Crisis solved: Governments can never run out of money!

Byline: | Category: Economy, Taxes & Spending | Posted at: Friday, 18 March 2011

The Nation’s William Mitchell, who is also a research professor of economics and director of the Centre of Full Employment and Equity at Australia’s University of Newcastle, has just penned what is perhaps the most asinine treatise on economics ever written.  In fact, the word “asinine” does not nearly begin to convey the level of economic obtuseness contained within.

What follows are some excerpts, some comments, and a single question by which I can demonstrate that the Mitchell Theory is a complete fraud:

“Austerity will worsen the crisis, because it is built on a lie. Public deficits do not cause inflation, nor do they impose crippling debt burdens on our children and grandchildren. Deficits do not cause interest rates to rise, choking private spending. Governments cannot run out of money.”  Yes, if by “money” you mean those pieces of paper containing portraits of dead presidents, then yes, governments cannot run out of money.  Weimar Germany showed us that governments can print so much money that there are bushel loads available for all.  But Weimar also demonstrated that ”money” can indeed run out of value.

“The neoliberal narrative has run into some inconvenient facts. Interest rates remain low . . .”  Indeed, when the government, in the form of the Federal Reserve “buys” the majority of America’s newly issued debt, it does seem to have a way of keeping interest rates down.  It will be interesting to see what happens in the months after June when the second round of “quantitative easing” ends.

“In most of the developed world inflation is falling, and where it is rising, it is due to rising energy and food costs rather than excessive deficits.”  Cart.  Horse.  Energy and food prices are increasing because of inflation.  Rising prices are not the cause of inflation, any more than rising mercury is the cause of higher temperatures.  Gas and food are more expensive because money is less valuable.  Inflation is a monetary phenomenon. 

To see why this is so, consider this thought experiment:  A distant island nation untouched by outsiders happens upon a treasure chest of paper money that washes upon its shore.  The paper itself has no intrinsic value, but perhaps because these native peoples are somehow also drawn toward pictures of dead white guys (DWGs), they decide to implement this paper scrip as currency.  For years, a loaf of bread costs the same quantity of DWGs, and an hour of labor never varies in price, and land never escalates in value.  Life goes on exceedingly well, until one day a native discovers a second chest with an equal quantity of money.  He’s rich! 

But then problems arise.  Because the “rich” man can afford to outbid any of his neighbors for anything, he does so, buying up the best land, hiring the best workers, and marrying the prettiest wives.  But what becomes of prices?  Well, once the second load of currency works its way into the island’s economy, the cost of everything effectively doubles.  It takes twices as many DWGs to buy the same loaf of bread.  That’s because there was no increase in the island’s economic output; only an increase in the money supply.   No additional value, but twice the currency means that value of each DWG is eventually half.

In fact, there’s probably a good study idea in here for someone to analyze the speed with which prices rise after a money supply change as a function of the velocity of money.  One of the consequences of our recent economic troubles is that the velocity of money dropped.  If my hunch is right, that would delay the consequences of inflation.  This is perhaps why people like Mr. Mitchell are able to fool followers who are similarly blind to the inflationary dangers of the steps taken by the government and the Fed.

“But the government is not a big household. It can consistently spend more than its revenue because it creates the currency. Whereas households have to save (spend less than they earn) to spend more in the future, governments can purchase whatever they like whenever there are goods and services for sale in the currency they issue. Budget surpluses provide no greater capacity to governments to meet future needs, nor do budget deficits erode that capacity. Governments always have the capacity to spend in their own currencies.  Why? Because they are the issuers of their own currencies, governments like Britain, the United States, Japan and Australia can never run out of money.”  The list of nations that have mistakenly thought this is a long one going back at least to the days that Romans reduced the quantity of silver in the denarius.  From Ancient Rome to Habsburg Spain to Zimbabwe, we know that this is not true.

“Why, then, do governments borrow? Under the gold standard governments had to borrow to spend more than their tax revenue. But since 1971 that necessity has lapsed. Now governments issue debt to match their deficits only as a result of pressure placed on them by neoliberals to restrict their spending. Conservatives know that rising public debt can be politically manipulated and demonized, and they do this to put a brake on government spending. But there is no operational necessity to issue debt in a fiat monetary system.” [Emphasis in original.] 

My question is a different one:  If the Mitchell Theory is correct, why then do governments tax?

The answer is simple: They have to, because even governments are not immune to the first law of thermodynamics.  Energy, be it economic or otherwise, cannot be created from nothing.  William Mitchell of the Centre of Full Employment and Equity is just another in a long line of charlatans promising perpetual motion machines.  And the folks at the Nation join the list of fools who have gone broke following frauds.

I commend the entire article to you as an example of sophistry of the highest order.

RELATED:  Forbes’ Reuven Brenner discusses a similar subject:  “Macroeconomics’ New Alchemy: Getting Something for Nothing.”

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4 Responses to “Crisis solved: Governments can never run out of money!”

  1. Michael Says:

    Wow, nice ad hominem attacks.

    However, you have completely failed to address the substance of Mitchell’s piece. None of your historical anecdotes provides any evidence that a government like the US is unable to spend more of its own credits than it collects in taxes.

    You do not understand thermodynamics when you say that credit money cannot be created out of nothing. It can be created out of 1′s and 0′s in a computerized banking system, which requires electricity. It does not require that anything, including other credit-monies, be taken away from taxpayers.

    Governments like the US tax in order to create the demand for their currency to circulate. Since all citizens must pay taxes, in dollars, all citizens must earn dollars to pay their taxes. Taxation drives circulation of money through the private sector; it does not finance creation of money by the central bank.

    Apparently you didn’t hear that the gold window was closed almost 40 years ago. Commodity money is now history, just like the Romans, the Habsburgs, and the Weimar Republic.

    You are only the sophist here.

    Ed: Wow, nice mischaracterization of arguments–both mine and Mr. Mitchell’s.

    I never said that a government like the US is unable to spend more of its own credits than it collects in taxes. In fact, I’d even go so far as to say that as long as the average percent rate of growth of the economy exceeds the average annual deficit as a percent of GDP, a government that borrows in its own currency can continue to borrow bigger and bigger deficits indefinitely. That’s not where we’ve been the past three years–where deficit spending is in the upper single digits while growth has been anemic–or even more alarmingly, it’s not even projected to be the case that we will have deficits lower than growth rate for years to come.

    And Mr. Mitchell never said that taxes would have to be raised to pay back the debt. In fact, he said the opposite: that there was an unlimited amount of debt that would never have to be paid back because the government can continue to print indefinite amounts of money out of thin air.

    But where you really lost me was when you said that money, for money to be valid, it “does not require that anything . . . be taken away from taxpayers.” Then in the next paragraph you say that governments must “tax in order to create the demand for their currency to circulate.” Which is it?

    Furthermore, your argument that fiat money only circulates because of taxes is specious. At a zero percent tax rate a fiat currency will still circulate. Why? because currency circulates easier than barter. Consumption creates the demand for currency, not taxes. At a zero percent tax rate, a stable amount of fiat currency will still circulate. (See the island example above.) Sure, without a source of revenue, the government is going to find it difficult to borrow against that currency, not to mention operate, but that’s a different problem that has nothing to do with the value of money.

    When you’ve got a coherent argument, come back. But, so as to not further embarass yourself, I would first suggest a little von Mises. Feel free to gloss over his commodity-based currency discussions (which by the way, was a nice red herring you threw in there–one that I never advocated), but make sure you understand his general point of how money gets its value.


  2. Michael Says:

    Government debt does not need to be “paid back” if by back you mean off. There is no requirement that total outstanding public debt ever be finally settled once and for all, unless and until the US government is placed into receivership and all its assets are liquidated. Don’t hold your long-winded breath waiting for that to happen though.

    What Mitchell says, and what I say, is that raising tax rates to service the public bond issue is unnecessary, because at full employment, rising tax revenues occur at constant tax rates, as a result of growing national income. The key concept is full employment.

    There is no basis for your theory that some magical ratio of deficit-to-GDP exists beyond which creating more currency, and more treasuries, becomes impossible. Given sufficient wind-power to run the banking computers, the government can literally and indefinitely create credit money (bank deposits) out of the air. This is equivalent to saying the government controls the money supply.

    The users of the currency on the other hand determine the demand for money. So long as the supply of money does not seriously outstrip the demand for money, money remains more or less valuable, and sought after. It is safe to say that the demand for US dollars remains high, although if you disagree I would be happy to relieve you by PayPal of any burdensome accumulation of dollars that might be weighing you down.

    I did not say anything about the “validity” of money, whatever that might be. Instead, I said that money can be supplied by the government, ex nihilo, aside from the power needed to run the banking computers. The demand for dollars, while supported by dollar denominated tax obligations, is much greater than merely the tax bill, precisely because the government’s promises to pay are valuable, in and of themselves.

    What you say on the other hand, is that currency is easier than barter. You are comparing apples and orchards. The US government derives no benefit from the circulation of a currency it does not issue or spend in. If no taxes were required, people certainly would not decide to barter everything, but they might very well choose an alternative unit of account or store of value that the US government doesn’t have the legal ability to create at will. By exacting taxes, a floor is placed underneath the demand for the government-issued currency, as opposed to any old currency. The government-issued currency is thus, other things equal, preferable to another potential unit with no such tax obligation and demand floor.

    The power to create a valuable, circulating currency at will, and buy things and hire people with it, is the primary advantage of a modern money system, for exactly the reasons Mitchell describes. The specious argument, that no such advantage is gained because the government must “pay back” its debts and therefore can never create and spend currency, is yours.

    If you are really interested in understanding this important issue, and not merely the bloviating sophist I suspect you to be, I would suggest Keynes General Theory of . . . Money. Nobody has ever claimed, even in jest, that we are all Miseans now.

    Ed: I’ve read Keynes. And even Keynes wasn’t a Keynesian as you understand it to mean.

  3. Mitch Says:

    I’m with Michael – I don’t see how you demonstrated that Professor Mitchell’s theory* is a complete fraud. And you accuse Michael of presenting an incoherent argument, when in fact his argument is completely in accordance with the theoretical premises of its seminal school of thought: Chartalism, or the “state theory of money.” Furthermore, in its more recent incantations as “modern monetary theory” or “endogenous money theory.” If you don’t believe me consider Michael’s first comment again after reading Knapp’s, “State Theory of Money” [1924], L. Randall Wray’s “Credit and State Theories of Money: The Contributions of A. Mitchell Innes [2004], Wray’s “Understanding Modern Money” [1998], Abba Lerner’s, “Economic Steering Wheel,” or any number of working papers published through the Levy Institute or the Center for Full Employment and Price Stability. While you may not agree with Prof. Mitchell’s argument or Michael’s defense of the same, it is not fair to say that they are incoherent or “asinine.”

    Worse, you claim to demonstrate just how fraudulent Mitchell’s argument is but fail to do so. First, you attempt to expose the falsity of Mitchell’s claim that “governments cannot run out of money,” by comparing sovereign currency governments, such as what Mitchell refers to, with the Weimar Republic. You reason that since Weimar Germany experienced hyperinflation in post-Versailles Europe, governments in general will experience the same problem if they engage in deficit spending (presumably on some arbitrary debt to GDP metric). This is a fallacious claim. Weimar is unlike today’s sovereign currency governments in that it had considerable debts denominated in foreign currencies. Reparations were paid in pounds, dollars, francs, etc. In the absence of any productive capability in Germany as a result of Versailles treaty conditions and the aftermath of the war, Germany had to float bonds in lieu of exports to collect the currencies required to satisfy foreign debts. As a result their bonds were subject to the market, and yields became endogenous. That is to say, they couldn’t raise the yield enough to entice investors to hold their bonds. So they turned to the printing press. However, since you cannot print the currency of another sovereign nation you still have the convertibility issue to deal with in which case you run into an exchange rate issue that will result in hyperinflation. This process explains what happened to Russian GKOs in the 1990s until the central bank stopped offering convertibility to foreign currencies, and explains the Zimbabwe hyperinflation as well. What it does not account for are the conditions that affect modern sovereign currencies, such as the US, UK, New Zealand, Japan, etc. These countries issue debt that is denominated in their own currency, thereby eliminating the possibility of endogenous bond yields. Those governments set the prices of their bonds, and those that wish to earn a rate of return (such as trading partners) will hold bonds rather than keep their reserves in a checking account at the issuing country’s central bank. Therefore, you present a false analogy and have failed to demonstrate any fraud here.

    Second, you dismiss Mitchell’s point regarding inflation. You accuse him of committing a post hoc fallacy by arguing that inflation is caused by food and fuel price increases. Unfortunately, if you are correct that he is indeed committing the fallacy, then your rebuttal commits the same. You attempt to discredit Mitchell’s fallacy by pointing out that price increases can’t be caused by inflation because inflation causes price increases. What you are really arguing about is which way to read the Fisher equation: MV = PY. You are reading causality from left to right, and Mitchell is reading causality from right to left. In either case there must be a theoretical justification, else each case is left with the post hoc problem. But, each side does have a theory. Yours is rooted in Classical Political Economy and epitomized by Friedman and the monetarists. Austrians have relied on the Friedmanian approach for their capital based theory of money. Mitchell’s is rooted in the post-Keynesian tradition that suggests that the money supply floats and adjusts to the interest set by the central bank and the aggregate level of effective demand. Like you have said in your reply to Michael, money is demanded for consumption. This is true, but the key point is that banks create money on demand to meet the liquidity needs of its clients. The level of money creation depends entirely on the ability of banks to meet the liquidity requirements of its institutional clients.

    There is a considerable body of empirical evidence to suggests that firms possess the power to set prices. See the literature on administered pricing [Berle & Means, Means, and esp. Fred Lee]. This evidence of the pricing power in the modern corporation coupled with cost-push theories of inflation present an entirely legitimate explanation of the sort of inflation Mitchell describes. Since the theory allows for a causal procession implied by reading the QTM equation from right to left, then the old “cart before the horse” argument is invalid.

    Now the Classical / Austrian / Monetarist claim to left – right causality cannot be established by reference to your thought experiment. There is not a shred of evidence in existence that documents the effect of exogenous money shocks on a closed system the way in which you suggest it does with your island example. Indigenous island nations that have never been exposed to some fixed quantity of foreign fiat currency, do not spontaneously develop a monetary system of production in the presence of the new found currency. If markets exist prior to the arrival of the new currency, then the new currency does not automatically displace the existing currency. And it is not safe to assume that the natural state of civilization is the barter system, and that money-things emerge from it in order to better facilitate exchange. This is ahistorical. The anthropological record points towards the tendency for money to precede markets. Money was initially created as a system of control and to establish markets. See Charles Goodhart on anthropological evidence for chartalism.

    I appreciate your reasoned argument, some of which is correct, some of which I would refute. But I’ll specifically address this assertion: “There is not a shred of evidence in existence that documents the effect of exogenous money shocks on a closed system the way in which you suggest it does with your island example.”

    Actually there is such an example. It is Habsburg Spain. “Enriched” by ahistorically huge imports of gold and silver from Spanish discoveries in the New World, Spain suffered terrible inflation. What, however didn’t inflate was the value of Spain’s commerce. Instead, all that Spain enjoyed was more coinage. The value of money comes not from its intrinsic worth, a point on which we can probably agree. Instead it comes from what it can purchase. Whether it is a fiat currency, which obviously has no intrinsic value, or a coinage currency, the value of which is greater than the coin’s inherent metallic industrial value, both are forms of fiat currency. This is where I differ from von Mises. He brought everything back to a hard currency. (He might ultimately be right, but for a very different reason than that which he asserts.) Regardless, Spain went on a buying binge fueled by the illusion of an increase of money brought about through an increase of precious metals. Why they foundered, defaulting five times in the 16th/17th centuries was because the growth of their “money supply” far outstripped the growth of their economy.

  4. Michael Says:

    There you go, talking about obsolete commodity money again. And as for “Keynes wasn’t a Keynesian”…. no kidding, he was KEYNES. I didn’t even use the word “Keynesian” anywhere, so I fail to see why you would presume that I have somehow misunderstood its meaning. That’s good that you’ve read Keynes though. I suggest you read him again, if you care to understand the relationship between employment, interest, and money.

    Keynes wrote before modern money had fully developed, but he certainly understood what money basically is, when it is separated from material money-things, as it has been in the US for forty years. Money is information, credits, accounting. It is not the numerator in some cosmic ratio, constantly revaluing the total sum of economic output by spooky action at a distance. It is bank deposits. The banking system cannot run out of money to lend, any more than the NFL can run out of points to put up on the scoreboards. However, banks may very well run out of credit-worthy customers to lend to–indeed that is why it is essential that the state function not only as lender of last resort but as borrower of last resort as well, in order to maintain demand at a level commensurate with full employment. Just as Professor Mitchell describes.

    Ed: You’re hopeless. Money is worth what the market says it is; not what government demands it to be. Any further attempt to discuss economics with you is pointless. Since I’m a believer in the primacy of markets and you’re a disciple of government dictates uber alles, there is no common ground betweeen us.