Monetarily Sovereign Government Doesn’t Have Insolvency Risk on Spending, and Taxation Doesn’t Give The Funds to It: An Intro of MMT. By: Unggul Purnomo Aji

 

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Basic Foundation

MMT puts an accentuation on looking the economy through the sovereignty level of the currency and using the balance sheet analysis (or simple T-account) for digging up the monetary phenomena which is integrating all of economic units including Government and Non-government (either financial or non-financial sector) to grab the consistent and careful summation on the whole of economic phenomenon.

 

Sovereignty of Currency

Sovereignty of currency is a flexibility level of the authority for monetizing the money. The full level of the sovereignty is when a country applies the fiat money (1 country, 1 currency), floating its exchange rate, having no foreign denominated debt, and its currency is demanded internationally. The example is like USA, UK, Japan, Australia and Canada. Those countries have no constraint for doing such spending (fiscal deficit, trade deficit), affordability problem is not an important issue because they can simply just use central bank’s keyboard for crediting and debiting the money (monetary instrument). The real limit in those country are real resources; how much the capacity of available resources could be utilized.

 

Other countries mostly have less sovereignty level than those countries mentioned before, it is caused by the various phenomena such as having large foreign denominated debt, its currency is less demanded internationally, pegging the currency or having dependency on imports. However, as long as a country spends and taxes with its own currency (having the central bank) it can purchase everything domestically including the wasting resources -such as unemployment- because all of domestic economic unit always receive its monetary instrument as a unit of account to redeem the tax. This condition (ex. purchasing the existing unemployment) can be utilized for conducting the desire output agenda like building up public infrastructure, doing social work or even to increase the productive output capacity. The example is almost clearly like what had happened in the Roosevelt –New Deal- era.

 

In exception, EU members have different setting with other countries, even for injecting the money to domestic private sector (doing fiscal deficit) they can’t. The reason lies in their spectrum as the currency user not as the currency issuer. This happens because they have been giving up their monetary power to European Central Bank (ECB). Then, their spending and taxing are using ECB’s monetary instrument (Euro) in which make them have the same position as a state/local government which is unable to monetize the money.

 

In this writing, we will discuss regarding to first, monetarily sovereign government doesn’t have any constraints for spending. Second, tax doesn’t give the funds to this type of government. Third, borrowing in its own currency is totally misleading for a country in which uses its own currency in spending and taxing, the government bond that has been issued is a private sector saving account. Fourth, the state-owned enterprises profit has the same function with the tax. Fifth, trade deficit is beneficial for a country in which its currency is demanded internationally.

 

Balance Sheet (T-account) Analysis.

Every economic unit has a balance sheet, it is an accounting document that records assets and liabilities. The difference between its assets and liabilities is called net worth, or equity, or capital (Assets = Liabilities + Net Worth). To analyse the dynamics of balance sheet, economists mostly use simple T-account. This is because of sometimes the data of assets and the liabilities are hard to be found, so, by using the simple logic of T-account we could still grab the inherent and consistent analysis depicting the economic phenomena.

 

Here we present about how to maximize the potency of monetarily sovereign government which has no solvency problem. First of all we should look at the balance sheet of central bank:

 

 

After this, we will see through using T-account how exactly when the government spends & taxes its money, the mechanism of why government issues its bond and what the impacts on non-government sector, also looking the phenomenon that state owned enterprises profit is equal –in same logic- with tax and why trade deficit is sustainable for a country like US.

 

#Case no. 1: Government Spending.

When the government wants to buy a car from Mr A (private domestic sector) who has an account at Bank U while the price of the car is $100, the following mechanism is:

 

Fed
ΔAssets	ΔLiabilities and Net Worth
	Reserve Balances (L2): +$100 Treasury Account (L3): -$100

 

Bank U
ΔAssets	ΔLiabilities and Net Worth
Reserve: +$100	Deposit of Mr A: +$100

 

Mr A
ΔAssets	ΔLiabilities and Net Worth
Car: -$100 Account of Mr A: +$100

 

The simple explanation is The Treasury spends $100 on its checking account in The Fed to the account of Mr A. You may have a question, from where the treasury has the money? Is it coming from tax or from bond issuance?

 

This is the wrong question that most of people conduct with. Treasury can always have the money either directly (central bank marks up the number of its treasury checking account) or indirectly (by providing the reserves to the economy first and then treasury will have the money on its account through issuing the bond). Tax is a destruction of money

 

The central idea is: the reserve should be injected first! Following the preposition S(TAB) means Spending first and then Taxing and Borrowing is how the monetarily sovereign government works. In another simplest mechanism, when the treasury wants to do such spending (buying a car), it gives a command to the central bank to mark up Mr A account just through keystrokes (just by using keyboard on the central bank’s computer). It can be done even when the treasury doesn’t have the reserve. The result is the same:

 

Fed
ΔAssets	ΔLiabilities and Net Worth
	Reserve Balances (L2): +$100 Treasury Account (L3): $0

 

Bank U
ΔAssets	ΔLiabilities and Net Worth
Reserve: +$100	Deposit of Mr A: +$100

 

Mr A
ΔAssets	ΔLiabilities and Net Worth
Car: -$100 Account of Mr A: +$100

 

As long as a country has the central bank and the economy is manufactured by using its own currency for taxing and spending, this type of government can buy everything domestically including purchasing of all un-utilized resources such as unemployment. They can be hired for working on useful scheme program for building up public infrastructure, reforestation, social welfare work, and whatever the job that the government wants to provision.

 

Some people who have a strong beliefs that government’s money is coming from the taxation should consider this question “when there is no money that has been spent in the first time, how the government conducts the taxation activities?” Some people are saying that “oh money is coming from barter!” and then my question is “since 5000 years since Mesopotamia, money has always come from the authority, where is the evidence proving that money is coming from barter? Who puts the name rupiah in Indonesia’s currency, society or authority?”

 

In sum, when the treasury spends its money in indirect way –issuing the government bond first to increase the number of its account on the central bank then spends it- the money should be on the economy first (spending first then taxing and borrowing). Doing spending based on tax is totally misleading.

 

#Case no. 2: Government Taxing.

Let’s imagine with using the previous example, now the government decides to tax Mr A 20% of its income ($20), the following mechanism will be like this:

 

Fed
ΔAssets	ΔLiabilities and Net Worth
	Reserve Balances (L2): $80 Treasury Account (L3): +$20

 

 

Bank U
ΔAssets	ΔLiabilities and Net Worth
Reserve: $80	Deposit of Mr A: $80

 

 

Mr A
ΔAssets	ΔLiabilities and Net Worth
Account of Mr A: $80

 

Mr A checking account has been debited by the treasury at $20 then the reserve and deposit at Bank U are decreased also. Note that even though taxation is increasing the treasury checking account at the Fed, it doesn’t mean that taxation gives the fund to the government. It is because of the reserve should be in the economy first before it can be taxed. The purpose of taxation is just to destroy the net financial wealth held by the non-government sector (Mr A).

 

In a brief addition, tax actually has 4 functions: 1) to drive money 2) limit inflationary pressures 3) redistributing the wealth (destroying the excess of wealth on some group of population) 4) to encourage or discourage certain behaviour. However, tax on profit and other costs out of income such as payroll tax, healthcare worker insurance, and private pension fund will induce inflation, discourage employment and stimulate the economic instability. This part will be discussed later in my separate writing. However, “giving the funds to the government is not the function of tax.”

 

#Case no. 3: When The Government Issues The Bond

Orthodox argument that has been believed and spread by mainstream media, stupid economist or even garbage politician is that the government is same with the household, it has to tax and borrow first before it can spend (TAB)S. We have been explaining supposing to S(TAB) that taxing and borrowing doesn’t fund the government. The next question is why the government issues the bond?

 

The bond that is issued either by treasury or central bank has the purpose to drain the excess reserve inside of the banking system to achieve its target rate. When the government doesn’t do this it means the interest rate would be going to zero. Taxation is one of the tools to drain the excess reserve but it has dated schedule in which it is incapable to respond the flexibility of the payment system which should be overnight. When the reserve is too much it will cause the downward pressure on the fed funds rate. Thus, issuing the bond or selling it is important to maintain its target rate.

 

Moreover when some stupid economists say this bond issuance will crowd out private domestic money, I argue that this is wonky statement. The reason lies on the T-account analysis which we will explore after this. The conclusion is “The Government Bond is A Private Sector Saving Account”. Following the previous example, in which the government now issues $30 T-bond bought by Mr A, the result is:

 

Fed
ΔAssets	ΔLiabilities and Net Worth
	Reserve Balances (L2): $50 T-Bond: +$30

 

Bank U
ΔAssets	ΔLiabilities and Net Worth
Reserve: $50	Deposit of Mr A: $50

 

Mr A
ΔAssets	ΔLiabilities and Net Worth
Account of  Mr A: $50 T-Bond: +$30

 

The bond now is becoming another asset of Mr A in which will give the interest income more than what he has been obtained from bank U. The mechanism will be same when the T-bond is bought by the bank. It is very liquid asset and has no insolvency risk. Whenever the bond holders want to withdraw it to the cash, the central bank could easily change its account into the cash -from the yellow dollar to the green dollar- effortlessly by only using keystrokes.

 

#Case no. 4: (SOE) State Owned Enterprise’s profit is actually same with the tax

When the people listen about an enterprise they thing that it has to produce as much profit as possible. It is true for a private enterprise to act as a merely profit oriented, however, it would be different when we discuss regarding to SOE. SOE such as national electric company that fully or even partially owned by the state should be on the loss because when it grabs the profit it will have the same function like the tax, destroy the net financial of private domestic sector, because the profit will flow to the treasury aka same with tax. Why SOE should record a loss? The reason is simply, its loss will add a net financial wealth. The following mechanism when a SOE, let say an national electric company- obtains $10 as a profit and continuing the previous example when Mr A still has $50 cash would be like this:

 

SOE (national electric company)
ΔAssets	ΔLiabilities and Net Worth
Profit: +$10	Net Worth: +$10

 

Because the economy is the social relation that someone’s asset is someone’s liability, and someone’s profit is representing someone’s loss, then Mr A should pay $10 to that SOE, thus his cash will be $40 left.

 

Mr A
ΔAssets	ΔLiabilities and Net Worth
Account of  Mr A: $40 T-Bond: $30

 

Bank U
ΔAssets	ΔLiabilities and Net Worth
Reserve: $40	Deposit of Mr A: $40

 

Then SOE profit flows into the treasury account:

 

Fed
ΔAssets	ΔLiabilities and Net Worth
	Reserve Balances (L2): $40 T-Bond: $30 Treasury Account (L3): +$10

 

From this analysis, it is true that the function of SOE’s profit has the similarity with the tax because it drains and destroys the net financial wealth of Mr A (the private domestic sector), in this case the seller’s net financial wealth is decreasing from $50 to $40.

 

In addition, SOE ideally should be owned fully by the government. When SOE is partially owned (let say 50% government and 50% private) this kind of SOE still needs a profit because private sector is currency user, they have insolvency risk and having no capability to monetize money. The concept like public private partnership is inherently flaw.

 

#Case no. 5: Trade Deficit is Sustainable and Beneficial as long as Your Currency is Demanded Internationally.

Some orthodox economists which are following the mercantilist curriculum always say that the trade deficit is unsustainable and dangerous to the future development of the economy. This analogy come into place when they analyse the relation between US and China. US experiences a huge trade deficit to China, and the economists under the president Trump have decided to apply the trade war –increasing the tax on import from China- to reduce its deficit. Now the question is “does the trade war is a correct policy?”

 

For a country in which its currency is demanded internationally such as United States, England, Japan, Australia, Canada the mercantilist law will never work. Coming back to the case between US and China, when China does export to the US it will receive the US Dollar in exchange. China can accumulate as much USD as possible as they want. Somehow they change the cash (green dollar) to the Treasury bond (yellow dollar) because they know that holding the cash will not give then any interest payment.

 

You should know that the USD held by China is never going out from the balance sheet of The Fed (L4). Thus, paying back the Treasury bond which is held by them can be done effortlessly by using the keystroke on The Fed. Furthermore, China now is owning useless paper from US, they are unable to deplete it except for doing import from US. Then, when US restrict its own export to China, China will unable to consume the USD they hold, another words US has benefit because it enjoys consuming the goods and services from China and China doesn’t. Rather, China now is holding the useless paper. Thus, Trade War policy is actually misleading.

 

Continuing the previous example, now we will see when our private domestic sector (Mr A) buys the goods and services that amount $10 to China. The following analysis will be like this:

 

Fed
ΔAssets	ΔLiabilities and Net Worth
	Reserve Balances (L2): $30 China’s account (L4): +$10

 

China
ΔAssets	ΔLiabilities and Net Worth
Account of China at The Fed: $10

 

 

Mr A
ΔAssets	ΔLiabilities and Net Worth
Account of  Mr A: $30 T-Bond: $30

 

Bank U
ΔAssets	ΔLiabilities and Net Worth
Reserve: $30	Deposit of Mr A: $30

 

Now China decides to change its saving account to buy T-Bond, the following T-account will be like this:

 

 

Fed
ΔAssets	ΔLiabilities and Net Worth
	Reserve Balances (L2): $30 China’s account (L4): $0 T-bond held by China: $10

 

China
ΔAssets	ΔLiabilities and Net Worth
Account of China at The Fed: $0 T-bond: $10

 

The Fed can always pay back the T-bond held by China by just swapping the yellow dollar to green dollar through using keystrokes, insolvency risk on behalf of government is not existing on this case.

 

In addition, only few countries which have ability conducting trade deficit sustainably. Something that should be underlined for a country in which its own currency isn’t demanded internationally, it is still able to buy everything domestically.