Pragmatic Capitalism

Capital for Living a More Practical Life


NPR is reporting on secret discussions inside the Clinton administration back in the late 90’s when the government briefly ran a budget surplus (via Business Insider).  The Clinton economic team was building models to project when they could pay off the national debt and any potential risks associated.   His economic team was clearly confused by the predicament.  While they viewed the surplus as necessary, they were also bothered by some risks.  The report says:

“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 of f 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.”

It’s a rather bizarre and really a very embarrassing document for the Clinton administration.  It essentially shows how confused the Economic Council was with regards to the operations of our monetary system.  Whether it is the bizarre editing of the document and the uncertainty regarding some operations or just the flat out questioning of their surplus to begin with.  The one thing we can confirm is that the Clinton surplus was an utter disaster.  I won’t rehash my past story on this in its entirety, but for the uninitiated:

“What happened next directly contributed to the current malaise in the US economy.  If we look at the sectoral balances we can see exactly what the Clinton surplus did.  As the US economy was running a current account deficit in excess of 2% in the mid 90′s the US government began to shrink the deficit.  This wasn’t entirely misguided, however, it was taken to an extreme.  As the current account remained steady near 2% the government’s balance continued to shrink and went positive in 1999.  All the while the domestic private sector is being driven into deficit.  Why?  Because the government was not spending enough to allow the domestic private sector  to net save.  So what happens as Americans attempt to counteract this?”

“They fund their lifestyles in other ways.  This means going into debt.  As you can see from household debt levels Americans were taking on an increasingly large amount of debt in order to sustain their lifestyles.  We all know what happened in 2000 as the dotcom bubble burst and the economy was thrown into a tailspin.”

Yes, the “fiscally prudent” Clinton surplus was actually a disastrous economic strategy given the balance of payments at the time.  But even more disturbing in this document is the repeated comments about needing to fund the future spending of the US government.  The very highest economists in our government appeared oblivious of the fact that the USA is a currency issuer completely autonomous in this currency and having no outside funding constraint (as in an inability to create money). They said:

“Regardless of how the Fed proceeds, by 2012 the public debt will be retired according to current projections, leaving the government with net receipts above its expenditures. In order to deal with financial obligations mid century, the government may choose to save, and indeed invest this surplus.”

They really think they have to “save” before they “invest”.  They were (are) working entirely under a convertible currency paradigm where they believed the USA can “run out of money”.  Contrary to popular opinion, an autonomous currency issuer in a non-convertible floating exchange rate system does not have a solvency constraint like a household or business does.

The monetary operation discussion is equally bizarre.  You would have thought that this would make the Clinton team reconsider their actions.  After all, when one plays this whole scenario out they must reconsider their premise to begin with.  If eliminating the government’s debt results in reduced instruments for private sector saving and an alteration in the Fed’s operations then perhaps the convertible paradigm they were thinking under was not exactly correct?  But it never dawned on them that the government’s debt was merely the private sector’s savings and not some funding source.  Eliminating the debt was the difference between giving Grandma a checking account and a savings account.   Furthermore, they never fully recognize that Fed policy could still be achieved without issuing bonds.  They see the elimination of the Treasury market as some great risk to monetary operations.  Now we know this is nonsense as the Fed can achieve monetary policy via interest on reserves.

The whopper in the piece is a fairly random comment about the financial industry in general:

“The financial services industry has grown tremendously in this country over the past eight years, and done a very good job ofhandling growth and the increased risks that accompany it.”

No comment needed after that one.  This is all just more evidence that our leaders lack a coherent and complete understanding of our monetary system (as well as the true risks associated with it).  It’s a frightening reality and no one should be surprised that we are in the mess we’re in today given these basic mistakes.

* Update – Title changed due to semantic reasons.

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