naked capitalism

This is an updated version of a post which I originally wrote at Credit Writedowns.

Regular readers know that, while I have a little of what Marshall Auerback calls deficit terrorism in my DNA, I fully support fiscal stimulus as a means to arrest a deep downturn. 

The horrendous Keynesian nightmare

My move into Keynesian mode came in December 2008 with Confessions of an Austrian economist. In fact, I have argued the Obama Administration needed to use more stimulus in early 2009, not less (see January 2009′s Obama’s stimulus bill is a tough sell so far as an example).

As early as February 2009, I argued that Obama took a middle road on stimulus and taxes that leads nowhere which would discredit stimulus as a policy tool. And that is indeed what has happened.

Now, of course many of you don’t feel that way because you share my visceral disaffection for deficit spending. But I laid out where the US economy is headed without stimulus in "The recession is over but the depression has just begun" six months ago.  And right now we are heading exactly where I said we would. Witness my last post on the economy "US GDP growth rate is unsustainable; recovery will fade"

Anyway, the point is that the US economy will not be able to sustain recovery for long without stimulus. The likely result of withdrawing stimulus is a recession that is deeper than the last one aka a major depression.

Deficits as far as the eye can see

But right now, a lot of talking heads are trying to bamboozle people with tales of woe about hyperinflation and sovereign bankruptcy in the US to support specific claims about what deficit spending can and can’t do. Deficit hawks, in particular, are on the warpath – a completely predictable outcome since I anticipated it just as Obama was elected in November 2008 (see Beware of deficit hawks).

Of course the US deficits are too large. Come on: 10% deficits as far as the eye can see are unsustainable over the long-term. The key word, however, is long-term. However, no one seems to understand the difference between short-term and long-term and the debate has become an ideological free-for-all.

Last month, I told you I am throwing in the towel on policy makers because it’s clear that Obama has been captured by the deficit hawks and we are headed for a painful recession within the next two years (maybe even as soon as next year).

The politics of economics

So let’s stop talking about policy as if we are going to change anything. I started moving away from stimulus happy talk to focus on malinvestment in December of last year.

The policy debates aren’t working because the actual mechanics of a fiat monetary system are being obscured by ideological political debates. So, what I want to do is lay the foundations of modern money with you so we can strip away the politics and ideology from the economics.

Here’s an example of the politics. Yesterday, President Obama addressed University of Michigan graduates in what I would call a "Best and Brightest" or "Government is Good" narrative of government policy.  reviewing the event, the Wall Street Journal wrote:

President Barack Obama delivered a passionate defense of government action to University of Michigan graduates on Saturday, as he appealed for civility amid the virulent partisanship that has flowered during his term.

In his first commencement address of the 2010 graduation season, Mr. Obama used the backdrop of the financial crisis, a deadly mine disaster and the looming environmental catastrophe in the Gulf of Mexico to defend his government activism against accusations of overreach and socialism.

"Government is what ensures that mines adhere to safety standards and that oil spills are cleaned up by the companies that caused them," he told an estimated 92,000 graduates, faculty and families packed into the Big House stadium, his largest audience since Inauguration Day. "We know that too much government can stifle competition and deprive us of choice and burden us with debt. But we’ve also seen clearly the dangers of too little government—like when a lack of accountability on Wall Street nearly leads to the collapse of our entire economy."

Mr. Obama chose a venerable setting to appeal for "a basic level of civility in our public debate." He cited John F. Kennedy’s 1960 address here that fostered the Peace Corps, and Lyndon Johnson’s graduation address that launched the Great Society.

The vision Obama set forth in the speech is of government as a agent of positive change.  However, reflecting upon this Speech today, Arnold Kling wrote "Is Government a Menace?," espousing a view diametrically opposed to Obama’s with direct references to fascism.  Kling writes:

Government is not "us." Government is a relatively small handful of people with far too much power. Their exercise of vast powers is neither moral, Constitutional, nor effective. The power of the people does not include the power to stop bailouts or to stop health care reform. The power to elect our leaders is a very weak power. Our laws are passed by a Congress that, rather than enjoying the support of the vast majority of Americans, is according to polls opposed by the vast majority of Americans.

The Washington Post headlined President Obama’s speech "a fiery plea for civility." Basically, he was calling on people to submit to his will and that of his party. But just as I would never donate money to a charity that gives to billionaires, I will not support the expansion of power for those who already exercise far too much.

I am willing to forego the use of the term "fascist" to describe our current government. The amount of physical intimidation that we face today is nothing compared to what people faced under Hitler.

However, Hitler did not just get the reluctant obedience of those who feared the violence of his government. He obtained most of his support from people who willingly looked up to him as representing the German "us." The shocking thing about German history is not the people who reluctantly submitted to Hitler’s authority under threat. It is the people who were attracted by his fiery pleas.

Yes, government is a menace. It is less of a menace in the U.S. today than it was in Germany in 1933. But it is a menace.

These are the ideological battle lines that are being drawn in the debate about government policy during this period of economic crisis.

Policy is exogenous and deficits are endogenous

My goal over a series of posts to be published here and at Credit Writedowns is to demonstrate that fiscal deficits and surpluses are endogenous to our economic system and depend on exogenous policy decisions which are inherently political and ideological. 

Let me give you an example. What if we allowed the US economy to proceed without making one economic policy decision for the next two years? What would happen? The answer is that the government would have a fiscal deficit of X billions of dollars exactly matched by X billions of surpluses in the non-government sector (remember the sectors must balance). The deficit outcome is endogenous. It is a function of the inputs i.e. of the private sectors desire to save and the government’s spending decisions. 

On the other hand, government economic policy decisions are exogenous. They are input variables which alter outcomes. This is an important point because if we know how the monetary system works, then we can get a much better handle on how different policy decisions actually affect deficits and surpluses. And remember, policy decisions are almost entirely political. That is they are driven by ideological positions.

So, if I say to you that I am against government spending and it must be cut, this creates a specific outcome path. On the other hand, if I say I am pro-stimulus, this too creates a specific outcome.

Modern Money

Here’s how I am going to go about this one:

I went to a conference on Modern Monetary Theory (MMT) on Wednesday. Over the next few weeks, I will present some ideas from the Modern Money people (Randy Wray, Marshall Auerback, Bill Mitchell, etc). I’ll start the post titles with "MMT:…."

I will take a somewhat antagonistic approach because I think that’s probably going to the best way to introduce this to people who have a more libertarian bent like myself.

Now, my bio says:

From an ideological perspective, Edward calls himself a libertarian realist: a firm believer in the primacy of markets over a statist approach. but not in an ideological way. Often government intervention and oversight is not just wanted but warranted.

What that essentially means is that when I think about government, I view it with suspicion and my inclination is to seek to limit its size and scope. That means I have an innate disaffection for big government, deficit spending, money printing, etc. – but not in an ideological way.  It all depends on the circumstances. (For instance, see "A few thoughts about the limitations of government" which outlines my ideological positioning).

So, my goal in this is to separate the policy and the politics from the mechanics of how our fiat money system operates. That way it will be clear what is actually happening in our monetary system right now and what is pure political posturing. You will also then probably see a lot of congruence between how I see the economic mechanics and how Marshall sees them.  The difference, of course, is ideology.

The way I intend to position this is that Modern Money Theory economists are really the True Modern Money Operations economists because they present the true mechanics of modern fiat money operation, which I will show you.

Now, policy decisions are largely political, exogenous decisions about which informed decision-makers can disagree. And it depends on one’s view of the role of government, which I outlined in late 2008 in "A brief philosophical argument about the role of government."

If we aren’t at least informed about the mechanics of how modern money works, it is very difficult to have an intelligent debate about deficits, social security, fiscal stimulus or anything else for that matter. 

I know that I have learned a lot from what the likes of Randy Wray and Bill Mitchell have said (remember, I studied economics in a time heavily influenced by the prevailing economic orthodoxy).  I don’t ‘buy into’ a lot of what they propose on policy, but on modern money they have it right.

The purpose is to present the underpinnings where we can all agree and separate it from the ideological piece. I will take the limited government side. My ideological foil in this will be Marshall Auerback.  Afterward, I hope we can have a framework from which to talk about the political piece.

I hope you enjoy the debate and a presentation of the ideas.