By J.D. ALT Since the Democrat’s presidential debates, the attacks on progressive candidates for their “unrealistic” proposals to address the biggest challenges we face as a collective society have intensified dramatically. The primary criticism is the enormous price-tag associated with each of the big-ticket issues they propose to undertake: universal healthcare, mitigating climate-change, eliminating college debt, free pre-school daycare, re-envisioning and rebuilding America’s infrastructure, a job guarantee and a universal basic income for every citizen. The attacks come from both conservative Republicans and centrist Democrats, each of whom are avowed believers in fiscal “responsibility” and balanced federal budgets. Unfortunately, while there is growing sympathy with the
J.D. Alt considers the following as important: J. D. Alt, MMT, Modern Monetary Theory
This could be interesting, too:
Michael Hudson writes International Trade and MMT with Keen, Hudson
Matias Vernengo writes Modern Money Theory in the Tropics: A Reply to Agustin Mario
Peter Dorman writes Monetary Sovereignty, Sanctions and Russian Economic Policy
Michael Stephens writes Join Us for the 2022 Levy Institute Summer Seminar
By J.D. ALT
Since the Democrat’s presidential debates, the attacks on progressive candidates for their “unrealistic” proposals to address the biggest challenges we face as a collective society have intensified dramatically. The primary criticism is the enormous price-tag associated with each of the big-ticket issues they propose to undertake: universal healthcare, mitigating climate-change, eliminating college debt, free pre-school daycare, re-envisioning and rebuilding America’s infrastructure, a job guarantee and a universal basic income for every citizen. The attacks come from both conservative Republicans and centrist Democrats, each of whom are avowed believers in fiscal “responsibility” and balanced federal budgets.
Unfortunately, while there is growing sympathy with the progressive goals themselves, the advocates of those goals still don’t have a convincing explanation or formula for how the federal government will pay for it all. The best they can come up with is that we’ll increase taxes on the super-wealthy and the big corporations—or that it’s simply unacceptable, conceptually, that the world’s richest democracy cannot manage to achieve these goals for a healthy society. So long as these are the progressive narratives—even if they manage to win the upcoming elections—the goals will never be achieved. To create genuine, wide-spread support for undertaking the big-ticket issues we face, it will be necessary to explain to America how its monetary system actually works.
So, how do we get there? So far, the Modern Money narrative is bumping hard against an even harder ceiling of disbelief. Even the progressive political advocates themselves cannot—or will not—make a direct attempt to explain it. This, of course, is pragmatically understandable: the first candidate who makes the attempt will likely not survive the pushback of public ignorance and misinformation. Nevertheless, until this challenge is tackled, we can write off the “progress” in “progressivism.” A strategy needs to be established and implemented to create a Modern Money Explanation and frame it to be easily understood and politically palatable.
A few thoughts toward that end
I recently watched the blood drain from Erin Burnette’s cheeks as she announced on CNN, with one of her most consternated expressions ever, that Bernie Sanders had “admitted” his Medicare-for-All program would “cost” $40 trillion. Her blanched expression said it all: How could he even be dreaming that the federal government was going to pony up $40 trillion to pay for America’s healthcare? I’d like to up the ante: it won’t “cost” $40 trillion, but $320 trillion! The narrative we’re trying to create must help Erin (and everyone else) wrap their intelligence around that scale of number—and realize that, in and of itself, it is both immensely meaningful and totally meaningless.
How do I figure? First, Bernie’s $40 trillion price tag is calculated for a 10-year period. But why arbitrarily use a decade’s calculation? Are people going to stop needing healthcare ten years from now? A more meaningful calculation, I would argue, is over a lifetime—so I’m figuring 80 years. Let’s proclaim it then: at today’s prices, Medicare-for-All will require a payment of $320 trillion for each generation of Americans!
Next, we must consider in what sense this number has meaning. Erin’s facial capillaries are clearly responding to the egooptic (a word I just made up) perception that when I “spend money” what happens is that, first, I have to get it from somewhere, second I spend it in exchange for something else and, third, I consequently don’t have it any more. From an egooptic point of view, this is clearly what happens. Erin’s mistake, however, is imagining that the currency issuing U.S. federal government is an egooptic entity—like a person, or a family, or a business. This factually is not the case.
To see why, first consider what the $320 trillion represents. Does it represent a finite amount of some thing the federal government needs to get its hands on—or does it represent the measurement of something, as in “three hundred feet of ribbon”? If America were still on the gold-standard, and the government had to be able to redeem every U.S. dollar for 32oz of precious metal, then $320 trillion would factually represent a finite amount of gold (which would vaporize Medicare-for-All in an instant, because there is not anywhere close to $320 trillion worth of gold on the planet).
If, instead, $320 trillion is a measurement of something, two questions arise: (a) What is being measured? And (b) is it possible for that thing to get so large that we run out of units of measurement? Can a ribbon get so long that we run out of “feet”?
The answer to the first question is: our calculated $320 trillion represents and measures the amount of healthcare services a generation of American citizens will need to obtain over their lifetime. Whether you think it’s an absurdly big number is irrelevant. It is what it is, and there are only two ways it could be made smaller: (1) reduce the amount of healthcare services the generation will need, or (2) change the unit of measurement—i.e. define the “foot” to be longer so the ribbon is, say, only 200 feet long when you measure it instead of 300.
The answer to the second question is established by the U.S. Federal Reserve Act (established, in other words, by “fiat”). This democratically imposed component of the American social contract gave the Federal Reserve (American’s central bank) the authority to create units of measurement—U.S. currency—as needed to measure whatever length of ribbon the American people choose to produce and consume. It was not always the case this could be made to happen. Prior to the U.S. Federal Reserve Act, when the U.S. (at the demand of east-coast financiers) was returning to the gold-standard after the civil war, southern and western farmers in America produced, at every harvest, ribbons and ribbons of corn and cotton which they could not sell for the simple reason there was not enough currency to measure it—creating, year after year, extraordinary hardships and economic crisis. The Federal Reserve Act changed that.
Which means that if a generation of American citizens decides they want or need to consume $320 trillion worth of healthcare services, the Federal Reserve is authorized to create the U.S. currency necessary to enable it to happen. The only impediment would be if there aren’t enough doctors, nurses, radiologists, examination rooms, surgical suites, bandages, drugs, etc. available to provide for the demand—in which case the citizens will, obviously, only consume what’s available (and the Federal Reserve will create the commensurate amount of currency).
In other words, just because we have a theoretically infinite number of “feet” to measure ribbon with doesn’t in itself produce an infinite amount of ribbon. Or, to put it another way: the issue isn’t whether there’s enough “feet” to measure (i.e. pay for the production and consumption of) our ribbon, but rather how much ribbon is actually available to be measured. Erin’s real concern, therefore, should be whether America’s boundaries contain enough real resources that can be marshalled to provide $320 trillion worth of healthcare over the course of a generation.
This brings us to the second aspect of why Erin should let her cheeks return to their rosy blush: From a non-egooptic perspective (shall we call it, “sociooptic”?) the $320 trillion price tag for a generation of healthcare doesn’t represent a cost, it represents an earnings. Specifically, it represents what a very large sector of American businesses and citizens are going to EARN by the act of providing healthcare services to America. In other words, unlike the egooptic perspective (after the spending occurs the money is “gone”!) the sociooptic view sees that in order for money to be EARNED it must first be spent. This may sound like a chicken-and-egg paradox—which happens first, does the money get spent, or does it get earned so that it subsequently can be spent? From the Federal Reserve’s perspective, however, there is no paradox at all: if new money needs to be spent in America, the Fed simply creates it.
How can the Federal Reserve do that?
There are certain rules and procedures that must be followed, of course. It doesn’t happen arbitrarily because someone thinks it should happen. It happens in response to something. So, how does the Fed know when new money needs to be created? One way it knows is when, at the end of an American business day, there are more checks and interbank transactions to be cleared at the central bank than there are Reserves held in the various bank’s Reserve accounts. This means the bank’s collectively have created more “bank-dollars” (which are claims on their Reserves) through loan operations than there are Reserves to back up the claims. When this occurs, the Fed automatically creates new dollars to cover the shortfall. (A shortfall is not ever allowed to occur because the entire U.S. financial system depends on the certainty that, at the end of every business day, all the legitimate claims on bank Reserves clear.)
But the Fed does not just give the new dollars to the bank’s Reserve accounts for free. What happens is the Fed keystrokes the new dollars into the needful bank’s Reserve account in exchange for some collateral ponied up by the bank. The Fed now holds the bank’s collateral, and the bank holds the new dollars in its Reserve account—which enables the claims on those Reserves, generated by its expanded loan activity, to be fulfilled. Voila! New money that American enterprise has demonstrated it needs—by virtue of the willingness of people and businesses to borrow, and the willingness of banks to loan—has been created. Presumably, when the bank’s outstanding loan is repaid with interest, it will redeem its collateral from the Fed using the profits derived from that interest.
Private debt, then, driven by the expectations of PROFIT-MAKING enterprise, is one of the primary instigators of new money creation by the Federal Reserve. There is another driver, however, equally important, that is shrouded in even greater (if that is possible) and more obfuscating confusion: the creation of new money by the Fed’s purchase of U.S. treasury bonds on the open market. What our explanation needs to make clear is that this operation is not only a money-creating action, the dollars it generates are specifically targeted toward the NON-PROFIT enterprises of the public good.
Here is where Modern Money takes flight!
The Treasury is the spending arm of the U.S. government. (If Medicare-for-All is implemented, the $320 trillion will be spent by the Treasury.) The dollars the Treasury spends come from two sources: (1) federal tax collections from America’s businesses and families; and (2) the issuing of U.S. treasury bonds (by the Treasury) in exchange for Reserves from the U.S. banking system.
The first source is intuitively well understood by virtually everyone: the federal government wants to spend dollars for something, so it collects tax-dollars from citizens and businesses for the spending. The second source arises from the situation where the federal government can’t even come close to collecting enough tax-dollars to cover the spending Congress has decided is both necessary and desirable for the public good. So, what to do? Answer: The Treasury issues U.S. treasury bonds and trades them for Reserves from the banking system to cover the spending shortfall. This second source of new spending dollars for the federal government is not only misunderstood, it is willfully misunderstood (and the misunderstanding willfully manipulated) by politicians and ideological pundits seeking to control the American agenda.
The misunderstanding is easy to encourage and nurture because, to a casual observer, it appears obvious that when the Treasury issues a bond, it is undertaking a debt it will have to repay with future revenues. Just like each one of us, personally, must calculate (or hope) that our future income will be adequate to pay off a debt we undertake, so must the federal government make the same calculation. End of argument. If the U.S. federal government takes on a debt, it will have to come up with future revenues (TAXES!!!) to pay it off.
Framed this way, it doesn’t take mathematical sophistication to quickly “demonstrate” that America already has a far greater “debt” than it can ever hope to repay with future tax revenues. But this framing—which creates an unsolvable dilemma for American politics—hides a fundamental untruth in its logical premise. And it is this untruth, and our misapprehensions about it, that prevent us from confidently undertaking the big-ticket issues we face as a collective society—issues which private enterprise will not, or cannot, undertake because they do not fit into a profit-making business model.
Is a treasury bond a “debt” or not?
A thought experiment can reveal the untruth I’m referring to. Ask yourself: could the Treasury pay for things—like, say, Medicare expenses—directly with treasury bonds, instead of first trading those bonds for Reserves, and then using the Reserves to pay the Medicare invoices? Assuming there’s no statute to prevent such payments, the only question is whether the Medicare providers would accept the treasury bonds as payment. If they were, in fact, willing to do that, then the Treasury, when it created a bond, would not be creating a “debt,” but would be creating “money,” as it was needed, to fulfill the spending assignments appropriated by Congress. But why would a Medicare provider—or a climate mitigation contractor, or a community college administrator, a pre-school daycare operator—agree to accept a treasury bond, for payments promised, instead of U.S. dollars?
The answer is because U.S. treasury bonds have a liquidity that is virtually equal to cash: anyone who receives a treasury bond as payment can easily and quickly trade it for U.S. dollars. This interchangeability is unique to U.S. treasury bonds. Corporate bonds or municipal bonds do not have the same liquidity for the simple reason that they each entail some level of real risk that the entity issuing the bond will be unable to redeem it or make its promised interest payment. Why do treasury bonds and corporate-municipal bonds differ in this regard?
To see why, consider that corporations and municipalities—like small businesses and households—must earn the dollars necessary to redeem their bonds. If things don’t go as planned—if corporate profits fall, or local tax revenues decline—the future revenues the bond redemption depends on fail to materialize, and the bondholder loses all or some of his investment. The corporation or the municipality cannot simply issue new dollars as necessary to make the bond good. Which is precisely what the U.S. Federal Reserve can and does do, without fail, in the case of U.S. treasury bonds.
The U.S. federal government, then, does not have to collect tax revenues in order to redeem treasury bonds. It does NOT depend on “future revenues” to repay its “debts.” If you want proof of this, simply consider that over the course of U.S. history, the federal government has issued and redeemed over $20 trillion worth of bonds which have not been repaid with tax revenues. How can the federal government do this while American families, businesses, corporations, and local governments cannot?
Our thought experiment shows us: When the U.S. Treasury issues its bonds, it is actually issuing new “money.” Whether that “money” is spent directly to the suppliers of goods and services—who then trade it for dollars from the banking industry—or is traded first to the banking industry for dollars, which are then spent by the Treasury, is an instance of Einstein’s “equivalence principle”: if you can’t tell the difference between two things, they are the same thing. U.S. treasury bonds, then, are nothing more than “future dollars” that have value today precisely because their future value, and the interest premium they bear, is the most ironclad, risk-free, guarantee that exists in the modern world today. And the U.S. Treasury is authorized to create these “future dollars,” as needed, to pay for any expenditures authorized by Congress.
For all of that, our thought experiment turns out to be unnecessary because a very simple operation— coordinated between the U.S. Treasury and the Federal Reserve banking system—makes it possible for the Treasury to spend today the future dollars it creates with its treasury bonds. I’ll make this short:
- The Treasury issues a treasury bond.
- The Federal Reserve keystrokes new reserves—equal to the value of the treasury bond—into one of its banks’ Reserve account in exchange for some collateral.
- The bank trades the new Reserves to the Treasury in exchange for the treasury bond.
- The Federal Reserve returns the bank’s collateral in exchange for the treasury bond.
End result: The Treasury has new spending money equal to the value the treasury bond just issued. The bank is returned to the same position it originally held. The Fed has on its balance sheet the newly issued treasury bond. The Fed now “owns” something it logically doesn’t need at all, ever—future dollars. If you want to run your own thought experiment, I’ll leave it to you to think that one through. (Hint: why does it need something it creates, as needed with keystrokes?) The important work our explanation needs has already been accomplished:
The U.S. Treasury has created the money it needs to buy (from the American people themselves) the non-profitable goods and services that Congress has determined, through its democratic processes, are in the best interests of America’s collective society.
Now we know WHY America is rich!
Is America rich because we have a lot of wealthy people and giant corporations our government can levy taxes on? Is it rich because we have huge capital markets our government can borrow dollars from to pay for our collective needs? Modern Money shows that neither of these are the reason. America is truly rich because, first, it possesses abundant real resources—trained, educated, and creative labor, advanced technologies, water, forests, minerals, fertile soils and temperate growing seasons—and, second, because it possesses and manages a sovereign monetary system that enables us to pay ourselves whatever dollars are necessary to marshal those real resources for our collective benefit. The big-ticket issues we confront, then, are not something to be afraid of. They are something we can afford to pay ourselves to do—and should celebrate the doing of.