Aftermath

by James Rickards

  Mainstream economists, prominently Nobel Prize–winners Paul Krugman, formerly of Princeton University and now at the City University of New York, and Joseph Stiglitz of Columbia University, were scathing in their attacks on Reinhart and Rogoff. They claimed the failure to use more fiscal stimulus, really deficit spending, would not only hurt growth in the short term, but would lead to long-term losses as temporary unemployment segued into structural unemployment due to lost skills and lost connections to the workplace.

  Other views emerged. Economist and Keynes biographer Robert Skidelsky neatly summed up the main lines of thought following the financial crisis:

  After the immediate threat of a depression was averted, economists vigorously debated the merits of withdrawing stimulus so early in the recovery.10 Their arguments, which can be broken down into four identifiable positions, open a window onto the role that macroeconomic theory played in the crisis. Those in the first camp claimed that fiscal austerity—that is, deficit reduction—would accelerate the recovery in the short run. Those in the second camp countered that austerity would have short-run costs, but argued that it would be worth the long-run benefits. A third camp, comprising Keynesians, argued unambiguously against austerity. And the fourth camp maintained that, regardless of whether austerity was right, it was unavoidable, given the situation many countries had created for themselves.

  The first view suggests austerity produces short-run benefits through a confidence boost—if private citizens saw governments acting prudently on fiscal policy, they would have greater confidence in the future and begin to invest, borrow, and spend more. While appealing, there was little empirical evidence to support this view. Certainly, the experience in Europe, where fiscal stimulus was reduced and economic contraction resumed not long after the crisis, tended to negate this hypothesis. In any case, this view was quickly abandoned by all but a few scholars.

  The second view is the one espoused by Reinhart and Rogoff. They do not reject the idea that efforts to rein in runaway spending might slightly reduce growth in the short term. Their point is that failure to reduce deficits is almost certain to create a wealth gap—the difference between actual and potential growth—that will grow in a nonlinear fashion and leave society substantially poorer over time. In extreme cases, hyperinflation, outright debt defaults, currency collapses, and social disorder are in the cards.

  The third view is the neo-Keynesian dogma of Krugman, Stiglitz, Brad DeLong of UC Berkeley, and most mainstream economists. This view says if growth is below potential because of lack of aggregate demand, it is the duty of government to fill the demand gap with government spending. Resulting growth relative to austerity will have multiplier effects and eventually return a country to trend growth. Resulting government debt will be manageable because increased growth expands the denominator of the debt-to-GDP ratio. It’s not that debt will go down, it’s that growth will be sufficiently robust to make added debt sustainable.

  The fourth view is more conclusory than analytic. It looks to markets rather than economic theory. If the market will not refinance your maturing debts, then austerity, either voluntary or involuntary, is the only possible outcome. On this view, it is better for countries to manage an austerity process on a voluntary basis than have austerity imposed in a disorderly way by creditors. This view certainly applies to individual cases where the borrower has no access to further credit. Yet where the IMF, EU, or a central bank printing press are on call to bail out an insolvent nation, forced austerity by creditors can be averted with or without voluntary austerity by the debtor. Policy choices and outcomes then become more political than economic. As Skidelsky frames it, the policy debate really does come down to Krugman-Stiglitz versus Reinhart-Rogoff, with their respective supporters and peers cheering them on.

  In an open letter to Paul Krugman dated May 25, 2013, Reinhart and Rogoff took on their toughest critic with a nuanced reply to Krugman’s prior ad hominem attacks.11 The Reinhart-Rogoff open letter begins with an observation that the global debt situation today is unprecedented in history. It’s true the United States had debt-to-GDP ratios at the end of the Second World War slightly higher than today’s level. Yet the rest of the world was not nearly as indebted; in fact, the destruction wrought by the Second World War and the elimination of debt owed by vanquished powers such as Nazi Germany and Imperial Japan created ample scope for productive investment and high growth in defeated countries.

  In addition, the U.S. had bonded debt, but did not have the enormous contingent liabilities we have today for Medicare, Medicaid, student loans, Social Security, veterans’ benefits, farm credit, housing credit, and the myriad programs the United States funds outside the formal government budget. The United States has an astounding $37 trillion of unfunded pension liabilities coming due over the next few decades. If these and other contingent liabilities were added to bonded debt, the U.S. debt-to-GDP ratio would be over 1,000 percent, not the 120 percent recorded at the end of the Second World War.

  Reinhart and Rogoff make the point that almost all debt owed by the United States at the end of the Second World War was owed to its own citizens and banks. Today, over 15 percent of U.S. debt is owed to foreign countries including China, Taiwan, and Japan. These foreign holders are likely to be more aggressive than U.S. citizens and banks at diversifying out of U.S. debt and not rolling over maturing debt if they have doubts about U.S. willingness to pay or the prospects for inflation. In short, U.S. and global debt has never been greater and the debt structure never more unstable.

  The debate between the Krugman-Stiglitz view and the Reinhart-Rogoff view will rage on for years inside academia. Meanwhile, in the real world, the effects of excessive debt are impossible to ignore. Reinhart and Rogoff point to two possible outcomes of the current unsustainable debt situation. These two outcomes correspond to T. S. Eliot’s bang and whimper paths.

  The bang point is a rapid collapse of confidence in U.S. debt and the U.S. dollar. At best, this means higher interest rates in order to attract investor dollars to continue financing the deficits. Of course, higher interest rates mean larger deficits, which makes the debt situation worse.

  The whimper path consists of another twenty years of slow growth, austerity, financial repression (where interest rates are held below the rate of inflation to gradually extinguish the real value of debt), and an ever-expanding wealth gap. In effect, the next two decades of U.S. growth would look like the last two decades in Japan. Not a collapse, just a slow, prolonged stagnation.

  Eliot was candid when he told the Saturday Review he did not know how the world would end. Yet his larger point was that it didn’t matter. Both bang and whimper were tragic.

  Modern Monetary Follies

  The oldest joke in academia is that faculty debates are so bitter because the stakes are so small. That punch line sums up the raging crossfire now under way between three schools of economic thought—the neo-Keynesians (NKs), the post-Keynesians (PKs), and the modern monetary theorists (MMTs). If you picture the faculty lounge equivalent of a West Side Story gang fight involving the Jets, Sharks, and NYPD, you’re on the right track.

  The NKs hold the high ground. This is the school that clings most closely to John Maynard Keynes’s original concepts of aggregate demand, sticky wages, and the importance of government deficits to boost demand when consumers are in a liquidity trap, hoarding cash and refusing to spend. The NKs emerged immediately after Keynes’s death in 1947 under the leadership of Paul Samuelson at MIT and John Hicks at the London School of Economics. In recent decades, the NKs have updated Keynes to incorporate monetarism as developed over the twentieth-century first by Irving Fisher then later by Milton Friedman of the University of Chicago. This blending of neo-Keynesian and monetarist ideas is called the neo-Keynesian consensus, (sometimes the “new neoclassical synthesis”). This new synthesis of Keynesians and monetarists agrees that market failure is real, yet disagree on whether the remedy of government intervention makes matters worse. The
NK’s most important political victory in recent years was the $831 billion stimulus spending program of “shovel-ready” projects pushed through Congress in February 2009 in response to the global financial crisis. It turned out to be the latest in a long line of stimulus failures. In addition to Paul Krugman, prominent NKs today include Larry Summers and Brad DeLong. When pundits and politicians refer to mainstream economics, they’re referring to NKs.

  The main rival gang to the NKs are the PKs. Post-Keynesians also built on a foundation laid by John Maynard Keynes, with important differences, and a rejection of some Keynesian tenets. The PKs branched off from the NKs in the mid-1970s, around the same time Keynesians joined forces with monetarists. PKs agree with NKs on aggregate demand and the need for government spending, yet PKs are more progressive and focused on income inequality and worker-friendly policies. They reject the idea that the economy is an equilibrium system that tends toward full employment and that sticky wages are the main impediment to full employment. Instead they call for an aggressive use of monetary policy, especially low interest rates to finance more government spending, as a solution to unemployment, low wages, and weak demand. Prominent PKs include Joan Robinson, Paul Davidson, and Michal Kalecki.

  The newest and smallest economic cadre are the MMTs. Modern monetary theorists offer a curious blend of progressivism consistent with PK views, but resurrect a pre-Keynesian concept called chartalism, which Keynes himself endorsed. MMTs are a small but ascendant clique. They are gaining attention from mainstream economists, politicians, and the media. The reason for this increased attention is not hard to discern. MMTs offer the world what the world wants most—free money.

  MMTs and PKs are alike in their progressive outlook and emphasis on job creation. They also agree on their point of divergence from the NKs, which is heightened attention to money-creation channels. MMTs and PKs point to the ease with which social problems might be addressed through fiat money alone rather than the fiscal channels favored by the NKs. Yet PKs pay some attention to political and statutory constraints on central bank operations; MMTs do not. As far as MMTs are concerned, the central bank printing press is there for the taking. Any social issue that can be addressed with money should be addressed, because money creation imposes no constraint on government spending.

  PKs recognize the U.S. Treasury has a borrowing and spending function and the Federal Reserve creates money and targets interest rates. The two institutions were created separately and have difference governance. The Treasury and Fed work together in myriad ways. The Treasury has an account at the Fed, the Fed buys Treasury debt with printed money, and the Fed remits profits to the Treasury. The Fed acts as fiscal agent of the Treasury in foreign exchange market operations. Still, the institutions have boundaries to be respected by economists and policymakers. The Treasury does not create money and Treasury spending will be constrained if Congress does not authorize it or if the Fed does not accommodate it with low rates and asset purchases.

  MMTs throw these constraints aside. In effect, MMTs treat the Treasury and Fed as if they were a single entity. The legal distinctions pointed to by PKs (and NKs, when they think about it) are just welds in a complicated plumbing system that flows continuously from end to end. In the modern monetary theory model, the Treasury creates money by spending. When the Treasury spends money it reduces its bank account at the Fed, but increases private sector bank accounts of citizens or companies who are recipients of their spending. In this sense, private sector wealth is increased by Treasury spending. The more the Treasury spends, the richer the private sector becomes.

  Inside the financial plumbing, certain accounting entries are made, but these have no impact on the basic premise that Treasury spending equals money creation and increased private welfare. Treasury spending creates so-called high-powered money, or HPM, by substituting Treasury notes (a form of low-powered credit money) on the Fed’s balance sheet for the HPM formerly deposited in the Treasury’s bank account. The Treasury’s HPM is now deposited in the private bank accounts of the recipients of Treasury spending, such as contractors, consultants, and policy beneficiaries. By combining the Treasury and the Fed, a deus ex machina is created, in which spending is conducted at will and monetized seamlessly. The MMT crew asks rhetorically, “Where would money come from in the first place if the Treasury didn’t spend it?”

  The appeal of this approach is obvious to progressives and politicians alike. MMT devotees are not coy in their claims. One of the leading treatments on the subject is Free Money: Plan for Prosperity (2005) by Rodger Malcolm Mitchell.12 The brightest advocate of MMT is Professor Stephanie Kelton, née Bell, of Stony Brook University. In 2015, Kelton was chief economist for the U.S. Senate Budget Committee minority staff, led by ranking member Bernie Sanders, Socialist from Vermont. Kelton became an economic adviser to the Sanders presidential campaign in 2016. As Sanders gears up his 2020 presidential campaign, Kelton is expected to play a prominent role in shaping his spending and economic platform.

  In the Kelton-Sanders version of MMT, crumbling infrastructure can be fixed immediately by spending money on improvements. The $1.6 trillion mountain of student loan debt impeding household formation and turning the millennials into debt slaves is remedied with debt forgiveness. Unemployment and underemployment can be cured with a guaranteed basic income, in the form of a monthly check sent to every American, with no work requirements or other strings attached. These and other government programs can be funded by Treasury expenditures and debt monetization. Private welfare will be enhanced dollar for dollar, or even more as the benefits of government spending spread to the private sector.

  Kelton is also a portal to the dark side of MMT—the government’s monopoly on violence and willingness to use it against citizens who demur from the fiat dollar fandango. MMT purports to be a new twenty-first-century approach to the problems of government finance and economic growth. In fact, it is old wine in new bottles. MMT advocates admit this by embracing the tenets of chartalism. Georg Friedrich Knapp is considered the father of chartalism, based on his work The State Theory of Money, published in 1924.13 Yet Kelton and other scholars have traced the idea back even further, to Adam Smith’s The Wealth of Nations (1776), and even Plato.14 Old wine indeed. There is no better guide to the definition of chartalism than Professor Kelton herself.

  In a pellucid piece, “The Role of the State and the Hierarchy of Money” (2001), Professor Kelton offers a concise history of chartalism and an overview of its application by economists as diverse as Adam Smith, John Maynard Keynes, and Hyman Minsky.15 Chartalism states that a form of money has value if the state proclaims that money acceptable as payment for taxes. Since taxes are mandatory, enforced by fines and imprisonment for nonpayment, any form of money accepted by the state as taxes must be obtained by individuals so they can pay their taxes. It is this status as acceptable for taxes, not legal tender laws or intrinsic value, that makes a form of money valuable. In Kelton’s words, money is a “creature of the state.” Kelton writes:

  What makes a currency valid as money is a proclamation by the state that it will be accepted at its pay offices; what makes it acceptable to its citizenry is its usefulness in settling these liabilities ….16 [Georg] Knapp explained the process by which a “ticket” or “token” becomes Chartal money:

  When we give up our coats in the cloak-room of a theatre, we receive a tin disc of a given size bearing a sign, perhaps a number. There is nothing more on it, but this ticket or mark has legal significance; it is a proof that I am entitled to demand the return of my coat. When we send letters, we affix a stamp or ticket which proves that we have by payment of postage obtained the right to get the letter carried. (Knapp 1924, p. 31).

  The defining characteristic of a Chartal means of payment, “whether coins or warrants,” is that “they are pay-tokens, or tickets used as a means of payment.” … The cloak-room token and the stamp, like the money of the state, gain their validity by virtue of proclamation.

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p; According to Kelton, your money is like the coat-check ticket because the state says so.

  From this reasoning, Kelton and her ilk expand in all directions. If money is what the state says it is, then anything can be money, including gold. Prior to the late twentieth-century, most state money was gold. Kelton claims gold was money not because of scarcity or utility, but because the state proclaimed it money as a matter of custom more than necessity. Once paper became the object of the proclamation, paper became money and gold fell by the wayside. Today, the proclamation covers digital dollars, which serve just as well as paper or gold.

  Kelton also explains the double-entry accounting behind chartal money. Such money is always an asset and a liability at the same time. A dollar is a liability of the central bank that creates it and an asset of the citizen who holds it. Once a tax obligation arises, that is a liability of the citizen and an asset of the state. The citizen tenders his asset (the dollar) to extinguish his liability (the tax bill). From the state’s perspective, both the liability and the asset are extinguished together when the taxes are paid. As Kelton explains, “the state actually accepts only its own liabilities in payment to itself.”17 This may conjure up an image of a snake swallowing its tail, but it’s really a simple accounting exercise.

  Kelton makes two other points in laying the foundation for MMT. The first is that debt and credit are the same viewed from different perspectives. If the state issues dollars as transfers to citizens, the state is the debtor because dollars are central bank liabilities, and citizens are creditors because they accept and hold the debt. For MMT, money is debt. This is not true if the state proclaims gold to be money, because gold has commodity value independent of the state, but Kelton glosses over this since gold is not proclaimed to be money today.