PKT
mailing list archive
[ Other Periods  | Other mailing lists  | Search  ]
Date:  [ Previous  | Next  ]      Thread:  [ Previous  | Next  ]      Index:  [ Author  | Date  | Thread  ]

Re: Keynesian State of the Union



Bill Mitchell wrote:

every dollar the government spends provides the essence for the non-govt sector
to pay its taxes not the other way round.
Exactly.  Moreover, if government does not spend, the system will have no money.  PRivate money cannot exist without the enforcement of contract law, which means it ultimately is backed by government money.


We have to break this notion that government spending needs to be financed.
Right again.

When a government issues currency and circulates money through the banking system, it is in essence issuing credit to the economy that it is entitled to receive back in taxes. Government then spends the tax money on goods and services that the public provides. The surplus money that is not returned by taxes is government credit floating around the economy to keep it operating financially.

It is important to understand that money issued by the government, unlike private money, is not IOUs from the issuer. Money, when issued by government as a legal tender, is a credit from the government good for the payment of taxes, and for settling "all debts, public and private", as printed plainly on all Federal Reserve notes. A US dollar is a Federal Reserve note that entitles its holder to exchange it at any of the six Federal Reserve Banks for another Federal Reserve note of the same face value, no more and no less, at least since 1971 when the late president Richard Nixon took the dollar off the gold standard.

Even before 1971, while an ounce of gold was officially pegged at $35 by president Franklin Roosevelt on January 31, 1931, a domestic holder of a dollar note could only exchange it at a Federal Reserve Bank for another dollar note, since US citizens were forbidden by law to own gold. Only foreigners could demand gold for dollar up to 1971.

A government bond, which on the surface looks like a government debt, is merely a call on government credit previously issued, withdrawing dollars from the money supply by providing a government bond. Government bonds are the living proof that money is not an IOU from the government, otherwise when government sells or redeems bonds, it is perpetrating a Ponzi scheme of paying off old debt with new debt, rather than exchanging debt instruments (bonds) with credit instruments (dollars).

Sovereign debt is fundamentally different from corporate debt. A corporate bond entitles its holder to claim its face value in dollar notes that the bond-issuing corporation cannot create by itself. It must earn dollars with the bond proceeds to pay interest on the bonds. At the time of redemption, if the corporation already spent the bond proceeds, it must then earn back or sell assets or borrow the dollars from somewhere to redeem the bond.

In contrast, a government bond entitles its holder to claim from a Federal Reserve Bank its face value in dollars that the government can print at will, even if it already spent the bond proceeds. The interest on the bond is also paid with dollars of which the government has an unlimited supply. Part of the dollars that the government spends will come back from the public in the form of taxes. The rest will stay in the economy to finance its operations.

So if the government runs a surplus, meaning it takes in more tax money than it spends, it drains money from the economy, forcing the economy to contract. A budget deficit is in essence an injection of more government credit into the economy.

Private citizens can own assets, but whenever such assets are monetized with dollars, one trades those assets for credit from the US government that other market participants in the economy will accept because, aside from its status of legal tender as defined by law, it is good for negotiating tax liabilities.

Technically, a government never borrows. It issues tax credit in the form of money. So when former president Ronald Reagan said the government does not make any money, only the private sector does, he was merely mouthing conventional wisdom, with no clear understanding of the true nature of money and credit. In fact, money is all that government makes. Thus any government that takes on foreign-currency debt or allows its economy to do so is taking unnecessary risk.

The main function of sovereign debt is not to make up for any shortfalls in government funds. Such shortfalls cannot exist by definition. Rather, sovereign debt instruments act as fundamental collateral for the nation's credit market. The Fed Open Market Desk buys and sells government securities to maintain the Fed funds target rate set by the Federal Reserve Board. The repo (repurchase agreement) market, which provides overnight and short-term funds for banks, operates with government securities as collateral.

Thus IMF conditionalities of reducing sovereign debt by imposing budget surpluses and price deflation as a cure for a distressed credit market of excessive foreign debt is merely adding gasoline to fire.

As a sovereign bond is redeemed with cash, it is in essence replacing a call instrument on government credit with government credit. When government securities are withdrawn and cash floods the economy, the debt market shrinks because the amount of collateral shrinks and the amount of cash increases, reducing the need for credit, and the economy contracts with cash inflation, unless the cash is immediately recirculated as private debt or investment.


Henry C.K. Liu

[ Other Periods  | Other mailing lists  | Search  ]