When I was in London recently, I was repeatedly assailed with the idea that the…
In The role of literary fiction in perpetuating neo-liberal economic myths – Part 1, I noted introduced the idea that fictional literature plays a significant role in framing false economic concepts and, thus, can promotes neo-liberal biases among the readership, even when the plot of the narrative is ostensibly about something other than economics. In other words, what parades as fiction becomes a powerful tool for spreading ideological propaganda, often in a very subliminal or subtle way. In Part 2, I demonstrate that further and provide correct Modern Monetary Theory (MMT) interpretations of popularised economic statements that the characters in the book in focus (The Mandibles) weave into their conversation as if they are accepted facts. The lesson is clear. To further advance Modern Monetary Theory (MMT) ideas, novelists who are sympathetic to the cause should construct their narratives consistent with the MMT principles, where economic matters are touched upon in their work. This will help to counter the misconceptions that arise in literary fiction when authors engage with flawed neo-liberal arguments about the monetary system. It might also help educate book reviewers who often, knowingly or unknowingly, reinforce the myths in the main text.
To start, consider the way book reviewers fail to correct the record. In the case of Lionel Shriver’s work – The Mandibles: A Family, 2029-2047 (published May 2016) – which is our demonstration novel, the press reception of the book tended to reinforce its claim to reality.
In Part 1, I noted that Shriver has made it plain in many interviews that the motivation for the book was to present “a cautionary tale about today” (Source).
The Australian Fairfax press review of the book (June 3, 2016) – The Mandibles review: Lionel Shriver’s family saga of the world going bung – claimed that Shriver’s “trick … is to take what might be a schematic parable of a plotline and then fill it with all the circumstantial realistic air in the world so that we will feel we inhabit this endangered dumpster of a universe as if it were our own.”
It also reinforces Shriver’s claim that the book is not some dystopian fantasy by saying that Shriver:
… is so well-informed about the eloquence of risk that lies beneath the American economy. She is intimately aware of how much trust has to underwrite the greenback as well as God-given American democracy …
So the reader, who might be perusing reviews before purchasing and reading the novel, will be already trained to accept that Shriver has a strong command of economic matters and and firm understanding of the inner workings of the monetary system.
This just reinforces the gullibility of the readership and perpetuates false ideas.
As another example, the Irish Times review (May 14, 2016) – The Mandibles review: future shock family – told the readership that the book is “laced with Shriver’s spicy intellect, her unapologetic eye for detail” and:
… is a not-too-distant epoch in which children are no longer able to write with a pen and paper, but instead understand perfectly the specifics of monetising national debt.
All adding ‘credibility’ to the fiscal discussion that is woven throughout the book.
We left yesterday’s discussion with Douglas Mandible (in 2029) discussing the financial collapse with his son, Carter.
His first parry was the standard Austrian School, gold bug claim that the US dollar has lost 95.8 per cent of value since 1913. We demonstrated how misleading that particular claim is.
Even a mainstream, neo-classical economist (which I generally refer to as the dominant neo-liberal group in the profession) would reject the gold bug claim.
But Shriver is apparently not fussed by consistency. She presents a pot-pourri of fiscal scaremongering drawn from disparate camps as if they belong to a unified and accepted body of theory and praxis.
After the gold bug discussion between Douglas and Carer, Shriver then launches into doomsday scenarios that the mainstream economists typically use to attack government.
Shriver writes that:
Douglas now immersed himself in the more recently minted genre of apocalyptic economics, rehearsing debt-to-GDP ratios … America in particular has been getting away with murder-playing on the heartbreaking international belief in Treasury bonds as the ultimate ‘safe haven.’ Really, the blind trust bears all the irrational hallmarks of theology. What else, financially, is there to believe in besides the full faith and credit of the United States? So we’ve borrowed for basically nothing on the basis of a childlike credulity for thirty years. You know the Fed’s been steadily trying to monetize the debt … buying American bonds was a sign of worldwide gullibility.
This is a statement of the repetitive theme in the book that foreign purchases of US government treasury debt have been propping up American government spending and, without it, the US government has no financial viability.
A corollary of this theme, is that the power lies in the hands of those foreigners who hold the US government debt rather than the issuer, the US government.
Of course, the Chinese could liquidate their holdings of US government debt. But in doing so they would devastate their own fortunes. As we will see such a liquidation would have no bearing on the US government’s capacity to buy goods and services for sale in US dollars but would seriously undermine the trading capacity of China. None of this is recognised in Shriver’s narrative.
The importance of who purchases US government debt is close to zero when assessing the capacity of the US government to run its fiscal policy program.
The US government is the only government that issues US currency so it is impossible for the Chinese to ‘fund’ US government spending.
Modern Monetary Theory (MMT) demonstrates that the external deficit countries ‘finance’ the desire of the external surplus nations to accumulate financial assets denominated in the currencies of the deficit countries. If the deficit countries stopped purchasing that desire would be unfulfilled.
The propensity to foreign-held US public debt is a direct result of the trade patterns between the countries involved (and cross trade positions).
For example, China will automatically accumulate US-dollar denominated claims as a result of it running a current account surplus against the US.
These claims are initially held somewhere within the US banking system and can manifest as US-dollar deposits or interest-bearing bonds. The difference is really immaterial to US government spending and in an accounting sense just involves adjustments within the banking system.
The accumulation of these US-dollar denominated assets (bits of paper and electronic bank balances) is the ‘reward’ that the Chinese (or other foreigners) get for shipping real goods and services to the US (principally) in exchange for less real goods and services being shipped from the US.
Given real living standards are based on access to real goods and services, you can work out, from a macroeconomic perspective, who is on top.
Please read my blog – Modern monetary theory in an open economy – for more discussion on this point.
Note, I used the qualifier ‘from a macroeconomic perspective’. A US worker in Detroit who has endured unemployment as a result of cheaper imports coming from nations with lower labour standards (pay and conditions) than the US is unlikely to be among those who benefit.
The US thus benefits from China’s willingness to deprive its citizens of material wealth (use of its own real resources) and net ship its ‘labour’ and other real resources embodied in the exports to other nations.
This is not to deny that when an economy experiences a depletion of foreign exchange reserves or finds the exchange terms of its own currency against foreign currencies it requires to purchase essential imports it has to take some hard decisions in relation to its external sector.
This is especially so if it is reliant on imported fuel and food products. In these situations, a burgeoning external deficit will threaten the dwindling international currency reserves.
In some cases, given the particular composition of exports and imports, currency depreciation is unlikely to resolve the CAD without additional measures.
The depreciation, in turn, raises the relative costs of imports, and imparts an inflationary bias to the economy. Moreover, depreciation leads to expectations of further depreciation and fuels the run out of the currency. There may be no interest rate that is high enough to counter expectations of losses due to depreciation and possible default.
The reality is that a nation facing a lack of ability to purchase imports, for whatever reason, has to either increase its exports or reduce its imports.
For less developed countries faced with currency crises, there is probably no short-run alternative but to urgently restore reserves of foreign currency either through renegotiation of foreign debt obligations, international donor assistance or default.
For an advanced nation, similar constraints might apply and a sudden shift in international sentiment against the nation or other financial assets denominated in that currency are no longer deemed as desirable, then adjustments in the flow of real goods and services sourced from foreigners are required.
And, as I explain in this blog – Ultimately, real resource availability constrains prosperity – the limits for a nation are clear – if it cannot command access to real resources owned by foreigners the it must rely on the resource wealth it has for sale in its own currency.
But none of that reduces the financial capacity of the currency-issuing government to purchase whatever is for sale in that currency.
It might also be the case that certain accounting procedures are rehearsed by the US Treasury and the Federal Reserve bank before the former spends US dollars.
These voluntary constraints – shunting cash from bond sales into a particular account that is then debited when government spending occurs – are just a chimera.
The intrinsic financial capacity of the US government is clear – it issues the currency.
The stupidity of these voluntary constraints would become more obvious if the US Congress passed a law that required all Treasury officials to run a lap of the President’s Park each day, which is near the Treasury Building on 15th Street North West in the District of Columbia, before it could formalise each government spending transaction.
Such a rule would have as much logic as the sort of accounting gymnastics that are operating in practice.
Ultimately, the US government is not dependent on the financial markets. The latter are dependent on the government spending! And China would have to find other assets to hold if it did not invest the US dollar earnings it makes from its trade surpluses against the US in US treasury bonds.
Please read my blog – Who is in charge? February – for more discussion on this point.
Shriver also linked the ‘foreign funding of US government deficits’ myth with the related claim that as the private bond markets were losing confidence in the dollar, the Federal Reserve was “steadily trying to monetize the debt”.
This is another one of those mainstream deceptions and is introduced to logically point to the next causal argument in the neo-liberal chain against government deficits – that the central banks will cause hyperinflation as the currency collapses and it spews ‘money’ into an economy already saturated with the increasingly worthless money.
The popular image of citizens pushing wheelbarrows full of $US100 bills to buy a loaf of bread, while crazed-central bankers in basements are running printing presses at breakneck speed, is then conjured up.
In this context, Shriver has Douglas Mandible’s saying to Carter that “monetizing the debt” amounted to:
You loan me ten bucks. I photocopy the bill four times, give you back one of the copies, and announce that we’re square. That’s monetizing the debt: I owe you nothing, and you’re stuck with a scrap of litter.
This is not remotely what the orthodox concept of debt monetisation refers to. It is really just a restatement of the argument that the more of a currency that is issued, the lower its value.
Shriver wants her readers to believe the false claim that continually expanding the money supply will inevitably be inflationary.
To monetise means to convert to money. Gold used to be monetised when the government issued new gold certificates to purchase gold.
In a broad sense, a federal (fiat currency issuing) government’s debt is money, and deficit spending is the process of monetising whatever the government purchases.
All government spending in a flexible exchange rate system, is operationalised by the government crediting bank accounts (directly or indirectly by issuing cheques). This process adds to bank reserves. Alternatively, taxation payments to government result in bank accounts being debited and reserves being reduced.
So among other impacts, a fiscal deficit is a net reserve add or a net credit to commercial bank accounts.
If we understand the banking operations that accompany these transactions further, we will learn that those who receive the net payments from the government are in possession of bank liabilities which are matched by the banks’ reserve positions which are central bank liabilities. Some of the deposits are held in the form of cash but this is a nuance.
Note that irrespective of what else the government (via the treasury or the central bank) does in relations to the operational management of the cash system (bond sales) and/or aggregate demand management (taxation changes), government spending is the same process.
So the alleged three sources of finance (taxes, debt-issuance, or ‘money printing’) noted in the mainstream textbook literature are misnomers and mislead you into thinking that the process of government spending differs depending on how it is ‘financed’.
But in terms of debt monetisation, students are taught to believe that:
… with the central bank’s cooperation, the government can in effect finance itself by money creation. It can issue bonds and ask the central bank to buy them. The central bank then pays the government with money it creates, and the government in turn uses that money to finance the deficit. This process is called debt monetization. (excerpt from Blanchard’s 1997 macroeconomics textbook, page 429).
Following Blanchard’s conception, debt monetisation is usually referred to as a process whereby the central bank buys government bonds directly from the treasury.
In other words, the federal government borrows money from the central bank rather than the public. Debt monetisation is the process usually implied when a government is said to be ‘printing money’, although MMT proponents will never use that terminology, because government spending is done by crediting bank accounts (as above). No printers are involved!
Debt monetisation, all else equal, is said to increase the money supply and, ultimately, lead to severe inflation.
The mainstream macroeconomics text book argument that increasing the money supply will cause inflation is based on the Quantity Theory of Money.
The Quantity Theory of Money, a leftover from the Classical era, is expressed in symbols as MV = PQ. In English, this says that the money stock (M) times the turnover per period (V) is equal to the price level (P) times real output (Q).
The mainstream argument linking increasing M to P makes two major assumptions:
1. V is fixed (despite empirically it moving all over the place).
2. Q is always at full employment as a result of market adjustments – so the economy is assummed to be unable to physically produce more output in response to rising spending (MV).
In applying this theory the mainstream thus deny the existence of unemployment or idle capacity. The more reasonable mainstream economists admit that short-run deviations in the predictions of the Quantity Theory of Money can occur but in the long-run all the frictions causing unemployment will disappear and the theory will apply.
In general, the Monetarists (the most recent group to revive the Quantity Theory of Money) claim that with V and Q fixed, then changes in M cause changes in P – which is the basic Monetarist claim that expanding the money supply is inflationary.
They say that excess monetary growth creates a situation where too much money is chasing too few goods and the only adjustment that is possible is nominal (that is, inflation).
One of the contributions of Keynes was to show the Quantity Theory of Money could not be correct. He observed price level changes independent of monetary supply movements (and vice versa) which changed his own perception of the way the monetary system operated.
Further, with high rates of capacity and labour underutilisation at various times (including now) one can hardly seriously maintain the view that Q is fixed. There is always scope for real adjustments (that is, increasing output) to match nominal growth in aggregate demand.
So if increased credit became available and borrowers used the deposits that were created by the loans to purchase goods and services, it is likely that firms with excess capacity will react to the increased nominal demand by increasing output.
Even at full employment, productivity growth and investment means that the level of real output commensurate with all productive resources being fully utilised is always expanding.
So as long as the volume of spending (MV) keeps pace with the real capacity of the economy, there is unlikely to any price response from firms keen to preserve market share.
Thus, even if the money supply is increasing, the economy may still adjust to that via output and income increases up to full capacity. Over time, as investment expands the productive capacity of the economy, aggregate demand growth can support the utilisation of that increased capacity without there being inflation.
Moreover, Modern Monetary Theory (MMT) demonstrates that the orthodox concept of central bank monetising the deficit is largely inapplicable to a fiat currency monetary system with flexible exchange rates.
It stems from the fallacious idea that the national government faces a fiscal constraint in the same way that a household operates.
Students are taught that deficits are inflationary if financed by so-called ‘debt monetisation’ or squeeze private sector spending if financed by debt issue because they soak up what is claimed to be a finite pool of savings and thus push up interest rates, choking off private borrowing.
The latter claim categorically fails to understand that private banks do not loan out reserves and create deposits (and liquidity) whenever they issue a loan to a credit-worthy borrower. It also fails to understand that when deficits promote income growth, saving increases, and so cannot be considered a finite pool.
Once you understand that and that the monetary operations surrounding government spending do not alter the inflation risk inherent in any spending, government or non-government then we can move on to put the concept of debt monetisation into a real world perspective.
The reality is that the fear of debt monetisation is unfounded, not only because the government doesn’t need money in order to spend but also because the central bank does not have the option to monetise any of the outstanding government debt or newly issued government debt.
Why is the central bank so constrained?
As long as the central bank has a mandate to maintain a positive target short-term interest rate, the size of its purchases and sales of government debt are not discretionary.
The central bank’s lack of control over the quantity of reserves underscores the impossibility of debt monetisation in typical times.
The central bank is unable to monetise the government debt by purchasing government securities at will because to do so would cause the short-term target rate to fall to zero or to any support rate that it might have in place for excess reserves.
Why is that?
I discuss it in detail in the introductory suite of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3 – for basic Modern Monetary Theory (MMT) concepts.
In summary, central bank operations aim to manage the liquidity in the banking system such that short-term interest rates match the official targets which define the current monetary policy stance.
The main instrument of this liquidity management is through open market operations, that is, buying and selling government debt.
When the competitive pressures in the overnight funds market drives the interbank rate below the desired target rate, the central bank drains liquidity by selling government debt.
This open market intervention therefore will result in a higher value for the overnight rate. Importantly, we characterise the debt-issuance as a monetary policy operation designed to provide interest-rate maintenance.
What might drive these competitive pressures in the overnight funds market?
When the government runs a fiscal deficit, it is adding more reserves to the banking system (via the spending) than it is draining reserves (via the taxation).
So on any particular day, a fiscal deficit means the reserves are rising overall. Any particular bank might be short of reserves but overall the sum of the bank reserves are in excess. It is in the commercial banks interests to try to eliminate any unneeded reserves each night. Surplus banks will try to loan their excess reserves on the Interbank market. Some deficit banks will clearly be interested in these loans to shore up their position and avoid borrowing from the lender of last resort (the central bank) which is typically more expensive.
The upshot, however, is that the competition between the surplus banks to shed their excess reserves drives the short-term interest rate down.
But, all these transactions net to zero and so the non-government banking system cannot by itself eliminate a system-wide excess of reserves that the fiscal deficit created.
The excess is drained by central bank open market operations. That is, the bond sales (debt issuance) allows the RBA to drain any excess reserves in the cash-system and therefore curtail the downward pressure on the interest rate. In doing so it maintains control of monetary policy.
Accordingly, the concept of debt monetisation is a non sequitur. Once the overnight rate target is set the central bank should only trade government securities if liquidity changes are required to support this target.
Given the central bank cannot control the reserves then debt monetisation is strictly impossible.
Imagine that the central bank traded government securities with the treasury, which then increased government spending. The excess reserves would force the central bank to sell the same amount of government securities to the private market or allow the overnight rate to fall to the support level.
This is not monetisation but rather the central bank simply acting as broker in the context of the logic of the interest rate setting monetary policy.
The alternative to an open market operation, is for the central bank to pay a competitive rate on excess reserves. You will appreciate that this will eliminate the motive of the banks with surplus reserves to seek a competitive return in the interbank market and thus allow the central bank to maintain a positive target interest rate.
But, in substance, this is equivalent to selling an interest-bearing bond to the private banks. The name of the account where the funds are recorded might be different (bonds in the first case, interest-earning reserves in the second) but the effect is the same. The non-government sector receives a flow of income from the government sector (either a bond interest payment or an excess reserve interest payment) and holds a financial asset it can cash in any time.
So it is only when the central bank is prepared to allow the interest rate to drop to zero can it ‘monetise’ government debt without any other liquidity management intervention.
Why is the zero interest rate situation different? Then the central bank does not have to drain the excess reserves by selling government bonds to the markets even if there is an on-going fiscal deficit adding to those excess reserves on a daily basis.
The competitive processes within the interbank market will ensure there is a zero interest rate.
In fact, this is the preferred MMT position – no government debt issued, overt monetary financing (that is, the equivalent of debt monetisation) and zero interest rates.
In Chapter 4 of The Mandibles we are introduced to the POTUS, who it turns out is of Hispanic ethnicity, again an illusion to alleged demographic shifts in the US between now and 2029.
President Alvarado, presents all his speeches in Spanish before providing an English version.
Another part of the family, Willing, a 12 year old is watching the President address the nation but his mother Florence, who is the daughter of Carter, decides to catch it later.
Alvarado announces that the speculative attacks on the US dollar have been:
… designed to raise the cost of financing our national debt, which would translate into you the American taxpayer keeping less of your hard-earned income.
Of course, this is the standard neo-liberal line. That taxpayers, ultimately are the source of funds that the government spends.
But for the non-government sector to get the funds that they remit to relinquish their tax obligations, the government has had to spend them into existence. Spending has to pre-date tax payments, which means, as a matter of elementary logic that the taxes cannot cause the spending!
Please read my blog – Taxpayers do not fund anything – for more discussion on this point.
The President continued and claimed that the introduction of the bancor was an international conspiracy where the “rogue IMF” had decreed that:
American bonds held by foreign investors must henceforth be redeemed in bancors, at an unfavorable exchange rate … American bonds sold to foreign investors must henceforth be denominated in bancors-which is a challenge to our very sovereignty as a nation.
Which if it ever occurred would mean nothing in relation to the US governments ability to spend US dollars. They could simply determine that the bond auctions were off limits to non-US citizens, or, instruct the central bank to buy the debt not sold to US citizens (up to the volume necessary to match the fiscal deficit), or, better still, stop issuing debt altogether.
So even if a ‘rogue IMF’ intervened in this way, the only losers would be the foreigners running external surpluses against the US who would have dollars in bank accounts earning nothing and no access to a ‘safe’ interest-earning bond.
The POTUS then bans US citizens from holding these bancors, which would, in effect, stop imports.
He also confiscates all private gold reserves, which according the Shriver’s narrative, is to “mobilize our resources to defend our liberty” – that is, provide the government with funds. Gold exports are also prohibited.
First, the US government does not need ‘funds’ in order to spend US dollars.
Second, think about it logically, if there is to be no trading of gold, not private holdings of gold and no exports of gold, how would the confiscation help the government spend – which is an act of providing net financial assets to the non-government sector in exchange of the real resources owned by the latter sector?
Finally, the POTUS announces that the government will default on all outstanding debt because:
In the interest of preserving the very nation that would meet its obligations of the future, we are compelled to put aside the obligations of the past. All Treasury bills, notes, and bonds are forthwith declared null and void. Many a debtor has wept in gratitude for the mercy of a wiped slate, the right to a second chance, which for individuals and corporations alike all fair-minded judicial systems like our own have enshrined in law. So also must government be able to draw a line and say: here we begin afresh.
The point is that outstanding debt obligations do not hinder a currency-issuing government’s capacity to run deficits (or surpluses) in the future.
A past deficit (surplus) does not mean the government has less (more) spending capacity tomorrow.
The only way a large interest bill on public debt might limit the capacity of the government to spend today is that the income flow to the non-government sector would reduce the real resource space necessary for non-inflationary government spending.
But history tells us that that sort of problem is unlikely to ever be binding.
And if it was looking to become a problem, the central bank always has the capacity to control yields, down to zero and hence interest payments.
So it is a nonsensical claim by Shriver’s POTUS that they have to default to free up fiscal space. Another neo-liberal myth.
The rest of the book continues in this vein. But in Parts 1 and 2 I have dealt with most of the key neo-liberal myths that are woven into the story as if they are facts or have some relevance to reality.
I urge all prospective authors who want to discuss economics in their next book to base the narrative on Modern Monetary Theory (MMT) principles. That will help our cause immeasurably, presuming the books have wide sales.
Reclaiming the State Lecture Tour – September-October, 2017
For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project homePage.
For sale – Just released book at discount price
I have stock of the book (paperback version) available for sale at discounted prices, well below the current market price from the booksellers.
If you would like a copy signed by yours truly then you should send me an E-mail me (Bill.Mitchell – @ – newcastle.edu.au deleting the – and space before and after the @ sign) with your location and I will send you PayPal details plus postage costs.
The discounted price I can make the book available (while my stock lasts) is $AUD28 plus postage.
My stocks are limited.
That is enough for today!
(c) Copyright 2017 William Mitchell. All Rights Reserved.