Category: federal debt

The Crack in Our Windshield

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May 28, 2023

by Stephen Stofka

This week’s letter is about debt, both public and household. Since 9-11, the public federal debt  has grown five times. The causes include costly wars in Iraq and Afghanistan, a global financial crisis followed by a slow recovery, tax cuts passed under the Trump administration and a once-in-a-century pandemic. Ten percent of the $32 trillion debt was added during the first three months of the pandemic. As the deadline approaches when the government will not be able to make timely payments to vendors and bondholders, we ask why do we have this thing called a debt limit?

Denmark is the only other country in the world to require an approval of a debt limit after the spending has been approved. Their legislators raised the limit so high that it might be a century before the issue comes up again. That leaves only the U.S. in the world where a debt limit debate is a threat. Neither party wants to repeal this century old law because it has the potential to be a powerful negotiating tool. It allows one party to negate or modify the funding priorities that the other party passed in the last legislative session. This is a game of chicken played for high stakes.

Some have criticized the Biden administration for not starting negotiations sooner. However, the House did not put anything on the negotiating table until they passed a bill on April 26th, just a month ago. Given the fractured Republican caucus, it was not clear that Speaker McCarthy could get a bill passed in the House. French Hill, R-Ark., told Roll Call “The whole purpose of this is to compel the president to negotiate — and to demonstrate to Washington, D.C., that Kevin McCarthy has the votes to raise the debt ceiling.” Four House members defected and the vote barely squeaked by at 217-215. Although George Santos, R-NY, is facing prosecution for fraud, money laundering and theft of public funds, McCarthy has allowed him to keep his seat at a time when every vote is crucial.

In 2011, the Republican House balked at raising the limit but the only legislation they could pass was an affirmation that they would not raise the limit without some unspecified spending cuts. Republicans were unable to agree on terms that they could pass in the House. Despite that, President Obama made the mistake of negotiating with Speaker John Boehner, and the two struck a so called Grand Bargain. Lacking anything in written legislation from the House, a bipartisan committee in the Senate came up with a different proposal and Obama tried to negotiate a compromise between the two versions with Boehner. Boehner could not get any changes past the most conservative members in his caucus. According to Politico reporter Tim Alberta (2017), the staff of Jim Jordan, R-OH, had been working secretly with outside groups to sway enough House members to vote against Boehner’s bargain. Jordan apologized but the incident exacerbated tensions between the warring factions within the Republican House. As Vice-President at the time, Biden would have learned a valuable lesson. Get something in writing before starting negotiations.

In contrast to the growth of the public debt, the growth in household debt has decreased since the financial crisis and the housing bust. The chart below compares the two types of debt, public and household, in two 13 year periods before and after the financial crisis.  

From 1994-2007, the public debt (GFDEBTN) grew 5% per year while household debt rose 8.7% annually. As a percent of disposable income, household debt jumped from 78% at the end of 1994 to 124% at the end of 2007. Chiefly responsible was the doubling of mortgage debt (HHMSDODNS) during the first seven years of the 2000s. Lax underwriting standards allowed families with poor credit scores of less than 620 to secure mortgages. Millions lost their homes during the housing bust, banks tightened lending standards and Americans were forced to go on a credit diet.

Since the financial crisis, American household balance sheets have improved. Household debt has grown by only 2.2% per year, about half the growth rate of personal income (DSPI). As a result, debt as a percent of disposable income had fallen to 91% at the end of 2022. The public finances have not fared as well. Although federal tax receipts, including FICA taxes, have increased 8% annually, expenditures and social benefit payments have outpaced tax receipts, resulting in a 7.2% annual increase in the public debt since the end of 2009.  

This week David Leonhardt (2023) with the New York Times presented a graph of voter policy preferences derived from recent polls. The fiscal liberals in both parties outweigh the fiscal conservatives, a trend sure to promote the growth of the public debt. In the 2011 debt limit duel, Republican leaders like Paul Ryan championed privatization of Social Security and cutting back on benefit programs. In the decade since, neither of those proposals are popular with the party’s base. Instead McCarthy will appeal to the social conservatives in the party and insist on work requirements for benefit programs. As Leonhardt notes, the fight for Democrat and Republican swing voters is taking place in the quadrant of voters who are socially conservative but fiscally liberal, nicknamed the “Scaffles.”

The government’s spending becomes household income in some form or another, an accounting identity that joins the growth in public and household debt. Our economy, laws and regulatory framework promote financial crises and exacerbate social problems. Policymakers, economists and social scientists can debate the causes, extent and severity of the problems but acknowledge the reality.  We may discover that our experiment in governance does not scale as our population grows and congregates in cities, as our technology advances and we become accustomed to greater energy use. The spread of mass communication and social media since World War 2 has exacerbated rather than resolved our ideological and cultural differences. The growth of our public debt indicates that we expect more from our government than our economy or political framework is able and willing to pay for. Like a crack in our windshield, it will continue to grow.

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Photo by Ivan Vranić on Unsplash

Keywords: public debt, household debt, mortgage debt, debt limit

Alberta, Tim. 2017. “John Boehner Unchained.” POLITICO Magazine. https://www.politico.com/magazine/story/2017/10/29/john-boehner-trump-house-republican-party-retirement-profile-feature-215741/ (September 27, 2022).

Federal Reserve Bank of New York. (2023, May). Quarterly report on household debt and credit. https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2023Q1

The various FRED data series used in this post were HHMSDODNS Mortgage Debt, HCCSDODNS Consumer Credit Debt, GFDEBTN Public Debt, DSPI Disposable Personal Income.

Leonhardt, D. (2023, May 25). Ron DeSantis and the “scaffle” vote. The New York Times. https://www.nytimes.com/2023/05/25/briefing/ron-desantis.html

Political Horses in Harness

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January 29, 2023

by Stephen Stofka

This week’s letter is about the debt ceiling. It has been ten days since Janet Yellen, Secretary of the Treasury, began using “extraordinary measures” to pay federal obligations as the nation waits for Congress to raise the debt ceiling. The U.S. is the only country in the world that requires legislative authorization of its debt after the legislature has already authorized the spending, then appropriated the money for that expense.

Each year, the federal government and each of the states conducts an annual appropriations process that allocates money to each state or federal department or agency. By law, states must balance their budgets – in a pro forma manner, at least. They sometimes employ accounting mechanisms to defer expenses to a later year or accelerate revenues into a current fiscal year to achieve that balance. The federal government does not have a balanced budget constraint but Congress does occasionally play a dangerous game of budget “chicken” when it wants to send a message to the other party.

Political parties are ever conscious of their branding and each claims to be a good financial steward of the public’s taxes. Each claims that the other party is irresponsible. Paying the interest on the debt takes funding from other programs without doing anything. While this may be true and the interest on the debt is rising, it is less than 2% of GDP, far below the 2.5% – 3% of GDP during the 1980s and 1990s.  

The press, politicians and public argue over who is responsible and whether to cut programs or increase revenues. When Republicans are out of power, as they are now, they call for spending cuts. Democrats call for revenue increases, particularly higher taxes on the rich. When Republicans were in power from 2017-2019, they increased the deficit each year, ending 2019 with a deficit of almost $1 trillion. In 2020, the deficit was $3.1 trillion. A month after the 2020 election was over, Congress added another $920 billion for Covid relief. The Trump administration added $6.5 trillion to the debt, or 21% of today’s total debt of $31 trillion.

Shortly after Mr. Biden took office in January 2021, Congress passed the American Rescue Act which provided another $1.9 trillion in relief. The two relief packages before and after the start of Biden’s term added up to $2.8 trillion and was responsible for the entirety of the 2021 deficit of $2.775 trillion. The Republican House will pin the blame for the debt on the Biden administration and programs like Social Security and Medicare. When a party is out of power, they can indulge in what is called position-taking. The firebrand rhetoric is popular with the Republican base and, since there is no possibility that those programs will be cut, politicians can claim to be prudent or for small government. When a party is actually in power, politicians have to be careful with political blustering. Their constituents are more likely to think that such cuts are possible and will vote them out of office.

For forty years, the Republican party has run on a theoretical assumption that tax cuts will spur enough economic activity that the increased tax revenue will more than pay for the cuts. There is no evidence supporting that claim but claims do not need evidence to be effective at raising funds and winning votes. For almost sixty years, Democrats have touted federal social programs as a path to greater equality and equitability.

In any game of chicken, the danger is that neither side gives in. Relying on estimates of income tax revenue in the next few months, some economists project that Secretary Yellen can continue to take ever more extraordinary measures until June. At the last big debt limit showdown in 2011, people argued over the constitutionality of the Treasury printing a $1 trillion coin and handing it over to the Federal Reserve to cover any expenses, including interest payments and bond redemption. This year, the idea is again a popular debating point on social media.

Like the filibuster, the debacle of the debt limit debate continues because each party wants to have power yet check the other party’s power, a dilemma that neither can escape. They are two horses harnessed together pulling the wagon of state. With reins in hand, the public is under the impression that it is driving the wagon but it is not. The parties pay attention only to the harness that binds each to the other.  

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Photo by Jacek Ulinski on Unsplash

Different Rules

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May 2, 2021

by Steve Stofka

This past week President Biden presented some details of the American Family Plan to Congress (WH, 2021). The goal of the proposals is to restore some equity in our economic and political system. Some ask whether the estimated cost of $1.8 trillion is too much. The Federal debt just crossed above the 100% line of debt to GDP. Will the debt cause global investors to demand higher interest for loaning the U.S. money? Will the higher government spending lead to higher inflation? Could a U.S. default on debt payments and interest provoke a global financial crisis even worse than the one in 2008?

How worried are investment managers around the world who hold and manage trillions of US debt? When debt holders are worried about default, they want a higher risk premium, a higher return or interest rate on the debt they hold. When foreign investors are worried that the dollar will significantly depreciate in the next four to five years, a medium term, they want higher interest to compensate for the depreciation of the dollar. When we compare international interest rates in the medium term, we don’t see worry reflected in higher interest rates. We see that the rest of the world is treating U.S. debt as though it were cash.

A mix of interest rates for U.S. debt is 1.61% (UST, 2021). Around the world, Germany’s debt is considered a benchmark of safety because the country has a strong credit rating and is a prudent manager of their finances and economy. Germany’s interest rate mix is a negative .36% (FRED, 2021. Details on the data series are in the footnotes at the end of this blog). The difference between those two rates indicates how much foreign holders expect the U.S. currency to depreciate over several years – about ½% per year. Unlike Germany, the U.S. has total control of monetary policy so that is worth at least ½% annually in risk premium. The real interest rate on the U.S. debt is about 0%, the same rate as cash. How much U.S. debt does the rest of the world hold?

The Congressional Budget Office estimated that the rest of the world owned 40% of all U.S. publicly held debt at the end of 2019 (CBO, 2020). That percentage has probably changed since the pandemic, but I’ll use that as a proxy for the percent of the currently held public debt of $21.6T. Given that percentage estimate, money managers around the world own $8.6 trillion of US debt at an effective average real interest rate of 0%. Why would they do that? A large part of U.S. debt is being used as an effective currency.

The percent of circulating currency in the U.S. to GDP is almost 10%. Remember that currency is a liability of the government that issues the currency. If US Debt held by the rest of the world is $8.6T, then it is about 12.7% of an estimated $68T in rest-of-the-world GDP. The Fed is often accused of “printing money.” We could replace $8.6 trillion of all foreign held debt with cash and the liability would shift from the U.S. Treasury’s balance sheet to the Federal Reserve’s balance sheet. Since the Federal Reserve is also an agency of the U.S. government, it is like moving an I.O.U. from the left pocket to the right pocket. Why are the rules different for the U.S.?

It is the leading economic power and, since WW2, the global financial leader. As the leader, the U.S. is responsible for a global medium of exchange. When Britain was the world’s financial leader the pound and British debt was used as cash around the world. Isn’t gold or silver supposed to be that global currency?

The world has never formally adopted a gold standard. After the war of 1870, European nations agreed to a gold standard in the hopes that this dependent interconnection would prevent another world war. It didn’t. Countries cheat when they want to go to war. Despite the gold standard, Britain’s pound and her debt was the dominant currency around the world. Consols, a perpetual bond that never came due, were first issued by Britain in the 18th century. They were finally retired a few years ago. Anything that will reliably hold an agreed upon value will do as a currency, including debt.

What would happen if the U.S. defaulted on its debt tomorrow? History provides a guide. After WW2, Britain’s debt held by foreigners was about 1/3 of its GDP. It’s economy crippled by the war, that debt was forgiven. The world kept on turning and the U.S., its primary debtor, became the dominant economic power and financial leader. The U.S. debt held by foreigners is currently 39% of GDP, a bit more than Britain’s was after WW2. Should the U.S. default or be unable to pay its interest, China, the largest U.S. creditor, would probably become the financial leader.

The debt of the U.S. has not been paid off since 1835. On the books are remnants of debts from past wars, international and domestic. They include Civil War debts, expenses from WW1 and WW2. Once the U.S. became the financial leader, it was expected to foot the bill for global stability just as Britain had done for 150 years. The U.S. debt includes the war debts of Britain, France and Germany, and partial forgiveness of bond debt from the 1980s crisis in Latin America. It includes war expenses for the Vietnam War and other wars meant to bring global stability. The financial leader of the world carries some of the world’s debt on its books. If China were to take the leadership position, it would assume some of that past debt and become the bearer of those global responsibilities.

Despite its vibrant people, culture and economy, China has an autocratic system of governance. As President Biden noted in his speech this week, Chinese leaders believe that democracy is an outmoded political system. Would I feel comfortable with China as the financial leader? No. I’m an American who has known only the U.S. dollar as the dominant world currency. I have lived in British countries where the people were not comfortable with U.S. leadership. Americans are used to U.S. dominance. Others see only the privileges of being the financial leader and regard the American attitude as arrogance. With that privilege comes extraordinary responsibility and expense. The rules are different.

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Photo by Sharon McCutcheon on Unsplash

CBO. (2020, March). Federal debt: A primer. Retrieved May 01, 2021, from https://www.cbo.gov/publication/56309

U.S. Treasury (UST). (2021, March). Interest rates and prices. Retrieved May 01, 2021, from https://www.treasurydirect.gov/govt/rates/avg/2021/2021_03.htm

White House (WH). (2021, April 28). Fact sheet: The American Families Plan. Retrieved May 02, 2021, from https://www.whitehouse.gov/briefing-room/statements-releases/2021/04/28/fact-sheet-the-american-families-plan/

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These data series can be view at the Federal Reserve web site, https://fred.stlouisfed.org/

Trade-weighted exchange rate is 112.44 (DTWEXBGS). Germany’s interest rate mix is -.36 (FRED IRLTCT01DEM156N). The percent of circulating currency to U.S. GDP is 9.5% (CURRCIR / GDP *100). Publicly held Federal debt is $21.6 trillion (FYGFDPUN).

Finding the Right Wires

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February 14, 2021

by Steve Stofka

Since WW2, households have traditionally held more debt than the federal government as a percent of GDP. I’ll call it %Debt. The biggest component of household debt is mortgages, and includes car loans, student loans, credit card debt, etc. A decade ago, Federal %Debt surpassed households, effectively allowing households to reduce their debt level and put it on the federal balance sheet.

Federal debt spiked during the pandemic while household debt levels have risen only 1.5%. For decades, deficit hawks have long warned that rising federal debt levels could cause an economic implosion that would make the Great Depression look tame by comparison. They may be right – finally.

There are two ways that the federal %Debt can go down. The first is to grow the economy; that’s the GDP in the denominator of Debt / GDP. The second way is to reduce the level of Debt, the numerator. It is unlikely that Congress is going to raise taxes enough to reduce the debt, so that leaves only one way to reduce %Debt – grow the economy faster than the growth in federal debt.

To do that, consumers need to spend money because their spending makes up 70% of GDP. There are three ways to increase spending. The first is to increase incomes faster than economic growth but that has not been happening for several decades. The real growth in middle class incomes over the past 30 years is only 15%, or 1/2% per year average.

The non-partisan Congressional Budget Office projects that total incomes will increase by an average of $33B per year over the next decade if the minimum wage is raised to $15 over the next five years (CBO, 2021). That increase of 1.5% in GDP will not change the federal %Debt by much.

The second way to increase GDP is for consumers to take on more debt. A rise in housing prices has lifted the net worth of many households, who can tap into that equity to increase their spending. However, households are already choked with debt. The two largest generations, the Millennials and the Boomers are offsetting each other’s spending. Older Boomers are reducing spending as Millennials increase their purchases. The Millennials have been crushed by the financial crisis a decade ago and again with the Covid crisis. Many feel like they came along at the wrong time in history and are cautious. When consumers pay down debt, they spend less and that lowers GDP growth.

The third way is probably the trend of the future. The federal government will continue to pile debt on its balance sheet and shift income onto households in the hopes that consumers will spend money and grow the economy faster than the rise in federal debt. There is a concept called the multiplier and economists argue over its value. It is the total effect of spending in an economy when the government spends $1. That depends on consumer and business confidence, which depends on the amount of debt each sector holds. The IMF estimates that the multiplier is about 1.5, so that $1 of spending equals $1.50. If so, deficit spending might grow the economy faster than the federal debt grows.

I’ll return to a proposal I discarded earlier – increasing taxes, particularly on the top 10% who don’t spend as much of their incomes on consumer goods as the bottom 90%. Under the Budget Reconciliation rule in the Senate, the Democrats could pass tax legislation that undoes the 2017 tax cuts that the Republicans passed using that reconciliation process. In his campaign proposals, President Biden limited any tax increases to those making $400,000 or more, a small sliver of the population.

Income distribution is skewed toward the upper 5%, who will fight vigorously to keep what they have. They will complain – and they have a point – that they are already paying higher taxes in the form of lost income because interest rates are so low. Those with savings are being paid a paltry amount in interest but the low rates reduce the interest on the debt that the federal government pays each year. Boomers on fixed incomes are having to reduce their savings faster  to meet monthly expenses.

The structure of income distribution is weak. No, it’s not a problem with capitalism, as some like to claim. This is a problem with political policy which pre-dates capitalism. A small group of people in a nation take command of the distribution levers and direct more of the nation’s income to themselves. In the 1700s, the problem was thought to originate with monarchy and aristocracy. Democracy was going to cure the problem, but it didn’t. Communism was going to cure the problem and it didn’t. Socialism – the middle way between capitalism and communism – was going to solve the problem, but the EU demonstrates that socialism simply slows growth, increases structural unemployment, and does little to solve the persistent problem of distributional inequalities.

Governments worry about exogenous factors like Covid, war, or a dramatic shift in commodity prices. While those do produce crises, they do so because of endogenous factors – weaknesses in a nation’s political and economic system that award property rights in such a way as to exacerbate social tensions. The Great Depression and Financial Crisis were examples.

Since the Financial Crisis a decade ago, people in nations around the world have been raising their fists and their voices. The productivity gains that capitalism promoted had ameliorated the centuries old problem of political oligarchies, but no economic system can solve what is fundamentally a political problem.

Those who voted for former President Trump in 2016 did so thinking that he was a political outsider who could “drain the swamp,” i.e., bust up the political oligarchy that controls Washington. He became part of that oligarchy, feeding the monster, because it relied on his lack of political expertise.

Those who voted for President Biden hope that his decency and moderation will help craft legislation that unlooses the grip that the oligarchy has on our political process. Which wires do we pull to disconnect the oligarchy?

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Photo by Victor Barrios on Unsplash

Congressional Budget Office (CBO). (2021, February 08). The budgetary effects of the raise the Wage act of 2021. Retrieved February 13, 2021, from https://www.cbo.gov/publication/56975

Tax Policy Center. (2020, May). What is reconciliation? Retrieved February 13, 2021, from https://www.taxpolicycenter.org/briefing-book/what-reconciliation

Forgiveness

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January 24, 2021

by Steve Stofka

Some members of the Democratic Party have called for a forgiveness of all student debt, which the Federal Reserve estimates at more than $1.7 trillion, which has doubled since the onset of the financial crisis and recession in 2007-8. On the campaign trail, President Biden seemed receptive to a forgiveness of $10,000 as a uniform application of policy (Urban, 2020).

Many of us react instinctually to debt forgiveness, ready to condemn the idea outright because we were taught as children to pay our debts. The ancient Greeks committed individuals and families to slavery for failure to pay their debts (ABI, n.d.). The Romans allowed creditors to dismember debtors. American colonists had debtors flogged, ears cut off and imprisoned.

Our laws have become more forgiving in the past three centuries, but the attitudes of many Americans have not improved as much. In the depths of the 2009 recession, CNBC reporter Rick Santelli criticized a mortgage debt relief program and ignited a storm of passion that contributed to the formation of the Tea Party movement. Will a student debt forgiveness program arouse similar sentiments?

A week before Congress passed the CARES act on March 27, 2020, Education Secretary Betsy DeVos suspended payments on federal student loans payments (DOE, 2021). The CARES act formalized that suspension but only for six months. President Trump then directed her to continue the suspension of payments and waiver of interest. President Biden has continued that policy until September 2021.

Who got the loan money? Some of it went to for-profit institutions. Students at for-profit institutions total two million, less than 5% of the 42 million students enrolled in higher education (Bennett et al., 2010). During the financial crisis, for-profits received a lot of criticism for abusive recruitment practices, low graduation rates, high default rates and poor student outcomes. Under tightened regulations during the Obama administration, several lost eligibility for federal student loans and subsequently shut down.

Ok, goes the argument, some students got a bad deal. Shouldn’t they still have to honor their contracts? What if the government forgave all debts involving a product or service which did not perform as promised? The buyer would no longer have to be diligent about quality. Eventually the quality of goods and services would decrease. Those who use this argument see debt forgiveness of any kind as a slippery slope to the downfall of the entire economy and the impoverishment of society.

The bulk of the $1.7 trillion of outstanding debt was paid to public educational institutions, who have raised tuition far above the general rate of inflation. Since 1985, inflation adjusted tuition has doubled (NCES, 2021). Over the past two decades, states have cut back their funding for higher education, throwing the extra burden onto students. In analyzing the shift, Douglas Webber found that the student burden had tripled since 2000 (2017).

Where did the money go? To state institutions. Imagine each student wearing a backpack loaded with 10 pounds of debt. State governments took 20 pounds of weight off their books and put it in the backpacks of the students, those least able to bear that burden. A forgiveness of debt, total or partial, would take some or all that weight out of the backpacks of each student and put it on the Federal balance sheet.

At its core, debt is about justice, a subject that we struggle to discuss rationally because we are social animals who process the subject of fairness with our monkey brains. In 18th century England, the punishment for crimes, including debt, was in proportion to the outrage of society at the criminal. In a more rational approach, the philosopher and legislator Jeremy Bentham introduced a “felicity calculus” that would guide legislators and judges to enact punishments that were proportional to the consequences of a crime and the profit of the crime to the criminal.

Our laws no longer treat debtors as criminals, but in the case of a student’s debt, how is society to judge the profit that a student will earn over a lifetime from their education? On average they will make a higher income and pay higher taxes. If all student debt is forgiven, one student will receive a benefit of $100,000 while another will receive a $30,000 benefit. Is that just? I personally think a $10,000 uniform forgiveness is more just. A debt forgiven cannot be unforgiven; moderation is the key.

We can never agree on issues of distribution of benefits. Small children argue whether they got the same amount of chocolate milk if the glasses are shaped differently. In the parable of the workers in the vineyard, workers who only worked one hour received the same amount of money as those who had worked all day. Is that fair? The landowner insisted that it was his money to do whatever he wanted.

In a democracy, we have an instinctual sense that the Federal government’s money does not belong to the government. Some of us claim an equal say in how that money is spent, whether we pay a small amount or a large amount of federal tax. Some of us decide the justice of debt forgiveness as though the debt was owed to us personally. Some of us don’t see this as a personal issue; the federal debt is as remote as the Andromeda galaxy. Those two groups cannot agree.

In a democracy, we argue about the rules. We compete to elect the people who make the rules. Half of us like the rules; half don’t. A democracy survives only as long as each half can forgive the other half for their tyranny while they were in the majority. As long as each half feels that they are getting a turn at making the rules, there is a grudging tolerance, if not forgiveness, and a democracy survives. When one half of the people feel as though they are shut out of the rule making process, the fighting starts. If we can’t practice some forgiveness we don’t deserve a democracy. Tyranny and aristocracy are the political choices of those who don’t forgive. I’ll take democracy.

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Notes:

Photo by Pang Yuhao on Unsplash

American Bankruptcy Institute (ABI). (n.d.). A (Very) Brief History of Bankruptcy and Debt in the West. Retrieved January 23, 2021, from https://www.abi.org/feed-item/a-very-brief-history-of-bankruptcy-and-debt-in-the-west

Bennett, D., Lucchesi, A., & Vedder, R. (2010, June 30). For-Profit Higher Education: Growth, Innovation and Regulation. Retrieved January 23, 2021, from https://eric.ed.gov/?id=ED536282

NCES. (2021). The NCES Fast Facts Tool provides quick answers to many education questions (National Center for Education Statistics). Retrieved January 23, 2021, from https://nces.ed.gov/fastfacts/display.asp?id=76

Urban Institute & Brookings Institute, Tax Policy Center (Urban). (2020, October 15). An Updated Analysis of Former Vic President Biden’s Tax Proposals. [PDF]. Retrieved from https://www.urban.org/sites/default/files/publication/103075/an_updated_analysis_of_former_vice_president_bidens_tax_proposals_1.pdf

U.S. Dept. of Education (DOE). (2021). Coronavirus and Forbearance Info for Students, Borrowers, and Parents. Retrieved January 23, 2021, from https://studentaid.gov/announcements-events/coronavirus

Webber, D. A. (2017). State divestment and tuition at public institutions. Economics of Education Review, 60, 1-4. doi:10.1016/j.econedurev.2017.07.007

Remove Impeachment?

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February 9, 2020

By Steve Stofka

Despite a strong labor market and a rising stock market, last year’s deficit was the largest in seven years (Tankersly, 2020). The tax cut package of 2017 has not delivered the promised economic growth. The first estimate of 2019 GDP annual growth was 2.3% (FRED, n.d.), the average during the past four years of the Obama administration. According to Mr. Trump, that growth rate was a “disaster” under Obama. Now it is a good growth rate. In his State of the Union address this week, President Trump said that “our economy is the best it has ever been” (CPR, 2020).

Growth during the three years of the Trump administration has averaged 2.5%, slightly above the tepid rate of growth under Obama. The growth standard is 3.0%, the average during the last fifty years of the 20th century.

How to make a tired nag of an economy look like a racehorse? The White House Council of Economic Advisors compared GDP growth during the Trump administration to growth projections of 2.0% made before the 2016 election (CEA, 2020). That comparison makes the growth rate look ½% higher than expectations. A component of GDP growth is government spending, whether that spending is borrowed or not. That additional growth has come at the expense of the Federal debt (CBO, 2020).

Like the Obama administration before, the Trump administration has bought itself GDP growth by borrowing money from the rest of the world and spending it. Without those annual deficits, GDP growth would have been negative for the past 15 years. The stock market has climbed 33% since the 2016 election because the money is flowing freely from Washington and the Federal Reserve. The amount of borrowed and printed money that the Federal government pumps into the economy creates additional profits for companies.

As predicted, President Trump was found not guilty by the Senate. Since the founding of the country, three Presidents have been tried for impeachment but not convicted. Let’s look at the Presidents who were not impeached even though they committed arguably impeachable offenses.

 President Franklin Delano Roosevelt was not impeached by a Democratic House for lying to Congress about the lend lease program to Britain in 1940. President Lyndon Johnson was not impeached by a Democratic House for lying to Congress about the Gulf of Tonkin attack in Vietnam in 1964 (Moise, 2019). President Ronald Reagan was not impeached by a Democratic House for his complicity in selling arms to Iran (Brown U., n.d.).

All of these were matters were of grave national importance to the American people. President Clinton was impeached by a Republican House for lying to them about his affair with a White House aide. Tawdry, yes. National importance? No.

Since no president has been convicted of impeachment, should we enact a Constitutional amendment to nullify impeachment? The arguments we have today about impeachment reflect the same arguments made by delegates at the Constitutional Convention in 1787 (Klarman, 2016). Some thought that state legislatures should initiate impeachment proceedings. The “New Jersey” plan proposed that a majority of state governors could remove a president. Some wanted to give the Congress power to remove a president at will, but others thought that would make the president subservient to Congress. Thinking that Congress might threaten impeachment as retribution for a presidential veto, some advocated against impeachment at all. Shouldn’t the voters decide, they argued? If the president were elected every two years, the voters could vote a president out of office at the next election. A Presidential term should last longer than two years was the counterargument. Most of the delegates agreed that impeachment was a check on a president and decided to include it in the Constitution.

What offenses should be subject to impeachment? The delegates disagreed on that as well. Some thought it should be for “malpractice or neglect of duty” but others thought the offenses needed to be more serious. “Treason, bribery, and corruption” was suggested, but “corruption” was not specific enough. “Maladministration” was proposed but was rejected. How about “other high crimes and misdemeanors against the State?” Well, that was more specific than “corruption” and “maladministration,” but not too specific as to straitjacket Congress. The final language inserted in the Constitution was “Treason, Bribery, or other high Crimes and Misdemeanors” (Article II, Section 4). Today, we argue about that wording. Go figure.

When the Constitution was written, the delegates did not contemplate a political system with two parties. Within two decades, they realized their mistake and initiated the 12th Amendment to have the president and vice-president elected together from the same party.

Some Constitutional delegates worried that the impeachment process would become politicized. History has shown that they were right. Should we admit that a conviction of impeachment is practically impossible? We must either lower the threshold for conviction in the Senate from a super-majority of 67 Senators to a majority vote, or remove the idea of impeachment from the Constitution entirely. What do you think?

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Notes:

Brown U. Research. (n.d.) Understanding the Iran-Contra Affairs: The Beginning of the Affair. [Web page]. Retrieved from https://www.brown.edu/Research/Understanding_the_Iran_Contra_Affair/i-thebeginning.php

Colorado Public Radio (CPR). Transcript & Video: President Donald Trump’s 2020 State Of The Union. [Web page]. Retrieved from https://www.cpr.org/2020/02/04/transcript-video-president-trumps-2020-state-of-the-union/

Congressional Budget Office (CBO). (2020, January). Budget and Economic Data. Retrieved from https://www.cbo.gov/about/products/budget-economic-data#2 Note: 2019’s Federal deficit was 4.7% of GDP, 40% higher than the 3.3% deficit in 2016, the last year of the Obama administration.

Council of Economic Advisors (CEA). (2020, January 30). United States GDP Growth Continues Exceeding Expectations. Retrieved from https://www.whitehouse.gov/articles/united-states-gdp-growth-continues-exceeding-expectations/

Federal Reserve (FRED). (2020, January 30).  Real Gross Domestic Product (GDPC1). [Web page]. Retrieved from https://fred.stlouisfed.org/series/GDP

Klarman, M. J. (2016). The framers coup: the making of the United States Constitution. New York, NY: Oxford University Press. (pp 235-237).

Moïse Edwin E. (2019). Tonkin Gulf and the escalation of the Vietnam War. Annapolis, MD: Naval Institute Press, (Preface). Sample retrieved from https://books.google.com/books?hl=en&lr=&id=0UEnAnvQ978C&oi=fnd&pg=PR11&dq=gulf+of+tonkin+vietnam+war

Photo by Darren Halstead on Unsplash

Tankersley, J. (2020, January 13). Budget Deficit Topped $1 Trillion in 2019. NY Times. [Web page]. Retrieved from https://www.nytimes.com/2020/01/13/business/budget-deficit-1-trillion-trump.html

The Homeowners’ Association

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August 18, 2019

by Steve Stofka

Two quick asides before I get into this week’s topic. A cricket perched on the top of a 7′ fence. It drew up to the edge of the top rail, learned forward, raised its rear legs as though to jump, then settled back. It did this twice more before jumping 8′ out then down into a soft landing on some ground cover. How far can crickets see, how often do they injure a leg if they land incorrectly and do they get afraid?

The bulk of the personal savings in this country is held by the top 20% of incomes, and it is this income group that received the lion’s share of the 2017 tax cuts. It’s OK to bash the rich but that top 20% probably includes our doctor and dentist. Before you start drilling or cutting me, I want to make it perfectly clear that I was not criticizing you, Doc.

In 2016, the top quintile – the top 20% – earned 2/3rds of the interest and dividend income (Note #1). Due to falling interest rates over the past three decades, real interest and dividend income has not changed. Real capital has doubled and yes, much of it went to those at the top, but the income from that capital has not changed. That is a huge cost – a hidden tax that gets little press. The real value of the public debt of the Federal Government has quadrupled since 1990, but it pays only 20% more in real interest than it did in 1990 (Note #2). Here’s a graph of personal interest and dividend income adjusted to constant 2012 dollars. Thirty years of flat.

Ok, now on to a story. Economists build mathematical models of an economy. I wanted to construct a story that builds an economy that gradually grows in complexity and maybe it would help clarify the relationships of money, institutions and people.

Let’s imagine a group of people who move into an isolated mining town abandoned several years earlier. The houses and infrastructure need some repairs but are serviceable and the community will be self-sufficient for now. The homeowners form an association to coordinate common needs.

The association needs to hire lawn, maintenance and bookkeeping services, and security guards to police the area and keep the owners safe.  How does the association pay for the services?  They assess each homeowner a monthly fee based on the size of the home. How do the homeowners pay the monthly fee?  Each homeowner does some of the services needed. Some clean out the gutters, others fix the plumbing, some keep the books and some patrol the area at night. They work off the monthly fee.

How do they keep track of how much each homeowner has worked? The association keeps a ledger that records each owner’s fee and the amount worked off. The residents sometimes trade among themselves, but it is rare because barter requires a coincidence of wants, as economists call it. Mary, an owner, needs some wood for a project and Jack has some extra wood. They could trade but Mary doesn’t have anything that Jack wants. He tells Mary to go down to the association office and take some of her time worked off her ledger and credit it to Jack’s monthly fee. Mary does this and they are both happy (Note #3).

As other owners learn of this idea and start trading work credits, the association realizes it needs a new system. It prints little pieces of paper as a substitute for work credits and hands them out to owners who perform services for the association. These pieces of paper are called Money (Note #4).

The money represents the association’s accounts receivable, the fees owed and accruing to the association, and the pay that the association owes the owners for the work they have done. Then the association notices that there are some owners who are not doing as well as others. It assesses an extra fee each month from those with larger homes and gives that money to needy homeowners.  These are called transfers because the owners who receive the money do not trade any real goods or services to the association. In this case the association acts as a broker between two people. Let’s call these passive transfers. We can lump these transfers together with exchanges of goods and services.

Then some people from outside the area start stealing stuff from the homeowners. The association needs to hire more security guards, but homeowners don’t want to pay a special one-time assessment to pay for the extra guards.

Instead of printing more Money, the association prints pieces of paper called Debt. Homeowners who have saved some of their money can trade it in for Debt and the association will pay them interest. Homeowners like that idea because Money earns no interest and Debt does. The association uses the Money to pay for the extra security guards.

But there are not enough people who want to trade in their Money for Debt, so the association prints more Money to pay the extra security guards.

Let’s pause our story here to reflect on what the words inflation and deflation mean. Inflation is an increase in overall prices in an economy; deflation is a decrease (Note #5). Inflation occurs when the supply of money fuels a demand for goods and services that is greater than the supply of goods and services. Ok, back to our story.

So far so good. All the Money that the association has printed equals a trade or a passive transfer. Let’s say that the association needs more security guards and no one else wants to work as a security guard because they can make more Money doing jobs for other homeowners. The association makes a rule called a Draft. Homeowners of a certain age and sex who do not want to work as security guards will be locked up in the storage room of the community center.

Now there’s a problem. Because the association has taken some homeowners out of the customary work force, those people are not available for doing jobs for other homeowners, who must pay more to contract services. This is one of several paths that leads to inflation. To combat that, the association sets price controls and limits the goods that homeowners can purchase. After a while, the outsiders are driven off and the size of the security force returns to its former levels.

Now all the extra Money that the association printed to pay for the security force has to be destroyed. As homeowners pay their dues, the association retires some of the money and shrinks the Money supply. However, there is a time lag, and prices rise sharply (Note #6).

Over the ensuing decades, there are other emergencies – flooding after several days of rain, a sinkhole that formed under one of the roadways, and a sewer system that needed to be dug up and replaced. The association printed more Debt to cover some of the costs, but it had to print more Money to pay for the balance of repairs. Because the rise in the supply of Money was a trade for goods and services, inflation remained tame.

There didn’t seem to be any negatives to printing more Money, so the homeowners passed a resolution requiring that the association print and pay Money to homeowners who were down on their luck. These were active transfers – payments to homeowners without a trade in goods and services and without some offsetting payment by the other homeowners.

So far in our story we have several elements that correspond with the real world: currency, taxes, social insurance, the creation of money and debt and the need to pay for defense and catastrophic events. Let’s continue the story.

With the newly printed Money, those poorer homeowners could now buy more goods and services. The increased demand caused prices to rise and all the homeowners began to complain. Realizing their mistake, they voted on an austerity program of higher homeowner fees and lower active transfers to poorer homeowners.

Because homeowners had to pay higher fees, they didn’t have enough extra Money to hire other services. Some residents approached the association and offered to repair fences and other maintenance jobs, but the association said no; it was on an austerity program and cutting expenses. Some residents simply couldn’t pay their fees and the problem grew. The association now found that it received less Money than before the higher fees and Austerity program. It cut expenses even more, but this only aggravated the problem.

Finally, the association ended their Austerity program. They printed more Money and hired homeowners to make repairs. Several homeowners came up with a different idea. There is another housing development called the Forners a few miles away. They are poorer and produce some goods for a lower price. The homeowners can buy stuff from the Forners and save money. There are three advantages to this program:

  1. Things bought from the Forners are cheaper.
  2. Because the homeowners will not be using local resources, there will be less upward pressure on prices.
  3. The homeowners will pay the association for the goods bought from the Forners and the association will pay the Forners community with Debt, not Money. Since it is the creation of Money that led to higher prices, this arrangement will help keep inflation stable.

As the homeowners buy more and more stuff from the Forners, the money supply remains stable or decreases. After several years, homeowners are buying too much stuff from the Forners and there is less work available in the community. As homeowners cannot find work, they again fall behind in paying their monthly fees.

Several of those in the association realize that they don’t have enough Money to go around in the community. There is a lot to do, and the homeowners draw up a wish list: repairs to the roads and helping older homeowners with shopping or repairs around their home are suggested first. A person who is out of work offers to lead tours and explain the biology of trees for schoolchildren. The common lot near the clubhouse could use some flowers, another homeowner suggests. I could use a babysitter more often, one suggests, and everyone nods in agreement. I could teach a personal finance class, a homeowner offers. Another offers to read to homeowners with bad eyesight and be a walking companion to those who want to get more exercise.

Everyone who contributes to the welfare of the community gets paid with Money that is created by the association. What should we call the program? One person suggests “The Paid Volunteer Program,” and some people like that. Another suggests, “The Job Guarantee Program” and everyone likes that name so that’s what they called it (Note #7).

So far in this story we have two key elements of an organized society:

  1. Money – a paper currency created by the homeowner association.
  2. Debt – the amount the association owes to homeowners (domestic) and the Forners (international).

Next week I hope to continue this story with a transition to a digital currency, banks and loans.

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Notes:

  1. In 2016, the top 20% of incomes with more than $200K in income, earned more than 2/3rds of the total interest and dividends. IRS data, Table 1.4
  2. In 2018 dollars, the publicly held debt of the Federal government was $4 trillion in 1990, and $16 trillion now. In 2018 dollars, interest expense was $500B in 1990, and is $600B now.
  3. In David Graeber’s Debt: The First 5000 Years, there is no record of any early societies that had a barter system. They had a ledger or money system from the start.
  4. In the Wealth of Nations, Adam Smith – the “father” of economics – defined money as that which has no other value than to be exchanged for a good. This essential characteristic makes money unique and differentiates paper money from other mediums of exchange like gold and silver.
  5. An easy memory trick to distinguish inflation from deflation. INflation  = Increase in prices. DEflation = DEcrease.
  6. The account of the increased force of security guards – and its effect on prices and regulations – is the simple story of money and inflation during WW2 and the years immediately following. The process of rebalancing the money supply by the central bank is difficult. Monetary policy during the 1950s was a chief contributor to four recessions in less than 15 years following the war.
  7. A Job Guarantee program is a key aspect of Modern Monetary Theory.

Trends

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April 14, 2019

by Steve Stofka

In the current housing market, there are .4 new homes started for every 100 people, near century long lows. The Millennials (1981-1996) are now the largest generation in history but home builders are not responding to the population boom (Note #1). In the 1970s, home builders started triple that number of homes in response to the swelling number of Boomers coming of age.

Have you heard that there won’t be enough workers to support Social Security and Medicare payments for the retiring Boomer generation? Here’s the ratio of seniors to the core work force aged 25-54. Yes, it has gone up since the Financial Crisis.

Here’s the ratio of seniors to all workers. Each worker’s social security taxes are “funding” benefits for three seniors. The Social Security fund was never a separate fund, only an accounting gimmick that politicians enacted eighty years ago. As former Fed chairman Alan Greenspan explained, the federal government can continue to make payments to seniors (Note #2).

Have you heard that the interest on the debt is going to grow so large that it will crowd out all other spending? As a percentage of total expenses, it is at a low level.  Each year the federal government runs a deficit of about 2.4% (Note #3). Can it continue to do that indefinitely? Yes.

Each day we hear a lot of half-truths and outright lies. As the 2020 Presidential election gets nearer, half-baked versions of reality will grow like mold on bread. The Constitution was structured to encourage debate as an alternative to war among ourselves. The 1st Amendment guarantees everyone a right to spout half-truths and lies. Two dominant political parties compete for our belief in their version of the truth. This is the land of argument.

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Notes:

  1. Pew Research has redefined the Millennial generation as those born 1981-1996.
  2. YouTube video of Alan Greenspan explaining to Representative Paul Ryan that the Federal Gov’s checks are good
  3. The 80-year average of deficits is 2.4%. Not including debt for wars, it is 2.2%, per Steve Keen, author of Debunking Economics.

The Start of the Beginning

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April 7, 2019

by Steve Stofka

In 1971 former President Nixon announced that the U.S. was abandoning the gold standard of fixed exchange that had existed for almost thirty years. Within a short time, other leading nations followed suit. Each nation’s currency simply traded against each other on a global currency, or FX, market.

Since oil was priced in dollars and the world ran on oil, the U.S. dollar became the world’s reserve currency. Each second of every day, millions of US dollars are traded on the international FX markets. The demand for US dollars is strong because we are a productive economy. The euro, yen and British pound are secondary currency benchmarks.

When the U.S. wants to borrow money from the rest of the world, the U.S. Treasury sells notes and bills collectively called “Treasuries” to large domestic and foreign banks who “park” them in their savings accounts at the Federal Reserve (Fed), the U.S. central bank (Note #1). The phrase “printing money” refers to a process where the Federal Reserve, an independent branch of the Federal Government, buys Treasury debt on the secondary market. It may surprise many to learn that the Fed owns the same percentage of U.S. debt as it did in 1980. The debt in real dollars has grown seven times, but the percentage held by the Fed is the same. That is a powerful testament to the global hunger for U.S. debt. Here’s the chart from the Fed’s FRED database.

FedResHoldTreasPctDebt

In 1835, President Andrew Jackson paid off the Federal debt, the one and only time the debt has been erased. It left the country’s banking system in such a weak state that subsequent events caused a panic and recession that lasted for almost a decade (Note #2). Government debt is the private economy’s asset. Paying down that debt reduces those assets.

About a third of the debt of the U.S. is traded around the world like gold. It is better than gold because it pays interest and there are no storage costs. Foreign businesses who borrow in dollars must be careful, however. They suffer when their local currency depreciates against the dollar. They must earn even greater profits to convert their local currency to dollars to make payments on those dollar-denominated loans.

Each auction of Treasury debt is oversubscribed. There isn’t enough debt to meet demand. In a world of uncertainty, the U.S. government has a long history of respect for its monetary obligations. As the reserve currency of the world, the U.S. government can spend at will. Even if there were no longer a line of domestic and foreign buyers for Treasuries, the Federal Reserve could “purchase” the Treasuries, i.e. print money. Let’s look at the difference between borrowing from the private sector and printing money.

When the private sector buys Treasuries, it is effectively trading in old capital that cannot be put to more productive use. That old capital represents the exchange of real goods at some time in the past. In contrast, when the government spends by buying its own debt, i.e. printing money, it is using up the current production of the private sector. This puts upward pressure on prices. Let’s look at a recent example.

Quantitative Easing (QE) was a Fed euphemism for printing money. During the three phases of QE that began in 2009, the Fed bought Treasury debt. That was an inflationary policy that countered price deflation as a result of the Financial Crisis. In August 2009, inflation sank as low as -.8% (Note #3). It was even worse, but inflation measures do not include the dividend yield on money. To many households, inflation felt like -2% (Note #4). The Fed’s first round of QE did provide a jolt that helped drive prices up by 3% and out of the deflationary zone.

During the five years of QE programs, the Fed continued to fight itself. The QE programs pushed prices upwards. Near zero interest rates produced a deflationary counterbalance to the inflationary pressures of printing money. Because inflation measures do not include the yield on money, the Fed could not read the true change in the prices of real goods in the private sector. The economy continues to fall below the Fed’s goal of 2% inflation. There are still too many idle resources.

Leading proponents of Modern Monetary Theory (MMT) remind people that yes, the U.S. can spend at will, but that it must base its borrowing on policy rules to avoid inflation. A key component of MMT is a Job Guarantee (JG) program ensuring employment to anyone who wants a job. A JG program may remind some of the WPA work programs during the Great Depression. Visitors to popular tourist attractions, from Yellowstone Park in Wyoming to Carlsbad Caverns in New Mexico, use facilities built by WPA work crews. Today’s JG program would be quite different. It would be locally administered and targeted toward smaller public works so that the program was flexible.

The U.S. government has borrowed freely to go to war and has never paid that debt back. Proponents of MMT recommend that the U.S. do the same during those times when the private economy cannot support full employment. That policy goal was given to the Fed in the 1970s, but it has never been able to meet the task of full employment through crude monetary tools. With an active program of full employment, the Fed would be left with only one goal – guarding against inflation.

There are two approaches to inflation control: monetary and fiscal. Monetary policy is controlled by the Fed and includes the setting of interest rates. If the Fed’s mandate was reduced to fighting inflation, it could more readily adopt the Taylor rule to set interest rates (Note #4).

Fiscal policy is controlled by Congress. Because taxation drains spending power from the economy, it has a powerful control on inflation. However, changes in tax policy are difficult to implement because taxes arouse passions. We are familiar with the arguments because they are repeated so often. Everyone should pay their “fair share,” whatever that is. Some want a flat tax like a head tax that cities like Denver have enacted. Others want a flat tax rate like some states tax incomes. Others want even more progressive income taxes so that the rich pay more and the middle class pay less. Some claim that income taxes are a government invasion of private property rights.

Because tax changes are difficult to enact, Congress would be slow to respond to changes in inflation. The Fed’s control of interest rates is the more responsive instrument. The JG program would provide stability to the economy and reduce the need for corrective monetary action by the Fed. The program would help uplift those in marginal communities and provide much needed assistance to cities and towns which had to delay public works projects and infrastructure repair because of the Financial Crisis. As sidewalks and streets get fixed and graffiti cleaned, those who live in those areas will take more pride in their town, in their communities, in their families and themselves. This makes not just good economic sense but good spiritual sense. We can start small, but we must start.

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Notes:

1. Twenty to twenty-five times each month, the Treasury auctions U.S. government debt. Many refer to the various forms of bills and notes as “treasuries.” A page on the debt
2. The Panic of 1837
3. The Federal Reserve’s preferred measure of inflation is the Personal Consumption Expenditure Index, PCEPI series.
4. The annual change in the 10-Year Constant Maturity Treasury fell below -1% at the start of the recession in December 2007 and remained below -1% until July 2009. FRED series DGS10. John Maynard Keynes had recommended the inclusion of money’s yield in any index of consumer demand. In his seminal work Foundations of Economic Analysis (1947), economist Paul Samuelson discussed the issue but discarded it (p. 164-5). Later economists did the same.
5. The Taylor rule utility at the Atlanta Federal Reserve.

 

The Nature of Money

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March 31, 2019

by Steve Stofka

Modern Monetary Theory (MMT) helps us understand the funding flows between a sovereign government and a nation’s economy. I’ve included some resources in the notes below (Note #1). This analysis focuses on the private sector to help readers put the federal debt in perspective. In short, some annual deficits are to be expected as the cost of running a nation.

What is money? It is a collection of  government IOUs that represent the exchange of real assets, either now or in the past. Wealth is either real assets or the accumulation of IOUs, i.e. the past exchanges of real assets. When a sovereign government – I’ll call it SovGov, the ‘o’ pronounced like the ‘o’ in love – borrows from the private sector, it entices the holders of IOUs to give up their wealth in exchange for an annuity, i.e. a portion of their wealth returned to them with a small amount of interest. A loan is the temporal transfer of real assets from the past to the present and future. This is one way that SovGovs reabsorb IOUs out of the private economy. In effect, they distribute the historical exchange of real assets into the present.

What is a government purchase? When a SovGov buys a widget from the ABC company, it also borrows wealth, a real asset that was produced in the past, even if that good was produced only yesterday. The SovGov never pays back the loan. It issues money, an IOU, to the ABC company who then uses that IOU to pay employees and buy other goods. A SovGov pays back its IOUs with more IOUs. That is an important point. In capitalist economies, a SovGov exchanges real goods for an IOU only when the government acts like a private party, i.e. an entrance fee to a national park. Real goods are produced by the private economy and loaned to the SovGov.

What is inflation? When an economy does not produce enough real goods to match the money it loans to the SovGov, inflation results. Imagine an economy that builds ten chairs, a representation of real goods. If a SovGov pays for ten people to sit in those ten chairs, the economy stays in equilibrium. When a SovGov pays for eleven people to sit in those ten chairs, and the economy does not have enough unemployed carpenters or wood to build an eleventh chair, then a game of musical chairs begins. In the competition for chairs, the IOUs that the private economy holds lose value. Inflation is a game of musical chairs, i.e. too much money competing for too few real resources.

A key component of MMT framework is a Job Guarantee program, ensuring that there are not eleven people competing for ten jobs (Note #2). Labor is a real resource. When the private economy cannot provide full employment, the SovGov offers a job to anyone wanting one. By fully utilizing labor capacity, the SovGov keeps inflation in check. The  idea that the government should fill any employment slack was developed and promoted by economist John Maynard Keynes in his 1936 book The General Theory of Employment, Money and Interest.

The first way a SovGov vacuums up past IOUs is by borrowing, i.e. issuing new IOUs. I discussed this earlier. A SovGov also reduces the number of IOUs outstanding through taxation, by which the private sector returns most of those IOUs to the SovGov.

Let’s compare these two methods of reducing IOUs. In Chapter 3 of The Wealth of Nations, Adam Smith wrote that government borrowing “destroys more old capital … and hinders less the accumulation or acquisition of new capital” (Note #3). Borrowing draws from the pool of past IOUs; taxation draws more from the current year’s stock of IOUs. Further, Smith noted that there is a social welfare component to government borrowing. By drawing from stocks of old capital it allows current producers to repair the inequalities and waste that allowed those holders of old capital to accumulate wealth. He wrote, “Under the system of funding [government borrowing], the frugality and industry of private people can more easily repair the breaches which the waste and extravagance of government may occasionally make in the general capital of the society.”

Borrowing draws IOUs from past production, while taxation vacuums up IOUs from current production. Since World War 2, the private sector has returned almost $96 in taxes for every $100 of federal IOUs. Since January 1947, the private sector has loaned the federal government $371 trillion dollars of real goods, the total of federal expenditures (Note #4). What does the federal government still owe out of that $371 trillion? $15.5 trillion, or 4.17% (Note #5). If the private sector were indeed a commercial bank, it would expect operating expenses of 3%, or $11.1 trillion (Note #6). What real assets does the private sector have for the difference of $4.4 trillion in the past 70 years? A national highway system and the best equipped military in the world are just two prominent assets.

The federal government spends about 17-20% of GDP, far lower than the average of OECD countries (Note #7). That is important because the accumulated Federal debt of $15.5 trillion is only .9% of the $1.7 quadrillion of GDP produced by the private sector since January 1947. Our grandchildren have not inherited a crushing debt, as some have called it. In the next forty years, the U.S. economy will produce about $2 quadrillion of GDP (Note #8). If tomorrow’s generations are as frugal as past generations, they will generate another $18 trillion of debt.

Adam Smith called a nation’s debt “unemployed capital,” a more apt term. The obligation of a productive nation is to put unemployed capital to work for the community. Under the current international system of national accounting, there is no way to account for the accumulated net value of real assets, or the communal operating expenses of the private economy. Without a proper accounting of those items, we engage in noisy arguments about the size of the debt.

In next week’s blog, I’ll examine the inflation pressures of government debt. I’ll review the Federal Reserve’s QE programs and why it has struggled to hit its target inflation rate of 2%. We’ll revisit a proposal by John Maynard Keynes that was discarded by later economists.

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Notes:
1. A video presentation of SovGov funding by Stephanie Kelton . For more in depth reading,  I suggest Modern Monetary Theory by L. Randall Wray, and Macroeconomics by William Mitchell, L. Randall Wray and Martin Watts.

2. L. Randall Wray wrote a short 7 page paper on the Job Guarantee program . A more comprehensive 56-page proposal can be found here 

3. Adam Smith’s The Wealth of Nations was published in 1776, the year that the U.S. declared independence from Britain. Smith invented the field of economics. The book runs 900 pages and is available on Kindle for $.99

4. Federal Expenditures FGEXPND series at FRED.

5. At the end of 1946, the Gross Federal Debt held by the public was $242 billion (FYGFDPUB series at FRED). Today, that debt total is $15,750 billion, or almost $16 trillion dollars. The difference is $15.5 trillion. The debt held by the public does not include debt that the Federal government owes itself for the Social Security and Medicare “funds.” Under these PayGo pension systems, those funds are nothing more than internal accounting entries.

6. In 2017, the Federal Reserve estimated interest and non-interest expenses for all commercial banks at 3% (Table 2, Column 3).

7. Germany’s government, the leading country in the European Union, spends 44% of its GDP Source

8. Assuming GDP growth averages 2.5% during the next forty years.

9. International Accounting Standards Board (IASB) sets standards for public sector accounting.