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This Could Change Everything

Dick Wagner, JD, CFP and Don St. Clair, CFP, EA
23rd Annual Far West Roundup

August 9-12, 2012

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

- Dick Wagner, JD, CFP


Textbook Explanation
Money derived from barter Spontaneously originates in Private Sector Replaces clumsy barter Eliminates "doublecoincidence of wants" Reduces transaction costs


Evolution of Money
Primitive monies Stones, beads, shells, feathers, fish, cattle, etc. Precious metals - coins Paper with metal backing Fiat money - based on Trust?

Textbooks Conclude
Money is what money does Unimportant in its own right Largely ignored in many economic models


Graeber: Not So Fast
No archeological evidence All money is debt Roots in penal system Unit of measurement


Credit & State Theories

Anthropologists, Sociologists, & Numismatists find origins in credit/debt relations Palace communities, Mesopotamia, ancient Egypt State/Temple/Authority plays central role Chartalist/Cartalist

John Maynard Keynes
"The age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-ofaccount.... To-day, all civilized money is, beyond the possibility of dispute, chartalist."


Regardless of Origin
Today, all money exists as an IOU, representing a social debt relationship It is abstract, and like an "inch" or a "yard," it can be measured, but not seen or felt In any modern nation, the money of account is chosen by the national government A nation's IOUs are recorded in this money of account (e.g. US Dollar, British Pound, Japanese Yen) Money is not an object. It exists as credit/debit entries. Coins and paper are representations of money, not vice versa

Today, Sovereign Governments
Define the money-ofaccount Impose taxes, fees, obligations Decide what they will accept as payment Choose how they will make their own payments

Taxes Drive Acceptance
Government defines money/ what it will accept as payment Makes payment (spends) in that same money-of-account Requires taxes be paid in the money-of-account it defines


But Taxes Do Not Fund Spending

Government does not "need" our money Not to raise revenue per se Taxes function to regulate the economy by regulating aggregate demand


How a Currency Issuer Spends
By directing its bank (usually the central bank) to credit someone's account This frequently (and increasingly) happens without even writing a check In the "modern money" era, government spending is accomplished through electronic keystrokes (Bernanke) The government neither has, nor doesn't have dollars in an account somewhere

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

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


Hierarchy of Money

Anyone can create money (social debt relationship) Trick is to have it accepted (Minsky) But private sector cannot create net financial assets

Government Banks Non-Financial Business Households

The US Hierarchy
Issues the currency at the top of the pyramid Taxes and spends in dollars Non-convertible, fiat money

US $


On Gold Standard
Pre-1973, Bretton Woods Promised to convert US$ to gold at a fixed price Dollars were subordinate Had to limit spending to protect gold reserves

Gold US $


Other Countries
Did not issue currency at the top of the pyramid Had to limit spending to protect (US$) reserves Sacrificed control of interest rates Heavily dependent on trade surpluses

US $ Ruble, Peso, etc.


Look familiar?
The Euro is effectively a foreign country from the perspective of the individual nations Currency is divorced from the nation ("One Market, One Money")

"Euro" Greece, Spain, etc.


The Eurozone
No EMU nation issues the currency that sits at the top of the pyramid Governments can "run out" of Euros Must pay market interest rates Heavily dependent on trade surpluses

"Euro" Italy, Portugal, etc.


Under Bretton Woods
Promised to convert US$ to gold at a fixed price Dollars were subordinate Had to limit spending to protect gold reserves

Gold US $


Everything Changed!
Except the textbooks Nobody rang the bell Dollars no longer subordinate Money no longer the object


Sovereign Money Matters
A sovereign currency ISSUER that does not peg to another's or offer to convert, can never "go broke," or "run out of money" It can afford anything for sale in the domestic unit of account It does not need to borrow its own currency It can set the policy interest rate at any level It has expanded policy space


But isn't the US Broke?
"We're out of money"


Within Our Means

"The government, just like every American household, has to live within its means"


Is the Government Like a Household?
No - not anymore Not since we abandoned the gold standard We ended Bretton Woods We have "modern money" created by keystrokes on a computer But... we act as if we're still stuck in a fixed exchange rate world

The ISSUER of the currency can always pay
"[A] government cannot become insolvent with respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such claims without limit"

-Alan Greenspan 1997

Deficit Hawks want Immediate Cuts
Opposes deficit spending on principle Often favors "sound money" (e.g. gold standard or 100% reserve backing) Would legislate rules to mandate balanced budgets

Deficit Doves want Eventual Cuts
Supports limited deficit spending in tough economic times Want the budget balanced over the business cycle Support rules to limit the size of the deficit Prefer to wait until after the economy begins to recover before imposing austerity

More Deficit Aviary
New bird in town, the Deficit Owl Modern Monetary Theory (MMT) Exposes the fallacies in conventional economic theories Views unemployment as socially harmful and economically inefficient


Within Our Means?

Unused energies. Unmet needs.

The MMT Deficit Owl
Assigns no arbitrary limit to the size or duration of the deficit Uses a sectoral balance sheet approach to relate deficit to the rest of the economy


Sectoral Balances
In any given period, sectoral balances show whether a particular part of the economy is:
Spending more than its income (deficit) Spending less than its income (surplus) Spending just equal to its income (balanced budget)


Accounting for Deficits
The laws of double-entry accounting apply All sectors cannot take in more than they spend (i.e. be in surplus) All sectors cannot spend more than they take in (i.e. be in deficit) Unless all 3 sectors are in balance, at least one sector will be on deficit



Private Sector Balance
As a general rule, the private sector needs to be in surplus Households and firms cannot continually borrow more than their income At some point, lenders will run out of credit worthy borrowers who are willing to spend Private debt levels may become unsustainable (Minsky's Financial Instability Hypothesis) When an expansion driven by private sector debt reaches an end, sales soften, jobless claims trend higher, and economic activity falters

Private Sector Debt


Unemployment Follows


Achieving a Private Sector Surplus
Unless/until we run a trade surplus, the government must run a deficit Only countries with trade surpluses can avoid running government deficits Not everyone can be a net exporter!

But We're Terrified of Deficits
What if people lose trust in the dollar? What if China refuses to buy our bonds? What if interest rates skyrocket?


What About Inflation?


Japan is Instructive


Bond Vigilantes?




Quantitative Easing
Despite decades of it's own QE

Inflation in Japan is non-existent


What Have We Learned?
The government's deficit is equal to the non-government sector's surplus The US can never go broke or forced into bankruptcy Sovereign constraints are Real, not Monetary Deficits do matter

So What?
Observations Entitlements Our Own Theory Current Policy Options What's Next?


Money is No Object Constraints are never Monetary Views Full Employment as Socially Desirable

Money is Not the Object Constraints are often Imagined Prioritizes Numerators over Denominators

Payroll tax creates new Government "Debt" Constraints are Selfimposed Medicare Parts B & D "adequately financed into the indefinite future"

A Borrowed Theory
Cost of Capital Infinite Time Horizons Lack of Spending Opportunity No Spending Imperative


LifeCycle of Household
Learn, Earn & Borrow Earn, Invest & Deleverage Divest, Spend-down & Consume


Policy Choices
Raise taxes, cut spending - or both Prudent advice for an OVERheated economy Why then, are these the only policy options on the table?


What's Our Role?
In the National Debate? In macro-economics? In educating our clients? Our community(s)?


Want More?


Complemetary Currencies?
Time Banking UMKC Buckaroo Denison Volunteer Dollars


So Why the Weak Recovery?
Policy makers significantly underestimated the severity of the crisis They don't understand banking They think deficits are under the government's control They think "confidence" will improve if we shrink the deficit