Storms of comments on the economic collapse of the lockdown have been met with some reoccurring statements from the Keynesians and MMT believers. Nikki Haley wrote on Twitter that state budgets should have had rainy day funds ready for events like this, which seems like an obvious comment. She was then attacked for now knowing the mathematical axiom: Government Budget Deficit = Private Net Saving. Therefore she should have known that saving is only possible through the dissaving of government.
On top of this, we are usually thought of as stupid anti-scientific “literary” economists for not understanding basic math.
However, when we try to imagine saving as dependent on a government issuing bonds, it seems absurd. That’s because it is. The notion has recently been covered and smashed by economist Robert Murphy.
This supposed accounting law is not new, and has often captured the interest of interventionists and socialists as an excuse for government budget deficits. This article was originally published at Modern Treatise.
The proposals of universal healthcare and the Green New Deal from Democratic candidates for president in 2020 have focused debate on the issue of affordability of these massive government programs. Although originally a trademark of the Democratic Socialist wing of the party, these programs have been embraced by all of the presidential candidates in the party so far. With cost estimates released, debate has ensued over the affordability of these plans, and if anything is clear the mainstream left no longer believes in any limits to permanent deficit spending. However, debate is useless if we are operating on completely different paradigms of economic theory, and if we look closer, the leftist candidates, with their economic advisors and supporters, are injecting a completely different reality into the discussion to justify their programs. This idea, called Modern Monetary Theory, is embraced by the former economic advisor to Bernie Sanders, Stephanie Kelton, and was also recently mentioned by Alexandria Ocasio-Cortez as an idea that should gain some consideration. Without going any further, it is extremely convenient that a new kind of objective science should come along to back the idea of unlimited government spending for politicians on the left.
Many Modern Monetary Theory (MMT) economists say that they are simply describing the state of the economy as it is, and are therefore non-political in their conclusions (and to their credit, many stay away from politics). However, the reason MMT is gaining traction now is the far left’s infatuation with a theory that fulfills their wildest dreams, especially after the release of the Green New Deal. Modern Monetary Theory states that since the government maintains a monopoly on the issuance of fiat currency it cannot go bankrupt. Economic activity is determined by the government restricting the supply of money, which the public demands because it is required to pay taxes. All deficit spending is financed by fiat money created out of thin air by the central bank, and taken out of the economy through taxation. Therefore, according to MMT, taxation is not a means to finance government spending but a means to remove fiat money from the economy to limit inflation. Furthermore, and very important to MMT, is the idea that it is shown through macroeconomic accounting tautologies that private net saving is equal to government budget deficits. With this, they take a sharp stance against fiscally conservative proposals for austerity.
Before deeper analysis, MMT has problems that will need clarification. The theory assumes that the concept of money, a medium of exchange, is inherently invented by governments. This is a clear contrast to traditional theories on the origin of money, and the idea that society will not use a liquid medium of exchange to trade goods and services without a government enforced monopoly on money is already hard to believe. MMT theorists also describe money as a perfect government monopoly, which is not necessarily true for the Federal Reserve System, which is rather a government-created banking cartel where the private backs inflate much of the money supply through fractional reserve banking. This should raise questions to the idea that MMT simply describes the current monetary reality. We also must assume away the threat of hyperinflation in the MMT paradigm, which is difficult to ignore in a concept that gives the government unlimited power to create and spend fiat money out of thin air.
Beyond those explanations, however, is the central point made by proponents of Modern Monetary Theory, deriving to the popular progressive notion that “deficits don’t matter”. But not only do deficits not matter, according to MMT mathematics, but they also have a direct relationship to private net saving, which they conclude in their rhetoric to mean an expansion of the private sector. A summary of this accounting explanation simply uses two basic national income accounting identities.
The first as follows:
GDP = C+I+G+(X-M)
Where (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X — M) [i.e., exports minus imports].
GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.
Then the two identities are equated:
C+S+T = C+T+G+(X-M)
Then, consumption (C) is canceled out and the algebra is re-arranged, creating what the MMT economists refer to as “sectoral balances”.
(I-S) + (G-T) + (X-M) = 0
The sectoral balances are the private domestic balance (I-S), the budget deficit (G-T), and the current account balance (X-M).
By canceling out international trade (X-M), and re-arranging some more, the following equation is deduced:
(G-T) = (S-I) or
Government Budget Deficit = Private Net Saving
So, as Modern Monetary Theory concludes, and as its leftist followers believe, the private sector cannot save if the government does not spend. As economists confirm this belief, as Nick Rowe does, this seems to explode the free-market calls for austerity in government finance. The political proponents of MMT want us to believe that it is proven with basic mathematics that the private sector cannot grow without government deficit and that austerity is equal to capital destruction. Regardless of all the logical problems with this idea, it seems that proponents will robotically respond with this accounting tautology when the logical errors are brought up, as Nick Rowe did to economist Robert Murphy in the provided link, which can be a roadblock in the discussion.
Contrary to the MMT implications, the missing puzzle piece is right in the accounting tautology, as shown by Dr. Murphy in his article. Why does it seem so illogical that the expansion of capital in the private sector would depend on government deficits when the equation clearly shows that government budget deficits are equal to private net saving? As Murphy points out because they have redefined “private net saving” in the tautology. Convenient!
When we think of saving, we think of resources deferred from consumption to expand production in the future, or people collectively saving more than they borrow. As Murphy explains, “When MMTers speak of “net saving,” they don’t mean that people collectively save more than people collectively borrow. No, they mean people collectively save more than people collectively invest”. But what is the point of defining private saving by subtracting private investment? The reason saving benefits society, and the reason it has significance in economics, is private investment. It is investment that accumulates capital in society, lowers prices, and improves real wages, so when MMT economists make this tautology, what are they equating to (G-T)? Probably just an empty term to fit the mathematics, because all private saving is investment. All resources deferred from present consumption increase loanable funds, and therefore create the ability for society to accumulate capital, and no government budget deficit is necessary to let this happen. So if we turn the concept of private saving into the term (S-I), where we subtract from saving the factor that makes it beneficial to society, we can correctly say that (G-T) = (S-I). But this has no meaning nor reaches the conclusion MMTers want to draw.
Here is what economists and proponents of MMT from the left seem to get under the radar: when they explain the accounting tautology to make an intimidating factual representation of their claim, they redefine “private net saving” to the meaningless term (S-I). But when they make their conclusion, they imply that a reduction in a budget deficit actually does reduce private investment! In Murphy’s short comments with Nick Rowe, what Murphy was doubting is the idea that the private sector cannot accumulate wealth without deficits, “In particular, I think it is crazy when people say that if the federal government runs a budget surplus, then by simple accounting the private sector can’t save”. When Rowe replies he concedes that saving is redefined to meet the equation. Yet when MMTers draw conclusions from this tautology, they use the original definition of saving to get the idea across that the private sector cannot grow without government running a deficit, which is absurd. So from the mathematics to the conclusion, that would be flipping the definition of private saving, with one to fit the tautology and one to draw the desired conclusion.
With this in mind, it can make perfect sense of how individuals in the private sector can save and the final equation (G-T) = (S-I) can be true. This is because saving involves setting aside resources in the present in order to have more wealth in the future. There is no need to logically include a government budget deficit for this to be true.
Although the identity does not prove that private investment is dependent on government budget deficits, it can suggest that an increase in government spending is related to a decrease in private investment as Murphy points out. This is another way to look at the equation that the leftist followers of MMT probably don’t want us to notice. If government spending (G) increases, it does not necessarily mean that the new version of saving (S) also increases, it could also mean that (I) has decreased. Furthermore, unlike the conclusions MMT proponents draw (especially on the left), this is actually logically possible as well, because if government is issuing an increased amount of treasury bonds it must also be redirecting privately saved funds into government projects when they otherwise would have been invested into relatively more productive private investments.
As a whole, Modern Monetary Theory has many different angles to be questioned, especially in the way the Democratic Socialists would likely want to use it. Stephanie Kelton makes clear the intentions of MMT, especially as a former economic advisor to Bernie Sanders and former Chief Economist on the U.S. Senate Budget Committee 2015 minority party. I must be clear that if the Democratic presidential candidates for 2020 want to hold on to the Green New Deal, Modern Monetary Theory is likely to gain more traction. That is why it is important to understand where it is misleading from all angles. From the fallacies, it brings from Keynesianism, the ignorance of the threat of monetary inflation, and the intentionally misleading accounting tautologies. When Democratic Socialists in the near future pick up on MMT in order to create realistic grounds for national healthcare and other enormous spending projects it should be perfectly clear that the motive is not objective “science” or environmental protection, but increased government power and control.