I have written a series of posts on this blog questioning the wisdom of fiscal austerity in the United States today. Inevitably when I make such an argument, I get comments along the lines of “what about Zimbabwe!”, “it’ll lead to hyperinflation!” and “they’re even worse off than Greece!” But these worries are all based on fundamental misunderstandings on how the monetary system works. To recap:
- You cannot make an analogy between the finances of a household or a corporation, and those of a country. Individuals have to pay back their debts over their lifetimes, and cannot sustainably spend more than they earn without going bankrupt. Governments, on the other hand, have the power to create money, which makes any analysis of their finances very different. The fact that the US has been able to run deficits almost continually over its 220 year existence makes this point clear.
- The analogy to Greece is also false. When Greece, Portugal, Spain and Ireland joined the euro zone, they all gave up monetary sovereignty. Greece has to borrow to cover its deficits and is now at the mercy of the bond markets. This is not true of the US.
- A sovereign nation that is the monopoly issuer of its own currency cannot possibly default (unless it chooses to do so for political reasons). There are no issues in “funding” its deficit. Inflation becomes a concern only if the government continues to run large deficits as the economy approaches full capacity. We are a very long way from this situation today.
- Any waste associated with government spending during recessions is absolutely dwarfed by the inefficiency of having a large segment of the population unemployed.
This week, Bill Mitchell (of Billy Blog fame) has an excellent article in The Nation that makes many of the same points. He also goes into a long history of how the “unquestioned dominance of neoliberal ideology” has come to be embraced by both major political parties today, and how this ideology is in fact one of the major causes of the recent crisis.
When President Obama announced in December 2009 that “We don’t have enough public dollars to fill the hole of private dollars that was created as a consequence of the crisis,” the leader of the largest economy in the world told us that, despite having caused the worst economic crisis in eighty years, neoliberalism was still firmly in charge. The global economic crisis might suggest that the neoliberal promise—that markets can self-regulate and deliver sustained prosperity for all—was a lie. But that doesn’t seem to have registered with governments, which have, without exception, built their responses to the crisis on a series of myths—the same myths that caused the crisis.
Despite millions remaining jobless and poverty rates rising, governments have claimed that there is no alternative but to impose austerity by cutting budget deficits. In the United States and among most parties in Europe—whether in government or opposition—the unquestioned dominance of neoliberal ideology has reduced economic debate to questions of nuance. So conservatives eschew tax increases and want larger spending cuts, whereas progressives favor a combination of spending cuts and tax increases. This homogenization of the political debate has not only stifled progressive voices; it is also obscuring the only credible route to recovery.
What began as a problem of unsustainable private debt growth, driven by an out-of-control financial sector aided and abetted by government deregulation, has mysteriously morphed into an alleged sovereign debt crisis. As private spending collapsed in 2007–08, budget deficits (public spending minus taxes) rose to bridge the gap. Now conservatives, some of whom were direct beneficiaries of bailout packages in the early days of the crisis, tell us that our governments are bankrupt, that our grandchildren are being enslaved by rising public debt burdens and that hyperinflation is imminent. Governments are being pressured to cut deficits despite strong evidence that public stimulus has been the major source of economic growth during the crisis and that private spending remains subdued…
Austerity is now viewed as inevitable. But is any of this true? The short answer is no, but it needs careful explanation, because the neoliberal arguments against deficits—at least some of them—are seductive.
Neoliberals claim that governments, like households, have to live within their means. They say budget deficits have to be repaid and this requires onerous future tax burdens, which force our children and their children to pay for our profligacy. They argue that government borrowing (to “fund” the deficits) competes with the private sector for scarce available funds and thus drives up interest rates, which reduces private investment—the “crowding out” hypothesis. And because governments are not subject to market discipline, neoliberals claim, public use of scarce resources is wasteful. Finally, they assert that deficits require printing money, which is inflationary…
When British Prime Minister David Cameron said that the government deficit is just like credit-card debt and that Britain was facing bankruptcy, he was invoking the false neoliberal analogy between national budgets and household budgets. This analogy resonates strongly with voters because it attempts to relate the more amorphous finances of a government with our daily household finances. We know that we cannot run up our household debt forever and that we have to tighten our belts when our credit cards are maxed out. We can borrow to enhance current spending, but eventually we have to sacrifice spending to pay the debts back. We intuitively understand that we cannot indefinitely live beyond our means. Neoliberals draw an analogy between the two, because they know we will judge government deficits as reckless. But the government is not a big household. It can consistently spend more than its revenue because it creates the currency. Whereas households have to save (spend less than they earn) to spend more in the future, governments can purchase whatever they like whenever there are goods and services for sale in the currency they issue. Budget surpluses provide no greater capacity to governments to meet future needs, nor do budget deficits erode that capacity. Governments always have the capacity to spend in their own currencies.
Why? Because they are the issuers of their own currencies, governments like Britain, the United States, Japan and Australia can never run out of money. President Obama was wrong to suggest otherwise. Most people are unaware that a major historical event occurred in 1971 when President Nixon abandoned what had been called the gold standard (or US-dollar standard). Under that monetary system, which had endured for eighty-odd years (with breaks for war), currencies were convertible into gold, exchange rates were fixed and governments could expand their spending only by increasing taxes or borrowing from the private sector. After 1971 governments issued their own currencies, which were not convertible into anything of value and were floated and traded freely in foreign currency markets. Most nations have operated “fiat monetary systems” ever since, and as a result national governments no longer have to “fund” their spending. The level of liquidity in the system is not limited by gold stocks, or anything else.
Zimbabwe! Yes, a Bob Marley song. But it has also become the one-word response conservatives use to scare us into believing that deficits cause hyperinflation (the cry used to be Weimar!). The reality is this: if the economy is operating at full capacity—which means it cannot produce any more new products—then attempts by the government to expand spending will cause inflation. But up to that point, governments can run deficits forever without causing inflation. By supporting spending in an economy not at capacity, deficits induce more production rather than higher prices, since companies will be happy to supply the growing demand.
The full article goes into a lot more detail. You may not agree with everything he says, but it’s a fascinating read.
Along similar lines, Paul Krugman (who is a bit hit and miss these days) has a very good column in Friday’s New York Times bemoaning the complete lack of political attention to the plight of the long-term unemployed.
More than three years after we entered the worst economic slump since the 1930s, a strange and disturbing thing has happened to our political discourse: Washington has lost interest in the unemployed.
Jobs do get mentioned now and then… But no jobs bills have been introduced in Congress, no job-creation plans have been advanced by the White House and all the policy focus seems to be on spending cuts.
So one-sixth of America’s workers — all those who can’t find any job or are stuck with part-time work when they want a full-time job — have, in effect, been abandoned.
It might not be so bad if the jobless could expect to find new employment fairly soon. But unemployment has become a trap, one that’s very difficult to escape. There are almost five times as many unemployed workers as there are job openings; the average unemployed worker has been jobless for 37 weeks, a post-World War II record.
In short, we’re well on the way to creating a permanent underclass of the jobless. Why doesn’t Washington care?
That’s a very good question indeed.