This Could Change Everything

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Dick Wagner, JD, CFP and Don St. Clair, CFP, EA

23rd Annual Far West Roundup August 9-12, 2012

"Money is the most powerful and pervasive secular force on the planet. Yet for most, it's a source of mysticism and mystery."

- Dick Wagner, JD, CFP

What is Money?

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Textbook ExplanationMoney derived from barter

Spontaneously originates in Private Sector

Replaces clumsy barter

Eliminates "double-coincidence of wants"

Reduces transaction costs

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Evolution of MoneyPrimitive monies

Stones, beads, shells, feathers, fish, cattle, etc.

Precious metals - coins

Paper with metal backing

Fiat money - based on Trust?

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Textbooks Conclude

Money is what money does

Unimportant in its own right

Largely ignored in many economic models

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Graeber: Not So Fast

No archeological evidence

All money is debt

Roots in penal system

Unit of measurement

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Credit & State Theories

Anthropologists, Sociologists, & Numismatists find origins in credit/debt relations

Palace communities, Mesopotamia, ancient Egypt

State/Temple/Authority plays central role

Chartalist/Cartalist

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John Maynard Keynes

"The age of Chartalist or State Money was reached

when the State claimed the right to declare what thing should answer as money to

the current money-of-account.... To-day, all

civilized money is, beyond the possibility of dispute,

chartalist."

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Regardless of OriginToday, all money exists as an IOU, representing a social debt relationship

It is abstract, and like an "inch" or a "yard," it can be measured, but not seen or felt

In any modern nation, the money of account is chosen by the national government

A nation's IOUs are recorded in this money of account (e.g. US Dollar, British Pound, Japanese Yen)

Money is not an object. It exists as credit/debit entries. Coins and paper are representations of money, not vice versa

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Today, Sovereign Governments

Define the money-of-account

Impose taxes, fees, obligations

Decide what they will accept as payment

Choose how they will make their own payments

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Taxes Drive Acceptance

Government defines money/what it will accept as payment

Makes payment (spends) in that same money-of-account

Requires taxes be paid in the money-of-account it defines

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But Taxes Do Not Fund Spending

Government does not "need" our money

Not to raise revenue per se

Taxes function to regulate the economy by regulating aggregate demand

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How a Currency Issuer Spends

By directing its bank (usually the central bank) to credit someone's account

This frequently (and increasingly) happens without even writing a check

In the "modern money" era, government spending is accomplished through electronic keystrokes (Bernanke)

The government neither has, nor doesn't have dollars in an account somewhere

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Modern MoneyPelley: "Is that tax money that the Fed is spending?"

Bernanke: "It's not tax money. [W]e simply use the computer to mark up the

size of the account."

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Hierarchy of Money

Government

Banks

Non-Financial Business

Households

Anyone can create money (social debt relationship)

Trick is to have it accepted (Minsky)

But private sector cannot create net financial assets

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The US Hierarchy

US $

Issues the currency at the top of the pyramid

Taxes and spends in dollars

Non-convertible, fiat money

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On Gold Standard

US $

Gold

Pre-1973, Bretton Woods

Promised to convert US$ to gold at a fixed price

Dollars were subordinate

Had to limit spending to protect gold reserves

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Other CountriesDid not issue currency at the top of the pyramid

Had to limit spending to protect (US$) reserves

Sacrificed control of interest rates

Heavily dependent on trade surpluses

US $

Ruble, Peso, etc.

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Look familiar?

The Euro is effectively a foreign country from the perspective of the individual nations

Currency is divorced from the nation ("One Market, One Money")

"Euro"

Greece, Spain, etc.

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The EurozoneNo EMU nation issues the currency that sits at the top of the pyramid

Governments can "run out" of Euros

Must pay market interest rates

Heavily dependent on trade surpluses

"Euro"

Italy, Portugal, etc.

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Under Bretton Woods

US $

GoldPromised to convert US$ to gold at a fixed price

Dollars were subordinate

Had to limit spending to protect gold reserves

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Everything Changed!

Except the textbooks

Nobody rang the bell

Dollars no longer subordinate

Money no longer the object

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Sovereign Money MattersA sovereign currency ISSUER that does not peg to another's or offer to convert, can never "go broke," or "run out of money"

It can afford anything for sale in the domestic unit of account

It does not need to borrow its own currency

It can set the policy interest rate at any level

It has expanded policy space

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But isn't the US Broke?

"We're out of money"

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Within Our Means

"The government, just like every American

household, has to live within its means"

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Is the Government Like a Household?

No - not anymore

Not since we abandoned the gold standard

We ended Bretton Woods

We have "modern money" created by keystrokes on a computer

But... we act as if we're still stuck in a fixed exchange rate world

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The ISSUER of the currency can always pay

"[A] government cannot become insolvent with

respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such

claims without limit"

-Alan Greenspan 1997

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Deficit Hawks want Immediate Cuts

Opposes deficit spending on principle

Often favors "sound money" (e.g. gold standard or 100% reserve backing)

Would legislate rules to mandate balanced budgets

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Deficit Doves want Eventual Cuts

Supports limited deficit spending in tough economic times

Want the budget balanced over the business cycle

Support rules to limit the size of the deficit

Prefer to wait until after the economy begins to recover before imposing austerity

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More Deficit Aviary

New bird in town, the Deficit Owl

Modern Monetary Theory (MMT)

Exposes the fallacies in conventional economic theories

Views unemployment as socially harmful and economically inefficient

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Within Our Means?

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Unused energies. Unmet needs.

The MMT Deficit OwlAssigns no arbitrary limit to the size or duration of the deficit

Uses a sectoral balance sheet approach to relate deficit to the rest of the economy

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Sectoral Balances

Spending more than its income (deficit)

Spending less than its income (surplus)

Spending just equal to its income (balanced budget)

In any given period, sectoral balances show whether a particular part of the economy is:

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Accounting for DeficitsThe laws of double-entry accounting apply

All sectors cannot take in more than they spend (i.e. be in surplus)

All sectors cannot spend more than they take in (i.e. be in deficit)

Unless all 3 sectors are in balance, at least one sector will be on deficit

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Private Sector BalanceAs a general rule, the private sector needs to be in surplus

Households and firms cannot continually borrow more than their income

At some point, lenders will run out of credit worthy borrowers who are willing to spend

Private debt levels may become unsustainable (Minsky's Financial Instability Hypothesis)

When an expansion driven by private sector debt reaches an end, sales soften, jobless claims trend higher, and economic activity falters

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Private Sector Debt

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Unemployment Follows

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Achieving a Private Sector Surplus

Unless/until we run a trade surplus, the government must run a deficit

Only countries with trade surpluses can avoid running government deficits

Not everyone can be a net exporter!

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But We're Terrified of Deficits

What if people lose trust in the dollar?

What if China refuses to buy our bonds?

What if interest rates skyrocket?

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What About Inflation?

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Japan is Instructive

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Bond Vigilantes?

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Devaluation?

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Quantitative Easing

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Inflation in Japan is non-existent

Despite decades of it's own QE

What Have We Learned?The government's deficit is equal to the non-government sector's surplus

The US can never go broke or forced into bankruptcy

Sovereign constraints are Real, not Monetary

Deficits do matter

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So What?

Observations

Entitlements

Our Own Theory

Current Policy Options

What's Next?

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Observations

Money is No Object

Constraints are never Monetary

Views Full Employment as Socially Desirable

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Money is Not the Object

Constraints are often Imagined

Prioritizes Numerators over Denominators

MMT CFP

Entitlements

Payroll tax creates new Government "Debt"

Constraints are Self-imposed

Medicare Parts B & D "adequately financed into the indefinite future"

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A Borrowed TheoryCost of Capital

Infinite Time Horizons

Lack of Spending Opportunity

No Spending Imperative

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LifeCycle of Household

Learn, Earn & Borrow

Earn, Invest & Deleverage

Divest, Spend-down & Consume

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Policy Choices

Raise taxes, cut spending - or both

Prudent advice for an OVERheated economy

Why then, are these the only policy options on the table?

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What's Our Role?In the National Debate?

In macro-economics?

In educating our clients?

Our community(s)?

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Want More?

WWW.NewEconomicPerspectives.org!54

@DeficitOwl

Complemetary Currencies?

Time Banking

UMKC Buckaroo

Denison Volunteer Dollars

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So Why the Weak Recovery?

Policy makers significantly underestimated the severity of the crisis

They don't understand banking

They think deficits are under the government's control

They think "confidence" will improve if we shrink the deficit

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Owls Doves Hawks

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