Author: Marshall Auerback

How the elites are vying to undo the social safety net — and hurt our chances for recovery.

Harold Meyerson is spot on: “Of all the gaps between elite and mass opinion in America today, perhaps the greatest is this: The elites don’t really believe we’re still in recession. Or maybe, they just don’t care.” What is even more galling is that, having been the greatest beneficiaries of the government’s largesse over the past 2 years, these very same people now decry the government’s “irresponsible” and “unsustainable” fiscal policy.

The collective amnesia and moral turpitude of these elites is truly mind-boggling.

Why do we have a deficit of about 10% of GDP right now when it was less than 2% about 3 years ago? The reasons are: the Obama stimulus, the TARP, and the slower economy (which arose in response to a major financial crisis, not because the government began an irrational and irresponsible spending binge). A slower economy leads to lower revenues (less income=less taxes paid since most tax revenue is based on income, and lower tax brackets) and higher spending on the social safety net.

Conveniently lost in all of this furor about the deficit are the beneficiaries of this recent government largesse. It’s certainly not the unemployed or the vast majority of people who do not work in the financial services industry.

And let’s stop with the now prevailing meme (regurgitated most recently in John Heilemann’s New Yorker Magazine piece, “Obama is from Mars, Wall Street is from Venus”) that the costs of the financial bailout are minimal thanks to the “successful” measures taken to “save” our financial system (as if it is worth saving in its current incarnation). With the conspicuous exception of Simon Johnson, virtually all analysts fail to factor in the fact that our public debt to GDP ratio has moved from 40% of GDP to 90% in the space of 2 years, directly as a consequence of the crisis of 2008.

Naturally, the deficit terrorists are now out in force about this fact, conveniently forgetting the underlying cause of this increase. So are the journalists who cover it, Meyerson being a conspicuous exception. In a market economy, where most of us have to work to make a material living, the threats posed by the likes of Pete Peterson and the deficit hawk brigade represent a true impingement on our right to work. As my friend Bill Mitchell notes, “the neo-liberals deliberately undermine the right to work of millions and force them into a state of welfare dependence and then start hacking into the welfare system to deny them the pittance that the system delivers.”

The elites who decry this government spending (especially the ones from Wall Street) are akin to a person providing someone with 5 packs of cigarettes a day and then bemoaning the fact that the recipient irresponsibly contracted lung cancer.

What will happen to the deficit as and when the economy finally improves? The Obama stimulus and TARP go away in a few years regardless. Tax revenues increase and safety net spending falls. We’re back to “norma,l” with deficits around 2-4% depending on the state of the economy, which is where we’ve been for the past 30 years aside from 1998-2001. Even CBO agrees, though what happens to the Bush tax cuts will have an effect of about + or – 2% of GDP (depending on whether they are extended or ended, respectively).

In fact, full employment is also the best “financial stability” reform we could implement, because with jobs growth comes higher income growth and a corresponding ability to service debt. That means less write-offs for banks and a correspondingly smaller need to provide government bailouts.

Fiscal austerity, by contrast, won’t cut it. Our elites seem think that you can cut “wasteful government spending” (that is, reduce private demand further) and cut wages and hence private incomes and not expect major multiplier effects to make things significantly worse. Of course, that “wasteful”, “unsustainable” spending never seems to apply to the Department of Defense, where we always seem to be able to appropriate a few billion, whenever necessary. “Affordability” principles never extend to the Pentagon, it appears.

Our policy-making elites also seem to have bought the IMF line that the fiscal multipliers are relatively low and that the automatic stabilizers (working to increase deficits as GDP falls) will not drown out the discretionary cuts in net spending arising from the austerity packages. The overwhelming evidence is that this viewpoint is wrong and implementation of policies based on it cause generational damages in lost output, lost incomes, bankruptcy and lost employment (especially denying new entrants from the schooling system a robust start to their working life).

The real issue is that those who are better off don’t want to have government intervention in economic affairs unless it benefits them. With typical ingratitude, Wall Street is now threatening to cut campaign donations for Obama and the Democrats because of their proposals to impose more regulation on the financial sector. However, when the government intervenes with bailouts, Wall Street stands first in the queue, cap in hand. No one wants to bear the actual discipline of markets if that means losses. Those at the high end of income distribution aren’t against every kind of government intervention, but are frequently against certain types of government intervention that might make the workers stronger, or create competition for private businesses (in the case of a public option in health care reform, for example).

Full employment is the real value that should guide economic policy, not the bogus emphasis on financial ratios that just play into the hands of the financial sector. Somehow, I doubt that this is the underlying principle guiding our “counsel of wise men” who are deliberating the future of Social Security and Medicare behind closed doors as the rest of us debate this issue in the open.

Roosevelt Institute Senior Fellow Marshall Auerback is a market analyst and commentator. Read more at New Deal 2.0 –>

Join the conversation about this story »

Virtually the entire world’s press is now focusing on the travails of the euro zone, but continues to draw the wrong lessons from what now afflicts the region. But Americans might be pleased to know that this collective economic insanity is not restricted to the pages of the right wing press or the rantings of Fox News commentators such as Glenn Beck. No America, you can rejoice! This has become a fully fledged global disease. You are not alone.

As I have pointed out before, no euro zone government issues its own currency. Consequently, they have to “finance” every euro they spend. And, as Bill Mitchell notes, if tax revenues do not cover pre-existing spending desires, then all of these countries (including Germany) have to issue debt. The current crisis is manifested by the bond markets’ unwillingness to lend to the PIIGS governments any longer because they are beginning to query the PIIGS’ national solvency.

These funding constraints do not apply to the US government, which is sovereign in the US dollar and can never be revenue constrained.

The same applies to the UK government, although to judge from the comments of the new coalition Conservative-Liberal Democratic Government Cabinet, one would be hard-pressed to discover that fact. Will someone please remind the UK’s new Chancellor of the Exchequer, George Osborne, that the UK is not Greece? Osborne attended Eton, one of Britain’s elite private educational institutions, but they clearly didn’t do a good job of teaching him economics out there, if one is to judge by his recent statements: “If anyone doubts the dangers that face our country if we do not, they should look at what is happening today in Greece and in Portugal.”

The UK is a sovereign nation that issues its own currency and freely floats it on foreign exchange markets. Perhaps the keyboard operators have gone on strike (like British Airways), or the country has a paper shortage and can no longer write checks, but given the plethora of comments emanating from virtually all members of the UK commentariat, one has to assume plain ignorance. Just today, the incoming Chief Treasury secretary, David Laws, warned the British electorate that the UK has well and truly “run out of money.” Hold on to those pounds, or you’re doomed.

In defense of the current Greek, Spanish and Portuguese governments, they find themselves in a fiscal straitjacket not of their own making. It is a by-product of the Maastricht Treaty and the Stability and Growth Pact. The UK, by contrast, is willingly choosing to commit economic suicide. If the government had some understanding of the characteristics of its monetary system and the position of the currency in that system, they would stop worrying about debt ratios and deficit ratios and focus more on reversing the job loss and doing nothing to undermine the economy’s capacity to recover. The Labour Party opposition ought to be secretly screaming with delight, although the Brown Administration clearly didn’t know any better and therefore fully deserved to lose the last election.

The new UK coalition government has a choice. So do the Baltic nations, where a much more severe, more devastating and downright deadly crisis in the post-Soviet economies is taking place. Somehow the travails of countries such as Latvia and Estonia have escaped widespread press notice. The US and UK would do well to take note, because the Baltic Republics have well and truly imbibed the neo-liberal Kool-Aid peddled by the likes of the IMF.

On June 2009, the newly-appointed Latvian Prime Minister, Valdis Dombrovskis, made a national public radio address and said that his country had to accept major cuts in the budget because they would allow the country to receive the next installment of its IMF/European Union bail-out loans. He said the country was faced with looming “national bankruptcy” and then proceeded to ensure the validity of that claim by implementing the economic equivalent of carpet bombing. In effect, he turned the Baltic republic into an industrial wasteland via the most virulent form of neo-liberal economics.

Having broken free from the chains of the former Soviet Empire, Latvia promptly surrendered its currency sovereignty by pegging its currency against the Euro. This means it has to use monetary policy to manage this peg. The domestic economy also has to shrink if there are downward pressures on the local currency emerging in the foreign exchange rates. So instead of allowing the currency to make the adjustments necessary, the Latvian government handled the “implied depreciation” by devastating the domestic economy. (Public sector pay has been cut by 40 percent over the last year, while the economy has contracted by almost a third.)

But now, cries the government, there is light at the end of the tunnel! In the first quarter, GDP declined by a mere 6%! Well, when a country experiences a cumulative decline greater than anything sustained by the US during the Great Depression, I suppose a mere 6 per cent contraction seems like positive boom times again. And sure enough, Prime Minister Dombrovski has proclaimed this as “confirmation of the economy’s flexibility” – what is left of it – and “yield from reforms and the fiscal consolidation program, the so-called internal devaluation,” according to The Baltic Course. “Infernal devaluation” is a more appropriate description.

The currency peg is nonsensical, even though devaluation would be severely disruptive given the current nominal contracts held by the Latvian private sector. Around 80 percent of all private borrowing in Latvia is in euros, with the Swedish banks being the most exposed in Latvia. And, of course, the devaluation would undermine Latvia’s ambitions to join the EMU (hardly an exclusive club worth joining these days, as any Greek, Spaniard or Italian would likely tell the Latvians). The debate in Latvia about the EMU is that it will provide financial stability for the country. The fact that membership destroys their fiscal sovereignty is never raised in the public debate, narrowing the range of policy options that the political classes are prepared to discuss, and thereby legitimizing nonsensical ideas that a contraction of a “mere” 6% is something worth celebrating.

All of this pain for an exclusive club — the euro zone – which today looks on the verge of imploding.

And Latvia is not alone. By virtue of its low public debt, and low inflation rate, Estonia has become the new poster boy for the IMF. Its budget deficit was 1.7 percent of gross domestic product in 2009, well within the 3 percent Maastricht limit, while its government sector debt was the lowest in the EU at 7.2 percent, according to the Statistics Estonia. Estonia could pay off all its public debts and still have reserves left over, which is why the country has been provisionally admitted to join the European Monetary Union in 2011.

So, should Greece, with public deficit of 13% and public debt of 113% (both as percentage of GDP), follow Estonia, bite the bullet and get down to slashing budget and wages? Or Spain? Like all of the euro zone nations, Estonia has no exchange rate policy option because the Kroon is pegged to the euro, so its fiscal policy is similarly externally constrained. The euphoria around Estonia should die rather quickly when one looks at the GDP performance in 2009. It fell nearly 15%; Greece’s GDP contracted just 2%. More recently, according to the Baltic Post, the number of jobs in Estonia is the lowest in almost 25 years. The release of Estonia’s first quarter labor statistics show that the unemployment rate grew by nearly four percentage points in comparison to the end of 2009 and reached nearly 20%. God help the rest of the world if it manages to emulate this “success story.” While their governments seems to think that by joining the EMU they will be “shock-proofed,” they should just get rid of the “proofed” part and realize that they will shock their citizens into a new kind of indentured servitude.

Roosevelt Institute Senior Fellow Marshall Auerback is a market analyst and commentator.

This guest post previously appeared at NewDeal2.0

Join the conversation about this story »

(This guest post previously appeared at NewDeal2.0)

Arthur Conan Doyle’s literary creation, Sherlock Holmes, once solved a murder by noting the dog that didn’t bark. It doesn’t take Holmes’s ingenuity to see that the plan on offer for Greece is clearly a rescue package which doesn’t rescue. It’s a dog’s breakfast.

Greece indeed is being offered a financial aid package of around 22 billion euro, but no funding will be made available until the country fails to find funding elsewhere, entirely obviating the point of the bailout. Greece, like all borrowers, simply offers securities at ever higher rates until it finds the needed buyers. Failure, in theory, is defined as the rate reaching infinity with no buyers. At that time, the euro members would step in with a loan offer at a non concessional rate which would then presumably be infinity. As George Friedman of Stratfor has noted, “That is akin to offering a homeowner, who is about to default on a mortgage, a refinancing offer that equals or increases his mortgage rates above the rate he already cannot pay.”

This makes no sense at all, of course. In reality, it’s a statement that says Greece is on its own. It means that the EMU nations will stand by without taking action as observers of the standard market default process of Greek funding rates going into double and then triple digits as happens to all failed borrowers of externally managed currencies, including nations with fixed exchange rates.

So much for European solidarity. Even worse, German Chancellor, Angela Merkel has managed to secure the backing of France for her proposal for a joint International Monetary Fund and bilateral aid package from euro-zone countries should Greece need help, which is a shame, given that recent remarks by French Finance Minister Christine Lagarde suggested that Paris better understood the nature of the current crisis.

An interesting question which has hitherto been unanswered by the mainstream media: why did the Greek debt crisis erupt with such sudden ferocity in the past month or so? As many observers have noted, if these countries had their own national currencies, they could allow their currencies to float, which would potentially allow some stimulus via the external sector. More significantly, they are unable to use the expansionary fiscal policies that would help pull their economies out of recession. Of course, both France and Germany also violated these rules and were never punished for their transgressions. Indeed, the selective applications of the rule in EMU have made it more apparent that this is nothing more than a liquidationist gambit on the part of Berlin and now, it appears, Paris.

A liquidationist gambit is the removal, by power, of government from the society. Liquidation occurs when society has ceased to be a center of power, and has become a center of weakness. It therefore becomes far more prone to corporate predation. It does not mean that government becomes either smaller or less intrusive, but that government’s traditional role of mobilizing resources for broader public purpose is impaired. These are some of the instruments which are characteristic of liquidation gambits:

1. Looting
2. Corporatism and cartelization
3. Brow-beating (societal interest above self interest, power as power, cooptation and betrayal) particularly via manufactured bankrupcties
4. Shams and accounting frauds

The unseemly side of the Franco-German power play came to the fore last week: ECB President Jean-Claude Trichet ostensibly took some pressure off Greece by extending emergency lending rules, saying its bonds won’t be cut off from ECB refinancing operations next year in case Moody’s Investors Service lowers its rating to a level comparable with other companies. Of course, this occurred only after the Greeks cried “Uncle”.

Why were these lending rules threatened to be removed in the first place? This has never been adequately explored. Trichet’s statements marked a reversal for the ECB, which said in January that it wouldn’t soften its collateral policy for the sake of a single country. The bank was scheduled to reintroduce pre-crisis rules at the end of 2010.

This basically confirmed my earlier suspicions that this entire crisis was triggered by the ECB at the behest of the Germans. The ECB closed the lending window to Greece, which had been dealing with the inherent operational constraints of the EMU by buying Greek government debt, repo-ing it to ECB, and then taking the reserves from that and buying more government debt. The Germans surely took offense to that, since it is Weimar 2.0 from their paranoid perspective. Ireland has also been using this loophole. Of course, that Germany and France were serial violators of these EMU imposed constraints (when they routinely ran budget deficits in excess of 3% of GDP) never seemed exorcise the President of the ECB to the same degree.

Given the loss of Greece’s independent currency creating function, the repo mechanism was likely the only way to get “vertical money” into Greece, once ECB stopped expanding its balance sheet as the crisis died down. So various European central bankers started mentioning in front of microphones that ECB rule waiver would be up at year end, (the one that lets ECB hold and repo lower quality rated euro zone government debt) and, presto, a fully-fledged crisis emerges in Greece.

How convenient, especially as it finally gave Berlin the leverage to fully impose its version of hair shirt economics on those allegedly lazy southern Mediterranean scroungers. Left conveniently unstated is the idea that the longer the PIIGS are forced to wallow in stagnant growth, the more persistent will be the very budget deficits and the larger the public debt to GDP ratios for which they are now being punished. It’s akin to someone having a high temperature because he/she is suffering from influenza and therefore denying that person medicine on those grounds. Trying to work against the automatic stabilizers with austerity programs will be futile unless you start dismantling some of the automatic capacity, which gives rise to these stabilizers.
Which is exactly what is happening at present. As Bill Mitchell has noted:

“European countries have stronger automatic stabilisers than most other nations because they have historically given better protection to their workers and retirees etc. The push for austerity is seeking to undermine these provisions in part and in my view that is one of the hidden agendas in all of this.”

We would agree with Mitchell and go further by noting the hypocritical nature of the cuts demanded here. As is the case in the US, fiscal austerity seems only to apply when dealing with “wasteful” social spending, because at the same time France and Germany were imposing harsh austerity conditions on the Greeks in exchange for their “support”, Berlin and Paris are using the leverage created by the debt crisis to force Athens to buy their weaponry and warplanes even as they urge those “profligate” Greeks to cut public spending and curb its budget deficit. France is pushing to sell six frigates, 15 helicopters and up to 40 top-of-the-range Rafale fighter aircraft. Greek and French officials said President Nicolas Sarkozy was personally involved and had broached the matter when Papandreou visited France last month to seek support in the financial crisis, according to The Economic Times.

Talk about gunboat “diplomacy”! The Germans like to argue that nations such as Greece, Portugal, Spain, Ireland and Italy blew the opportunity that interest rates converging down gave them to get labor productivity up with new investment. In Berlin’s eyes, it is all their fault they can’t “achtung baby” and get their lazy work forces in line, with lower unit labor costs, like the Germans themselves managed after 7 years of deflating their own country into the ground following on from reunification (of course, this conveniently in the days before the creation of the Stability and Growth Pact).

Surely there was a better way? Rather than the austerity cold bath to break the back of labor and induce a private income deflation with a decidedly Fisherian debt deflation cast to it, would it not be better for current account countries to reinvest the surpluses in the deficit nations in the form of direct foreign investment, or PIIGS government bonds directed solely at public investment that will improve productivity in periphery and have ripple effects on private investment, or run it through the European Investment Bank?

Or the creation of a supranational authority, but not one which replicates the austerity ethos embodied in the Stability and Growth Pact — rather one which emphasizes the principle that the only fiscally sustainable policy is one that promotes full employment. As we’ve said before, this could be done via a Government Job Guarantee program. We would need a supranational authority which is geared toward a full employment goal. Such a program would potentially be even more attractive in Europe, given that minimum wages and income support packages are far more generous in than in the US, consequently leaving less scope to use the JG program as a means to replace a strong social welfare benefits model with some form of indentured slavery, which is something one could potentially envisage developing in the US.

Acknowledging that crony capitalist politicians do have this proclivity toward supporting corporate predation and wasteful spending and giving goodies to their campaign contributors, a genuine Job Guarantee Program that automatically adjusts to insure the private sector can actually realize its desired net nominal savings position largely frees the system from political parasites while increasing the freedom of the private sector to achieve its goals. And it is consistent with the idea of re-employng the country via, say, green tech initiatives.

If the Franco-German axis proves resistant to this idea, then it might be time for the Greeks, Portuguese, Italians, Spanish, Irish, etc., to send a different message to Chancellor Angela Merkel. To quote those noted political philosophers, Keith Richards and Mick Jagger, “Angie…ain’t it time to say goodbye?”

An exit from the euro zone would clearly create a short term problem because the PIIGS nations that wanted to exit would have to deal with a foreign currency debt burden. It is unclear how the transfers back into the central banking system from the ECB noted above would serve to offset the “euro exposure” upon exit. And there is also likely to be collateral damage within the remaining EMU nations’ banking systems, given the amount of PIIGS debt that they likely hold. But ultimately as part of a painful adjustment process it might require the nation to default which could manifest as a negotiated settlement where the creditors accepted the local currency (or nothing). It would be painful and messy. But a long, drawn-out process of wage cutting is the other way and that will have to be a decade-long adjustment. Far more costly, other words, in the long run. And, as Keynes, noted insightfully, in the long run, we’re all dead.

Join the conversation about this story »

(This guest post previously appeared at NewDeal2.0)

They certainly know what “schadenfreude” means in Germany. But the attempt by the German paper, Der Spiegel, to link the UK to the travails of Greece, takes the concept to a malicious and irrational extreme:

The British pound is tottering. The economy finds itself in its worst crisis since 1931, and the country came within a hair’s breadth of a deep recession. Speculators are betting against an upturn. Instability in the banking sector has had a more severe impact on government finances in Great Britain than in other industrialized countries. London’s budget deficit will amount to £186 billion (€205 billion, or $280 billion) this year — fully 12.9 percent of gross domestic product.

Sounds pretty, grim, especially given that Britain’s budget deficit is even higher than that of the “corrupt” Greeks, whom the Germans also seem so intent on abusing in print and punishing for their alleged fiscal profligacy.

But the article itself is rife with intellectual dishonesty. You cannot mindlessly conflate EMU states — Germany included — which operate with no real fiscal authority as sovereign states in the full sense — with countries, such as the United Kingdom, which fortunately has a government with currency issuing monopolies operating under flexible exchange rates (even though the British haven’t quite figured it out). And, as strange as it may sound, public sector profligacy at this time is preferable to Germanic style prudence, because as the private sector’s spending and borrowing go into hibernation, government borrowing must expand significantly to compensate. Even the French Finance Minister, Christine Lagarde, seems to understand that fact  (and is taking heat from her German “allies” as a result). Her sin? She had the temerity to suggest that Berlin should consider boosting domestic demand to help deficit countries regain competitiveness and sort out their public finances. Noting that “it takes two to tango”, Lagarde suggested that an expansionary fiscal policy had a role to play here, not simply “enforcing deficit principles”.

Of course, that’s harder to do in the euro zone, given the insane constraints put forward as a condition of euro entry. As a consequence of these rules, the EMU nations cannot even run their own region properly. They have established a system which has consistently drained aggregate demand and brought increasingly high levels of unemployment to bear on their respective populations. In the words of Bill Mitchell:

The rules that the EU made up and then imposed on the EMU via the Maastricht Treaty’s Stability and Growth Pact were not based on any coherent models of fiscal sustainability or variations that might be encountered in these aggregates during a swing in the business cycle. The rules are biased towards high unemployment and stagnant growth of the sort that has bedeviled Europe for years.

Having conspicuously failed to deliver prosperity to their own countrymen, the Germans now see fit to lecture the UK (after taking out the Greeks, of course) on the grounds of Britain’s “crass Keynesianism” (in the words of Axel Weber, the President of the German Bundesbank).

There is no question that the UK has some unique features which make it more than just another casualty of the global credit crunch. It foolishly leveraged its growth strategy to the growth in financial services and is now paying the price for that misconceived policy, as the industry inevitably contracts and restructures as a percentage of GDP. This structural headwind will no doubt force the UK authorities to adopt an even more aggressive fiscal posture than would normally be the case. This is politically problematic, given that the vast majority of the UK’s policy makers (and the chattering classes in the media) still cling to the prevailing deficit hysteria now taking hold all over the world. But the reality is that the UK has considerably greater fiscal latitude of action than any of the euro zone countries, including Germany.

Let’s go back to first principles: In a country with a currency that is not convertible upon demand into anything other than itself (no gold “backing”, no fixed exchange rate), the government can never run out of money to spend, nor does it need to acquire money from the private sector in order to spend. This does not mean the government doesn’t face the risk of inflation, currency depreciation, or capital flight as a result of shifting private sector portfolio preferences. But the budget constraint on the government, the monopoly supplier of currency, is different than what most have been taught from classical economics, which is largely predicated on the notion of a now non-existent gold standard. The UK Treasury cuts you a benefits check, your check account gets credited, and then some reserves get moved around on the Bank of England’s balance sheet and on bank balance sheets to enable the central bank (in this case, the Bank of England) to hit its interest rate target. If anything, some inflation would probably be a good thing right now, given the prevailing high levels of private sector debt and the deflationary risk that PRIVATE debt represents because of the natural constraints against income and assets which operate in the absence of the ability to tax and create currency.

Unlike Germany, or any other EMU nation, there is no notion of “national solvency” that applies here, so the idea that the UK should follow Greece down the road to national suicide reflects nothing more than the traditional German predisposition to sado-monetarism and deficit reduction fetishism. A commitment to close the deficit is also what doomed Japan throughout most of the 1990s and 2000s, when foolish premature attempts at “fiscal consolidation” actually increased budget deficits by deflating incipient economic activity. Why would you tighten fiscal policy when there is anemic private demand and unemployment is still high?

Remember Accounting 101. It is the reversal of trade deficits and the increase in fiscal deficits, which gets a country to an increase in net private saving, ASSUMING NO STUPID SELF IMPOSED CONSTRAINTS along the lines proposed by Germany under the Stability and Growth Pact (which should be re-christened the “Instability and Non-Growth Pact”). Ideally, we want the deficits to be achieved in a good way: not with automatic stabilizers driving the budget into deficit because unemployment is rising and tax revenue is falling as private demand falters, but one in which a government uses discretionary fiscal policy to ensure that demand is sufficient to support high levels of employment and private saving. That in turn will stabilize growth and improve the deficit picture. Once this is achieved, any notions of national insolvency (or more “Greek tragedies”) should go out the window.

The UK can do this, even if its policy makers fail to recognize this. But not in the eyes of Der Spiegel, which warns that “tough times are ahead for the United Kingdom, so tough, in fact, that none of the parties has dared to say out loud what many in their ranks already know. At a minimum, Britons can look forward to higher taxes and fees.” And much lower growth if that prescription is followed.

We suspect that many in Germany and the rest of Europe understand this. So what other motivations are at work here? Clearly, calling attention to the state of Britain’s public finances and drawing specious comparisons to Greece in effect invites speculative capital to take its collective eye off the euro zone and focus it on the UK. Given that the alleged “Greek solution” proposed recently by the European Commission does nothing to resolve the country’s underlying problems, it behooves the euro zone countries to draw attention elsewhere before their collective resolve to defend their currency union comes under attack again.

And heaven forbid that the UK was actually successful (admittedly unlikely today, given the paucity of British political leaders who truly understand how modern money actually works). If Her Majesty’s Government spending actually managed to conduct fiscal policy in a manner which supported higher levels of employment and a more equitable transfers of national income (via, for example, a government Job Guarantee program) then what would be the response in the euro zone? Wouldn’t this cause its citizens to query what sort of bogus economic “expertise” that has been fed to them from their technocratic elites over the past two decades? The same sort of neo-liberal pap fed to the US courtesy of groups such as the Concord Coalition.

No question that public spending should be carefully mobilized to ensure that it is consonant with national purpose (not corporate cronyism). But the idea perpetuated by Der Spiegel that the government is somehow constrained by some self imposed rules with no reference to the underlying economy is comedy worthy of a Brechtian farce. Unfortunately, this particular German joke is no laughing matter.

Join the conversation about this story »

(This guest post originally appeared at NewDeal2.0)

We’ve persistently taken the view that there is no economic doctrine, no magic number, which would imply a firm external constraint as far as public spending goes, when dealing with a sovereign government issuing debt its own floating rate, non-convertible currency. At some point, we may indeed have a resource constraint, or an inflation constraint, but not a national solvency issue. Yet the hysteria surrounding fiscal policy has moved from the realm of rational debate and metamorphosed into a matter of national theology. Hardly a day goes by, it seems, where groups such as the Concord Coalition or the Peter G. Peterson Foundation do not bring us the message that we are all doomed unless we do something drastic to cut back our mounting federal debt.

A new book by former IMF economist by Kenneth Rogoff and Professor of Economics (and Research Associate at the National Bureau of Economic Research) Carmen Reinhart — This Time It’s Different; Eight Centuries of Financial Folly — has given greater academic legitimacy to the prevailing deficit hysteria. The authors purport to show that once the gross debt to GDP ratio crosses the threshold of 90%, economic growth slows dramatically. President Obama’s proposed budget will soon cross that line, so the cries of the deficit hawks have intensified.

Although the historical data which Rogoff and Reinhart amass — 8 centuries and all — sound very impressive, it is hard to see what sort of relevance a country operating under, say, an 18th century gold standard, has in regard to a country operating under a 21st century fiat currency system.

A sovereign government is never hostage to the dictates of financial capital because it no longer faces the external constraint that was always present under a gold standard regime. A nation that adopts its own floating rate currency can always afford to put unemployed domestic resources to work. Its government may issue liabilities denominated in its own currency (for interest rate maintenance reasons or to offer its savers an interest-bearing alternative to cash), and will service any debt it issues in its own currency. Whether its debt is held internally or externally, it faces neither insolvency risk, nor “structural” growth shortfalls which Rogoff/Reinhart allege when public debt levels get too high.

Nor does it make sense to lump together private and public debt, as Rogoff and Reinhart do in the book. A failure to distinguish sovereign government debt from the debt of non-sovereign governments, households, and firms calls into question the relevance of the Reinhart and Rogoff study at least as far as it applies to countries, such as the US with non-convertible currencies and flexible exchange rates. Lumping together government and private debt is meaningless and simply heightens the bogus hysteria surrounding government fiscal policy activism. Government debt is a net private asset, while private debts must net to zero. Private saving, however accomplished, increases the future consumption possibilities for the household sector at the expense of current consumption. Saving is foregone consumption which in normal times (barring huge financial crashes) will enhance future consumption.

In this context, because the household sector is revenue-constrained, it has to sacrifice consumption possibilities now to improve them later. It can increase consumption now beyond income via increasing its indebtedness or selling assets (past saving) but the budget constraint has to be obeyed at all times. But, of-course, this sort of reasoning doesn’t apply to the government. A budget surplus does not create a cache of money that can be spent later. Government spends by crediting a reserve account. That balance doesn’t “come from anywhere”, as, for example, gold coins would have had to come from somewhere. By the same token payments to government (such as via taxation) reduce reserve balances. Those payments do not “go anywhere” but are merely accounted for. A budget surplus exists only because private income or wealth is reduced, NOT because the taxes per se fund government spending directly (which would represent a true constraint).

Consequently, it makes no sense to add together the US federal government’s debt and the US private sector’s debt. It is in this regard that the Clinton budget SURPLUSES had such a deleterious impact on the US non-government sector in the late 1990s: Government surpluses squeezed the liquidity of the private sector in the late 1990s, which forced greater reliance on PRIVATE debt, creating the foundations for much of today’s economic fragility. If the US government had run sufficient budget deficits (which it could always have done because the government faced no external funding constraint) to finance the desire to save for the non-government sector overall, then the spending patterns would have been different (more public goods, less private goods) and the non-government sector would not have been forced into as much indebtedness.

Note also that we need to distinguish between debt that is denominated in domestic currency versus that which is denominated in foreign currency-again a distinction that is not always clear in the Reinhart and Rogoff book. It’s like the difference between, for example, Japan and Argentina. In the case of the latter, the currency board arrangement effectively hamstrung monetary and fiscal policy. The central bank could only issue pesos if they were backed by US dollars. So dollars had to be earned through net exports which would then allow the domestic policy to expand. When exports crashed, the funding mechanism became untenable. By contrast, Japan has continued to issue debt denominated in its own currency and cannot therefore be subject to default risk; and as it represents a nongovernment sector’s net financial wealth because of the income transfer to the non-government sector, it cannot be the cause of low growth.

It may well be the case that a government that operates a pegged currency regime, or taps the markets for substantial quantities of foreign debt to finance growth, will encounter precisely the problems articulated by Rogoff and Reinhart. Reaching a limit of 90% debt to GDP might well represent a danger area and consign these countries to subpar growth for many years. But for countries like the US, Japan, Canada or Australia, which have little or on foreign currency public debt, and adopt a free-floating, non-convertible currency regime, the Rogoff/Reinhart analysis has virtually no relevance. It should not be used as a stick with which to beat back the governments that want to deploy fiscal policy to embrace full employment policies.

Join the conversation about this story »

See Also:

• Economist Rogoff Who Predicted The U.S. Crisis And A European One, Now Predicts A China Collapse
• Rogoff: America Has Defaulted Before And It Will Run Into Trouble Again
• Bill Gross: Markets Will Soon Discover How Sovereign Nations Can Go Bust Just Like Companies

(This guest post originally appeared at NewDeal2.0)

Usually, we dread the regular Congressional testimonies of the Fed Chairman. They generally constitute a mix of obfuscation on the part of Mr. Bernanke mixed with political grandstanding on the part of Congress. But occasionally, a glimmer of truth comes through, as occurred today in this exchange between the chairman of the Federal Reserve and Congressman Barney Frank:

Frank: Do you think there is any realistic prospect of America’s defaulting on its debt in the near future?

Bernanke: Not unless Congress decides not to pay….

So there you have it. If Congress doesn’t pass the debt ceiling, the Treasury can default. But this constraint is not operationally inherent in the monetary system. It is put there by the same Congress that could (and should) revoke the unnecessary constraints, much as the European Union could (if it chose to do so) could eliminate its arbitrary rules limiting government expenditure. This is a problem of “willingness to pay” and not “ability to pay”, as the government is at all times in control of its spending process. In short, here we have the Chairman of the Federal Reserve openly acknowledging that, short of voluntary political constraints, there are no financial constraints on the ability of a sovereign nation to deficit spend.

To anticipate the usual objections that we usually encounter whenever we point this out, please note that this doesn’t mean that there are no real resource constraints on government spending; this should be the real concern, not financial constraints. Government spending should be analyzed in regard to its effects on the real economy, which means that it should, like Goldilocks, be neither “too hot” (or else inflation will result), or “too cold” (as is the case today, where we have an economy characterized by high unemployment and significant resource underutilization) Debating whether the social losses due to operating below full employment are higher than economic losses due to inflation or currency depreciation, are germane discussions to POLITICAL debate, but totally separate from the issue of national solvency.

So what’s with the Fed Chairman’s obsession with fiscal sustainability, when Bernanke knows that there is no insolvency issue?

There’s obviously a degree of self-interest here. As head of the nation’s central bank, Mr. Bernanke (like any other central banker) is keen to assert the primacy of monetary policy over fiscal policy, despite the fact that the former’s impact on real economic activity is far more ambiguous. The manipulation of interest rates may be used to control inflation and that inflation expectations may have an influence on the spreads at the longer end of the yield curve. But the way in which interest rate manipulation (that is, monetary policy) impacts on inflation is unclear: rising interest rates certainly increase costs for borrowers and may choke of aggregate demand but equally they increase incomes for those with interest-rate sensitive portfolios which may add to aggregate demand. Fiscal policy, by contrast is far more targeted in terms of the impact it seeks to achieve.

There is also a political dimension: the financial class (whose views still reflect the predominant economic thinking at the Fed and on Wall Street), benefits from the deflationary bias imparted as a consequence of these artificial financing rules, which are remnants of the gold standard era. But in reality this is a denial of the essence of the fiat monetary system that we now live in and there is thus no economic basis for these constraints. Keeping unemployment high provides a strong means of disciplining wage demands and enhancing profits.

A stable ratio of federal debt to GDP may or may not be the right policy objective. But it is neither more nor less “sustainable,” under different economic conditions, than a rising or a falling ratio and Mr. Bernanke implicitly recognized that in his testimony today. We wish he had gone further. It is not, as Professor James Galbraith has argued, “a hidden evil. It is not a secret shame, or even an embarrassment. It does not need to be reversed in the near or even the medium term. If and as the private economy recovers, the ratio will begin again to drift down. And if the private economy does not recover, we will have much bigger problems to worry about, than the debt-to-GDP ratio”.

The public is told that government spending causes inflation and is warned that if we do not control the budget deficits that a Weimar Germany fate awaits us. Conveniently forgotten is that German production capacity was either significantly damaged by WWI, or redirected toward output required by the military. Additionally, Weimar Germany faced large foreign claims from war reparations, as well as exploding budget deficits. By 1919, it is reported the German budget deficit was equal to half of GDP, and by 1921, war reparation payments represented one third of government spending (the so-called London ultimatum required annual installment payments of $2b in gold or foreign currency, in addition to a claim on just over a quarter of the value of German exports).

Neither of these conditions remotely pertains to the US today. In the highly unlikely event that inflation started to accelerate in the US, a highly non-unionized workforce has neither the bargaining power nor the access to credit to keep up with rising prices. Household claims on real resources would wither under inflation as real wages would simply fall behind.

The reality is that all questions of “national insolvency” or fiscal sustainability go by the wayside whenever Wall Street or some other major corporate interest demands a hand-out from the government. And if they don’t get satisfaction from one party, they’ll shift their support to the other, as Wall Street is doing today According to new data compiled for The Washington Post by the Center for Responsive Politics, the securities and investment industry went from giving 2 to 1 to Democrats at the start of 2009 to providing almost half of its donations to Republicans by the end of the year. Similarly, commercial banks and their employees also returned to their traditional tilt in favor of the GOP after a brief dalliance with Democrats, giving nearly twice as much to Republicans during the last three months of 2009.

The naked self-interest of the financial sector trumps all. All this talk about “free markets” and the virtues of “private market disciplines” go out the window should the actual discipline of markets impose losses on these institutions. Virtually the moment the handouts are made, in comes the discussion of national insolvency and the public mobilization against further government spending. Never do we step back and ask the question – what is the public purpose being served by net government spending? Perhaps this is the line of enquiry that should be directed at Ben Bernanke the next time he appears before Congress and lectures us on fiscal and monetary policy.

Join the conversation about this story »

See Also:

• Now Even Germany Is Breaching The Euro Zone Deficit Limits
• Niall Ferguson’s Deficit Warnings For The US Are Nothing But Excessive Hysteria
• The ‘Budget Deficit Crisis’ Is A Myth, And It’s Getting In The Way Of Obvious Reform

(This guest post originally appeared at NewDeal2.0)

What is a fiscal crisis? When does deficit spending become “unsustainable”? Today, we can see net public spending rising (sharply as a percentage of GDP in some cases) as private spending has plummeted. Still, unemployment has skyrocketed. So whatever government spending has hitherto taken place has been insufficient to offset the loss of private sector output.

Here is the true nature of  today’s “crisis”: Governments are unwilling to net spend at a sufficient scale to stop the increase in unemployment. That unwillingness reflects a political constraint — which is now being dressed up by some as a matter of national security or a symptomatic of “political gridlock,” as the NY Times seeks to argue (”Party Gridlock in Washington Feeds Fear of a Debt Crisis“).

Exhibit A: According to the NY Times, it is “the unwillingness of the two parties to compromise to control a national debt that is rising to dangerous heights.”  Given the state of the economy, maybe we should be thankful for political gridlock, especially if it has prevented deficit terrorists like soon-to-retire Senator Evan Bayh from implementing some of his crazier ideas about cutting back government spending.

We’re always told that our debt levels have risen to “dangerous heights”, but we seem to mix up the causation. Budget deficits go up as growth slows due to the automatic countercyclical stabilizers; they don’t cause the slowdown, but merely represent it. What Senator Bayh, and others of his ilk fail to understand is that while you can cut spending, and raise taxes, you cannot eliminate deficits via legislative fiat in the absence of dis-saving from some other non-government sector.

My main critique of the deficit hawks is that they (and policy makers and investors who embrace their philosophy) simplistically focus on changing one sector’s financial balance without taking into consideration the implications for other sectors. If sharp reversals of fiscal deficits are attempted, the domestic private sector’s ability to service debt will be impaired unless large current account surpluses can be achieved. That means domestic wage deflation (which will get their private sectors to financial instability straight away) or a magnificent explosion of labor productivity and product innovation, the likes of which we have no reason to expect will spontaneously arise in the near future.

Even though the US doesn’t operate under the same kinds of explicit constraints as the European Monetary Union (EMU), a fundamental misunderstanding of how our actual modern monetary system works is driving us to the same stupid conclusions and outcomes as the EU.

Here’s a better demonstration of what we are talking about, courtesy of Professor Bill Mitchell from the University of Newcastle

It’s worth reading this piece in its entirety, but the main point we want to highlight is Mitchell’s analysis of data from the US Office of Management and Budget. He points out that in the summary for receipts and outlays from 1930 to today (along with projections to 2015), “the US government’s budget was generally in deficit of varying proportions of GDP 67 of those years (that is, 84 per cent of the time).” Mitchell also notes (as both Randy Wray and I have discussed several times before ) that each time the government has tried to push its budget into surplus, a major recession followed which forced the budget via the automatic stabilizers back into deficit.

These deficits have provided support for private domestic saving over most of this period. In times of significant national crisis — the Great Depression and World War II — budget deficits as a percentage of GDP rose as high as 30%.

Now, if budget deficits were truly as injurious to national security as the many of the deficit hawks now allege, why on earth would a country want to run them during wartime, when presumably the threat to our national security is at its greatest? Taking this logic to its perverse extreme, why would one ever declare war at a time of rising budget deficits, given the extent to which they are said to imperil our national wellbeing? National “solvency” or “affordability” never seem to be applied consistently across the board. Only when the issue of social welfare arises, do claims of fiscal profligacy become part of the debate.

Parenthetically, it is also worth overlaying US government fiscal deficits with movements in interest rates and inflation rates and changes to US tax regimes. These can all be seen at the US Treasury’s web site. You will see that they bear no statistically significant relationship with budget deficit levels per se over this entire period. The strongest relationship that can be established is the relationship between deficits and expenditure and hence economic growth (and employment growth).

Yet almost daily, we are bombarded with assertions bordering on the theological to the effect that budgetary profligacy, escalating health care costs and an aging population will inevitably lead to a day of “fiscal reckoning”. Read Don Peck’s story in   the latest Atlantic Magazine: “How a New Jobless Era will Transform America“.

The story recounts what is undoubtedly the real intergenerational war that is being set up before our eyes. Forget about future public debt service becoming a yoke around the neck of future generations. The retired and retiring baby boomers want their high nominal fixed incomes plus purchasing power preservation (if not deflation) now and until the day they die. The youth want jobs and the prospects of a life worth living. The fiscal rectitude wing is literally strangling the baby in the crib today by denying a sensible fiscal response for the current generation’s plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow.

Viewed from that perspective, the terms of the debate have been truly twisted around. Granted, it is obviously more difficult to make the case for more government spending when legitimate distrust reasonably exists of dysfunctional financial and governmental systems. We have failed to adequately harness that distrust (and both President Obama and his Democrat allies are hugely culpable in this regard), which is naturally a distrust the deficit hawks can easily exploit today to satisfy their own agenda.

But at least the US has also been the common ground of populists and small “d” democratic reformers, and somehow, we have to find a way to speak to that effectively.

Join the conversation about this story »

See Also:

• Niall Ferguson’s Deficit Warnings For The US Are Nothing But Excessive Hysteria
• The ‘Budget Deficit Crisis’ Is A Myth, And It’s Getting In The Way Of Obvious Reform
• Stop Freaking Out About The Deficit — It’s Just More Republican Scaremongering

(This guest post originally appeared at the author’s blog)

Agreement has been reached in Europe on a “rescue” package for Greece. But it’s no cause for celebration. It’s the kind of “rescue” sensation one experiences after paying out what’s left in one’s wallet when confronted with a robber with a gun. The insanity of self-imposed budgetary constraints will be manifest to all soon enough. Economists and the EU bureaucrats who advocate a slavish adherence to arbitrary compliance numbers fail to comprehend the basis of government spending. In imposing these voluntary financial constraints on government activity, they deny essential government services and the opportunity for full employment to their citizenry.

Score another one, then, for the high priests of fiscal rectitude. Harsh cuts, tax increases — this is by no means a recovery policy. The capital markets have got their pound of flesh. But Greece is no more able to reduce its deficit under these circumstances than it is possible to get blood out of a stone. Politically, it means ceding control of EU macro policy to an external consortium dominated by France and Germany. Greece becomes a colony.

Nor will the policies work, as the ’strict enough conditions’ imposed will further weaken demand in Greece and, consequently, the rest of the European Union. Furthermore, the rapidly expanding deficit of Greece has benefited the entire EU because it supported aggregated demand at the margin, and the sudden reversal contemplated by this package will reverse those forces.

The requirement that budget deficits should be zero on average and never exceed 3 per cent of GDP or gross national debt levels should not exceed 60 per cent of GDP not only restrict the fiscal powers that governments would ordinarily enjoy in fiat currency regimes, but also violates an understanding of the way fiscal outcomes are effectively endogenous, as Bill Mitchell has noted on several occasions.

Meanwhile, Greece and the rest of the Euro zone is being revealed as necessarily caught in a continual state of Ponzi style financing that demands institutional resolution of some sort to be sustainable. The separation of the monetary authorities from the fiscal authorities and the decentralization of the fiscal authorities have inevitably made any co-ordination of fiscal and monetary policy difficult. The ECB is effectively the only “federal” institution within the euro zone. This is particularly problematic during times of financial stress or in periods in which there is marked regional disparity in economic performance.

In the short term, a move by the ECB to distribute 1 trillion euro to the national governments on a per capita basis would alleviate the short term problems of the “PIIGS” nations (Portugal, Ireland,. Italy, Greece and Spain). Ultimately, though, the most logical solution is the creation of a supranational entity that can conduct fiscal policy in much the same way as the creation of the European Central Bank can do monetary policy on a supranational level (or the dissolution of the European Monetary Union altogether). Absent that, Greece, Portugal, Italy, yes, even Germany, functionally remain in the same position as American states, unable to create currency and therefore always subject to solvency risks which the markets may question at any time. It’s a recipe for built-in financial and political instability.

The Government of the European Union (in reality a bunch of heads of state as there is no “United States of Europe” to think of) has called the Greek government to implement all these measures in a rigorous and determined manner to effectively reduce the budgetary deficit by 4% in 2010, and “invited” the ECOFIN Council to adopt its recommendations at a meeting of the 16th of February.

It’s probably not the sort of invitation that any sovereign nation would normally accept, but Greece, like the rest of the Euro zone nations, has voluntarily chosen to enslave itself with a bunch of arbitrary rules which have no basis in economic theory. It is also being denied the use of an independent currency-issuing capacity.

This is no way for any country to achieve growth and financial stability. With no capacity to set monetary policy, fiscal policy bound by the Maastricht straitjacket, and its exchange rate fixed, the only way Greece or any of the euro zone nations can change their competitive position within the EMU is to harshly bash workers’ living conditions. That is a recipe for national suicide. And it will not reduce the deficit, because as we noted above deficits are largely determined endogenously, not by legislative fiat. The deficits reflect failing economic activity, particularly when a government is institutional constrained from implementing proactive policy to reduce output gaps left by falling private sector activity. That the measures will be imposed by an entity lacking total democratic legitimacy in Greece is only likely to exacerbate existing strains.

Why is a 4 per cent across-the-board cut being demanded of Greece? What’s the significance of that number? There is no particular budget deficit to GDP figure that is desirable or not independent of knowing about other macroeconomic settings. Just as there is no rationale provided for any of the “performance criteria” underlying the European Monetary Union’s Stability and Growth Pact. The treaty stipulated that countries seeking inclusion in the Euro zone had to fulfill amongst other things the following two requirements: (a) a debt to GDP ratio below 60 per cent, or converging towards it; and (b) a budget deficit below 3 per cent of GDP. Why 3%? Why it is 60 per cent rather than 30 or 54 or 71 or 89 or any other number that someone could write on a bit of paper? And yet we have these random numbers being used to gauge whether Greece is conducting its fiscal affairs in a proper and “responsible” manner.

This is the kind of thinking which has led to the relatively poor economic performance of many of the EU economies during the 1990s and most of the previous decade. All entrants to EMU strived to meet the stringent criteria embodied in the Stability Pact (whose principles, although largely formalized by the Maastricht Treaty in 1997, were essentially established at the beginning of the 1990s in preparation for monetary union). From 1992 to 1999, the growth of national income averaged 1.7 percent per annum in the euro-zone countries, compared with the 2.5 percent per annum averaged by the United Kingdom over the same time period. Moreover, the unemployment rate fell substantially in the United Kingdom (as well as in the United States and Canada), but tended to rise in the euro-zone countries, most notably in France and Germany.

A cavalier refusal by the EU’s technocrats to debate and address the concerns of those who feel threatened by a headlong rush into a more all-encompassing political and monetary union without adequate democratic safeguards has lent legitimacy to the views of populist politicians, such as France’s Jean Marie le Pen, and a corresponding rise of extremist parties all across the EU. This is a phenomenon that tends to arise when voters sense that their concerns are not even being considered by what they would characterize as a corrupt and cozy political class.

The EU must eliminate the underlying assumption that fiscal policy, since it can be influenced directly by the political process, should always be completely politically constrained. If anything, the performance of Euroland’s core economies over the past few years has demonstrated the total limitations of technocratic fiscal and monetary policy.

And yet this kind of deficit-bashing insanity is spreading like a cancer across the global economy. We all should know when the economy is in trouble. High unemployment; sluggish growth in output, productivity, wages; high inflation etc., these are all things which have meaning to us on an individual and collective basis. A budget deficit, by contrast, is just a number. It’s akin to blaming the thermometer when it registers that someone has a flu bug. Any doctor would legitimately be called a quack if he proposed a cure for influenza by sticking the thermometer in a bucket of ice until we got the right “reading” that was deemed to be acceptable to him.

Yet this is exactly what the poor Greeks have now been blackmailed into signing up for. Heaven help the US if it begins to move further down that road, as many are now suggesting.

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.

Watch: Everything You Need To Know About The Greece Bailout

Join the conversation about this story »

See Also:

• Here’s Proof That They Don’t Have A Deal Yet On Greece
• Striking Greek Unions Send A Message: Screw You Europe, Where’s Our Bailout?
• Greek Unions Strike To Stop Spending Cuts Aimed At Ending Debt Crisis

(This guest post originally appeared at NewDeal2.0)

America’s Triple AAA credit rating could be at risk should its nascent economic revival not develop into a full-blown recovery, Moody’s Investor Service warned yesterday. The credit ratings agency cautioned that if the US were to grow at slower pace than expected, the largest economy in the world’s already-extended finances could be over-stretched, in turn damaging its AAA credit rating.

Dis-credited ratings agencies

Sound familiar? The so-called “Big Three” ratings agencies have been making claims like this for years: in Japan, the UK and, now, the United States. It is worth recalling that these are the same organizations which, as recently as 2007, were conferring Triple AAA ratings on subprime mortgage paper. Did that work out well for you?

The real news here is that anybody takes anything these discredited rating agencies say seriously. As my colleague, Randy Wray, has already suggested, the top three ratings agencies — Moody’s, Fitch, and S&P — should all be ignored. In fact, Wray is right to suggest that we should prohibit regulated and protected institutions from using any ratings by this group. Their history of failure makes my beloved Toronto Maple Leafs seem like a veritable hockey dynasty in comparison.

Moody’s war on governments freely deploying fiscal policy is nothing new: In November 1998, the day after the Japanese government announced a large-scale fiscal stimulus to its ailing economy, Moody’s Investors Service began the first of a series of downgradings of the Japanese government’s yen-denominated bonds by taking the Aaa (triple A) rating away. The next major Moody’s downgrade occurred on September 8, 2000.

Then, in December 2001, Moody’s further downgraded the Japan Governments yen-denominated bond rating to Aa3 from Aa2. On May 31, 2002, Moody’s Investors Service cut Japan’s long-term credit rating by a further two grades to A2, or below that given to Botswana, Chile and Hungary.

Why Japan doesn’t bounce checks

What was the long term impact of these downgrades? Well, since that time, Japan’s debt/GDP has gone over 200%, and all with a zero or near-zero interest rate policy for over a decade, and 10-year Japanese Government Bonds (JGBs) were continually issued in any size the Japanese government wanted, at the lowest rates in the world.

This, despite the country’s dire economic circumstances: Last year, not only did Japan’s economy fall in percentage terms by three times that of the U.S.; it fell in percentage terms in a year by more than the U.S. economy fell from cyclical peak to cyclical trough in all of its recessions and depressions over the last two hundred years with the exception of 1837-1841, 1929-1933, and perhaps the panic of 1907. Japan’s business expansion in this past decade was driven almost entirely by the growth in exports and an increase in business fixed investment which was itself driven for the most part by the growth in exports. If one looks at the peak to trough decline in Japanese GDP over the last year or so, almost three quarters of it was due to the collapse in exports.

And yet despite these dire economic circumstances, the Japanese government has yet to bounce a check. The country’s central bank has the ABILITY to clear any Ministry of Finance check for ANY size, simply by adding a credit balance to the member bank account in question. Yes, the BOJ could be UNWILLING to clear ANY check, but that is an entirely different matter than being UNABLE to credit an account. Operationally, concepts of the BOJ not having “sufficient funds” to credit member accounts are functionally inapplicable.

Sadly, not even all Japanese policy makers appear to understand this. BOJ board member Seiji Nakamura sounded much like the ratings agencies themselves when he spoke of the need for the US, the UK, and Japan to get their debts down to a “sustainable level” (a level which, curiously, is never defined, because there is no modern economics textbook which offers clear explanations of what constitutes a “sustainable” public debt position). Unfortunately, Nakamura continued in this vein, insisting that Japan’s reliance on fiscal stimulus to spur an expansion without having a strategy to cut public debt would only exacerbate the government’s fiscal situation, and place the country in the same position as Greece, Spain and Portugal.

He’s wrong. The position of Japan, like the US, is very different, because both can operationally issue unlimited quantities of debt in their own national currencies. By contrast, as we have argued before, the relationship of member countries in the Euro zone to the European Central Bank (ECB) is more similar to that of the national treasuries of member states of the United States to the Fed than it is of the US Treasury to the Fed. In the US, states have no power to create currency; nor does Greece, Spain, or any euro zone nation. In this kind of circumstance, taxes really do ‘finance’ state spending and states really do have to borrow (sell bonds to the markets) in order to spend in excess of tax receipts because they are users of a currency, not its creator. Eventually, one hopes that even the Germans will begin to appreciate this point, as they persistently frustrate any rational response to mitigate the possibility of a major national insolvency within the EMU.

But they are not there yet. Purchasers today of Greek, Spanish or Portuguese bonds do worry about the creditworthiness of these nations much as we might also fret about California’s ultimate solvency. That solvency fear is now spreading across the Euro zone and creating contagion effects in all of the world’s capital markets right now.

What about the United States? Well, according to Steven Hess, Moody’s lead analyst for the United States ,”The Aaa rating of the U.S. is not guarantee…So if they don’t get the deficit down in the next 3-4 years to a sustainable level, then the rating will be in jeopardy.” This assessment is made without any mention of what the net spending would be achieving or what the non-government sector might be doing by way of debt-retrenchment and saving. It also assumes that the surpluses in the coming years are attainable, which seems unlikely if the US is bullied into cutting back expenditures, as Moody’s advocates.

We also have no idea how Moody’s defines “sustainable” levels of debt. Even if the US sought to identify a debt threshold in the way in which the European Monetary Union has done, this threshold would tell us nothing at all about fiscal discipline. Imagine an economy faced with a sequence of aggregate demand failures due to private sector pessimism. Without any change in fiscal parameters, the government would see its deficit increasing and because it voluntarily ties net spending to debt-issuance, the former will also rise. You can easily construct circumstances where the debt/GDP ratio could skyrocket without any discretionary change in fiscal policy at all, as Bill Mitchell and Joan Muysken describe in their book, Growth and Cohesion in the European Union.

The running-out-of-money myth

Unlike Moody’s, we think it is absurd to say that the government is going to ‘run out of money’ as our President has repeated. It is not dependent on China or anyone else. There is no operational limit to how much government can spend, when it wants to spend. This includes making interest payments and Social Security and Medicare and Medicaid payments. It includes all government payments made in dollars to anyone.

And if Moody’s (or any other ratings agency) genuinely thinks that government debt is intrinsically evil and that surpluses should be the stated goal of US government policy (in order to safeguard America’s Triple AAA rating) then it must spell out the full consequences of this policy choice. The ratings agencies appear incapable or (at the very least) unwilling to explain the essential sectoral relationships that link the government, private and external sectors. They seem to think that you can have everything – a budget surplus and high private saving and debt reduction. You cannot as a matter of plain accounting logic unless you suddenly start net exporting in great volumes, (which has not happened to the US in its post W.W. II history), or if the domestic private sector is either choosing to deleverage or use leverage less than in the past, that means it will take large and increasing fiscal deficits, or small and decreasing trade deficits, or some combination of the two, in order to achieve trend real GDP growth paths. Otherwise, the result is stagnation or in the extreme, debt deflation. That will not do much to enhance America’s credit rating.

So if the political preference is for the government to deficit spend less, (as Moody’s implicitly advocates), what other sector is ready and willing to reduce its net saving position? The reduction in fiscal deficits cannot occur without an offsetting reduction in domestic private or foreign net saving (the latter being the inverse of the trade deficit). If the answer is that no other sector is willing or able to reduce its net saving, then income growth in the economy will have to adjust downward. Which means higher unemployment, lower growth and more social misery.

That is where the perverse logic of the ratings agencies take us, which people ought to remember the next time yet another one of these silly debt downgrade scare stories makes the front pages of the financial press.

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.

Join the conversation about this story »

See Also:

• Moody’s: Government Debt Is Vastly Understated, And On Its Current Path America Will Be Downgraded
• Bank Of Japan Pressured To Let Loose Even More Liquidity As Crushing Deflation Deepens
• Evercore CEO Altman: Obama’s Deficit Will Cause An International Currency Crisis In The Next Two years

(This post originally appeared at NewDeal2.0)

Last Friday, Mr. Obama and the GOP staged the equivalent of a British Parliamentary Question Period in front of the TV cameras. It showed the quick-thinking, articulate President at his best. Unfortunately, the subsequent Saturday morning national radio address showed him at his worst. Obama reiterated the need for job creation, even as he decried government deficits, which allegedly imperil our long term economic prosperity. It’s like calling for an open house policy, whilst simultaneously putting explosives on the door knobs.

“As we work to create jobs, it is critical that we rein in the budget deficits we’ve been accumulating for far too long – deficits that won’t just burden our children and grandchildren, but could damage our markets, drive up our interest rates, and jeopardize our recovery right now”.

Give Obama credit. He packs a veritable trifecta of innocent, but deadly, frauds into one sentence — government debt is bad, markets determine interest rates, and  deficits represent a form of “intergenerational theft.” Then, he adds several new ones to boot.

Unfortunately, he’s got it backwards. The deficits he decries actually help to sustain demand and create jobs, thereby supporting the economy — not destroying it. And he reflects a commonly held belief that growing government debt represents a burden on our children and grandchildren, implicitly suggesting that future generations will have to reduce consumption in order to pay the taxes required to pay off the outstanding debt. Related to this is the fallacy that too much bond issuance will create a “debtors’ revolt”, whereby “the markets” will force the country to pay higher interest rates in order to “fund” its spending.

A Few Overlooked Facts on Deficits

Where to begin? Since the days of George Washington’s administration, national budget deficits and increased public debt have been the rule on all but about six very short occasions. And the US has generally prospered. Why? Far from being a burden, the deficits, and the corresponding government bonds, constitute the foundation of private financial wealth in any nation that creates its own sovereign currency for use by its citizens. Debt owed by the government yields net income to the private sector, unlike all purely private debts, which merely transfer income from one part of the private sector to another. In basic national accounting terms, government deficits equal non-government savings surpluses.

Private holdings of government bonds also constitute an income source — that is, the government interest payments on its outstanding debt constitute another avenue for stimulus. So when the government retires debt, it reduces private incomes — just as when it runs budget surpluses, it constrains private sector demand directly by reducing private income and access to adequate currency. Just ask any pensioner if he/she is happy when the income stream from annuities has declined.

Take away that debt, and you take away income. It is no coincidence that the budget surpluses of the Clinton years (wrongly trumpeted as a great fiscal triumph by President Obama) subsequently led to recessions: government budget surpluses ultimately restrict private sector demand and income growth and force greater reliance on PRIVATE debt. Does anybody think it is a coincidence that two of the longest and largest periods of budget surpluses in America history — the periods of 1997-2000 and 1927-1930 — were followed by calamitous economic collapses?

There are ample analyses which explain how government surpluses drain aggregate demand (here, here, and here). Suffice to say, a government budget surplus has two negative effects for the private sector: the stock of financial assets (money or bonds) held by the private sector, which represents its wealth, falls; and private disposable income also falls as tax demands exceed income. And, as Stephanie Kelton has noted, the case of Japan illustrates that despite a debt-to-GDP ratio in excess of 100%, the Bank of Japan never lost the ability to set the key overnight interest rate, which has remained below 1% for about a decade. And, the debt didn’t drive long-term rates higher either.

Furthermore, now that we’re off the gold standard, Chinese and other Treasury buyers do not “fund” anything for us, contrary to the completely false and misguided scare stories that deficit hawks and, and now Obama, implicitly endorse. (Click here for an explanation). Legions of economists, investment advisors, Wall Street practitioners and policy makers continue to peddle such gold-standard thinking to their citizens nationwide. To paraphrase Churchill, “It is as though a vast Gold Standard curtain has descended across the entire body of public thinking.”

Obama’s Deficit Confusion

Let’s consider a real world example to demonstrate the President’s conceptual confusion on government deficits. We’re in a recession. Our American citizen who was working in a pie shop has lost his job even though his productivity was just as high during the boom years. As the recession intensified, pie demand fell, as did consumer demand in general. Fearing that their wealth holdings are not going to appreciate as quickly as they did in prior periods, households are saving more money out of their income flows.

The pie guy wants to exercise his freedom to work hard for money. So do 152 million other people. But there are jobs available for only 138 million of them, given current business perceptions of money profit prospects from production now and in the future. The pie guy is stuck with over 15 million other people who would like to exercise their freedom to work hard for money. Over 6 million of those people have been trying to exercise that freedom for over half a year, with no luck. They are dumpster diving for leftover pie scraps.

In desperation, the pie guy has gone back to the pie shop to offer his services for a lower money wage, but unit pie demand is still down, even though the owner has cut pie prices. However, the pie owner, facing lower prices per pie, decides to hire the pie guy back at a lower wage and fires one of his other workers to scratch his way to a little higher profit. Are we all any better off? I suppose pies are cheaper, but then so to are incomes earned by pie makers lower.

In that situation, someone else has to take up the spending slack. Fortunately, we live in an economic system in which a government can freely spend and fill the gap left by the private sector. It has the unique capacity to spend without the constraint of a private firm on productive job creation, thereby increasing output, not just redistributing it. Just giving the pie firm a payroll tax cut on new hires is not going to generate more jobs. Rather, giving it to all employees will lead to more pie sales. Instead of decrying the government deficits, then, the President should be celebrating them as a form of economic salvation.

The problem obviously isn’t about money which a government can always create. The ultimate irony is that in order to somehow ‘save’ public funds for the future, as the President appears to be advocating, what we do is cut back on expenditures today, which does nothing but set our economy back and cause the growth of output and employment to decline. Worse yet, the great irony is that the first thing governments generally cut back on is education — the one thing the mainstream agrees should be done that actually helps our children 50 years down the road. Education cutbacks — as any Californian can tell you — are something that does hurt us, as well as harming our children AND our grandchildren down the road. This is the true “intergenerational theft”, not “runway” government spending.

The False Household Budget Analogy

Like many other people who embrace the nostrums of the Concord Coalition (an advocacy group supporting the deficit hawk themes), the President continues to view government spending through a false household budget analogy:

“There are certain core principles our families and businesses follow when they sit down to do their own budgets. They accept that they can’t get everything they want and focus on what they really need. They make tough decisions and sacrifice for their kids. They don’t spend what they don’t have, and they make do with what they’ve got.”

Yes, it’s true: If households spend more than their income now, they have to borrow. To pay the loan back they have to ensure that they can dedicate adequate income in the future, either by increasing incomes somehow or diverting existing income from consumption. If a household borrows too much, it will face major corrections in its balance of income and expenditure and consequently may have to seriously forgo spending later.

That is the logic that the users of the currency have to consider every day. They have to finance every $ they spend and so planning is required to ensure they don’t blow out their personal balance sheets. If all households attempt to net save by spending less than they are earning, and businesses attempt to net save (reinvesting less than their retained earnings), then private sector incomes and real output will decline absent an increase in government spending.

But it’s not the same for a government. The government is the creator of a currency. It can spend now. It can also spend later. And it can service and pay back the debt without compromising anything. A government, unlike a household or a private business, can choose to exact greater tax revenues by imposing new taxes or raising tax rates.

Notwithstanding the obvious reality that sovereign governments have no solvency risk because they create their own currency, most financial commentators (and the President’s own advisors) still waste their time talking about sovereign default risks. Unfortunately, the President implicitly legitimizes this sort of talk when he speaks about the need for government to embrace budgeting like a household does. This is what we presume he has in mind when he discusses the long term dangers of government deficits. Firms, households, and even state and local governments require income or borrowings in order to spend. But the federal government’s spending is not constrained by revenues or borrowing. It is constrained only by what our population chooses as national goals.

Getting Past the Deficit Myth

We would all rather live in a world where profit prospects are so abundant that business investment spending is high enough to insure full employment given household preferences to save out of income flows. But historical and current experience suggests that is a rare configuration indeed. Ideally, that would be the business sector investing more than it retains in earnings. But in recent decades, this happens only during asset bubbles, and we know how that story ends. Alternatively, the foreign sector could deficit spend — the US could run a trade surplus. But the reality is that US firms have chosen to reinvest in low cost production centers abroad (or would prefer to use free cash flow to engage in short run shareholder value maximization through various financial engineering efforts, including M&A) so the US-based production structure no longer matches foreign demand very well. Ironically that leaves government fiscal deficit spending as the sole remaining mechanism to insure the freedom of its citizens to work hard for money.

The President, unfortunately, has yet to put the pieces of the puzzle together. He also fails to understand the idea that a government like the United States — i.e. one that issues a sovereign currency — can meet any and all outstanding financial obligations, provided the debts are denominated in the national currency. In this regard, the size of the national debt is irrelevant. This myth, and this myth alone, underpins arguments by orthodox economists against government activism in macroeconomic policy. The President does his Administration and the country no service by continuing to jump on this mythical bandwagon.

Myths may constitute good grounds for literature, but they are a horrible foundation for sound economic policy.

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.

Join the conversation about this story »

See Also:

• Deficit Hawk Logic: Hummers, Howitzers, And Helicopters, Yes. Health Care, No
• Don’t Worry: Prosperity Is Just Around The Corner
• Look At This Future-Generation Crushing Budget Obama Just Unveiled

(This post originally appeared at NewDeal2.0)

Every instinct the President has honed, every voice he hears in Washington, every inclination of our political culture urges incrementalism, urges deliberation, and an abundance of caution, particularly in regard to our “unsustainable government spending.”  And for all of his apparent newfound populist vigour, it now appears that the President is about to heed these voices of caution.  The moves against the banks, coupled with yesterday’s announcement of a spending freeze and previously voiced support for a bipartisan commission on the deficit, all point to Clinton-style triangulation.

The Wall Street Journal reports that President Obama intends to propose a three-year freeze in spending that accounts for one-sixth of the federal budget.  The move is designed “to attack the $1.4 trillion deficit” and would “propose limits on discretionary spending unrelated to the military, veterans, homeland security and international affairs, according to senior administration officials. Also untouched are big entitlement programs such as Social Security and Medicare.”

As with so much else with this president, the effect, then, is likely to be cosmetic, but it sends out an awful statement about Obama’s increasingly “Hoover-esque” governing philosophy, and the future likely direction of fiscal policy. The cuts will apparently be supplemented with some “middle class friendly” proposals to be introduced in the State of the Union Address.  But the words of the Who’s Pete Townsend spring to mind from the song “Won’t Get Fooled Again”:

“Meet the new boss / Same as the old boss.”

Any kind of spending cuts in the middle of the worst recession since the Great Depression is insane.  What we are beginning to see is the return of Herbert Hoover and the “liquidationists.”

As my friend Mike Norman reminded me, Obama opposed the idea of a spending freeze during the campaign, when it was proposed by McCain.  McCain lost the presidency.  Now Obama supports it???

What’s next?  Raising taxes as the Japanese did in the middle of their recession in the mid-1990s?

Those who rant about the runaway size of government in the US should just go to the BEA statistics page.  Bill Mitchell points out that government spending as a percentage of real GDP has actually DECLINED over the past year: “In March 2003 it was 9.4 per cent (and it wasn’t much less than about 10 years earlier as well).  It peaked at 12.4 per cent in September 2008 at the height of the crisis when investment was heading south and consumption was still in decline.  A year later it was at 11.4 per cent.”

It’s certainly not the image of an out of control, wildly spending, “socialist” government.

If Barack Obama continues to listen to the siren songs of the deficit terrorists, he will almost certainly be a one-term president.

Join the conversation about this story »

See Also:

• Barack "Hoover" Obama
• Obama Blazes The Path To Economic Suicide
• The Spending Freeze: Appalling On Every Level

(This guest post originally appeared at the author’s blog)

Speaking of President Obama, Karl Rove writes, “After a year of living in his fiscal fantasy world, Americans realize they have a record deficit-setting, budget-busting spender on their hands.”  Well, given his history with former President Bush, it certainly takes one to know one.

But it is hard to understand how the concept of “budget busting” applies to a government which, as a sovereign issuer of its own currency, can always create dollars to spend.

There is, in other words, no budget to “bust”. A national “budget” is merely an account of national spending priorities, and does not represent an external constraint in the manner of a household budget.

A Deficit Spending Limit Disaster

What do commentators such as Mr. Rove really think would have happened if there had been tight fiscal rules in place preventing any (or only some) discretionary response in net spending? Consider a real world example. In December, Spanish unemployment rose to 19.3% (the highest in more than a decade), capping a year that saw the nation’s jobless rate soar to double the Euro- zone average. According to the Merco Press, the number of people registering for unemployment benefits increased by 54,657, or 1.41 percentage points from November to 3.92 million. From a year earlier, unemployment climbed by 25%; youth unemployment is now 40 per cent. The only good piece of news this year was that the number of jobs destroyed in 2009 was 200,000 less than in 2008. That’s the sort of statistic which, in the US would likely prompt grave warnings about the need to pursue “exit strategies”.

Spain, like the other countries within the European Union (EU), has other problems, because the nation has voluntarily decided to accede the so-called “Stability and Growth Pact” (SGP), which arbitrarily limits national government deficit spending to 3% of GDP, whilst limiting overall public debt as a percentage to GDP of 60% (even though there is no economic theory in evidence to justify these arbitrary figures). Since the inception of European Monetary Union (EMU), the conflict within the EU on how to co-ordinate economic policy on the supranational level has been recurrent. It fully illustrates the core problem at the heart of the EMU and its related Stability and Growth Pact. Politically, the interpretation of the euro zone’s stability pact is largely left in the hands of unelected bureaucrats, operating out of institutions which are devoid of any kind of democratic legitimacy.

More fundamental are the institutional flaws. The relation of member countries to the European Monetary Union (EMU) is more similar to the relation of the treasuries of member states of the United States to the Fed than it is of the US Treasury to the Fed. In the US, states have no power to create currency; neither do the countries within the EU. By the same token, purchasers of US state bonds do worry about the creditworthiness of states, and the ability of American states to run deficits depends at least in part on the perception of creditworthiness. While it is certainly true that an individual state can always fall back on US government help when required (although the recent experience of California makes that assumption less secure), it is not so clear that the individual countries in the euro zone are as fortunate.

The euro dilemma that Spain faces, then, is somewhat akin to the problems of a country like Iceland or Latvia. They operate under a system which prevents their government from spending money freely – precisely the sort of thing that the deficit terrorists in the US advocate on a regular basis (particularly those who call for constitutionally mandated balanced budgets, as exists in many state budgets).

Facing a worsening economic situation, the Spanish government has done what any reasonable fiscal authority would do and that is to expand its budget deficit. A significant proportion of the rising deficit is being driven by its automatic stabilizers, which is normal and sensible. But their impact to stabilize incomes is negated to a large degree by the SGP.

Why it’s Folly to Balance Budgets During a Recession

Spain illustrates the futility of seeking to impose balance budgets during a recession. It makes things worse. Budgets inexorably tend to deficit when economic activity slows and tax revenues collapse. If not addressed soon, this structural flaw at the heart of the European Union suggests problems ahead for the long-run viability of the euro, and certainly points to growing intra-European political tensions. (In that regard, it is interesting to note the recent comments by the Mayor of Athens in regard to Greece’s comparably adverse unemployment situation: “Germany owes us €10.5bn from the 2nd World War, they should give us that back and we can equate it all up, automatically our deficit falls to 5%…”).

The debate about public debt limits is arcane in the extreme and harks back to gold standard logic which is no longer applicable. It was always clear – by the nature of the structure of their monetary system (divorce between the fiscal and monetary sovereignty) that the system would not cope in a major economic crisis such as now, where unemployment is skyrocketing. As much as one can complain about the size and direction of the US government spending, the country at least is in a position (should it choose to do so) to exercise fiscal leadership, and the institutional capacity to implement it. But if the US imposes anything like the constraints on government spending demanded by the deficit warriors, we’ll have Spanish style levels of unemployment.

The Spanish government does not have the ability to provide fiscal leadership in their winter of recession because of the voluntary constraints they have imposed on their fiscal capacity courtesy of EMU membership. That is why almost one in five Spaniards is now unemployed, with no prospect of respite. With the degree of fiscal maneuver limited in all EU nations, growth in the euro zone depends on 1) a low enough interest rate to fuel private domestic spending (probably requiring asset bubbles, as in Spain, Irish housing markets), 2) entrepreneurial innovation, and 3) cost cutting, the last of which tends to suppress domestic demand. The net result has been a region has been left largely on a stagnant growth path since unification because it cannot run large enough current account surpluses given Asian cost structures and Asian exchange rate linkage to the US dollar (although it has tried to use relocation of production to Eastern Europe to gain an edge). The euro region basically rides on the back of global growth, which previously depended on the Anglo private sector deficit spending, which was largely sponsored by asset bubbles.

Having shut down their policy options in order to discipline themselves, they are stuck in a hard grind, which now will get even harder as fiscal retrenchment is attempted. Perhaps enough people will conclude after a decade of trying to work within a number of self-imposed policy constraints, it is time to try something else. I wonder how long the euro in its current incarnation can last? Is this really what the US wants? Because that is the ultimate implication of a policy which arbitrarily seeks to constrain government spending in the manner in which the Karl Roves, Robert Rubins and Pete Petersons of this world are currently advocating.

Getting Government Spending Right

So what is the “right” level of government spending? Obviously, we want the government spending to be done efficiently. We don’t want government spending to become inflationary. Keep in mind — the public purpose behind government doing all this is to raise an army, operate a legal system, support a legislature and executive branch of government, promote public infrastructure, promote basic research, etc. So there are quite a number of tasks that even the most conservative voters would have the government perform.

Ultimately, the ‘right amount of government spending’ is an economic and political decision that has nothing to do with government finances. The real ‘costs’ of running the government are the real goods and services it consumes; the real cost of the government using all these real goods and services is that those resources would other wise be available for the private sector. So when the government takes those real resources for its own purposes, fewer real resources are left for private sector activity. What matters is that taxes are set to balance the economy and make sure it’s not too hot or not too cold. And government spending is set at the ‘right amount’ to provide the requisite services and full employment. Getting caught up in the mythology of “financing” considerations or arbitrary self-imposed constraints with no bearing in any economic theory at all is the wrong path. That way lies Spain. Is this the future we want for the US?

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.

Join the conversation about this story »

See Also:

• Robert Rubin Is Back: Noooooo!!!
• New Year, Same Old Deficit Hawk Rubbish
• Obama’s Newfound Populism: All Hat No Cattle

(This guest post originally appeared at NewDeal2.0)

When in doubt, create a commission. It’s always the best way to legitimize stupid ideas. In that regard, it is dispiriting to see 2010 usher in the same discredited dogma that has done so much to contribute to the economic misery of the past decade.

According to the Washington Post: “The limit on the government’s credit card to a record $12.4 trillion gave a significant boost to a proposal to appoint a special commission to make the tough decisions that will be required to dig the nation out of debt. ”

Sadly, (but predictably), President Obama has voiced support for such a plan, as have 35 Democratic and Republican senators, who have signed on to legislation that would create a bipartisan commission with broad power to force painful spending cuts and tax increases through Congress.

Please note the focus of the commission: Cutting Medicare, Medicaid and Social Security and other forms of “unsustainable entitlement spending and a massive accumulated public debt”, which are allegedly “threatening to undermine the nation’s economy and the U.S. credit rating abroad.”

Well, so much for an open-mindedness and fact finding! Even before its official inception, the proposed commission is starting with remarkably partisan assumptions about debt and entitlement programs. What is so inherently “unsustainable” about our current levels of government debt? In the early Victorian period, for example, the British government debt to GDP ratio was nearly 200 per cent and almost reached that level again in the early 1920s.  The historian Lord Macaulay noted that at every stage of debt increase, “it was seriously asserted by wise men that bankruptcy and ruin were at hand; yet still the debt kept on growing, and still bankruptcy and ruin were as remote as ever.”

The ideas which underlie this new commission also display fundamental ignorance about double-entry bookkeeping principles which have been in existence for over 7 centuries.

In truth, today’s deficit hawks are nothing more than zealots — poised again to preach their nonsensical theology that government deficits are dangerous and need to be cut, without honestly explaining the full consequences of their recommendations. If households attempt to net save by spending less than they are earning, and businesses attempt to net save (reinvesting less than their retained earnings), then private sector incomes and real output will decline absent an increase in government spending. The danger of premature fiscal tightening was illustrated in the US in 1936-37, when the ending of a war veterans’ bonus and the introduction of Social Security taxes helped push the US back into recession when recovery from the Great Depression was far from complete.

The deficit terrorists only begrudgingly note (if at all) that absent the absorbing role of budget deficits over the last couple of years, we would have had a full Great Depression experience. Government deficits, as Paul Krugman has noted on numerous occasions, saved the world from a much more calamitous experience, yet these deficits are still characterized as something like Norman Bates’s murderous “mother” in the attic of Bates Motel, ready to destroy our helpless population under the nefarious guise of “socialism” or worse. The phobias created by supposedly apolitical organizations such as Pete Peterson’s Concord Coalition or the tea party brigades intimidate policy makers into modifying their fiscal responses to the point where they are insufficient to fill the spending gap left by private sector withdrawal.

Budget deficits per se tell us nothing about the state of the economy; nor do they inherently indicate that any given level of government spending is unsustainable. Pro-active fiscal policy will allow the private sector to have healthier finances by providing spending stimulus over time to generate income growth (and private saving) when it is targeted toward creating full employment, not bank bailouts. Bad fiscal policy, by contrast, simply reflects a collapse in private spending and correspondingly lower tax revenues, and the concomitant failure of government s to act so as to prevent increased social welfare payments (such as unemployment insurance or food stamps) from coming into play as a result of this declining economic activity.

A truly non-partisan commission would seek to analyze budget deficits and government spending within that paradigm. But that’s not the objective here. It is particularly galling to see the main beneficiaries of last year’s bailouts being the main champions of “reforming” government entitlement spending, stopping the fiscal expansion in its tracks before it truly starts to reduce unemployment on Main Street.

As we come into a new decade, however, we should always remember that there is no reason to have any unemployment in excess of so-called “frictional unemployment” (people in the process of moving between jobs). When private sector demand fails, the correct role for the public sector should be to absorb all the workers into the public sector via a Job Guarantee program.

There is never a shortage of work — just a shortage of available employers. When the private sector is unwilling or unable to hire additional workers, the only sector that is left is the public sector. One doesn’t have to be a “socialist” to point out that despite the slight recent improvement in the jobs picture (meaning only that things have not got any worse), we need 12 million new jobs just to deal with workers who have lost their jobs since the crisis began, plus those who would have entered the labor force (such as graduating students) if conditions had been better. At least another 12 million more jobs would be needed on top of that to get to full employment-or, 24 million in total.

Instead of obsessing about budget deficits (which rise as a consequence of unemployment), we would be far better served by commissions (if these stupid things are needed at all) which deal with the rapid escalation of joblessness that occurs during recessions. Why not focus on a new, New Deal program with a permanent and universal job guarantee that will supply as many jobs as there are job seekers? We have an enormous number of unemployed people who are drawing significant social welfare payments. Why not use a lot of that same money and deploy them in productive labor?

It is a no-brainer and the only reason governments do not do this is because (as our friend Bill Mitchell notes), they are blinded by an ideology that says they “cannot afford it” and “it would be unproductive” and “private firms might find it hard employing people again” and all the rest of the wrongful and tedious arguments that get wheeled out by the deficit terrorists.

A lot of people in the private sector don’t want this scheme because they prefer the disciplining effect of high unemployment to sustain a low wage model for their workers. Of course, they would never put it so crassly, but employers benefit when working people fear unemployment. Since workers also can vote, however, those seeking to prevent the adoption of a full employment policy do so under the rubric of “non-partisan” commissions, which seek to perpetuate adverse conditions for labor under the guise of patriotic concerns about “unsustainable government spending”.

By the same token, the government itself won’t address the real issues. Why? Because it is bought by the very beneficiaries of the current system, and also because most politicians cling to outmoded economic theories that are predicated on 19th century gold standard concepts such as “affordability” or “fiscal sustainability”. These concepts have no applicability in a fiat currency system, where a government can always generate the spending power required to sustain full employment.

There is no financial constraint on the government introducing a Job Guarantee program to maintain “shovel ready” labor for the private sector. Only political will and good sense are constrained. We begin the year with hope that President Obama will redirect his considerable powers of oratory in order to help the electorate understand this. And with that thought, let’s ensure that 2010 becomes a much happier and more productive time for the vast majority of people — those who have not collected a massive bank bonus check courtesy of the American taxpayer.

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.

Join the conversation about this story »

See Also:

• Obama’s Newfound Populism: All Hat No Cattle
• The Chinese Are Not Our Bankers, And Obama Doesn’t Need To Kowtow Towards Them
• Dear Lloyd Blankfein: Here’s The REAL Purpose Of The Banking System