* This post was written in 2011 before Mr. Roche founded Monetary Realism, a post-MMT school that was formed due to several disagreements Mr. Roche and many other former MMT proponents had with the school of thought. For more info on the difference in views please see here. For more on MR’s views please see here.
Some pundits are unhappy with the Oracle of Omaha’s proclamation that a debt crisis is not an issue for the USA. They reference the following comments from a few weeks ago and cite the comments as “silly talk”:
“The United States is not going to have a debt crisis as long as we keep issuing our debts in our own currency. The only thing we have to worry about is the printing press and inflation.”
And when someone starts claiming that Buffett is talking “silly” you should probably start wondering who is actually being silly because, as Buffett likes to say, “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.” I can assure you of two things – this MarketWatch article will take you less than half an hour to read and Warren Buffett is not the patsy in it.
The article uses all the same misconceptions that are common in the media today. In some form, they argue that the USA, being just like a household, is fiscally constrained and must maintain its balance sheet in the exact same way that a household or business would. Of course, this is totally illogical because the USA is a sovereign currency issuer with an endless supply of currency in a free floating exchange rate system. Households, businesses, US states and EMU members are all constrained in their ability to spend because they are all currency users. They must always collect revenues or amass debt before they can spend. The USA works in the exact opposite way. As a currency issuer, the US government can always procure funds so it has no solvency constraint.
Now, an interesting aside arose the other day during my conversation regarding Austrian economics (feel free to skip the next two paragraphs if you were not involved in the Austrian debate as it is a minor tangent). A very astute commenter noted that the Fed could provide reserve balances with which the private sector can save. In other words, the government need not deficit spend in order for the private sector to save. That’s all well and good, however, it is not realistic. We did not create a government so that the Federal Reserve could feed its various minions with reserve balances. We created a government because we believed that this supra entity could provide some public purpose.
As highly social pack animals, it’s not surprising that we form large united groups that work to generate some public purpose. In establishing these supra entities we establish ways in which the members of these societies can interact in attempts to achieve greater prosperity by leveraging the abilities and knowledge of the entire group. In modern times, that has always involved a common currency and some level of public spending by the supra entity on these various public works. Spending necessitates taxation. And the tax system in a modern fiat government is the glue that binds. But in order to tax this government must first name the thing that can be used for tax payments and it must actually create these notes. So, while it’s technically correct that a government need not spend in order for the private sector to save, it is not realistic because reality shows that governments exist for specific reasons and they therefore spend for specific reasons. Removing the government from the equation and concluding that the private sector can still save because of the Federal Reserve is not based in any sort of reality.
But I digress. The article cited several “experts” on the history of debt. Of course, the king defaultista, Niall Ferguson was trotted out to show how “silly” Buffett is:
[Buffett] “must know this is nonsense.” Ferguson continues, “Britain had complete monetary sovereignty in the mid-1970s and yet the IMF had to be called in. I could give numerous other examples. And then there is the inflation risk, which is implicit in his statement. We won’t have a debt crisis because we can print unlimited quantities of paper dollars. If that’s the good news, I don’t want to hear the bad.”
Now, it’s helpful to put things in perspective. Ferguson has been predicting the demise of the US empire for well over a decade. In a 2003 working paper he said the following:
“So what will happen? And when? The answers to both these questions depend on how quickly Americans wake up to fiscal reality. Perhaps the hardest thing to figure out is why they haven’t done so already. Even financially sophisticated Americans seem not to appreciate the fragility of the country’s fiscal position.”
He went on to discuss how the bond market would one day awake and yields would surge and catastrophe would strike:
“A widening gap between current revenues and expenditures is usually filled in two ways. The first is by selling more bonds to the public. The second is by printing money. Either response leads to a decline in bond prices and a rise in interest rates – the incentive people need to purchase bonds.”
There’s a reason why Ferguson writes books, teaches and doesn’t run a fixed income trading desk – he could have blown up several hedge funds betting against US government bonds since 2003. And yes, it is important to point out these horrible calls because someone who has been wrong as long as Ferguson must reconsider their thesis or be shunned by the investing public. Being right matters in this world. Particularly when we are discussing matters that influence millions of people. This is not a joke to me and should not be a joke to anyone else. And frankly, we should all be sick and tired of people who trot out the same old tired arguments year after year and fool people into buying their new book. We are talking about people’s lives so if you’re going to spend the better part of a decade being wrong you should do everyone a favor and either alter your thesis, stop pretending to be an expert in these matters or start writing books on different subjects.
But despite being wrong about the collapse of America and its inevitable bankruptcy for a decade now, Ferguson’s points are not entirely without merit. As Britain proved, a monetarily sovereign government can choose to go bankrupt or accept aid from an outside entity. The USA could choose to default on its debt tomorrow if it wanted to. The game of chicken that is currently being played with the debt ceiling should make that clear. But that’s a political choice and not an operational choice. Only the USA can issue dollars and because our debt is entirely denominated in the currency that we have endless supply of it is operationally impossible for the USA to default on its debt in the same way that a household, state, business or EMU country can. It is an irrefutable fact that the USA cannot run out of the dollars that only it can produce.
But as Buffett pointed out, the government can cause horrid inflation by spending in excess of productive capacity. This clearly isn’t the case currently. Core inflation is just 1.3% and the headline figure is just 3.1%. And almost the entire spread over core is due to motor fuel prices. To blame the USA’s below trend inflation (yes, below trend even with near record high gasoline prices) on spending policies is simply misleading. In addition, the US money supply is not growing above trend (see here for proof) so all of the fear mongering about Fed “money printing” has turned out to be flat out wrong.
As for hyperinflation - I have studied the history of hyperinflations and written extensively on it. Hyperinflation is a uniquely psychological event that results in complete rejection of the sovereign currency. It primarily occurs during a regime change. Is hyperinflation a risk currently? I would put the odds at slightly higher than 0%. There is very little in the current environment in the USA that is consistent with past cases of hyperinflation.
Next up was “pre-eminent scholar of monetary policy”, Allan Meltzer who brought out another classic fear mongering point:
“We can have a crisis if the Chinese or Japanese start selling their mountains of dollar debt, or if the dollar collapses instead of declining, and if we get a big inflation.”
This is beyond misleading. China accumulates dollars reserves because they choose to run a FX peg with the USA and a trade surplus. By definition, their central bank accumulates dollar reserves because of this. There are only a few things China can do with their dollar reserves. They can let them sit in the equivalent of a checking account collecting dust. Or they can buy USD denominated assets. Now, they can try to buy Chevron again, but we all know how that ended up. Instead, they choose to buy interest bearing paper in the form of US Treasuries. The USA doesn’t need China to buy treasuries. Their purchases don’t “fund” anything. We don’t call China before we sell bonds and make sure that they are there to buy. China gets pieces of paper with old dead white men on them in exchange for real goods and services. If they choose to stop accumulating these pieces or paper then they need to dramatically alter their domestic economic policy. Ironically, most of the people who argue that China is manipulating their currency are the same people saying that we need China to buy our bonds….And as for China selling? Well, who are they going to sell to? And why would they do anything that might be to the detriment of the trade partner that they willingly choose to rely on for much of their economic growth? As you cans see, the fear mongering doesn’t add up when you think about it all rationally.
Next up is Desmond Lachman of the conservative American Enterprise Institute who cites the good old bond vigilantes:
“If the markets think that the U.S. public debt situation is out of control,” he says, “and that the Fed is going to print money to inflate the U.S. out of its debt problems, blood will be spilt in the bond market as people dump Treasuries until interest rates rise very high to compensate them for the inflation risk. That will be disastrous for the stock market and for the U.S. economy.”
Ah yes, those beloved (and very sleepy) bond vigilantes. For some perspective on how dreaded these vigilantes are we should reference the recent history of long bond yields:
Long bond yields are a function of Fed policy and inflation. As previously mentioned, core inflation is hardly a concern and the Fed remains at 0%. I won’t bore readers with the mechanics of the bond market, but let’s just all agree that, at 3.1%, these vigilantes sure are bad at their job. Actually, they’re quite good because they’ve correctly predicted that high inflation and government default are low probability events currently.
Senator Alan Simpson, who co-chaired the bipartisan debt commission is later quoted in the piece saying:
“It won’t be the old slippery slope crap that we read about,” he said. “It’ll be very swift and very dramatic, like in Greece or Ireland or Portugal or Spain or wherever. I don’t know where this is going, but I tell you, it won’t take long.”
It’s amazing that this man was running the debt commission. He doesn’t even understand the difference between the EMU and the USA. The EMU nations are the functional equivalents of the US states – they are currency users! Yes, they are revenue constrained and yes, they are susceptible to debt crisis. But comparing the USA to the nation of Greece is entirely illogical and misleading. Just because they are both countries doesn’t mean they are equivalent in terms of their monetary systems. This sort of mistake speaks magnitudes about the state of our current leadership. The people in the very highest offices are making the simplest of mistakes when it comes to understanding our monetary system. It’s no wonder the country is such an economic mess currently….Unfortunately, most of this stuff is such high finance that we could never expect the average citizen to understand it to any extent that they would actually get upset and demand change. So people like Alan Simpson continue to influence policy.
Next up is Laurence Kotlikoff of Boston University (who co-authored the inaccurate working paper from above with Niall Ferguson). He says:
“On the face of it,” he says, “his statement is true right up to the point that it’s not. That is to say, we have some capacity to borrow, but it is not unlimited and the market will shortly make that clear, in my opinion.”
He wrote the same exact thing in 2003. Again, there’s a reason why Kotlikoff isn’t running a fixed income trading desk. Kotlikoff clearly believes that the bond market funds our spending. And he clearly doesn’t understand the mechanics of the bond market. If he had understood this in 2003 he would have never written such comments. Since he’s writing it today it’s clear that he still doesn’t understand.
The article concludes by demanding that Warren Buffett elaborate on his comments and explain why he is not wrong:
“With the debt stakes so high, Warren Buffett owes it to his legion of admirers and the public at large to explain more fully what he means in saying categorically, “the U.S. is not going to have a debt crisis.”
Warren Buffett doesn’t owe anyone anything. What the American public owes to itself is to learn how our monetary system actually works. And these academics and policymakers that are cited in the MarketWatch piece owe it to the American public to learn how the system actually works. There is one thing that is helping to destroy this great nation and that is the persistent fear mongering that is constantly peddled by people who are pushing a political agenda based on false perceptions of the US monetary system. This environment of perpetual fear is helping to scare the greatest entrepreneurs in the world from doing what they do best. In the meantime, the rest of the world is eating our lunch.
All of this fear mongering is misguided, but helping to do one thing well – cause the currency users to fear the economy they exist within. And therein lies the most interesting component of this entire debate. These misguided fears could be the very thing that threaten this country the most. It’s time for Americans to stop being scared by old rich white men selling books and newsletters. And if we had a leader who understood all of this he/she would stand up in public and tell the American citizenry that they have nothing to fear but fear itself. Unfortunately, that leader doesn’t exist.