(This item originally appeared at Forbes.com on August 3, 2021.)
Before beginning The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy (2020), by Stephanie Kelton, I was prepared for certain predictable arguments about how governments can finance themselves with outright money creation. This is actually true, to a certain degree, and the Federal Reserve’s job is to figure out what that degree is. This is one of the oldest topics in economics: The very first book about monetary economics in the history of the West, De Moneta (circa 1360), by the French cleric Nicholas Oresme, was about this very subject. In those days before paper banknotes, kings “printed money” by stamping coins with higher denominations, or diluting them with base metals. They might take a silver coin marked “one franc” and restamp it as “two francs,” in effect making a new franc appear out of the ether, which they could then spend. (The effect was to cut the value of the franc in terms of silver in half.) The Romans pioneered this practice in the third century AD. It did not go well. By the mid-fourth century, nominal prices were two million times higher. The term that economists use to describe the profit inherent in producing money is called “seignorage.” The term comes from the French seigneur, or Lord, showing that it has long been claimed by Kings. It has been a part of the English language since the fifteenth century.
Since pretty much everyone over the age of twelve knows that printing money willy-nilly tends to cause the value of currencies to asymptotically approach zero, Kelton’s first goal is to explain why that won’t happen. We are immediately led to Chapter 2: “Think of Inflation.” Here I was amazed to find the body of economic understanding concerning money neither tortured, abused, nor even interpreted sensibly but incompletely, but simply forgotten. It makes no appearance. Instead, we have a basically Keynesian model, which inherently assumes that money is stable in value. Let me explain:
John Maynard Keynes, in response to the difficulties of the Great Depression, basically argued that a currency devaluation would relieve debtors and help raise employment, since it would effectively reduce the real value of workers’ wages. He also argued that interest rates could be manipulated lower, which also would tend to require excessive money creation. This would encourage business to borrow money to invest in new projects, which would also result in the hiring of new employees. Although Keynes was also a fan of expanded government spending, his arguments were mostly along the lines of currency devaluation and interest rate manipulation. That’s why the title of his famous 1936 book was: The General Theory of Employment, Interest and Money.
Keynes died in 1946, just after finishing the negotiations establishing the postwar Bretton Woods System in 1944, which relinked currency values worldwide to gold. “Keynesian” thinking was still rather radical in the 1930s, contrary to what was generally taught in universities at the time. After Keynes death, it became institutionalized. It became the regular economics taught in universities, as codified by people like Paul Samuelson.
However, particularly in the United States, these postwar Keynesians had their hands tied by Bretton Woods and the gold standard. They couldn’t devalue currencies on a whim, or even affect interest rates much. Their most immediate experiences were of World War II, the gigantic levels of government spending that accompanied it, and the burst of employment and economic activity that it created. So, their attention turned especially toward the government spending aspects of Keynesianism, or “fiscal stimulus.” In this model, “inflation” comes from, basically, the supply and demand of resources. When “aggregate demand” rises more than “aggregate supply,” prices rise. This makes perfect sense, in the context of stable currency value, which is what they had during the Bretton Woods period when these notions were popularized. The idea was to have the government spend more money (“fiscal stimulus”) when the economy was weak and there were unused resources (recession), and then reduce the spending when the economy was stronger and unemployment was low. The Keynesians were so lost in this stable money supply/demand view of “inflation” that, when the dollar was again devalued during the 1970s, they had no idea what was going on. Keynes himself would have understood it perfectly.
Kelton argues that, as long as there are unused productive resources in the economy (basically, unemployment), the government can print money out of thin air, spend it, and everything is okey-dokey. It is not a monetary argument at all. Nowhere do we hear, for example, that the money supply is too much or too little, or can grow safely a X% per year, or that currency values are rising or falling or anything of that sort. It is based on the Keynesian assumption that money is stable in value. We just look at “resources,” such as unemployed people.
“Economists typically distinguish between cost-push and demand-pull drivers of inflationary pressures. … For example, a serious drought could lead to massive crop failures and food shortages that send prices soaring as supply collapses. … Demand-pull inflation occurs when businesses raise prices due to changes in buying habits. … Think of it this way. Every economy has its own internal speed limit. It’s only possible to produce so much, at any point in time, given the real resources—people, factories, machines, raw materials—available in that moment. During a recession, people lose jobs and companies turn off machines and allow them to sit idle. In that environment, spending can safely increase because workers can be rehired, and machines can be brought back online to produce more output. [pages 46-47]“
And, that’s it. Now freed of any need for concern about “inflation,” Kelton is then ready to spend with abandon on a long list of programs that she favors. Basically, it is Bernie Sanders’ dream agenda, freed of any financial constraints. (Kelton served as economic advisor to Bernie Sanders in 2016.) One of these is a continuous Federal jobs program, where anyone who wanted a job could go to the Federal Government, and be given employment at a “living wage,” which, in practical terms, she says is $15 an hour plus health and other benefits. Kelton suggests that about twelve million people could be part of this program, rising during recessions and falling during recoveries. More money pays for expanded government healthcare, education, transportation, environmental issues, infrastructure, housing, retiree benefits, and on and on, since there is hardly reason to stop once we fire up the printing presses. It’s all fine as long as there are “unused resources,” which means: people in the Federal Government’s guaranteed-job program.
Recently, the Federal Government has been the beneficiary of the Basel III international banking agreement reached in 2010, with full phase-in through 2019. This required banks to hold high cash reserves at the Federal Reserve, a return to common banking practice before 1960. Since this “cash” didn’t exist, it had to be created. This has allowed the Federal Reserve to increase its money creation by dramatic amounts for a decade. This money creation has effectively been a form of government finance, since the Federal Reserve buys Treasury bonds (in effect, making them disappear from the private market) in this process. But, as of the end of 2020, this new bank requirement has been completely satisfied. It was a one-time windfall adjustment. It is likely that any new aggressive monetary expansion by the Federal Reserve would have stronger inflationary effects. The new money would be “excess.”
Along the way, the U.S. political system has become accustomed to having the Federal Reserve effectively finance much of its spending via money creation. They aren’t really sure how this happened, but it sure was fun. Kelton gives no explanation of this at all: it is not mentioned. But, the rising popularity of writers like Kelton show a broad urge to spend without constraint. Congress is still piling up new spending commitments, including President Biden’s latest $4.5 trillion “infrastructure” spending proposal.
Often, societies get into a lot of trouble when they start printing money. Sometimes, the results are so horrible that a new conviction forms concerning the importance of currency reliability. The American Colonies experimented with governments paying bills with fiat paper for a century, beginning when the Massachusetts Colony paid soldiers in paper money in 1690. Much of the Revolutionary War was paid for with fiat paper issued by the Continental Congress, known as the “Continental Dollar.” It was hyperinflated into oblivion in the 1780s. This ended the Americans’ fiat paper experimentation. “No State shall … emit bills of credit [fiat paper currency]; [or] make any thing but gold and silver coin a tender in payments of debts …” reads Article I Section 10 of the Constitution. In practice, the letter of this law was immediately contradicted by President George Washington himself, who allowed the establishment of the First Bank of the United States in 1791, which introduced a uniform paper currency. Nevertheless, the spirit remained: the United States embraced the principle of a currency linked to gold for nearly two centuries thereafter, until 1971.
