The intractable Great Depression some 85 years ago led to the intellectual thought that perhaps it’s possible for a government to “policy” its way out of a deep economic hole. The question is, can economic growth be created out of thin air by passing a resolution or law, or by printing paper? This is basically all that governments have to work with.
And when John Maynard Keynes came along with his General Theory in the middle of the Great Depression, he suggested ideas that governments would begin to implement in post-World War II economic recessions. Now those ideas are leaping into the next phase, when government spending takes place with reckless abandon causing government deficits to be automatically financed by the central bank.
The general theme is that the government obtains cash via selling its debt (Treasury securities) and in turn spends the cash on public or private goods or outright gifting it to individuals — or, in a new variation of the theme, providing non-recourse corporate loans, as was done with Trump’s PPP. But to gift and hope for spending — which in turn generates more income — requires raising cash first, and that presents the question of how that will take place.
Now if the government were to raise the cash via taxation, there would be no need to finance deficits — but it would be counter-productive as it depletes private spendable income and investment incentives. So, how can the government raise the money to give away to the private sector with the least objection?
First, it should be noted that when the game was first played, the cash was raised from selling bonds to private parties, hence tapping private savings. The ability to sell the bonds hinged on the credit quality of the government to repay said debt and the interest rate offered and the emotions that could be stirred.
As a kid, I remember saving $17 and walking to the nearest bank to buy a zero-coupon savings bond that paid $25 ten years later (and when I was in college, I cashed it in). I was funding the government as a child! And for many years, tapping the pool of private savings, in this manner, was sufficient for the government to get by.
But with WWII, there was a surge of debt to be sold that exceeded private savings. Then (as now) the government turned to the central bank as the next-easiest “mark,” as the cash only needed to be printed by the Bureau of Printing and Engraving (shown above). In this case, the central bank has the ability to buy more debt, not based on credit quality or rate paid, but the pressure on the Fed Governors to be “patriotic” and go along with the scheme.
Virtually all Federal Reserve chairmen were willing to go along with wartime pressures, but at least one did “fade the heat.” It must be mentioned that William McChesney Martin did so during Vietnam, when the government wished to provide funding for both “guns and butter.” But those instances when the Fed Governors objected out loud have been rare.
So basically, if it’s systematically done (through money financing of fiscal deficits), it becomes the institutionalization of the central bank expansion of money to pay for additional issuance of government debt in amounts above tax revenues needed to meet Congress’s desire to spend. Our present scheme for monetary expansion that is based on achieving full employment, without inflation, would be replaced by a new money expansion rule which today goes by the moniker of Modern Monetary Theory, or MMT.
MMT is a scheme by which the Fed answers the call to print whatever is needed to finance the remaining deficit above tax receipts and the sale of bonds to private parties.
But there are some problems with this approach. It is vulnerable to expectations that are priced into government bond markets. That is, interest rates on the secondary bond market become a reflection of investors’ understanding of two potential outcomes: 1) the probability of ultimate default on government bonds, resulting from financing “reckless abandon” spending; and/or 2) the expectation that monetary finance will generate inflation fears from increases in money and spending.
Buyers and sellers of government bonds in the secondary market, in which said securities trade until maturity, are priced to reflect both of those risks that MMT seems not to take account of.
Recognizing those possibilities if MMT were institutionalized would very likely cause secondary markets to price in the default and inflation risks that fiscal deficits with automatic monetary coverage would be expected to generate.
By the Fed rubber stamping the financing of government deficits with new money, both political parties would be prone to propose and vote on a plethora of spending bills leading to quid pro quo giveaways to their respective constituencies.
Source: The Spellman Report
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