Is Washington tacitly operating under a new monetary theory?

December 24, 2017

In 2002 when soon-to-be-dismissed U.S. Treasury Secretary Paul O’Neill warned then Vice President Dick Cheney that the Bush administration’s tax cuts would drive up deficits and threaten the health of the economy, Cheney famously answered: “You know, Paul, Reagan proved deficits don’t matter.”

In the wake of the recently approved federal tax cut,voices concerned about the damage that deficits will do are rising again.

What’s curious is that since Cheney’s rebuke of O’Neill, growing federal government deficits seem not of have mattered. In fact, the largest deficits ever boosted the economy after the 2008-09 recession, exceeding $1 trillion annually for four years.

All of this suggests that the federal government has for a long time been operating under an unspoken monetary theory, namely, that government spending does not need to be backed by revenues and that the debt issued to fill the gap between spending and revenues will have little effect now or in the future.

But isn’t there some level of federal debt which would cripple the federal government and the U.S. economy?  A common metric for measuring this debt is the ratio of federal debt to annual gross domestic product (GDP). When one looks at a graph of this, the growth in debt seems perilous, rising from a low of around 30 percent of GDP in the early 1980s to more than 100 percent of GDP today.

Seemingly more perilous is the rapid growth in Japanese government debt. That debt has soared from a low of around 40 percent of GDP in 1990 to almost 200 percent of GDP now. Yet, the oft-prophesied demise of Japanese government finance has not occurred.

What the United States and Japan share in this regard is that each issues its own sovereign currency. That means both could theoretically retire their entire government debt in one day by issuing sufficient currency to buy up all the outstanding bonds. (A smarter way would be to do this very gradually without announcing it. In the alternative, the legislature could pass a law requiring government bondholders to sell their bonds back to government at a pre-determined price—something bondholders would certainly dislike since the price is likely to favor the government.)

What this tells us is that any government that issues its own currency will never run out of money to pay back bondholders. That’s, in part, why there is no panic among Japanese and American owners of government debt. What the above further tells us is a bit more shocking: Such governments don’t even need to issue debt to finance their operations.

And, so long as a government doesn’t issue more currency than the economy can produce goods and services for, it won’t create price inflation (defined as too much money chasing too few goods).*

The only reason for governments which control their own currency to levy taxes then is to create demand for that currency. If someone has to pay taxes in the government-issued currency, he or she will want to receive at least some payment in that currency. As it turns out, so will everyone else. As a result it becomes simply more convenient if everyone adopts the country’s sovereign currency as their unit of account and medium of exchange.

All of what I’ve just described fits neatly into what is called Modern Monetary Theory (MMT), the premises of which are so deceptively simple that it is hard for people to believe them. But Japan and the United States seem already to be operating under that theory save for one act—the act of issuing copious amounts of government debt, something that is entirely unnecessary under MMT.

The idea that governments which issue their own sovereign currency must rely on private credit—mostly from wealthy citizens—to finance themselves is an illusion. But it’s an illusion that the monied class hopes no one will see through. For if the public does see through it, government debt—which is used like a weapon to promote cuts in social spending—would cease to frighten anyone (and may be gradually eliminated). That means spending policy would become much more flexible than previously imagined.

So, it turns out that Dick Cheney was right—but not for reasons which he and the new rentier class would ever be willing to admit, namely, that the government doesn’t need loans from rich people or loans of any kind. Bondholders therefore can’t really hold the government hostage. Realizing this and acting on it would seriously diminish the influence of the rich in the halls of power and make a realignment of spending priorities possible.


*This is an important check on the creation of money. A complete discussion of this would require a separate piece covering the physical limits the economy faces with regard to resources (especially energy), climate and infrastructure.

Image: Allegory of inflation during the Bakumatsu era. Pre-1868 anonymous Japanese artist. Japan Currency Museum. Via Wikimedia Commons

Kurt Cobb

Kurt Cobb is a freelance writer and communications consultant who writes frequently about energy and environment. His work has appeared in The Christian Science Monitor, Common Dreams, Le Monde Diplomatique,, OilVoice, TalkMarkets,, Business Insider and many other places. He is the author of an oil-themed novel entitled Prelude and has a widely followed blog called Resource Insights. He is currently a fellow of the Arthur Morgan Institute for Community Solutions.

Tags: debt, dollar, monetary theory