Why Minsky Matters (part 2)

October 25, 2021

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Here I summarize L. Randall Wray’s description of Hyman Minsky’s theory of the investment cycle, which is the part of his economics most based on Keynes. Keynes and Minsky viewed the investment cycle as an endogenous phenomenon generated from within the economy, not an exogenous phenomenon triggered by external events. As Wray puts it, “it is in the nature of capitalism to cycle due to ‘whirlwinds’ of optimism and pessimism.”

Think macro

Making a shift from microeconomic thinking to macroeconomic thinking is essential for understanding Minsky. This is mainly a matter of avoiding the fallacy of composition, which is the logical error of assuming that whatever is true on the individual level is also true at the aggregate level.

When most people think about building wealth at the individual level, they think about the importance of thrift. People who spend their entire income on current consumption cannot build wealth, but people who save and invest can. But in the aggregate, thrift can work against economic growth, a phenomenon Keynes called the “paradox of thrift.” If all the households in the economy were to become more thrifty at once, businesses would respond to the lack of aggregate demand for their products by running at less than full capacity and employing fewer workers. That would reduce national income and the capacity to build national wealth.

Macroeconomic thinking also has implications for what really drives the economy. In the national accounting, the income side of the economy must balance the spending side, if all forms of spending are included. Everybody’s income is tied to somebody’s spending—if not consumer spending then business investment, government spending, or foreign purchases of our exports. But when income and spending both grow or shrink, which is driving which?

At the personal level, income seems to drive spending, since you don’t usually spend what you don’t have. You can buy things on credit, but how much credit a bank will extend to you also depends on your income. But macroeconomists like Keynes and Minsky argue that spending is what drives income. If businesses don’t spend on the means of production like land, labor and factories, they don’t create income for individual households. Notice also that capitalist enterprises do not just invest from their existing profits. They often borrow to build their businesses, even before they have turned a profit. And they are not necessarily just borrowing from someone else’s income either, since borrowing often involves the creation of money. Capitalist firms, in cooperation with the banking system (and, as we’ll see, with government), function as creators of income and wealth, not just spenders of income. This creative function is not automatic—automatic creativity would be a contradiction in terms—but is subject to endogenous fluctuations, the boom and bust cycles that are endemic to capitalism.

Not surprisingly then, a macroeconomic theory of capitalism must focus on the investment decisions of capitalists!

Investment decisions

Wray’s economics text, coauthored with William Mitchell and Martin Watts, defines investment as the “flow of spending which is devoted to increasing or maintaining the stock of productive capital.” Suppose a firm is considering an investment in new equipment. Minsky argued that the decision to invest depends on a comparison of two prices:

  • The demand price is how much the firm would be willing to pay for the equipment, given the firm’s expectations about how much the equipment would add to future revenues;
  • The supply price is the price the firm would have to pay for the equipment, including the cost of financing the purchase if it is to be made with borrowed money.

If the demand price exceeds the supply price, the firm will normally make the investment. However, the calculation of a demand price depends on expectations of future revenue, which the firm cannot know with certainty. Optimism—a positive business outlook—plays an important role. One firm’s optimism helps create income for others because its spending puts money in the hands of other firms and their workers. In the aggregate, investment is one factor in the determination of overall business profit. Minsky incorporated Michal Kalecki’s macroeconomic theory of profit that derived this result mathematically. In the aggregate, it is investment that drives profits, not profits that necessarily fund or limit investment.

Once an economic expansion begins, what Minsky called the “peculiar circularity of a capitalist economy” can accelerate it. Optimism feeds investment; aggregate investment creates income; income enables consumer spending; spending creates profit; and profit helps maintain optimism. Profit does not automatically lead to more investment, but it does invite firms to infer that they are doing something right, and that more of the same kind of investment may lead to more profit.

Macroeconomics also includes the role of government, and the analysis of profits by Kalecki and Minsky takes that into account. In Kalecki’s profit equation, G – T (government spending minus taxes) is a positive determinant of profit along with I (investment). Think about it. If government spends more than it taxes, that creates more income for the private sector, some of which ends up as profits in the hands of capitalists. What winds up as wages for workers gets subtracted from the profit equation. This is, of course, relevant to Kelton’s The Deficit Myth, which pleads for a macroeconomic understanding of deficit spending. It can have more positive effects than a deficit in your household budget!

From boom to bust

What could possibly go wrong with an economic expansion driven by investment spending and fueled by optimism?

As optimism is validated by increasing profits, firms are tempted to engage in riskier behavior. They continue to invest, even if that means going more deeply into debt. They may reduce their margins of safety, such as the collateral they provide to qualify for financing, the positive net worth they can show on their balance sheet, and the liquid assets they can fall back on if revenues fall short of expectations. As the economy booms, some overoptimistic firms run into trouble and default on their obligations.

Once an economic boom has raised expectations sky high, “…anything that lowers expected future profitability can push today’s demand price of capital below the supply price, reducing investment and today’s profits below the level necessary to validate past expectations on which demand prices were based when previous capital projects were begun.” The price that firms are willing to pay for new capital goods declines because firms aren’t so sure they want to take on more debt for the sake of dubious future returns. At the same time, the supply price of capital rises if lenders charge higher interest rates to firms with more existing debt.

What would lower expected future profitability? Maybe markets for many goods have become saturated because consumers have already bought as much as they want or can afford. That suggests a lesson for firms: Creative investment requires imagination, not just producing more and more of the same thing.

Another factor that helps turn boom to bust is a reduction in fiscal stimulus by government. As an economic expansion proceeds, government collects more tax revenue from rising incomes and spends less on things like unemployment compensation and public assistance. It may also adopt a more restrictive monetary policy to prevent inflation, with higher interest rates that raise the cost of borrowing.

As confidence in future profits erodes, businesses shift their priorities from investing at all cost to improving their margins of safety to avoid financial problems. The decline in investment then reduces aggregate income and consumer spending. Not only does optimism turn to pessimism, but pessimism feeds on itself by producing poor aggregate results that validate the pessimism. Acceleration turns into deceleration, until expansion turns into contraction.

The role of the financial system in amplifying such boom and bust cycles will be the topic of the next post.


Why Minsky Matters

October 20, 2021

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L. Randall Wray. Why Minsky Matters: An Introduction to the Work of a Maverick Economist. Princeton: Princeton University Press, 2016.

This book is an introduction to one of the most important critics of mainstream economics in the twentieth century. Although he did not live to see the 2007 global financial crisis, Minsky’s understanding of the economy led him to anticipate how it would unfold. His work is getting a lot of attention now that the crisis has generated some reassessment of economic theory, as crises usually do. Minsky’s ideas are part of the foundation for the emerging Modern Monetary Theory, now well represented not only by the author of this book, but also by Stephanie Kelton, whose The Deficit Myth I reviewed recently.

Hyman Minsky (1919-1996) studied mathematics at the University of Chicago and economics at Harvard. He taught at Berkeley from 1957 to 1965 and at Washington University in St. Louis from 1965 to 1990. After retiring from teaching, he was associated with the Levy Economics Institute at Bard College, a nonprofit research and policy organization specializing in alternatives to mainstream economics. Wray, who was once Minsky’s teaching assistant, calls Minsky “the smartest guy in the room, in every room.”

L. Randall Wray is a Professor of Economics at Bard College and Senior Scholar at the Levy Economics Institute.

The nature of the economy

Minsky’s disagreements with mainstream neoclassical economics were fundamental. He objected to its portrayal of a free-market economy as a self-stabilizing machine seeking equilibrium. Market forces supposedly move the economy toward a state in which supply equals demand, everything that is produced can be sold, and resources are allocated most efficiently. Deviations from equilibrium come from exogenous (externally caused) shocks, such as a global shortage of some commodity or excess spending by government. The economy is something like a climate-control system regulated by a thermostat. During the so-called “Great Moderation,” the 25 years preceding the financial crisis, many economists came to think of the central bank as the thermostat, raising or lowering the interest rate if the economy was either too hot (high inflation) or too cold (high unemployment). Some economists even proposed making such decisions more automatic by devising a rigid rule to govern them.

By the way, I have been noticing how scientists in a variety of disciplines have been challenging mechanistic models lately: biologists who say that an organism is more than a molecular copying machine, or neuroscientists who say that a brain is more than a computing machine. Sociologists have long questioned whether the machine metaphor is very useful for understanding societies and their institutions, which are creators of new culture and organized behavior. Minsky’s work is in the tradition of institutional economists like Thorstein Veblen, who was a sociologist as well as an economist. Minsky praised the University of Chicago for teaching economics as “part of the study of society…vastly superior to the usual practice of teaching economics in isolation in a specialized course.” That was before the ideas of Austrian economists and Milton Friedman came to dominate the Economics Department.

Minsky rejected the assumption that the economy is naturally stabilizing. He argued that market forces generate instability endogenously (internally). In fact, he said that “stability is destabilizing,” since a period of stable growth tends to alter expectations, policies and behaviors in ways that undermine stability itself. For example, confidence in continued profits can breed overconfidence and riskier behavior. Minsky saw this happening in a big way in the 1980s and 90s.

Society needs a variety of institutions to constrain instability and keep the economy working in the service of societal goals. That means especially the whole government, not just the central bank. Minsky said that “the institutions established through public policy play a vital role in determining what form capitalism takes; and…laissez faire is a prescription for economic disaster.”

Although he held an undergraduate degree in mathematics as well as a doctorate in economics, Minsky was skeptical of formal mathematical models that were devoid of historical and institutional context. He said “to be useful, analytical tools have to be embedded in an understanding of the institutions, traditions and legalities of the market.” Wray makes a similar criticism in his own macroeconomics textbook (coauthored with William Mitchell and Martin Watts):

Over the past half century mainstream macroeconomics has become increasingly devoid of relevance to our understanding of how modern monetary economies operate. In part this is due [to] an increased emphasis on mathematical models underpinned by simplistic assumptions that reduce human behaviour to that of a ‘rational agent’ who maximizes simple goals in at worst a ‘risky’ economic environment.

A revolutionary Keynesian

Minsky considered himself a follower of John Maynard Keynes, having been a teaching assistant to Keynesian Alvin Hansen at Harvard. However, he was disappointed in how Hansen, Paul Samuelson and others had integrated Keynesian ideas into the mainstream “neoclassical synthesis.” Minsky regarded Keynes as a revolutionary thinker whose revolution had been aborted. Mainstream economists acknowledged that government fiscal policy could be useful in combating recessions, but they did not take seriously enough his analysis of why recessions kept happening. Rather than moving toward an equilibrium where resources are optimally allocated, an economy could get stuck at a low level of utilization where producers lack the confidence to spend on production, and workers lack the income to spend on consumption. Minsky took chronically high unemployment as a sign that capitalism wasn’t working very well.

After the stagflation of the 1970s, the monetary school led by Milton Friedman discredited Keynesian fiscal policy as it was then practiced and minimized the role of government in the economy. At a time when Keynes was largely out of fashion, Minsky preserved and elaborated on Keynes’s analysis of investment cycles. Calling himself a “financial Keynesian,” he added the idea that the financial system amplifies those cycles, endogenously producing dangerous swings between financial booms and busts.

The following posts will start with Minsky’s theory of investment cycles and financial cycles, and then go on to discuss his take on the history of capitalism and his proposals for making it work better.


Why Isn’t Democracy Working?

October 12, 2021

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I woke up this morning to more headlines announcing disagreement among Democrats regarding President Biden’s $3.5 trillion spending bill. Ah, if only Democrats could get their act together, the country could move forward. But is that the real story?

Once upon a time, the United States had a two-party system with a range of opinion within both parties. The Democrats were more liberal, but contained some moderates and conservatives, at least on some issues. The Republicans were more conservative, but contained some moderates and liberals on some issues. Neither party could stray too far from the center without risking popular support, and both had to reach across the aisle from time to time to get things done. In order to pass liberal bills like the Voting Rights Act, Democrats needed moderate Republicans to offset the opposition of Southern Democrats.

Today, bipartisan cooperation is conspicuously missing. About the only one of President Biden’s proposals that both parties can support is improvements in physical infrastructure. Republicans have an explanation for the larger legislative impasse: that Biden has a radical socialist, fiscally irresponsible agenda that the American people do not want and his own party cannot agree on. I want to play down the last part of that narrative, since it is nothing new. The Democratic Party has been a loose coalition of various interest groups for a long time. “Democrats disagree” is about as newsworthy as “Republicans don’t like taxes.” What is more unusual and troubling is Republican lockstep opposition to just about everything Democrats want to do.

How radical?

Most of the president’s domestic agenda is in the same spirit as the Affordable Care Act, which has become more popular as Americans have come to understand what it really does. Biden’s main objective is to help working families afford services they need in order to be productive. Making child care more affordable so that parents can take jobs without child-care costs devouring their paychecks. Making college more affordable so that students can prepare for today’s jobs without starting their careers deeply in debt. Providing paid family leaves for new parents and other family caregivers. Extending the child tax credit so that people can afford to raise children at all. Letting Medicare negotiate prescription drug prices with pharmaceutical companies so that people can afford their medications. These are the kinds of things that many other countries are already doing, and they poll well with a majority of the American people.

Biden’s plan calls for spending $3.5 trillion over ten years, and he proposes to pay for it by rolling back some of the Trump tax cuts of 2017, mainly the parts affecting corporations and the wealthiest 2% of taxpayers. The top personal income tax bracket would go back up from 37% to 39.6%, where it was before 2017 and where it is scheduled to return in 2025 anyway if Congress takes no action. (And remember that the actual rate that rich taxpayers pay is far lower than that because of tax deductions and loopholes, and because the top rate only applies to income that exceeds a high threshold.) The corporate tax, which was lowered from 35% to 21% in 2017, would go up to 28%.

Some economists argue that certain forms of spending help make people more productive and employable, and therefore can reduce unemployment without increasing inflation, even if the spending is not paid for with tax increases. (See The Deficit Myth.) But even economists who do not make that argument often expect more economic stimulus from spending on useful services than on tax cuts for the wealthy. Either way, the important point is that the Biden plan is neither especially radical nor fiscally irresponsible.

The real problem

Then why is it so hard to get it done? The most obvious answer cites two Democratic senators who just don’t accept the rationale for the proposals But while I don’t share the conservative views of Joe Manchin or Kyrsten Sinema, I don’t really expect unanimous consent from the Democrats in Congress. The real problem is unified opposition from a Republican Party that has been purging moderate voices from its side of the aisle for years. Moderate Republican politicians are now an endangered species, thanks to campaigns by rich donors with anti-government views and vested interests in the status quo, like the Koch brothers (see Kochland), propaganda from right-wing media like Fox News, and most recently the Trump movement. Every elected Republican is now expected to support all tax cuts, oppose initiatives like Obamacare, block action on climate change, and propagate the Big Lie that Trump won the 2020 election.

The Senate filibuster allows a 41-vote minority to stop senators from debating and voting on any bill. Filibustering used to mean extending debate, but now it means avoiding debate altogether in what once was known as the “world’s greatest deliberative body.” The filibuster is not in the Constitution, but is only a Senate rule that a majority can change at any time. When they were in charge, Republicans abolished it for approving Supreme Court nominations, so that Democrats would be unable to block President Trump’s nominees. (That’s how we got the most conservative court in almost a century.) Today, a new voting rights bill—needed because conservative justices threw out the old one—seems unlikely to overcome a Republican filibuster. Another way around the filibuster is the “reconciliation” process, but that applies only to certain budget bills, and it requires the Democrats to be as united in their support as the Republicans are in their opposition. That’s not bipartisanship.

Republican Senators even used the filibuster to block a vote on raising the debt ceiling, which has to be done to finance the deficit increased by the Republicans themselves during the Trump administration. (They relented, temporarily, but are threatening to block it again in December.) Why oppose something that almost everyone agrees has to be done? The aim is to force the Democrats to raise the debt ceiling all by themselves, through reconciliation, so that Republicans can dishonestly attribute the change to Democratic spending plans. (If you ever have the opportunity to go out to dinner with Mitch McConnell, don’t do it. He will probably order an expensive meal, stick you with the bill, and then if you pay it tell everybody what a wasteful spender you are!)

The greatest danger here is that Republicans will make good on their threat to block the debt ceiling increase. That would be an act of financial terrorism, since a democratic government cannot function without the confidence of its citizens. People will not buy and hold government bonds at reasonable rates without the “full faith and credit” of the U.S. Treasury, which has never defaulted on an obligation. Republicans seem more interested in making the Biden administration fail than making government work. Mike Pence has even said that the purpose of the Congressional investigation into the January 6 assault on the Capitol is to distract attention from Biden’s “failed agenda.” He did not mention that Senate Republicans are refusing to allow that agenda even to be debated.

While blocking Senate debate on voting rights, Republicans are working at the state level to keep Republicans overrepresented in state legislatures and Congressional delegations. They are accomplishing this through redistricting, gerrymandering, and restrictive voting laws that disproportionately impact Democratic voters. Worse still, they are trying to make it easier for state legislators and administrators to overturn election results if Democrats win. And of course, they continue to rally around Donald Trump despite strong evidence that he encouraged foreign interference with the 2020 election and tried have its results thrown out. I cannot think of a greater threat to our democracy in my lifetime.

One more form of obstruction deserves dishonorable mention. Opposition to vaccination and masking is strongly associated with Republican Party affiliation, Trump support and watching Fox News. It has prolonged the pandemic, delayed the economic recovery, and cost thousands of lives.

Restoring bipartisanship

Few Americans want a system in which one party has unrivaled power. That is too susceptible to corruption. But those of us who believe in the two-party system have to do more than encourage both parties to reach across the aisle and compromise. We must first demand that each party play by the rules of democracy, like engaging in honest debate, encouraging every citizen to vote, and respecting the outcomes of fair elections. Supporters of a democratic society have an obligation to stand up and vote down a party that is willing to lie and cheat in order to win. We must be willing to send a strong message that an increasingly authoritarian party must either change its ways or suffer massive defeat at the polls. Only then can two or more major parties thrive and hopefully cooperate to move the country forward. I only hope that it is not already too late.

The Deficit Myth (part 3)

September 1, 2021

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In the first six chapters of The Deficit Myth, Stephanie Kelton discusses the six misconceptions about the deficit I have covered in my last two posts. The last two chapters of this rather short but provocative book are called “The Deficits That Matter” and “Building an Economy for the People.”

The deficits that matter

According to Kelton, the gap between the number of dollars the federal government takes from the economy in taxes and the dollars it puts into the economy with spending doesn’t matter as much as most people think it does. For a government with monetary sovereignty, deficits are part of the normal functioning of the economy, and in fact are a useful way of developing its untapped resources. The deficits that really matter are the gaps between our current economy and the economy we could have if we made better use of our natural and human resources.

The good jobs deficit is the gap between the jobs we are creating and the jobs we could create. For the past few decades, “job growth has been overwhelmingly concentrated in low-skill, low-paid occupations.”

The savings deficit is the gap between what Americans need to save for such purposes as college education and retirement and what they are able to save out of their existing wages. Non-mortgage household debt rose by a trillion dollars between 2013 and 2019.

The health-care deficit is the gap between the health care that is possible and the health care Americans can afford. Compared to other developed countries in the OECD, the United States has the lowest average life expectancy.

The education deficit is the gap between the education today’s good jobs demand and the education Americans can pay for. The cost of college has risen much faster than incomes, one of the biggest reasons for the surge in household debt.

The infrastructure deficit is the gap between the state of the nation’s infrastructure and what it should be, according to the American Society of Civil Engineers. ASCE graded the difference as D+ vs. B, and put a price tag of $4.59 trillion on the task of bringing it up to standards.

The climate deficit is the difference between the global temperature change expected under current policies and the much smaller change permissible if we are to avoid a climate catastrophe. “To hit the [smaller] target, the world will need to cut its fossil fuel use in half by 2030 and eliminate all fossil fuel consumption by 2050.”

The democracy deficit underlies all of the other deficits. Consistent with the logic of Modern Monetary Theory, every deficit is someone else’s surplus. For Kelton, an excess of power for the few is the counterpart of a shortage of power for the many. She then cites the kinds of statistics that have become familiar: The wealthiest 10% own over 70% of the wealth, and the richest three billionaires own more than the entire bottom half of the population. She also cites research showing that when the policy preferences of the rich conflict with those of the majority, it is usually the rich who have their way. The obvious example is that tax cuts for those who pay the most taxes take precedence over spending increases for things that Americans say they want.

An economy for the people

Like many economic theories, Modern Monetary Theory has a descriptive side and a prescriptive side. My favorite passage in the section on the descriptive side was this one:

As an analytic framework, MMT is about identifying the untapped potential in our economy, what we call our fiscal space. If there are millions of people looking for paid work and our economy has the capacity to produce more goods and services without raising prices, then we have the fiscal space to bring those resources into productive employment.

This, of course, is very different from treating the economy as a self-balancing machine that functions fine as long as government does as little as possible. MMT represents a fundamental shift of philosophy that may or may not appeal to enough policymakers to make a difference.

On the prescriptive side, MMT aims to give precedence to fiscal policy, despite calling itself a monetary theory. It has a strong monetary premise—the monetary sovereignty of nations like the United States—but it sees that condition as potentially liberating the nation to spend in more constructive ways. It is not at all like the monetary school inspired by Milton Friedman, who recommended limiting inflation by strictly controlling the growth of the money supply, and had little use for fiscal policy at all. MMT gives fiscal policy a major role in growing the economy.

To some degree, fiscal policy already revs up automatically when the economy contracts. When incomes fall, so does tax revenue, while federal spending for things like unemployment insurance and food stamps rises. The federal job guarantee recommended by MMT would be “a powerful new automatic stabilizer,” employing more people whenever jobs are scarce. Kelton describes it as a “highly decentralized Public Service Employment (PSE) program that offers paid work at a living wage (we recommend $15 per hour) with a basic package of benefits that include health care and paid leave.” She estimates that about 15 million people could be employed. The Department of Labor could fund and administer the program, but local communities would have a lot to say about the specific work to be done. The work could address the “deficits that matter” described above, by such means as adult education and training or environmental projects.

As I said at the start, this is a more optimistic economics that emphasizes real resources instead of artificial budget constraints. Kelton’s final thought:

In the United States, where we have an abundance of resources and labor, there is no reason we cannot embark on a policy agenda that results in provisioning our entire population with quality health services, providing each worker with adequate and appropriate advanced education and job training, upgrading our infrastructure to meet the demands of a low-carbon world, and ensuring adequate housing for everyone while redesigning our cities to be clean, beautiful, and nurturing of community spirit….

With the knowledge of how we can pay for it, it’s now in your hands to imagine and to help build the people’s economy.

The Deficit Myth (part 2)

August 30, 2021

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Myth #4: Government deficits crowd out private investment, making us poorer

The logic of this familiar argument goes like this: The country has a limited supply of “loanable funds,” money that people are willing and able to save and invest. When government has to borrow in order to finance a budget deficit, that puts it in competition with private firms for loanable funds and raises interest rates. That discourages private investment and damages the long-run growth of the economy.

Kelton says that the historical evidence does not support this argument. She quotes Timothy Sharpe, who found that “the empirical evidence reveals crowding-out effects in nonsovereign economies, but not within sovereign economies.” The difference, consistent with Kelton’s general argument, is that sovereign economies influence the supply of loanable funds by their power to create money. This myth is another example of thinking the wrong way around, putting borrowing first—as in (TAB)S—instead of spending first—as in S(TAB). With spending first, “the government’s own deficit supplies the dollars that are needed to purchase the bonds” (emphasis in original). The demand for dollars to borrow goes up, but so does the supply.

Although the historical experience does not support the claim that government borrowing leads to investment-crushing interest rates, Modern Monetary Theory does make the case that borrowing keeps rates from going too low. If the government were to put too many dollars into the economy without borrowing some of them back, that could produce a surplus of loanable funds and very low interest rates, which in turn would trigger inflation by encouraging too much private borrowing and spending. “From an MMT perspective, the purpose of selling bonds is not to ‘finance’ government expenditures (which have already taken place) but to prevent a larger infusion of reserves from pushing the overnight interest rate below the Fed’s target level” [for controlling inflation].

The public and private sectors of the economy work in tandem. Kelton calls them buckets. For every deficit in one sector, the other sector has a corresponding surplus, and vice versa. (A third bucket, the foreign sector, is discussed in the next section.) This helps explain why government budget surpluses tend to contract the economy. When the federal budget is in surplus, the government is taking out more dollars in taxes than it is giving back in spending. But that means the private sector is in deficit, giving up more dollars to government than it receives through government spending. That means, “It’s fiscal surpluses, not fiscal deficits, that eat up our financial savings” and reduce our capacity to invest for the future.

On the other hand, the combination of public deficit/private surplus has the potential to help grow the economy. How much it will, however, depends on how productively the surplus is used. What has been disappointing about the recent economy is the sluggish growth despite the large deficits. The Trump tax cuts were another big gift to the private sector, but the benefits went mostly to the wealthy. From this perspective, what the country needs to do is not put an end to deficit spending, but use it to invest in more of what most people need.

Deficits can be used for good or evil. They can enrich a small segment of the population, lifting the yachts of the rich and powerful to new heights, while leaving millions behind. They can fund unjust wars that destabilize the world and cost millions their lives. Or they can be used to sustain life and build a more just economy that works for the many and not just the few.

Myth #5: The trade deficit means America is losing

Here Kelton introduces the third bucket in MMT accounting, the foreign sector. It includes all the other countries with which we trade. Now all three sectors must be in balance. The total of any dollar surpluses must equal the total of any deficits. For purposes of understanding that balancing act, the US trade deficit is actually a foreign sector surplus. “America’s trade deficit arises from the rest of the world’s desire to accumulate a surplus of US currency.” People in many countries are happy to hold US dollars in reserve, rather than convert them to some other currency. They like having dollars available either to buy American goods or to invest in what is still one of the strongest economies on the planet. That includes investing in bonds that are backed by the full faith and credit of the US government.

In return for our dollars, we get “stuff”—a lot of material things that other countries can make better—or at least more cheaply—than we do. Up to a point, global trade is a win-win, not a loss at all.

However, since the trade deficit represents a foreign surplus, it must be balanced by some kind of domestic deficit, either in the private sector or the public sector, or both. We don’t want more dollars flowing out of the private sector than coming in, because that means fewer dollars to spend or invest in our own economy. The only logical alternative is for the federal government to spend more than it taxes. As long as we have a trade deficit, “only Uncle Sam can supply enough dollars to keep the private sector in surplus. To do that, the government must run budget deficits that exceed the US trade deficit.”

That conclusion reinforces the conclusion of the previous section that government deficits create private-sector surpluses. But not all government deficits are equally conducive to a strong economy. Think of all the ways that government can run a deficit—cutting taxes, increasing transfer payments like unemployment compensation, buying more weapons, spending more on health care, and so forth. Why not use deficit spending to address what most concerns Americans about the trade deficit—loss of American jobs? (Not to say that free trade is the only reason for losing them. Automation is reducing the demand for labor in many industries, and will do so even more in the future.) Kelton wants to shift from a policy that tolerates joblessness for the sake of austerity and low inflation, to one that guarantees a federal job to any unemployed person who wants to work. Whether that is inflationary would depend on how productively the additional workers are employed. The goal would not be to pay people for pointless busywork, but to get them doing publicly useful work that the private sector is not getting done. “With decent jobs guaranteed for all, workers can engage in a public-led industrial policy aimed at producing sustainable infrastructure and a wider array of public services.” More on that in the next post.

Kelton is very critical of the recent policies for dealing with globalization. We have run federal deficits that pump dollars into the private sector. But we have increased deficits not so much with useful public investments as with tax cuts that primarily benefit the wealthy. We hold wages down in the mistaken belief that cheap labor—as opposed to smarter labor—is the only way to compete globally. We punish Americans for buying foreign products by taxing them with tariffs.

The Trumpian approach to trade creates strife and a zero-sum race to the bottom over too few globally available jobs. Already, President Trump’s tariffs have failed to revive American manufacturing, raised prices for US consumers, invited retaliation from China, and contributed to a slowdown in the global economy. All in subservience to the trade deficit myth.

Kelton refuses to believe that we have to accept slow growth, wage stagnation, and tariffs as the price for living in a global economy. Instead, we can combine the government’s ability to create dollars with the unrealized potential of our workforce. We have nothing to fear from global trade, as long as we do a better job of creating qualified workers and good jobs at home. Government spending on human capital development and a federal job guarantee can lead the way.

This chapter also puts American complaints about globalization in perspective by acknowledging the plight of the truly disadvantaged peoples of the global economy. They are the poorest developing countries, with nothing to export but cheap labor and raw materials—often a legacy of colonialism—but needing dollars to import other necessary goods. Their reliance on a few basic commodities makes their economies vulnerable to fluctuations in world prices, and their dependence on foreign capital puts them at the mercy of speculative investors, who often invest intermittently and selectively instead of contributing to longer-term, diversified development. International banking policies create additional problems for these countries, as when richer countries raise interest rates to fight inflation, increasing poorer countries’ debt burden; and when, as a condition of assistance, international agencies impose austerity measures that further increase unemployment and poverty. And we think the global economy is hard on us!

Myth #6: “Entitlement” programs like Social Security and Medicare are financially unsustainable

This myth is another consequence of thinking that all government spending must be paid for with taxes. Franklin Roosevelt set up the Social Security system that way by creating a new payroll tax to fund it. Current workers would pay in so that current retirees could draw out. As people started living longer, the ratio of retirees to workers increased, making that particular funding method harder to sustain. Making matters worse, recent generations of workers have also faced slower wage growth and loss of traditional pensions with guaranteed benefits.

What is really unsustainable here is not the idea that retirees should have a decent income, but the particular funding method the government has been required to use. Kelton makes that point very effectively by contrasting how the government’s own reports distinguish different entitlement programs:

Social Security’s programs and Medicare’s Hospital Insurance are considered fiscally unsustainable because the government isn’t committed to making payments, while Medicare Parts B and D get a clean bill of health because Congress has granted the legal authority to make the payments no matter what else happens.

Social Security could also have a clean bill of health by a simple change in the law committing the government to make their payments come what may. Federal Reserve Chairman Alan Greenspan acknowledged as much when Congressman Paul Ryan, an advocate for Social Security privatization, asked him to confirm that the system was in trouble:

Greenspan started by dismissing the entire premise behind Ryan’s question. “I wouldn’t say that the pay-as-you-go benefits are insecure,” he said, “in the sense that there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.

As usual, the point here is not that the government can spend whatever it likes. It is that the real limit on spending is the country’s ability to grow its resources and use them wisely, something that the government of a democratic society can influence. “We should stop asking the question, How will we pay for it?, and start asking, How will we resource it?” The price we pay if we do end up spending beyond our resources is inflation. But even that has the upside of spreading the pain around instead of singling out the elderly to bear the burden of our economic mistakes. (OK, that last point is mine, but I suspect that Kelton would agree.)

Here’s a good summary of the MMT perspective:

Our big challenge isn’t cost. It’s making sure that our economy is producing the right output mix over the coming decades. The problem isn’t a lack of bits and bytes on some electronic spreadsheet. The problem is a lack of vision. There are many ways to improve life for all of us, even in a world of limited resources, if we’re smart enough to imagine them and brave enough to try.