A colleague asked for my thoughts on this article/column by Michael Manning in the State News, the Michigan State student newspaper, so I thought I’d post it for all.
Basically Mr. Manning reaches the right conclusions with a correct, but weak case. In looking at the issue of the size of the U.S. national debt and the panicked concerns many politicians are now expressing about the “urgent need to cut the deficit”, he concludes:
Republicans have decided to use this opportunity to further their party’s political agenda, feeding off of the public’s misunderstanding of national debt.
Although the debt is growing at an alarming rate, it does not mean the end of times or the end of American economic dominance. Public debt largely is misunderstood and used as a tool to scare everyday Americans.
He’s right. The debt is not the end of times nor will it end American economic prosperity (other policies may do that!). And he’s absolutely right that public debt is largely misunderstood.
But the arguments for why it’s not a crisis and how it’s misunderstood are even stronger than he argues. Essentially, Manning argues that most all of the debt is owed to “ourselves”, meaning either American citizens, American corporations/banks, or other units of government (Social Security program, The Federal Reserve, etc). That’s all true, but there are bigger reasons why the national debt doesn’t really matter.
He quotes Glenn Beck and then responds:
In the words of Glenn Beck, “China, some day, will want their payment, America. They will demand payment and they will receive their payment.
And if we can’t pay, they will do what any other bank would do, emotionlessly take the collateral that they now own. That will be our oil reserves, our land, our resources, our rare minerals, our coal, whatever it is.”
How much stake do these Chinese bankers actually have in America? They own a mere 7.5 percent, or about $1 trillion dollars of the national debt.
Yes, China only holds a small amount of the debt. But that’s not really why they won’t “repossess the collateral”. The reason China won’t foreclose on the U.S. more complex. First, Glenn Beck is absolutely ignorant. There is not “collateral” on government debt. The only security for the loan is the “full faith of the U.S. government”. In other words, if the U.S. didn’t want to pay, or if it wanted to payoff with new bonds, or if it wanted to payoff with newly created “money”, that’s their privilege. The lender knows that at the beginning. There is no international court of claims where one country can foreclose on another for a bad debt. What happens when a nation defaults on it’s debt? Basically the lenders (usually banks in other countries) get really upset. They stamp their feet. They call serious meetings. Serious communiques are issued. Foreign ministers get “concerned”. Then they re-write the debt and the lenders take a loss. Nothing else. Because it can’t! The idea of China “emotionlessly” claiming our “oil reserves, land, our resources,” etc. is absurd. How does Mr. Beck propose this happens? China just pulls a couple ships up to Texas, kicks everybody out and tows the state of Texas home to China? Or maybe China just moves in, digs up our coal and ships it home while everybody in West Virginia stands around? Or does Mr. Beck believe China will invade and forcibly take over (a nation with enough nuclear weapons to make dust of all us many times)? It’s ludicrous. I repeat. The government is NOT like a household, and that means there’s no analogy between holders of US debt and a car loan or mortgage you took from the bank.
But the national debt is more misunderstood than just this false household analogy. Indeed, it’s even misunderstood by many economists. The issue has to do with money. The U.S. government, being (1) a sovereign nation that creates it’s own money . that (2) borrows in it’s own currency and (3) has a fiat currency with floating exchange rate, means the government (federal) cannot go broke or ever not be able to pay back bonds and interest when they are due. This is because the government creates and is the source of the underlying “base money”. It can always create more money to pay the bonds when due. Now I know many folks, including many economists who haven’t updated their understanding of the monetary system since the 1971, will say “but, but, but that’s printing money and that creates inflation.”. No it isn’t. And no it doesn’t. The government doesn’t pay it’s bills or payoff bonds with “money”. They send checks drawn on The Federal Reserve Bank. Those checks are accepted by your local bank when you deposit them. When your local bank gives the check to The Fed, The Fed provides the bank with bank reserves. Bank reserves are not money. Bank reserves do not circulate. And, since 1971 at least, bank reserves do not limit or really influence how much money is in circulation. How much your local bank loans out creates money. And The Fed creates reserves to match what’s needed. (for a more in-depth explanations, see Bill Mitchell’s blog BillyBlog or the UMKC Economic Perspectives or this blog and search on “MMT”).
Now some, including many economists, claim that creating new bank reserves is inflationary. But this is based entirely on an outdated theory called the quantity theory of money which hasn’t proven useful, accurate, or valid for over 40 years, largely because it’s based on having a gold standard or fixed exchange rates (both of which Nixon abolished). Inflation happens when the nominal economy grows too fast and the central bank controls that through interest rates, not quantities of bank reserves or money. I realize that some of this may sound counter to what folks may find in a lot of econ 101 textbooks, but that’s because the textbooks really haven’t been updated to reflect modern monetary theory or modern central banking operations in the way they work since the end of fixed exchange rates and gold standard. In economics we have a problem with zombie ideas refusing to die.
Finally, there’s another very important reason the Chinese or anybody else that holds U.S. debt in large amounts don’t have a problem with the size of our debt. That’s because the “debt” itself, the bonds, really shouldn’t be thought of as “debt”. Government debt is really more like “paper money that pays interest”. Again this is sovereign national debt – see above conditions. If you are a state government or a nation like Greece or Ireland that foolishly gave away control of their currency to some foreign central bank, it’s different. That debt is really debt. But national, sovereign, floating exchange rate, government “debt”, the kind the U.S., Japan, Australia, U.K., Canada, and a host of other nations have isn’t really “debt”. It’s a form of interest-paying risk-free cash. It’s used by pension funds, banks, and investors as a risk-free asset. Indeed, at one point in the previous decade when Australia was actually paying down it’s debt and not issuing new bonds, the banking community persuaded the government to borrow anyway just so the bonds would exist.
So, Mr. Manning is correct, but he’s even more correct than he argued. The national debt is misunderstood. And a false crisis is being created in order to push an alternative agenda.
7 thoughts on “The Misunderstood National Debt”
This problem of a misunderstanding of the economy in the context of modern money theory (MMT) is a recurring one which is particularly confusing to those who do not have the background in economics which the blogger at EconProph.com is attempting to translate for his academic audience/readership. While I went through the simplified models which Dr Bill Mitchell provided on billy blog, the difficulties which that author (who I assumed to have coined the acronym MMT) presented is that his writing is not corrected grammatically and occasionally omits adequate clarification; the section on this blog dealing with MMT is well written as that on The Pragmatic Capitalist.com blog site. However, most non-economists do not have the time or interest which I have, and concepts such as ‘vertical’ and ‘horizontal’ money [stock vs flow] are beyond the comprehension of many including most of the members of government. It would seem as if the people who try to explain MMT concepts to government officials continue to run into this communication impasse. After all these government officials should be responsible for understanding conditions which are of importance to the national economic well being when using a fiat currency is employed under conditions where about old-fashioned concepts which were appropriate for the USA prior to 1971, they haven’t been appropriate since the USA went off the gold/precious metal standard. Yet, confusion persists.
As an aside, while I write this and listen to the CSPAN program in which members of the HR confront Fed Reserve chairman Bernanke, it is clear that the committee members in the HR haven’t a clue. Bernanke is doing his typical half-assed job of communicating over the heads of his audience. This isn’t necessarily entirely the Fed chief’s fault; it is highly likely that the HR committee members will do something irrational in order to satisfy their local supporters rather than try to understand what they should be doing, then act accordingly.
William, thanks for the feedback. Both about the comments process – I’ll check on that. Right now it’s pretty much a box-stock WordPress.com hosted site but I’ll check into it.
Regarding the explanations of MMT, that’s also useful feedback. As my time opens up towards later in spring and into summer, I want to try to write a series of more lay-man terms guides to MMT. You’re right that Bill Mitchell and a lot of the others are probably a little difficult to understand if you’re not used to the lingo, terminology and concepts. They are often arguing with/against other economists. I don’t have a lot to contribute in terms of research but maybe I can contribute more to the effort via explanation. Such an effort would do double duty for me since I’m frustrated that the textbooks for principles of macro are so outdated in this regard. I could use this stuff in class.
You are absolutely right that the folks in HR (and the media) don’t have a clue. Sometimes their intuition is right that ‘everything we’re told by The Fed, Treasury, and banks isn’t necessarily how it really works’, but unfortunately they then fall prey to the Austrians, gold-bugs, and deficit terrorists. Folks who do or should know better, such as Bernanke, The Fed, the bank economists, and many mainstream economists simply either haven’t updated their knowledge from what they were taught years ago under fixed rates & gold standard, or they find it convenient for ideological, political, and financial reasons to promote the old concepts.
After posting, I noticed a few grammatical fluffs; you may be able to get the sense anyway. It might be useful to modify this comment process to include a preview step.
As a follow-up, I have left messages at a half-dozen or more MMT blog sites with my suggestions; the most recent was left at Mike Norman’s site this morning. A part of this comment is as follows:
My view is that the blogs which focus on MMT tend to attract enthusiasts and to ignore the great masses who cannot/do not wish to get further confused by discussions of a technical/ theoretical nature. MMT advocates would do well to attempt to provide more basic information in a palatable form; my suggestion is to figure out a way to explain to the great ‘un-enlightened’ why they should learn the difference between conventional/neo-liberal economics which dominates MSM discussions and MMT which provides a relatively simple and rational explanation of how the economy might be managed to benefit the average American citizen rather than the kleptocratic socialist elite [who not only run crooked casino games and, thus, are consistent in their lack of either morals or ethics]. If that were accomplished the stupid mistakes currently being made might be avoided/rectified in the future.
Specific suggestions involve development of combined audio/visual techniques (videos) which utilize animation, cartoons, comic characters, etc. in order to get the correct MMT messages acrosss. An example which demonstrates the principle, but employes a non-economist’s interpretation of K Marx’s Kapital has been developed by Brendan McCooney (Kapitalism101.com). I left Brendan a message to which there has been no reply:
At other sites I have mentioned animation techniques which seem to be very useful (see the RSA animations relative to David Harvey’s lecture on Marxism); I personally have no interest in learning about other economic theories at this point in time, though I realize that for these types (audio plus visual +/- written) of communication to be effective it would be necessary that a software ‘expert’ would have access to/oversight from a competent economist. For some reason, I keep thinking that an academic environment would be beneficial in this regard, but one never knows.
As an aside, I notice that my Roboform password/log-in software enters my email address in the Name box above; is there a slight glitch with the WordPress software or my Roboform?
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I understand that about 1/2 of the national debt consists of time deposits in the form of securities bought by private and foreign investors at the Federal Reserve Bank. Those deposits are always there to be returned with interest when the securities mature. Furthermore the Fed will create whatever interest is needed on the mature securities. So, a large part of the so-called national debt is not really debt in the form of the government’s borrowing to fund its operations.
In other words our government is not borrowing from China and Japan (the two largest foreign investors in US securities) to fund its operations. The belief that our government borrowed money from these countries comes from a confusion resulting from the fact that the Treasury has been required since 1917 to borrow money rather than just simply create it out of thin air as needed. It did this during Abraham Lincoln’s administration in the Civil War. The dollars were known as greenbacks because of the color of the ink on the back of the bills. However, the securities of the Chinese do not represent borrowing. They represent obligations of the Federal Reserve to return the money invested at the time of the securities maturity. But the Chinese money is there all along. It’s a different kind of obligation from borrowing to fund the government.
Think of these securities as like CD’s at a bank, time-deposit accounts.
Money borrowed to fund deficit spending (money to be spent by government not backed by tax collections) is also obtained by Treasury selling securities to big US banks and financial institutions. Treasury will usually roll over these debts; but the Fed can permit that until deflation afflicts the economy and needs new money injected into circulation. Then the Fed will buy back those securities with money it creates out of thin air. The effect will be to redeem the debt to the banks for the money borrowed. The Fed will now possess the securities, but it is not eligible to be paid the full face value, since it is already an entity and agent of the government which bought them with government powers to create money. The Fed is only owed 6% of the interest on the securities it has bought as a transaction fee to help it fund its operations. Any surplus will be returned to the Treasury. The securities still have the obligation to pay a holder the face value of the security at maturity. If the securities are already mature or mature in possession of the Fed, the Fed can/will swap them for new securities with new interest and maturity dates from the Treasury. The Fed will sell these during inflationary times to banks to drain down their reserves and curtail their lending, which would otherwise create new money in the private sector.
When the Fed buys back the securities from banks used to fund deficit spending, the deficit spending money borrowed from the banks becomes debt-free. So it is as if the Treasury created the money itself debt-free. This is how the national debt on deficit spending is redeemed. If the banks now with restored reserves begin to lend again on the basis of the restoration of their reserves, then the money will enter circulation and potentially could be inflationary, unless there is currently a deflation which can absorb the new money at stable prices until full production and employment is reached.
That the Treasury was forced since 1917 to borrow rather than create its money represented the banks’ insistence on being paid interest on all money created, a kind of boondoggle. But that is how our system works.
Treasury can issue securities to banks to cover any shortfall in its spending and when the Fed buys them back, if and when, that cancels the debt on them.
So our government can always clear any debt by just creating money as needed.
This does not mean that creating new money will always create inflation, because as long as the new money is injected into circulation during deflation prices will stay stable, unless other forces like scarcity of raw materials in nature or due to speculators cornering the commodities market reduces supply. In those cases the government should not create new money unless other sources of materials are available to replace the material supply.
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