Austerians Will Eat Themselves

A recent report by NPR reveals that the Clinton Administration’s intention to pay off public debt raised self-inflicted conundrums. The consternation is evident in a document that makes for tragicomic reading. Cullen Roche has already done a great job of discussing the document from an MMT perspective and Tom Hickey has also drawn attention to the story. I won’t repeat what has already been discussed elsewhere, but will reflect on one of the implications of a government deciding to pay off the entire public debt.

Clintonian Conundrums

An excerpt from a draft of the document uncovered by NPR reads:

In the year 2000, the U.S. Treasury began actively buying back the public debt; we should all appreciate the tremendous achievement this represents for the Nation as a whole. As the previous section described there are good reasons for our current fiscal discipline and the public savings that accompany it to continue. We must realize however, that a sharp reduction in Federal debt and the possible accumulation of a Federal asset raises at least three important issues. First, investors looking for an asset free of credit risk can no longer count on an abundant supply of U.S. Treasury securities, and Treasury securities may no longer provide a reliable benchmark for other interest rates. Second, the Federal Reserve may have to change the mechanisms by which it conducts monetary policy. Third, continued surpluses after the public debt has been paid off will require the Federal government to acquire assets; either directly or though the Social Security Trust Fund. This raises issues about what kinds of assets might be acquired, and the best way to manage this task.

We know from the sectoral balances that the deficit of the government sector equals the surplus of the non-government sector. An implication is that budget surpluses correspond to aggregate net dissaving by the non-government.

Further, total outstanding public debt is simply the accumulated budget deficits of prior periods, and so equal to the accumulated net saving of the non-government. It therefore mirrors the net financial wealth of the non-government.

If the government pays off all outstanding public debt, it will have extinguished the net financial wealth of the non-government. To persist with budget surpluses beyond that point would require the non-government to relinquish real assets to the government in order to meet its tax obligation.

It should not be surprising, then, that a policy of extinguishing the accumulated net financial wealth of the non-government with the further intention to persist with budget surpluses by acquiring assets from the non-government (third concern raised) could have undesirable side effects for the non-government!

Yet, an objection to this paragraph of the draft was that:

You have no unequivocal statement here in the first paragraph that the paydown of the debt is a good thing. notwithstanding the challenges it presents.

In other words, the paragraph contained no unequivocal statement that extinguishing the net financial wealth of the non-government is a good thing. This supposedly needed to be fixed.

A conspiracy theorist might suspect that the Clinton Administration in fact understood sectoral balances and used this knowledge to hand over a wobbly economy (massive private indebtedness) to the Republicans.

In at least one country, the first concern (the removal of a risk-free financial asset) actually entered the public debate explicitly. In an enlightening post, Bill Mitchell discusses how the issue played out in Australia. A conservative government’s repayment of public debt led to displeasure in the financial community, purportedly because the removal of a risk-free financial asset would make pricing risk more difficult (complete nonsense) but really because they would lose a risk-free positive interest payment (corporate welfare).

The government’s solution, once the public debt was paid down, was to use the budget surpluses to speculate in the financial markets! This basically amounted to confiscating assets from the non-government and using the proceeds to speculate. If it “worked”, there would be a further transfer of nominal claims on real wealth from the non-government to government.

Why the government would wish to transfer to itself nominal claims that it could create whenever it desired through its currency-issuing capacity is beyond comprehension. The neoliberal reasoning, of course, was that the “savings” would come in handy if deficit spending were pursued at some time in the future, due to the orthodox construction of a ‘government budget constraint’. Needless to say, there is no sense in which such “public savings” have any impact on a sovereign currency issuer’s financial capacity to spend.

The Clinton Administration considered similar approaches:

Of course it is possible to keep both the benchmark Treasury and allow fiscal surpluses to continue to pay down the national debt. This would require that we diversify the Social Security Trust Fund (investment options and concerns are described below). Under such a scenario, the trust fund would invest in something other than Treasuries, while the federal government could maintain it’s current fiscal policy and the public market for Treasury instruments. Because the Trust funds would no longer purchase the same quantity of Treasury instruments, the federal government would face, declining OASI receipt pass through and a decrease in this finance. The federal government’s effective expenditure to receipts ratio would rise. The Treasury could solve the Fed’s short-term problem without involving the Social Security Trust Fund by creating a further Federal investment fund to save for future financial demands- as described later in this section.

According to Mitchell, most of the discussion on the left in Australia was along similar lines. An ostensibly left-leaning research center submitted a proposal from economists that accepted the same analytical foundation as the two main parties; namely, the ‘government budget constraint’ framework. Mitchell’s Centre of Full Employment and Equity (CofFEE) prepared the only dissenting view.

In relation to the U.S. economy, Randall Wray provided a good explanation of the consequences of paying down public debt along with historical examples in a post earlier this year.

Budget Surpluses Mean a Shrinking Non-Government

When the government taxes more than it spends – repeatedly – it is actually acting to shrink the size of the non-government.

Once the public debt is paid off, further government surpluses require the deficit sector (non-government) to sell private assets to government in order to meet the tax bill..

It should be clear what will happen as a result of such relentless austerity. The non-government will shrink and the government will expand. Budget surpluses, in real terms, will result in a bigger government and a smaller non-government.

Austerians will eat themselves.


8 thoughts on “Austerians Will Eat Themselves

  1. Ironically, many of the austerians are either Austrian school Libertarians or neoliberals who favor increased privatization, but if their austerianism were followed to its logical conclusion, socialism would be the result.

    Sounds like the road to serfdom to me.

  2. I don’t follow how the logical conclusion is socialism, however I agree with the road to serfdom. The proof is in the current pudding around the world.

  3. Senexx, increases privatization results in fewer government services and less injection of net financial assets. This means that consumers have to buy services at market rates. The game is to run up market rates to the limit of the public’s ability to borrow, in order to increase rents. Due to the mechanics of interest compounding this leads to a situation where debts cannot be payed. They debt-deflation kicks in, and losses multiply. Then government has to step in to prevent collapse. A good example of this was the Great Depression and New Deal, which the right considers the origin of socialism in the US. The US is on that course again, although so far it has been socialism for the rich this time. That is provoking social unrest. The GFC is not over yet, and the next leg down is going to make it clear that this is Great Depression II. The only reason that this is not recognized now is that automatic stabilization is place to mask it but not enough to repair it.

    We know from MMT analysis that balanced budgets and surpluses result in economic contraction in the absence of an offset since the private sector cannot disssave indefinitely, being revenue constrained. Contraction leads to larger and larger deficits through automatic stabilization, or to extreme social unrest in the absence of sufficient stabilization.

    For example, MMT economists predicted that “expansionary fiscal austerity” would lead to larger deficits due to falling tax receipts and increasing automatic stabilization, as well as producing social unrest, which is usually interpreted as from the left. And in Greece, we are seeing increasing rioting. In fact, there is a rumor of a secret report to the Troika that expansionary fiscal austerity is not working.

    Moreover, budget surpluses — taxing more than spending — removes wealth from the private sector, exactly what the right calls “socialism” — transferring private resources to the state.

    So the call from the right for greater privatization and fiscal discipline is not the panacea they think it is.

  4. Hi. Can I get a clarification on this paragraph: Further, total outstanding public debt is simply the accumulated budget deficits of prior periods, and so equal to the accumulated net saving of the non-government. It therefore mirrors the net financial wealth of the non-government.

    I understand that “total outstanding public debt is simply the accumulated budget deficits of prior periods”. This is a definition of terms.

    I understand that total outstanding public debt “mirrors the net financial wealth of the non-government.” The tricky word here is “net”. Net financial wealth excludes financial wealth where the debtor and creditor are both in the non-government sector. So it’s only “net” private wealth if it is government debt. I get that.

    If the above interpretations are correct, you don’t need to go over them for me.

    The part I don’t understand is where you say that total outstanding public debt is “equal to the accumulated net saving of the non-government.” This implies that every dollar borrowed by the government sector immediately (or say, within a year) ends up as savings of the non-government sector. I know that the quantity of money in savings is very high compared to the quantity not in savings, but still this one just doesn’t sound right.

    What is your definition of “savings”?

    Are you really saying that every dollar of Federal deficit spending ends up added to someone’s savings? If so, can you point me to something at FRED that shows it happening?


  5. It’s not ‘savings’, it’s ‘net savings’ which is an entirely different concept.

    I hate having to use the word ‘savings’ in that phrase because it is a loaded word that people understand to have a particular meaning and it confuses matters. There is a similar problem with the phrase ‘inflation’ which has a subtly different meaning in economics terms.

    But there’s not really a better word for it.

    Remember that we are dealing with final value products here and aggregates. Then you consider two of the measures of GDP.

    Firstly the income basis as assigned to households, ie:

    GDP = C + S + T

    GDP is the total of what is consumed, what is saved and what is paid in taxes.

    Secondly the expenditure basis;

    GDP = C + I + G + (X – M)

    Which says that GDP is what is consumed plus ‘gross private domestic investment’ plus government spending and the balance of imports/exports. M is imports, X is exports.

    Combine those together and you’ll get the following:

    (S – I) = (G – T) + (X – M)

    rearrange and you get

    (G – T) = (S – I) + (M – X)

    So ‘net financial savings of the non-government sector’ is (S – I) + (M – X).

    See Question 3 on this week’s Billy Blog quiz:

  6. That’s correct, Neil. Thanks.

    I actually don’t mind the term ‘net saving’ or, alternatively, ‘aggregate saving’, although I agree it can be somewhat confusing.

    The relevance of the term is easier to see for a closed economy. Net saving is then S – I. Here, S is disposable income, YD (= Y – T), minus C. So net saving is YD – (C + I). In words, net saving or aggregate saving is disposable income minus private spending.

    In an open economy, the non-government includes the domestic private sector and the external sector. Both these sectors can save in financial assets denominated in the domestic currency. The domestic private sector receives disposable income YD and spends C + I. The external sector receives revenue M and spends X. So non-government net saving is the amount received, YD + M, minus the amount spent, C + I + X.

  7. Thank you both.

    I have seen these equations before of course, but now I can see the relevance of them.

    I have to go look at ’em for a while. Thanks again.

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