the government’s currency occupies a central place in our economic lives. Once a tax-backed currency like the US dollar is introduced, it usually becomes the standard unit in which everything else is priced.

Only the scorekeeper is different.

Uncle Sam doesn’t need dollars. When he collects taxes from us, he’s just subtracting away some of our dollars. He doesn’t actually get any dollars. It’s jarring, I know. This is our first Copernican moment. It’s why one journalist at the Financial Times described MMT as an autostereogram — You know, one of those two-dimensional images that doesn’t look like much until you focus your gaze a certain way, and then the image behind the image comes into view, revealing an intricate 3-D visual of a painted desert or a great white shark.

I promise you there’s a shark in this image — you just need to train your eyes by staring at it:

Similarly, once you see the world the way an MMT economist does, you’re able to see that the government’s ability to spend doesn’t revolve around the taxpayer dollar, and the whole fiscal paradigm shifts.

Tomorrow we’ll cover why, even though the government doesn’t need the taxpayer to spend, they still bother taxing and borrowing.

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