In “All Together Now: There Is No Deficit/Debt Problem,” I warned against the message calling for deficit reduction that the President will probably deliver in his State of the Union Address next month. I argued that there was no deficit/debt problem and that it is essential to reject the President’s framing of the issue and move on cope with the real problems of the economy and American Society. That piece stands alone. But I also think it would be useful to examine each of the specific fairy tales the President is likely to tell in making his case justifying austerity measures which are certain to be counter-productive. This post focuses on one these fairy tales; the narrative that the Government is running out of money.

We first heard that from the President on May 23, 2009 in a C-SPAN interview with Steve Scully There he said:

SCULLY: You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?

OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we’ve made on health care so far. This is a consequence of the crisis that we’ve seen and in fact our failure to make some good decisions on health care over the last several decades.

Since then, the President has reinforced his view that the Government is short of money, especially when he created the National Commission on Fiscal Responsibility and Reform. But, in addition, he’s always acted as if he believes the Government has a Government Budget Constraint (GBC), and he’s never acted as if he believed that the Government is in a unique position because it is the issuer and not just the user of its own currency.

What’s really behind this angst is, ostensibly, the mistaken idea that the Government can run out of money and so go broke, and that it is doing so. But this fear, if it is real, is due to a misunderstanding, a throwback to the days before 1971, when the currency had to be backed by some finite amount of a commodity such as gold.  . . .

We live in a different time. All the money issued by the Government today is backed by nothing except the full faith and credit of the United States of America, and that means that our Government can always use its constitutional authority to create money to pay its previous debts at any point in time, as long as it chooses to spend to meet its obligations. There’s no solvency issue and no solvency risk. America can’t go broke. The Government doesn’t finance its expenditures, either through taxing or borrowing. So even if it has a temporary inability to tax or to borrow it can’t go broke, unless its political authorities (including Congress) fail to honor its obligations in violation of the provisions of Section 4 of the 14th Amendment to the US Constitution. To get a better understanding of why this is true, take a look at this passage from the transcript of the presentation of Professor Stephanie Kelton given at the Fiscal Sustainability teach-In Counter-Conference (held at George Washington University on April 28th 2010).

” . . . the government is the issuer of its currency. It is not like a household. It doesn’t have to raise money by borrowing or collecting taxes in order to spend. Those of us in the private sector have to earn or borrow dollars before we can spend. The government must spend first. And we say this, and sometimes people have a hard time understanding that. How can the government spend first? How can it not spend first? How could the government collect taxes, in dollars, first? It first had to have spent those dollars into existence. The spending has to come before the payment or the collection of taxes. The government must spend first. Government spending is not (we use this term a lot) operationally constrained by revenues. It doesn’t need tax payments and bond sales in order to fund itself. It is not operationally constrained. The only relevant constraints are self-imposed constraints. We talked a little bit about this earlier, things like debt ceilings. That’s a self-imposed constraint. Rules that prevent the Treasury from running an overdraft in its account at the Fed. That’s a self-imposed constraint. It is a constraint that is imposed by Congress. Rules that prevent the Fed from buying Treasury bonds directly from the Treasury, so-called monetizing the debt, is a self-imposed constraint. [00:14.36]

How does the government actually spend? It spends by writing checks on its account at the Federal Reserve Bank. What we see, and what we hear all the time is that the government is spending a hundred, taxes are ninety and it sells bonds equal to ten. So, what we see is an attempt to coordinate the government’s spending with taxes and bond sales and it creates the illusion that what’s happening is that the government is taking money from us and using it to pay for the things that it purchases. But that’s not really what’s going on. As Warren likes to say, the government neither has nor does not have any money at any point in time. It is simply the scorekeeper. So what happens when the government spends? [00:15:24]

Let’s suppose that the U.S. Treasury issues a check for a hundred million dollars to Halliburton. What happens? The Fed marks down the Treasury’s balance. It subtracts one hundred million from the Treasury’s account at the Fed. Halliburton takes the check and deposits it wherever Halliburton happens to bank. I chose Bank of America. So Bank of America marks up Halliburton’s balance by a hundred million dollars. The Fed marks up the size of Bank of America’s reserve account (this is some reserve accounting, hang in there; it’s a little dry). The Fed, in the clearing process, credits Bank of America with a hundred million dollars in its reserve account. [00:16:08]

So what’s happened at the end of the day? What are the effects of government spending? The monetary base increases. We call that ‘high powered money’. Those are the bank reserves. The monetary base increases by a hundred million. The money supply increases by a hundred million. The money supply is all the checking accounts and traveler’s checks and a couple other things, but by and large, those are the deposits, ordinary everyday checking accounts. So the money supply increases. So what is the lesson from this? The lesson is that government spending creates new money, both high-powered money, bank reserves, and the more narrow definition of money, M1. They both increase as a consequence of government spending. [00:16:50]

How about when the government collects taxes? What happens there? Say you write a check for five thousand dollars to the IRS on your personal checking account, and you bank at Wells Fargo. Wells Fargo marks down the balance in your account, minus five thousand. The check gets sent from the IRS to the Treasury’s bank. The Treasury banks at the Fed. The Fed marks up the Treasury’s balance by five thousand, and the Fed marks down Wells Fargo’s balance by five thousand. What happens at the end of the day? The effects of paying taxes (See, when you pay taxes, there’s nothing there. Everything just disappears.) The monetary base decreases. Bank reserves go down by five thousand, so the base goes down. The money supply also goes down because you drew on your checking account. So, the money supply goes down by five thousand, the narrow measure, M1, and the monetary base goes down as well. Paying taxes destroys money. It doesn’t give the government anything. It doesn’t get anything. It eliminates those liabilities. They are, for all intents and purposes, destroyed. [00:18:06]

That’s if you pay with a check. What would happen if you actually sent the government your cash? Every once it awhile it seems like you hear about some crazy person who does this in protest. They get a huge sack, usually of coins just to make it really offensive and difficult on some poor bean counter. Let’s say you have a tax liability and it’s a hundred dollars and you just mail in a one hundred dollar bill. Apart from the shock of opening the envelope, what are they going to do with this? What do we do with this? Send it to the Fed. That’s where the Treasury banks. Goes to the Fed, and what do they do with it? They shred it. They shred it. Why would they shred it, I mean literally shred it, if they needed it to buy things, if they could use it to spend? Because they don’t use it to spend and they don’t need it to buy things. [00:19:06]”

So, as Stephanie Kelton indicates, the Government spends by marking up private sector accounts. The Warren she refers to in the transcript is Warren B. Mosler, another Conference participant, and a pioneer in clarifying the operational facts of how the Government actually spends. Warren’s analogy, which you’ll also find described in his book The 7 Deadly Innocent Frauds, characterizing the Government as a scorekeeper at an athletic event, leads him to ask whether it makes sense to look at the scorekeeper (the Government) as either having or not having points so that it makes sense to ask whether it can run out of points. Of course, it doesn’t make sense to see the scorekeeper that way. It only makes sense to view the scorekeeper (the Government) as having an unlimited authority to create points (US Dollars) to serve its purposes. So, of course, the Government cannot run out of US Dollars except due to its own self-constraints.

There are a number important self-constraints, imposed by Congress, that are hamstringing this scorekeeper beyond the constitutionally envisioned constraint of the Executive Branch spending only what Congress authorizes and appropriates. 1) The Congress prevents the Treasury from running a negative balance in its Federal Reserve accounts as a result of its spending. 2) The Congress also mandates that the Treasury issue debt to prevent such negative balances. 3) It also imposes a debt limit on the amount of debt that can be issued at any time.

None of these self-constraints are necessary. Potentially, they can interfere with the ability of the Government to pay its legitimate obligations including repaying its debts, and since section 4 of the 14th Amendment clearly says that the validity of the debts of the United States cannot be questioned, this raises of the question of the constitutionality of these constraints. A very important question currently, since many Republicans in the House are looking forward to refusing to raise the debt limit when the issue comes up in March — a voluntary act on the part of the US Government that calls our debt repayments into question.

Why doesn’t President Obama appear to know these facts about the impossibility of the US running out of US Dollars to pay its debts and buy things with? Well, perhaps he does know about it. Certainly, Alan Greenspan knows that “A government cannot become insolvent with respect to obligations in its own currency.” And Ben Bernanke knows that the US hasn’t used tax money to bail out the banks. So, it’s reasonable to assume that the President must know that we can never run out of money. So, why, pray tell, does he tell us that we’ve already run out of it?

We have to stop believing in the myth that the Government can’t do things because its money is limited, and start believing in the idea that the Government is us acting together to solve serious American problems that can’t wait. The Government belongs to all of us. It is ours, and we shouldn’t let the President or anybody else, talk us into the fairy tale that we shouldn’t use its unlimited authority to issue money to help us to act together to solve our serious and long-standing problems. That way lies the decline and fall of the United States. It is national suicide.

There are more Fairy Tales that are likely to appear in the President’s State of the Union Message. I’ll cover them in upcoming posts..

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).