> This text is from: http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf "One of the brightest minds in finance." CNBC (6/11/10) our real world economy. To put it as simply as possible, many of the most dangerous beliefs about the way the economy functions would "Warren Mosler is one of the most original and clear-eyed have some relevance if the U.S. were on a strict gold standard. Yet, participants in today's debates over economic policy." obviously, the U.S. dollar has had no link whatsoever to gold since JAMES GALBRAITH, FORMER EXECUTIVE DIRECTOR, JOINT ECONOMIC the break-up of the Bretton Woods system. COMMITTEE AND PROFESSOR, THE UNIVERSITY OF TEXAS - AUSTIN So what are the deadly (yet perhaps innocent) frauds? First, government finance is supposed to be similar to household finance: "I can say without hesitation that Warren Mosler has had the most government needs to tax and borrow first before it can spend. profound impact on our understanding of modern money and government Second, today's deficits burden our grandchildren with government budgets of anyone I know or know of, including Nobel Prize winners, debt. Third, worse, deficits absorb today's saving. Fourth, Social Central Bank Directors, Ministers of Finance and full professors at Security has promised pensions and healthcare that it will never Ivy League Universities. It is no exaggeration to say that his ideas be able to afford. Fifth, the U.S. trade deficit reduces domestic concerning economic theory and policy are responsible for the most employment and dangerously indebts Americans to the whims of exciting new paradigm in economics in the last 30 years - perhaps longer foreigners - who might decide to cut off the supply of loans that we - and he has inspired more economists to turn their attention to the real need. Sixth, and related to fraud number three, we need savings to world of economic policy than any other single individual." finance investment (so government budgets lead to less investment). DR. MATTHEW FORSTATER, PROFESSOR OF ECONOMICS, UNIVERSITY And, finally, higher budget deficits imply taxes will have to be higher OF MISSOURI - KANSAS CITY in the future - adding to the burden on future taxpayers. Mosler shows that whether or not these beliefs are innocent, "Warren is one of the rare individuals who understand money and they are most certainly wrong. Again, there might be some sort of finance and how the Treasury and the Fed really work. He receives economy in which they could be more-or-less correct. For example, information from industry experts from all over the world." in a nonmonetary economy, a farmer needs to save seed corn to WILLIAM K. BLACK, ASSOCIATE PROFESSOR OF ECONOMICS & LAW, 'invest' it in next year's rop. On a gold standard, a government UNIVERSITY OF MISSOURI - KANSAS CITY really does need to tax and borrow to ensure it can maintain a fixed exchange rate. And so on. But in the case of nonconvertible currency "He [Warren Mosler] represents a rare combination: someone who (in the sense that government does not promise to convert at a fixed combines an exceptional knowledge of finance with the wisdom and exchange rate to precious metal or foreign currency), none of these compassion required to get us an array of policies that will bring us myths holds. Each is a fraud. back to sustainable full employment." The best reason to read this book is to ensure that you can MARSHALL AUERBACK, GLOBAL PORTFOLIO STRATEGIST, RAB recognize a fraud when you hear one. And in his clear and precise CAPITAL AND FELLOW, ECONOMISTS FOR PEACE & SECURITY style. Mosler will introduce you to the correct paradign to develop an understanding of the world in which we actually live." "In this book, Warren Mosler borrows John Kenneth Galbraith's L. RANDALL WRAY, PROFESSOR OF ECONOMICS, UNIVERSITY OF notion of 'innocent fraud' and identifies seven of the most MISSOURI - KANSAS CITY, RESEARCH DIRECTOR, CENTER FOR FULL EMPLOYMENT & PRICE STABILITY, SENIOR SCHOLAR, LEVY destructive yet widely held myths about the economy. Like ECONOMICS INSTITUTE, AUTHOR OF UNDERSTANDING MODERN Galbraith, Mosler chooses to accept the possibility that the fraud MONEY, THE KEY TO FULL EMPLOYMENT AND PRICE STABILITY AND is unintentionial, resulting from ignorance, misunderstanding or, EDITOR, CREDIT AND STATE THEORIES OF MONEY: THE CONTRIBUTIONS most likely, from application of the wrong economic paradigm to OF A. MITCHELL INNES SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY WRITINGS of WARREN MOSLER (found on www.moslereconomics.com) WARREN MOSLER The Seven Deadly Innocent Frauds Galbraith/Wray/Mosler submission for February 25 Mosler Palestinian Development Plan Soft Currency Economics Full Employment AND Price Stability A General Analytical Framework for the Analysis of Currencies and Other Commodities The Natural Rate of Interest is Zero 2004 Proposal for Senator Lieberman EPIC - A Coalition of Economic Policy Institutions An Interview with the Chairman What is Money? The Innocent Fraud of the Trade Deficit: Who's Funding Whom? The Financial Crisis - Views and Remedies Quantitative Easing for Dummies Tax-Driven Money VALANCE CO., INC. CONTENTS Foreword ..............................................................................1 Prologue ...............................................................................5 Overview..............................................................................9 Introduction........................................................................11 Part I: The Seven Deadly Innocent Frauds ........................13 Fraud #1 .......................................................................13 Fraud #2 .......................................................................31 Fraud #3 .......................................................................41 Fraud #4 .......................................................................51 COPYRIGHT(C)Warren Mosler, 2010 Fraud #5 .......................................................................59 Published by Valance Co., Inc., by arrangement with the author Fraud #6 .......................................................................63 www.moslereconomics.com Fraud #7 .......................................................................67 All rights reserved, which includes the right to reproduce this book Part II .................................................................................69 or portions thereof in any form whatsoever except as provided by the U.S. Copyright Law. Part III ................................................................................99 Library of Congress Cataloging-in-Publication Data in progress for ISBN: 978-0-692-00959-8 The text of this book is set in 12 pt. Times. Printed & bound in the U.S.A. 16 15 14 13 12 11 10 10 9 8 7 6 5 4 3 2 1 FIRST IMPRESSION VALANCE CO., INC. SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Foreword Warren Mosler is a rare bird: a self-taught economist who is not a crank; a successful investor who is not a blowhard; a businessperson with a talent for teaching; a financier with a true commitment to the public good. We have co-authored testimony and the occasional article, and I attest firmly that his contributions to those efforts exceeded mine. Many economists value complexity for its own sake. A glance at any modern economics journal confirms this. A truly incomprehensible argument can bring a lot of prestige! The problem, though, is that when an argument appears incomprehensible, that often means the person making it doesn't understand it either. (I was just at a meeting of European central bankers and international monetary economists in Helsinki, Finland. After one paper, I asked a very distinguished economist from Sweden how many people he thought had followed the math. He said, "Zero.") Warren's gift is transparent lucidity. He thinks things through as simply as he can. (And he puts a lot of work into this - true simplicity is hard.) He favors the familiar metaphor, and the homely example. You can explain his reasoning to most children (at least to mine), to any college student and to any player in the financial markets. Only economists, with their powerful loyalty to fixed ideas, have trouble with it. Politicians, of course, often do understand, but rarely feel free to speak their own minds. Now comes Warren Mosler with a small book, setting out his reasoning on seven key issues. These relate to government deficits and debt, to the relation between public deficits and 1 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY private savings, to that between savings and investment, to Social Security and to the trade deficit. Warren calls them Nor is the public debt a burden on the future. How could "Seven Deadly Innocent Frauds" - taking up a phrase coined it be? Everything produced in the future will be consumed by my father as the title of his last book. Galbraith-the-elder in the future. How much will be produced depends on how would have been pleased. productive the economy is at that time. This has nothing to do with the public debt today; a higher public debt today The common thread tying these themes together is does not reduce future production - and if it motivates wise simplicity itself. It's that modern money is a spreadsheet! It use of resources today, it may increase the productivity of the works by computer! When government spends or lends, it economy in the future. does so by adding numbers to private bank accounts. When it taxes, it marks those same accounts down. When it borrows, it Public deficits increase financial private savings - as a shifts funds from a demand deposit (called a reserve account) matter of accounting, dollar for dollar. Imports are a benefit, to savings (called a securities account). And that for practical exports a cost. We do not borrow from China to finance our purposes is all there is. The money government spends doesn't consumption: the borrowing that finances an import from come from anywhere, and it doesn't cost anything to produce. China is done by a U.S. consumer at a U.S. bank. Social The government therefore cannot run out. Security privatization would just reshuffle the ownership of stocks and bonds in the economy - transferring risky assets Money is created by government spending (or by bank to seniors and safer ones to the wealthy - without having any loans, which create deposits). Taxes serve to make us want other economic effects. The Federal Reserve sets interest rates that money - we need it in order to pay the taxes. And they where it wants. help regulate total spending, so that we don't have more total spending than we have goods available at current prices - All these are among the simple principles set out in this something that would force up prices and cause inflation. But small book. taxes aren't needed in advance of spending - and could hardly be, since before the government spends there is no money to Also included here are an engaging account of the tax. education of a financier and an action program for saving the American economy from the crisis of high unemployment. A government borrowing in its own currency need never Warren would do this by suspending the payroll tax - giving default on its debts; paying them is simply a matter of adding every working American a raise of over 8 percent, after tax; by the interest to the bank accounts of the bond holders. A a per capita grant to state and local governments, to cure their government can only decide to default - an act of financial fiscal crises; and by a public employment program offering a suicide - or (in the case of a government borrowing in a job at a modest wage to anyone who wanted one. This would currency it doesn't control) be forced to default by its bankers. eliminate the dangerous forms of unemployment and allow us But a U.S. bank will always cash a check issued by the US to put our young people, especially, to useful work. Government, whatever happens. 2 3 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Warren's heroes, among economists and apart from my Prologue father, are Wynne Godley and Abba Lerner. Godley - a wonderful man who just passed away - prefigured much of this work with his stock-flow consistent macroeconomic The term "innocent fraud" was introduced by Professor models, which have proved to be among the best forecasting John Kenneth Galbraith in his last book, The Economics of tools in the business. Lerner championed "functional finance," Innocent Fraud, which he wrote at the age of ninety-four meaning that public policy should be judged by its results in in 2004, just two years before he died. Professor Galbraith the real world - employment, productivity and price stability coined the term to describe a variety of incorrect assumptions - and not by whatever may be happening to budget and debt embraced by mainstream economists, the media, and most of numbers. Warren also likes to invoke Lerner's Law - the all, politicians. principle that, in economics, one should never compromise The presumption of innocence, yet another example of principles, no matter how much trouble other people have in Galbraith's elegant and biting wit, implies those perpetuating understanding them. I wish I were as a good at observing that the fraud are not only wrong, but also not clever enough to principle as he is. understand what they are actually doing. And any claim of prior understanding becomes an admission of deliberate fraud All in all, this book is an engaging and highly instructive - an unthinkable self-incrimination. read - highly recommended. Galbraith's economic views gained a wide audience during the 1950s and 1960s, with his best selling books The James K. Galbraith Affluent Society, and The New Industrial State. He was well The University of Texas at Austin connected to both the Kennedy and Johnson Administrations, June 12, 2010 serving as the United States Ambassador to India from 1961 until 1963, when he returned to his post as Harvard's most renowned Professor of Economics. Galbraith was largely a Keynesian who believed that only fiscal policy can restore "spending power." Fiscal policy is what economists call tax cuts and spending increases, and spending in general is what they call aggregate demand. Galbraith's academic antagonist, Milton Friedman, led another school of thought known as the "monetarists." The monetarists believe the federal government should always keep the budget in balance and use what they called "monetary policy" to regulate the economy. Initially that meant keeping the "money supply" growing slowly and steadily to control inflation, and letting the economy do what it may. However they never could come up with a measure of money supply that did the 4 5 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY trick nor could the Federal Reserve ever find a way to actually coined "stagflation" - the combination of a stagnant economy control the measures of money they experimented with. and high inflation. Paul Volcker was the last Fed Chairman to attempt to I entered banking in 1973 with a job collecting delinquent directly control the money supply. After a prolonged period of loans at the Savings Bank of Manchester in my home town of actions that merely demonstrated what most central bankers Manchester, Connecticut. I was the bank's portfolio manager had known for a very long time - that there was no such thing by 1975, which led to Wall St. in 1976, where I worked on as controlling the money supply - Volcker abandoned the the trading floor until 1978. Then I was hired by William effort. Blair and Company in Chicago to add fixed income arbitrage Monetary policy was quickly redefined as a policy of to their corporate bond department. It was from there that I using interest rates as the instrument of monetary policy rather started my own fund in 1982. I saw the "great inflation" as than any measures of the quantity of money. And "inflation cost-push phenomena driven by OPEC's pricing power. It had expectations" moved to the top of the list as the cause of every appearance of a cartel setting ever-higher prices which inflation, as the money supply no longer played an active caused the great inflation, and a simple supply response that role. Interestingly, "money" doesn't appear anywhere in the broke it. As OPEC raised the nominal price of crude oil from latest monetarist mathematical models that advocate the use of $2 per barrel in the early 1970's to a peak of about $40 per interest rates to regulate the economy. barrel approximately 10 years later, I could see two possible Whenever there are severe economic slumps, politicians outcomes. The first was for it to somehow be kept to a relative need results - in the form of more jobs - to stay in office. value story, where U.S. inflation remained fairly low and First they watch as the Federal Reserve cuts interest rates, paying more for oil and gasoline simply meant less demand waiting patiently for the low rates to somehow "kick in." and weaker prices for most everything else, with wages and Unfortunately, interest rates never to seem to "kick in." salaries staying relatively constant. This would have meant a Then, as rising unemployment threatens the re-election of drastic reduction in real terms of trade and standard of living, members of Congress and the President, the politicians turn to and an even larger increase in the real terms of trade and Keynesian policies of tax cuts and spending increases. These standard of living for the oil exporters. policies are implemented over the intense objections and dire The second outcome, which is what happened, was for predictions of the majority of central bankers and mainstream a general inflation to ensue, so while OPEC did get higher economists. prices for its oil, they also had to pay higher prices for what It was Richard Nixon who famously declared during the they wanted to buy, leaving real terms of trade not all that double dip economic slump of 1973, "We are all Keynesians different after the price of oil finally settled between $10 and now." $5 per barrel where it remained for over a decade. And from Despite Nixon's statement, Galbraith's Keynesian views where I sat, I didn't see any deflationary consequences from lost out to the monetarists when the "Great Inflation" of the the "tight" monetary policy. Instead, it was the deregulation 1970s sent shock waves through the American psyche. Public of natural gas in 1978 that allowed natural gas prices to rise, policy turned to the Federal Reserve and its manipulation of and therefore, natural gas wells to be uncapped. U.S. electric interest rates as the most effective way to deal with what was utility companies then switched fuels from high-priced oil to 6 7 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY what was still lower-priced natural gas. OPEC reacted to this supply response by rapidly cutting production in an attempt to keep prices from falling below $30 per oil barrel. Production was cut by over 15 million barrels a day, but it wasn't enough, OVERVIEW and they drowned in the sea of excess world oil production as electric utilities continued to move to other fuels. This book is divided into three sections. Part one Seven Deadly Innocent Frauds of Economic Policy immediately reveals the seven "innocent frauds" that I submit are the most imbedded obstacles to national prosperity. They are presented in a manner that does not require any 1. The government must raise funds through taxation or prior knowledge or understanding of the monetary system, borrowing in order to spend. In other words, government economics, or accounting. The first three concern the federal spending is limited by its ability to tax or borrow. government's budget deficit, the fourth addresses Social Security, the fifth international trade, the sixth savings and 2. With government deficits, we are leaving our debt burden investment, and the seventh returns to the federal budget to our children. deficit. This last chapter is the core message; its purpose is to promote a universal understanding of these critical issues facing our nation. 3. Government budget deficits take away savings. Part two is the evolution of my awareness of these seven deadly innocent frauds during my more-than-three decades of 4. Social Security is broken. experience in the world of finance. In Part three, I apply the knowledge of the seven deadly 5. The trade deficit is an unsustainable imbalance that takes innocent frauds to the leading issues of our day. away jobs and output. In Part four, I set forth a specific action plan for our country to realize our economic potential and restore the American dream. 6. We need savings to provide the funds for investment. 7. It's a bad thing that higher deficits today mean higher taxes tomorrow. April 15, 2010 Warren Mosler 67 Chimney Corner Circle Guilford, CT 06437-3134 8 9 SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Introduction This book's purpose is to promote the restoration of American prosperity. It is my contention that the seven deadly innocent frauds of economic policy are all that is standing between today's economic mess and the full restoration of American prosperity. As of the publication of this book, I am campaigning for the office of U.S. Senator from my home state of Connecticut, solely as a matter of conscience. I am running to promote my national agenda to restore American prosperity with the following three proposals. The first is what's called a "full payroll tax holiday" whereby the U.S. Treasury stops taking some $20 billion EACH WEEK from people working for a living and instead, makes all FICA payments for both employees and employers. The average American couple earning a combined $100,000 per year will see their take-home pay go up by over $650 PER MONTH which will help them meet their mortgage payments and stay in their homes, which would also end the financial crisis. Additionally, the extra take-home pay would help everyone pay their bills and go shopping, as Americans return to what used to be our normal way of life. My second proposal is for the federal government to distribute $500 per capita of revenue sharing to the state governments, with no strings attached, to tide them over and help them sustain their essential services. The spending power and millions of jobs funded by people's spending from the extra take-home pay from the payroll-tax holiday restores economic activity, and the States' revenues would return to where they were before the crisis. 11 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY My third proposal calls for a restoration of American prosperity through a federally-funded $8/hr. job for anyone willing and able to work. The primary purpose of this program Part I: The Seven Deadly Innocent Frauds is to provide a transition from unemployment to private-sector employment. A payroll-tax holiday and the state revenue- sharing would bring an immediate flurry of economic activity, Deadly Innocent Fraud #1: The federal government must raise funds through with private-sector employers quickly seeking to hire millions of taxation or borrowing in order to spend. In other additional workers to meet growing demand for their products. words, government spending is limited by its ability Unfortunately, past recessions have shown that businesses are to tax or borrow. reluctant to hire those who have been unemployed, with the long-term unemployed being the least attractive. Transitional employment also would draw these people into the labor force, Fact: giving them a chance to demonstrate what they can do, and Federal government spending is in no case show that they are responsible and can get to work on time. operationally constrained by revenues, meaning This includes giving the opportunity of work to many of those that there is no "solvency risk." In other words, who have a harder time finding private-sector employment, the federal government can always make any and all including high-risk teenagers, people getting out of prison, the payments in its own currency, no matter how large disabled and older as well as middle-aged people who have the deficit is, or how few taxes it collects. lost their jobs and exhausted their unemployment benefits. While this program would involve the lowest expenditure of Ask any congressman (as I have many times) or private my three proposals, it is equally important as it helps smooth citizen how it all works, and he or she will tell you emphatically and optimize the transition to private-sector employment as that: "...the government has to either tax or borrow to get the the economy grows. funds to spend, just like any household has to somehow get the money it needs to spend." And from this comes the inevitable So, how am I uniquely qualified to be promoting these question about healthcare, defense, social security, and any proposals? My confidence comes from 40 years' experience and all government spending: in the financial and economic realm. I would venture that I'm perhaps the only person who can answer the question: "How How are you going to pay for it???!!! are you going to pay for it?" My book takes on this issue and encourages the return of economics study to the operational This is the killer question, the one no one gets right, realities of our monetary system. and getting the answer to this question right is the core of the public purpose behind writing this book. In the next few moments of reading, it will all be revealed to you with no theory and no philosophy- just a few hard cold facts. I answer this question by first looking at exactly how government taxes, followed by how government spends. 12 13 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY How does the Federal Government Tax? Can you now see why it makes no sense at all to think that the government has to get money by taxing in order to spend? Let's start by looking at what happens if you pay your In no case does it actually "get" anything that it subsequently taxes by writing a check. When the U.S. government gets your "uses." So if the government doesn't actually get anything check, and it's deposited and "clears," all the government does when it taxes, how and what does it spend? is change the number in your checking account "downward" as they subtract the amount of your check from your bank balance. Does the government actually get anything real to How the Federal Government Spends give to someone else? No, it's not like there's a gold coin to Imagine you are expecting your $2,000 Social Security spend. You can actually see this happen with online banking payment to hit your bank account, which already has $3,000 - watch the balance in your bank account on your computer in it. If you are watching your account on the computer screen. Suppose the balance in your account is $5,000 and you screen, you can see how government spends without having write a check to the government for $2,000. When that checks anything to spend. Presto! Suddenly your account statement clears (gets processed), what happens? The 5 turns into a 3 and that read $3,000 now reads $5,000. What did the government your new balance is now down to $3,000. All before your very do to give you that money? It simply changed the number in eyes! The government didn't actually "get" anything to give to your bank account from 3,000 to 5,000. It didn't take a gold someone else. No gold coin dropped into a bucket at the Fed. coin and hammer it into a computer. All it did was change They just changed numbers in bank accounts - nothing "went" a number in your bank account by making data entries on anywhere. its own spreadsheet, which is linked to other spreadsheets And what happens if you were to go to your local IRS office in the banking system. Government spending is all done by to pay your taxes with actual cash? First, you would hand over data entry on its own spreadsheet called "The U.S. dollar your pile of currency to the person on duty as payment. Next, monetary system." he'd count it, give you a receipt and, hopefully, a thank you for Here is a quote from the good Federal Reserve Bank helping to pay for social security, interest on the national debt, Chairman, Ben Bernanke, on 60 Minutes for support: and the Iraq war. Then, after you, the tax payer, left the room, he'd take that hard-earned cash you just forked over and throw SCOTT PELLEY: Is that tax money that the Fed it in a shredder. Yes, it gets thrown it away. Destroyed! Why? There's no is spending? further use for it. Just like a ticket to the Super Bowl. After you enter the stadium and hand the attendant a ticket that was CHAIRMAN BERNANKE: It's not tax money. worth maybe $1000, he tears it up and discards it. In fact, you The banks have accounts with the Fed, much the can actually buy shredded money in Washington, D.C. same way that you have an account in a commercial So if the government throws away your cash after bank. So, to lend to a bank, we simply use the collecting it, how does that cash pay for anything, like Social computer to mark up the size of the account that Security and the rest of the government's spending? It doesn't. they have with the Fed. 14 15 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY The Chairman of the Federal Reserve Bank is telling us in thing. Nor is it dependent on "getting" dollars from China or plain English that they give out money (spend and lend) simply anywhere else. All it takes for the government to spend is for by changing numbers in bank accounts. There is no such thing it to change the numbers up in bank accounts at its own bank, as having to "get" taxes (or borrow) to make a spreadsheet the Federal Reserve Bank. There is no numerical limit to how entry that we call "government spending." Computer data much money our government can spend, whenever it wants doesn't come from anywhere. Everyone knows that! to spend. (This includes making interest payments, as well as Where else do we see this happen? Your team kicks a field Social Security and Medicare payments.) It encompasses all goal and on the scoreboard, the score changes from, say, 7 government payments made in dollars to anyone. points to 10 points. Does anyone wonder where the stadium > This is not to say that excess government spending got those three points? Of course not! Or you knock down 5 > won't possibly cause prices to go up (which is inflation). pins at the bowling alley and your score goes from 10 to 15. > But it is to say that the government can't go broke and can't be Do you worry about where the bowling alley got those points? > bankrupt. There is simply no such thing.1 Do you think all bowling alleys and football stadiums should So why does no one in government seem to get it? have a 'reserve of points' in a "lock box" to make sure you Why does the Ways and Means Committee in Congress can get the points you have scored? Of course not! And if the worry about "how we are going to pay for it?" It could bowling alley discovers you "foot faulted" and lowers your be that they believe the popular notion that the federal score back down by 5 points, does the bowling alley now have government, just like any household, must somehow first more score to give out? Of course not! "get" money to be able to spend it. Yes, they have heard We all know how data entry works, but somehow this has that it's different for a government, but they don't quite gotten turned upside down and backwards by our politicians, believe it, and there's never a convincing explanation that media, and, most all, the prominent mainstream economists. makes sense to them. > Just keep this in mind as a starting point: The federal > government doesn't ever "have" or "not have" any > dollars. > It's just like the stadium, which doesn't "have" or "not 1 > I know you've got this question on your mind right now. I answer it a bit > have" a hoard of points to give out. When it comes to the later in this book, but let me state the question and give you a quick answer > to tide you over: > dollar, our government, working through its Federal agencies, > the Federal Reserve Bank and the U.S. Treasury Department, > Question: If the government doesn't tax because it needs the money to > is the score keeper. (And it also makes the rules!) > spend, why tax at all? You now have the operational answer to the question: > Answer: The federal government taxes to regulate what economists call "How are we going to pay for it?" And the answer is: the > "aggregate demand" which is a fancy word for "spending power." In short, same way government pays for anything, it changes the > that means that if the economy is "too hot," then raising taxes will cool it > down, and if it's "too cold," likewise, cutting taxes will warm it up. Taxes numbers in our bank accounts. > aren't about getting money to spend, they are about regulating our spending The federal government isn't going to "run out of money," > power to make sure we don't have too much and cause inflation, or too little as our President has mistakenly repeated. There is no such > which causes unemployment and recessions. 16 17 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY What they all seem to miss is the difference between > has a box of points. When it comes to the dollar, our federal spending your own currency that only you create, and spending > government is the scorekeeper. And how many coupons do a currency someone else creates. To properly use this common the parents have in the parent/child coupon story? It doesn't federal government/household analogy in a meaningful way, matter. They could even just write down on a piece of paper we next look at an example of a "currency" created by a how many coupons the children owe them, how many they household. have earned and how many they've paid each month. When The story begins with parents creating coupons they then the federal government spends, the funds don't "come from" use to pay their children for doing various household chores. anywhere any more than the points "come from" somewhere at Additionally, to "drive the model," the parents require the the football stadium or the bowling alley. Nor does collecting children to pay them a tax of 10 coupons a week to avoid taxes (or borrowing) somehow increase the government's punishment. This closely replicates taxation in the real "hoard of funds" available for spending. economy, where we have to pay our taxes or face penalties. In fact, the people at the U.S. Treasury who actually spend The coupons are now the new household currency. Think of the money (by changing numbers on bank accounts up) don't the parents as "spending" these coupons to purchase "services" even have the telephone numbers of - nor are they in contact (chores) from their children. With this new household currency, with - the people at the IRS who collect taxes (they change the parents, like the federal government, are now the issuer of the numbers on bank accounts down), or the other people at their own currency. And now you can see how a household the U.S. Treasury who do the "borrowing" (issue the Treasury with its own currency is indeed very much like a government securities). If it mattered at all how much was taxed or with its own currency. borrowed to be able to spend, you'd think they at least would Let's begin by asking some questions about how this new know each other's phone numbers! Clearly, it doesn't matter household currency works. Do the parents have to somehow for their purposes. get coupons from their children before they can pay their From our point of view (not the federal government's), we coupons to their children to do chores? Of course not! In need to first have U.S. dollars to be able to make payments. fact, the parents must first spend their coupons by paying Just like the children need to earn the coupons from their their children to do household chores, to be able to collect the parents before they can make their weekly coupon payments. payment of 10 coupons a week from their children. How else And state governments, cities, and businesses are all in that can the children get the coupons they owe to their parents? same boat as well. They all need to be able to somehow get Likewise, in the real economy, the federal government, just dollars before they can spend them. That could mean earning like this household with its own coupons, doesn't have to get them, borrowing them, or selling something to get the dollars the dollars it spends from taxing or borrowing, or anywhere > they need to be able to spend. In fact, as a point of logic, the else, to be able to spend them. With modern technology, the > dollars we need to pay taxes must, directly or indirectly, from federal government doesn't even have to print the dollars it > the inception of the currency, come from government spending spends the way the parents print their own coupons. > (or government lending, which I'll discuss later). Remember, the federal government itself neither has nor Now let's build a national currency from scratch. Imagine doesn't have dollars, any more than the bowling alley ever a new country with a newly announced currency. No one has 18 19 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY any. Then the government proclaims, for example, that there So while our politicians truly believe the government > will be a property tax. Well, how can it be paid? It can't, needs to take our dollars, either by taxing or borrowing, for > until after the government starts spending. Only after the them to be able to spend, the truth is: > government spends its new currency does the population have > the funds to pay the tax. We need the federal government's spending to get the > To repeat: the funds to pay taxes, from inception, come funds we need to pay our taxes. > from government spending (or lending). Where else can they We don't get to change numbers, like the federal > come from?2 government does (or the bowling alley and the football Yes, that means that the government has to spend first, stadium).4 And just like the children who have to earn or to ultimately provide us with the funds we need to pay our somehow get their coupons to make their coupon payments, taxes. The government, in this case, is just like the parents we have to earn or somehow get US dollars to make our tax who have to spend their coupons first, before they can start payments. And, as you now understand, this is just like it actually collecting them from their children. And, neither the happens in any household that issues its own coupons. The government, nor the parents, from inception, can collect more coupons the kids need to make their payments to their parents of their own currency than they spend. Where else could it have to come from their parents. possibly come from?3 And, as previously stated, government spending is in no case operationally constrained by revenues (tax payments and > borrowings). Yes, there can be and there are "self-imposed" > constraints on spending put there by Congress, but that's 2 For those of you who understand reserve accounting, note that the Fed > an entirely different matter. These include debt-ceiling can't do what's called a reserve drain without doing a reserve add. So what > rules, Treasury-overdraft rules, and restrictions of the Fed does the Fed do on settlement day when Treasury balances increase? It does repos - to add the funds to the banking system that banks then have to buy > buying securities from the Treasury. They are all imposed the Treasury Securities. Otherwise, the funds wouldn't be there to buy the > by a Congress that does not have a working knowledge Treasury securities, and the banks would have overdrafts in their reserve > of the monetary system. And, with our current monetary accounts. And what are overdrafts at the Fed? Functionally, an overdraft is a loan from the government. Ergo, one way or another, the funds used to buy > arrangements, all of those self imposed constraints are the Treasury securities come from the government itself. Because the funds to > counterproductive with regard to furthering public purpose. pay taxes or buy government securities come from government spending, the government is best thought of as spending first, and then collecting taxes or borrowing later. 3 Note on how this works inside the banking system: When you pay taxes by 4 writing a check to the federal government, they debit your bank's reserve Just a quick reminder that our state and local governments are users of the account at the Federal Reserve Bank reserves can only come from the Fed; the U.S. dollar, and not issuers, like the federal government is. In fact, the U.S. private sector can't generate them. If your bank doesn't have any, the check states are in a similar position as the rest of us: we both need to get funds into you write results in an overdraft in that bank's reserve account. An overdraft is our bank accounts before we write our checks, or those checks will indeed a loan from the Fed. So in any case, the funds to make payments to the federal bounce. In the parent/children analogy, we and the states are in much the same government can only come from the federal government. position as the children, who need to get first before they can give. 20 21 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY All they do is put blockages in the monetary plumbing Federal Government checks don't bounce. that wouldn't otherwise be there, and from time to time, create problems that wouldn't otherwise arise. In fact, it A few years ago I gave a talk titled, "Government Checks was some of these self-imposed blockages that caused the Don't Bounce" in Australia at an economics conference. In latest financial crisis to spill over to the real economy and the audience was the head of research for the Reserve Bank contribute to the recession. of Australia, Mr. David Gruen. It was high drama. I had been > The fact that government spending is in no case giving talks for several years to this group of academics, and > operationally constrained by revenues means there is no I had not convinced most of them that government solvency > "solvency risk." In other words, the federal government wasn't an issue. They always started with the familiar, "What > can always make any and all payments in its own Americans don't understand is that it's different for a small, > currency, no matter how large the deficit is, or how few open economy like Australia than it is for the United States." > taxes it collects. There seemed to be no way to get it through their (perhaps) over-educated skulls that at least for this purpose, none of that This, however, does NOT mean that the government matters. A spreadsheet is a spreadsheet. All but one Professor can spend all it wants without consequence. Over-spending Bill Mitchell and a few of his colleagues seemed to have this can drive up prices and fuel inflation. mental block, and they deeply feared what would happen if the markets turned against Australia to somehow keep them from > What it does mean is that there is no solvency risk, which being able to "finance the deficit." > is to say that the federal government can't go broke, and there So I began my talk about how U.S. government checks > is no such thing as our government "running out of money to don't bounce, and after a few minutes, David's hand shot up > spend," as President Obama has incorrectly stated repeatedly.5 with the statement familiar to all modestly-advanced economic > Nor, as President Obama also stated, is U.S. government > students: "If the interest rate on the debt is higher than the rate > spending limited by what it can borrow. > of growth of GDP, then the government's debt is unsustainable." > So the next time you hear: "Where will the money for > This wasn't even presented as a question, but stated as a fact. > Social Security come from?" go ahead and tell them, "It's > I then replied, "I'm an operations type of guy, David, so > just data entry. It comes from the same place as your score > tell me, what do you mean by the word 'unsustainable'? Do > at the bowling alley." > you mean that if the interest rate is very high, and that in 20 > Putting it yet another way, U.S. government checks > years from now the government debt has grown to a large- > don't bounce, unless the government decides to bounce its > enough number, the government won't be able to make its > own checks. > interest payments? And if it then writes a check to a pensioner, > that that check will bounce?" > David got very quiet, deep in thought, thinking it through. > "You know, when I came here, I didn't think I'd have to think > through how the Reserve Bank's check-clearing works," he stated, 5 Quotes from President Barack Obama in an attempt at humor. But no one in the room laughed or made 22 23 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY a sound. They were totally focused on what his answer might be. Why the Federal Government Taxes It was a "showdown" on this issue. David finally said, "No, we'll clear the check, but it will cause inflation and the currency will go So why then does the federal government tax us, if it down. That's what people mean by unsustainable." doesn't actually get anything to spend or need to get anything There was dead silence in the room. The long debate was to spend? (Hint: it's the same reason that the parents demand over. Solvency is not an issue, even for a small, open economy. 10 coupons a week from their children, when the parents don't Bill and I instantly commanded an elevated level of respect, actually need the coupons for anything.) which took the usual outward form of "well of course, we There is a very good reason it taxes us. Taxes create an always said that" from the former doubters and skeptics. ongoing need in the economy to get dollars, and therefore an > I continued with David, "Well, I think most pensioners ongoing need for people to sell their goods and services and > are concerned about whether the funds will be there when > labor to get dollars. With tax liabilities in place, the government > they retire, and whether the Australian government will be > can buy things with its otherwise-worthless dollars, because > able to pay them." To which David replied, "No, I think they > someone needs the dollars to pay taxes. Just like the coupon > are worried about inflation and the level of the Australian tax on the children creates an ongoing need for the coupons, > dollar." Then Professor Martin Watts, head of the Economics which can be earned by doing chores for the parents. Think of > Department at the University of Newcastle inserted, "The Hell a property tax. (You're not ready to think about income taxes > they are, David!" At that, David very thoughtfully conceded, - it comes down to the same thing, but it's a lot more indirect > "Yes, I suppose you're right." and complicated). You have to pay the property tax in dollars So, what was actually confirmed to the Sydney academics or lose your house. It's just like the kids' situation, as they need in attendance that day? Governments, using their own to get 10 coupons or face the consequences. So now you are currency, can spend what they want, when they want, just motivated to sell things - goods, services, your own labor - to get like the football stadium can put points on the board at the dollars you need. It's just like the kids, who are motivated to will. The consequences of overspending might be inflation do chores to get the coupons they need. or a falling currency, but never bounced checks. Finally, I have to connect the dots from some people > The fact is: government deficits can never cause a needing dollars to pay their taxes to everyone wanting and > government to miss any size of payment. There is no solvency using dollars for almost all of their buying and selling. To do > issue. There is no such thing as running out of money when that, let's go back to the example of a new country with a new > spending is just changing numbers upwards in bank accounts currency, which I'll call "the crown," where the government > at its own Federal Reserve Bank. levies a property tax. Let's assume the government levies this Yes, households, businesses, and even the states need to have tax for the further purpose of raising an army, and offers jobs dollars in their bank accounts when they write checks, or else to soldiers who are paid in "crowns." Suddenly, a lot of people those checks will bounce. That's because the dollars they spend who own property now need to get crowns, and many of them are created by someone else - the federal government - and won't want to get crowns directly from the government by households, businesses, and the states are not the scorekeeper serving as soldiers. So they start offering their goods and for the dollar. services for sale in exchange for the new crowns they need and 24 25 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY > want, hoping to get these crowns without having to join the learned economist today would say that "taxes function to reduce > army. Other people now see many things for sale they would aggregate demand." Their term, "aggregate demand," is just a fancy > like to have - chickens, corn, clothing and all kinds of services term for "spending power." > like haircuts, medical services and many other services. The > The government taxes us and takes away our money for > sellers of these goods and services want to receive crowns to > one reason - so we have that much less to spend which makes > avoid having to join the army to get the money they need to > the currency that much more scarce and valuable. Taking > pay their taxes. The fact that all these things are being offered > away our money can also be thought of as leaving room for > for sale in exchange for crowns makes some other people join > the government to spend without causing inflation. Think of > the army to get the money needed to buy some of those goods > the economy as one big department store full of all the goods > and services. > and services we all produce and offer for sale every year. We > In fact, prices will adjust until as many soldiers as the > all get paid enough in wages and profits to buy everything in > government wants are enticed to join the army. Because until > that store, assuming we would spend all the money we earn > that happens, there won't be enough crowns spent by the > and all the profits we make. (And if we borrow to spend, > government to allow the taxpayers to pay all of their taxes, and > we can buy even more than there is in that store.) But when > those needing the crowns, who don't want to go into the army, > some of our money goes to pay taxes, we are left short of the > will cut the prices of their goods and services as much as they > spending power we need to buy all of what's for sale in the > have to in order to get them sold, or else throw in the towel and > store. This gives government the "room" to buy what it wants > join the army themselves. > so that when it spends what it wants, the combined spending > The following is not merely a theoretical concept. It's exactly of government and the rest of us isn't too much for what's for > what happened in Africa in the 1800's, when the British established sale in the store. > colonies there to grow crops. The British offered jobs to the local However, when the government taxes too much - relative > population, but none of them were interested in earning British to its spending - total spending isn't enough to make sure > coins. So the British placed a "hut tax" on all of their dwellings, everything in the store gets sold. When businesses can't sell > payable only in British coins. Suddenly, the area was "monetized," all that they produce, people lose their jobs and have even less > as everyone now needed British coins, and the local population money to spend, so even less gets sold. Then more people lose > started offering things for sale, as well as their labor, to get the their jobs, and the economy goes into a downward spiral we > needed coins. The British could then hire them and pay them in call a recession. > British coins to work the fields and grow their crops. Keep in mind that the public purpose behind government This is exactly what the parents did to get labor hours from their doing all this is to provide a public infrastructure. This includes > children to get the chores done. And that's exactly how what are the military, the legal system, the legislature and the executive > called "non convertible currencies" work (no more gold standards branch of government, etc. So there is quite a bit that even the > and very few fixed exchange rates are left), like the U.S. dollar, most conservative voters would have the government do. > Japanese yen, and British pound. > So I look at it this way: for the "right" amount of Now we're ready to look at the role of taxes from a different > government spending, which we presume is necessary to angle, that of today's economy, using the language of economics. A > run the nation the way we would like to see it run, how high 26 27 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY > should taxes be? The reason I look at it this way is because > That means we should NOT grow the size of government > the "right amount of government spending" is an economic > to help the economy out of a slowdown. We should already > and political decision that, properly understood, has nothing > be at the right size for government, and therefore not add to > to do with government finances. The real "costs" of running > it every time the economy slows down. So while increasing > the government are the real goods and services it consumes > government spending during a slowdown will indeed make > - all the labor hours, fuel, electricity, steel, carbon fiber, hard > the numbers work, and will end the recession, for me that is > drives, etc. that would otherwise be available for the private > far less desirable than accomplishing the same thing with the > sector. So when the government takes those real resources for > right tax cuts in sufficient-enough size to restore private-sector > its own purposes, there are that many fewer real resources left > spending to the desired amounts. > for private-sector activity. For example, the real cost of the Even worse is increasing the size of government just > "right-size" army with enough soldiers for defense is that there because the government might find itself with a surplus. > are fewer workers left in the private sector to grow the food, Again, government finances tell us nothing about how large > build the cars, do the doctoring and nursing and administrative the government should be. That decision is totally independent > tasks, sell us stocks and real estate, paint our houses, mow our of government finances. The right amount of government > lawns, etc. etc. etc. spending has nothing to do with tax revenues or the ability to Therefore, the way I see it, we first set the size of government borrow, as both of those are only tools for implementing policy at the "right" level of public infrastructure, based on real benefits on behalf of public purpose, and not reasons for spending or and real costs, and not the "financial" considerations. The monetary not spending, and not sources of revenue needed for actual system is then the tool we use to achieve our real economic and government spending. political objectives, and not the source of information as to what I'll get specific on what role I see for government later > those objectives are. Then, after deciding what we need to spend in this book, but rest assured, my vision is for a far more > to have the right-sized government, we adjust taxes so that we all streamlined and efficient government, one that is intensely > have enough spending power to buy what's still for sale in the focused on the basics of fundamental public purpose. > "store" after the government is done with its shopping. In general, Fortunately, there are readily available and infinitely > I'd expect taxes to be quite a bit lower than government spending, sensible ways to do this. We can put the right incentives in > for reasons already explained and also expanded on later in this place which channel market forces with guidance to better > book. In fact, a budget deficit of perhaps 5% of our gross domestic promote the public purpose with far less regulation. This > product might turn out to be the norm, which in today's economy will result in a government and culture that will continue is about $750 billion annually. However, that number by itself to be the envy of the world. It will be a government that is of no particular economic consequence, and could be a lot expresses our American values of rewarding hard work and > higher or a lot lower, depending on the circumstances. What innovation, and promoting equal opportunity, equitable > matters is that the purpose of taxes is to balance the economy outcomes and enforceable laws and regulations we can > and make sure it's not too hot nor too cold. And federal respect with true pride. > government spending is set at this right amount, given the size But I digress. Returning to the issue of how high taxes need > and scope of government we want. to be, recall that if the government simply tried to buy what 28 29 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY > it wanted to buy and didn't take away any of our spending > power, there would be no taxes - it would be "too much money > chasing too few goods," with the result being inflation. In Deadly Innocent Fraud #2: > fact, with no taxes, nothing would even be offered for sale With government deficits, we are leaving our debt > in exchange for the government money in the first place, as burden to our children. > previously discussed. To prevent the government's spending from causing that > Fact: kind of inflation, the government must take away some of our > Collectively, in real terms, there is no such spending power by taxing us, not to actually pay for anything, > burden possible. Debt or no debt, our children get to but so that their spending won't cause inflation. An economist > consume whatever they can produce. would say it this way: taxes function to regulate aggregate > demand, not to raise revenue per se. In other words, the This deadly innocent fraud is often the first answer most > government taxes us, and takes away our money, to prevent people give to what they perceive to be the main problem > inflation, not to actually get our money in order to spend it. associated with government deficit spending. Borrowing now > Restated one more time: Taxes function to regulate the means paying for today's spending later. Or, as commonly > economy, and not to get money for Congress to spend. seen and heard in the media: > And, again, the government neither has nor doesn't have > dollars; it simply changes numbers in our bank accounts "Higher deficits today mean higher taxes tomorrow." > upward when it spends and downwards when it taxes. All of this is, presumably, for the public purpose of regulating the And paying later means that somehow our children's real economy. standard of living and general well-being will be lowered in But as long as government continues to believe this first of the future because of our deficit spending now. the seven deadly innocent frauds, that they need to get money Professional economists call this the "intergenerational" from taxing or borrowing in order to spend, they will continue debt issue. It is thought that if the federal government deficit to support policies that constrain output and employment and spends, it is somehow leaving the real burden of today's prevent us from achieving what are otherwise readily-available expenditures to be paid for by future generations. economic outcomes. And the numbers are staggering! But, fortunately, like all of the seven deadly innocent frauds, it is all readily dismissed in a way that can be easily understood. In fact, the idea of our children being somehow necessarily deprived of real goods and services in the future because of what's called the national debt is nothing less than ridiculous. Here's a story that illustrates the point. Several years ago, I ran into former Senator and Governor of Connecticut, Lowell Weicker, 30 31 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY and his wife Claudia on a boat dock in St. Croix. I asked Governor > When government spends without taxing, all it does Weicker what was wrong with the country's fiscal policy. He > is change the numbers up in the appropriate checking replied we have to stop running up these deficits and leaving the > account (reserve account) at the Fed. This means that when burden of paying for today's spending to our children. > the government makes a $2,000 Social Security payment So I then asked him the following questions to hopefully > to you, for example, it changes the number up in your illustrate the hidden flaw in his logic: "When our children > bank's checking account at the Fed by $2,000, which also build 15 million cars per year 20 years from now, will they > automatically changes the number up in your account at your have to send them back in time to 2008 to pay off their debt? > bank by $2,000. Are we still sending real goods and services back in time to > Next, you need to know what a U.S. Treasury security 1945 to pay off the lingering debt from World War II?" > actually is. A U.S. Treasury security is nothing more than a And today, as I run for the U.S. Senate in Connecticut, > savings account at the Fed. When you buy a Treasury security, nothing has changed. The ongoing theme of the other > you send your dollars to the Fed and then some time in the candidates is that we are borrowing from the likes of China > future, they send the dollars back plus interest. The same holds to pay for today's spending and leaving our children and > true for any savings account at any bank. You send the bank grandchildren to pay the bill. > dollars and you get them back plus interest. Let's say that your Of course, we all know we don't send real goods and > bank decides to buy $2,000 worth of Treasury securities. To services back in time to pay off federal government deficits, > pay for those Treasury securities, the Fed reduces the number and that our children won't have to do that either. > of dollars that your bank has in its checking account at the Nor is there any reason government spending from > Fed by $2,000 and adds $2,000 to your bank's savings account previous years should prevent our children from going to work > at the Fed. (I'm calling the Treasury securities "savings and producing all the goods and services they are capable of > accounts," which is all they are.) producing. And in our children's future, just like today, whoever > In other words, when the U.S. government does what's is alive will be able to go to work and produce and consume their > called "borrowing money," all it does is move funds from real output of goods and services, no matter how many U.S. > checking accounts at the Fed to savings accounts (Treasury Treasury securities are outstanding. There is no such thing as > securities) at the Fed. In fact, the entire $13 trillion national giving up current-year output to the past, and sending it back in > debt is nothing more than the economy's total holdings of time to previous generations. Our children won't and can't pay us > savings accounts at the Fed. back for anything we leave them, even if they wanted to. > And what happens when the Treasury securities come due, Nor is the financing of deficit spending anything of any > and that "debt" has to be paid back? Yes, you guessed it, the consequence. When government spends, it just changes > Fed merely shifts the dollar balances from the savings accounts numbers up in our bank accounts. More specifically, all the > (Treasury securities) at the Fed to the appropriate checking commercial banks we use for our banking have bank accounts > accounts at the Fed (reserve accounts). Nor is this anything new. at the Fed called reserve accounts. Foreign governments have > It's been done exactly like this for a very long time, and no reserve accounts at the Fed as well. These reserve accounts at > one seems to understand how simple it is and that it never the Fed are just like checking accounts at any other bank. > will be a problem. 32 33 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Federal Government Taxing and Spending Does we allow them to buy. And look at what happened recently Influence Distribution - the Federal Reserve cut rates, which reduced the interest Japan earns on its U.S.-Treasury securities. (This discussion Distribution is about who gets all the goods and services continues in a subsequent innocent fraud.) that are produced. In fact, this is what politicians do every time This is all perfectly legal and business as usual, as each they pass legislation. They re-direct real goods and services year's output is "divided up" among the living. None of the by decree, for better or worse. And the odds of doing it for real output gets "thrown away" because of outstanding debt, no better are substantially decreased when they don't understand matter how large. Nor does outstanding debt reduce output and the Seven Deadly Innocent Frauds. Each year, for example, employment, except of course when ill-informed policymakers Congress discusses tax policy, always with an eye to the decide to take anti-deficit measures that do reduce output and distribution of income and spending. Many seek to tax those employment. Unfortunately, that is currently the case, and that "who can most afford it" and direct federal spending to "those is why this is a deadly innocent fraud. in need." And they also decide how to tax interest, capital > Today (April 15, 2010), it's clear that Congress is taking gains, estates, etc. as well as how to tax income. All of these > more spending power away from us in taxes than is needed to are distributional issues. > make room for their own spending. Even after we spend what In addition, Congress decides who the government hires > we want and the government does all of its massive spending, and fires, who it buys things from, and who gets direct > there's still a lot left unsold in that big department store called payments. Congress also makes laws that directly affect many > the economy. other aspects of prices and incomes. > How do we know that? Easy! Count the bodies in the Foreigners who hold U.S. dollars are particularly at risk. > unemployment lines. Look at the massive amount of excess They earn those dollars from selling us real goods and services, > capacity in the economy. Look at what the Fed calls the yet they have no assurance that they will be able to buy real > "output gap," which is the difference between what we could goods and services from us in the future. Prices could go up > produce at full employment and what we are now producing. (inflation) and the U.S. government could legally impose all > It's enormous. kinds of taxes on anything foreigners wish to buy from us, Sure, there's a record deficit and national debt, which, which reduces their spending power. you now know, means that we all have that much in savings Think of all those cars Japan sold to us for under > accounts at the Fed called Treasury securities. Incidentally, $2,000 years ago. They've been holding those dollars in > the cumulative U.S. budget deficit, adjusted for the size of the their savings accounts at the Fed (they own U.S. Treasury > economy, is still far below Japan's, far below most of Europe securities), and if they now would want to spend those > and very far below the World War II U.S. deficits that got us dollars, they would probably have to pay in excess of out of the Depression (with no debt burden consequences). $20,000 per car to buy cars from us. What can they do about If you've gotten this far into this book you may already the higher prices? Call the manager and complain? They've know why the size of the deficit isn't a financial issue. So traded millions of perfectly good cars to us in exchange for hopefully, you know that taxes function to regulate the credit balances on the Fed's books that can buy only what economy, and not to raise revenue, as Congress thinks. When I 34 35 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY look at today's economy, it's screaming at me that the problem So let's start by looking at how we got to where we are is that people don't have enough money to spend. It's not today with China. It all started when China wanted to sell telling me they have too much spending power and are over- things to us and we wanted to buy them. For example, let's spending. Who would not agree? suppose that the U.S. Army wanted to buy $1 billion worth of > Unemployment has doubled and GDP is more than 10% uniforms from China, and China wanted to sell $1 billion worth > below where it would be if Congress wasn't over-taxing us and of uniforms to the U.S. Army at that price. So the Army buys > taking so much spending power away from us. $1 billion worth of uniforms from China. First, understand that > When we operate at less than our potential - at less both parties are happy. There is no "imbalance." China would > than full employment - then we are depriving our children rather have the 1 billion U.S. dollars than the uniforms or they > of the real goods and services we could be producing on wouldn't have sold them, and the U.S. Army would rather have > their behalf. Likewise, when we cut back on our support the uniforms than the money or it wouldn't have bought them. > of higher education, we are depriving our children of the The transactions are all voluntary, and all in U.S. dollars. But > knowledge they'll need to be the very best they can be in back to our point - how does China get paid? > their future. So also, when we cut back on basic research > China has a reserve account at the Federal Reserve Bank. > and space exploration, we are depriving our children of all > To quickly review, a reserve account is nothing more than a > the fruits of that labor that instead we are transferring to the > fancy name for a checking account. It's the Federal Reserve > unemployment lines. > Bank so they call it a reserve account instead of a checking So yes, those alive get to consume this year's output, and > account. To pay China, the Fed adds 1 billion U.S. dollars to also get to decide to use some of the output as "investment > China's checking account at the Fed. It does this by changing goods and services," which should increase future output. > the numbers in China's checking account up by 1 billion U.S. And yes, Congress has a big say in who consumes this year's > dollars. The numbers don't come from anywhere any more output. Potential distributional issues due to previous federal > than the numbers on a scoreboard at a football come from deficits can be readily addressed by Congress and distribution > anywhere. China then has some choices. It can do nothing and can be legally altered to their satisfaction. > keep the $1 billion in its checking account at the Fed, or it can > buy U.S. Treasury securities. So How Do We Pay Off China? Again, to quickly review, a U.S. Treasury security is nothing more than a fancy name for a savings account at the Those worried about paying off the national debt can't Fed. The buyer gives the Fed money, and gets it back later with possibly understand how it all works at the operational, interest. That's what a savings account is - you give a bank nuts and bolts (debits and credits) level. Otherwise they money and you get it back later with interest. would realize that question is entirely inapplicable. What So let's say China buys a one-year Treasury security. All they don't understand is that both dollars and U.S. Treasury that happens is that the Fed subtracts $1 billion from China's debt (securities) are nothing more than "accounts," which checking account at the Fed, and adds $1 billion to China's are nothing more than numbers that the government makes savings account at the Fed. And all that happens a year later on its own books. when China's one-year Treasury bill comes due is that the Fed 36 37 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY removes this money from China's savings account at the Fed China now has its money back. It has a (very large) U.S.- (including interest) and adds it to China's checking account at dollar balance in its checking account at the Fed. If it wants the Fed. anything else - cars, boats, real estate, other currencies - it has Right now, China is holding some $2 trillion of U.S. to buy them at market prices from a willing seller who wants Treasury securities. So what do we do when they mature and dollar deposits in return. And if China does buy something, the it's time to pay China back? We remove those dollars from Fed will subtract that amount from China's checking account their savings account at the Fed and add them to their checking and add that amount to the checking account of whomever account at the Fed, and wait for them to say what, if anything, China bought it all from. they might want to do next. Notice too, that "paying off China" doesn't change China's This is what happens when all U.S. government debt stated $U.S. wealth. They simply have dollars in a checking comes due, which happens continuously. The Fed removes account rather than U.S. Treasury securities (a savings dollars from savings accounts and adds dollars to checking account) of equal dollars. And if they want more Treasury accounts on its books. When people buy Treasury securities, securities instead, no problem, the Fed just moves their U.S. the Fed removes dollars from their checking accounts and dollars from their checking account to their savings account adds them to their savings accounts. So what's all the fuss? again, by appropriately changing the numbers. It's all a tragic misunderstanding. Paying off the entire U.S. national debt is but a matter China knows we don't need them for "financing our of subtracting the value of the maturing securities from deficits" and is playing us for fools. Today, that includes one account at the Fed, and adding that value to another Geithner, Clinton, Obama, Summers and the rest of the account at the Fed. These transfers are non-events for the administration. It also includes Congress and the media. real economy and not the source of dire stress presumed > Now let me describe this all in a more technical manner for by mainstream economists, politicians, businesspeople, > those of you who may be interested. When a Treasury bill, note and the media. > or bond is purchased by a bank, for example, the government One more time: to pay off the national debt the government > makes two entries on its spreadsheet that we call the "monetary changes two entries in its own spreadsheet - a number that > system." First, it debits (subtracts from) the buyer's reserve says how many securities are owned by the private sector is > account (checking account) at the Fed. Then it increases changed down and another number that says how many U.S. > (credits) the buyer's securities account (savings account) at the dollars are being kept at the Fed in reserve accounts is changed > Fed. As before, the government simply changes numbers on its up. Nothing more. Debt paid. All creditors have their money > own spreadsheet - one number gets changed down and another back. What's the big deal? > gets changed up. And when the dreaded day arrives, and the > So what happens if China refuses to buy our debt at current > Treasury securities which China holds come due and need to be > low-interest rates paid to them? Interest rates have to go up > repaid, the Fed again simply changes two numbers on its own > to attract their purchase of the Treasury Securities, right? > spreadsheet. The Fed debits (subtracts from) China's securities > Wrong! > account at the Fed. And then it credits (adds to) China's reserve They can leave it in their checking account. It's of no > (checking) account at the Fed. That's all - debt paid! consequence to a government that understands its own 38 39 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY monetary system. The funds are not used for spending, as previously described. There are no negative consequences of funds being in a checking account at the Fed rather than a Deadly Innocent Fraud #3: savings account at the Fed. Federal Government budget deficits take away What happens if China says, "We don't want to keep a savings. checking account at the Fed anymore. Pay us in gold or some other means of exchange!" They simply do not have this Fact: option under our current "fiat currency" system6 as they would Federal Government budget deficits ADD to have known when they sold the uniforms to the U.S. Army savings. and had the money put into their checking account at the Fed. If they want something other than dollars, they have to buy it Lawrence Summers from a willing seller, just like the rest of us do when we spend our dollars. Several years ago I had a meeting with Senator Tom Some day it will be our children changing numbers on what Daschle and then-Assistant Treasury Secretary Lawrence will be their spreadsheet, just as seamlessly as we did, and our Summers. I had been discussing these innocent frauds with parents did, though hopefully with a better understanding! But the Senator, and explaining how they were working against for now, the deadly innocent fraud of leaving the national debt the well-being of those who voted for him. So he set up this to our children continues to drive policy, and keeps us from meeting with the Assistant Treasury Secretary, who is also a optimizing output and employment. former Harvard economics professor and has two uncles who > The lost output and depreciated human capital is have won Nobel prizes in economics, to get his response and > the real price we and our children are paying now that hopefully confirm what I was saying. > diminishes both the present and the future. We make do > I opened with a question: "Larry, what's wrong with the > with less than what we can produce and sustain high levels > budget deficit?" He replied: "It takes away savings that could > of unemployment (along with all the associated crime, > be used for investment." I then objected: "No it doesn't, all > family problems and medical issues) while our children are > Treasury securities do is offset operating factors at the Fed. It > deprived of the real investments that would have been made > has nothing to do with savings and investment." To which he > on their behalf if we knew how to keep our human resources > retorted: "Well, I really don't understand reserve accounting, > fully employed and productive. > so I can't discuss it at that level." Senator Daschle was looking on at all this in disbelief. This Harvard professor of economics, Assistant Treasury Secretary Lawrence Summers didn't understand reserve accounting? Sad but true. So I spent the next twenty minutes explaining the 6 In 1971, the US went off the gold standard for international accounts, "paradox of thrift" (more detail on this innocent fraud #6 formally ending all government-guaranteed convertibility of the U.S. dollar. later) step by step, which he sort of got right when he finally 40 41 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY responded: "...so we need more investment which will debit (subtract from) the account called "government" when show up as savings?" I responded with a friendly "yes," government spends, they also credit (add to) the accounts after giving this first year economics lesson to the good of whoever gets those funds. When the government account Harvard professor, and ended the meeting. The next day, I goes down, some other account goes up, by exactly the same saw him on a podium with the Concord Coalition - a band amount. of deficit terrorists - talking about the grave dangers of the Next is an example of how, operationally, government budget deficit. deficits add to savings. This also puts to rest a ridiculous new > This third deadly innocent fraud is alive and well at the very take on this innocent fraud that's popped up recently: > highest levels. So here's how it really works, and it could not "Deficit spending means the government borrows from > be simpler: Any $U.S. government deficit exactly EQUALS one person and gives it to another, so nothing new is added - > the total net increase in the holdings ($U.S. financial assets) of it's just a shift of money from one person to another." In other > the rest of us - businesses and households, residents and non words, they are saying that deficits don't add to our savings, > residents - what is called the "non government" sector. but just shift savings around. This could not be more wrong! > In other words, government deficits equal increased "monetary So let's demonstrate how deficits do ADD to savings, and not > savings" for the rest of us, to the penny. just shift savings: > Simply put, government deficits ADD to our savings (to the > penny). This is an accounting fact, not theory or philosophy. 1. Start with the government selling $100 billion > There is no dispute. It is basic national income accounting. For in Treasury securities. (Note: this sale is voluntary, > example, if the government deficit last year was $1 trillion, it which means that the buyer buys the securities > means that the net increase in savings of financial assets for because he wants to. Presumably, he believes that > everyone else combined was exactly, to the penny, $1 trillion. (For he is better off buying them than not buying them. those who took some economics courses, you might remember No one is ever forced to buy government securities. that net savings of financial assets is held as some combination They get sold at auction to the highest bidder who is of actual cash, Treasury securities and member bank deposits at willing to accept the lowest yield.) the Federal Reserve.) This is Economics 101 and first year money banking. It is beyond dispute. It's an accounting identity. Yet it's 2. When the buyers of these securities pay for them, misrepresented continuously, and at the highest levels of political checking accounts at the Fed are reduced by $100 authority. They are just plain wrong. billion to make the payment. In other words, money Just ask anyone at the CBO (Congressional Budget in checking accounts at the Fed is exchanged for the Office), as I have, and they will tell you they must "balance new Treasury securities, which are savings accounts the checkbook" and make sure the government deficit equals at the Fed. At this point, non-government savings is our new savings, or they would have to stay late and find their unchanged. The buyers now have their new Treasury accounting mistake. securities as savings, rather than the money that was As before, it's just a bunch of spreadsheet entries on in their checking accounts before they bought the the government's own spreadsheet. When the accountants Treasury securities. 42 43 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY 3. Now the Treasury spends $100 billion after the sale saving enough and we would have to work harder to save of the $100 billion of new Treasury securities, on the more. Then a few pages later, there was a graph with one line usual things government spends its money on. showing the surplus going up, and another line showing savings going down. They were nearly identical, but going in opposite 4. This Treasury spending adds back $100 billion to directions, and clearly showing the gains in the government someone's checking accounts. surplus roughly equaled the losses in private savings. There can't be a budget surplus with private savings 5. The non-government sector now has its $100 increasing (including non-resident savings of $U.S. financial billion of checking accounts back AND it has the assets). There is no such thing, yet not a single mainstream $100 billion of new Treasury securities. economist or government official had it right. Bottom line: the deficit spending of $100 billion directly Al Gore added $100 billion of savings in the form of new Treasury securities to non-government savings (non-government means Early in 2000, in a private home in Boca Raton, FL, I everyone but the government). was seated next to then-Presidential Candidate Al Gore at a The savings of the buyer of the $100 billion of new fundraiser/dinner to discuss the economy. The first thing he Treasury securities shifted from money in his checking asked was how I thought the next president should spend the account to his holdings of the Treasury securities (savings coming $5.6 trillion surplus that was forecasted for the next 10 accounts). Then when the Treasury spent $100 billion years. I explained that there wasn't going to be a $5.6 trillion after selling the Treasury securities, the savings of recipients surplus, because that would mean a $5.6 trillion drop in non- of that $100 billion of spending saw their checking accounts government savings of financial assets, which was a ridiculous increase by that amount. proposition. At the time, the private sector didn't even have So, to the original point, deficit spending doesn't just that much in savings to be taxed away by the government, and shift financial assets (U.S. dollars and Treasury securities) the latest surplus of several hundred billion dollars had already outside of the government. Instead, deficit spending directly removed more than enough private savings to turn the Clinton adds exactly that amount of savings of financial assets to the boom into the soon-to-come bust. non-government sector. And likewise, a federal budget surplus I pointed out to Candidate Gore that the last six periods of directly subtracts exactly that much from our savings. And surplus in our more than two hundred-year history had been the media and politicians and even top economists all have it followed by the only six depressions in our history. Also, I BACKWARDS! mentioned that the coming bust would be due to allowing the In July 1999, the front page of the Wall Street Journal budget to go into surplus and drain our savings, resulting in a had two headlines. Towards the left was a headline praising recession that would not end until the deficit got high enough President Clinton and the record government budget surplus, to add back our lost income and savings and deliver the and explaining how well fiscal policy was working. On the aggregate demand needed to restore output and employment. right margin was a headline stating that Americans weren't I suggested that the $5.6 trillion surplus which was forecasted 44 45 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY for the next decade would more likely be a $5.6 trillion deficit, Treasury securities in the market, and that adds to savings and as normal savings desires are likely to average 5% of GDP investment." To that I responded, "No, when we run a surplus, over that period of time. we have to sell our securities to the Fed (cash in our savings That is pretty much what happened. The economy fell accounts at the Fed) to get the money to pay our taxes, and our apart, and President Bush temporarily reversed it with his net financial assets and savings go down by the amount of the massive deficit spending in 2003. But after that, and before surplus." Rubin stated, "No, I think you're wrong." I let it go we had had enough deficit spending to replace the financial and the meeting was over. My question was answered. If he assets lost to the Clinton surplus years (a budget surplus takes didn't understand surpluses removed savings, then no one in away exactly that much savings from the rest of us), we let the the Clinton administration did. And the economy crashed soon deficit get too small again. And after the sub-prime debt-driven afterwards. bubble burst, we again fell apart due to a deficit that was and When the January 2009 savings report was released, and remains far too small for the circumstances. the press noted that the rise in savings to 5% of GDP was the > For the current level of government spending, we are highest since 1995, they failed to note the current budget deficit > being over-taxed and we don't have enough after-tax income passed 5% of GDP, which also happens to be the highest it's > to buy what's for sale in that big department store called the been since 1995. > economy. Clearly, the mainstream doesn't yet realize that deficits Anyway, Al was a good student, went over all the details, add to savings. And if Al Gore does, he isn't saying anything. agreeing that it made sense and was indeed what might happen. So watch this year as the federal deficit goes up and savings, However, he said he couldn't "go there." I told him that I too, goes up. Again, the only source of "net $U.S. monetary understood the political realities, as he got up and gave his talk savings" (financial assets) for the non-government sectors about how he was going to spend the coming surpluses. combined (both residents and non-residents) is U.S. government deficit spending. Robert Rubin But watch how the very people who want us to save more, at the same time want to "balance the budget" by taking away Ten years ago, around the year 2000 just before it all fell our savings, either through spending cuts or tax increases. apart, I found myself in a private client meeting at Citibank They are all talking out of both sides of their mouths. They are with Robert Rubin, former U.S. Treasury Secretary under part of the problem, not part of the solution. And they are at the President Clinton, and about 20 Citibank clients. Mr. Rubin very highest levels. gave his take on the economy and indicated that the low Except for one. savings rate might turn out to be a problem. With just a few minutes left, I told him I agreed about the low savings rate Professor Wynne Godley being an issue and added, "Bob, does anyone in Washington realize that the budget surplus takes away savings from the Professor Wynne Godley, retired head of Economics non-government sectors?" He replied, "No, the surplus adds at Cambridge University and now over 80 years old, was to savings. When the government runs a surplus, it buys widely renowned as the most successful forecaster of the 46 47 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY > British economy for multiple decades. And he did it all with > political. The right-sized deficit is the one that gets us to where > his "sector analysis," which had at its core the fact that the > we want to be with regards to output and employment, as well > government deficit equals the savings of financial assets of the > as the size of government we want, no matter how large or how > other sectors combined. However, even with the success of his > small a deficit that might be. > forecasting, the iron-clad support from the pure accounting > What matters is the real life - output and employment - size > facts, and the weight of his office (all of which continues to > of the deficit, which is an accounting statistic. In the 1940's, > this day), he has yet to convince the mainstream of the validity > an economist named Abba Lerner called this, "Functional > of his teachings. > Finance," and wrote a book by that name (which is still very > So now we know: > relevant today). > - Federal deficits are not the "awful things" that the > mainstream believes them to be. Yes, deficits do > matter. Excess spending can cause inflation. But the > government isn't going to go broke. > - Federal deficits won't burden our children. > - Federal deficits don't just shift funds from one person > to another. > - Federal deficits add to our savings. > So what is the role of deficits in regard to policy? It's > very simple. Whenever spending falls short of sustaining > our output and employment, when we don't have enough > spending power to buy what's for sale in that big department > store we call the economy, government can act to make > sure that our own output is sold by either cutting taxes or > increasing government spending. Taxes function to regulate our spending power and the economy in general. If the "right" level of taxation needed to support output and employment happens to be a lot less than government spending, that resulting budget deficit is nothing to be afraid of regarding solvency, sustainability, or doing bad by our children. > If people want to work and earn money but don't want to > spend it, fine! Government can either keep cutting taxes until > we decide to spend and buy our own output, and/or buy the > output (award contracts for infrastructure repairs, national > security, medical research, and the like). The choices are 48 49 SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Deadly Innocent Fraud #4: Social Security is broken. Fact: Federal Government Checks Don't Bounce. If there is one thing that all members of Congress believe, it's that Social Security is broken. President (elect) Obama has said "the money won't be there," President Bush used the word "bankruptcy" four times in one day and Senator McCain often claims that Social Security is broken. They are all wrong. > As we've already discussed, the government never has > or doesn't have any of its own money. It spends by changing > numbers in our bank accounts. This includes Social Security. > There is no operational constraint on the government's ability > to meet all Social Security payments in a timely manner. It > doesn't matter what the numbers are in the Social Security > Trust Fund account, because the trust fund is nothing more > than record-keeping, as are all accounts at the Fed. When it comes time to make Social Security payments, all the government has to do is change numbers up in the beneficiary's accounts, and then change numbers down in the trust fund accounts to keep track of what it did. If the trust fund number goes negative, so be it. That just reflects the numbers that are changed up as payments to beneficiaries are made. One of the major discussions in Washington is whether or not to privatize Social Security. As you might be guessing by now, that entire discussion makes no sense whatsoever, so let me begin with that and then move on. What is meant by the privatization of Social Security, and what effect does that have on the economy and you as an individual? 51 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY The idea of privatization is that: Therefore, unless we want to risk a high percentage of our 1. Social Security taxes and benefits are reduced. seniors falling below the poverty line, the government will 2. The amount of the tax reduction is used to buy be taking all the risk. specified shares of stock. They are both terribly mistaken. (Who would have thought!) 3. Because the government is going to collect that > The major flaw in this mainstream dialogue is what is called much less in taxes, the budget deficit will be that > a "fallacy of composition." The typical textbook example of a much higher, and so the government will have to > fallacy of composition is the football game where you can see sell that many more Treasury securities to "pay for > better if you stand up, and then conclude that everyone would it all" (as they say). > see better if everyone stood up. Wrong! If everyone stands up, then no one can see better, and all are worse off. They all are Got it? In simpler words: looking at the micro level, which is individual Social Security - You have less taken out of your paycheck for Social participants, rather than looking at the macro level, the entire Security each week. population. - You get to use the funds they no longer take from you > To understand what's fundamentally wrong at the macro to buy stocks. > (big picture, top down) level, you first have to understand that - You later will collect a bit less in Social Security > participating in Social Security is functionally the same as payments when you retire. > buying a government bond. Let me explain. With the current - You will own stocks which will hopefully become > Social Security program, you give the government your worth more than the Social Security payments that > dollars now, and it gives you back dollars later. This is exactly you gave up. > what happens when you buy a government bond (or put your > money in a savings account). You give the government your From the point of view of the individual, it looks like an > dollars now and you get dollars back later plus any interest. interesting trade-off. The stocks you buy only have to go up Yes, one might turn out to be a better investment and give you modestly over time for you to be quite a bit ahead. a higher return, but apart from the rate of return, they are very Those who favor this plan say yes, it's a relatively much the same. (Now that you know this, you are way ahead large one-time addition to the deficit, but the savings of Congress, by the way.) in Social Security payments down the road for the government pretty much makes up for that, and the Steve Moore payments going into the stock market will help the economy grow and prosper. Now you are ready to read about the conversation I had Those against the proposal say the stock market is too several years back with Steve Moore, then head of economics risky for this type of thing and point to the large drop in at the CATO institute, now a CNBC regular and a long- 2008 as an example. And if people lose in the stock market, time supporter of privatizing Social Security. Steve came the government will be compelled to increase Social down to Florida to speak about Social Security at one of my Security retirement payments to keep retirees out of poverty. conferences. He gave a talk that called for letting people put 52 53 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY their money in the stock market rather than making Social > Warren: "And the people who sold the stock then have Security payments, contending that they will be better off > the money from the sale which is the money that buys the over time when they retire. Also, he argued that a one-time > government bonds." increase in the government budget deficit will be both well > Steve: "Yes, you can think of it that way." worth it and probably "paid down" over time in the expansion > Warren: "So what has happened is that the employees to follow, as all that money going into stocks will help the > stopped buying into Social Security, which we agree economy grow and prosper. > was functionally the same as buying a government bond, > At that point I led off the question and answer session. > and instead they bought stocks. And other people sold > Warren: "Steve, giving the government your money now > their stocks and bought the newly-issued government > in the form of Social Security taxes and getting it back > bonds. So looking at it from the macro level, all that > later, is functionally the same as buying a government > happened is that some stocks changed hands and some > bond, where you give the government money now, and it > bonds changed hands. Total stocks outstanding and total > gives it back to you later. The only difference is the return > bonds outstanding, if you count Social Security as a > that seniors will get." > bond, remained about the same. And so this should have > Steve: "OK, but with government bonds, you get a higher > no influence on the economy or total savings, or anything > return than with Social Security, which only pays your > else apart from generating transactions costs?" > money back at 2% interest. Social Security is a bad > Steve: "Yes, I suppose you can look at it that way, but I > investment for individuals." > look at it as privatizing, and I believe people can invest > Warren: "OK, I'll get to the investment aspect later, but > their money better than government can." > let me continue. Under your privatization proposal, the > Warren: "Ok, but you agree that the amount of stocks > government would reduce Social Security payments > held by the public hasn't changed, so with this proposal, > and the employees would put that money into the stock > nothing changes for the economy as a whole." > market." > Steve: "But it does change things for Social Security > Steve: "Yes, about $100 per month, and only into > participants." > approved, high quality stocks." > Warren: "Yes, with exactly the opposite change for > Warren: "OK and the U.S. Treasury would have to > others. And none of this has even been discussed by > issue and sell additional securities to cover the reduced > Congress or any mainstream economist? It seems you > revenues." > have an ideological bias toward privatization rhetoric, > Steve: "Yes, and it would also be reducing Social Security > rather than the substance of the proposal." > payments down the road." > Steve: "I like it because I believe in privatization. I > Warren: "Right. So to continue with my point, the > believe that you can invest your money better than > employees buying the stock buy them from someone else, > government can." > so all the stocks do is change hands. No new money goes > into the economy." With that I'll let Steve have the last word here. The proposal in > Steve: "Right." no way changes the number of shares of stock or which stocks 54 55 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY the American public would hold for investment. So at the > What we need to do is make sure that the one guy working macro level, it is not the case of allowing the nation to "invest > is smart enough and productive enough and has enough capital better than the government can." And Steve knows that, but it > goods and software to be able to get it all done, or else those doesn't matter - he continues to peddle the same illogical story > retirees are in serious trouble, no matter how much money he knows is illogical. And he gets no criticism from the media > they might have. So the real problem is, if the remaining apart from the misguided discussion as to whether stocks are > workers aren't sufficiently productive, there will be a general a better investment than Social Security, will the bonds the > shortage of goods and services. More "money to spend" will government has to sell take away savings that could be used > only drive up prices and not somehow create more goods for investment, if the government risks its solvency by going > and services. The mainstream story deteriorates further as it even deeper into debt and all the other such nonsense we're continues: "Therefore, government needs to cut spending or calling innocent frauds. increase taxes today, to accumulate the funds for tomorrow's Unfortunately, the deadly innocent frauds continuously expenditures." By now I trust you know this is ridiculous and compound and obscure any chance for legitimate analysis. evident that the deadly innocent frauds are hard at work to > And it gets worse! The 'intergenerational' story continues undermine our well-being and the next generation's standard > something like this: "The problem is that 30 years from now of living as well. > there will be a lot more retired people and proportionately We know our government neither has nor doesn't have > fewer workers (which is true), and the Social Security trust dollars. It spends by changing numbers up in our bank > fund will run out of money (as if a number in a trust fund is an accounts and taxes by changing numbers down in our bank > actual constraint on the government's ability to spend...silly, accounts. And raising taxes serves to lower our spending > but they believe it). So to solve the problem, we need to figure power, not to give the government anything to spend. > out a way to be able to provide seniors with enough money to It's OK if spending is too high, causing the economy > pay for the goods and services they will need." With this last to "overheat" (if we have too much spending power for > statement it all goes bad. They assume that the real problem of what's for sale in that big department store called the > fewer workers and more retirees, which is also known as the economy). But if that's not the case, and in fact, spending > "dependency ratio," can be solved by making sure the retirees is falling far short of what's needed to buy what's offered > have sufficient funds to buy what they need. for sale at full employment levels of output, raising taxes > Let's look at it this way: 50 years from now when there and taking away our spending power only makes things > is one person left working and 300 million retired people (I that much worse. > exaggerate to make the point), that guy is going to be pretty And the story gets even worse. Any mainstream economist > busy since he'll have to grow all the food, build and maintain will agree that there pretty much isn't anything in the way of > all the buildings, do the laundry, take care of all medical needs, real goods we can produce today that will be useful 50 years > produce the TV shows, etc. etc. etc. What we need to do is from now. They go on to say that the only thing we can do > make sure that those 300 million retired people have the funds for our descendants that far into the future is to do our best to > to pay him??? I don't think so! This problem obviously isn't make sure they have the knowledge and technology to help > about money. them meet their future demands. The irony is that in order 56 57 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY > to somehow "save" public funds for the future, what we do > is cut back on expenditures today, which does nothing > but set our economy back and cause the growth of output Deadly Innocent Fraud #5: > and employment to decline. And worse yet, the great The trade deficit is an unsustainable imbalance > disappointment is that the first thing our misguided leaders that takes away jobs and output. > cut back on is education - the one thing that the mainstream > agrees should be done that actually helps our children 50 Facts: > years down the road. > Imports are real benefits and exports are real Should our policy makers ever actually get a handle > costs. Trade deficits directly improve our standard of on how the monetary system functions, they would realize > living. Jobs are lost because taxes are too high for a that the issue is social equity, and possibly inflation, but > given level of government spending, not because of never government solvency. They would realize that if they > imports. want seniors to have more income at any time, it's a simple matter of raising benefits, and that the real question is, what By now you might suspect that, once again, the mainstream level of real resource consumption do we want to provide has it all backwards, including the trade issue. To get on track for our seniors? How much food do we want to allocate to with the trade issue, always remember this: In economics, it's them? How much housing? Clothing? Electricity? Gasoline? better to receive than to give. Therefore, as taught in 1st year > Medical services? These are the real issues, and yes, giving economics classes: > seniors more of those goods and services means less for us. > The amount of goods and services we allocate to seniors is Imports are real benefits. Exports are real costs. > the real cost to us, not the actual payments, which are nothing > more than numbers in bank accounts. > In other words, going to work to produce real goods and And if our leaders were concerned about the future, they > services to export for someone else to consume does you no would support the types of education they thought would be > economic good at all, unless you get to import and consume most valuable for that purpose. They don't understand the > the real goods and services others produce in return. Put more monetary system, though, and won't see it the "right way > succinctly: The real wealth of a nation is all it produces and around" until they do understand it. > keeps for itself, plus all it imports, minus what it must export. Meanwhile, the deadly innocent fraud of Social A trade deficit, in fact, increases our real standard of living. Security takes its toll on both our present and our future How can it be any other way? So, the higher the trade deficit well-being. the better. The mainstream economists, politicians, and media all have the trade issue completely backwards. Sad but true. To further make the point: If, for example, General MacArthur had proclaimed after World War II that since Japan had lost the war, they would be required to send the U.S. 2 million cars a year and get nothing in return, the result would have been a major 58 59 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY international uproar about U.S. exploitation of conquered There is no reason, apart from a complete misunderstanding of enemies. We would have been accused of fostering a repeat our monetary system by our leaders that has turned a massive of the aftermath of World War I, wherein the allies demanded real benefit into a nightmare of domestic unemployment. reparations from Germany which were presumably so high > Recall from the previous innocent frauds, the U.S. can and exploitive that they caused World War II. Well, MacArthur > ALWAYS support domestic output and sustain domestic full > did not order that, yet for over 60 years, Japan has, in fact, > employment with fiscal policy (tax cuts and/or govt. spending), > been sending us about 2 million cars per year, and we have even when China, or any other nation, decides to send us real > been sending them little or nothing. And, surprisingly, they goods and services that displace our industries previously > think that this means they are winning the "trade war," and we doing that work. All we have to do is keep American spending > think it means that we are losing it. We have the cars, and they power high enough to be able to buy BOTH what foreigners > have the bank statement from the Fed showing which account want to sell us AND all the goods and services that we can > their dollars are in. produce ourselves at full employment levels. Yes, jobs may be Same with China - they think that they are winning because lost in one or more industries. But with the right fiscal policy, they keep our stores full of their products and get nothing in there will always be sufficient domestic spending power to be return, apart from that bank statement from the Fed. And our able to employ those willing and able to work, producing other leaders agree and think we are losing. This is madness on a goods and services for our private and public consumption. In grand scale fact, up until recently, unemployment remained relatively low > Now take a fresh look at the headlines and commentary we even as our trade deficit went ever higher. > see and hear daily: So what about all the noise about the U.S. borrowing from > - The U.S. is "suffering" from a trade deficit. abroad like a drunken sailor to fund our spending habits? Also > - The trade deficit is an unsustainable "imbalance." not true! We are not dependent on China to buy our securities > - The U.S. is losing jobs to China. > or in any way fund our spending. Here's what's really going > - Like a drunken sailor, the U.S. is borrowing from > on: Domestic credit creation is funding foreign savings. > abroad to fund its spending habits, leaving the bill to > What does this mean? Let's look at an example of a typical > our children, as we deplete our national savings. > transaction. Assume you live in the U.S. and decide to buy a car > > made in China. You go to a U.S. bank, get accepted for a loan > I've heard it all, and it's all total nonsense. We are and spend the funds on the car. You exchanged the borrowed > benefiting IMMENSELY from the trade deficit. The rest of funds for the car, the Chinese car company has a deposit in the the world has been sending us hundreds of billions of dollars bank and the bank has a loan to you and a deposit belonging worth of real goods and services in excess of what we send to to the Chinese car company on their books. First, all parties them. They get to produce and export, and we get to import are "happy." You would rather have the car than the funds, or and consume. Is this an unsustainable imbalance that we need you would not have bought it, so you are happy. The Chinese to fix? Why would we want to end it? As long as they want to car company would rather have the funds than the car, or they send us goods and services without demanding any goods and would not have sold it, so they are happy. The bank wants loans services in return, why should we not be able to take them? and deposits, or it wouldn't have made the loan, so it's happy. 60 61 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY There is no "imbalance." Everyone is sitting fat and happy. They all got exactly what they wanted. The bank has a loan and a deposit, so they are happy and in balance. The Deadly Innocent Fraud #6: Chinese car company has the $U.S. deposit they want as We need savings to provide the funds for savings, so they are happy and in balance. And you have the investment. car you want and a car payment you agreed to, so you are happy and in balance as well. Everyone is happy with what Fact: they have at that point in time. Investment adds to savings. > And domestic credit creation - the bank loan - has > funded the Chinese desire to hold a $U.S. deposit at the Second to last but not the least, this innocent fraud > bank which we also call savings. Where's the "foreign undermines our entire economy, as it diverts real > capital?" There isn't any! The entire notion that the U.S. resources away from the real sectors to the financial > is somehow dependent on foreign capital is inapplicable. sector, with results in real investment being directed > Instead, it's the foreigners who are dependent on our in a manner totally divorced from public purpose. In > domestic credit creation process to fund their desire to fact, it's my guess that this deadly innocent fraud might > save $U.S. financial assets. It's all a case of domestic credit be draining over 20% annually from useful output and > funding foreign savings. We are not dependent on foreign employment - a staggering statistic, unmatched in human > savings for funding anything. history. And it directly leads the type of financial crisis Again, it's our spreadsheet and if they want to save we've been going through. > our dollars, they have to play in our sandbox. And what > It begins with what's called "the paradox of thrift" in the > options do foreign savers have for their dollar deposits? > economics textbooks, which goes something like this: In our > They can do nothing, or they can buy other financial > economy, spending must equal all income, including profits, > assets from willing sellers or they can buy real goods > for the output of the economy to get sold. (Think about that > and services from willing sellers. And when they do for a moment to make sure you've got it before moving on.) > that at market prices, again, both parties are happy. The If anyone attempts to save by spending less than his income, buyers get what they want - real goods and services, other at least one other person must make up for that by spending financial assets, etc. The sellers get what they want - the more than his own income, or else the output of the economy dollar deposit. No imbalances are possible. And there is won't get sold. not even the remotest possibility of U.S. dependency on Unsold output means excess inventories, and the low sales foreign capital, as there is no foreign capital involved means production and employment cuts, and thus less total income. anywhere in this process. And that shortfall of income is equal to the amount not spent by the person trying to save. Think of it as the person who's trying to save (by not spending his income) losing his job, and then not getting any income, because his employer can't sell all the output. 62 63 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY > So the paradox is, "decisions to save by not spending > So what do our leaders do in their infinite wisdom when > income result in less income and no new net savings." > investment falls, usually, because of low spending? They > Likewise, decisions to spend more than one's income by going > invariably decide "we need more savings so there will be > into debt cause incomes to rise and can drive real investment > more money for investment." (And I've never heard a single > and savings. Consider this extreme example to make the > objection from any mainstream economist.) To accomplish > point. Suppose everyone ordered a new pluggable hybrid car > this Congress uses the tax structure to create tax-advantaged > from our domestic auto industry. Because the industry can't > savings incentives, such as pension funds, IRA's and all sorts currently produce that many cars, they would hire us, and > of tax-advantaged institutions that accumulate reserves on a borrow to pay us to first build the new factories to meet the > tax deferred basis. Predictably, all that these incentives do is new demand. That means we'd all be working on new plants > remove aggregate demand (spending power). They function to and equipment - capital goods - and getting paid. But there > keep us from spending our money to buy our output, which would not yet be anything to buy, so we would necessarily be > slows the economy and introduces the need for private sector "saving" our money for the day the new cars roll off the new > credit expansion and public sector deficit spending just to get assembly lines. The decision to spend on new cars in this case > us back to even. results in less spending and more savings. And funds spent on the production of the capital goods, which constitute real This is why the seemingly-enormous deficits turn out investment, leads to an equal amount of savings. not to be as inflationary as they might otherwise be. > I like to say it this way: "Savings is the accounting record In fact it's the Congressionally-engineered tax incentives > of investment." to reduce our spending (called "demand leakages") that cut deeply into our spending power, meaning that the government Professor Basil Moore needs to run higher deficits to keep us at full employment. Ironically, it's the same Congressmen pushing the tax- I had this discussion with a Professor Basil Moore in 1996 advantaged savings programs, thinking we need more savings at a conference in New Hampshire, and he asked if he could to have money for investment, that are categorically opposed use that expression in a book he wanted to write. I'm pleased to federal deficit spending. to report the book with that name has been published and > And, of course, it gets even worse! The massive I've heard it's a good read. (I'm waiting for my autographed > pools of funds (created by this deadly innocent fraud copy.) > #6, that savings are needed for investment) also need to > Unfortunately, Congress, the media and mainstream > be managed for the further purpose of compounding the > economists get this all wrong, and somehow conclude that > monetary savings for the beneficiaries of the future. The > we need more savings so that there will be funding for > problem is that, in addition to requiring higher federal > investment. What seems to make perfect sense at the micro > deficits, the trillions of dollars compounding in these funds > level is again totally wrong at the macro level. Just as loans > are the support base of the dreaded financial sector. They > create deposits in the banking system, it is investment that employ thousands of pension fund managers whipping > creates savings. around vast sums of dollars, which are largely subject 64 65 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY to government regulation. For the most part, that means investing in publicly-traded stocks, rated bonds and some diversification to other strategies such as hedge funds Deadly Innocent Fraud #7: and passive commodity strategies. And, feeding on these It's a bad thing that higher deficits today mean "bloated whales," are the inevitable sharks - the thousands higher taxes tomorrow. of financial professionals in the brokerage, banking and financial management industries who owe their existence to this 6th deadly innocent fraud. Fact: I agree - the innocent fraud is that it's a bad thing, when in fact it's a good thing!!! Your reward for getting this far is that you already know the truth about this most common criticism of government deficits. I saved this for last so you would have all the tools to make a decisive and informed response. First, why does government tax? Not to get money, but instead to take away our spending power if it thinks we have too much spending power and it's causing inflation. Why are we running higher deficits today? Because the "department store" has a lot of unsold goods and services in it, unemployment is high and output is lower than capacity. The government is buying what it wants and we don't have enough after-tax spending power to buy what's left over. So we cut taxes and maybe increase government spending to increase spending power and help clear the shelves of unsold goods and services. And why would we ever increase taxes? Not for the government to get money to spend - we know it doesn't work that way. We would increase taxes only when our spending power is too high, and unemployment has gotten very low, and the shelves have gone empty due to our excess spending power, and our available spending power is causing unwanted inflation. So the statement "Higher deficits today mean higher taxes tomorrow" in fact is saying, "Higher deficits today, when unemployment is high, will cause unemployment to go down 66 67 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY to the point we need to raise taxes to cool down a booming economy." Agreed! Part II: The Age of Discovery I was born in the Manchester Memorial Hospital on September 18, 1949. My parents are Daniel and Muriel Mosler, and I was the oldest of three children. My brother Seth was born in 1951 and my sister Susan in 1955. We lived in an apartment on West Middle Turnpike before moving to a three-bedroom house at 47 Marion Drive in 1960. We lived there for about three years before selling the house and moving to a nearby rental due to financial difficulties. I attended Wadell School and then Buckley elementary school after we moved. I went to Illing Jr. High School and then Manchester High School where my father had also graduated in 1937. We were what seemed to be a typical middle class Manchester family. My father worked as an accountant, tried managing a liquor store, sold life insurance and did tax preparation. My mother was an RN (registered nurse) and worked nights at Manchester Memorial Hospital. I suspect I contracted my car disease at the age of maybe 8. I recall taking apart old lawn mowers and using the parts to make motorbikes and go-carts, using bolts and often wooden parts. Getting anything welded was a luxury outside of the family budget. And I might still be able to name on sight every U.S. car built from 1955 to 1975. I recall sitting on the sidewalk of the main road through town with my brother naming the cars as they drove by. I had a variety of odd jobs in high school, including teaching kids to swim at a day camp, working at a local department store, mowing lawns and shoveling snow for the neighbors. I got through high school with average grades, but my teachers always told me that I had "potential" if I would only 68 69 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY apply myself. This was the standard assessment of the majority get the money back. That could mean anything from phone of American high school students, though I did do reasonably calls to trying to get the borrower to make his payments to well on my SAT's, with a low 700 score in math and a low 600 repossessing the car or other collateral and selling it for as score in the verbal section. much as possible. Collection methods also included home After I graduated from high school in 1967 (about 30TH visits, using the legal system to secure legal judgments against out of a class of about 575), I attended the University of the debtors and attaching bank accounts or garnishing wages Connecticut, a public university, primarily because it only cost to directly collect the money owed to the bank. $300 per year for residents. Because I had accepted a $1,000 I quickly realized that this was where the rubber meets the scholarship and a slide rule from a local organization to study road for the entire credit system. Without enforcement, there is engineering, I spent my first two years as an engineering no extension of credit. Loans were only as good as the ability student. I then switched my major to economics, and received to collect them. Years later, I would recognize this was also a B.A. in 1971, which also happened to be the year things true of the currency itself, and that the value of the dollar was got bad enough for President Nixon to implement price and only as good as the federal government's ability to enforce tax wage controls and take the United States off the gold standard collection. (More on this later.) internationally. We were in a recession, inflation had hit 3%, After a year of doing collections, Paul gave me lending and France had tried to take their gold home from Fort Knox. authority for loans up to $1,000. This was a responsibility I When I graduated in 1971, I experienced a recession first took very seriously. I was now responsible for lending other hand. I recall one job interview at National Cash Register that people's money, which for me was a far greater responsibility began with this friendly but resigned greeting from the hiring than lending my own money. manager: "I don't know why you and I are here. We're laying I remember having ongoing discussions with Paul on people off." what could be called the "theory of lending" and the "logic of I spent the next eighteen months working odd jobs, banking." The idea is that anyone can make loans so selectively including a stint as a pool attendant in Miami Beach, where I that there will never be any losses. But the trick is to make put out mats and umbrellas for 25-cent tips and a $20 a week loans where money might be lost, but where the odds were (GROSS) salary. To get by with paying me that little, the high enough so the interest the bank was making on the loans management also let me sleep in the storage room. more than made up for the small amount of expected losses. I finally got a real job in 1973, when I got a haircut and My collections experience brought home the nuances of re-applied for a job at the Savings Bank of Manchester in my what made loans go bad. It also made very clear that even with home town. (They told me after I was hired I was turned down very high lending standards regarding the borrower's income, the first time because my hair was too long.) time on the job, home equity and past payment records, many I started in the bank's personal loan department, where other things could go wrong that could cause a borrower who my first responsibility was to collect delinquent loans. Paul looked like a very good risk at the outset to default. Job losses, Coupe, the department head, handed me the collection books illnesses, personal problems, car accidents and death all had and added with a smile, "there's gold in them there books." some probability of taking place some percentage of the time. Once a loan was delinquent, my job was to figure out how to I understood that the lender would try and quantify all these 70 71 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY risks before a loan was extended, and attempt to determine if First, I calculated the total monthly fixed expenses, the interest rate the bank intended to charge would be sufficient assuming a 50% occupancy rate. Then, I did the math to cover the losses from loans that went bad, and still provide a backwards, and calculated that if we could rent out half the good return to the bank. rooms at $49 per week, we would break even. This was only Yes, we could tighten standards and reduce losses, but $7 per day, a significantly lower rate than the going rate of $15 we would make very few loans and not be profitable. If we per day for most motels at the time. But once we had half the were too lax with our standards, we would make a lot more motel filled up at the relatively low weekly rate and all our loans but the losses would eat up the profits. The answer expenses were covered, then the daily rents from the rest of the was somewhere in between. The right answer to running a rooms would make us profitable. There seemed to be no risk profitable bank, in the lending arena at least, lays somewhere to this strategy, but I needed to get approval from higher-ups in the middle of the two extremes of having standards that are at the bank. too high and standards that are too low. As Paul used to tell I made a presentation to our bank's Vice President, Bill me, when reviewing my loans that had gone bad, "If you aren't Johnson, where I outlined my strategy. Bill readily gave me taking some losses, you're costing the bank money." the go-ahead. I put my first ad in the local paper announcing I currently own a "buy here pay here" used car lot. All of the new weekly rate, and within days the $49 per week rooms our borrowers are sub prime or less, and I make the lending started filling up. I was pleasantly surprised and pleased decisions myself. Of every 100 new loans, 3 or 4 seem to go that there was a demand for my new offering. As it turned bad and cost me a few dollars after the car is repossessed and out, quite a few respectable local professional people would resold. And I still wonder with each application if I'm being occasionally have "domestic issues" and need a place to stay too tight or too lax. After 40 years, the basic concepts of for a few weeks. determining credit-worthiness still seem to hold. We got those rooms filled, and the motel started showing Not long after I had been given lending authority, the bank some profit. We soon sold it for a decent price and made a little foreclosed on a small (maybe 50 rooms) motel in downtown profit on the original loan. Manchester named Piano's, after the former owners. Paul Not long after that, the president of the bank retired, and sent me to manage it. The goal was to improve its operations Bill Johnson took his job. Bill had been running the securities sufficiently to get it sold as soon as possible, at as good a price portfolio. I think Bill liked the way I had handled the motel as possible. We were in the banking business, and didn't want foreclosure, so he promoted me to "investment officer" and I to be in the motel business. became the portfolio manager. While the portfolio was very When I arrived at the motel, I noticed that all the light bulbs small - only $5 million in stocks and $5 million in short-term were missing. "Welcome to what happens when borrowers go investments - the scale of the responsibility seemed very large bad!" I thought to myself. The first thing I did was arrange to to me at the time. My previous lending authority had been only get some basic maintenance done to the motel, including some $5,000, and that had seemed large. Now I was responsible for new light bulbs. I also began formulating a strategy to increase $10 million of the bank's money. room revenues, so that a potential purchaser could see some My hands were shaking when I made my first call to actual cash flow, increasing the likelihood we could sell it. purchase a $500,000 Certificate of Deposit for the bank. Don 72 73 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Chardenierre of the Merrill Lynch office in Hartford was on "We just put our money in a regular savings account at the other end of the phone. I introduced myself to Don and another savings bank at the 5.25% rate and let them worry asked for an interest rate offering from Merrill Lynch on the about it!" I said in the meeting. half a million dollars I wished to invest. Very politely, Don told "Why would we help another bank by doing that?" asked me that the minimum investment they handled was $1 million, one of the more senior executives. but that he would see what they could do for me. I thanked him My mentor and bank president Bill Johnson responded, and hung up the phone, now feeling very small! "What will they do with the money, except take a loss?" Managing the bank's stocks meant attending meetings The skeptical executive had no answer to Bill's question, with our financial advisor, Ted Ladd of Standish, Ayers, and and his silence caused more than a little amusement at the Woods in Boston. Bill, now our bank president and one of the meeting. The idea was approved. finest human beings anyone can know, would take me to the The next day, I got in the car and started visiting other meetings at the an old inn in Sturbridge, Mass., to meet with banks, trying to open a savings account for our bank. Several Ted and discuss our portfolio of equities, as well as external banks wouldn't accept our money. I remember a couple branch factors including the economy and the financial markets. We managers who were nearly in tears when their bosses turned would also discuss possible changes in our holdings. Since down their request to accept our money for deposit into their Ted was given full discretion to manage the $5 million in our bank. stock portfolio, there wasn't much for me to do in that half of "First they tell me to get deposits, and then you come in the job. with $100,000, and they won't take it. What do they want me But the other half of my job - managing our $5 million to do?" one of the branch managers moaned. in short-term investments - was entirely managed in house, After a few days I finally managed to get my banks extra and I was free to come up with ideas to make the best of few hundred thousand dollars invested in savings accounts that money. at other savings banks at the 5.25% rate--1.25% higher than We had been keeping most of the $5 million in bank CDs what we would have received from CDs. (I asked for the (certificates of deposit) with maturities of about 6 months. At free toasters the other banks were giving away at the time to that time, we were paying 5.25% in interest to the depositors anyone opening a new deposit, but not one of the banks would in our bank's savings accounts. This rate was fixed by law, and give me one!) so all savings banks were paying that rate to their depositors. By now, after my experiences with the motel turnaround, Unfortunately, we could only earn about 4% on our short-term and the improvement in the bank's return on short-term investments in CDs, as that's where the Federal Reserve was investments, I had a clear sense that I had an aptitude for setting short-term interest rates. the logic of finance. I had the ability to, now and then, see This seemed like an odd situation to me. During one of our opportunities that others had overlooked. regular management meetings at the bank, I suggested that instead About this time, there was a new type of mortgage-backed of buying short-term CDs that paid us a 4% interest rate, we should security, called a GNMA (pronounced "Ginny May") pass simply go to another savings bank, and open a regular savings through. You could buy a GNMA pass through, and it would account that paid the 5.25% they were required by law to pay. pay interest just like a mortgage investment. But you weren't 74 75 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY > STOPPED reading Tue 22 Aug 2017 getting a mortgage payment from a single property; you were that same $1 million in GNMA's to secure our borrowing. buying a participation in a large pool of individual mortgages This meant a locked-in profit for the bank - we borrowed at and getting your share of all the payments. And all the 4.5% and made 5.5% on the transaction. The management payments were fully guaranteed by the U.S. government, so team approved the trades, and I booked my first fixed income there was no default risk. But, since the interest rates paid were mortgage-backed securities arbitrage profit. That's what the a lot lower than the mortgage rates we were getting locally, it term "arbitrage" means - the simultaneous purchase and sale didn't make sense for our bank to invest in them. of the same securities, commodities or foreign exchange in However, I discovered something else was happening with different markets to profit from unequal prices." GNMA securities. The Wall Street dealers were offering them That Friday night, at about 8 pm, I got a call at home for sale for future delivery dates. In other words, you could from Jim Saxon from Salomon Brothers in New York City. buy and sell them for delivery in the future. For instance, in He inquired, "Hi, I'm in a late sales meeting, and we are March you could buy GNMA securities for delivery in March, discussing your GNMA trade. Can you tell me one more time but you could also buy them for delivery in June or even how it works?" September. The price for these securities would be determined At the time, Salomon Brothers was the top Wall Street in March, but you didn't receive them or pay for them until Fixed Income House. (Years later in the 1990's, they ran into the agreed-upon future delivery date. Also, the market prices a small market manipulation issue with U.S. Treasury and, as to purchase the same GNMA security for delivery in March, a result, were taken over by Citibank.) I found out later from June, or September differed. Something about this new kind of three of their senior managers that during their high flying security and the price differential based upon the different time years in the 1980's, it was my ideas that had been instrumental of delivery intrigued me. I started looking at the prices for the in getting them named managing directors. These three different delivery dates, trying to understand what they were managing directors went on to form a hedge fund, called Long based on. I somehow noticed that the prices were such that if I Term Capital, where they developed their own ideas, this time bought the GNMA's for March delivery, and at the same time with Nobel Prize winning economists. sold them for June delivery, my actual earnings for that three In those early 1970's when I worked there, the Savings month period would be higher than if I bought a 3-month CD Bank of Manchester was one of those thousands of dull, for the bank, or put the funds in a savings account at another boring savings banks that paid 5.25% to their depositors and bank. Additionally, I discovered I could borrow the money to financed homes with 8%, 30-year mortgages. We got to work pay for the GNMA securities for the same 3 months at an even at 8:30 am, and left to play golf (Or softball. My shoulder lower rate. still isn't quite right from trying to throw someone out at the So I went back to our management team with a proposal. plate from the outfield) around 4 pm. And in 1972, with a U.S. We could buy $1 million in GNMA's for March delivery, and population of just over 200 million, these plain, dumb, boring at the same time sell them for June delivery, and the prices savings banks financed 2.6 million new housing starts, with were such that we would earn a 5.5% annual rate on our money no secondary markets, no futures markets, and very modestly for that 90 day period. And, at the same time, our bank could paid employees (I started at $140 per week, and had worked borrow $1 million at only 4.5% for the same 90 days by using my way up to $200 per week as an investment officer). 76 77 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Today, with a population of over 300 million, a massive better deal with Shearson. I stayed at Bache in Hartford, where financial sector, untold financial innovations, and unlimited I was now getting full commissions on all the clients for any financial resources and liquidity, if we manage to get 2 million business I could do. In my first month I made $5,000 which housing starts a year, it's proclaimed an unsustainable bubble. was a very high number for me. It was 1976. Life was good. More on that kind of "progress" later in this book. And then I got another job offer. Jay Pomerenze offered me a job on Wall Street with Wall Street Bankers Trust Co. as an Assistant Vice President of Sales and Trading of GNMA securities. Jay was the GNMA trader at George Weisse was a broker at Bache and Company, and Bankers. I knew him from my Savings Bank of Manchester he was one of the brokers on my list to call when we needed days. My primary contact at Bankers was Bill Lovern, to do any transactions. We never did much actual business, who introduced me to Jay when I had become interested in but we did have several discussions of financial markets GNMA's. Most memorable on my first trip to Wall St. was and trading strategies. George was doing very well with his lunch at Kabuki where Bill took me for a new thing called brokerage business that focused on buying and selling public sushi. Bill left Bankers for Weeden while I was still at Bache, utility stocks. and I had stayed in touch with Jay. In 1975, George was looking for an assistant who could Jay said the job paid $30,000 a year. I said I was making both help him with his utility stock business and at the $60,000 where I was ($5,000 the first month times 12 = same time cover what were called second tier institutions $60,000). He said he'd go and talk to the higher-ups and got for Bache's other products, including bonds and other fixed back to me with a $45,000 offer. I accepted. income securities. He offered me a starting salary of $15,000 I moved from Hartford, Conn. where I had been paying a year, which was roughly 50% more than the bank was $125 a month for rent to New York City, where my one paying, and a chance to make more if successful. That year, bedroom at 80th and York on the 20th floor was $525 a I joined Bache as George's assistant. I remember getting into month. Federal taxes were 50%, and in New York City, work one day with George talking on the phone while lying state and local taxes took away about another 20%. I was on the floor. I asked what happened. He said his back went taking home only about $350 a week from my gross pay of out again. So I asked how it happened. He told me that he maybe $900. After rent, I was about back to where I was at had been carrying big rocks up to his house from the river the savings bank. behind it. Turns out he had a bad back and this would happen At Bankers, Jay and I pioneered the use of a variety of the on a regular basis. When it wasn't carrying rocks it was new derivative products. These financial products were being playing tennis or something like that. I got my SEC Series 7 introduced on the Chicago and New York futures markets at the license soon after I joined the firm, which qualified me to sell time. They included new futures market contracts, various kinds securities for life. of options and regular securities traded for future delivery dates. George was making serious money with his institutional I also recall discussions from those days that trace the equity sales, and was very, very good at what he did. He left history of my understanding of monetary operations. At some Bache about a year after I got there, cutting himself a much point while I was at Bankers, the Fed raised the discount 78 79 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY rate. Our trading manager, Alan Rogers, said he hoped the I came to know that type of thing back then, when no one else Fed didn't just give the banks the money. He said the money seemed to get it, including members of the Fed and Treasury. supply was too high and the Fed needed to take some of it In 1978, one of my clients, Colonial Mortgage, defaulted away. I thought about that for a moment and told him the Fed on an obligation to buy GNMA securities which I had sold to had to supply the money, as it couldn't come from anywhere them. When the time had come to pay for the securities and else. The banking system was just a T account with assets take deliveries, they didn't have the money, and the price of the and liabilities, and you can't just take away the assets. There securities had gone down. So our trading desk sold them at a is no such thing. He then said, "Well, there's $300 billion loss. This default occurred shortly after the credit department sloshing around in Europe, and they could use some of that." of Bankers Trust had sent a senior credit team to visit Colonial I replied that those were all T accounts as well and it wasn't a Mortgage, and after extensive analysis, had established their possibility, as a matter of accounting. The point here is I must credit lines. have been thinking about that quite a bit back then, maybe in As an Assistant Vice President of Sales and Trading, my discussions with Jay and others, to have been able to use it responsibilities were not to determine the credit-worthiness of with confidence in a relatively high-level discussion with the my clients. In fact, I wasn't allowed to do that. That was the trading manager on the trading desk. job of the credit department. My job was to help Bankers Trust Well, Erich Heiniman, senior economist at Morgan make money by utilizing the credit lines that had been, after Stanley, came out with the same position as Alan, which was long analysis, established for that purpose. published in the Wall St. Journal. My future partner, Cliff Even though I had nothing to do with determining the Viner, a portfolio manager at Phoenix Mutual Insurance in credit-worthiness of Colonial Mortgage, I was assigned blame Hartford, directed me to the Morgan Stanley editorial that for their default. This was a first-hand view of corporate argued, as Alan did, that the Fed should not give the banks bureaucracy in action, as the various managers, including the funds this time. I told Cliff how it worked and why the those on the credit team who had failed to accurately Fed would necessarily "give" the banks the funds. Cliff called assess Colonial's credit worthiness, scrambled to avoid any Morgan Stanley who gave him a double talk answer. I gave responsibility. No one came to my defense. Enough said about Cliff a response to that answer and he called them back. They this up-close look at institutional structure at work. then told Cliff that they retracted their position. The Fed, of All along I was contributing quite a bit to the overall profits course, added the reserves the next day with open market of the trading desk. One February, Jay was on vacation and I operations. The alternative would have been bank overdrafts, sat in to do the trading. February was a 28-day month that year, which carry a higher interest rate than the Fed's fed funds and month end was on a weekend. target, but are loans from the Fed nonetheless, though booked Interest rates were something like 12%, and I knew GNMA somewhat differently. securities paid interest based on a 30-day month even when There are other examples as well. I recall Alan wondering there were only 28 days in the month. So I started making where the $2 billion to buy the Treasury 2-year notes would very tight markets for the sales force. In fact, I would offer to come from. I answered it's the same money that they deficit buy or sell GNMA's at the same price, with no spread at all. spend that buys the Treasury notes. I don't know how or why However, my bid (the price I would buy at) was for the Friday 80 81 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY before month end, and my offered price was for the Monday was more like it, that that was what he wanted to see. following month end. The extra 2 days interest I would get for The other account was Larry Burke at Oppenheimer. He buying on Friday and selling for Monday at the same price was was an aggressive government bond trader, and we started over $500 per million dollars worth of securities. doing quite a bit of bond business (not all that profitable but Because of the knowledge of the 2 days' free interest, our certainly very active). The problem was that our trading desk sales force had the highest bids and lowest offers of anyone on wasn't quite ready for dealing with a "real" trader, so we Wall St. - we did a lot of business, and made a lot of money. missed a lot of business another firm would have done. When the February trading results were announced in March, More interesting was the day Larry called me and said he Alan Rodgers calmly read the results for each trader. For had to get out of about $10 million long bonds right away. I perspective, back then, making over $1 million a year in total knew our long bond trader, Paul Lagrande, wasn't in a position profits for the entire trading floor was considered to be very to make a competitive bid for that large a position. I suggested good. Alan announced each trader individually: "2-year note to Larry that he let Paul do the best he could in the broker's trader - up $10,000, ten-year note trader - down $5,000...." market and just take a small commission for helping him get And then he said: "GNMA - up $432,000, but that's just the bonds sold. Larry agreed, and I told Paul he had an order to "carry." Turns out he was dismissive of the money I had made sell Larry's bonds the best he could, and take a $1500 markup, (not to mention the market share gained) because it wasn't regardless of what price he got. made taking "real market risk." Well, Paul didn't get it. He had never been given an order When bonus time came around, things took another turn to sell bonds like that. He got defensive and said, "There's a for the worse for me. My sales manager, Rich Molere, told 99 1/2 bid on the screen, but I can't pay that." I said I knew that me I wasn't getting a bonus because my business was mainly and that I wasn't asking him to buy the bonds from Larry in GNMA securities, and Bankers Trust was a "Government advance. I explained that he just had to sell $10 million bonds Bond Shop." I suggested he take a look at the accounts I to the brokers at the best price he could get. After a couple of was assigned and maybe help me get some government bond back and forths, he sold the bonds to the brokers markets at a business from them. He looked through the list and realized good price, then said "Now what do I do? I'm short!" I said, that all of the accounts were mortgage bankers and savings & "You buy the bonds from Larry at the prices you sold them loan banks that did only GNMA business and none would ever less the $1500, which is your profit." He wrote the tickets and do any bond business. So he said he'd give me some "bond was all smiles...and so was Larry. It was a win/win situation. accounts" to see what I could do. I had proven to Rich that I could sell government bonds for The first was Chase Advisors, run by Bill Burke, who Bankers Trust. I also knew that that and $10 would get me a became a good friend of mine. The first thing I did was set up cup of coffee. a "research meeting" where I visited them with Alan Lerner, Fortunately, another opportunity was developing for me. our chief economist. We made a presentation to their group. Buzz Newton, head of the Corporate Bond Department at That went well, and the next day, Chase "rewarded" us with William Blair and Company in Chicago, asked me to start an order for a few 2-year Treasury notes that made us about a a fixed income arbitrage department as part of his corporate $200 profit, if that. Rich congratulated me and said that that bond department. Buzz was one of my clients at Bankers 82 83 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Trust, and though he rarely did a trade with me, he liked my at a loss. While looking at the spread, it dawned on me to ideas and saw the value of bringing me in to implement those calculate how much I'd lose if I put the trade on and, worst ideas. case, simply failed to deliver the bonds I had sold short for I told Buzz I had a pretty good job at Bankers Trust. He March and didn't cover that fail until I took delivery of bonds I explained that the position at Wm Blair and Co. had no salary. had bought for April delivery. It turned out that the loss would Instead, I would get a retail payout of 30% of my net profits. A be only 5/8ths of a point. So selling March and buying April very short time later I was in Chicago working at Blair. at a 3/4 spread, with a 'worst case' of losing only 5/8 points if I failed to deliver the entire month of March, would still be a 1/8 Chicago point profit. And there was a fair chance that the spread would narrow some time before that and the actual profit would be Moving to Chicago from New York City was like taking larger. So I took this idea to Alan Rogers, the trading manager, off tight shoes. You don't realize they're tight until after you and he rejected the idea, saying "Bankers Trust is not going to take them off. NYC might have 5 dry cleaners on every block put on a position knowing it's going to fail to deliver on time." I and Chicago only one, but you only need one. It was the same tried to point out I didn't know we would fail, and in fact, I was with the people. Chicago allows people to be nicer, friendlier, hoping the spreads would narrow before that because the profit with little or no edge. In NYC there's often aggression for would be several times larger. Additionally, failing to deliver no further purpose. It seemed an argumentative way of life was not only "not a crime," the counterparty taking delivery compared to Chicago. actually preferred that you failed to deliver, as he then didn't While I was at Wm Blair, I took on two partners: Justin have to pay for the bonds until you did deliver, and earned very Adams from the NYC office of First Boston, Corp. and Cliff high rates of interest on his money while waiting for you to Viner from Phoenix Mutual in Hartford, Connecticut. Justin deliver. In fact, Jay and I had made hundreds of thousands of was a GNMA trader at First Boston, working with Larry dollars due to people failing to deliver to us. Alan would hear Fink, who went on to start Blackrock, which is probably the none of it. I then called Justin at First Boston and explained most successful asset management firm in the world. I got to the trade, and why I wasn't allowed to do it. He immediately know Justin while I was working at Bankers Trust. I filled in put several hundred million of it on for First Boston and had for Jay trading GNMA's when he was away on vacation. I a very good month, providing liquidity for real investors and remember at one point during the month of February, GNMA narrower spreads for them as well. 81/4% securities trading for March delivery were 3/4 of a point I knew Cliff from my time at Bache working for George more expensive than they were for April delivery. It was very Weiss. Cliff worked upstairs in the same building, managing tempting to sell them short for March and at the same time buy 5 equity portfolios for Phoenix Mutual in Hartford. George them for April delivery, hoping that the spread would narrow knew Cliff and had me cover him for bonds. The first idea before it was time to deliver the bonds I had sold for March I showed Cliff was a UTC convertible bond that was selling delivery. The problem was that there were only a few weeks only 1/32 above its actual conversion value. Cliff gave me an left for prices to "normalize" and there was the risk the spread order to buy them at a price equal to the conversion value, would widen further and I'd be forced to close out my positions which never did happen. 84 85 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY At Wm Blair, we were a very effective team. Justin and note to be auctioned in May would affect the June futures I worked on the trading strategies, while Cliff covered the contract but not the March futures contract. handful of accounts that paid us commissions to piggyback A week or so before the contract opened, the CBT onto our ideas. For the next five years, we were responsible (Chicago Board of Trade) conducted "practice trading" for for maybe 80% of Wm Blair's profits, which increased every the floor brokers. I inquired as to what the futures prices were year we were there, and we made lots of money for our clients for March and June for the practice trading session. Turned as well. out that the March contract was trading at 100, and the June A lot of those early profits came from arbitraging the at 1001/2. We calculated that with the March contract at 100, newly-introduced futures contracts - the cash markets. We June was only worth 991/2. Seems that the floor traders doing were among the first to grasp the concept of imbedded options the practice trading didn't realize that the new 10-year notes in the various futures contracts. To give you an example of what which would be auctioned in June would lower the value of the all that means, when the new 10-year Treasury note futures June contract, but not the March contract, which reflected the contract was announced in the early 80's, the first thing we did value of the current 10-year note. was attempt to figure out what the correct prices for the futures With the opening of the new contract in just a few days, contracts should be. The futures contract was a set of rules that we started discussing which broker to use. About that time, we told you what prices you would pay if you bought a futures got a call from a Vince Ciaglia, who worked at a firm called contract, kept it until it expired and then took delivery of any Stotler. We'd never done much business with Vince, until this of the eligible 10-year Treasury securities. And, as they still call. Vince started asking me what I thought the March/June do today, every three months the U.S. Treasury would auction spread should be. He wasn't sure and started asking what we off billions of brand new 10-year Treasury notes. Knowing the thought the new 10-year Treasury note that would be deliverable current price of the eligible 10-year U.S. Treasury securities, in June might do to the spread. I told him that we were looking one could calculate what the prices should be for the new 10- at the same thing and asked if he wanted our business for this year Treasury futures contracts. trade in return for talking exclusively to us. He agreed. The next But there was another element. The new futures contracts discussion with Vince was about which floor broker to use (the would be for March, June, September, and December delivery floor broker was the person down at the exchange who did the dates, like all the other futures contracts. The first contract was actual buying and selling in what was called the "futures pit," for March delivery and the second for June delivery. However, back before electronic trading) so that when our order was what was different for March and June delivery was that the new entered, the floor broker wouldn't scare the other traders. Vince 10-year note that would be auctioned in May would obviously had the ideal broker named Les. Les was a broker who worked not be deliverable in March, before it was issued, but would be in both the bean pit and the bond pit, and the last time he was in eligible to be delivered in June. Additionally, at that time, each the bond pit, he had put his order in backwards and then had to new 10-year note that the U.S. Treasury auctioned came at a go back in and trade his way out of his mistake. higher yield than the older Treasury securities. This meant that When the 10-year futures market started trading on May 3, the June contract should be expected to trade at a lower price 1982, the first quotes had June about 1/8% higher than March. than the March contract, because the new "cheaper" Treasury Not as good as we'd hoped for, but still a very long way from 86 87 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY being 1/2% under March, which was what we thought was fair the prices we were paying for the deliverable bonds. (The CBT value. So we sent Les into the pit to buy 5,000 March contracts had initiated a 30-year bond contract several years before it and sell 5,000 June contracts at the spread of 1/8%. Each introduced the 10-year note futures in 1982) The prices of the contract represented $100,000 worth of Treasury securities, so bonds and the bond futures were such that if we held the bonds this was a $500,000 order. Back then, a position like that could until June and then delivered them we would make a reasonably be "safely" taken on with less than $5 million in available large profit. We knew of no reason why the spreads were so capital. wide. It was like buying eggs from a farmer and selling them to Les went into the pit and came out a few minutes later, the store and making a large profit. However, shortly after we reporting all 5,000 done at our price. Seems the other brokers put this trade on our books, the market changed dramatically, thought he was making another mistake, that he was supposed for unknown reasons, and it was suddenly possible to put the to be selling March and buying June based on where they same trade in at prices that represented an even larger profit. thought prices should be from practice trading. So thinking While this is good news if you have more "dry powder" to add there was easy money again coming their way, they filled his to your position, at the same time the position we already had order out of their own trading accounts and then waited for in place was showing a substantial, $1 million loss. Let me him to discover his error and come back into the pit to try and give you an analogy to try to explain how this works. Suppose reverse what he'd done and take another loss. Ten minutes you are offered a free, $10 bill if you agree to come and pick it later, when Les still hadn't come back, they suspected the worst up in 30 days, and you take it. Then the next day things change - that he wasn't coming back, and they started scrambling to and they are offering free $20 bill in 30 days. Sounds good, cover their positions as best as they could. I don't know what but now your first contract, to pick up the $10 bill in 30 days happened after that, except that over the next few weeks we actually represents a loss of $10, because why would anyone made almost $3 million (back when that was a lot of money) take your $10 bill when there are currently $20 bills being as the March/June spread did indeed gravitate to what we had offered? And so if you wanted to get out of your obligation to calculated as "fair value." It was a very good month for Wm get a free $10 in 30 days, you would have to pay someone $10, Blair and Company. so he could get the same $20 the other guy is offering. And, On a look back, those five years I spent at William Blair the real problem is that if you decide to stay with your contract in Chicago were my formative years. (Ned Janotta, the Senior to get a free $10 bill in 30 days, you have to now post $10 Partner at Blair, remains one of the most astute, honorable with the exchange so that if you take a hike and they have to and personable individuals one could possibly encounter, liquidate your contract they don't have to take the $10 loss. fortunately for me, as this next episode illustrates.) What I immediately sat down with Ned, explaining that the could have been an unceremonious end instead turned out to position was to make us a $1 million profit when we delivered be the beginning of the best of times for both Wm Blair and our bonds in June, but that the prices had changed, and we Company and for me as well. had to either meet a $1 million margin call, or close out the It was early 1980. We had purchased 30-year U.S, position and sustain a $1 million loss. He asked what would Treasury bonds and sold the June delivery, 30-year bond happen if we waited until June. I explained that we would get futures contracts, which had become very expensive relative to both our originally contracted $1 million profit and $1 million 88 89 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY in margin money back. I also said there was no guarantee the Blair and Company as one of our partners. position wouldn't move further against us, but in any case by Illinois Income Investors specialized in fixed income the June delivery date we'd get it all back plus $1 million. arbitrage, utilizing both actual securities and related derivative Ned made the call, said he agreed with our plan to stay products, with a market neutral/0 duration strategy. That meant with the trade, and the meeting was over. Other Wall Street we promised no interest rate exposure, rates going up or down trading desks were not as fortunate. There were stories of their were not supposed to be a factor in the level of profits. We managers forcing them to exit their positions immediately at were paid 35% of the profits but no fixed management fees. substantial losses. Over the next fifteen years, we continued the success Not long after that meeting, the prices of gold and silver we'd had at William Blair and Company. Including the time collapsed, as did the Treasury note futures we had sold short, at Blair, we established a 20-year track record (from 1978 to our margin money was returned and our expected profits were 1997) with only one losing month, a drop of a tenth of one realized. And we also discovered what was happening behind percent on a mark to market that reversed the next month, the scenes. The billionaire Hunt brothers (back when that was and no losing trades that any of us can recall. III was ranked a lot of money) had been buying the same Treasury futures we Number One in the world for the highest risk-adjusted spreads had been selling short with the profits they were making buying by Managed Account Reports through 1997. When I stepped silver and driving prices up to almost $60/oz (today silver is down, Cliff Viner took control of about $3.5 billion in capital still under $20/oz). That is what had caused our temporary and $35 billion in assets. The 1996 drama with the Tokyo "mark to market" loss. And it was the collapse of the gold and Futures exchange along with philosophical differences with a silver prices that forced the Hunt brothers to liquidate both new partner told me it was a good time to take a break. their silver positions and their bond futures positions, and The designation for the September 1996 futures contract return our trade to profitability. What made this all the more for the 10-year JGB's (Japanese government bonds) was interesting was how that happened. It seems the owners of JBU6, which at one time was to be the title of this book, the COMEX, the NY exchange where the silver futures were before the term "innocent fraud" was coined. This time, again traded, sold short for their personal accounts when silver went for some unknown reason, the JBU6 (the September futures over $50/oz, and then drastically raised margin requirements contract) was, to me, mispriced. But this time it was on the for the Hunts, forcing them to liquidate and lose billions (and Tokyo exchange, this time it was too cheap, this time there restoring our profits) as the price of silver dropped to under was a large interest rate swap market and this time we had $10/oz. And this was all perfectly legal at the time. over $3 billion under management, bwtwalom (back when that In 1982, Justin, Cliff and I were aware the markets were was a lot of money). Slowly, over the months leading up to large enough for us to manage more capital without hurting September, we and our clients began to buy the JBU6 and pay our returns for our investors. It didn't make sense to do that fixed on 7 to 10-year yen labor swaps. Without going into a lot within the legal structure of a broker-dealer like William Blair. more detail, it's enough to understand that paying a fixed rate Ned helped us to raise more capital and keep the business on a swap was roughly equivalent to selling real bonds short. separate from William Blair. We formed our own company, So we were using the cheap futures market to buy bonds and Illinois Income Investors, (later shortened to III), with Wm sell them at what we thought was a higher price via the interest 90 91 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY rate swap market. The position got very large, approaching positions. I found Craig Foster at Credit Suisse in Tokyo. 7,500 contracts, which represented over $7 billion worth He was long about 7,000 contracts and had a similar trade of bonds (yes, bwtwalom). Around then, we noticed that on. Perfect! One last piece, if we were to take delivery of we had contracted to take delivery of more of the cheapest what was now some $20 billion of JGB's (still a lot of to deliver JGB's than the government of Japan had issued. money), we needed to borrow the money to pay for them. That added a new dimension. If we took delivery, the other Craig made the call to Switzerland and relayed the good side would have to give us something, and if the cheapest news; he had a $20 billion line from his home office. bonds to deliver weren't available, they would be forced to We were bullet proof. deliver more expensive bonds to us, which meant higher When the notice day came, the day when the other side profits. And, if supply of that more expensive bond was has to tell you what bonds they are delivering to you, we were exhausted, they would be forced to deliver an even more notified that the other side was mostly going to deliver to us expensive bond. the cheapest bonds possible. Fine, except that there weren't While this looked very attractive to us, the nagging that many. We considered the possibility that they somehow question was why anyone would be selling us the had gotten extra bonds that didn't previously exist from the futures contracts at what looked to be very low prices. Bank of Japan. Then we started getting the calls asking us to Additionally, at this point, the September futures contract lend them the bonds they needed to deliver to us and wanted also looked cheap vs. the December '06 and March '07 to know what price we would charge them. This was madness! futures prices, so we also bought September and sold They had to have the bonds. They were committed to deliver December and March futures. But the futures remained them to us, and the penalty for failing to deliver was absolute cheap and we kept adding to our position. We got up to dismissal from the yen bond markets and unknown fines from over 14,000 contracts for III and for our AVM clients the Bank of Japan for disrupting their financial system. We before the delivery date, and the futures were still cheap. were on the good side, buying Japans bonds via their futures Astounding! I had our repo trader check to see if the market. They like people to buy their bonds. It was the other bonds we were expecting to be delivered were available side that had the explaining to do. They had been selling to be borrowed. I was guessing the dealers who had sold billions of Japan's bonds short and didn't even have any to short to us were maybe going to deliver borrowed bonds deliver. The Bank of Japan did some serious wrist slapping to us. But no, there were still bonds to be borrowed - and over that. borrowed relatively cheaply. So we borrowed the bonds Well, we did lend them the bonds, but at a price. Since we ourselves to make sure that no one did an end run around did need the dealers to stay in business, we let them out at a us, and tried to deliver borrowed bonds, not that it mattered price of about half of what they probably would have charged all that much if they did, but I wasn't keen on taking any us had the situation been reversed (maybe a lot less than half). chances at this point. Perhaps we should have been tougher on them, but we walked The next step was finding a dealer who we could use away with about $150 million in profits for our side and went to take delivery. I was hoping to find one who had the on record as having engineered the largest futures delivery of same trade on so we could take delivery on the combined all time, last I checked. 92 93 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Italian Epiphany take a $10 bill to the Treasury Department and demand gold for it, they won't give it to you because they simply are not I now backtrack to the early 1990's, to conclude this legally allowed to do so, even if they wanted to. They will give narrative leading up to the seven deadly innocent frauds. you two $5 bills or ten $1 bills, but forget about getting any It was then that circumstances led me to the next level of gold. understanding of the actual functioning of a currency. Historically, government defaults came only with the likes Back then, it was the government of Italy, rather than the of gold standards, fixed exchange rates, external currency United States, which was in crisis. Professor Rudi Dornbusch, debt, and indexed domestic debt. But why was that? The an influential academic economist at MIT, insisted that Italy answer generally given was "because they can always print was on the verge of default because their debt-to-GDP ratio the money." Fair enough, but there were no defaults (lots of exceeded 110% and the lira interest rate was higher than the inflation but no defaults) and no one ever did "print the money," Italian growth rate. so I needed a better reason before committing millions of our Things were so bad that Italian Government Securities investors funds. denominated in lira yielded about 2% more than the cost A few days later when talking to our research analyst, Tom of borrowing the lira from the banks. The perceived risk of Shulke, it came to me. I said, "Tom, if we buy securities from owning Italian government bonds was so high that you could the Fed or Treasury, functionally there is no difference. We buy Italian government securities at about 14%, and borrow send the funds to the same place (the Federal Reserve) and the lira to pay for them from the banks at only about 12% for we own the same thing, a Treasury security, which is nothing the full term of the securities. This was a free lunch of 2%, raw more than account at the Fed that pays interest." meat for any bond desk like mine, apart from just one thing; So functionally it has to all be the same. Yet presumably the the perceived risk of default by the Italian government. There Treasury sells securities to fund expenditures, while when the was easy money to be made, but only if you knew for sure that Fed sells securities, it's a "reserve drain" to "offset operating the Italian government wouldn't default. factors" and manage the fed funds rate. Yet they have to be The "Free Lunch" possibility totally preoccupied me. The functionally the same - it's all just a glorified reserve drain! reward for turning this into a risk free spread was immense. So Many of my colleagues in the world of hedge fund I started brainstorming the issue with my partners. We knew management were intrigued by the profit potential that might no nation had ever defaulted on its own currency when it was exist in the 2% free lunch that the Government of Italy was not legally convertible into gold or anything else. offering us. Maurice Samuels, then a portfolio manager at There was a time when nations issued securities that were Harvard Management, immediately got on board, and set convertible into gold. That era, however, ended for good in 1971 up meetings for us in Rome with officials of the Italian when President Nixon took us off the gold standard internationally government to discuss these issues. (the same year I got my BA from U-Conn) and we entered the era Maurice and I were soon on a plane to Rome. Shortly after of floating exchange rates and non convertible currencies. landing, we were meeting with Professor Luigi Spaventa, While some people still think that the America dollar is a senior official of the Italian Government's Treasury backed by the gold in Fort Knox, that is not the case. If you Department. (I recall telling Maurice to duck as we entered 94 95 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY the room. He looked up and started to laugh. The opening proclaiming "Yes! And the International Monetary Fund was maybe twenty feet high. "That's so you could enter this is making us act pro cyclical!" My question had led to the room in Roman times carrying a spear," he replied.) realization that the IMF was making the Italian Government Professor Spaventa was sitting behind an elegant desk. He tighten policy due to a default risk that did not exist. was wearing a three-piece suit, and smoking one of those Our meeting, originally planned to last for only twenty curled pipes. The image of the great English economist John minutes, went on for two hours. The good Professor began Maynard Keynes, whose work was at the center of much inviting his associates in nearby offices to join us to hear the economic policy discussion for so many years, came to mind. good news, and instantly the cappuccino was flowing like Professor Spaventa was Italian, but he spoke English with a water. The dark cloud of default had been lifted. This was time British accent, furthering the Keynesian imagery. for celebration! After we exchanged greetings, I opened with a A week later, an announcement came out of the Italian question that got right to the core of the reason for our trip. Ministry of Finance regarding all Italian government bonds "Professor Spaventa, this is a rhetorical question, but why - "No extraordinary measures will be taken. All payments is Italy issuing Treasury securities? Is it to get lira to spend, will be made on time." We and our clients were later told we or is it to prevent the lira interbank rate falling to zero were the largest holders of Italian lira denominated bonds from your target rate of 12%?" I could tell that Professor outside of Italy, and managed a pretty good few years with Spaventa was at first puzzled by the questions. He was that position. probably expecting us to question when we would get our Italy did not default, nor was there ever any solvency risk. withholding tax back. The Italian Treasury Department was Insolvency is never an issue with nonconvertible currency and way behind on making their payments. They had only two floating exchange rates. We knew that, and now the Italian people assigned to the task of remitting the withheld funds Government also understood this and was unlikely to "do to foreign holders of Italian bonds, and one of these two something stupid," such as proclaiming a default when there was a woman on maternity leave. was no actual financial reason to do so. Over the next few Professor Spaventa took a minute to collect his thoughts. years, our funds and happy clients made well over $100 million When he answered my question, he revealed an understanding in profits on these transactions, and we may have saved the of monetary operations we had rarely seen from Treasury Italian Government as well. The awareness of how currencies officials in any country. "No," he replied. "The interbank rate function operationally inspired this book and hopefully will would only fall to 1/2%, NOT 0%, as we pay 1/2% interest on soon save the world from itself. reserves." His insightful response was everything we had hoped As I continued to consider the ramifications of government for. Here was a Finance Minister who actually understood solvency not being an issue, the ongoing debate over the U.S. monetary operations and reserve accounting! (Note also that budget deficit was raging. It was the early 1990's, and the only recently has the U.S. Fed been allowed to pay interest on recession had driven the deficit up to 5% of GDP (deficits are reserves as a tool for hitting their interest rate target) traditionally thought of as a percent of GDP when comparing I said nothing, giving him more time to consider the one nation with another, and one year to another, to adjust for question. A few seconds later he jumped up out of his seat the different sized economies). 96 97 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Gloom and doom were everywhere. News anchor David Brinkley suggested that the nation needed to declare bankruptcy and get it over with. Ross Perot's popularity was on the rise with his fiscal responsibility Part III: Public Purpose theme. Perot actually became one of the most successful 3rd party candidates in history by promising to balance the Functions of government are those that best serve the budget. (His rising popularity was cut short only when community by being done collectively. These include: The he claimed the Viet Cong were stalking his daughter's military, the legal system, international relations, police wedding in Texas.) protection, public health (and disease control), public With my new understanding, I was keenly aware of the funding for education, strategic stockpiles, maintaining risks to the welfare of our nation. I knew that the larger federal the payments system, and the prevention of "races to deficits were what was fixing the broken economy, but I the bottom" between the states, including environmental watched helplessly as our mainstream leaders and the entire standards, enforcement standards, regulatory standards media clamored for fiscal responsibility (lower deficits) and and judicial standards. were prolonging the agony. What has made the American economy the envy of It was then that I began conceiving the academic paper the world has been that people working for a living make that would become Soft Currency Economics. I discussed sufficient take-home pay in order to be able to purchase it with my previous boss, Ned Janotta, at William Blair. the majority of the goods and services they desire and He suggested I talk to Donald Rumsfeld (his college are produced. And what American business does is roommate, close friend and business associate), who compete for those dollars with the goods and services personally knew many of the country's leading economists, they offer for sale. Those businesses that produce goods about getting it published. Shortly after, I got together and services desired by consumers are often rewarded with "Rummy" for an hour during his only opening that with high profits, while those that fail fall by the wayside. week. We met in the steam room of the Chicago Racquet The responsibility of the federal government is to keep Club and discussed fiscal and monetary policy. He sent me taxes low enough so that people have the dollars to spend to Art Laffer who took on the project and assigned Mark to be able to purchase the goods and services they prefer McNary to co-author, research and edit the manuscript, from the businesses of their choice. which was completed in 1993. Today, unfortunately, we are being grossly overtaxed Soft Currency Economics remains at the head of the for the current level of government spending, as evidenced "mandatory readings" list at www.moslereconomics.com by the high level of unemployment and the high level of where I keep a running blog. It describes the workings of excess capacity in general. People working for a living the monetary system, what's gone wrong and how gold are getting squeezed, as they are no longer taking home a standard rhetoric has been carried over to a nonconvertible large enough pay check to cover their mortgage payments, currency with a floating exchange rate and is undermining car payments and various routine expenses, nevermind any national prosperity. extra luxuries. 98 99 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY To address the current financial crisis and economic collapse, National Service Jobs I recommend a number of proposals in the pages ahead. The next recommendation of mine is to fund an $8/hour national service job for anyone willing and able to work; this A Payroll Tax Holiday will include child care, the current federal medical coverage I recommend that an immediate "payroll tax holiday" and all of the other standard benefits of federal employees. be declared whereby the U.S. Treasury makes all FICA, This is a critical step to sustain growth and foster price Medicare and other federal payroll tax deductions for all stability. This provides a transition from unemployment to employees and employers. This proposal will increase the private sector employment. Businesses tend to resist hiring the take-home pay of a couple making a combined $100,000 unemployed, and especially the long-term unemployed. This per year by over $650 per month, restoring their ability to national service job provides a transition from unemployment make their mortgage payments, meet their routine expenses, to employment, and, as the economy recovers (due to my first and even do a little shopping. People with money to spend two proposals), businesses will hire from this pool of labor to will immediately lead to a pickup in business sales, which meet their needs for more workers. will quickly result in millions of new jobs to serve the increased demand for goods and services. And people Universal Health Care Coverage able to make their mortgage and loan payments is exactly what the banking system needs most to quickly return to My proposal regarding health care is to give everyone over health, not government funding that can only keeps them the age of 18 a bank account that has, perhaps, $5,000 in it, limping along with loans that continue to default. The only to be used for medical purposes. $1,000 is for preventative difference between a good loan and a bad loan is whether or measures and $4,000 for all other medical expenses. At the not the borrower can make his payment. end of each year, any unspent funds remaining of the $4,000 portion are paid to that individual as a "cash rebate." Anything above $5,000 would be covered by a form of Medicare. There Revenue sharing would be no restrictions on purchasing private insurance My second proposal is to give the U.S. state governments policies. an immediate, unrestricted $150 billion of revenue sharing This proposal provides for universal health care, on a per capita basis (about $500 per capita). Most of the maximizes choice, employs competitive market forces to states are in dire straights as the recession has cut into their minimize costs, frees up physician time previously spent normal revenue sources. By pushing back federal funds on in discussion with insurance companies, rewards "good a per capita basis, it will be "fair" to all and not specifically behavior" and reduces insurance company participation. "reward bad behavior." This distribution will give the states This will greatly reduce demands on the medical system, the immediate relief they need to sustain their essential substantially increasing the supply of available doctor/patient services. As the economy recovers, their revenues will time and makes sure all Americans have health care. To increase to pre-recession levels and beyond. ensure preventative measures are taken, the year-end rebate 100 101 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY can be dependent, for example, on the individual getting an Second, the government should also remove the $250,000 annual check up. And though it is federally funded, it can be cap on insured bank deposits, as well as remove regulations administered by the states, which could also set standards pertaining to bank liquidity, at the same time that it allows and requirements. the Federal Reserve to lend unsecured to member banks. The There is no economic school of thought that would Federal Reserve should lower the discount rate to the fed funds suggest health care should be what's called a "marginal rate (and, as above, remove the current collateral requirements). cost of production" means that it is bad for the economy The notion of a "penalty" rate is inapplicable with today's non- and our entire standard of living to have business pay for convertible currency and floating exchange rate policy. health care. This proposal eliminates that problem for the American economy in a way that provides health care for Third, an interbank market serves no public purpose. It everyone, saves real costs, puts the right incentives in place, can be eliminated by having the Federal Reserve offer loans promotes choice and directs competitive forces to work in to member banks for up to 6 months, with the FOMC (Federal favor of public purpose. Open Market Committee, the collection of Fed officials who meet and vote on monetary policy) setting the term structure of rates at its regular meetings. This would also replace many Proposals for the Monetary System of the various other lending facilities the FOMC has been First, the Federal Reserve should immediately lend to its experimenting with. member banks on an unsecured basis, rather than demanding Fourth, have the Treasury directly fund the debt of collateral for its loans. Demanding collateral is both the FHLB (Federal Home Loan Bank) and FNMA (the redundant and obstructive. It is redundant because member Federal National Mortgage Association), the U.S. Federal banks can already raise government-insured deposits and housing agencies. This will reduce their funding costs, issue government-insured securities in unlimited quantities and this savings will be directly passed on to qualifying without pledging specific collateral to secure those home buyers. There is no reason to give investors today's borrowings. In return, banks are subject to strict government excess funding costs currently paid by those federal regulation regarding what they can do with those insured housing agencies when the full faith and credit of the US funds they raise, and the government continuously examines government is backing them. and supervises all of its member banks for compliance. With the government already insuring bank deposits and making Fifth, have FNMA and the FHLB "originate and sure only solvent banks continue to function, the government hold" any mortgages they make, and thereby eliminate is taking no additional risk by allowing the Federal Reserve that portion of the secondary mortgage market. With to lend to its member banks on an unsecured basis. With the Treasury funding, secondary markets do not serve public Federal Reserve lending unsecured to its member banks, purpose. liquidity would immediately be normalized and no longer be a factor contributing to the current financial crisis or any Sixth, increase and vigorously enforce mortgage fraud future financial crisis. penalties with Federal agencies. 102 103 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Strategic Stockpiles c) Minimizing government disruption of outcomes for mortgage backed securities holders; When families live on remote farms, for example, it makes d) Minimizing the moral hazard issue. sense to store perhaps a year or more of food for crop failures and other potential disruptions of the food supply. However, families With this proposal, the foreclosure process is allowed to living in cities, as a practical matter, instead can only save U.S. function according to law, so no contracts are violated. And dollars. Unfortunately, in the event of actual shortages of food renting to the former owner at a fair market rent is not a subsidy, and other strategic supplies, numbers in bank accounts obviously nor is the repurchase option at market price a subsidy. will not do the trick. It is therefore a matter of public purpose to insure that there are actual strategic reserves for emergency consumption. Currently we have a strategic oil reserve. This How We Can All Benefit from the Trade Deficit should be extended to stores of other necessities for the purpose The current trade gap is a reflection of the rest of the world's of emergency consumption. The purpose should not be to support desires to save U.S. financial assets. The only way the special interest groups, but to provide the consumer with real foreign sector can do this is to net export to the U.S. and keep supplies of actual consumables for rainy days. U.S. dollars as some form of dollar financial assets (cash, securities, stocks, etc). So the trade deficit is not a matter of A Housing Proposal for the Financial Crisis: the U.S. being dependent on borrowing offshore, as pundits proclaim daily, but a case of offshore investors desiring 1) If the owner of a house about to be foreclosed wants to hold U.S. financial assets. To accomplish their savings to remain in the house, he notifies the government, desires, foreigners vigorously compete in U.S. markets by which then buys the house during the foreclosure sale selling at the lowest possible prices. They go so far as to period from the bank at the lower of fair market value force down their own domestic wages and consumption in or the remaining mortgage balance. their drive for "competitiveness," all to our advantage. If they 2) The government rents the house to the former lose their desire to hold U.S. dollars, they will either spend owner at a fair market rent. them here or not sell us products to begin with, in which 3) After two years, the house is offered for sale and case that will mean a balanced trade position. While this the former owner/renter has the right of first refusal to process could mean an adjustment in the foreign currency buy it. While this requires a lot of direct government markets, it does NOT cause a financial crisis for the U.S. involvement and expense, and while there is room for The trade deficit is a boon to the US. There need not be a dishonesty at many levels, it is far superior to any of "jobs issue" associated with it. Appropriate fiscal policy can the proposed plans regarding public purpose, which always result in Americans having enough spending power to includes: purchase both our own full employment output and anything a) Keeping people in their homes via affordable rents; the foreign sector may wish to sell us. The right fiscal policy b) Not interfering with existing contract law for works to optimize our output, employment and standard of mortgage contracts; living, given any size trade gap. 104 105 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Industries with Strategic Purpose direct benefits of more output from more workers, the indirect benefits of full employment should be very high as well. Our steel industry is an example of a domestic industry These include increased family coherence, reduced domestic with important national security considerations. Therefore, violence, less crime, and reduced incarcerations. In particular, I would suggest that rather than continuing with the general teen and minority employment should increase dramatically, steel tariffs recently implemented, defense contractors should hopefully, substantially reducing the current costly levels of be ordered to use only domestic steel. This will ensure a unemployment. domestic steel industry capable of meeting our defense needs, with defense contractors paying a bit extra for domestically- Interest Rates and Monetary Policy produced steel, while at the same time lowering the price for non-strategic steel consumption for general use. It is the realm of the Federal Reserve to decide the nation's interest rates. I see every reason to keep the "risk free" interest Using a Labor Buffer Stock to let Markets Decide the rate at a minimum, and let the market decide the subsequent Optimum Deficit credit spreads as it assesses risk. Since government securities function to support interest To optimize output, substantially reduce unemployment, rates, and not to finance expenditure, they are not necessary for promote price stability and use market forces to immediately the operation of government. Therefore, I would instruct the promote health-care insurance nationally, the government can Treasury to immediately cease issuing securities longer than offer an $8 per hour job to anyone willing and able to work 90 days. This will serve to lower long-term rates and support that includes full federal health-care benefits. To execute investment, including housing. Note, the Treasury issuing this program, the government can first inform its existing long term securities and the Fed subsequently buying them, agencies that anyone hired at $8 per hour "doesn't count" as recently proposed, is functionally identical to the Treasury for annual budget expenditures. Additionally, these agencies simply not issuing those securities in the first place. can advertise their need for $8 per hour employees with I would also instruct the Federal Reserve to maintain a the local government unemployment office, where anyone Japan like 0% fed funds rate. This is not inflationary nor is it willing and able to work can be dispatched to the available the cause of currency depreciation, as Japan has demonstrated job openings. This job will include full benefits, including for over 10 years. Remember, for every $ borrowed in the health care, vacation, etc. These positions will form a national banking system, there is a $ saved. Therefore, changing rates labor "buffer stock" in the sense that it will be expected that shifts income from one group to another. The net income effect these employees will be prone to being hired away by the is zero. Additionally, the non government sector is a net holder private sector when the economy improves. As a buffer stock of government securities, which means there are that many program, this is highly countercyclical anti-inflationary in a more dollars saved than borrowed. Lower interest rates mean recovery, and anti-deflationary in a slowdown. Furthermore, it lower interest income for the non-government sector. Thus, it allows the market to determine the government deficit, which is only if the borrower's propensity to consume is substantially automatically sets it at a near "neutral" level. In addition to the higher than that of savers does the effect of lower interest rates 106 107 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY become expansionary in any undesirable way. And history has confidence whatsoever. Yet government "finance" in lira shown this never to be the case. Lower long term rates support was never an issue. Government lira checks never bounced. investment, which encourages productivity and growth. High If they had been relying on borrowing from the markets to risk-free interest rates support those living off of interest sustain spending, as the mainstream presumed they did, they payments (called rentiers), thereby reducing the size of the would have been shut down long ago. Same with Japan - over labor force and consequently reducing real national output. 200% total government debt to GDP, 7% annual deficits, downgraded below Botswana, and yet government yen checks The Role of Government Securities never bounced, and 3-month government securities fund near 0%. Again, clearly, funding is not the imperative. It is clear that government securities are not needed to The U.S. is often labeled "the world's largest debtor." "fund" expenditures, as all spending is but the process of But what does it actually owe? For example, assume the U.S. crediting a private bank account at the Fed. Nor does the government bought a foreign car for $50,000. The government selling of government securities remove wealth, as someone has the car, and a non-resident has a U.S. dollar bank account with buying them takes funds from his bank account (which is a $50,000 in it, mirroring the $50,000 his bank has in its account U.S. financial asset) to pay for them, and receives a government at the Fed that it received for the sale of the car. The non-resident security (which is also a U.S. financial asset). Your net wealth now decides that instead of the non-interest bearing demand is the same whether you have $1 million in a bank account or deposit, he'd rather have a $50,000 Treasury security, which he a $1 million Treasury security. In fact, a Treasury security is buys from the government. Bottom line: the US government gets functionally nothing more than a time deposit at the Fed. the car and the non-resident holds the government security. Now Nearly 20 years ago, Soft Currency Economics was written what exactly does the U.S. government owe? When the $50,000 to reveal that government securities function to support interest security matures, all the government has promised is to replace rates, and not to fund expenditures as generally perceived. It the security held at the Fed with a $50,000 (plus interest) credit goes through the debits and credits of reserve accounting in to a member bank reserve account at the Fed. One financial detail, including an explanation of how government, when asset is exchanged for another. The Fed exchanges an interest the Fed and Treasury are considered together, is best thought bearing financial asset (the security) with a non-interest bearing of as spending first, and then offering securities for sale. asset. That is the ENTIRE obligation of the U.S. government Government spending adds funds to member bank reserve regarding its securities. That's why debt outstanding in a accounts. If Govt. securities are not offered for sale, it's government's currency of issue is never a solvency issue. not that government checks would bounce, but that interest rates would remain at the interest rate paid on those reserve Children as an Investment Rather than an Expense balances. In the real world, we know this must be true. Look at how Anyone who pauses to think about it will realize that our Turkey functioned for over a decade - quadrillions of liras of children are our fundamental real investment for the future. deficit spending, interest rate targets often at 100%, inflation It should be obvious to all that without children, there won't nearly the same, continuous currency depreciation and no be much human life left in 100 years. However, our current 108 109 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY institutional structure - the tax code and other laws and one time this included "the ability to fight a prolonged war incentives on the books - have made our children an expense on two fronts" much like the European and Pacific fronts of rather than an investment. And a lot of behavior most of World War II. Other objectives have included the ability to us would like to see not happen, including deficiencies in strike mostly anywhere in the world within a certain number education, child neglect and abuse and high rates of abortion, of hours with a force of a pre-determined size, to maintain air could be addressed by modifying the incentives built into our superiority and to be able to deliver nuclear weapons against financial system. the Soviet Union and other potentially hostile nations which can direct nuclear weapons at the U.S. and, more recently, Public Purpose to have the capability of using drones to assassinate hostile individuals remotely anywhere in the world. For me, all federal public policy begins and ends with These are all military objectives. Some are general, some public purpose. I begin with a brief list of the functions of very specific. In the United States, they are ultimately political government, all of which comprise what can be called public choices. For me this means the President, as Commander in infrastructure, that in my estimation do serve public purpose Chief, submitting these types of high-level military objectives and should be provisioned accordingly. to Congress for approval, and then working to achieve those The first is defense. It is my strong belief that without objectives by proposing more specific military options to adequate military defenses, the world's democracies (a word accomplish our national goals. The President proposes I'll use for most forms of representative governments) are objectives and what is needed to accomplish those objectives, at risk of physical invasion and domination by nations with and the Congress reviews, debates, and modifies the objectives dictatorships and other related forms of totalitarianism. While and proposals to meet those objectives, and appropriates the democracies will move to defend themselves, in today's resources it decides necessary to meet what it decides best world, it is most often the dictatorships that move militarily serves the nation's military objectives. to attack other nations without the provocation of a military Most of the world's democracies (and particularly those threat. Examples include Pakistan threatening India, North with a U.S. military presence) have, however, come to rely on Korea threatening not only South Korea but others in the the assumption that the U.S. would ultimately defend them. region, Russia supporting military actions against most any Often, though not always, this is through formal alliances. western democracy, Israel under constant threat of attack by This ultimate reliance on the U.S. military has resulted in these all the region's dictatorships and the Taliban attempting to take nations not allocating what would otherwise be substantial control of Afghanistan and disrupt any attempt at establishing portions of their real wealth to their national defense. One representative government. It is evident to me that if the option for addressing this issue would be to meet with the western democracies decided to abandon all defense measures world's democracies and establish what a "fair contribution" they would immediately become subject to hostile invasion on to the U.S. defense effort would be for these nations, and then multiple fronts. Therefore, there is a critical public purpose go so far as to publish a "non defense" pledge for those who being served by allocating real resources to national defense. refuse to contribute their fair share of real goods and services The next step is to set the objectives of our defense effort. At to the common defense. 110 111 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY The 'right sized' defense has everything to do with actual nothing to do with whether the budget is in surplus or deficit. defense needs, and nothing to do with the total expenditures of They use the monetary system which provides no information dollars necessary to meet the nation's defense needs. Nor need for all their information. there any mention of "how are we going to pay for it" as taxes function to regulate aggregate demand and not to raise revenue Inflation! per se. The way we, the current generation, always "pay for I"' is by the real resources - goods and services - that are allocated OK, so the risk of running a deficit that is too large is to the military that could have remained in the private sector not insolvency - the government can't go broke - but excess for private consumption. That real cost includes all the people aggregate demand (spending power) that can be inflationary. serving in the military who could have been working and While this is something I've never seen in the U.S. in my 60- producing goods and services in the private sector for private year lifetime, it is theoretically possible. But then again, this consumption. That includes everything from auto workers to can only happen if the government doesn't limit its spending tennis instructors, lawyers, doctors, and stock brokers. by the prices it is willing to pay, and, instead, is willing to pay The "right size" and "right type" of defense can change ever higher prices even as it's spending drives up those prices, dramatically over relatively short periods of time. China's as would probably the case. capability of shooting down satellites and Iranian medium And now here is a good place to review what I first wrote range nuclear missiles that could threaten our shipping are but back in 1992 for Soft Currency Economics which came out two examples of how the advance of military technology can in 1993: very quickly make prior technologies instantly obsolete. Both objectives and options must be under continuous review, and Inflation vs. Price Increases there can be no let up in advancing new technologies to do all we can to stay on the leading edge of military effectiveness. Bottom line, the currency itself is a public monopoly, which About 10 years ago I was discussing the military with a means the price level is necessarily a function of prices paid member of the Pentagon. He said that we needed to increase by the government when it spends, and/or collateral demanded the size of the military. I said that if we wanted to do that we when it lends. The last part means that if the Fed simply lent should have done it ten years ago (1990) when we were in without limit and without demanding collateral we would all a recession with high unemployment and excess capacity in borrow like crazy and drive prices to the moon. Hence, bank general. Back then, with all that excess capacity, a build up of assets need to be regulated because otherwise, with FDIC- the military would not have been taking as many productive insured deposits, bankers could and probably would borrow like resources away from the private sector as it would have done crazy to pay themselves unlimited salaries at taxpayer expense. during a period of full employment. He responded, "Yes, but And that's pretty much what happened in the S & L crisis of back then we couldn't afford it, the nation was running a budget the 1980's, which also helped drive the Reagan boom until it deficit; while today with a budget surplus, we can afford it'. was discovered. Much like the sub prime boom drove the Bush This is completely backwards! The government never has nor expansion until it was discovered. So it now goes without saying doesn't have any dollars. The right amount of spending has that bank assets and capital ratios need to be regulated. 112 113 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY But let's return to the first part of the statement - "the price higher inflation. To say this policy is problematic is a gross level is a function of prices paid by govt. when it spends." understatement, but no one seems to have any alternative What does this mean? It means that since the economy needs that's worthy of debate. the government spending to get the dollars it needs to pay All the problematic inflation I've seen has been caused taxes, the government can, as a point of logic decide what it by rising energy prices, which begins as a relative value wants to pay for things, and the economy has no choice but to story but soon gets passed through to most everything and sell to the government at the prices set by government in order turns into an inflation story. The "pass through" mechanism, to get the dollars it needs to pay taxes, and save however many the way I see it, comes from government paying higher dollar financial assets it wants to. Let me give you an extreme prices for what it buys, including indexing government example of how this works: Suppose the government said it wages to the CPI (Consumer Price Index), which is how wasn't going to pay a penny more for anything this year than it we as a nation have chosen to define inflation. And every paid last year, and was going to leave taxes as they are in any time the government pays more for the same thing, it is case. And then suppose this year all prices went up by more redefining its currency downward. than that. In that case, with its policy of not paying a penny It is like the parents with the kids who need to do chores more for anything, government would decide that spending to earn the coupons they need to pay the monthly tax to their would go from last year's $3.5 trillion to 0. That would leave parents. What is the value of those coupons? If the parents the private sector trillions of dollars short of the funds it needs pay one coupon for an hour's worth of work (and all the to pay the taxes. To get the funds needed to pay its taxes, prices work is about equally difficult and equally "unpleasant"), would start falling in the economy as people offered their then one coupon will be worth an hour's worth of child unsold goods and services at lower and lower prices until they labor. And if the children were to exchange coupons with got back to last year's prices and the government then bought each other, that's how they would value them. Now suppose them. While that's a completely impractical way to keep prices that the parents paid two coupons for an hour's worth of going up, in a market economy, the government would only work. In that case, each coupon is only worth a half hour's have to do that with one price, and let market forces adjust all worth of work. By paying twice as many coupons for the other prices to reflect relative values. Historically, this type of same amount of work, the parents caused the value of the arrangement has been applied in what are called "buffer stock" coupons to drop in half. policies, and were mainly done with agricultural products, But what we have is a government that doesn't whereby the government might set a prices for wheat at which understand its own monetary operations, so, in America, the it will buy or sell. The gold standard is also an example of a seven deadly innocent frauds rule. Our leaders think they buffer stock policy. need to tax to get the dollars to spend, and what they don't Today's governments unofficially use unemployment tax they have to borrow from the likes of China and stick as their buffer stock policy. The theory is that the price our children with the tab. And they think they have to pay level in general is a function of the level of unemployment, market prices. So from there the policy becomes one of not and the way to control inflation is through the employment letting the economy get too good, not letting unemployment rate. The tradeoff becomes higher unemployment vs. get too low, or else we risk a sudden hyperinflation like the 114 115 WARREN MOSLER SEVEN DEADLY INNOCENT FRAUDS OF ECONOMIC POLICY Weimar Republic in Germany 100 years or so ago. Sad but an inflation story, at least initially, which then becomes an true. So today, we sit with unemployment pushing 20% if inflation story as the higher imported costs work their way you count people who can't find full-time work, maybe 1/3 through our price structure with government doing more of our productive capacity going idle, and with a bit of very than its share of paying those higher prices and thereby modest GDP growth - barely enough to keep unemployment redefining its currency downward in the process. from going up. And no one in Washington thinks it's unreasonable for the Fed to be on guard over inflation and ready to hike rates to keep things from overheating (not that rate hikes do that, but that's another story). And what is the mainstream theory about inflation? It's called "expectations theory." For all but a few of us, inflation is caused entirely by rising inflation expectations. It works this way: when people think there is going to be inflation, they demand pay increases and rush out to buy things before the price goes up. And that's what causes inflation. What's called a "falling output gap," which means falling unemployment for all practical purposes, is what causes inflation expectations to rise. And foreign monopolists hiking oil prices can make inflation expectations rise, as can people getting scared over budget deficits, or getting scared by the Fed getting scared. So the job of the Fed regarding inflation control becomes managing inflation expectations. That's why with every Fed speech there's a section about how they are working hard to control inflation, and how important that is. They also believe that the direction of the economy is dependent on expectations, so they will always forecast "modest growth" or better, which they believe helps to cause that outcome. And they will never publicly forecast a collapse, because they believe that that could cause a collapse all by itself. So for me, our biggest inflation risk now, as in the 1970's, is energy prices (particularly gasoline). Inflation will come through the cost side, from a price-setting group of producers, and not from market forces or excess demand. Strictly speaking, it's a relative value story and not 116 117