Saturday, February 2, 2013

These are not my original questions.  I've rephrased them slightly, based on ones posted at NEP by Nathan Becker. I'f you're already  familiar with MMT, you'll know the answers, but if you're not, please consider them seriously and think about how a classical economist would answer them.

1.  It is a fact that US Federal taxes can only be paid in US dollars, so what comes first, taxes or dollars? Where do the US dollars come from before our taxes are paid?

2.  It is widely thought that the US government borrows dollars. How did the lenders get these dollars in the first place? Can you borrow something that doesn't yet exist?

3.  If we really are borrowing from someone, shouldn't the lender be the one setting the interest rates and not the borrower? How come the US govt can set the interest rate at which it wants to borrow and how come the rates keep going down even as it borrows more and more?

If these questions seem baffling, I recommend reading

Just to whet your appetite, the MMT answers are

1.  Dollars come first, obviously, or we wouldn't have any to pay taxes with.  The thing not obvious to classical economics is that the dollars are created (from nothing) by US government spending.  Government spending, then, is not funded by taxes.  The government need not collect taxes first, before it can spend (though we do have laws, anachronism from the days of the gold standard, that say it does have to tax, or borrow, first.)

MMT doesn't talk about it, but I think this is how dollars originally came into existence:  there was gold, or foreign money like British pounds or Spanish dubloons, and the US government purchased it (spending) from the owners, issuing paper certificates (dollars) for it.  At the same time, taxes were levied, and payment was required in US dollars;  British pounds and Spanish dubloons were not accepted in payment of tax.  This gave value to the dollars, since nothing else would keep the taxpayer out of jail.  This is the essence of monetary sovereignty.

2.  Obviously you can't borrow something that does not exist.  The dollars that these lenders have were created by US government spending.  The Chinese central bank can hold dollar balances in its "checking" account at the Fed, or it can hold the dollars in the form of interest-bearing "savings" accounts at the Fed (aka Treasury bills and bonds).  They can transfer funds between these accounts just as you can do at your bank, or in your brokerage account.  The Treasury securities were created from nothing by the Treasury department, and sold to some special US banks known as "primary dealers", and then resold to others who desired a risk-free, interest-bearing investment (e.g., pension funds and foreign governments).

3.  The US government is the only source of dollars.  The US can set the interest rate on Treasuries because it stands ready to buy or sell them in any required quantity at the rate they set, through the Federal Reserve.

If you read a lot at NEP, you will see it stated that private banks create money when they lend.  They do create money, but that is not the same as creating dollars.  Your deposits in bank accounts are an obligation of the bank, a loan from you to the bank, denominated in dollars, but they are not dollars.  The currency in your pocket is dollars.  If your bank fails, you have no dollars (except what you might get from FDIC).  Just like if your buddy borrows money from you and then goes bankrupt and doesn't repay you.

There is a lot more to it, but think about this:  if the US government can create as many dollars as it wants, without taxing or borrowing, then what is all the fuss about the size of the deficit and the "national debt"?  The government can always pay any obligation that is denominated in US dollars, and there is no possibility of involuntary default.  There is no financial constraint.

But what about inflation?  Inflation can only occur if government spending creates demand for more product than the economy can produce.  As long as there is high unemployment, additional production is possible and inflation is not.  Today, still reeling from the Great Recession, we need more spending and lower taxes.  Our representatives are contemplating the opposite.

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