{"id":9643,"date":"2010-05-12T18:51:23","date_gmt":"2010-05-12T07:51:23","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=9643"},"modified":"2010-05-12T18:51:23","modified_gmt":"2010-05-12T07:51:23","slug":"what-part-of-accounting-dont-they-get","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=9643","title":{"rendered":"What part of accounting don’t they get?"},"content":{"rendered":"

\t\t\t\tWell last night’s Australian federal budget was a total disgrace. Which means I am either crazy or the most of the rest of the commentators are because they are all hailing it as wonderful piece of policy. Lately, I have increasingly been reading this claim that governments have to conduct “fully-funded spending” as some sort of icon of fiscal responsibility. The Australian treasurer said it repeatedly in his speech and in his following press interviews. Whenever I read or hear that idea I say quietly: What part of accounting don’t they get?
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\nWhat is it about accounting that the Australian Treasurer doesn’t understand (or at least the Treasury officials advising him don’t want to admit)? More on that later but first some background.<\/p>\n

The New York Times chose to publish this article on May 11, 2010 – Greece, Debt and a Lesson for the U.S.<\/a> – which was written by one David Leonhardt, who has a bio which says he is a mathematician by training but now writes about economics. He should have brought his arithmetic skills to his economics because the reasoning is lacking.<\/p>\n

Leonhardt wants to push the “Greek today, US tomorrow” barrow. He presents a pathetic case. His strategy is to manipulate the fears of those who he thinks do not understand anything at all about economics – the general public. He ends up revealing that he hasn’t much idea himself about the way different monetary systems operate (EMU and the fiat system of the US) function.<\/p>\n

He probably succeeds in scaring himself with this debt explosion nonsense such is his level of ignorance.<\/p>\n

So we get the standard “(t)he numbers on our federal debt are becoming frighteningly familiar”:<\/p>\n

\nThe debt is projected to equal 140 percent of gross domestic product within two decades. Add in the budget troubles of state governments, and the true shortfall grows even larger. Greece’s debt, by comparison, equals about 115 percent of its G.D.P. today.<\/p>\n

The United States will probably not face the same kind of crisis as Greece, for all sorts of reasons. But the basic problem is the same. Both countries have a bigger government than they’re paying for. And politicians, spendthrift as some may be, are not the main source of the problem.<\/p>\n

We, the people, are.\n<\/p><\/blockquote>\n

So from this you would understand that a rise in public debt reflects a government spending beyond its means – spendthrift behaviour. And you would form the view that a government should not do this because spendthrift behaviour is somehow wasteful, profligate (how many times have we read about the profligate Greeks in the last month – Answer: too many), indulgent – moralise away!<\/p>\n

But there is no mention of what drives the deficit.<\/p>\n

There is also no mention of the fact that the rise in public debt is a voluntary choice made by the government under pressure from the neo-liberal ideology. They could legislate not to increase debt anytime they could get away with it and nothing much would happen other than the debt ratio would start falling and become zero at some point in time.<\/p>\n

And – most importantantly, there is no mention of the way in which the public deficit interacts and responds to behaviour in the other sectors of the economy (the external and private domestic sectors). I will come back to this later because it is a point that escaped the Australian Treasurer when he delivered last night’s federal budget.<\/p>\n

You also get the conflation of levels of government – state and federal. The former using the currency that is issued by the latter. But no mention of that crucial difference.<\/p>\n

You also get the conflation of monetary systems – EMU and fiat – the former denying any national government currency sovereignty the latter bestowing a very complete and powerful sovereignty on the national government. But no mention of that crucial difference.<\/p>\n

So just from that opening gambit you would conclude that Mr Leonhardt is an economics illiterate. I don’t mean to be unkind but it is he who is putting his views out as one of an expert.<\/p>\n

But the political point is clear – people elect governments. It just happens that there is not a level playing field in our democracies. The media is highly influential in shaping the opinions of the voters. And the top-end-of-town with the cash is able to infiltrate the political process in a myriad of ways to distort public perceptions and mis-represent policy choices etc.<\/p>\n

Anyway, Leonhardt claims that the political process in the US is ambiguous:<\/p>\n

\nWe have not figured out the kind of government we want. We’re in favor of Medicare, Social Security, good schools, wide highways, a strong military – and low taxes. Dealing with this disconnect will be the central economic issue of the next decade, in Europe, Japan and this country.\n<\/p><\/blockquote>\n

So this is a disconnect that is confected. To construct this as a disconnect you have to make some assumptions. He doesn’t list them and maybe even doesn’t know he is making them – given his grasp of the material (note Europe and Japan and the US are run together as being equivalent).<\/p>\n

The assumptions are that the US government is revenue constrained. But no sovereign government is ever revenue constrained because they issue the currency in use under monopoly conditions.<\/p>\n

So the disconnect arises because the likes of Leonhardt run these smokescreens and people believe them.<\/p>\n

Anyway, Leonhardt then lectures us on fiscal restraint and how politically unpopular it is when it comes to actually dealing with the public spending excesses.<\/p>\n

\nThe message seems clear: woe unto the politician – in Washington, Athens or London – who tries to go beyond platitudes and show some actual fiscal restraint.<\/p>\n

This situation obviously can’t continue, as Robert Greenstein, perhaps the leading liberal budget expert, points out. Mr. Greenstein’s politics make him sympathetic to the worry that all the deficit talk will become an excuse to pull back on stimulus spending while unemployment remains high or to gut social programs. But he also knows the numbers well enough to understand that our Greece moment, whether it takes the form of a crisis or not, is coming.\n<\/p><\/blockquote>\n

“our Greece moment” – what a lovely (meaningless) turn of phrase. The US will never have a Greece moment in that the government is facing bankruptcy. The US government has no risk of insolvency. If it continues to issue debt to match its deficits then the bond yields demanded by the markets may rise. If the US government doesn’t like that it can issue debt in the short-maturity range only and allow the Federal Reserve to control yields (more or less).<\/p>\n

The Greek government has no such opportunities or capacities available to it.<\/p>\n

Greenstein, who is the Director of the Center on Budget and Policy Priorities, which is “a nonprofit policy institute that conducts research and analysis on fiscal policy matters and an array of federal and state programs and policies” recently gave Testimony on the Need to Implement a Balanced Approach to Addressing the Long-Term Budget Deficits<\/a> before the US Committee on Ways and Means, Subcommittee on Select Revenue Measures.<\/p>\n

His summary points for the US fiscal situation were:<\/p>\n

\n… our current fiscal path is simply unsustainable over the longer term. Federal deficits and debt will rise to unprecedented and dangerous levels if current policies remain unchanged … <\/p>\n

Digging ourselves out of this predicament will require action on both sides of the budget … We will not be able either to finance the kind of government that Americans want …<\/p>\n

Congress should try to get deficits down to about 3 percent of GDP by mid-decade. Deficits at that level would keep the debt from rising as a share of the economy and thus would go a long way toward reassuring our creditors and putting the budget on a more sustainable path.\n<\/p><\/blockquote>\n

You get the drift. He tries to appear progressive (and reasonable) in his testimony by arguing that the Ways and Means Committee “aspires to a debt-to-GDP ratio of 60 percent (which implies deficits of about 2.3 percent of GDP), whereas we think that a 70 percent debt-to-GDP ratio (with deficits around 3 percent of GDP) is sustainable”.<\/p>\n

Neither ratio has any real meaning. Greenstein is a deficit dove and they are part of the problem.<\/p>\n

But Greenstein and Leonhardt are transfixed on the “long-term deficit” which will grow because:<\/p>\n

\nAs societies become richer, citizens tend to want better schools, better medical care and other government services. This country is following that pattern, but without paying the necessary taxes. That combination has us on a course to Greece-like debt.\n<\/p><\/blockquote>\n

Rising tax revenue will not increase the real resources available to the economy. Rising tax revenue reduces the access that the private sector has to existing real resources and thus allows the government sector to have increased access.<\/p>\n

This has nothing to do with the taxes funding the government spending. Taxes function to create idle real resources which can then be deployed by the government. But there has to be real resources available in the first place.<\/p>\n

So as societies become richer and citizens want more government services etc – then they will be able to have them if (a) the real resources necessary to deliver these services are available; and (b) the political compromise is consistent. Neither of these conditions have anything to do with the number next to the fiscal deficit at any point in time.<\/p>\n

The US government will always be able to purchase what is available for sale in US dollars if it thinks the politics are amenable. This is so whether they are running surpluses or deficits of whatever magnitude you want to write down on a piece of paper.<\/p>\n

The long-term problem is about productivity, real resource availability and productive capacity. None of those things are going to be helped by running austerity programs now. Quite the opposite.<\/p>\n

Leonhardt continues to argue about the need for tax hikes and spending cuts and matching spending with taxes – to make sure the US “pays for what it spends”. He thinks this will be “unpleasant” but not spell “doom”.<\/p>\n

He concludes that “(w)e need to make choices” and then quotes one Alan Krueger, who is the chief economist at the US Treasury Department:<\/p>\n

\nIt’s not a matter of whether we have the resources to solve our problems … It’s a matter of political will.\n<\/p><\/blockquote>\n

With a chief economist like that no wonder economic policy making in the US is so dismal. The truth is that “it is all a matter of whether the US has the (real) resources to solve their problems … and then it becomes a political issue as to where those resources are allocated”.<\/p>\n

But Leonhardt’s notion that governments have to make sure they “pay for their spending” is a recurring theme. Of-course, it implies a balanced budget. It is also based on an implicit notion that the government is like a household and cannot go on spending more than it earns.<\/p>\n

Well, if someone would do me a favour and E-mail Leonhardt and give him the good news.<\/p>\n

The US government like all sovereign governments can always spend more than it earns – continuously and indefinitely – because the concept of “earning” is redundant. Unlike a household or a corporation, the sovereign government doesn’t need to earn to spend. That is a fundamental part of having a fiat currency system.<\/p>\n

It might hide behind institutions (like debt-issuance mechanisms) and rhetoric (like we are running out of money) but the operational reality is that behind all these smokescreens – the US government is not revenue-constrained.<\/p>\n

But the point goes deeper than this. Trying to prescribe rules about fiscal conduct – like the US government should “pay for its spending” – as stand-alone behavioural constraints – misses the point that the fiscal balance is largely endogenous. Endogenous to what? To the behaviours of the other sectors.<\/p>\n

In other words, inflexible fiscal rules that sound fine to the puritanical brigade are unlikely to represent responsible fiscal management when applied to the ultimate goals of government activity – to advance public purpose.<\/p>\n

Being specific – if the private domestic sector wanted to spend exactly the same amount it earned and the external accounts were balanced at all times (exports = imports adjusted for invisibles) then the government could run a balanced budget without damaging national income. Whether this was a full employment spending level overall would depend. If not, then the only way to advance higher GDP and employment growth would be to push the government into deficit, or the private sector in deficit or the external sector into surplus or some consistent combination of all three.<\/p>\n

Australian Federal Budget<\/strong><\/p>\n

This issue came up constantly during the Australian budget speech last night. I wasn’t going to write anything about this dismal policy statement but the point has to be made by someone given how creepy the main commentary is today – like glowing endorsements of the fiscal responsibility that the government is displaying – that sort of nonsense.<\/p>\n

The Treasurer’s Budget Speech<\/a> to Parliament was full of misrepresentations and misunderstandings about the options his government has. He claimed that the Budget met “the highest standards of responsible economic management”. Why?<\/p>\n

\nEvery dollar of new policy in this Budget has been offset across the forward estimates, as we meet the strict confines of our responsible fiscal strategy.<\/p>\n

A strategy that will see the budget return to surplus in three years time, three years ahead of schedule, and ahead of every major advanced economy.<\/p>\n

A strategy that will pay off debt three years sooner – again ahead of every major advanced economy – without increasing taxes as a share of the economy beyond the level we inherited from our predecessors.\n<\/p><\/blockquote>\n

So Leonhardt could have written this speech.<\/p>\n

Consider the following analysis. The following graph is constructed from the official Australian budget data available in Statement 10: Historical Australian Government Data<\/a> of Budget Paper No.1 and the RBA Statistical Bulletin<\/a> for the external account data. The private domestic balance (SI\/GDP) is derived as an analytical solution. All data is expressed as a percentage of GDP.<\/p>\n

What is this analytical solution? Recall that the Sectoral Balances<\/a> are derived from the National Accounts and summarise the flows in and out of each of the three sectors:<\/p>\n