"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Monday, January 3, 2011

The US Debt Ceiling and Modern Monetary Theory

From Bloomberg: 
Austan Goolsbee, chairman of the U.S. Council of Economic Advisers, said if Congress fails to raise the debt ceiling, the “impact on the economy would be catastrophic.” 
“I don’t see why anybody’s playing chicken with the debt ceiling,” Goolsbee said today on ABC’s “This Week” program. “If we get to the point where we damage the full faith and credit of the United States, that would be the first default in history caused purely by insanity.”

Austan Goolsbee is right - up to a point.  Either politicians don't understand our monetary system, or they are risking an immediate deflationary collapse of the US economy in order to score points with an economically ignorant constituency.  The United States, thru Congress, has a self imposed debt ceiling that has been moved up higher multiple times since its inception in 1917.  The debt ceiling is a construct of the gold standard era, when government spending and the price of gold were managed together.  Today, however, it is a political hot potato that no politician wants to be seen holding for long.

But if we look to Modern Monetary Theory (MMT), the debt ceiling should not be something to be concerned about in times of severe economic and credit contraction.  However, our trading partners may think otherwise.  MMT sounds like a great way to manage a monetary system when viewing the domestic economy, but viewed globally, trading partners and the market in general, ultimately decide the value of a currency.  Thus China is increasingly entering into non-dollar denominated trade agreements, and the role of the US Dollar, as reserve currency, is diminishing.  Furthermore, the currency wars are still ongoing, as well as  the institution of capital controls.  These cannot be ignored in my opinion,  They are a direct result of the US's management of the US Dollar.

But back to the debt limit, and why it is important that it should be raised.  Money is created by both lending in the private sector, and by government spending.  If the money supply is contracting, a deflationary force begins to grow, impacting the ability of people and companies to service their debts.  Debt defaults commence, and a feedback loop of  money destruction begins.  This is what worries those that understand our monetary system today.  An economy, unlike a private person,  can not be told to cut spending to "balance the budget."  If a person gets a pay cut, he must cut down his expenses.  But if an economy gets a cut in the money supply, a debt destruction spiral begins as less money is available to pay the growing interest in an economy.

As I said earlier, money is created by the private banking sector's generation of loans (out of thin air) and Government Spending via the relationship between Congress, the Fed and the Treasury.  So we must ask ourselves, how strong is private credit growth?  Let's look at some charts:

(click on charts for larger image)

Pretty scary, right?  The last chart tells us this global to a large degree.  But here's the other issue:  As money is created in the current environment, there is a diminishing rate of return on every dollar created:

And GDP has been growing at a much slower rate than the total debt and corresponding interest payments.  And so, the US Government, through deficit spending, and the Federal Reserve, thru QEx, where "x" is the latest version of electronic money creation, need to both step in to pick up the slack.

Nonetheless, people need to understand that the government's actions, although contributing to a small bump in GDP growth, are mostly successful in delaying an inevitable collapse and not creating a sound, organically growing economy.

I know that MMT'ers believe in the sound stewardship of money, and they too disagree to a large extent with the bank bailouts.  But their theories rely on political, fiscal, and monetary leadership that does not exist in the real world.  And they, like modern Keynesians and Monetarists neglect to understand the role of credit in a purely fiat system that never allows debt to be truly extinguished.  Debt between nations under a gold standard was truly extinguished.  Gold, unlike government bonds, settled accounts in a way that extinguished debt completely.  Today's fiat is always born of debt and allows both debt and trade imbalances to accumulate to such a degree that only collapse is the inevitable and unavoidable endgame.

And so, the debt must grow.  It is the only option we have left that allows us to continue this charade of "wealth creation" and maintaining the status quo.  At this point, to be honest, if I were a politician, I would be doing the same thing.  The masses are too economically ignorant.  And to force a depression, or to force a tumultuous change in the monetary system for a better future would be an act of political suicide.  My only contention is that our current leaders are still selling out to the same vested interests that to a large degree, caused this crisis.  Whereas basic mathematics tells us the system needs to grow until it collapses by itself, morality does not have to be ignored.   Who gets the money and why has been a major issue for me.  Whereas the top 1% have prospered in this crisis, the bottom 90% has felt the most pain.

My next post will be on the three things to watch for 2011:  The Ten Year Treasury Yield, the Price of Oil, and the Price of Gold.   These are the three canaries in the coal mine, and so far, they are not looking too healthy, that is, their costs are rising.  This tells me that a major crisis is brewing for 2011.


Jim Slip said...

Heh, I'm still trying to digest MMT. While on the lookout for information on the web, I came across this blog:


The guy is obviously a proponent of MMT, Australian (afaik Australia has a trade deficit, but not an account deficit, thanks to their mining industry and the surge in commodity prices, and yes, they do issue their own free-floating currency).

The main reason I'm posting this article is because it tackles a very intriguing point of MMT, that of vertical and horizontal transactions. The article makes the point that private credit is leveraging of vertical transactions, with no new net financial assets being created. Only vertical transactions do that. Here is an interesting excerpt:

"Credit money (say, a bank demand deposit) is an IOU of the issuer (the bank), offset by a loan that is held as an asset. The loan, in turn, represents an IOU of the borrower, while the credit money is held as an asset by a depositor. On this view, money is neither a commodity (such as coined gold), nor is it ‘fiat’ (an asset without a matching liability)."

Anonymous said...

How sick is our world?
When property prices are expected to go higher just because a 20-nothing buys a house, when that city is waiting for her as for a Messiah just because she’s the daughter of palin and has been in that stupid dwts … then you know we are doomed.

Misthos, your MMT articles are very good, they explain the whole flaw we are in and how unsustainable the financial world has become. Due to MMT that was in the fabric and “they” knew it from the very beginning.

I’ve read today also golemxiv’s expectations for this year and just like last year same time I should think the fraud pyramid is about to break down. This year I don’t. Much worse, I think we, people on the edge are the first.

That “Spiegel” article is worrying for the EU. I smell a conditioning campaign overall in MSM. It's not real information, it's conditioning or confirmation for old "conspiracies" becoming reality. Everyday we become a little more slaves and serfs. We know nothing about where they want to bring us to, nothing. We try to guess. We are on the hook with our future, we only might still have hopes, but if they are to become true? Anyway, living in this environment is a punishment.

Misthos said...

Fauvi, I touched upon some of your points on today's post.

I think the reason the world is so unbalanced is that most people have no idea how it functions; how are monetary system works. And so they are vulnerable.

But my biggest fear is that we are past the point where even the elites have control. The system will mathematically self correct, one way or another, despite policymakers' actions.

Misthos said...

Jim, I just had your comment posted, unfortunately it was originally tagged as spam, and I was just aware of it.

I'll look at the link you posted - it looks very interesting.