President Obama is Hoisted on His Own Budget-Busting Petard
So the President wants to keep the focus on jobs and the economy, and get serious about runaway spending. His problem, however, is that only half the message is getting through to Congress, which is starting to listen to him on the second point — at the expense of the first. Well, it’s his own fault. Even as the President (rightly) continues to trumpet the real economic benefits that have accrued from his $787 billion spending bill, which helped to sustain demand and create jobs, he capitulates to the common deficit dove position that our government ultimately faces a “national solvency” constraint. He and his advisors still do not realize that there is no economic doctrine, no magic number, which would imply a firm external constraint on public spending, when dealing with a sovereign government issuing debt its own floating rate, non-convertible currency.
Or to put it another way, Obama still fails to comprehend that a desired level of aggregate demand is altered by the public sector’s fiscal balance. So in the longer term, the public sector should tighten fiscal policy only if aggregate demand is deemed to be ‘too high’ — because we are close to full employment — and not to “fund” anything per se, as the President implies when he talks about dealing with “runaway government spending”. At that point, we may indeed have a resource constraint, or an inflation constraint, but not a national solvency issue.
Let’s take a step back and give the President a needed tutorial in Basic Macroeconomics 101. At an economy’s most basic level there are 3 major sectors: 1. a private sector that includes both households and firms, 2. a government sector that includes both the federal government and all levels of state and local governments, and 3. a foreign sector that includes imports and exports. At the aggregate level, the dollar spending of all three sectors combined must equal the income received by the three sectors combined. Aggregate spending equals aggregate income.
But there is no reason why any one sector must spend an amount exactly equal to its income. One sector can run a surplus (spend less than its income) so long as another runs a deficit (spends more than its income). And the government sector is in the unique position of being able to create new net financial assets, by virtue of its ability to create currency. When a private entity goes into debt, its liabilities are another entity’s asset. Netting the two, there is no net financial asset creation. When a sovereign government issues debt, it creates an asset for the private sector without an offsetting private sector liability. Hence government issuance of debt results in net financial asset creation for the private sector. Private debt is debt, but government debt is financial wealth for the private sector.
Solvency, then, is not an issue for the US government. In failing to recognize this crucial point, the President in effect legitimizes the position of the deficit hawks, who argue that national government fiscal policy is ultimately predicated on the type of constraints faced daily by households. Rather, the President should affirm that fiscal sustainability does not include any notion of financing imperatives faced by a sovereign government. Nor should he invoke the fallacious analogy between a household and the government.
Households neither have the power to levy taxes, nor issue currency, nor to demand that those taxes are paid in the currency it issues (well, they can do this, but it’s called “counterfeiting” and it’s a jailable offense). Rather, households are users of the currency issued by the sovereign government. Here the same distinction applies to businesses, which are also users of the currency. By virtue of the constitution, the US federal government is the sole issuer of our currency, and the dollar, which is nothing more than the government’s IOU, is always accepted in payment.
And to anticipate the next objection of the Flat Earth Economists, let’s deal with the risk of currency evaporation, which is usually alleged when we point out that the dollar is always accepted in payment. Consider the Russian financial crisis of 1998. Even then, the ruble didn’t vaporize and disappear. It just made a one-time adjustment from 6.45 to maybe 28 to the dollar, even though the entire payments system shut down for almost six months. This is despite the fact that in Russia in 1998, there was complete debt default of both local and foreign currency, no faith, total meltdown of GDP, and a central bank shut down. Yet the ruble neither disappeared, nor did Russians stop using it as the currency unit of account settlements.
The President must get out of the notion of defining “fiscal sustainability” in relation to some sort of arbitrary level of the public debt/GDP ratio. This is arguably the core weakness at the heart of the European Monetary Union today. As Professor Bill Mitchell notes, fiscal sustainability is directly related to the extent to which labor resources are utilized in the economy. The goal of fiscal policy to generate full employment. Even Ronald Reagan seemed to understand this concept better than President Obama. The goal of the Reagan tax cuts was to generate growth and reduce unemployment; the message wasn’t muddied by references to the importance of returning the federal government deficit to “manageable levels”, as the wars wind down and the economy recovers from the recession.
The concept of fiscal sustainability is not defined in terms of public solvency. A sovereign government is always solvent (unless it voluntarily imposes constraints on itself, as the US government and others are doing). The President must first point out that the collapse in private spending over the past two years has meant that output and employment growth are still at terribly depressed levels and urgent fiscal intervention is required. If the public deficit (which is, after all, nothing more than an accounting tally that reflects the gap between government receipts and expenditures) does rise to offset the fall in private spending, then aggregate demand can continue to support the high levels of output. Households will continue to reach their desired saving levels and employment will not fall. Double digit unemployment is de facto evidence that we are doing too little, not too much.
Failure to support economic growth via fiscal stimulus, as is now being urged by the deficit hawks and by the President “over the longer term”, will clearly worsen today’s dire situation. It will drive up the output gap — that is, the difference between potential or full employment output and actual output, the latter being determined by the state of overall spending power in the economy (see here for a broader explanation).
It is ironic that a President supposedly in possession of such great oratorical skills continues to muddy his message as badly as the BP oil spill is now tarnishing much of the Gulf coast. Obama is undoubtedly correct to focus on jobs and the economy, but wrong to obsess about “runaway spending”. Our economy faces such strong headwinds that a huge fiscal expansion is required — and this will mean deficits even larger and perhaps more prolonged than those now projected. We still need to replace 8 million lost jobs. If the President had any understanding of basic accounting identities, then he could make the case to the public far more coherently. He would also likely have greater success in channeling Congressional action toward genuine job creation, not the deviant form of crony capitalism that has inefficiently tied up so much of our government resources and helped to discredit the very actions that prevented the economy from going over a cliff. I’ll leave the final word to my friend, Warren Mosler, who understands these things better than the President (and most of Congress, apparently):
Fiscal policy does not have to introduce moral hazard issues. It can be used to sustain incomes from the bottom up at desired levels, and not for top down bailouts of failed businesses. Sustaining incomes will not keep an overbought market from crashing, but it will sustain sales and employment in the real economy, with business competing successfully for consumer dollars surviving, and those that don’t failing. That’s all that’s fundamentally needed for prosperity, along with a government that understands its role in supporting the public infrastructure.
Roosevelt Institute Senior Fellow Marshall Auerback is a market analyst and commentator.