The Seven Deadly Innocent Frauds of Economic Policy

By Warren Mosler .

The author has been called "one the brightest minds in finance" by CNBC in 2010. Nicknamed by many as the Morpheus of Modern Money, the author explains that prosperity is around the corner for the nation and everyone in it, not just the select few, but only if the public understands what is money, how monetary policy operates and how it can be used to achieve a public purpose without the need to raise taxes nor increase government borrowing. SO A WARNING: Are you ready to take the Red Pill to understand what is money, how it operates and to learn how to legitimately question the many choices made by the President and Congress including sequestration, budget cuts and the failure to create full employment? Are you willing to take a trip down the rabbit hole to find out how much of what you were taught about economics in college and almost everything you read in media about monetary policy is wrong? The rabbit hole is very deep. It will definitely challenge how you think about economics, monetary policy and how we, as a nation, are failing at producing our real full potential. As John Kenneth Galbraith once said, The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent. Your trip down the rabbit hole starts when you read the newspapers to find that the President and Congress are talking about the need to cut the deficit because it impacts our ability to save. They argue that the deficit takes money from the economy and thus restricts business access to capital. But as you start going down the rabbit hole, you find that:
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Government deficits do not take away from savings. The simple fact is that deficits add to savings to the penny. The total $U.S. government deficit

exactly EQUALS the total net increase in private sector holdings. In fact, its the trillion dollar deficit that has added trillions to our savings. Your head is spinning as you try to figure this out. DEFICITS = SAVINGS. You begin to wonder if this is the magic formula for finance just like Einsteins E=MC2 is for physics. While trying to figure out why you always thought the opposite, you hear on TV some politicians arguing for sequestration as well as fighting among each other with regards to what government programs they are going to slash spending for in order to balance the budget. But as you go further down the rabbit hole, you find out that: The government is not revenue constrained it does not need to tax nor borrow in order to spend. In fact, as a simple point of logic, from the inception, the government must spend first before it can tax or borrow. Where else can the dollars come from if they are not counterfeit? Your brain starts to become numb. The government does not need to tax nor borrow? You find this very difficult to comprehend. It makes no sense to you. It is not what you have been taught. It flies in the face of what you understand to be capitalism. There is pressure building up behind your eyes and you feel a headache is on the way. A Wall Street friend then informs you that we are very selfish because the deficits (our deficits) are the result of our selfish lifestyle needs and, as a result, we are leaving our debt burden to our children and grandchildren and our selfish infatuation with entitlements will hinder their future lifestyles and well-being. But as you go stagger down the rabbit hole, you find out that: Our children and grandchildren will get to consume what they produce. It has nothing to do with the deficit. You had initially thought that your friend had made a valid argument, but now you are confused. You then access the internet and find that the hot trending story of the day is about social security and how social security will make the nation bankrupt if it is not fixed. The rabbit hole initially had a steady decline, but it is now becoming very steep. As your pace accelerates you find that: Social Security is not broken federal checks never bounce and the government cannot be forced to go bankrupt. Congress, never the markets, decides what they want to do. You begin to wonder if everything you hear and read is simply propaganda. You remember being told that the government was not experienced in managing money and thus social security would be best served being privatized.

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The rabbit hole is becoming more intense information is flowing everywhere and you find deciphering it is simple. When you decipher the information, you find out that: Privatization of Social Security is simply a wheel spin. Nothing changes the macro-economy. Savings and investment stay exactly the same to the penny! The push for privatization is simply a means to generate more profits for the private sector. You then hear your father shout in your ear that if American families ran their households like the federal government, we would all be bankrupt. You now feel as if feel you are freefalling down the rabbit hole, but while everything is swirling around you see that:. The government is the issuer of the dollar and can mandate that people pay taxes with its dollars. Households cant and so households can run out of dollars. However, the U.S. can never run out of dollars. Whatever spending Congress decides to appropriate, it gets paid for with dollars that Congress creates. The only relevant question is what are the real effects on the economy, not on how many dollars Congress has to spend. All of a sudden you begin to feel a little light headed as endorphins rush through your body. You feel great because you are discovering the truth. Creating money by issuing debt is a political choice that simply benefits a privileged class. The objective, indeed the responsibility, of money creation is to create all the money needed to operate the economy and to remove any money in excess of what is needed. With some of the 7 Deadly Innocent Frauds explained, you can now see the possibilities and potential for government by making monetary policy work for a public purpose and generating societal prosperity for all. This book was originally published in 2010 and was principally targeted to the general public. This republication adds a PowerPoint presentation that the author made to hedge funds and investment banks in 2010 on the issues raised in this book. Those interested in the underlying economic dynamics for this book can find it in Soft Currency Economics. The book advances a large number of economic proposals including making banks a public utility. The Obama administration did partially and temporarily implement one of author's proposals - a payroll tax cut. However the payroll tax was reinstituted in early 2013. The author believes that this together with shrinkage in the deficit could have a detrimental effect on the economy. The author still favors the total elimination of the payroll tax for both companies and employees. Yes, you will ask what will happen to social security when there is no money in the government kitty to make payments when payments are due. Read the book and you will find the answer.

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From the Book

Deadly Innocent Fraud #3:
Federal Government budget deficits take away savings.
FACT: FEDERAL GOVERNMENT BUDGET DEFICITS ADD TO SAVINGS.

Lawrence Summers
Several years ago I had a meeting with Senator Tom Daschle and thenAssistant Treasury Secretary Lawrence Summers. I had been discussing these innocent frauds with the Senator, and explaining how they were working against the well-being of those who voted for him. So he set up this meeting with the Assistant Treasury Secretary, who is also a former Harvard economics professor and has two uncles who have won Nobel prizes in economics, to get his response and hopefully confirm what I was saying. I opened with a question: Larry, whats wrong with the budget deficit? He replied: It takes away savings that could be used for investment. I then objected: No it doesnt, all Treasury securities do is offset operating factors at the Fed. It has nothing to do with savings and investment. To which he retorted: Well, I really dont understand reserve accounting, so I cant discuss it at that level. Senator Daschle was looking on at all this in disbelief. This Harvard professor of economics, Assistant Treasury Secretary Lawrence Summers didnt understand reserve accounting? Sad but true. So I spent the next twenty minutes explaining the paradox of thrift (more detail on this innocent fraud #6 later) step by step, which he sort of got right when he finally responded: so we need more investment which will show up as savings? I responded with a friendly yes, after giving this first year economics lesson to the good Harvard professor, and ended the meeting. The next day, I saw him on a podium with the Concord Coalition - a band of deficit terrorists - talking about the grave dangers of the budget deficit. This third deadly innocent fraud is alive and well at the very highest levels. So heres how it really works, and it could not be simpler: Any $U.S. government deficit exactly EQUALS the total net increase in the holdings ($U.S.

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financial assets) of the rest of us - businesses and households, residents and nonresidents - what is called the non-government sector. In other words, government deficits equal increased monetary savings for the rest of us, to the penny. Simply put, government deficits ADD to our savings (to the penny). This is an accounting fact, not theory or philosophy. There is no dispute. It is basic national income accounting. For example, if the government deficit last year was $1 trillion, it means that the net increase in savings of financial assets for everyone else combined was exactly, to the penny, $1 trillion. (For those who took some economics courses, you might remember that net savings of financial assets is held as some combination of actual cash, Treasury securities and member bank deposits at the Federal Reserve.) This is Economics 101 and first year money banking. It is beyond dispute. Its an accounting identity. Yet its misrepresented continuously, and at the highest levels of political authority. They are just plain wrong. Just ask anyone at the CBO (Congressional Budget Office), as I have, and they will tell you they must balance the checkbook and make sure the government deficit equals our new savings, or they would have to stay late and find their accounting mistake. As before, its just a bunch of spreadsheet entries on the governments own spreadsheet. When the accountants debit (subtract from) the account called government when government spends, they also credit (add to) the accounts of whoever gets those funds. When the government account goes down, some other account goes up, by exactly the same amount. Next is an example of how, operationally, government deficits add to savings. This also puts to rest a ridiculous new take on this innocent fraud thats popped up recently: Deficit spending means the government borrows from one person and gives it to another, so nothing new is added - its just a shift of money from one person to another. In other words, they are saying that deficits dont add to our savings, but just shift savings around. This could not be more wrong! So lets demonstrate how deficits do ADD to savings, and not just shift savings: 1. Start with the government selling $100 billion in Treasury securities. (Note: this sale is voluntary, which means that the buyer buys the securities because he wants to. Presumably, he believes that he is better off buying them than not buying them. No one is ever forced to buy government securities. They get sold at auction to the highest bidder who is willing to accept the lowest yield.)
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2. When the buyers of these securities pay for them, checking accounts at the Fed are reduced by $100 billion to make the payment. In other

words, money in checking accounts at the Fed is exchanged for the new Treasury securities, which are savings accounts at the Fed. At this point, non-government savings is unchanged. The buyers now have their new Treasury securities as savings, rather than the money that was in their checking accounts before they bought the Treasury securities. 3. Now the Treasury spends $100 billion after the sale of the $100 billion of new Treasury securities, on the usual things government spends its money on. 4. This Treasury spending adds back $100 billion to someones checking accounts. 5. The non-government sector now has its $100 billion of checking accounts back AND it has the $100 billion of new Treasury securities. Bottom line: the deficit spending of $100 billion directly added $100 billion of savings in the form of new Treasury securities to non-government savings (non-government means everyone but the government). The savings of the buyer of the $100 billion of new Treasury securities shifted from money in his checking account to his holdings of the Treasury securities (savings accounts). Then when the Treasury spent $100 billion after selling the Treasury securities, the savings of recipients of that $100 billion of spending saw their checking accounts increase by that amount. So, to the original point, deficit spending doesnt just shift financial assets (U.S. dollars and Treasury securities) outside of the government. Instead, deficit spending directly adds exactly that amount of savings of financial assets to the non-government sector. And likewise, a federal budget surplus directly subtracts exactly that much from our savings. And the media and politicians and even top economists all have it BACKWARDS! In July 1999, the front page of the Wall Street Journal had two headlines. Towards the left was a headline praising President Clinton and the record government budget surplus, and explaining how well fiscal policy was working. On the right margin was a headline stating that Americans werent saving enough and we would have to work harder to save more. Then a few pages later, there was a graph with one line showing the surplus going up, and another line showing savings going down. They were nearly identical, but going in opposite directions, and clearly showing the gains in the government surplus roughly equaled the losses in private savings. There cant be a budget surplus with private savings increasing (including non-resident savings of $U.S. financial assets). There is no such thing, yet not a single mainstream economist or government official had it right.

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Al Gore
Early in 2000, in a private home in Boca Raton, FL, I was seated next to then-Presidential Candidate Al Gore at a fundraiser/dinner to discuss the economy. The first thing he asked was how I thought the next president should spend the coming $5.6 trillion surplus that was forecasted for the next 10 years. I explained that there wasnt going to be a $5.6 trillion surplus, because that would mean a $5.6 trillion drop in nongovernment savings of financial assets, which was a ridiculous proposition. At the time, the private sector didnt even have that much in savings to be taxed away by the government, and the latest surplus of several hundred billion dollars had already removed more than enough private savings to turn the Clinton boom into the soon-tocome bust. I pointed out to Candidate Gore that the last six periods of surplus in our more than two hundred-year history had been followed by the only six depressions in our history. Also, I mentioned that the coming bust would be due to allowing the budget to go into surplus and drain our savings, resulting in a recession that would not end until the deficit got high enough to add back our lost income and savings and deliver the aggregate demand needed to restore output and employment. I suggested that the $5.6 trillion surplus which was forecasted for the next decade would more likely be a $5.6 trillion deficit, as normal savings desires are likely to average 5% of GDP over that period of time. That is pretty much what happened. The economy fell apart, and President Bush temporarily reversed it with his massive deficit spending in 2003. But after that, and before we had had enough deficit spending to replace the financial assets lost to the Clinton surplus years (a budget surplus takes away exactly that much savings from the rest of us), we let the deficit get too small again. And after the sub-prime debt-driven bubble burst, we again fell apart due to a deficit that was and remains far too small for the circumstances. For the current level of government spending, we are being over-taxed and we dont have enough after-tax income to buy whats for sale in that big department store called the economy. Anyway, Al was a good student, went over all the details, agreeing that it made sense and was indeed what might happen. However, he said he couldnt go there. I told him that I understood the political realities, as he got up and gave his talk about how he was going to spend the coming surpluses.

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Ten years ago, around the year 2000 just before it all fell apart, I found myself in a private client meeting at Citibank with Robert Rubin, former U.S.

Robert Rubin

Treasury Secretary under President Clinton, and about 20 Citibank clients. Mr. Rubin gave his take on the economy and indicated that the low savings rate might turn out to be a problem. With just a few minutes left, I told him I agreed about the low savings rate being an issue and added, Bob, does anyone in Washington realize that the budget surplus takes away savings from the nongovernment sectors? He replied, No, the surplus adds to savings. When the government runs a surplus, it buys Treasury securities in the market, and that adds to savings and investment. To that I responded, No, when we run a surplus, we have to sell our securities to the Fed (cash in our savings accounts at the Fed) to get the money to pay our taxes, and our net financial assets and savings go down by the amount of the surplus. Rubin stated, No, I think youre wrong. I let it go and the meeting was over. My question was answered. If he didnt understand surpluses removed savings, then no one in the Clinton administration did. And the economy crashed soon afterwards. When the January 2009 savings report was released, and the press noted that the rise in savings to 5% of GDP was the highest since 1995, they failed to note the current budget deficit passed 5% of GDP, which also happens to be the highest its been since 1995. Clearly, the mainstream doesnt yet realize that deficits add to savings. And if Al Gore does, he isnt saying anything. So watch this year as the federal deficit goes up and savings, too, goes up. Again, the only source of net $U.S. monetary savings (financial assets) for the non-government sectors combined (both residents and non-residents) is U.S. government deficit spending. But watch how the very people who want us to save more, at the same time want to balance the budget by taking away our savings, either through spending cuts or tax increases. They are all talking out of both sides of their mouths. They are part of the problem, not part of the solution. And they are at the very highest levels. Except for one, Professor Wynne Godley.

Professor Wynne Godley

Professor Wynne Godley, retired head of Economics at Cambridge University and now over 80 years old, was widely renowned as the most successful forecaster of the British economy for multiple decades. And he did it all with his sector analysis, which had at its core the fact that the government deficit equals the savings of financial assets of the other sectors combined. However, even with the success of his forecasting, the iron-clad support from the pure accounting facts, and the weight of his office (all of which continues to this day), he has yet to convince the mainstream of the validity of his teachings.

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So now we know: - Federal deficits are not the awful things that the mainstream believes them to be. Yes, deficits do matter. Excess spending can cause inflation. But the government isnt going to go broke. - Federal deficits wont burden our children. - Federal deficits dont just shift funds from one person to another. - Federal deficits add to our savings. So what is the role of deficits in regard to policy? Its very simple. Whenever spending falls short of sustaining our output and employment, when we dont have enough spending power to buy whats for sale in that big department store we call the economy, government can act to make sure that our own output is sold by either cutting taxes or increasing government spending. Taxes function to regulate our spending power and the economy in general. If the right level of taxation needed to support output and employment happens to be a lot less than government spending, that resulting budget deficit is nothing to be afraid of regarding solvency, sustainability, or doing bad by our children. If people want to work and earn money but dont want to spend it, fine! Government can either keep cutting taxes until we decide to spend and buy our own output, and/or buy the output (award contracts for infrastructure repairs, national security, medical research, and the like). The choices are political. The right-sized deficit is the one that gets us to where we want to be with regards to output and employment, as well as the size of government we want, no matter how large or how small a deficit that might be. What matters is real life - output and employment NOT THE SIZE of the deficit, which is in of itself is just an accounting statistic. In the 1940s, an economist named Abba Lerner called this, Functional Finance, and wrote a book by that name (which is still very relevant today)

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Deadly Innocent Fraud #7

Its a bad thing that higher deficits today mean higher taxes tomorrow.
FACT: I AGREE - THE INNOCENT FRAUD IS THAT ITS A BAD THING, WHEN IN FACT ITS A GOOD THING!!! Your reward for getting this far is that you already know the truth about this most common criticism of government deficits. I saved this for last so you would have all the tools to make a decisive and informed response. First, why does government tax? Not to get money, but instead to take away our spending power if it thinks we have too much spending power and its causing inflation. Why are we running higher deficits today? Because the department store has a lot of unsold goods and services in it, unemployment is high and output is lower than capacity. The government is buying what it wants and we dont have enough aftertax spending power to buy whats left over. So we cut taxes and maybe increase government spending to increase spending power and help clear the shelves of unsold goods and services. And why would we ever increase taxes? Not for the government to get money to spend - we know it doesnt work that way. We would increase taxes only when our spending power is too high, and unemployment has gotten very low, and the shelves have gone empty due to our excess spending power, and our available spending power is causing unwanted inflation. So the statement Higher deficits today mean higher taxes tomorrow in fact is saying, Higher deficits today, when unemployment is high, will cause unemployment to go down to the point we need to raise taxes to cool down a booming economy. Agreed!

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