The Most Dangerous Idea

Bob Seawright’s excellent post on the Most Dangerous Ideas got me thinking – what really is the most dangerous idea in finance and economics today?   In my opinion, this is an easy one.  The most dangerous idea in the USA is this idea that the USA has “run out of money” or that our government cannot afford to do certain things.  I’ve explained this many times before, but this is a myth that just won’t die.  Here’s my previous explanation as to why the myth of government insolvency is indeed dangerous:

“The USA has an institutional arrangement in which it is a contingent currency issuer. That is, while the Treasury is an operational currency user (meaning it must always have funds in its account at the Fed before it can spend those funds) it has the extraordinary power to tax and issue risk free bonds that the public will always desire to hold so long as inflation is not extraordinarily high. In addition, even in a worst case scenario, the US Treasury can always rely on the Federal Reserve to supply the funds necessary to fund its spending.  Therefore, the US government can be thought of as a contingent currency issuer who can issue the funds to spend.  This makes it very different from a household.”

It’s just impossible for the US government to run out of money.  In fact, the real threat in the USA is not running out of money, but creating too much money!  In other words, when politicians talk about the debt ceiling and how we “can’t afford” this or that they’re getting everything backwards.  Now, it’s important to get the context of this discussion correct.  When I say that the USA can’t run out of money I am not saying that the government can just spend money like crazy or that there is no constraint at all.  I am just saying that the US government’s printing press doesn’t ever break (which should be rather obvious).  Here’s the most crucial piece:

“Of course, this means the constraint for the government is different from that of a household or business who can really “run out of money”.  The US government’s constraint is not that it will run out of funds, but that it could supply too much liquidity to the private sector thereby causing inflation.  So the US government’s real constraint is inflation and not solvency.  This is a vastly different issue than the one the US media usually harps on with regards to the budget deficit and the US government’s ability to “afford” its spending.”

I don’t know about you, but the data seems to confirm that inflation is not very high and aggregate demand is way too low.  If anything, the government could run much higher budget deficits (for instance, by cutting everyone’s taxes) and while that might induce some inflation, it might also put more money in people’s pockets which would help generate higher corproate revenues, more hiring and a stronger overall economy.  What a tax cut won’t do is cause us to eventually “run out of money”.  But Congress sure thinks it will.  And that’s a dangerously misguided understanding of the monetary system we have.

 See also:

Stop with the Money Printing Madness

Understanding the Modern Monetary System