The Myth of the American Sovereign Debt Crisis

Anti-austerity protests in Spain.

Since the initial days of the Obama administration, pundits and politicians alike have been predicting what, they call, “a complete government shutdown.” Fix the deficit, we need a balanced budget, cut spending; such is the rhetoric coming out of the Republican establishment that has deluded the political mainstream. As the federal public debt now approaches $16 trillion, it begs the question — when can we expect this doomsday scenario? When can we expect this assumed government collapse? And then there’s the endless threats of future hyperinflation — by the same crowd that has been making such silly “predictions” for over a century.

With all these individuals expecting a inflationary Armageddon and looming debt crisis, you would expect the argument to hold some water. To understand why such fears are unfounded, the nature of money has to first be properly understood in modern context. Its techicalities can be explained with an economic theory I find particularly fascinating; Modern Monetary Theory (MMT).

To start, we must realize that money is no longer pinned to gold. Its subsequent value is backed by the state (i.e. fiat money). This has profound implications in economic theory. For one, it means that the validity of the currency itself is based on the government maintaining a monopoly in controlling it. The government asserts this value through taxation. Thus, private confidence and taxation establish the basis of exchange value in a national economy; fiat value has no intrinsic value on its own. From this basis, can government truly “run out” of money, if it is its sole provider? Before the end of the Bretton Woods System in 1971, when currency was still pinned to gold, it most definitely could. Since moneyed printing was linked to gold in ratio, states were forced to limit their spending in accordance to revenue or be forced to promptly borrow from other governments. Now, the monetary system has been changed. Government is no longer like a a “credit card,” as its so absurdly claimed, that we just add our expenses to and pay for it a later. It is the issuer of currency, not a receiver of it as households in the United States are.

The economic flow can be broken down into two main spheres — the private sector and the public sector. The private sector accumulates assets by spending less than its income, resulting in savings. In retrospect, this savings increase is an accumulation of government-backed currency and bonds. Therefore, in order for private wealth to accumulate, government liabilities must rise parallel to it. In order for this to be done, government must spend more than it receives from taxation to create more IOUs (fiat money).  This is what is commonly as known as “the deficit,” which is the stock of government debt minus its tax revenue. Therefore, government’s financial liabilities are equal to the private sector’s net private financial assets, since a creation of private financial wealth demands a greater circulation of fiat money, which is created through printing currency. Interestingly enough, this means that when the budget is fully balanced, the net private financial wealth is at zero. And if a government enters a surplus, net financial falls into the negatives, since the private industry is now indebted to the public. Likewise, it is impossible for both the public and private sector to simultaneous experience surpluses since one’s ‘debt’ is the others surplus [1].

The above graph shows the aforementioned relationship. It can be represented by the following formula:

G – T = (S – I) + (M – X)

In which, government spending (G) minus taxation revenue (T) gives the fiscal situation, either deficit or surplus, represented by the blue line on the graph; this equals savings (S) minus investment (I) added to balance of payments (i.e imports minus exports) represented by the red line. The relationship is demonstrated quite clearly; in order for financial assets to rise, financial liabilities in the form of government deficits must rise as well. The correlation is especially strong in the dates after the dismantling of the Bretton Woods agreement, after which the United States become fully based on fiat currency rather than be linked to gold. Ever since, the values of deficit to private wealth has been relatively equal in their absolute values.

This, in itself, has profound implications. For one, now we understand the link between government deficits and accumulations of private financial assets. But now, ever more, we can now use taxation to curb negative externalities and to regulate key industries rather than to simply gather revenue since we now understand government’s monetary role. The function of government, in essence, changes and allows for it to further alleviate unemployment woes & elements of poverty. However, keeping economic oversight is crucial, since if deficit spending exceeds full employment, inflationary pressures can ensue because accumulation of financial assets, for the moment, would stagnate.

Now, the inevitable questionwhat about Greece? 

Greece is in a complex situation, much different than that of the United States. Greece uses the Euro, which is controlled by the European Central Bank of the Eurosystem,  the monetary central authority of the European Union. Since Greece lacks control over its own currency, it has been brought into complete chaos with forced austerity cuts, bailouts with strings attached, and violent public unrest. Since it lacks monetary sovereignty, being restrained to reserves beyond its grasp, it is unable to control its debt crisis. The same situation plagues the rest of Europe. The Euro states are unable to print their own currency, and are thus forced to succumb to the bullying of Germany to balance their budgets, which has left countries like Spain in disastrous economic conditions.

Oftentimes, the issue of Germany or even Zimbabwe is also brought up as a counter-argument to the validity of modern monetary theory to showcase hyperinflation caused by fiat currency. Economist Randal Wray addresses this issue in his writing, talking about Germany after WW1:

Yes, once the economy gets to full employment, then extra government deficit spending can start driving up prices. But what happened in Weimar Germany was very different. During that time, the government was forced to pay extremely large war reparations in foreign currencies which it didn’t have. So it had to aggressively sell its own currency and buy the foreign currency in the financial markets. This relentless selling continuously drove down the value of its currency, causing prices of goods and services to go ever higher in what became one of the most famous inflations of all time. By 1919, the German budget deficit was equal to half of GDP, and by 1921, war reparation payments represented one third of government spending. And guess what? On the very day that government stopped paying the war reparations and selling its own currency to buy foreign currency, the hyperinflation stopped [2].

Now, there is one particular example we can point to to show the prowess of MMT. Currently, Japan’s debt to GDP ratio is over 200% and growing:

And yet they experience no instances of “government shutdown.” Perhaps even more interestingly, they are the largest single non-eurozone contributor to the rescue projects that have been instated to ‘save’ the European Union — a total of $60 billion in March of 2012. Japan is even responsible for pumping in $100 billion dollars into the IMF during the height of the crisis in 2009, all whilst its adversaries deemed it to be “bankrupt” [3]. How is this possible? Why is Japan not defaulting? The key is in its monetary system and its handling of deficits. Most importantly, Japan controls its own debt; 95% of it is held domestically by the Japanese themselves, the rest being foreign owned by other central banks [4]. Since the debt is largely owned by the Japanese themselves, they are able to collectively maintain their deficits whilst also keeping an impressive social program system.

Although I elaborated on a really rudimentary view of Modern Monetary Theory, this should suffice as to how misguided the current discussions in the political realm are. Rather than discuss the structural issues of the American economic system, we’re bickering over the technicalities of a budget whilst standards of livings drop and income inequality rises. To make matter worse, a crucial aspect of debt is consciously ignored — the issue of private debt. Households are crippled by personal debt to make up for stagnant wages, an issue I actually discussed in detail in my piece on debt deflation and crisis. The situation is dire and the proposals to cut necessary programs for already-struggling families to “balance the budget” is laughable at best, and downright frightening at its very worst.


The Deficit: Nine Myths We Can’t Afford 

Deficits Do Matter, But Not the Way You Think

Marxism and Monetary Theory: A Bibliography 

Understanding the Modern Monetary System

Debt, Deficits, and Modern Monetary Theory


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