All Debt is Not Created Equal: Government Debt is NOT the Same as Private Debt

By Marshall Auerback, an investment strategist and analyst who writes for New Deal 2.0.

A major shortcoming in an otherwise thoughtful post by DoctoRX on deficit spending is a traditional mistake in which analysts seek to analogise the expenditures of government with that of a private household or business. The government is sovereign. This fact gives to government authority that households and firms do not have. In particular, government has the power to tax and to issue money. The power to tax means that government does not need to sell products, and the power to issue currency means that it can make purchases by emitting IOUs. No private firm can require that markets buy its products or its debt. Indeed taxation creates a demand for public spending, in order to make available the currency required to pay the taxes. No private firm can generate demand for its output in this way. Neither of these statements is controversial; both are matters of fact. Nor should they be construed to imply that government should raise taxes or spend without limit. However, they do imply that federal budgeting is different from private budgeting, and should be considered in its proper, public context.

It simply means that the government does not “need” money to “fund” its operations. It seems counter-intuitive, but the public actually needs the government’s money to pay its taxes rather than the government needing taxes to pay for highways, bridge repairs, schools, national defense, etc. For the household, paying back debt means they have to sacrifice current consumption (spending). For the government, no such financial constraint is imposed. Its ability to spend now is independent of how much debt it holds and what is spending was yesterday. That situation can never apply to a household or business firm.

Because the government is the only entity that gets to create money, it can “buy” whatever is for sale in terms of its money merely by providing that money to the public, which opens up a huge range of policy options. Putting this in concrete terms, the government–‘buys’ a new highway or a new aircraft carrier, as long as the construction materials and workers’ wages can be paid for in its own currency.

Where does the government get the money? The government creates this money by crediting bank accounts. It creates money with the stroke of a computer keyboard. New money is an entry on a spreadsheet, nothing more.

To put this in everyday terms, the dollars the government creates function something like tickets to the Super Bowl. As you go into the stadium, you hand the man a ticket worth $1000, and then he tears it up and throws it away. Why? Because the ticket has served its function: it has enabled you to gain entry to the event in question; similarly, a tax is paid to extinguish a state liability, but as soon as the tax is paid, it has no further value to the government. The tax receipt can be sent to the shredder. Tax payments (which discharge a liability to the state) then “drain” the money we call legal tender (otherwise known as “fiat currency”), which can be pictured as a movement of funds away from the private sector and “down the drain” as the money is literally burned, or simply wiped off the liability side of the Federal Reserve’s balance sheet.

How does the government taking your tax money and throwing it in a shredder pay for anything? The answer is that it doesn’t.

Taxes function to reduce aggregate demand, also known as spending power, and not to collect what the government needs to spend on something else.

As a matter of conceptual clarity, it makes no sense to say that a government ever “builds up a store of savings” that allows for higher spending capacity in the future. The government neither has or doesn’t have any dollars; it simply makes computer entries on a bank’s balance sheet, as Federal Reserve Chairman Bernanke described in the “60 Minutes” interview above.

It spends by changing numbers upwards in our bank accounts. Think of this like a football game. Awarding 6 points for a touchdown doesn’t “use up” some stock of points held by the stadium. It is “electronically credited” via the scoreboard. Nobody asks that the 6 points be “repaid” somehow.

You don’t “save” what you have the option of creating or not creating (i.e. fiat currency). Not spending, not “creating currency” via crediting bank accounts, simply means less present day economic output.

We all learned this as the paradox of thrift.

There is nothing to “save”. The government is never revenue constrained.

This is in contradistinction to the way users of the currency, versus the issuer of a currency, such as a household functions.

For them, spending is constrained by income. Their checks will bounce if there is no money in their accounts. And for users of the currency monetary savings can be stored to permit higher consumption in the future. And households don’t have an electronic printing press in their basements which would eliminate that constraint. As Rob Parenteau has already noted, this is called “counterfeiting” and it’s a jailable offence.

True, if a government spends too much after getting us to a state of full employment and higher economic growth, excessive government spending can create inflationary pressures. So to that extent, there is a limit. But acknowledging that unconstrained government spending can create inflation is not the same as arguing that it is in any way operationally constrained. Contrary to conventional “gold standard” thinking, where it is said that every DOLLAR SPENT HAS TO BE ‘FINANCED’ BY AN OUNCE OF GOLD ALREADY IN EXISTENCE, our government can afford anything that it is for sale in its own currency.

The debate therefore should not be focussed on “affordability” but on what our the national priorities of our government? The political process, not a non-existent gold standard, determines that if we want more killing toys then the national government can always meet those expectations in a fiscal sense, unless we run out of real resources. Likewise if we desire universal health care, in a manner where the government provides this as a national right, rather than foisting it on business as a marginal cost of production (remember, businesses are constrained in a way that governments are not).
Further, if there is a problem with excessive private indebtedness and overspending, then the mirror image of that has been the excessive fiscal drag that the national government inflicted on the USA between 1996 and 2007. If you want the economy to grow and produce the saving capacity (via income growth) to allow the private sector to repair their precarious balance sheets then the last thing you would want to do is run “tight Budgets … for a long time into the future”.

What is needed when the economy has been driven by private spending funded by ever-increasing levels of debt (and a contracting public sector as a proportion of total output) then what is required is a change in the composition of final expenditure – from private to public – unless you want to “scorch the earth” and deliberately contract the economy.

The consequences of overspending might be inflation or a falling currency, but never bounced checks a government creating its own currency can never go broke. Government spending limits ought to be set by our policy makers by considering what we, as a society, want, like universal healthcare, full employment, a well-functioning economy and our ability to accomplish this—not out of some preconceived notion of what is “affordable”.

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  1. Charles

    When “affordability” is measured in real terms, not nominal terms – and I would argue that it is the only measure that counts – governments are effectively constrained.
    So no, policy makers cannot introduce unlimited universal healthcare, full employment and anything else by pure fiat.
    “scorching the earth” through mis-allocation of public credit (like, say, fighting useless war)is frequently worse than “scorching the earth” doing nothing.

    read or re-read Bastiat’s broken window.

    1. Anonymous Jones

      I don’t think the point of the post was to argue that the government wasn’t constrained at all. The point was that the government wasn’t constrained by revenue to “spend” more in a fiat money system. The point was not that the government isn’t revenue constrained in acquiring a set amount of goods and services.

      I think the post would have been more concise and clear if it simply said flat-out that the decisions about deficits have a bigger effect on distribution of wealth rather than creation of wealth. Who to tax, how much to tax, where to spend, on whom to spend, whether there will be inflation, all these have profound effects of distribution of wealth, regardless of any effect on creation of wealth (which they almost certainly have as well).

      Also, I hope someone has pointed out to you the limits of the “fallacy” of broken windows. You have to assume a non-redistributive system and only evaluate the “closed” part of the system. If I break all the windows in San Diego and then tax everyone in Boston to pay for it, I can assure you that San Diego’s economy will be better off for it. This is not as far-fetched an example as it seems, if you consider that a huge amount of the western states’ wealth has come from hugely inefficient wealth transfers from the eastern states in the form of “ten cents on the dollar” water projects. Yes, if you look at the US as whole this shows the fallacy of using inefficient government spending for “growth.” If you only examine the western states, however, you would could get lost in what appears to be an oasis of growth. [Not to confuse the issue, but if one accepts that hard-to-measure negative externalities are inherent in radically skewed wealth distributions, “inefficient” wealth redistributions could actually be efficient when viewed in totality. I’m not arguing that, but it is not impossible.]

      As with every policy, it’s not just about whether it increases efficiency or decreases efficiency, but about who wins and who loses. In fact, I would argue that the latter distinction causes more of the anger we see regarding government policy, and perhaps we should spend more time on that subject than the former.

  2. kr

    So government spending is a bit like equity then… there’s no limit to issuing new equity, but diluting existing holders isn’t necessarily such a great idea. In theory the federal reserve is independent, but there’s no reason congress couldn’t nationalize it if they they chose to, so effectively it is part of the government.

    There is also one other important factor, which is that the holders of currency need to have faith that the government is not going to go creating money. Even if the government does not create the money now, just the perception that it might can significantly change behavior.

    So deficit spending (with federal reserve involvement) is really taxation-by-inflation, since there is no difference for the government to spend $x by creating new money vs collecting $x in taxes. Is taxation via inflation such a good idea?

    This would not apply for Euro-member countries, since they do not have the power to issue Euros. It also does not apply to debt issued in foreign currency.

  3. Graphite

    the public actually needs the government’s money to pay its taxes rather than the government needing taxes to pay for highways, bridge repairs, schools, national defense, etc

    The political process, not a non-existent gold standard, determines that if we want more killing toys then the national government can always meet those expectations in a fiscal sense, unless we run out of real resources.

    The post is, if nothing else, a demonstration of just how deep into self-evident absurdity a fiat currency system can take you.

    Makes you wonder what kinds of theories Roman thinkers were churning out back when the denarius was being denuded of its precious metal content.

    1. marc fleury


      I was recommended reading Randall Wray’s understanding modern money

      This post follows the logic of functional finance or chartal money:

      It is a fascinating read, if a bit thick (a la keynes). My initial gut reaction is like yours, that it is non_sense. I have been thinking about this for the past weeks. I

      Particularly i believe one of the sources of confusion is due to the attributes of money. It serves both as a store of value and a medium of exchange. Obviously as a medium of exchange it stimulates the economy. You print money and all you do is create economic activity in a very straightforward keynesian way. You print money are you stealing from the people? I think the answer is a matter of ideology. Since the people is the govt and vice_versa then strictly speaking, you are stealing from yourself; taking from your left pocket to your right but stimulating economic activity in the meantime. If however you view the govt as an evil 3rd party thing that steals from your pocket to give it to someone else; then you will view such propositions with horror.

      This of course does not apply to international relations. When a government prints money, as the US is doing currently, it is at the expense of foreign entities, bar an FX re-adjustment.

      The US is currently applying functional finances. An un-apologetic embrace of printing presses.

    2. Mike S


      Has any currency ever maintained its value?

      No. Because people thought that gold was money when it is not. Gold is something you purchase with money.

      I have a prediction: Within 10 years the model described in this post will be regarded as self-evident.

      As far as I can tell, your response is to mock it rather than critique it.

  4. William

    Somehow this fails the common sense test. Certainly all governments have the same ability to print money, why pray tell do that not have the same ability to spend it?

    Why are some governments “richer” than others?

    1. selise

      just because a government is not revenue constrained (it doesn’t need to tax or borrow in order to spend) doesn’t mean there are no constraints. one limit, if i understand correctly, is the capacity of the economy to produce (which, btw, i think also addresses your question on why some governments are “richer” than others — it’s the productive capability of the economy)

    2. Captain Teeb

      Hi William,

      To the foregoing comment about productive capacity, I would add that the dollar’s role as reserve currency allows the US government to tap the world’s productive capacity to the extent that the world wishes to hold dollars. This well has proven to be quite deep in the past, and may still have a ways to go, but we seem determined to find out where the limit lies.

    3. jake chase

      Taking this argument to its logical conclusion, Go’mint has no need to BORROW money and pay interest on the debt. Lincoln understood this and issued Greenbacks to finance the North victory in the Civil War. The bankers wanted to charge him 21% and he felt this was a bit high. Now you understand why Federal Reserve operations are a fraud and that the income tax exists to finance payment of the interest on the Go’mint debt. The principal never gets paid off, just keeps growing to provide money. Henry Ford said that if people understood money there would be a revolution tomorrow morning.

  5. Graphite

    Why are some governments “richer” than others?

    Why William, it’s just because they haven’t figured out what a pure *cornucopia* the ability to print their own currency represents! They lack that Auerback-esque enlightenment.

  6. vlade

    It is substantially true, but leaves out one very important fact – the citizens who are the employees of private businesses (and the private businesses) can switch to a different currency to deal with their assets and liabilities and switch to the “official one” only for the purpose of paying taxes. In practice, it’s very very hard these days, but it does happen (see Zimbabwe and a host of other states where there is both official and unofficial currency).

    Of course, the state can try to enforce the official currency, but given sufficient upheaval, they will fail Mostly because at that time the officers of the state charged with the enforcement don’t believe the official currency either and are willing to take bribes in the un-official one – and the laws are only as strong as the physical enforcemen is.

  7. Graphite

    Of course, the state can try to enforce the official currency, but given sufficient upheaval, they will fail

    Here’s where one appeals to that tried-and-true Keynesian refrain, “as long as there’s the political will ….”

  8. attempter

    No private firm can require that markets buy its products or its debt.

    That’s what corporatism is here to fix, isn’t it? Using the government as its strong-arm goon.

    We’re sure being required to buy a lot of finance sector debt lately, and worthless weapons as well. Now they want to make us buy junk insurance from the rackets.

    That’s what the fiat money scam lets them get away with. By contrast, recall how what forced LBJ to face reality on Vietnam wasn’t the military absurdity or the protests, but the Europeans threatening to demand gold for their dollars if he didn’t restrain the costs of the war and its inflationary tendency.

    Who can make such a threat to restrain Bush/Obama today?

  9. Fu

    > The public actually needs the government’s money to
    > pay its taxes

    Carrying the logic of this article a little further, governments are instituted among men so that they can pay taxes.

    Nevermind this:
    We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, — That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

  10. Tim Skinner

    A government creating its own currency can never go broke: let us each get our own printers going then and none of us, and none of our banks or employers, need ever go broke.

    I call it “The Paradox of Theft”.

    1. Ralph Musgrave

      The phrase “government defaulting on its debts” I think normally applies to where a government has borrowed the relevant sums from ABROAD. This very different from a government borrowing from its own citizens: it can simply use its printing press to repay its own citizens. In contrast, Argentina, for example over the last few decades has had a habit of borrowing US dollars, and then discovering, come the repayment date, that it hasn’t got any US dolloars.

  11. QQ

    I have a question – if the above is true, then how do Governments default on their debt / bonds ?

    Or are you talking only about the US in particular due to the role of the US Dollar?

    1. selise

      a question in return: has the gov of any country with a non convertible currency ever defaulted on gov debt?

    2. Marshall Auerback

      There is never an issue of default FOR ANY GOVERNMENT issuing debt in its own freely floating non-convertible currency, such as Japan. It doesn’t apply to the EU (because the nation states don’t actually issue currency and they are functionally in the same position as American states, where issues of solvency do arise), or countries which have pegged rate regimes (such as Latvia) or large amounts of foreign debt (which also creates an external constraint).
      I have never said there are NO CONSTRAINTS. I have simply argued that the constraints are POLITICAL. Modern monetary theory shows what opportunities a national government has – and leaves it to the political process to determine how they use those opportunities. That is a lot better than theories that tell us nothing about what the consequences of different government fiscal positions are (for example, pure credit economy analysis) or that tell us lies about these policy choices (for example, the entire edifice of mainstream neoclassical theory).

      Further, you might think that this is a desirable socio-economic goal for government to aspire to. For those who worry about resource allocation and efficiency (the typical mainstream economist) it always surprises me how they can advocate policies that create persistent unemployment. The daily loss of GDP that arises when there is high unemployment is staggering and dwarfs the so-called microeconomic inefficiencies (like ports not loading quite as fast as they might, or transport systems not being very well coordinated).

      Yet the mainstream seems obsessed with deregulation and privatisation to address these alleged microeconomic malfunctions while closing their eyes to the massive loseses arising from unemployment.

      1. Costard

        There is similarly never an issue of arrest for any murderer, because he can always take his own life. So tell us — of what practical value is an economic theory that considers suicide via currency an option on the table, what’s more a “desirable socio-economic goal”? And please explain why this would end more favorably for us than it has, in the past, for banana republics and African dictatorships and the soviets?

        We can break the back of unemployment, right now, today, by hiring people to push around boulders. Tomorrow you would find a market for boulders, and innumerable people leaving their jobs elsewhere to get in on the burgeoning boulder trade. By next week we would have a massive financial complex shuttling papers of boulder ownership. And huge amounts of wealth being diverted to development of the boulder industry and its numerous peripherals. And before long we would be in the same boat we’re in now… manufacturing and real production having fled overseas because it couldn’t pay competitive wages, because no one wanted to be an assembly line grunt when they could strike gold in the boulder trade, or in our case, the inflation-backed asset trade. So tell me, is this then efficiency?

        And perhaps you can illumine us further if you tell us, in your opinion, whether anything that causes unemployment is therefore “inefficient”. Is liquidating a failing business, or quitting because you dislike your job, or firing someone because they’re a poor worker, inefficient? How precisely would you end this pestilence, comrade?

        1. pebird

          Only to the extent that people can eat boulders – otherwise they would spend their money from their government jobs on real goods and services, increasing demand for deflating goods.

          Companies providing those real goods and services would increase production, further increasing demand, as employment increased.

          Government would need to then decrease the boulder-pushing job program to reduce inflationary pressures.

          Of course, instead of boulder-pushing, you could spend money on military ventures overseas or increased surveillance of private individuals, or building and cleaning public bathrooms, or teaching children how to read.

          There is always some public good (increase in public utility) that cannot be generated at a profit by private interests. We can choose to do without, only allow those that can pay to have access, or subsidize the public good.

        2. marc fleury

          Re: comrade comment and how to get rid of such pestilence.

          Right, the US of A has given birth to TBTF as a proxy for policy and massive bonuses funded by the public for the very incompetent people that helped create such a massive failure in the first place. Nice work, komrad.

      2. jake chase

        Yes, one would almost think they are being paid to worry about such things. Wait a minute. Most of them are!

        Galbraith told us economics was the only profession in which a person could achieve eminence without ever being right.

        Economics is Twentieth Century religion. Substitute the soverign consumer for God and you understand everything.

      3. Homer

        I seem to remember that the Federal Reserve is a private bank, not the government, and our government borrows money from this private bank. Saying that the default of a government is not an issue is rather naive. It has happened many times in the past and can happen again.

  12. Jim in MN

    I like this post for the issues that it raises and the clarity of the writing. Of course that doesn’t make it totally ‘right’. Here’s a simple question: given the ‘obvious facts’ of government finance, why isn’t ALL government spending financed by taxes, or none? Why have a mix of debt and taxes?

    There is to put it simply more going on here.

    1. Marshall Auerback


      The answer to your question is that the Treasury is not allowed to run an overdraft at the Fed. The legal structure is based on an old gold standard model whereby the government must issue bonds to “fund” the deficit. But given that the government is never revenue constrained, bonds do not in reality serve this purpose. They act as a savings alternative for people, and a tool through which the Fed can manage a reserve rate target. The legal question aside, the logic of your position is unassailable.

      1. jake chase

        Right now the risk free interest rate on Treasury Bills is 0.01%. Some saving alternative. Then again, you can take 30 year risk and get nearly four percent. Hmmmm. There’s a deal.

  13. reason

    you see the problem? It is not that there is anything wrong with your argument. It is just that there is an element, that denies the legitamacy of government (even a constitutional, democratically elected government). So long as the realise that the same logic denies the legitimacy of their property rights.

  14. But What do I Know?

    Then why in God’s name does the Federal government issue bonds? Why not just issue Federal Reserve Notes–or give the bonds to the Fed in exchange for the notes. Why have taxes at all?

    On the other hand, if money loses its motivating power, who will bring me my food and fuel?

    1. Captain Teeb

      Hi BWDIK,

      Deep questions you ask. Some possibilities:

      1. bonds and taxes were habits left over from earlier times
      2. bonds allow you to command resources while deferring the inflation caused by increasing the money supply
      3. taxes enable the government to gratify favored groups with tax breaks
      4. finally, to do everything with ever more cash would reveal the nature of the game too clearly

      1. But What do I Know?

        @ CT

        Those are all good points–they just don’t make me all warm and fuzzy inside :>)

        I just hope that not enough people figure this out–I’d like them to keep taking my money in return for stuff. . .

        @ Dave S

        Thanks for the link–I will read. . .

    2. marc fleury

      As Dave says, bonds are there to drain excess reserves as a mean for setting the overnight rate of money from a macro perspective. All rates pyramid on top of this rate. I learned from Randall Wray Understanding Modern Money.

    3. Ralph Musgrave

      You seem to be suggesting that there is some unnecessary paper shuffling going on between governments and central banks. I agree with that, but I don’t think you’ve correctly identified the excess paper shuffling. Needless to say I think I have identified this. At this post on my blog I poke fun at the UK government and the Bank of England for what I belief to be their “excess paper shuffling”.

  15. selise

    marshall, thanks. this is an excellent follow on post to rob parenteau and doctorx.

    you wrote:

    …our government can afford anything that it is for sale in its own currency.

    here, if not before, i start to get a bit confused because “what is for sale in our own currency” involves the special situation we’re currently in with the usa dollar the world’s primary reserve currency.

    for an important and illustrative example, how is it different for countries that don’t have the option of purchasing foreign oil in the their own currency?

    also, sort of related, what would happen if a country with large dollar reserves decided, for whatever reason, to instead of purchasing dollar based financial assets, start purchasing raw materials and anything else for sale globally in dollars. wouldn’t that create inflation? if so, how would it be substantially different than the hypothetical situation of excessive (or mistargeted) deficit spending by our own gov?

    1. Marshall Auerback

      If a foreign creditor decided not to accumulate treasuries, net spending would still occur – day by day – and provide stimulus to the economy. But the liquidity effects would just remain in the excess banking reserves and force the private sector to hold the new net financial assets pouring in each day via the deficits in the form of reserves rather than interest-bearing bonds.
      When a government bond becomes due for repayment, the sovereign government simply credits the bank account of the holder with the principle and interest and cancel the accounting record of that debt instrument. That’s the answer to the question: what happens if the Chinese decide they don’t want to buy our bonds any longer? The banking reserves would rise by that amount and the wealth of the private investor would change in mix from bond to bank deposit.
      China or Japan could easily decide to spend those dollars in the US (which would be great for growth), or they could park it in another currency, which would cause dollar weakness. But the dollar weakness is a one-off portfolio preference shift and doesn’t constrain the government’s ability to spend. Only inflation does that.

      1. selise

        thanks. i *think* i get that part (warren mosler has written about it on his blog). my question was what if, say, china or japan did not leave the reserves parked as bank deposits and did not spend them in the usa, but instead went on shopping spree, buying up access to things like oil (via long term contracts, out right purchase of oil companies, refineries and in the ground extraction rights) and other important resources to our economy. in other words, hoarding something other than dollars (that something being things our economy depends on too). i know this isn’t realistic (even if it could be done, wars have been fought over this kind of thing), but hypothetically wouldn’t it cause commodity price inflation which could then cause prices to rise here too (for example, big increase in cost of hydrocarbons increases cost of food).

        just trying to play it out in my head — what is economically (not politically, etc) possible.

        1. anon

          In that case, the Chinese current account surplus shrinks and there is no need for additional reserves build up.

    1. Lighthouse

      If I understand this model right, hyper-inflation would be a state change where the government can no long buy goods with its own currency. A substitute currency would squeeze out the official currency and the value of the official currency approaches zero.

      This would explain why FDR seized the gold when he devalued the dollar. Most of the gold was in the form of gold coin that could be circulated and it would have been an excellent substitute currency for a devalued dollar.

      Zimbabwe is a small country. It is very hard for a small country like Zimbabwe to control the amount of substitute currency that can enter the country.

      This model also ignores imports. Devaluing you own currency makes imports more expensive.

      Germany post-WWI actually pursued hyperinflation as govt policy. They thought it would force the Allies to abandon war reparations.

      A large, complex economy like the US, I am not sure that it will ever get hyperinflation unless the govt actually wants it to happen. Imports could get really expensive but it will be very hard for a substitute currency to get established unless the govt lets it.

    2. Marshall Auerback

      I would explain Zimbabwe in terms of a complete breakdown of government authority and consequently a situation in which the government loses its taxation authority which in turn gives value to the currency. If, for example, the debtors’ revolt extends to tax non-compliance, then you’ve got the makings of a severe inflationary problem due to widespread political dysfunction; that’s a fair point, Josh. Hyperinflations often occur when the government can print ever increasing quantities of money, but find little for sale, even as resources sit idle. The brief history of the Confederacy during the US civil war is an excellent illustration of this phenomenon. This does not require full employment; indeed, most hyperinflations take place with lots of unemployment because once hyperinflation sets in, it is virtually impossible to undertake ‘money now for money later’ operations..
      The printing press, then, becomes a symptom of the problem, not the cause because it is the breakdown of the tax system which causes the government’s fiat money to become worthless, not the running of the printing presses per se. Tax gives value to a fiat currency. When one has widespread tax avoidance, it marks the beginnings of true political dysfunction.

      I don’t think we’ve reached that point…yet. But it becomes an increasing risk for an administration that seems determined to recreate the financial conditions that led to the disaster we face now. It risks destroying its legitimacy whilst the rest of its political agenda is hijacked by a small group of wealthy plutocrats at the top.

  16. RockyR

    Pa-the-tic! if this is true, cease taxation tomorrow and fund all public expenditures through printing. complete and total nonsense.

    here, let me get you a towel.

    1. Marshall Auerback

      Rocky R,
      You wouldn’t cease taxation because taxation is what confers value on the currency. In your scenario we would have hyperinflation. Think of my Super Bowl ticket analogy. From the stadium’s point of view

      1. the stadium buys $ with its tickets.
      2. it can buy dollars with its tickets because people want to see the game and need tickets to get in.
      3. it collects the tickets when you enter and throws them away.

      From the govt’s point of view:

      1. the govt buys goods and services with its ‘tickets’- dollars
      2. it can buy goods and services with its dollars because we need them (at the macro level) to pay taxes
      3. when we pay the tax the govt throws them away.

      No tax liability and the dollars are worthless. With no taxes the nominal spending can’t buy anything. Yes, the taxes don’t “fund” anything, but they are required to bring forth the goods and services on the part of the population. When the tax is paid, the transaction is accounted for and our legal liability is relinquished and we have less purchasing power but that makes no difference to the government’s capacity to purchase goods and services now or later.

      Changes to tax rates are used by governments to modify aggregate demand – to allow households etc to have more or less purchasing power – but that has nothing to do with funding government spending. A sovereign government “funds” its own spending as it is the monopoly issuer of the currency. In that sense, the term “funding” is a non sequitur and should also be banned from our vocabulary when used in relation to government spending.

  17. Eric

    Excellent, but a couple of minor points. First, when the author uses the word “Government”, he is only speaking, in the case of the USA, of the federal government (so far). States are in a half-way position as they retain the ability to tax but not to issue money, although California’s foray into IOU territory clearly is testing that limitation. Second, while he mentions that something like government run health care is not required to achieve a profit like a private firm would be (even non-profits have to have results that have positive margins), the reality is that there is still an enourmous amount of content coming from non-governmental providers that would need to be judged by non-governmental measures. Hospital equipment companies, ambulance manufacturers, drug companies, laundry service providers, etc., etc. Unless the government is going to expand to nearly ridiculous levels, they do have some effective limitations.

    1. Marshall Auerback


      That is correct. I am assuming a national authority, although I did post something on Naked Capitalism a couple of months ago, where I did suggest that California could in effect create a currency operating in parallel with the US dollar by allowing people to use the IOUs to extinguish tax liabilities. We had a similar example of that in Argentina in 2001. It can work, but it’s probably too radical (esp for this government), and the problem of the states could easily be resolved via revenue sharing on a per capita basis, as my friend Warren Mosler has suggested many times.

  18. i on the ball patriot

    Regarding your title; All Debt is Not Created Equal: Government Debt is NOT the Same as Private Debt

    Government debt is private debt (of the many) when the private few in the private sector buy the government and control it. You glibly mention “our policy makers” but make no mention of the fact that when a government is corrupt and non responsive to the people, as it is in scamerica, it is a waste of time to suggest remedial measures.

    You do though inadvertently describe what is in the offing here …

    “What is needed when the economy has been driven by private spending funded by ever-increasing levels of debt (and a contracting public sector as a proportion of total output) then what is required is a change in the composition of final expenditure – from private to public – unless you want to “scorch the earth” and deliberately contract the economy.”

    That’s the game plan — ““scorch the earth”” — perpetual conflict in the masses. Control now trumps profit.

    What is needed is a clearer perception of the reality.

    Deception is the strongest political force on the planet.

  19. Some famous quotation on money, tax-ability, and creativity

    All Debt is Not Created Equal: Government Debt is NOT the Same as Private Debt
    All Goverments are not created equal: Each goverment Debt is valued by its people’s creativity

    Why, sir, there is every probability that you will soon be able to tax it!Said to William Gladstone, the Chancellor of the Exchequer, when he asked about the practical worth of electricity.— Michael FaradayQuoted in R. A. Gregory, Discovery, Or The Spirit and Service of Science (1916), 3.

    This probability is self-evidently now a reality. So And so, my fellow Americans, ask not what your country can do for you; ask what you can do for your country.

    John F. Kennedy

    Contrary to conventional “gold standard” thinking, where it is said that every DOLLAR SPENT HAS TO BE ‘FINANCED’ BY AN OUNCE OF GOLD ALREADY IN EXISTENCE, our government can afford anything that it is for sale in its own currency.

  20. fuguez

    A novel and tortuous way to express things.
    This basically can be used to also explain Japan that has very little foreign debt (rel. to GDP).
    The test will come when Government tries to reduce ‘outstanding money’ by taxing private entities to pay off its interest and principal. If it is unable to tax them enough to reduce its debt then one could imagine a scenario – in extremis – like Zimbabwe. Too high a tax rate reduces total tax receipts which means that total government debt issuance does have a limit to prevent inflation – which occurs when it prints money to make up shortfall.
    Government financing can go through the 3 stages of financing – hedge financing (tax), speculative(tax and debt) and ponzi (debt and printing).
    Private debt (or non sovereign) suffers deflation and default; Sovereign debt suffers from hyperinflation.

  21. Ian Lippert

    Looks like someone just passed their introductory macro class and now wants to show off on the internet. This post is just too rediculous for words. Is it just me, or has the quality of this blog gone down hill?

    1. marc fleury

      functional finance is certainly not intro macro, but rather a new narrative that sheds a lot of light on the relationship between money, govt and also banks. The dominant narrative, the neo classic and austrians are rich but not as incisive as the chartalist presentation above. I just read books on it, it is more fringe than mainstream and deserves the limelight to trigger valid commentary. Please put your shock in words.

  22. Edvard

    What a load of left wing debt apologist cods-wollop.

    Debt is debt and must be paid back, no matter where it exists. The difference is that instead of just one person being indentured util death, a nation is. The government is creating multi-generational slavery for a billion Americans, those living and those not yet born.

    And for what? Enriching a few at the cost of generations is the only result.

    Well, haha. The end result is that those few at the top are going to have those fraudulent gains taken off them, whether they like it or not, and the billion are not going to pay a dime, before this is over.

    1. marc fleury

      to be fair, the application of functional finance by prof Wray is to enact Employer of Last Resort (or ELR): Estimated cost of full employement is 50bill.

      I agree with you that today’s application of functional finance in the US by Bernanke et al is here to serve the rich. Witness the AIG bailout of CDS for the few investment banks. The application of functional finance is a political choice as the post correctly states:

  23. Edvard

    Q: What happens when a people conclude that their government officials have not acted on their behalf and have illegally and recklessly acquired debts to the nation without and against the consent of the people?

  24. gnk

    If that is the case, that a government can easily create debt to consume – then why did Tim Geithner need to assure the Chinese last summer that their US Ts are “safe.” That the US has a “strong” dollar policy?

    Why does the US cross it’s fingers and hold its breath in anticipation of foreign buyer Treasury activity?

    My answer: There is no free lunch – just like the law of thermodynamics. Yes, a government can print away, but consequences will exist nonetheless. The worst consequence? That the currency quickly approaches ZERO in value. Which in my mind, is a de facto default.

    Yes, a household’s headaches are not a government’s headaches. But guess what? The government has headaches the household does not.

    Both are restrained from profligate spending, and thus, profligate debt.

    1. jimbo

      ” why did Tim Geithner need to assure the Chinese last summer that their US Ts are “safe.””

      Because he’s an idiot, who doesn’t understand the basics of the very monetary system he’s in charge of.

  25. wethepeeple

    The author is a friend to the inflationists, and rightly equates Government with Federal Reserve. The author also fails to recognize that the United States of America was founded with the people as the ultimate sovereign over the Government. The people must be sovereign over their government, not the Government sovereign over the people!
    There are two categories of inflation, economic in the short term, and political in the long term.

    One of the best rebuttle of the New Deal was written by Garet Garett in “The People’s Pottage”, consisting of three essays. In “Ex America” Garett writes, “No government can
    acquire power and put it forth by law and edict. It
    must have the means. A tyrant may issue laws and
    edicts, but if he lacks the means to enforce them they
    have no fury. In the ancient case, means might be the
    direct command of labor, food, and materials. So the
    pyramids were built. In the modern case, means will
    be money.
    That is why every government in the secret recesses
    of its nature favors inflation. Inflation provides the
    means. Under pretense of making money cheap for the
    people, the government creates money for itself. When
    it goes into debt for what it calls the public welfare it
    first fills its own purse and then, as it spends the
    money, it extends its authority over the lives and
    liberties of the people. It suborns them. Their consent
    is bought. It is bought with the proceeds of inflation.”

    And further writes in the essay, “The Revolution Was”,

    “The fourth line was a doctrine invented and promulgated
    by New Deal economists—the doctrine of
    perpetual unlimited public debt. What difference did
    it make how big the debt was? It was not at all like a
    debt owing to foreign creditors. It was something we
    owed only to ourselves. To pay it or not to pay it meant
    only to shift or not to shift money from one pocket to
    another. And anyhow, if we should really want to pay
    it, the problem would be solved by a rise in the national
    Many infuriated people wasted their time opposing
    this doctrine as an economic fallacy. But whether it
    was a fallacy or not would be entirely a question of the
    point of view. From the point of view of what the New
    Deal has called the fetish of solvency it was a fallacy.
    But from the point of view of scientific revolutionary
    technic it was perfectly sound, even orthodox. From
    that point of view you do not regard public debt as a
    problem of public finance. You think of it only in
    relation to ends. A perpetual and unlimited debt represents
    deficit spending as a social principle. It means
    a progressive redistribution of wealth by will of government
    until there is no more fat to divide; after
    that comes a level rationing of the national income. It
    means in the end the cheapening of money and then
    inflation, whereby the middle class is economically
    murdered in its sleep. In the arsenal of revolution
    the perfect weapon is inflation.
    (And all of that was before the war, even before the
    beginning of the defense program.)”

    The New Deal as a totalitarian revolution, that went unchecked by unsuspecting people. Obama is unleashing a New Deal 2.0, as the author promotes. God help us! Reject a New Deal 2.0 as a larceny of the last threads of freedom, or as Garett writes we, the middle class will be “murdered” in our sleep, by inflation.

  26. Everybody knows

    Your problem that <a href=""everybody knows
    Leonard Cohen — Everybody Know lyrics

    Translation in progress. Please wait…

    Everybody knows that the dice are loaded
    Everybody rolls with their fingers crossed
    Everybody knows that the war is over
    Everybody knows the good guys lost
    Everybody knows the fight was fixed
    The poor stay poor, the rich get rich
    That’s how it goes
    Everybody knows
    Everybody knows that the boat is leaking
    Everybody knows that the captain lied
    Everybody got this broken feeling
    Like their father or their dog just died
    Everybody talking to their pockets
    Everybody wants a box of chocolates
    And a long stem rose
    Everybody knows
    Everybody knows that you love me baby
    Everybody knows that you really do
    Everybody knows that you’ve been faithful
    Ah give or take a night or two
    Everybody knows you’ve been discreet
    But there were so many people you just had to meet
    Without your clothes
    And everybody knows
    Everybody knows, everybody knows
    That’s how it goes
    Everybody knows
    Everybody knows, everybody knows
    That’s how it goes
    Everybody knows
    And everybody knows that it’s now or never
    Everybody knows that it’s me or you
    And everybody knows that you live forever
    Ah when you’ve done a line or two
    Everybody knows the deal is rotten
    Old Black Joe’s still pickin’ cotton
    For your ribbons and bows
    And everybody knows
    And everybody knows that the Plague is coming
    Everybody knows that it’s moving fast
    Everybody knows that the naked man and woman
    Are just a shining artifact of the past
    Everybody knows the scene is dead
    But there’s gonna be a meter on your bed
    That will disclose
    What everybody knows
    And everybody knows that you’re in trouble
    Everybody knows what you’ve been through
    From the bloody cross on top of Calvary
    To the beach of Malibu
    Everybody knows it’s coming apart
    Take one last look at this Sacred Heart
    Before it blows
    And everybody knows
    Everybody knows, everybody knows
    That’s how it goes
    Everybody knows
    Oh everybody knows, everybody knows
    That’s how it goes
    Everybody knows

  27. RebelEconomist

    A bit of a silly post – only true in the extreme case that the government can direct the central bank. If the central bank is independent and its management are principled, a fiat currency is as hard as a gold standard – better, actually, because a gold standard has the potential to be debased by a massive discovery of gold. The government may get the seigniorage from the central bank, but they do not control its amount. Granted, the Bernanke Fed looks helpful, but I do not think that they have sold out entirely yet.

    Actually, it is normally right wingers with a prejudice against state anything that like such posts.

    1. vlade

      govt giveth and govt taketh. Independence of any CB is purely legal issue, which can be overturned by the politicians (it’s a relatively new thing, after all). Most of the laws around CB also tend to have an “emergency” clause where the govt can effectively order CB what to do – I know UK Treasury can do so with BoE.

  28. Jonathan

    Remove this post quickly. You should be quite embarrassed. It is damaging to this site to post such nonsense.

  29. David Merkel

    This is why we have to go back to a commodity standard and limited government. You have described us to be slaves of a government that can take what it wants from us. I should not be that way.

    1. Graphite

      This is why we have to go back to a commodity standard and limited government. You have described us to be slaves of a government that can take what it wants from us.

      No, you see, we actually *need* to be enslaved in order to pay for all the wonderful help we get from whatever government 50%-plus-one of the country desires!

  30. selise

    we citizens have no standing to complain about the blindered and ignorant ideology of our country’s economists and politicians if we refuse to take off our own blinders and consider, with an genuinely open mind, new ideas — especially including the ones that rob and marshall are presenting here.

  31. Nick von Mises

    Interesting theoretical discussion but totally divorced from reality. Money is just a unit. Real economy relies on resources and these can’t be printed, only competed for. Government’s monopoly on currency and taxation allows them to outcompete private businesses but this should in no way be taken as evidence of a good thing.

    Sure, the government can raise taxes to 100% and print away but it won’t actually result in more highways, doctors and iPods. The fact the government isn’t technically bankrupt by some Keynsian definition doesn’t get the Weimar population fed.

    1. Jeff65

      The flip side of this coin that you don’t mention is that a lack of money should never impede the real economy of goods and services. “Money is just a unit” after all. The conflict is that it can’t be “just a unit” and a store of value at the same time. The more that money concentrates into the hands of a few, the more rent that can be demanded for its use. The store of value function is incompatible with it being “just a unit”.

  32. warren mosler

    and don’t forget the govt deficit = non govt savings of financial assets in that currency. by identity. not theory or philosophy or politics.

    note the ‘savings rate’ went up this year as the deficit went up. it was reported as the highest since 1993 which was the last time the deficit went up this high (ex tarp which doesn’t count). and saving was the lowest during the surplus years.

  33. winterspeak

    Great to see someone who actually understands how the monetary system works publish on Naked Capitalism.

    Also interesting to see some of the comments. The resistance to this idea is really strong!

  34. Kent

    Great article!

    Only problem is that we, the people and government don’t create our money – a private central bank creates “our” money – and it is debt-money with interest, an amount not created at same time – so all assets move towards bank ownership eventually due to interest.
    We need a public central bank to escape debt bondage.


  35. Bill

    Why is the Chineese government rich (at least rich enough to buy US assets and debt) and why are the Chineese people poor (no unemployment insurance, no health care insurance, etc)?

  36. nonplused

    Very interesting article, and makes perfect sense to me.

    I think the government sells bonds for the same reason they raise taxes, to reduce aggregate demand. If there were no bonds available for the Chinese to buy, they would be using their dollars to compete for the very goods and services the government wants.

    But, as logical as the whole article was, I think the devil is in the premise in this case. The way the government “affords” things is by printing additional money. Let’s say 1 trillion units of spending power, and this is sufficient to account for all private wealth and commerce. The government can then print an additional 1 trillion units (say dollars) for itself to spend. There are now 2 trillion units, of which the private sector has 1, and the government 1. The net effect is a transfer of 50% of the real spending power of the nation to the government. And since there are no more “real” goods and services created by this accounting trick (creating real wealth remains a physical activity, and it proceeds at its own geometric growth rate unless subverted by the government), the prices of goods and services must rise to 2 trillion. But the difference is the government has half of the spending power now.

    So the notion that no thing is unaffordable is patently ridiculous. The physical world must actually be able to produce what is desired out of spare capacity or it is unaffordable. No amount of monopoly money can add another property to the board.

    All of this was explained by von Mises many years ago. It’s not that he didn’t understand the process of a fiat currency, he understood it quite well. He explained things in a very similar many to the above. But he went on to point out that the net result is a transfer of wealth to the government and inflation.

    My sense is that the eventual long term inflation rate will be whatever portion of the GDP that is financed by government borrowing/printing. Which would explain why you can’t get a good 5 cent cigar anymore. If/when the Chinese decide to convert their dollars to physical wealth, which one would think they must do at some point, the inflation of the last several years will manifest itself.

  37. Costard

    This is a rather foolish post. Government may create currency but it cannot create wealth, only tax it. Inflation is a form of taxation, and the proper framing of this article would have been: the government can spend as it pleases, because it’s on your tab.

    There *is* something wonderfully heartwarming about the notion that a sovereign people can accomplish, not what they can afford, but what they can dream. I’m sure this is a great comfort to all of the Americans sitting on their asses, dreaming at this very moment. Perhaps if we press together, like penguins during the dark months of the year, we can keep reality at bay for just a little longer.

  38. pebird

    While it is true that banks create credit money, the money (a liability) they create is constrained by a corresponding asset – the loan. On a net basis, banks cannot create financial wealth, they DO enable the creation of physical wealth (as can governments – look at the highway system or the internet), but only governments can convert that physical wealth into financial assets (monetize the increase in real wealth).

    All is well and good until we come to the politics of the situation – it can be argued that the last 75 years of financial history has been a battle to determine if governments or private interests will determine who gets to monetize physical wealth. The bailout can be considered from this perspective – the financial markets get to determine which assets can be monetized – and by doing so, to the extent that toxic assets reduce the capacity of the real economy to produce output, taxes must increase to mop up excess liquidity (which happens as assets are monetized) and reduce inflation pressures. This is why the banks are sitting on those reserves – they need them to eventually monetize the crap – not lend out to new productive ventures.

    Also note that the government does not structurally require the issuing of debt to anyone to finance its operations (it does politically), it chooses to do so to provide holders of excess dollars a safe interest-bearing alternative. If those holders of dollars are foreign firms/countries, the issuance/purchase of debt affects exchange rates. If the debt was not issued, then those countries would either increase dollars reserves (non-interest bearing), or find an outlet for those dollars, they could buy back their own currency, strengthening their currency, or purchase US goods/services/assets. This is how China “manipulates” their exchange rate – if we didn’t offer the debt, the RMB would rise or China would need to recycle those dollars back to the US for goods and services. The US and China are in the low RMB game together by design.

    Unfortunately, you can’t get rid of taxes – that is the basis of demand for the currency (more so than the legal tender laws). However, as much as we hate taxes we have more control over what the government does (not anywhere near enough control), than we have over banks and their ability to set interest rates and willingness to lend. It depends which devil you choose to dance with.

    Commodity money (gold – or gold certificates) have their own problems – money cannot be a commodity – the producers of the commodity form monopolies and wealth creation is constrained by the ability to produce the commodity. Or prices decrease along with monetary units (how did the British half-penny come to be?) – which is fine but you have the same problem in reverse and debt finance becomes problematic. Or velocity must increase, which becomes uncontrollable and you have regular panics (see US financial history from independence to 1913).

    When you say debt is debt and must be paid back (with regard to public debt), ask yourself how do you monetize the physical wealth of a country? Banks cannot do this with credit money, because there is an asset and liability relationship – there is no net creation of financial wealth. If you believe the money supply must increase with increased physical wealth (for price stability) – should there be a democratic process in place that influences how that is distributed, or should it be left in the hands of a increasingly smaller group of private individuals?

    Modern monetary theory should be understood by anyone wanting to analyze the financial system, as the financial and political powers obviously get it (remember Cheney’s “deficit’s don’t matter”) – but the fight isn’t over the technical mechanisms we have at our disposal, it’s who gets to use them.

  39. john mayotte

    This is semantics. Sure government is sovereign and can issue its own debt, etc, but there are serious and significant consequences when a government is over indebted that effectively is the same thing as when a person is over indebted. SO sure the govt wont go broke like a person assuming the debt in its own currency, but so what. if the currency it prints in is worth much less or there is big inflation the affect on the citizens is very bad like it is for the person bankrupt. govt feeds off the economy and the healther the economy the better for the govt take and getting over indebteded does not help the economy get healthy in the long t erm. govt has limits even though as you say govt can print to its heart delight as a person cannot.

  40. pebird

    How do you monetize the increase in physical wealth? You have more stuff than before (lets assume that it is all in demand) how does more unencumbered money get created to represent the increase in physical wealth? The banks cannot create it – they can create money only with a corresponding loan asset. Remember money is a liability – against the physical good.

    If you want to own something free and clear – you need free and clear money available – otherwise the only money available will be bank money – and they only create the principal, not the interest/profits (less op costs + deposit interest) – so banks actually reduce the net money supply.

  41. Hugh

    Just a few random thoughts. There appear to be 3 frames which are confused here. The first is what a government can do with debt and currency domestically, as if it occurred in a closed system. The second is what a government can do given that it exists in an international economic community. And the third is what it can do in that international community if its currency is also the world economic system’s reserve currency. Now there are constraints or limits to what a government (we all know we are really talking about the US government here) can do under all of these. In the first of these our government would have the greatest scope of action, but this first frame is also the one that corresponds least to our reality because of our heavy international positions. The third gives us some slack because we can dump some of our problems internationally as long as foreign countries see a comparative greater advantage to holding on to the dollar as a reserve currency. But we can abuse this, and we have been. The second frame is the most constrained and the one which our high debt and economic weakness is trending toward.

    I would note too that taxes are not just about regulating aggregate demand, but far more importantly the distribution of that demand. I like to say that taxing is about social engineering. You can tax to create a nation of serfs and lords or one with a strong middle class and tamped down disparity at the extremes. The GDP of the two systems may be the same, but which do you want?

    Finally, it is rather silly to say that default is never an issue where governments are concerned seeing as we already have historical precedent for this. When we look at US debt, governmental and private, the options are to pay it back, inflate it away, or default on it in part. Now the first two of these aren’t going to work. Our economy is too weak and we are tracking to deflation. This would seem to suggest that a default is in our future. It probably won’t be called that. It will more likely be called a restructuring and be folded into some sort of international monetary agreement but in essence it will be a default.

    1. selise

      Finally, it is rather silly to say that default is never an issue where governments are concerned seeing as we already have historical precedent for this.

      what historical precedent? (same question i asked QQ above)

      p.s. i don’t think this post (and rob’s) are about frames. just accounting identities and what that means in terms of real economic constraints (not political, etc) on fed gov debt. as warren wrote above, “by identity. not theory or philosophy or politics.”

      1. Hugh

        Most of us would bring up Russia or Argentina but in fact, defaults happen much more commonly. Everytime debt is forgiven to Third World countries or a debt is converted to a grant as happens I believe in our military sales to countries like Israel you have a debt which is unpaid (a default) but is called something less stigmatizing. This is what I think will have to happen with us. The reality will be a default. The atmospherics will term it something else.

        1. stf

          Argentina and Russia had both pegged to the dollar. Apples and oranges. Find an example of a currency issuer under flexible exchange rates that has defaulted . . . that’s the only comparison.

          1. Hugh

            The problem that I have with this post and with your characterization is that it is facile. There is a playing at of terms. It can be fun but is ultimately a sterile exercise. While the terms can be qualified out of existence the underlying problem of debt and what to do about it remains. My point is that that debt, governmental and private, is not all going to be repaid. For me, that describes the conditions of a default. Your mileage may vary.

          2. Charles

            THe default on local currency Russian T-Bills, through a forced exchange into underpriced long term bonds, was effective AFTER the Ruble became a floating currency.
            There was a balance between defaulting through inflation and defaulting through debt restructuring that Russian and Foreigners (IMF) wanted to achieve. The final result was not 100% inflation and 0% restructuring, but rather in the middle.
            So the Russian government effectively defaulted in its fiat currency.

          3. Yves Smith Post author

            The reason the Russian default was a shocker was that it was widely recognized to be unnecessary. Russia could have honored its obligations. I suggest you read the history here.

          4. stf

            Russian default was on 8/17/98. Ruble was floated on 9/2/98. And, yes, it was unnecessary as the debt was in rubles, as long as they were willing to allow devaluation (which happened anyway). All this support my previous points.

          5. stf

            Warren Mosler on Russia (

            As a point of logic, the concept of ABILITY to pay being inherently revenue constrained is not applicable to the issuer of a currency. Any such constraints are necessarily self-imposed (including various ‘no overdraft’ legislation in some countries for the Treasury at the Central Bank). The issuer can always make payment of its currency by crediting the appropriate account or by issuing actual paper currency if demanded by the counter party.

            An extreme example is Russia in August 1998. The ruble was convertible into $US at the Russian Central Bank at the rate of 6.45 rubles per $US. The Russian government, desirous of maintaining this fixed exchange rate policy, was limited in its WILLINGNESS to pay by its holdings of $US reserves, since even at very high interest rates holders of rubles desired to exchange them for $US at the Russian Central Bank. Facing declining $US reserves, and unable to obtain additional reserves in international markets, convertibility was suspended around mid August, and the Russian Central Bank has no choice but to allow the ruble to float.

            All throughout this process, the Russian Government had the ABILITY to pay in rubles. However, due to its choice of fixing the exchange rate at level above ‘market levels’ it was not, in mid August, WILLING to make payments in rubles. In fact, even after floating the ruble, when payment could have been made without losing reserves, the Russian Government, which included the Treasury and Central Bank, continued to be UNWILLING to make payments in rubles when due, both domestically and internationally. It defaulted on ruble payment BY CHOICE, as it always possessed the ABILITY to pay simply by crediting the appropriate accounts with rubles at the Central Bank.

            Why Russia made this choice is the subject of much debate. However, there is no debate over the fact that Russia had the ABILITY to meet its notional ruble obligations but was UNWILLING to pay and instead CHOSE to default.

  42. jake chase

    All of you concerned about inflation: look around! The inflation is in asset values. A house built in 1948 and sold for $20 thousand is knocked down in 1995 and the lot sells for $2 million. The only difference is the neighborhood has gone down hill. Those of you worried about fiat money. We’ve had it since 1914. You’ll never get commodity price inflation without wage inflation. Instead you get trillions of dollars chasing their tails at the speed of light grabbing at ‘returns’.

    The Chinese will keep absorbing Treasuries until they achieve technological parity, at which point they will own the US and we will be Argentina, assuming of course that global warming doesn’t get us first.

  43. Waldo

    “Everybody knows that the dice are loaded
    Everybody rolls with their fingers crossed
    Everybody knows that the war is over
    Everybody knows the good guys lost
    Everybody knows the fight was fixed
    The poor stay poor, the rich get rich”

    Ah, poetry! Poetry at least takes effort and creation to produce the above. We need more of this and less financial fraudsters!!

    Very insightful blogs. Strong education in Yves’s bloggers. Very important and appreciate to read.

  44. John Greendale

    Not well thought through…

    “The consequences of overspending might be inflation or a falling currency, but never bounced checks a government creating its own currency can never go broke.”

    Really… governments that spend too much never go broke?

    We’re not worried that our goverment’s checks will bounce…. We’re worried about the devaluation of our currency/wealth/standard of living.

  45. Justicia

    “… our government can afford anything that it is for sale in its own currency.”

    Ah, but when oil (or whatever) is not longer for sale in dollars — watch out! Then we have to earn whatever currency these necessary commodities are denominated in.

    And when we exhaust the limits of essential resources (i.e., peak oil) all the money in the world won’t help us.

  46. Gary J

    Marshall – this is a well written piece but is fatally flawed. In fact, I would argue that you are merely using a technique that philosophers call “reductio ad absurdum” (literally reducion to absurdity).

    Your argument is flawed from its initial starting point. By alleging that we need the governments money to pay taxes, which in turn induces private citizens to economic activity to pay these taxes – is in one fell swoop stating that the chicken came before the egg.

    In the “real world” trade and economic activity came before taxes, thus to tax governments needed to offer some form of mutually agreed social contract (magna carta anyone?). Absent this social contract and our ability to repeal it at each and every election there would be NO TAXES.

    This social contract and electoral cycle is what regulates governments ability to print money or confiscate private assets (which in effect printing money achieves).

    Your whole argument relies on the absence of a social contract which actually existed before the imposition on taxes.

    Absent this fatal flaw your argument is indeed sound.

    1. Jeff65

      “In the “real world” trade and economic activity came before taxes”

      That’s obvious, but the notion of a sovereign or government issued money did not come before taxes.

    2. Marshall Auerback

      Gary (my apologies for earlier referring to you as “Jeffrey”,
      Actually, I don’t think the argument is incorrect. Logically, how does the taxpayer derive the currency with which to pay the taxes if the government doesn’t “create” the currency first? I think that everybody has this quaint notion (not validated by historical research, by the way) that money is a private invention of some clever Robinson Crusoe who tired of the inconveniences of bartering fish with a short shelf-life for desired coconuts hoarded by Friday. Self-seeking globules of desire continually reduced transactions costs, guided by an invisible hand that selected the commodity with the best characteristics to function as the most efficient medium of exchange. Self-regulating markets maintained a perpetually maximum state of bliss, producing an equilibrium vector of relative prices for all tradables, including the money commodity that serves as a veiling numeraire.

      All was fine and dandy until the evil government interfered, first by reaping seigniorage from monopolised coinage, next by printing too much money to chase the too few goods extant, and finally by efficiency-killing regulation of private financial institutions. Especially in the US, misguided laws and regulations simultaneously led to far too many financial intermediaries but far too little financial intermediation. Chairman Volcker delivered the first blow to restore efficiency by throwing the entire Savings and Loan sector into insolvency, and then freeing thrifts to do anything they damn well pleased. Deregulation, which actually dates to the Nixon years and even before, morphed into a self-regulation movement in the 1990s on the unassailable logic that rational self-interest would restrain financial institutions from doing anything foolish. This was all codified in the Basle II agreement that spread Anglo-Saxon anything goes financial practices around the globe. The final nail in the government’s coffin would be to preserve the value of money by tying monetary policy-maker’s hands to inflation targeting, and fiscal policy-maker’s hands to balanced budgets. All of this would lead to the era of the “great moderation”, with financial stability and rising wealth to create the “ownership society” in which all worthy individuals could share in the bounty of self-regulated, small government, capitalism.

      We know how that story turned out. In all important respects we managed to recreate the exact same conditions of 1929 and history repeated itself with the exact same results. Take John Kenneth Galbraith’s The Great Crash, change the dates and some of the names of the guilty and you’ve got the post mortem for our current calamity.

      The Keynesian institutionalist alternative is very different. Let me quote from Randy Wray, because I think he says it best:

      Money is not a commodity or a thing. It is an institution, perhaps the most important institution of the capitalist economy. The money of account is social, the unit in which social obligations are denominated. I won’t go into pre-history, but I trace money to the wergild tradition—that is to say, money came out of the penal system rather than from markets, which is why the words for monetary debts or liabilities are associated with transgressions against individuals and society. To conclude, money predates markets, and so does government. As Karl Polanyi argued, markets never sprang from the minds of higglers and hagglers, but rather were created by government.

      The monetary system, itself, was invented to mobilize resources to serve what government perceived to be the public purpose. Of course, it is only in a democracy that the public’s purpose and the government’s purpose have much chance of alignment. In any case, the point is that we cannot imagine a separation of the economic from the political—and any attempt to separate money from politics is, itself, political. Adopting a gold standard, or a foreign currency standard (“dollarization”), or a Friedmanian money growth rule, or an inflation target is a political act that serves the interests of some privileged group. There is no “natural” separation of a government from its money. The gold standard was legislated, just as the Federal Reserve Act of 1913 legislated the separation of Treasury and Central Bank functions, and the Balanced Budget Act of 1987 legislated the ex ante matching of federal government spending and revenue over a period determined by the celestial movement of a heavenly object. Ditto the myth of the supposed independence of the modern central bank—this is but a smokescreen to protect policy-makers should they choose to operate monetary policy for the benefit of Wall Street rather than in the public interest (a charge often made and now with good reason).

      So money was created to give government command over socially created resources. Skip forward ten thousand years to the present. We can think of money as the currency of taxation, with the money of account denominating one’s social liability. Often, it is the tax that monetizes an activity—that puts a money value on it for the purpose of determining the share to render unto Caesar. The sovereign government names what money-denominated thing can be delivered in redemption against one’s social obligation or duty to pay taxes. It can then issue the money thing in its own payments. That government money thing is, like all money things, a liability denominated in the state’s money of account. And like all money things, it must be redeemed, that is, accepted by its issuer. As Hyman Minsky always said, anyone can create money (things), the problem lies in getting them accepted. Only the sovereign can impose tax liabilities to ensure its money things will be accepted. But power is always a continuum and we should not imagine that acceptance of non-sovereign money things is necessarily voluntary. We are admonished to be neither a creditor nor a debtor, but try as we might all of us are always simultaneously both. Maybe that is what makes us Human—or at least Chimpanzees, who apparently keep careful mental records of liabilities, and refuse to cooperate with those who don’t pay off debts—what is called reciprocal altruism: if I help you to beat the stuffing out of Chimp A, you had better repay your debt when Chimp B attacks me.

      Apologies for the length of my response, but you raise an important point and I think we need to get the causality right.


      Marshall Auerback

      1. jpitt42

        You have a very peculiar and narrow definition of the term “market”. I think it causes you to argue against strawmen that don’t exist. In it’s simplest form, a “market” exists anywhere there is trade. Money is one means for facilitating trade between parties. Without trade, money has no meaning, so it can’t predate markets.

        Even before there was money, when a person gave part of his hard-earned crop to the sovereign, it was a market. It was given in exchange for not being beaten, imprisoned, or killed. That’s still a form of trade.

        Even if your theory is correct about money originally being created to facilitate easier tax collection, that doesn’t make a case for its continued use in that capacity. It can still function in an alternative role absent a sovereign.

  47. Jeff

    Economic capacity in a modern country is dependant on demand. While true that all a government can do is redistribute wealth, should this effect an increase in demand then production will rise to meet this demand i.e. inflation in a growing economy. The mechanism to increase demand is redistributive. The problem is surely that as the wealthy hold assets, and the poor don’t (the poor intrinsically have potential demand), redistribution through inflation acts as a regressive tax shifting wealth away from the poor(holding purely money) towards the rich(holding physical assets) without increasing demand. This is what is happening in the US today, we see asset inflation from the fiscal stimulus but a collapse in demand as the poor lose purchasing power. The solution would be to abandon the inflationary redistributive mechanism, and reduce taxation against the poor, while increasing taxation of the rich, something that is unfortunately impossible for the US.

  48. Steve

    This is one of the most stupid things I’ve ever read. By this reasoning, Zimbabwe should be a pillar of social and economic health. If government can just print money to buy whatever it wants, there’s no need to collect taxes. Hell, the government should get our economy going by handing each of us trillions of dollars to spend. The writer says the government”spends by changing numbers upwards in our bank accounts.” In my nearly 60 years of life the government has never changed the numbers upwards in my bank account, but every year it changes the numbers downwards in my bank account by taxing the hell out of me.

  49. Jeff

    What happens when no party will buy our debt at a reasonable price because of the risk involved? Can’t a government be insolvent if it can’t even make it’s interest payments?

  50. Publius

    Stupid article. So, while technically a government can indeed pay for whatever it wants through the issuance of fiat money, laws of economics dictate that to the extent the money supply grows faster than real wealth, there will be inflation.

    Hence every two-bit banana republic that had 100% per month inflation rates (Argentina, pre-WWII Germany, etc ad naseum).

    Inflation even at relatively low rates (oh, like during the Carter administration) is intensely destructive to private enterprise.

    And, here’s the big thing you’re forgetting: fiat currency doesn’t feed people. Only actual enterprise and production of goods can feed people. Obama can spend all the fake money he wants but at some point there is a reckoning and reality will catch up.

  51. James Callaghan

    “ We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step. . . ”

  52. Jack

    The post seems to omit a couple of key relationships. First, it appears to view the economic world in the vacuum of the (U.S.) Government and the governed (taxed). The vast, and complex interconnections of a global economy (and the dollar’s role within it) appears neglected entirely. Second, the relationship between ‘money’ and ‘value’ or ‘wealth’ is not explored. As indicated in the comments above, Government does not create wealth … it seizes it. While this offering is defined as “reducing aggregate demand” for currency, most individuals see it quite differently … as it reduces their ability to make their own decisions regarding personal wealth. Granted, currency is no longer pegged to intrinsic value. Instead, it is pegged to a presumption of value and a “promise to pay”. It is intrinsically linked to both public and private debt. It is created via Treasury Bonds created by government and sold by the Fed.. It is consumed in order to pay private debt. “Legal Tender for all debts, public and private”. “Promise to pay” is implicit both for the government and for the individual. It implies value. A trade. Quid Pro Quo. As the government cannot create value in and of itself, it substitutes a commitment in the for of a legal note which can be used settle debt. Our currency derives it’s ability to settle debts (public and private) through faith and trust in the issuer. If the government relegates it’s currency to Monopoly money (by creating so much that it becomes greatly depleted of value or virtually worthless)it has defaulted on that obligation. While the checks may indeed never bounce, they will simply cease to be accepted. China does not own large portions of our debt because it is interested in “reducing aggregate demand” for U.S. currency, it owns them because they expect these debts to be ‘paid’ and for debt instruments to provide ‘value’ over some alternative mechanism. The U.S. enjoys huge leverage in the ability to issue what are generally considered to be the ultimate universal monetary tokens … readily accepted worldwide. Our government may exercise the ability to manipulate the ‘value’ of worldwide commerce to our advantage … an enormous advantage! A diluted, devalued dollar (overprinted) has some short term benefits in terms of trade. But longer term, if nations like China begin demanding debt payment in yen, euros or a basket of currencies over the dollar, our monumental advantage will cease to exist … in sort, we will have to begin paying our debts on the worlds terms … rather than our own. U.S. debt is indeed sovereign … and very different than private debt, but when it is defaulted or greatly reduced in ‘value’, the consequences are quite similar.

  53. Glaucus

    “Money is not a commodity or a thing. It is an institution, perhaps the most important institution of the capitalist economy. The money of account is social, the unit in which social obligations are denominated. I won’t go into pre-history, but I trace money to the wergild tradition—that is to say, money came out of the penal system rather than from markets, which is why the words for monetary debts or liabilities are associated with transgressions against individuals and society. To conclude, money predates markets, and so does government. As Karl Polanyi argued, markets never sprang from the minds of higglers and hagglers, but rather were created by government.”

    Yes, and as Lincoln maintained, the states were a creation of the federal government.

    What naked, anti-capitalist nonsense, and what a HUGE disappointment to find here of all places

  54. Jack

    Glaucus wrote;

    “Yes, and as Lincoln maintained, the states were a creation of the federal government.”

    That’s complete trash! Review your Revolutionary War History. The states created and ratified the federal government … not the other way around. Lincoln only ‘maintained’ the federation … (A Constitutional Republic BTW … NOT a Democracy).

    The original Constitution didn’t even specifically afford the federal government the right to create fiat currency … it only excludes that right from the states … who were required to make currency only from gold and silver. The F’ed and subsequent instruments of our current (exclusive fiat) monetary policy have only existed since about 1913.

    Can you imagine the brew ha ha if the individual States actually took advantage of the clause allowing them to issue their own gold and silver currency?? Montana produces gold, in theory it could Constitutionally issue ‘money’ independently of the Federal Reserve. That would be earth shaking.

  55. jaronson

    The author makes things look entirely too simple for the government by barely recognizing the effect of inflation. My analogy is that I would find it simple to fly around like a bird or a planet if I ignore the effect of gravity.

    If the government spends more than it taxes then you get inflation pure and simple. Inflation taxes savers while rewarding debtors. Since we have elections sooner or later the voters will get tired of the theft and we will have a revolt against inflation. This part of what Reagan did in the 80s.

    I view this article as an interesting thought experiment about a fantasy world we don’t have inflation.

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