The newly-released documentary film, “Finding the Money,” presents a sympathetic look at the people and doctrines of Modern Monetary Theory (MMT). Elsewhere I have provided a lengthy critique of the content, but in this post I wanted to focus on a viral clip from the film, in which Joe Biden’s chief economic advisor fumbles around, unable to answer a simple question.
Specifically, the head of the Council of Economic Advisers, Jared Bernstein, is asked why the US federal government borrows dollars, when after all, it canprintmore dollars at will. Here is his hilarious attempt at a response:
In the present post, I’ll give a better response than Bernstein managed. I’ll then conclude by showing that ironically, the MMTers—including Randall Wray, who was one of their gurus featured in the documentary—don’t understand either.
Why Does a Government Borrow Money When It Can Just Levy Taxes?
In the MMT documentary, the underlying mystery was that a government that is a “monetary sovereign” (such as the US, UK, and Japanese governments in today’s world) can issue more money at will. So why would the US government ever borrow dollars, or the UK ever borrow pounds, or the Japanese government ever borrow yen?
But before diving into that question, let’s answer a related one: Why does a powerful government ever borrow money, when it can simply levy a tax upon its citizens? For example, suppose the US government wants an additional $1 trillion to buy weapons and other supplies to go wage war against Putin. Why would the Treasury issue bonds to help defray this expenditure, rather than simply levying a surtax to raise the additional $1 trillion in revenue?
The great Austrian economist Ludwig von Mises explained the rationale way back in 1918, when he gave a report in Vienna on the Austro-Hungarian experience in the first World War. (I give the details in this article, as well as my subtle critique of Mises’ explanation of the war burden vis-à-vis future generations.) Mises first makes the point that the “real” (as opposed to paper money) resources needed to fight the war—the iron, steel, rubber, glass, fuel, manpower, etc.—obviously have to come from the present. The government can’t use a time machine to somehow suck goods from the future to be channeled into the war effort today. For every additional vehicle sent to the front lines, there was one fewer vehicle available for civilian use in the present.
However, even though there is a sense in which “the present generation” collectively bore the full weight of the war’s cost in the present, Mises went on to explain that when it came to financing the war in accounting terms, the government’s fiscal policy definitely had an impact on the share of the burden faced by different individuals.
So to revert to our modern situation in the United States, we can paraphrase Mises’ insights like this: If the US government were to levy our hypothetical $1 trillion war expense on (say) the top 100 million individual tax return filers ranked by last year’s reported income, it would work out to a lump sum surtax of $10,000 per filer. Many people don’t have $10,000 in extra cash just sitting around to hand over to the IRS. So for many of these taxpayers, they would need to borrow money in order to cough up an extra $10,000 to the Treasury right now. Additionally, the owners of fixed capital (such as factories and farms) might choose to sell off their holdings to raise the money, but many probably wouldn’t want to do that—so instead they could post their buildings or land as collateral to get a loan in liquid funds from a bank or other lender.
Notice that resorting to borrowing in order to pay the lump sum $10,000 Treasury surtax would be preferable for many households to simply tightening their belts. In other words, if borrowing weren’t an option, many of the taxpayers would find it possible to come up with an extra $10,000, particularly if they had a few months to pay it. They could choose to greatly restrict their standard of living, including selling off items like the family car. But rather than do that, many households would probably pay a portion of the tax bill out of current income, but defer the rest to the future via borrowing from the credit market.
And so we see that even though society as a whole “pays for the war” through real resources, in a financial sense it would be the owners of liquid assets who “paid” for it, while most others deferred the pain down the road.
After laying out these facts, Mises explains that the government effectively achieves the same outcome but with less friction, when its own treasury floats bonds in order to “pay for” the current wartime expense. (One reason there is less friction is that the government can typically borrow on better terms than private households.) The real resources for the war effort are still diverted out of present uses, and the owners of liquid assets still finance the expenditures, but in this route they lend directly to the government by buying its War Bonds, rather than lending to individual households who find the current tax bill untenable.
This is a critical point—and again, I spell it out more rigorously in my earlier article discussing Mises—so I want to emphasize it here at the end of this section: If the government raises $1 trillion by explicitly taxing the public, then the public is $1 trillion poorer (in financial terms). On the other hand, if the government only taxes (say) $100 billion and raises the other $900 billion by floating new bonds, then the public is only $100 billion poorer (in financial terms). Yes, it is true that the public still handed over $1 trillion in money to the government with which it will buy tanks, fighter jets, bombs, etc., but in the second avenue the people who handed over the $900 billion portion of it, received in exchange IOUs from the Treasury that have a current market value of $900 billion.
In this approach, the US government could spread the pain of the war cost over ten years. In other words, the people would only be taxed $100 billion per year for the decade. The total US debt would be $900 billion higher (than it otherwise would have been) at the end of the first year, $800 billion higher at the end of the second year, $700 billion higher at the end of the third year, and so on. After the tenth year, the federal debt would be back to where it otherwise would have been, had there been no $1 trillion one-shot war expense and corresponding decade of dedicated annual $100 billion surtaxes to pay for it. (We are ignoring interest expenses to keep the math easier.)
Think of it this way: Taxes are involuntary. People are effectively forced to pay them. But lending to the government is voluntary. People only buy government bonds if they believe the interest yield and associated default risk are worth it. This is the fundamental reason that deficit-financed government spending is more popular or less “painful” than balanced-budget government spending.
We can understand why it makes economic sense for a young couple to borrow money from a collection of retirees in order to buy a new house—with a commercial bank serving as the “middleman” in originating this mortgage. In the same way, it makes economic sense for workers or even capitalists with fixed assets to borrow money from capitalists with liquid assets in order to pay their allotted share of an unusually high government expense. The bond markets help borrowers and lenders find mutually beneficial rearrangements of the timing of income and expenditures, even though the mere issuance of IOUs per se doesn’t directly alter the productive capacity of the economy as a whole.
[EDIT: Added 5/18/24 for clarity:] To avoid confusion, we are not saying that a group of capitalists restrict their consumption by $900 billion in the year of the military surge. Rather, a group of capitalists who would have saved in other avenues almost the same amount are instead redirecting their savings into the new Treasury debt. In physical terms, society is redirecting resources that would have fostered higher consumption down the road into the war effort. This makes sense, because we already know that society as a whole will be "paying for" the present war effort by shrinking consumption over the next decade.
Why Does a Government Borrow Money When It Can Just Print New Money?
Now let’s tweak the above analysis. Suppose we have the same situation, where the US government wants to come up with an extra $1 trillion in order to buy a bunch of tanks and other equipment to go fight in Ukraine. We’ve seen above why it would ease the burden on certain members of the US taxpaying population to effectively spread the tax cost of the war over a ten-year stretch, rather than each household having to truly “pay for it” in one shot upfront.
The same logic applies if the US government turns to the Federal Reserve and asks it to simply monetize the expense. Specifically, if the government simply createdout of thin air a new $1 trillion in order to pay military contractors, hire more troops, buy more jet fuel, etc., then the American public would still effectively be bearing the “real” cost of the war in economic terms. Any steel, rubber, labor hours, etc. going into the war effort would be channeled away from potential use in the civilian sector. Americans in general would have less to consume in goods and services during the year, corresponding to the huge spike in output from the military-industrial complex.
But if the government financed the war simply by letting the Fed rip, then the distributional impact of the inflation might cause inordinate pain to particular households. The way inflationary finance works is by making goods and services so much more expensive that households (with their original income and savings) can’t afford to buy as much in the marketplace as they could before. So even though the IRS doesn’t directly suck dollars out of people’s bank accounts in this scenario, if the full $1 trillion is financed through printing up $1 trillion right now, certain households will be ravaged. This is especially the case for, say, retired individuals living on annuities or other fixed-income assets that don’t have a special CPI clause.
In this scenario, and for the exact same reason as before, the government might decide it would be fairer and less socially disruptive to only print (say) $100 billion in new money at first, while borrowing the other $900 billion. This allows the government to finance the $1 trillion price tag of the war effort, but with the public only suffering an implicit “inflation tax” of $100 billion in the first year. Then in Year 2, the government could print up an additional $100 billion in new money to retire $100 billion of the outstanding Treasury debt, and so on, until the full $1 trillion in new money had been issued in order to redeem the last penny of war debt. By the time the dust settled, US prices would have risen the full amount due to the influx of a new $1 trillion, but the crucial point is that the public would have had a decade to adjust and bear it.
The MMTers Don’t Know This
As the analysis above demonstrates, there can be a very sensible “public welfare” justification for issuing government debt, rather than relying on full taxation and/or inflationary finance, given that the government is going to make the expenditure. (In other words, I am certainly not endorsing a US government plan to wage war on Putin, and I also would have advised the Austro-Hungarian government to avoid World War I altogether.)
Yet as a last point, let me mention with irony that the MMTers don’t know the above. In the context of the documentary, it is pretty clear that Stephanie Kelton is asking the question rhetorically because she thinks the answer is, “There IS NO reason the Treasury should be issuing debt.” (For his part, MMT founder Warren Mosler in his debate with me at Columbia University explicitly said that he favored the Treasury ceasing its bond issuance altogether.)
Finally, L. Randall Wray, who (besides Kelton) was the star of the documentary, has a recent post in which he specifically addresses the viral Jared Bernstein clip. Here are the three possible reasons Wray lists to explain the seemingly mysterious practice of the US Treasury borrowing money when the Fed can simply create new dollars:
Let’s take a test. Which of the following is the best answer to [the] question?
1) Government must borrow to finance its deficits because printing money would cause massive inflation.
2) Government must borrow to finance deficits because that’s the law.
3) Government sells bonds to reduce downward pressure on interest rates.
Coming on the heels of my earlier discussion, I hope it’s clear to the reader that I think the right answer is 1). Yet Wray rejects this, by arguing:
The first answer is wrong because all government spending (no matter the budget balance) takes the form of a credit to the recipient’s bank deposit—which is included in everyone’s definition of money. While the term “printing” is a bit misleading—since payments take the form of an electronic entry to a bank balance sheet—the point is that all government spending increases the money supply. If that caused hyperinflation, we’d have hyperinflation all the time.
This is really frustrating, to realize that the chief gurus behind MMT are this dull. In the MMT framework, they view our hypothetical US government expenditure of $1 trillion as creating a new $1 trillion in the hands of the public. That’s not how I would describe it, but fine. But then, the MMT framework would also have to say that when the Treasury issues a new $1 trillion in bonds, that the government thereby subtracts $1 trillion in money from the economy. That’s why—even in the MMT framework—a purely bond-financed government expenditure doesn’t inflate the supply of US dollars, just as the Austrians, Chicagoans, and Keynesians would agree. The other schools would say, “The government doesn’t create new dollars if it just spends what it first borrowed,” but if the MMTers want to reverse the order and say the government creates the $1 trillion by spending it and then destroys the $1 trillion by borrowing it back, fine. Either way, the public isn’t holding more US dollars than at the start, and so we won’t see prices at the grocery store or gas pump zooming up the way they would without coupling the expenditure with a massive new bond issuance.
Conclusion
The MMTers are understandably proud of their new documentary, because it does a great job of showing that some of the “elite” orthodox economists don’t know what they’re talking about. However, just because their critics are often fools, doesn’t mean the MMTers are therefore correct. When it comes to the role of debt in government finance, the documentary and follow-up writing from leading MMT gurus show that they don’t know what they’re talking about, either.
Comments