Home > Main > MMT Part I: The Government gets to spend all it wants*

MMT Part I: The Government gets to spend all it wants*

November 25, 2010

I see lots of people around the internet misunderstanding the basics of Modern Monetary Theory (MMT).  It is not their fault.  There are few easy to understand descriptions of MMT.  Warren Moslers 7 Deadly Innocent Frauds is very good, but even this doesn’t give the whole vision in a few sentences.

The problem is not that MMT is difficult to understand – it isn’t.  The problem is that there is not a well established set of talking points that people can use as mental crutches to work through the ideas.

The usual story of money creation is easy:  The Fed has a printing press, and can create all the money it wants.    MMT doesn’t have anything like this – at least until this series.

First, lets restate that simple statement about money creation into one that is factually accurate:

The Government Treasury has a printing press, and it can create all the money it wants.

This is the major difference between MMT and the traditional view of the money creation process.  But while this seems like a trivial distinction, it is huge.  It makes a difference so large that no one post can contain it – heck, a series of books wouldn’t be enough.

This difference profoundly impacts the world financial system – and so few people even know about it that it makes me want to cry.  We are much poorer than we need to be because MMT is not widely understood.

The Government Treasury has a printing press, and it can create all the money it wants.

To understand Modern Monetary Theory (MMT), you need to think differently about the entire money creation process.  Do not try to put it into any framework until you are pretty sure you understand the very basics. Imitate, then innovate.

If you try to put it into a trading model or other framework too soon, you will miss the important basics, and then make egregious errors in the analysis.   Start simple.

Again:

The Government Treasury has a printing press, and it can create all the money it wants.

In your mind:

Separate federal deficit spending and borrowing. They are distinct and do not imply each other.  The government does not need to borrow in order to spend.  Think of government spending in this order to understand MMT:

1.  Government spends

2.  Government taxes and gets some of that money back

3.  There is extra spending that the government just spent.  It didn’t borrow and didn’t tax.

At this point, the government is running what for a normal person would be a checking account deficit. Yikes!!  But it cannot bounce checks because it is the government. It can always change the amount of money in its account upwards or downwards at will, and will not get thrown in jail for doing it.  There is nobody to stop them from printing more money at will.

It might help to imagine a world without any USD. How can the government borrow a USD that does not exist?  It cannot. It needs to spend before it can collect USD taxes or borrow USD from someone.

Then the borrowing part comes later and isn’t strictly necessary:

4. The government chooses to borrow money.

“Grokking” this division between government spending and borrowing is absolutely necessary to understand MMT.

How is it possible for the Government to just spend?

Much of MMT relies on the monopoly of legitimate use of force by the state.  This gives the state powers that other entities do not have, like the ability to take part of your paycheck or earnings from you.  Last I checked, only my wife and the government has this ability for my earnings.

This is a remarkable power.  But that isn’t the Governments only power. Not only can it take my stuff, it tells me exactly what kind of stuff it wants.  And that is U.S. Dollars.  The government orders me to stock up on U.S. Dollars so it can take them from me.

I cannot pay taxes in gold, or corn, or oil, or factories, or even Turkeys and Cranberry sauce.  I need to pay in U.S. Dollars.  This coercive power is far beyond what any person can make me do.  And I do it quite willingly.

The reason the Treasury can exchange worthless pieces of paper (or bits in a computer) for goods and services is because it can throw people in jail if they don’t pay taxes in those same worthless pieces of paper or bits.   They have a monopoly on the legitimate use of force, and I do not.

So here is the difference between the traditional theory:  The Treasury has a printing press and can print all the money it wants.

The reason I accept these worthless pieces of paper as money is:  The government has a monopoly on the legitimate use of force, so I accept their worthless pieces of paper.

Next up: Treasury and banks both create money, but only one can be perpetually bankrupt for a few hundred years in a row.

*The government gets to spend all it wants, but not without consequence.   But the major idea stands, money is created by government spending through the treasury, and not through any fed actions.   The consequence is inflation if deficit spending is too high, or deflation if it is too low.  I put in the asterisk in the initial post, but forgot to put in this bottom part which explains the asterisk, until today 12-20.

Advertisements
Categories: Main
  1. Peter D
    January 9, 2011 at 11:05 pm

    Thanks for that -would love to see part II. Specifically, why money created by the banks in not usually considered “inflationary”? Or is it simply called “credit expansion” and is it still inflation by another name?
    I understand that bank-created money is not Net, but if the liability is simply reserves supplied on demand by the Fed, then those liabilities do nothing to offset inflationary pressures from the newly created loans, I would think. Or am I totally off?

    • TC
      January 10, 2011 at 8:22 am

      Hi Peter,

      I had a bit of unexpected business at the end of the year, so I wasn’t able to get to part II yet.

      Bank created money doesn’t create inflation in buying goods usually, simply because people take out loans to buy things like durable goods or productive assets. Bank created money nets to zero – the bank has an asset, you have a liability – so at some point that liability needs to be paid back. Not many people borrow to spend on things like food or gas, except on a very temporary basis.

      So the inflationary pressures that come with bank lending tend to be focused on segments of the economy that do not impact consumers. Additionally, because the money needs to get paid back, it subtracts demand at some point in the future. So the net impact on any prices must be something like: buy a bit more today, buy a bit less tomorrow.

      As I am thinking about MMT more and more, I am starting to see just how twisted the Austrian mentality really is. If we need to borrow to be able to afford everything we can produce, then something quite serious must be wrong with money.

      • Peter D
        January 11, 2011 at 10:57 pm

        As I am thinking about MMT more and more, I am starting to see just how twisted the Austrian mentality really is. If we need to borrow to be able to afford everything we can produce, then something quite serious must be wrong with money.

        I am a dilettante and a novice to economics in general, not only to MMT. It seems to me that MMT in its insights allows us to take advantage of the full potential of the economy, as opposed to concentrating on numbers and measures that are meaningless without relation to economic realities. Deficit hawks are like people telling you that you can never drive your car and press gas continuously because you’ll go too fast and crash. MMTers say, of course you can! it all depends on the road conditions. When you need to brake – brake, when you need to step on the gas – step on the gas. And don’t forget to steer.
        But from what I gather most economists think that MMT is wrong. They either
        1) are right (i.e., MMT is indeed wrong)
        2) don’t get it
        3) oppose MMT because it threatens them

        I would like to know how (2) can be true – is there something very hard about MMT that a lot of not stupid people cannot understand it? That would imply the world is in some sort of “Earth is flat” phase of economic understanding.
        I hope that (1) is not the case.
        (3) would mean a world wide plague of dishonest economists and this is also kind of hard to believe
        So, (1) remains the most plausible hypothesis, even if it is depressing.
        These are just random thoughts, don’t feel obliged to respond.
        Thanks!

  2. Peter D
    January 9, 2011 at 11:06 pm

    Thanks for that -would love to see part II. Specifically, why money created by the banks in not usually considered “inflationary”? Or is it simply called “credit expansion” and is it still inflation by another name?
    I understand that bank-created money is not Net, but if the liability is simply reserves supplied on demand by the Fed, then those liabilities do nothing to offset inflationary pressures from the newly created loans, I would think. Or am I totally off?

    (Don’t know if the comment went thru, so, trying to post twice. Delete if needed)

  3. Peter D
    February 5, 2011 at 9:35 pm

    So, getting back to the important distinction between Fed and Government created money. I am probably not grokking it enough, but it seems to me most people realize it is the govt that can just “print money”. Most laymen don’t even know what the Fed is exactly. The problem there I think is that people assume money printing automatically results in inflation and/or currency devaluation.
    Given that, I still cannot understand why it is so hard for people to grok the sectoral balances accounting identity
    G-T = S-I + M-X
    which makes it clear that for a country with CAD (M-X>0) such as ours government deficit G-T is absolutely necessary for domestic private sector’s surplus S-I. I did not study economics but I had the impression that this equation is taught in every elementary economics course. What is then the objection people might have to this simple fact? What am I missing?

  1. No trackbacks yet.
Comments are closed.
%d bloggers like this: