Response to an email

I received an email a short while ago and I thought it would be instructive to share my reply comments. The email was from a reader of this blog who asked me to deconstruct one economist's points regarding stimlulus and gov't spending.

You asked how the current economic policies would affect you. A very quick answer is lower wealth. The stimulus spending is matched dollar for dollar by government borrowing, with the Treasury issuing Treasury securities. When these securities mature the government has 3 ways to pay the due money to security holders: 1) pay with tax receipts (You will have higher taxes) 2) pay by borrowing the money again (the private sector will be reduced as gov’t borrowing dominates the credit markets, raising interest rates and slowing private sector growth – meaning companies will have fewer profits, as well) 3) printing money (triggering inflation, causing decline in value of the dollar on international markets, and depleting the value of money holdings that you have.) The expansion in government and government control over the private sector is unprecedented. The private sector will grow more slowly as gov’t takes on more control and bigger size. Much of what Obama is doing is redistributing wealth for “fairness” or “justice” and he is much less concerned with economic growth as we have historically known it in this country. Free markets and free people also go hand in hand. Gov’t control expansion and lessening of freedom go hand in hand. That is the short explanation.

My comments:

Dear...

As usual, this guy is totally out-of-paradigm and wrong on every point he makes.

Deficit spending leads to higher wealth of the non-governmental sector by definition, as the non-governmental sector will end up holding more assets in the form of Treasuries. Assets minus liabilities equals net worth, or wealth, so if the amount of assets the public holds increases due to deficit spending, the public becomes wealthier by the amount of the deficit.

Only the deficit is said to be financed with borrowing (and even that is not really true).

The government spends by crediting bank accounts, which is done by a simple keystroke on the Treasury's spreadsheet. Spending is ongoing, so again, by defition, it is done before the sale of securities or the payment of taxes. The money to buy securities and pay taxes comes from government spending. Think of the game of Monopoly. If you land on "Community Chest" and it tells you that you have to pay a tax, you pay with money that was distributed by the game. In essence you gave back some of the game's money. Same with the way our system works. Furthmermore, because the government spends this way and since the Federal Gov't is the monopoly issuer of non-convertible currency it is not limited in how much it can spend.

The government pays for redemptions and/or the principal or interest on its debt the same way it pays for everything else: by crediting bank accounts. Thus, there is never a problem in meeting a redemption or paying principal and interest--at any interest rate!

The sale of Treasuries is not borrowing per se. It is designed to support an interest rate that the Fed chooses. Selling securities is how the Fed and Treasury manage the level of reserves in the banking system and the level of reserves determines the interest rate.

Taxes can either add fiscal drag or throttle it back, depending on whether taxes are increased or decreased. The government requires payment of taxes in its own currency, and that is what gives the currency value. Even if you don't owe taxes someone else probably does so most of the public naturally wants to hold some government money. However, the government's money is not the only money we have in our economy. There are many other forms of "private sector" money, like checking accounts and other demand deposits and all sorts of bank credit and private credit, which, by far, comprises most of what we call money.

Interest rates are a parameter set by the central bank. Period! That should be obvious to everyone by now. The Theory of Loanable funds (what he uses as the basis for his argument that government spending causes interest rates to rise) is just that--a theory--and it's wrong!

Free markets are a fallacy. What we have are competitive markets. All nations employ policy of various sorts to gain competitive and comparative advantage. In the U.S. we have always had taxes, regulations, tarriffs and other, public policy initiatives with economic goals, over-arching the market, as do other nations. Moreover, large corporations routinely dominate their markets by virtue of their size, making the idea of perfect competition nothing more than a quaint, yet inapplicable, ideal.

If he is talking about the growth of spending crowding out the private sector then he ought to look at the facts. In 1946 gov't spending was $36 billion annually, today it's approaching $4 trillion, yet interet rates are lower, we use less of our industrial capacity, 12 million people are unemployed, 5 million homes sit unsold, 3 million vehicles are waiting for buyers, people can't get health care even though the services are available to them, families can't send their kids to college even though there is room for them. In short, despite an 11,000% increase in government spending over the past 63 years, we still are not using all the wealth-producing capital--both real and human--that we have in this country.

-Mike