Imagine an economy that consists of two households, one firm, one bank, and one government.
The government issues $50 to each household (maybe they do some work for it), crediting their bank accounts and running a $100 deficit. Voila! There’s money!
Now one household works for the firm, creating $50 in value, goods. The firm gives the household $50 in equity — company stock — basically a promise to give them some amount of money in the future. (The firm posts the $50 in newly created value as an asset on the lefthand side of their balance sheet, and $50 as shareholder equity on the righthand side — a liability).
The household can’t use that equity to buy a pack of gum today, so they want to monetize it — sell it to someone else. There’s only one “someone” — the other household.
But what if the other household doesn’t want to buy it because they’ve only got $50 and want to hold it for the future? (It’s the babysitting coop dilemma.)
This is why in a growing economy where extra value is being created through people’s efforts, the government has to run deficits — creating money by crediting people’s/firms’ accounts with newly “printed” dollars.
If people can’t convert that extra value they’ve created into general-purpose “credit” (dollars) that can be exchanged for a variety of goods, they can’t spend. Which 1) gives them notably less incentive to create the value in the first place, and 2) prevents them from continuing the buying/selling log-rolling exercise that is our economy.
You’ve got a lot of newly created value/goods, but nobody with money to buy them.
Imagine if the cumulative government deficits today — the stock of money that government has spent into existence — were at the same level it was in 1900. The economy would be completely inoperable, locked up in primitive barter arrangements for lack of general-purpose money.
This is why government debt is not never, has not ever been, cannot ever be, paid off.
Another way to think about this: money — created, provided, by government as a public good — is a means for us to save consumption for the future. (“Saving consumption” is a funny concept, but it’s what we do when we put dollars under a mattress.) The only other way to do so is to create consumable real assets that will last, including those that can be used to create more consumables in the future (themselves being consumed in the process). It’s pretty impractical for a household to save all their consumption in this way, for all sorts of physical, personal, and logistical reasons.
Cross-posted at Angry Bear.
Comments
15 responses to “Why the Government Must Keep Running Deficits. Forever.”
This is a ridiculous argument, similar to “there cannot be a gold standard because there is not enough gold in existence to back paper money.” To refute the answer would take too long, but I suggest you read Economics in One Easy Lesson or How An Economy Grows and Why It Crashes. It will explain economics to you in simple terms.
http://www.ftense.com/p/recommended-reading.html
This is wrong. The government does not have to run budget deficits to meet new growth in wealth.
1. The country can be a net exporter which would have the same effect as a budget deficit.
2. The private sector could issue debt/equity (companies “monetize” other companies all the time this way – it’s called a leveraged buyout).
3. Prices could fall to adjust for the newly created “value”.
I should add a 4th way which is for the Fed to purchase assets directly.
@FDO
“This is wrong. The government does not have to run budget deficits to meet new growth in wealth.”
That is wrong.
“1. The country can be a net exporter which would have the same effect as a budget deficit.”
And is printing money just the same – where do you think the export nation would get it’s dollars?
“2. The private sector could issue debt/equity (companies “monetize†other companies all the time this way – it’s called a leveraged buyout).”
This won’t increase dollar or dollar-denominated financial wealth.
“3. Prices could fall to adjust for the newly created “valueâ€.”
The “deflation is our friend” argument.
“I should add a 4th way which is for the Fed to purchase assets directly.”
Purchasing financial assets doesn’t add net dollars to the non-government unless you are talking about purchasing real-estate and the like. I don’t know if that is legal and besides, why would that be superior to printing money?
True enough with an unbacked currency, and this is precisely the problem with it. Issuance of new money through debt makes it a function of the financial sector, and the problems with this are as theoretically obvious as they are historically manifest. Whatever the problems of a convertible money, it has the great virtue of being (at least potentially) self-regulating, democratic and apolitical.
On the other hand it is absurd to qualify money as “created, provided, by government as a public good”. Money is defined by function, not provenance. US laws mandate the US dollar, but this was not always the case. The Spanish dollar competed with the British pound as colonial currency, and at a different time company towns issued their own script. Redeemable bank notes were common. In the absence of laws that mandate a specific currency the market is well able to provide alternatives, and can insulate itself from the deflationary or inflationary movements of a specific currency without resorting to crude barter and cattle trading. Whether this is preferable or not, is an entirely different argument.
Steve,
This is why in a growing economy where extra value is being created through people’s efforts, the government has to run deficits — creating money by crediting people’s/firms’ accounts with newly “printed†dollars.
Noooooooooooooooooooooooooo…………..
This creeps into one of the posts up the page as well:
government money (created through deficit spending)
Money is not created through deficit spending. Money (in this context) is a liability of the CB.
@vimothy “Money is not created through deficit spending. Money (in this context) is a liability of the CB.”
The Fed does in the course of things eventually have to provide reserves to accomodate that deficit spending, so payments clear. But long-term those issuance mechanics are are the tail, not the big dog.
There is no kind of government money other than the kind created by the Fed. The supply of government money increases IFF the Fed increases it. Nothing to do with deficits in any direct sense.
Also, reserves are a very marginal issue vis-Ã -vis the total stock of outside money. Basically, pre-crisis US we’re looking at about $10 billion in reserves and $2 trillion in notes and coin.
@vimothy
Sorry, that’s a reply to Steve, above.
The household that wants to monetise its company stock can always do it at the bank rather than have government / central bank do it (as is implied by Costard above, I think). In fact over 90% of money in circulation is private bank created rather than central bank created.
Positive Money and the New Economics Foundation put the figure at 97%, though I think that’s a bit high. See:
http://www.positivemoney.org.uk/2011/11/97-owned-democratise-money-supply/
and http://neweconomics.org/projects/monetary-reform
Having thrown cold water on the above reason for deficits, there is actually a valid reason for constant deficits, even given no economic growth in real terms, and it’s thus.
We have committed ourselves to a 2% rate of inflation. That means that the real value of government debt and the monetary base will fall at 2% a year. Assuming the amount of government debt and monetary base that the private sector wants to hold remains constant in real terms, then that debt and base will have to be constantly topped up via a deficit.
Ralph,
Then govt debt would be constant in terms of its real level, but not necessarily in proportion to GDP.
And the base is not topped up by deficits. The base is topped up by the central bank, because base money is a central bank liability.
Vimothy,
I’ve never understood why people describe money as a liability of the issuer. With a convertible currency maybe it makes sense. But under a fiat system it seems completely backward to me. Taxes, seigniorage (in a sense) flow back from the holder, just like interest payments on a debt.
Of course, vis a vis some other private entity the cash in my pocket is my asset. But between me and the issuer it’s a different story. Maybe I just think too much in terms of ontology…?
Agog,
That might or might not be the case, but the issue here is different. It’s not a question of whether we should treat CB money as a “true” liability of the CB (I would say we probably should, though a reasonable case can be made for the obverse), but where CB money comes from. Does it come from the government when it deficit spends, or does it come from the CB when it acquires assets during OMO, etc?
Vimothy,
You’re right – to keep the debt and monetary base constant relative to GDP the deficit needs to be even more than I suggested.
Re the base being topped up by the central bank, that’s true in a sense. But if you regard treasury and central bank as a combined unit, then that combined unit must spew out base dollars for the private sector to be able to accumulate them.
Or put another way the process via which base is created is thus. Treasury borrows from the private sector and spends the money back into the private sector, which counts as a deficit. At that stage, the private sector has no additonal base. But the central bank from time to time buys back those bonds with money created from thin air. It’s actually being doing this at an unprecedented rate recently in the guise of Q.E. That’s the point at which the base rises. So the ultimate source of base money is the deficit.
Agog,
Re money being or not being a liability of the issuer, there is an important difference between central bank created money and private bank created money. A central bank undertakes to give holders of its money absolutely nothing in return for that money. So that’s not a liability of the central bank.
Private banks are different. If a private bank issues too much money to incompetent borrowers, the bank goes bust. It’s happened hundreds of times thru history.