Paul Krugman has another post up about the difference between money and debt. He raises a relevant question which starts to get to the heart of the real matter at hand:
“My concern is that when saying that money and debt are the same thing, it’s way too easy to lose sight of the real distinctions between monetary and fiscal policy that remain.”
If this were the movie Inception I’d be in the dream sequence one level deeper than Paul Krugman because I don’t quite think he’s asking the right question. The real question is not about confusion over monetary policy and fiscal policy, but the NEXUS of monetary policy and fiscal policy. In essence, does it matter whether a government self finances through direct deposit issuance or finances itself by selling bonds to the private sector?
As I explained previously, the design of our system is as such. Paul buys a bond at auction which gives the government a bank deposit which allows them to spend the deposit into Peter’s account. In short form, most government spending is bank deposit in (from Paul), bank deposit out (via government spending to Peter) PLUS net financial assets as bonds (to Paul). If the government were to self finance it wouldn’t sell the bond. It would just issue a net financial asset to Peter in the form of a bank deposit. Spending is primarily based on the relationship between current income relative to desired saving so there shouldn’t be much of a difference in all of this on an inflationary front (though one could argue that bonds are slightly less liquid than cash, but I think we’re splitting hairs there). Peter ends up with a deposit in either case and the private sector ends up with a net financial asset in either case. No big deal, right? Not quite.
Paul will still want to save in something that protects him from potential purchasing power loss of cash. So he’ll go out and search for a financial asset to provide that savings/income need. Now, the government could issue bonds to meet this need, but then we’re just sterilizing the deposit issuance and nothing is solved from the change in the system via direct deposit issuance. This is basically what the government does now and it’s hugely supportive to the private equity structure of “rentier capitalism”. If the government doesn’t issue the risk-free assets then we end up in an Izabella Kaminska world where there aren’t enough risk free assets and banks go crazy supplying the private sector with close (less stable) alternatives. We all know how that ends up. It’s inherently destabilizing.
So what this all really comes down to is rather simple. It comes down to whether we want to have a private sector banking system and a government that supports that system. Paul Krugman’s original question touches on this, but not quite in the right manner because the Fed, at the end of the day, is a public/private hybrid entity designed to support private banking. The alternative to this system is to start tearing down the walls of the Fed and start taking a jackhammer to the foundation of private banking. The government must choose to use the Fed and Treasury to support the capital structure of private banks or it must not support it and accept the destabilizing effects that will inevitably result in bailouts and government intervention. You can’t have it both ways.
In sum, yes, we could theoretically self finance, but a lack of risk free asset issuance will simply result in a destabilizing banking system. So we can self finance and issue the bonds, but then why bother changing the institutional structures from what they are today if this all ultimately ends up supporting the private equity structure of private banking in the end anyhow? It’s not even worth the trouble. On the other hand, the only way to self finance with direct deposit issuance without also creating an inherently fragile private banking system is to bring the banking system under the government umbrella in that dirty “N word” (no, not your favorite word, Quentin Tarantino). But then a bunch of bureaucrats end up managing their own form of the shadow banking system….
I’m afraid the best we’re going to do in altering the current system is to better regulate the banks and better understand the actual structure of the monetary system we have. The platinum coin created a great thought experiment for everyone and hopefully provided some important lessons and understandings about government spending and our monetary system, but this dream sequence is ending and it’s now time to wake up to the reality of our monetary system designed largely around the existence of private banking.
* For the real wonks, Scott Fullwiler has the only post up on all of this that displays a total understanding of the concepts at hand, but I’m not sure he’s deep enough in the dream sequence….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.