“Spain and the EU: Defict Terrorism in Action”

By Marshall Auerback, a fund manager and investment strategist who writes for New Deal 2.0.

Speaking of President Obama, Karl Rove writes, “After a year of living in his fiscal fantasy world, Americans realize they have a record deficit-setting, budget-busting spender on their hands.” Well, given his history with former President Bush, it certainly takes one to know one. But it is hard to understand how the concept of “budget busting” applies to a government which, as a sovereign issuer of its own currency, can always create dollars to spend. There is, in other words, no budget to “bust”. A national “budget” is merely an account of national spending priorities, and does not represent an external constraint in the manner of a household budget.

A Deficit Spending Limit Disaster

What do commentators such as Mr. Rove really think would have happened if there had been tight fiscal rules in place preventing any (or only some) discretionary response in net spending? Consider a real world example. In December, Spanish unemployment rose to 19.3% (the highest in more than a decade), capping a year that saw the nation’s jobless rate soar to double the Euro- zone average. According to the Merco Press, the number of people registering for unemployment benefits increased by 54,657, or 1.41 percentage points from November to 3.92 million. From a year earlier, unemployment climbed by 25%; youth unemployment is now 40 per cent. The only good piece of news this year was that the number of jobs destroyed in 2009 was 200,000 less than in 2008. That’s the sort of statistic which, in the US would likely prompt grave warnings about the need to pursue “exit strategies”.

Spain, like the other countries within the European Union (EU), has other problems, because the nation has voluntarily decided to accede the so-called “Stability and Growth Pact” (SGP), which arbitrarily limits national government deficit spending to 3% of GDP, whilst limiting overall public debt as a percentage to GDP of 60% (even though there is no economic theory in evidence to justify these arbitrary figures). Since the inception of European Monetary Union (EMU), the conflict within the EU on how to co-ordinate economic policy on the supranational level has been recurrent. It fully illustrates the core problem at the heart of the EMU and its related Stability and Growth Pact. Politically, the interpretation of the euro zone’s stability pact is largely left in the hands of unelected bureaucrats, operating out of institutions which are devoid of any kind of democratic legitimacy.

More fundamental are the institutional flaws. The relation of member countries to the European Monetary Union (EMU) is more similar to the relation of the treasuries of member states of the United States to the Fed than it is of the US Treasury to the Fed. In the US, states have no power to create currency; neither do the countries within the EU. By the same token, purchasers of US state bonds do worry about the creditworthiness of states, and the ability of American states to run deficits depends at least in part on the perception of creditworthiness. While it is certainly true that an individual state can always fall back on US government help when required (although the recent experience of California makes that assumption less secure), it is not so clear that the individual countries in the euro zone are as fortunate.

The euro dilemma that Spain faces, then, is somewhat akin to the problems of a country like Iceland or Latvia. They operate under a system which prevents their government from spending money freely – precisely the sort of thing that the deficit terrorists in the US advocate on a regular basis (particularly those who call for constitutionally mandated balanced budgets, as exists in many state budgets).
Facing a worsening economic situation, the Spanish government has done what any reasonable fiscal authority would do and that is to expand its budget deficit. A significant proportion of the rising deficit is being driven by its automatic stabilizers, which is normal and sensible. But their impact to stabilize incomes is negated to a large degree by the SGP.

Why it’s Folly to Balance Budgets During a Recession

Spain illustrates the futility of seeking to impose balance budgets during a recession. It makes things worse. Budgets inexorably tend to deficit when economic activity slows and tax revenues collapse. If not addressed soon, this structural flaw at the heart of the European Union suggests problems ahead for the long-run viability of the euro, and certainly points to growing intra-European political tensions. (In that regard, it is interesting to note the recent comments by the Mayor of Athens in regard to Greece’s comparably adverse unemployment situation: “Germany owes us €10.5bn from the 2nd World War, they should give us that back and we can equate it all up, automatically our deficit falls to 5%…”).

The debate about public debt limits is arcane in the extreme and harks back to gold standard logic which is no longer applicable. It was always clear – by the nature of the structure of their monetary system (divorce between the fiscal and monetary sovereignty) that the system would not cope in a major economic crisis such as now, where unemployment is skyrocketing. As much as one can complain about the size and direction of the US government spending, the country at least is in a position (should it choose to do so) to exercise fiscal leadership, and the institutional capacity to implement it. But if the US imposes anything like the constraints on government spending demanded by the deficit warriors, we’ll have Spanish style levels of unemployment.

The Spanish government does not have the ability to provide fiscal leadership in their winter of recession because of the voluntary constraints they have imposed on their fiscal capacity courtesy of EMU membership. That is why almost one in five Spaniards is now unemployed, with no prospect of respite. With the degree of fiscal maneuver limited in all EU nations, growth in the euro zone depends on 1) a low enough interest rate to fuel private domestic spending (probably requiring asset bubbles, as in Spain, Irish housing markets), 2) entrepreneurial innovation, and 3) cost cutting, the last of which tends to suppress domestic demand. The net result has been a region has been left largely on a stagnant growth path since unification because it cannot run large enough current account surpluses given Asian cost structures and Asian exchange rate linkage to the US dollar (although it has tried to use relocation of production to Eastern Europe to gain an edge). The euro region basically rides on the back of global growth, which previously depended on the Anglo private sector deficit spending, which was largely sponsored by asset bubbles.

Having shut down their policy options in order to discipline themselves, they are stuck in a hard grind, which now will get even harder as fiscal retrenchment is attempted. Perhaps enough people will conclude after a decade of trying to work within a number of self-imposed policy constraints, it is time to try something else. I wonder how long the euro in its current incarnation can last? Is this really what the US wants? Because that is the ultimate implication of a policy which arbitrarily seeks to constrain government spending in the manner in which the Karl Roves, Robert Rubins and Pete Petersons of this world are currently advocating.

Getting Government Spending Right

So what is the “right” level of government spending? Obviously, we want the government spending to be done efficiently. We don’t want government spending to become inflationary. Keep in mind — the public purpose behind government doing all this is to raise an army, operate a legal system, support a legislature and executive branch of government, promote public infrastructure, promote basic research, etc. So there are quite a number of tasks that even the most conservative voters would have the government perform.

Ultimately, the ‘right amount of government spending’ is an economic and political decision that has nothing to do with government finances. The real ‘costs’ of running the government are the real goods and services it consumes; the real cost of the government using all these real goods and services is that those resources would other wise be available for the private sector. So when the government takes those real resources for its own purposes, fewer real resources are left for private sector activity. What matters is that taxes are set to balance the economy and make sure it’s not too hot or not too cold. And government spending is set at the ‘right amount’ to provide the requisite services and full employment. Getting caught up in the mythology of “financing” considerations or arbitrary self-imposed constraints with no bearing in any economic theory at all is the wrong path. That way lies Spain. Is this the future we want for the US?

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  1. Ishmael

    What ad dilemma, should we go the way of Spain or the way of Argentina and Zimbabwe. Decisions decisions.

    Why not neither.

    Unfortunately, once politicians get the taste of deficit spending there is no stopping them. There is no pain in taxing them and if you have not noticed the deficits just grow bigger every year. In the end this results in a collapse of the currency which leads to a collapse of the government.

    Seems clear and has been repeated a number of times in history!

  2. dimitris

    Minor nitpick: The quote about the German WW2 reparation/debt was not by the Athens mayor, but by the Greek Le Pen/Griffin clone (clown?) (Karatzaferis).

  3. Marshall Auerback


    Thank you for the correction. Unfortunately, my knowledge of Greek is virtually non-existent, so I was relying on a 2nd hand translation. Still, it is interesting to me that this comment was made. It seems that the constraining aspects of the SGP (and the corresponding lack of democratic legitimacy at the heart of the system) is actually exacerbating long dormant tensions in Europe. This is manifesting itself through the growth of extremist parties, particularly the populist right. And it’s not a phenomenon limited to Greece, as you correctly note, as this guy is the Greek equivalent of Le Pen.
    Ismael, you set up a false dichotomy, as I specifically said that there is an inflation constraint in government spending. You have to distinguish between a political constraint and an operational constraint. And there’s nothing wrong with government deficit spending. It’s perfectly normal; it’s been going on for decades and it accommodates private sector savings. Read Martin Wolf’s recent column in the FT on the euro zone.

    “Then came the crash. Inevitably, it hit the most extended private sectors hardest. Between 2006 and 2009, the private sectors of Ireland, Spain and Greece shifted their balances between income and spending by 16 per cent, 15 per cent and 10 per cent of GDP, respectively. The offset was also quite predictable: it was a huge deterioration in the fiscal position. This underlines a point that economists seem amazingly reluctant to take on board: the fiscal position is unsustainable if the financing of the private sector is unsustainable. In these countries, the latter was just that, with dire consequences, as the crisis made evident.”


    I understand one variant of the veiled statement below to read as “a fiscal surplus is unsustainable if the financing of a private sector deficit is unsustainable.” That is the proper measure of “fiscal sustainability.

  4. Vinny G.

    Spain will also need to adjust things like pensions. There is no reason a Spanish high school educated store clerk should retire on 2000 Euros a month. Spain is not Germany, it’s not France, and it’s not even Italy. It is still a not-so-long-ago third world country that was catapulted into first world status via clever financial engineering and a great deal of speculative investing. Spain would do well to go to a second world level. This applies to Ireland as well.

    On the other hand, Greece is in far less danger simply because it is far more self-sufficient, and the average Greek does not depend on foreign investment for survival, not to mention that the Greek standard of living is far lower than anywhere in the EU (and that includes much of Eastern Europe). You can say that Greece is already so poor, it is hard to see how it can get much worse. Greece is not a first world country, and I think that may work to its benefit in this crisis.


  5. Ishmael

    Personally, I always thought it was going to be a disaster for the PIGS to join the EU. The one thing they offered was value for ones money which attracted people to live there and a source of foreign exchange. Once they locked into the EU they lost control of their ability to devalue and thus control their fate.

    With regard to this comment — And there’s nothing wrong with government deficit spending. It’s perfectly normal; it’s been going on for decades and it accommodates private sector savings.

    Ish here– Just because something went on for a long time does not make it correct. Running deficits is a way for the government to cover up problems and conceal them from the population. Basically, those private sector savings decreased in value every time the country ran additional deficits. The dollar lost over 93% of its value in the 20th century.

    Let us also not forget the deficits that Japan has ran up in the last 20 years. How has that worked out for them.

    The only reason the US has been allowed to run deficits for the extent and as long as it has is due to it being the reserve currency of the world. In summary, we have slowly been stealing from the rest of the world because they (except fot the French who spotted this early on) were unsophisticated and did not realize what was happening.

    Do not get me wrong. I agree that the occasional running of deficits is acceptable and in some cases such as war the incurrance of large deficits is justified; however, the incurring of continiously increasing deficits keeps the government and people from addressing real problems. In addition, 30 years of continiously increasing deficits has limited the government’s ability to address the current situation, but I doubt we would be in this situation if we had not ran these deficits.

    Deficits should be ran for a specific purpose and for a limited time. Other wise they become a drug which the country becomes hooked on and large and large doses are needed until deficits have no impact.

  6. danny

    Budget deficits are a simplistic, vague and wasteful approach to combating a receding economy. Excesive deficits will also serve to undermine confidence in the currency too.

    The main contractionary forces I can identify are the wasteful spending in military and other government departments. If the government streamlined, became more efficient and reduced taxes this would be a massive stimulus to the economy.

    The other main problem with the US economy is the constant trade deficits which leak money out the economy every year. The government has to reign in the trade deficits by regulating foreign investment to a level where trade balances on average. This will result in more US investment, employment, demand and higher taxation revenue while correcting the international trade inbalances.

    Also central banking needs to become transparent so that the destabilising forces of excessive credit creation are visible and therefore manageable.

    No too big to fail. If big banks come into problem nationalise them and immediately begin process of selling assets to private sector.

  7. Fred

    A very good analysis which explains clearly why we need a balanced budget amendment. After all, the solution to too much debt is surely not more debt. Do we really want to end up in the position of Spain by continuing with these massive budget deficits?

    Here’s my real question: will Marshall Auerback’s head explode or not upon reading the preceding paragraph and despairing at the possibility of talking reason with the deficit fanatics?

  8. Marshall Auerback

    “Budget deficits are a simplistic, vague and wasteful approach to combating a receding economy. Excessive deficits will also serve to undermine confidence in the currency too.”

    How do you explain Japan in that case? I don’t see their currency collapsing?

    As for the first sentence, it’s nice sounding rhetoric, but my answer would be that it depends entirely on the nature of the spending. For example, the spending to build the Panama Canal and the investment on the Internet reduced costs and massively increased productivity. Spending to blow them up would do the reverse. Like Danny, I agree that a lot of the government spending occurring today is inefficient and highly damaging to our standard of living. But phrases which suggest that “budget deficits are a simplistic, vague and wasteful approach to combating a receding economy” is both light on specifics and demonstrates a lack of working knowledge of actual monetary operations and public reserve accounting.
    For example, with a non-convertible currency and floating exchange rate, taxes, not interest rates, function to regulate aggregate demand, not raise revenue per se. Government neither has, nor doesn’t have dollars. It necessarily spends by changing numbers upward in bank accounts, and taxes and borrows by changing numbers down.

    These are operational fact beyond dispute. It is a starting point for a discussion and also for sensible policy solutions. The rest is empty sloganeering.

    1. danny

      Japans currency isnt collapsing but I never said deficits will make a currency collapse only that they are one factor out of many which contribute to reducing confidence in a currency. Japans currency isnt collapsing compared to most major currencies which represent mismanaged economies also. Japan also has manufacturing and trade surplusses to support its currency while in the context of America this is not the case.

      I do agree that it depends entriely on the nature of spending and the benefits from private sector demand from reduced taxation exceed greater government involvement. I do think government can contribute with greater infrastructure investment as this is obviously needed but this is a medium term benefit and not an immediate solution to this recesion. Reducing taxes is immediately benficial.

      Im not suggesting issuing a non convertible currency in order to regulate excesive foreign investment if that is what you meant at the bottom of your comment.

  9. Greg

    Thanks Marshall,

    Nice to see an MMT guy posting over here (could you get someone at Angry Bear to give you some face time).

    Most of you here are still wrongly equating government and private debt. Government debt never has to be paid back, unlike private debt. It is not something we “owe” but something we “own”.

    Stories about previous fiat regimes collapsing say nothing about fiat currencies, simply about the “people” making the decisions about them. Wasteful spending is wasteful whether the money has a peg to gold or not.

    Any references to Zimbabwe are pure hyperventilating. Zimbabwe (and Weimar Germany) were not “monetary” phenomena, they were the result of production destruction.

    Explore Marshalls ideas more thoroughly before you try to discredit them.

    1. danny

      Government debt has to be paid back. You can go ponzi and increase debt further by inflating and then offsetting the monetary inflation through taxation but what a rubbish approach this is.

      Too much intervention in terms of taxation and government spending places too much power in government hands. This gives government unlimited power to spend and finance whatever the government wants (wars, cronies, etc..) and also taxation policy under this approach is dubious IMO.

      Even if this system woks in some way it is inferior to a system of more limited government intervention and competitive free markets because government is in most instances an inferior allocator of resources when compared to a competitive private sector.

      1. Yves Smith Post author


        Government debts do not have to be paid back. Do you ever hear anyone arguing that a business that borrows has to pay it all back and run with no debt? Governments have far greater ability to refinance their debt than corporations do.

        Moreover, “free markets” is an internally inconsistent construct. The model in microeconomics, of single actors in markets, is incompatible with modern commerce. Perfect markets are a no-profit setting for business. Everything that businesses do, from product differentiation to seeking scale economies to creating consumer loyalty via branding, all create market inefficiencies that are anathema to the neoclassical model. But how or why would businesses operate if they did not have reasonable odds of earning a profit?

        1. dave

          Government debt is a rather sinister kind of tax. It take purchasing power away from private sector debt purchasers and transfers it to the government. In exchange the government guarantees a stream of future payments to the purchaser, and it is implied that those payments will translate into a certain level of real goods and services. People are far more willing to be taxed in this way because they don’t believe they are giving up anything, they believe they own future purchasing power rather then transferring it to the government via taxes and receiving nothing. That is why budget deficits are more politically feasible then current taxes.

          However, they do expect to be paid back. Rising interest rates on government debt are important, they are a signal that the things government are spending its money on are seen as wasteful and won’t help the government pay people back in real resources. That is why real interest rates on long term government debt are the highest they’ve been in a long time, its a risk premium. The low nominal rate is merely a result of low inflation caused by the collapse of private sector credit expansion.

          Government debt also messes up private sector economic decision making. People think they have assets that they really don’t. If the government taxes you then you know you don’t have any money and need to save and work more. If you buy a government bond you believe you have saved and invested in capital that can be used to produce future consumption. If its used to build the Panama Canal that might work, but if its used to bail out bankers then its “accounting savings” rather then “real savings”, and it sends all the wrong information to the private sector about its level of real capital.

          1. Yves Smith Post author


            Most of what you say is counterfactual. Government bond yields are very low by historical standards. We actually have negative interest rates on the short end of the curve, and using the real yields during the credit mania as any kind of norm is misleading.


            And there are plenty of times when real yields on the long bond were comparable to where they are now.

            For instance, inflation in 1995 and 1996 was below 3%, yet long bond yields were just below or a little over 7%. In the 1980s, real yields on the long bond were even higher. And this was a period when the budget was in surplus, which by your logic would say that real yields should be very low.

            The argument you are trying to make against government bonds applies to ANY bond investment.

            Government bonds are not a negative to private sector decision making. When the Clinton Adminsitration was running surpluses, there was a great deal of concern that there would be no government bonds outstanding one day, and that that would have negative repercussions. The government bond market is the benchmark for pricing all private bond issues. Moreover, pretty much every financial model uses a risk free rate as a crucial input.

          2. dave

            You just listed the nominal yields on treasuries, I’m talking about real yields. Real yields are very high right now when you consider deflation. We are in a period of deep credit contraction. While you can certainly see some reflection in consumer prices they are effected only indirectly. Credit has absolutely collapsed, which is why asset prices have come down. We are in deflation using any kind of broad metric of money and credit you pick.

            Of course nominal rates were higher at the ens of the 70s and early 80s because of stagflation. Real rates were high in the end too because volatile inflation rates introduced a risk premium to owning government bonds. Its entirely possible to have some inflation and stable real rates, if you have predictable inflation and responsible fiscal policy. The late 70s/early 80s was not an example of that, nor is today.

            Government bonds are a negative to private sector decision making because they are treated in a certain way for accounting purposes that does not reflect real world resource allocation. When a government bond is purchased someone takes current purchasing power and transfers it to the government, a transfer of real resources from the private sector to the government sector. The person receiving the bond wants to be able to consume in the future. In order for that to happen the real resources he gave up in the present have to be turned into productive capacity to supply the future real goods for the bondholders consumption. However, if those resources are not put to a productive purpose, but are instead squandered (war, bailouts, etc.) then there is no productive capacity present to supply him with future consumption.

            If the individual owned a privately issued bond then that bond would go into default, because the issuing company couldn’t pay. Thus because the investor lent his past resources to an entity that squandered it he would have no claim on future resources since the bond defaulted.

            With the government it can print its own money. So there is no default risk. People who own government bonds think they are pretty secure and have an airtight claim on future production. If the government doesn’t invest their money in productive capacity then it can’t pay back the agreement with the appropriate level of real goods. It can only pay back in inflated dollars to reduce its real goods burden. Inflation of course brings a whole host of problems with it, which sadly it seems people have forgotten about already.

            As for how it effects private sector savers it gives them a false reading of the level of productive capacity for future production. They have asset sheets full of government bonds promising to transfer future production to them. They think they have “saved” but they haven’t. Saving involves the building of productive capacity for future production, not keying in some accounting entries on a computer and calling it savings. Sadly, people who lend to the government don’t criticize how its used the way they do with a private company. The reason is that the government, via its ability to extract taxes backed up by police force, has first claim on all national resources. So whether or not the government invests peoples capital well they will always be the first in line. It promotes a false sense of capital levels that don’t really exist, they only exist as paper promises. There are no real resources where the accounting entries say there should be.

          3. Yves Smith Post author


            You clearly don’t bother reading what I write. I went back and looked at inflation rates. Did you? No. Real yields were as high as they are now in the 1990s, at a time when people were NOT alarmed about rising fiscal deficits. A 4% real yield on a 30 year bond is a pretty reasonable number. In fact I’d argue it is low merely given rate volatility over that time period. And you really don’t know history. Inflation peaked in 1982, and the yield curve then was steeply negative. We has DISINFLATION over the course of the 1980s, which should be favorable to long bond REAL yields, yet they were higher than 4% for extended period during the decade.

            As I said, and again you chose to ignore, the argument you made can be used against ANY bond. We have bonds financing unproductive buildings, unproductive companies (Enron, Citibank, GM for starters). Austrians stress the dangers of “malinvestment” and our credit crisis was a massive example of PRIVATE SECTOR bad investment. Massive overinvestment in housing did nothing for future productivity. Yet you act as if anything the public sector is a mere drag on the economy, and everything the private sector does is virtuous.

            You argue for “free markets” yet these same investors in free markets voluntarily buy government debt and pay the very lowest yield for it. They clearly do not agree with your view of the equation.

            Savings are always paper promises. There is no secure store of value. Too much savings, or too many investment dollars chasing too few good opportunities, leads to destabilizing boom-bust cycles.

          4. dave


            My definition of inflation is different from yours. I look at a variety of broad money and credit measures, not consumer prices. Most credit today is funneled towards assets, not consumer goods. Consumer goods inflation is a sideshow. So I don’t see inflation as flat to low today, I see it as solidly negative due to the collapse of private sector credit.

            Yes, what I said can be true of any bond, but investors tend to scrutinize private bonds a bit more fiercely. They don’t always get it right of course, but they at least make and attempt. And when they are wrong their private sector bonds default, wiping out their claim on future production thus eliminating a burden on future producers and signaling the bondholder that his capital base is depleted and needs to be rebuilt. Bankruptcy and default are the best features of capitalism, they allow resources to be reallocated away from wasteful purposes.

            With government bonds you don’t have a claim on future resources produced as a result of your investment (like when you lend money to GM) but rather have a claim on future resources based on the governments ability to extract it from the citizenry at large. So you decision to invest is not based on how the money is spent. If it is spent on things that raise the productivity of the citizenry at large that’s great, but if it isn’t you will still get paid ahead of everyone else because of the governments monopoly on the use of force. Thus the private market effect of price signaling is eliminated from capital allocation decisions and replaced with government decision making, and if the government gets it wrong there is no default so we all have to pay for it.

            If you think the public sector can make better capital allocation decisions then the private sector then the loss of market pricing information in the capital market is not a bad thing. If you believe the opposite then it is a bad thing. Obviously, capital allocation in both the public and private sectors is flawed and prone to error, but on the whole I think the private sector does a better job once you get passed the essential government services. It may have been a mistake for private bondholders to lend money to GM these last several years, but at least they caught on eventually. The government is still wasting money on them, and may be forever. Lastly, when GM went bankrupt private bondholders had their claims on future production eliminated, thus unburdening society. Not so with the government. Quite frankly I wish the government would do some selective defaults rather then inflate, just like many did in the 30s.

        2. Look On The Bright Side

          “Government debts do not have to be paid back. Do you ever hear anyone arguing that a business that borrows has to pay it all back and run with no debt? Governments have far greater ability to refinance their debt than corporations do.”

          Indeed they do, BUT there still is a limit. The PRC is not very keen on not being paid back on the Bonds. That’s why Turbo Tax Timmy made his Christmas announcement about covering the debts of Fannie and Freddy, right ?

          “Perfect markets are a no-profit setting for business”. I don’t spend much time lying awake at night worrying about the emergence of perfect markets.

          1. Yves Smith Post author

            All the academic work supporting the virtues of “free markets” is based on the assumption of perfectly competitive markets. And despite the PRC huffing and puffing, the only way for them not to keep buying our currency is to let theirs rise. They are committed to buying US financial assets. I agree this is not sustainable, but it is China, not us, despite all its saber rattling, that is deeply invested in this strategy.

            The real risk is that we selectively default, as in on CUSIPs owned by them.

          2. Look On The Bright Side

            Reflecting further, certainly gov;t can maintain a balance of less than zero but the individual bonds need to be paid back with interest.

            And in a perfect free market I suspect that people would be paid what they were worth; if that was not enough for an owner then they would have to make way for someone who would accept the wages. (Hmm. In a perfect market you would still have to be able to raise capital you could acquire the excess funds to purchase capital equipment). I could be a business owner under those circumstances.

          3. Look On The Bright Side

            I cannot find the reply button for the comment “All the academic work supporting the virtues of “free markets” is based on the assumption of perfectly competitive markets” so I will answer here.

            I believe the virtue of “free markets” is based on giving citizens means of support independent of government, not its alleged efficientcy; my concern is that without independence from politics I believe political campaigns would rapidly change from “Vote for Me because if you do and I win I’ll do something NICE for you” to “Vote for Me because if you DONT and I win I’ll do something TERRIBLE to you.”

          4. dave

            While selective default on Chinese obligations is probably the best route, I have extreme doubts it would happen. If there is one thing washington stands for its not rocking the boat, and that would be as big a wave as they come.

        3. danny


          Thanks for replying btw.

          Anyone that borrows has to pay that money back. You can borrow more as the debts get paid off and maintain your total debt at some arbitrary level but the whole point of lending some entity money is that they will pay it back. Nobody said a business should be run with no debt. You do hear businesses gettin asked to pay back all their debts by creditors when it is feared they no longer will be an ongoing entity though.

          The reason why government has a greater ability to pay off debt is because they can coerce the tax payers or just print if it gets really bad for them which is kinda undemocratic. Or in normal times the sheer size of government makes it more stable than any business obviously. But the whole premise of lending to the government is that they will honor the agreement to return the principle and interest.

          Nobody said free markets are perfect all Im saying is that free market arrangements in most markets are a more efficient manner of allocating resources when compared to an economy which depends heavily on central planning. Perfect markets with no profit seeking is unreasonable and in reality this construct cant exist because their is so many sectors, regions of an economy in which to operate a business that naturally competition is limited.

          You said: “everything businesses do, from product differentiation to seeking scale economies to creating consumer loyalty via branding, all create market inefficiencies that are anathema to the neoclassical model”. Can you imagine how many inneficiencies of the sort you mention would emerge in an economy that lends toward central planning?

          1. Marshall Auerback


            Once all is said and done, all inside private sector debts net out and we are left with the real stuff we produced plus gov’t debt which is nongovt financial wealth.

            Agreed that household indebtedness is a drag on the economy. Need to ramp up govt spending to create jobs, real stuff, and net financial wealth (govt debt).

            Spending by private citizens is constrained by the sources of available funds, including income from all sources, asset sales and borrowings from external parties. Federal government spending, however, is largely facilitated by the government issuing cheques drawn on the central bank. The arrangements the government has with its central bank to account for this are largely irrelevant. When the recipients of the cheques (sellers of goods and services to the government) deposit the cheques in their bank, the cheques clear through the central banks clearing balances (reserves), and credit entries appear in accounts throughout the commercial banking system. In other words, government spends simply by crediting a private sector bank account at the central bank. Operationally, this process is independent of any prior revenue, including taxing and borrowing. Nor does the account crediting in any way reduce or otherwise diminish any government asset or government’s ability to further spend.

            Alternatively, when taxation is paid by private sector cheques (or bank transfers) that are drawn on private accounts in the member banks, the central bank debits a private sector bank account. No real resources are transferred to government. Nor is government’s ability to spend augmented by the debiting of private bank accounts.

            In general, mainstream economics errs by blurring the differences between private household budgets and the government budget. Statements such as yours:

            “Anyone that borrows has to pay that money back. You can borrow more as the debts get paid off and maintain your total debt at some arbitrary level but the whole point of lending some entity money is that they will pay it back. Nobody said a business should be run with no debt. You do hear businesses gettin asked to pay back all their debts by creditors when it is feared they no longer will be an ongoing entity though”
            are plain wrong because they miss this fundamental distinction.

            Mainstream economics uses the government budget constraint framework (GBC) to analyse three alleged forms of public finance: (1) Raising taxes; (2) Selling interest-bearing government debt to the private sector (bonds); and (3) Issuing non-interest bearing high powered money (money creation). Various scenarios are constructed to show that either deficits are inflationary if financed by high-powered money (debt monetisation), or squeeze private sector spending if financed by debt issue. While in reality the GBC is just an ex post accounting identity, orthodox economics claims it to be an ex ante financial constraint on government spending.

            The GBC framework leads students to believe that unless the government wants to print money and cause inflation it has to raise taxes or sell bonds to get money in order to spend. People have the erroneous understanding that taxation and bond sales provide money for the government which they use to spend. So if the government increases its deficit (spending more than taxing) then it must be increasing its debt holdings or “printing money”, both of which are deemed undesirable.

            However the reality is far from this erroneous conception of the way the Federal government operates its budget. First, a household, uses the currency, and therefore must finance its spending beforehand, ex ante, whereas government, the issuer of the currency, necessarily must spend first (credit private bank accounts) before it can subsequently debit private accounts, should it so desire. The government is the source of the funds the private sector requires to pay its taxes and to net save (including the need to maintain transaction balances). Clearly the government is always solvent in terms of its own currency of issue

  10. Jon H.

    What matters is that taxes are set to balance the economy and make sure it’s not too hot or not too cold. And government spending is set at the ‘right amount’ to provide the requisite services and full employment.

    This is a key point. Somehow, taxes just as a concept alone has become demonized in the USA. In other countries, which are functioning better than the USA, taxes are higher but the bulk of the citizenry have at least SOME understanding of what they are for and accept them as a key balancer of forces in pursuit of a society that functions, not dysfunctions.

  11. a

    “Facing a worsening economic situation, the Spanish government has done what any reasonable fiscal authority would do and that is to expand its budget deficit. A significant proportion of the rising deficit is being driven by its automatic stabilizers, which is normal and sensible. But their impact to stabilize incomes is negated to a large degree by the SGP.”

    Let’s see, you *admit* that Spain has expanded its budget deficit in this downturn, but then you say it’s being negated by the SGP. So which is it? Do you realize what Spain’s budget deficit is close to 7% of GDP this year? That the SGP allows deficits over 3% when there is a recession? So what’s the problem? Where’s this famous “negation”?

    “Spain illustrates the futility of seeking to impose balance budgets during a recession.” Only – that’s not what’s happening. A deficit of 7% of GDP is not a balanced budget. Hell, a deficit of 3% of GDP is not a balanced budget. C’mon, this kind of hyperbole does your argument no good.

    “If not addressed soon, this structural flaw at the heart of the European Union suggests problems ahead for the long-run viability of the euro.” Ah, yes the Anglo-Saxons’ wet dream – the demise of the euro. They just can’t get over the euro. Well, one day you may be right. But then again, one day California may secede from the US. Shit happens, eventually. Things never last forever. So, in the end, arguing that things will not be permanent is hardly news.

  12. kevin de bruxelles

    Anglo-Saxon commentators spent much of the past ten years pounding the drum about what an excellent example Spain’s high growth economy was for the rest of Europe. Now that Spain’s foolishness has been exposed in following the Anglo Saxon model of deficit spending during a boom, unrestrained real estate bubbles, general short-termism, and hollowing out of the manufacturing sector, we are now being told again that Spain is the perfect example of why the European model is flawed.

    The truth is thought that lesson of the current crisis will surely be that the Anglo-Saxon model only works (and then just barely) if you control and manipulate the world’s reserve currency. Otherwise it is an unmitigated disaster.

    In general the Teutonic members of the European Union rejected the Anglo Saxon obsession with growth and instead ran budget surpluses (or very small deficits) during the good times. Thus they were sneered at and labelled “zero-growth” countries by the Anglo Saxon press. But this shows the basic contradiction at the heart of the Anglo Saxon model. The most important economic statistic by which economies are measured in the Anglo Saxon model is growth, and this encourages politicians to run deficits during the good times and even larger deficits in the bad times. Only the US can get away with this foolishness due to their control of the reserve currency. But for all the rest of the world, the way an economy weathers the down times has everything to do with how well they prepare themselves during the good times. Look at the countries in Europe that ran surpluses; they are doing fine and are more than able to run short term deficits to cushion the pain. So of course Spain is hurting now; during the summer and fall of the recent economic cycle they were down at the pub pounding down pints with their Anglo Saxon buddies while they laughed at the Teutonic fools out sweating in the fields pulling their harvest in. Now that the economic winter is tougher than expected, the Spanish are hurting and their Anglo Saxon buddies are using their example to condemn all of Europe. So don’t even expect Germany to come running to their assistance just to enable the Spanish and other PIIGS to slack off all over again next time.

    The fact is that for the most part (Greece excepted) the European countries struggling now are the countries that aligned themselves most closely with the Anglo Saxon economic model. Of course even in Spain they did not totally take on the Anglo Saxon ways, for example the Spanish banking system has remained strong due to very un-Anglo Saxon conservative reserve requirements. These PIIGS countries have backed themselves into a corner. They now can either leave the Euro if they want to continue their Anglo Saxon ways, taking a serious pounding in the process; or they can accept the inevitable penalty of a lower standard of living, stay in the Eurozone, get their fiscal shit together, and hope to do better during the next cycle by adopting the more conservative Teutonic (Continental) economic model. Either way they lose but by staying in the Eurozone they at least have a future.

    1. kevin de bruxelles

      I should have proofread. The second paragraph should start:

      The truth is though that the lesson of the current crisis…

    2. Diego

      I may agree with some of your comments, but not with this: “Now that Spain’s foolishness has been exposed in following the Anglo Saxon model of deficit spending during a boom, unrestrained real estate bubbles, general short-termism, and hollowing out of the manufacturing sector…”

      Deficit spending during a boom? Spain went from a 7% deficit in the last recession to a 2% superavit 2 years ago, lowering its public-debt level to one of the lowest in Europe. Spain’s current public debt is around 40%, compared to around 65% in Germany and 70% in France. So who’s been profligate?

      Moreover, Spain’s public spending has been directed at productive investment, such as high-speed rail, airports, high-capacity roads and science parks. Unlike France and Germany, which have made almost 0 investment in infrastructure over the last decade.

      Regarding the “hollowing out” of the manufacturing sector, well, you are just plain wrong: France’s manufacturing sector stands at 13% GDP (just like the US), compared to 17% in Spain. Did you know that Spain made more cars per capita than France? And around 3 times more cars per capita than Italy? Where’s the lack of manufacturing?

      “Look at the countries in Europe that ran surpluses” You may be refering to Spain and Scandinavia, since France and Germany have been breaking the 3% deficit ceiling *they* insisted to impose on euro countries for much of the last decade.

      1. kevin de bruxelles


        Thanks for correcting me, I see with further research you are spot on. For the “hollowing out of manufacturing” I based my comment on the huge current account deficit Spain used to run but that was in fact caused by excessive imports and not necessarily declining exports. As imports have been declining over the last year the deficit is coming into balance. And you are right that the Spanish budget deficits were not so bad all things considered.

    3. RebelEconomist

      I agree, and I am Anglo if not Saxon. The euro and the ECB were designed like the Buba, and France and the PIIGS joined in, because experience showed that the Teutonic way was better in the long run. Sadly, the PIIGS did not make the hard political choices in the good times to preserve their competitiveness, and are hitting the constraint of the hard euro harder than necessary, but I believe that if they can stick with it, it will not be as hard again – like giving up cigarettes gets easier with time. I am not especially pro-EU, and I hoped that post-Thatcher Britain had sufficient discipline to do it for themselves, but as events unfold, I am increasingly thinking that Britain should have joined the euro from a position of strength when public opinion was less sceptical around 2002.

  13. BigBadBank

    The best thing for the Euro would actually be for Germany to leave, so that it could sink to a more comfortable level for everybody else.

  14. Christian

    The problems Spain is having is related not so much to current deficits (which are huge) or their fiscal profligacy in the past, but that they had a multi-year boom based on cheap financing of consumption.
    Spain is having problems because their unit labor costs rose much faster than in other eurozone countries. That fall in competitiveness was hidden from consumers through extensive private borrowing to finance consumption.
    A boom based on consumption is quite fine, if it’s matched by rising incomes based on increased productivity. However the rise in unit labor costs and the external deficit clearly shows that it was not based on sustainable increases in income.
    Spain’s government may have run a budget surplus during the good times, but its private sector more than made up for that. In France and Germany on the other hand, the governments ran higher deficits, but those were financed by domestic savings.

    This crisis has shown that a focus on fiscal deficits by the SGP was too narrow/mis-targeted. If you lack your own currency, you should know that it’s storing up trouble when you have larger increases in income not matched by larger increases in productivity.

    Of course, Germany has learned (or rather should learn) that running large external surpluses is no good either if you invest them in dubious financial products and ultimately a sizable percentage of the goods you sold was actually free of charge courtesy of defaults.

    1. generic

      Even if they aren’t invested in dubious financial products large external surpluses are troublesome if they are achieved by suppressing your own wage level as is largely the case in Germany.

  15. Don

    I have a problem with Marshall [& Richard Koo] using Japan as a example of successful deficit spending [and also simplistically supporting most deficit spending] . Granted it probably kept things from being worse in Japan [& in 2008-9 for the developed nations], but the price has not yet been paid for that big build up in deficits for Japan. When Marshall says that Japanese deficit spending has been successful [& the currency has not dropped] it’s like Greenspan saying a few years ago that low interest rates and de-regulation had been very successful for the U.S. Let’s wait a few years before we judge how successful Japan [& the US/UK] have been.

    1. stf

      Marshall doesn’t suggest that deficits in Japan have been “successful,” (indeed, much of their deficit spending has probably been fairly poorly directed) only that the negative effects on interest rates and currency that everyone warns of have not happened. And it’s been since the early 1990s that they’ve run large deficits . . . you can wait a few more years if you want, but we’ve already had 15-20 years of adding to the national debt ratio. Waiting until it’s been 17-22 years instead won’t change that much.

  16. Yannis

    In fact, the Mayor of Athens (conservative) talked about “the political terrorists of Brussels”.

  17. Marshall Auerback

    Sometimes better to give real world examples, rather than theory. My friend, Scott Fulwiller, kindly sent me this a while back and I wonder if others will find it useful, too. It’s from a book written by Stuart Chase in 1943
    called “Where’s the Money Coming From?” (pages 1-3;
    http://www.questia.com/PM.qst?a=o&d=496998). The rest of the book isn’t MMT, but these observations at the beginning of the book have always been very well put in my opinion (even if he didn’t get theright answers for them).

    Excerpt from “Where’s the Money Coming From?” by Stuart Chase, 1943, p. 1-3

    IN 1925, Russia had been through a devastating war and a violent
    internal revolution. Her currency had been destroyed in a runaway
    price inflation, she was the world’s worst financial risk abroad and
    she had very little gold. Yet by the end of the first Five Year Plan
    in 1933, Russia had invested some 60 billion rubles in factories, new
    cities, cities, hydroelectric developments, armaments, houses,
    schools. There stood the new plant, ugly and solid. Without it Russia
    could never have met the onslaught of Hitler’s armies.

    Where did the money come from?

    In 1933 it was freely prophesied that Italy could not invade Ethiopia.
    She had no credit abroad and almost no gold. The effort would
    bankrupt her. Italy went ahead, conquered Ethiopia, and emerged
    without financial collapse.

    Where did the money come from?

    Hitler took over a Germany which was technically bankrupt. It had
    defaulted on its foreign obligations. When he proposed to build a
    powerful army, together with all kinds of grandiose public works, he
    was laughed at in London and New York. Germany was insolvent, and the
    whole idea was preposterous. The nations of Europe which have trembled
    under the thunder of panzer divisions know that Hitler built even more
    terribly than he promised.

    Where did the money come from?

    When Japan began to rattle her sword in the direction of Indo-China
    and challenge the United States and the British Empire, wiseacres said
    it was a bluff. The long years of the war in China had reduced the
    Japanese economy to a bag of bones. She was bankrupt and could not
    sustain a real fight. Yet she opened a new attack with devastating
    fury, and with military equipment in planes, tanks, artillery, ships,
    that was as excellent as it was unexpected.

    Where did the money come from?

    In 1939, the United States Congress declined to appropriate $4
    billions for highways, conservation, hospitals, freight cars, in the
    bitterly contested “lend-spend” bill. It was widely held that the bill
    would lead to ruin and national bankruptcy. Yet since the fall of
    France in 1940, Congress has appropriated almost $300 billions for
    armaments–seventy-five times as much as the lend-spend bill–and a
    large fraction of it has already gone into tanks and guns. Far from
    being ruined, our national vitality has never been more vigorous, and
    great financial moguls assure us that we shall be able to swing the
    national debt.

    Where did the money come from?

    After the war America will need to maintain full employment, operate
    its industries at substantial capacity, provide the essentials of life
    for all its own citizens, and help foreign peoples who are starving
    and unable to pay for the supplies. There will be a towering political
    demand for a world delivered from chronic depression.

    Where will the money come from?

    It is clear from these examples that what a great nation can “afford”
    in periods of crisis depends not on its money but on its man power and
    its goods. Russia, Italy, Germany, Japan, the United States, all used
    money in the situations mentioned, but money was obviously not the
    dominant factor. Man power and materials were the dominant factor.
    Yet at other times, when crisis was not so acute, the money for
    necessary tasks could not be found. Unemployment, insecurity, want,
    dragged on. This is a puzzling paradox. At certain times a nation can
    afford what at other times, with no less money, it cannot afford. At
    certain times we are afraid of national bankruptcy, and at other times
    we give it hardly a thought.

    If you don’t accept the notion that the goverment cannot create new net financial assets, how can you answer these questions?

  18. Tortoise

    Marshall always makes good points, so when Marshall talks I listen. The important point I get from his missive is that it is not the size of the deficit but what was done with it. Rather basic…

    Let me chime in with a couple of “hypothetical” situations.

    A. Assume a conservative government comes to power in a certain country. They raise taxes and fees on the majority who work (while lowering taxes on anyone who spends, particularly on housing) and slash spending on basic research and education and infrastructure (except prisons). Overall, they balance the budget or at least they say they want to.

    B. In a certain country, the government runs a deficit. Research and development, education, infrastructure, and high-value export industry are heavily (and underhandedly) subsidized. Consumption in general and housing in particular are penalized through taxes and administrative measures.

    Now which country will do better in the long term? And, for you who were patient enough to read my message, would you venture a guess on what actual situations A and B sound like?

  19. bena gyerek

    i know that this post wasn’t really about the sgp, and much more about u.s. domestic politics, but just as an fyi, the sgp has been totally discredited in europe for a long time now.

    it was originally insisted on by german finance minister theo waigel when monetary union was first being drawn up in the 1990s. but even then people thought it lacked credibility, because the punishment for transgressors would be a hefty fine imposed by the european commission. in what way would a fine help a country that had got itself into financial difficulties? it would be politically untenable and sounded like an empty threat.

    then in order to actually make the euro happen at all (on the second attempt in 1999), it was necessary to overlook the 60% debt/gdp criterion as most countries were failing it, robbing the euro of critical mass. as a result, even belgium and italy, each with debt/gdp > 100% at the time, were allowed in the initial wave.

    the 3% deficit/gdp criterion has also fallen by the wayside. both germany and france breached it BEFORE the financial crisis, and sarkozy has gone on record in saying that the criterion simply doesn’t apply to france (and by logical extension does not apply to any other country). if both germany and france are disregarding the sgp, there is no way that the european commission will act on it.

  20. Swampfox


    If you want to convince people that MMT is “The Theory” moving forward, perhaps you’d be better off not using some academic sophistry involving the USSR, Nazi Germany, Fascist Italy, and militant Japan as shining examples. Asking where the money came from in a society of slaves is really rich…

    Why not take it a step farther and ask the question about the Khmer Rouge. Where’d the money come from? (Don’t mind the skulls in the mud.)

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  22. catanyol

    “But if the US imposes anything like the constraints on government spending demanded by the deficit warriors, we’ll have Spanish style levels of unemployment”

    Sorry, but the US ALREADY has the same unemployment rate as Spain, it only counts unemployed people differently.

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