A Refutation of Mosler Economics and Mosler's 7DIF, Part III

The following is Part III in a seven part series, "A Refutation of Mosler Economics and Mosler's 7DIF", which seeks to critically examine the fiscal and monetary policy solutions offered by Warren Mosler [PDF], a former candidate for the US Senate in Connecticut in the 2010 election.

Warren Mosler:

Deadly Innocent Fraud #3:
Federal Government budget deficits take away
savings.
Fact:
Federal Government budget deficits ADD to
savings.

Let's see how Mosler fleshes this out.

Mosler:

This third deadly innocent fraud is alive and well at the very
highest levels. So here’s 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. financial assets) of
the rest of us - businesses and households, residents and non
residents - 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. It’s an accounting identity. Yet it’s
misrepresented continuously, and at the highest levels of political
authority. They are just plain wrong.

True: this is a financial accounting identity.

False: the belief (whether Mosler holds it or not) that increased financial savings necessarily represent increased real savings.

So far, Mosler has not stated whether he equates financial savings with real savings. Regardless, I will clarify that anyone who would state such a thing as "an increase in financial savings necessarily means an increase in real savings" would be wrong.

If the US government expands its budget deficit and thereby expands the total amount of financial savings as a result (because all debt is held by somebody outside of the government sector as savings, as per Mosler's statement of the accounting identity), it does not follow that the pool of real savings (anything which may serve as a capital good in the production of higher order goods, for example, machinery, food stocks, clothing stocks, commodity stockpiles, fuel supplies, etc.) is increased proportionally, as an identity.

In other words, it would be wrong to assume that, because larger government deficits represent larger financial savings, larger financial savings represent larger real savings and therefore larger government deficits mean larger real savings which means we are all wealthier and economically better off if the government expands its deficit.

Mosler proceeds to explain how government deficits add to (financial) 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.)

It is important to point out a clarification regarding Mosler's note that these purchases are "voluntary." They are "voluntary" within the conditions predicated by a government which has enacted legal tender laws (threat to use force against anyone who does not settle debts in the legal tender) and which guarantees its own ability to make good on its debts by its ability to ultimately tax individuals either directly or indirectly (through issuance of new money) to raise the funds needed. Of course, none of this can at all be considered "voluntary" because it rests on government's monopoly of the use of coercion.

The government does not make productive expenditures which return to the government its original cost plus profit (which can be used to pay principal and interest), unlike the productive expenditures of private investment. Government expenditure is consumptive-- once the government spends, it receives nothing in return. The wealth is gone. If the government finances its expenditures through debt, it must steal (tax) at some other time to raise the funds necessary to pay off the debt.

Without it's ability to steal (tax) the funds it needs to pay off its debt, the government would be left with nothing to pay off its debt. No one would voluntarily lend to the government who was at all concerned with getting a return on their loan because they'd realize the government would not have the ability to make good on that debt. The only people left financing the government's expenditures would be those who found it to be a charitable activity to do so.

It is within this context of coercion and manipulation of people's opportunities to dispose of what remains of their wealth as they see fit that Mosler states that people "voluntarily" buy government debt. Yes, no one is ever forced to buy government securities, but some people are forced to provide the government with the resources it needs to pay off these securities at time of maturity.

Mosler describes a conversation with Al Gore.

Mosler:

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 wasn’t 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 didn’t 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-to-come 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.

Mosler again is employing an unstated economic theory that he is using to interpret the events of the 2000s to reach a conclusion about the cause of the recession.

He claims that the deficit was "too small". It is unclear if he means to imply this was the cause of the "sub-prime debt-driven bubble" bursting or if he means to state that this was a contributing factor to the recession that followed, along with the government deficit which was "too small."

Mosler does not state how he calculates whether the deficit is "too small" before a recession occurs. It is "clear" to him in retrospect that if a recession occurs, it means the deficit was not large enough. But if this is true after the fact it must also necessarily be true before the fact and therefore there must be some theory or pattern of reasoning one could use to predict that the deficit is not "big enough" to meet the needs of the economy.

Individuals can save in vehicles other than government securities. If the government does not run a deficit and thereby expand the supply of government securities which people can place their savings into, individuals can choose to either spend their wealth on personal consumption or private savings/investments, such as bank deposits or the purchase of corporate debts.

Mosler doesn't explain why savings held with the government (Treasuries purchased by the non-government sector) serve to ward off recessions, but savings held with private businesses lead to recessions.

Mosler concludes:

So what is the role of deficits in regard to policy? It’s
very simple. Whenever spending falls short of sustaining
our output and employment, when we don’t have enough
spending power to buy what’s 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 don’t 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 the real life - output and employment - not
the size of the deficit, which is an accounting statistic. In the
1940’s, an economist named Abba Lerner called this,
“Functional Finance,” and wrote a book by that name
(which is still very relevant today).

You can read all about Abba Lerner's "functional finance" on Wikipedia here. Here are the major principles:

• Governments have to intervene; the economy is not self-regulating.

• The principal economic objective of the state should be to ensure a prosperous economy.

• Money is a creature of the state; it has to be managed.

• Fiscal policy should be directed in the light of its impact on the economy, and the budget should be managed accordingly, that is, 'balance' is not important in itself.

• The amount and pace of government spending should be set in the light of the desired level of activity, and taxes should be levied for their economic impact, rather than to raise revenue.

• Principles of 'sound finance' apply to individuals. They make sense for households and businesses, but do not apply to the governments of sovereign states, capable of issuing money.

Mosler states that "functional finance" is "still very relevant today." This appears to be approval of functional finance and therefore the principles of functional finance. We therefore have some insight into the economic theory Mosler is utilizing to reach his ultimate conclusions about how monetary policy should be employed to benefit the economy.

It would appear safe to say that Mosler does not understand the functioning of markets and that he is an advocate of Keynesian economics (Lerner is cited as the inspiration for the use of monetary and fiscal policy as the two tools of Keynesian economics) as the principles of functional finance are similar/in many cases the same as Keynesian economics.

Therefore, all criticisms and debunkings of Keynesian economic theory will likely similarly apply to Mosler economics. In attacking some of the premises and claims of Keynesian economics, the foundation of Mosler economics is similarly eroded.

Many authors have spent much time and effort debunking these claims independently. Here is one such effort on The Myth of Functional Finance. If you are interested in those efforts I suggest you search for them, principle by principle, on your own. I won't waste time by repeating them all here. Rather I will try, in the future as I have so far up to this point, to address these principles when Mosler seems to be inferring them or relying upon them in his analysis, even when he does not openly state that that is what he is doing.