Guest Post by John Armour
Last week Australia’s Prime Minister, Tony Abbott, said; “we are now borrowing to pay the interest on the money we’ve borrowed.” He added that if this didn’t stop we were “stuffed.”
This must make Abbott lead contender for the title of “The Stupidest Man in Australia.” His only serious challengers would be the Treasurer, Joe Hockey, and sidekick Mathias Cormann, who say equally dumb things on a daily basis.
Behind Abbott, Hockey and Cormann, one could reasonably nominate every member of the Press Gallery, the journalists (supposedly our best) who cover the important political issues of the day for the MSM, for the runner-up awards.
Last weekend, on the ABC’s “Insiders” program, four of the nation’s top journalists nodded sagely as one of them expounded on the necessity for “fiscal consolidation,” an oxymoron.
To those well versed in the mechanics of our monetary system it must seem as if our politicians and the press corps live in a parallel universe where black is white and water flows uphill.
Only in the blogosphere does one learn about the reality. Why is this so?
The answer seems to be that non-mainstream academic economists like Bill Mitchell decided to try using the internet to reach a wider audience, to describe how our monetary system really works, and bust a few myths, in the hope that the insights of MMT would then trickle up to policy makers and cut the rug from under the Neo-Liberal experiment.
One would have to say they have been spectacularly successful, but only up to a point.
Despite an enthusiastic lay following that seems to be growing exponentially, the advancement of MMT seems to have hit a wall when it comes to getting around the gatekeepers of the Neo-Liberal madhouse, the economists and financial and political journalists, who write for the MSM.
Keynes said the problem is not in understanding new ideas, but in getting rid of the old ones.
That’s certainly true, but MMT is just so damned confronting to deeply embedded “self-evident” truths. The instincts and “common sense” of Keynes’ “practical men” are of no help. MMT is counter-intuitive.
Proponents of MMT generally can’t understand why people don’t “get” MMT as it seems so obvious. They may have forgotten however, that at their critical point of ‘enlightenment’ they had to jump a number of conceptual barriers to get to the other side.
In my experience, these are the six (seemingly) “impossible things” you have to believe (before or after meals, it doesn’t matter) to have any hope of ‘getting’ MMT. Once you believe these “impossible things” however, the getting of wisdom follows quickly and logically.
The order of priority is based on my experience of the degree of ‘jaw dropped-ness’ as I’ve sought to explain to friends, family, and household pets.
(1) Taxes don’t fund anything
(2) The government doesn’t borrow from anybody to finance its spending
(3) The government’s fiscal balance (deficit) is the non-government sector’s surplus.
(4) The government creates currency by fiat (‘out of thin air’)
(5) Bond issuance is not borrowing.
(6) Banks lend without reserves constraints imposed by the central bank.
They are of course not “impossible things” but the absolute reality of the sovereign fiat monetary system we actually operate under.
I could’ve added a few more but I needed just six to fit my literary allusion (“Through the Looking Glass”).
Warren Mosler’s great little book “Seven Deadly Innocent Frauds of Economic Policy” covers all these points in detail as does Frank E. Newman’s “Six Myths that Hold Back America.”
Modern Monetary Theory: Real Economics 
Reblogged this on The Mugwump Post and commented:
John Armour tells it like it is with a dash of tongue in cheek humor thrown in for good measure.
Reblogged on The Mugwump Post 🙂
Reblogged this on MARGARET-ROSE STRINGER and commented:
I am so in love with the opening few par.s that I couldn’t not reblog this …
What funds government spending if not taxes (and borrowing)
By issuing bonds governments receive money that has to be paid back. It has borrowed that money, at interest.
Bill439BillClarke,
The theory starts by understanding what money itself is. It’s just an IOU issued by government. No silver no gold backs up those IOUs. So if you imagine yourself as a Sovereign Government who spends by issuing your IOUs you can appreciate that you don’t need to get back old IOUs in tax before you write out new ones.
In fact you must write out some IOUs before you can receive any back in tax. So, logically, the spending has to come first for an issuer of currency. Therefore equally logically there is no taxation needed for that spending.
So why do governments tax? It’s so they can stop anyone else spending those IOUs received back and so prevent inflation. And what does anyone do when they get back their own IOUs? Yes, they tear them up. That’s what Governments do too. They destroy money when they tax. And create it when they spend.
Once you see money as an IOU, issued by yourself, you can see that you can you can’t really borrow it back. It doesn’t make any sense. All you can do is swap one kind of IOU for another. So selling bonds is just swapping an IOU that doesn’t pay any interest for one that does pay some interest.
That’s the Lewis Carroll allusion. Its seems crazy at first sight, but that’s because we are used to life on one side of the mirror as currency users. If we imagine ourselves as currency issuers, on the other side, then it seems strange at first but logic still prevails!
“By issuing bonds governments receive money that has to be paid back. It has borrowed that money, at interest.”
That’s where the myth that the government has to borrow from the private sector so that it can spend really starts Bill.
The government issues bonds certainly, but not to finance its spending.
When the government deficit spends the excess (spend minus tax) ends up in the “reserve accounts” that the commercial banks keep at the central bank.
The commercial banks can’t lend this money out (contrary to belief) but they can lend it to each other. Banks need a certain level of reserves to function and borrowing from each other is one way they meet these requirements.
If all the banks have excess reserves (due to the government’s big spend) there’s no competition for the money and so the rate of interest they might otherwise have got, by lending to another bank needing reserves, falls to zero.
This ‘interbank lending rate’ is the rate the central bank likes to keep control of as it’s the benchmark rate for pricing all lending in the financial system.
So, if the interbank interest rate looks like it might fall to zero, the government issues bonds to mop up the excess reserves and put a floor under the interbank lending rate.
Because this happens simultaneously with the deficit spend it looks like the government is borrowing to finance its spending, but it’s nothing of the sort.
Why would the government borrow from the private sector when it can create as much money as it likes, ‘out of thin air’ ?
What’s more, when the government issues those bonds, all it’s really doing is ‘borrowing’ back the money it’s just spent.
Hi Peter,
You shouldn’t be even slightly sad about introducing expert opinion as we all do it to support our views. I don’t see that it matters if we call a bank note an IOU as its function in the economy is just the same.
It’s an interesting point you raise that if savings and lending under FRB are the same as now, boom and bust cycles would be about the same as now. That’s another thing I hadn’t thought about, so I will.
I think you are right that an increase in the money supply, by itself, doesn’t cause inflation. The velocity of money and the level of production of goods and services must be included too. If spending and demand fall the supply side will be greater than the money side and deflation, price falls, occur. On the other hand, if supply falls below the level of money and velocity then inflation looms.
So I have learned more about general economic theory, thanks to you.
I have replied by personal email rather than through the PM blog as, frankly, I didn’t want to clutter it up with matters not specifically on their proposals. I thought it significant that no-one else entered our discussion.
However, if you do not agree to carry on privately, I.m happy to return to the blog.
I enjoy and appreciate your comments.
Best wishes,
Bi
“The government issues bonds certainly, but not to finance its spending.”
I’m a bit slow Peter. I just noticed you explained all this in a lot more detail in your “Positive Money” part 3 article.
I’m not sure! But anyway if taxes don’t finance spending then neither do bond sales. Both are a way of removing excess liquidity , fancy name for spending power, so that when government itself spends, by creating new money, it isn’t inflationary.
Bond issues give the holder some interest too. Some people seem to begrudge the government paying interest and suggest bond sales are unnecessary. Normally it is just about enough to cover inflation so I can’t see why there should be any real objection to that.
Dividends on bonds are also a small stimulus to the economy.
We should be grateful for small mercies in these straitened times.
Bill recently asked in an email
“You still haven’t answered my point: if a bank note is an iou what does the government owe me? another bank note?”
That’s pretty much right! When money was on a gold standard the IOU was obvious. It was an IOU for some gold. Take away the gold and what’s left? Not a lot. But its still an IOU. Its a promise to accept that IOU in the same way as it would when the money was on the gold standard. Its a promise to give you a TV licence in exchange for a number of them, or a car licence or to accept them as payments for income tax whatever.
So if its an IOU it must be a debt too. We are used to the idea of debts as something that must be repaid. But if we understand that for every asset there must be an equal liability, the principle of bookkeeping, then it follows that for all of us to enjoy owning financial assets then someone else (ie government) must hold the debt. We don’t want that debt to be repaid. Because it can only be repaid by removing our assets.
Why do you say that that the tax I pay to the Inland Revenue or AFB is destroyed? Surely the Government just credits its account and spends it.
Because once we accept the idea that money is an IOU it doesn’t make any sense for the issuers of the IOU to have an account containing their own IOUs. I could start an account giving myself as many as I like but so what? They all net to zero because my assets and liability cancel out. It would make sense for everyone else to have an account of my IOUs though! Everyone else but not me!