Japan shows how to defuse debt
time-bomb By Ellen Brown
Threatening to default should not be
a partisan issue. In view of all the hazards it
entails, one wonders why any responsible person
would even flirt with the idea. Alan
S Blinder, Princeton professor of economics,
former vice chairman of the Federal Reserve.
A game of Russian roulette is being played
with the national debt ceiling. Fire the wrong
chamber of the gun, and the result could be the
second Great Depression.
The first Great
Depression led to totalitarian dictatorships, war
to consolidate power, and concentrations of
capital in the hands of a financial elite. The
trigger was a default on the global reserve
currency, in that case the pound sterling. The US
dollar is now
the global reserve currency.
The concern is that default could create the same
sort of global panic today. Dark visions are
evoked of the president declaring a national
emergency, Federal Emergency Management Agency
plans locking into place, camps being readied for
protesters, and the secret government taking over
...
This may all just be political
theater, but do we really want to get close enough
to the economic precipice to find out? The
conservative ideologues toying with the debt
ceiling are doing it to force cuts in the budget,
a budget that was already approved by congress.
Congress is being held hostage by a radical
minority pushing a risky agenda, one that is based
on an economic model that is obsolete.
High-stakes Gambling On May 16,
the Wall Street Journal published an opinion piece
titled ''The Armageddon Lobby,'' which claimed
that a ''technical default'' on the federal debt
was just ''political melodrama'' and not really a
big deal:
[B]ond markets can figure out the
difference between a genuine default when a
country can't pay its bills and a technical
default of a few days if it serves the purpose
of fixing America's fiscal mess.
Not
so, said Saudi Prince Alwaleed bin Talal in a May
20 interview on CNBC. ''That's gambling. This is
the United States. You're leading the whole world.
You cannot play games with that.''
It is
not just that the government could be brought to a
standstill, with a third of its bills now being
paid by borrowing; or that interest rates would
shoot up, forcing thousands of homeowners into
foreclosure. Failure to pay on the national debt
could trigger a default on the global reserve
currency. As one commentator described what could
go wrong:
[T]he consequences of a US default
could spark yet another global financial crisis.
The US could lose its triple-A rating, which
could cause a sell-off in Treasury notes by
institutional and foreign investors. This
sell-off could lead to higher interest rates,
and banks' balance sheets might be decimated by
the decline in their bond portfolios. Thus,
global banking and financial market liquidity
could dry up. Lending between institutions and
people or businesses could possibly cease
altogether or become cost prohibitive.
A rerun of 1931? The sort
of chaos that could ensue was seen when Great
Britain reneged on its deal to redeem pound
sterling banknotes in gold in 1931. The result was
the worst global depression in history. When the
pound went off the gold standard, markets
panicked. People rushed to exchange their paper
money for gold, in any currencies in which that
was still possible. The gold wound up hidden under
mattresses and in safety deposit boxes, unspent;
and the banks from which it was pulled, having no
reserves to back their loans, quit lending or
closed their doors. Credit froze; business ground
to a halt.
As other countries ran short of
gold, they too were forced to take their
currencies off the gold standard. The last
holdouts suffered the most, including the United
States, which kept its gold window open until
1933.
The 19th century had been plagued by
bank runs, caused by banks having too little gold
to back their outstanding loans. The Federal
Reserve was instituted in 1913 ostensibly to
prevent those runs, but its levee did not hold
back the run of the 1930s. In 1933, the country
suffered a massive banking collapse, forcing
President Franklin D Roosevelt to declare a
banking holiday and take the US dollar, too, off
the gold standard.
Freed from the
'Cross of Gold' The transition off the gold
standard was a painful one; but according to
Beardsley Ruml, Chairman of the Federal Reserve
Bank of New York, the country was the better for
it. In a paper read before the American Bar
Association in 1946, he said that going off the
gold standard had finally allowed the country to
be economically sovereign:
Final freedom from the domestic
money market exists for every sovereign national
state where there exists an institution which
functions in the manner of a modern central
bank, and whose currency is not convertible into
gold or into some other
commodity.
Freed from the strictures
of gold, Roosevelt was able to jump-start the
economy with deficit spending. As Marshall
Auerback details,
the next four years constituted the biggest
cyclical boom in US economic history. Real GDP
grew at a 12% rate and nominal GDP grew at a 14%
rate.
Then in 1937, Roosevelt listened to
the deficit hawks of his day and slashed the
deficit. The result was a surge in unemployment,
and the economy slipped back into depression.
What lifted the country out of the
doldrums was again deficit spending, liberally
engaged in to fund World War II. In wartime, few
people worry about the national debt. The debt grew to 120% of
GDP - twice what it is today - and wound up
sustaining another very productive period in US
history, one that set the country up to lead the
world in manufacturing for the next half century.
On inflation and taxes Ruml said
federal taxes were no longer needed to fund the
budget, which could be financed by issuing bonds.
The principal purpose of taxes, he said, was ''the
maintenance of a dollar which has stable
purchasing power over the years. Sometimes this
purpose is stated as 'the avoidance of
inflation'.''
The government could spend
as needed to meet its budget, drawing on credit
issued by its own central bank. It could do this
until price inflation indicated a weakened
purchasing power of the currency. Then, and only
then, would the money supply need to be contracted
with taxes.
''The dollars the government
spends become purchasing power in the hands of the
people who have received them,'' Ruml said. ''The
dollars the government takes by taxes cannot be
spent by the people,'' so the money supply can be
contracted with taxes as needed.
When the
economy is in a recession, however - as it is now
- the government needs to spend in order to get
purchasing power into the hands of the people.
Businesses cannot hire more workers until they
have more customers demanding their products, and
the customers won't come until they have money to
spend. The money (''demand'') must come
first. Adding money will not drive up
prices until the economy is at full employment.
Before that, increasing ''demand'' will drive up
''supply'' by setting the engines of production in
motion. When supply and demand rise together,
prices remain stable.
We now know that a
government can go quite far into debt without a
dangerous level of price inflation occurring -
much farther than the US has gone today. Besides
World War II, when US debt was 120% of GDP, there
is the remarkable example of Japan. Japan has
retained its status as the world's third largest
economy, although it has a debt to GDP ratio
of 226% - and it is still fighting deflation.
Critics of the deflationary theory point
to commodity prices, which are soaring today. But
if those prices were due to the economy being
awash with ''too much money chasing too few
goods,'' real estate prices would be soaring too.
Instead, the real estate market has collapsed.
What has actually happened is that the housing
bubble has transmuted into the commodity bubble,
as ''hot money'' has fled from one to the other.
The overall money supply is still in decline.
The deficit hawks have been predicting for
years that the federal debt would sink the dollar
and the economy, and it hasn't happened yet. In
fact the federal debt has not been paid off since
1835, and no disaster has resulted. The debt has
not only been carried on the government's books
but has continued to grow, and the economy has
grown and flourished along with it.
This
is not an economic anomaly. The economy has
flourished because of the national debt.
Nothing backs the currency today but ''the full
faith and credit of the United States.'' Money is
no longer a metal; it is an inflow and outflow, credits
and debits. The liabilities of the government
are the assets of the private economy. The
national debt is what backs the money supply.
Dealing with rising debt servicing
costs There is a potential time bomb in a
growing federal debt, but it is one that can be
defused. The debt has risen from $10 trillion to
$14 trillion just since the banking crisis of
2008, not from ''entitlements'' but due to the
Wall Street collapse and bailout. Just the
interest on this growing debt could cripple the
tax base if interest rates were at normal levels,
so they have had to be pushed almost to zero. The
result has been to create a dollar
carry trade. This has facilitated speculation
in commodities, a major cause of today's commodity
bubbles.
There is, however, a solution to
this problem, and it was discovered by Japan. The
government can spend, not by issuing bonds at
interest to the public, but simply by creating an
overdraft at the central bank, as Ruml
recommended. The Bank of Japan now holds an amount
of public debt equal to the country's GDP! As
noted by the Center for Economic and Policy
Research:
Interest on [Japanese] debt held by
the central bank is refunded back to the
treasury, leaving no net cost to the government
on this debt. . . . Japan continues to
experience deflation, in spite of the fact that
its central bank holds an amount of debt that is
roughly equal to its GDP. This would be
equivalent to the Fed holding $15 trillion in
debt.
Like the Bank of Japan, the
Federal Reserve now returns the interest it
receives to the government. With a rising interest
tab on the federal debt no longer a problem,
private interest rates could be allowed to rise to
normal levels.
Today the Fed is not
permitted to buy bonds directly from the Treasury
but must go through middleman bond dealers. But
that problem too could be fixed. In a supporting
statement in 1947, Federal Reserve Chairman
Marriner Eccles discussed a bill to eliminate the
unnecessary cost of these middlemen. He said the
Federal Reserve had been allowed to purchase
securities directly from the government from its
inception in 1914 until the Banking Act of 1935.
Then:
A provision was inserted in that act
requiring all purchases of government securities
by Federal Reserve banks to be made in the open
market, which means purchased chiefly from
dealers in Government bonds. Those who inserted
this proviso were motivated by the mistaken
theory that it would help to prevent deficit
financing....
Nothing constructive would
be accomplished by the proviso that the Reserve
System must purchase Government securities
exclusively in the open market. About all such a
ban means is that in making such purchases a
commission has to be paid to Government bond
dealers.
The interest cost and the
bond dealers' cut could both be eliminated by
allowing the Treasury to borrow directly from its
own central bank, interest free.
Nothing to fear but fear
itself We have been frightened into
believing that government debt is a bad thing, but
nearly all money today originates as debt. As
Marriner Eccles observed in the 1930s, ''That is
what our money system is. If there were no debts
in our money system, there wouldn't be any
money.''
The public debt is the people's
money, and today the people are coming up short.
Shrinking the public debt means shrinking more
than just the services the government is expected
to provide. It means shrinking the money supply
itself, along with the ability to provide the
jobs, wages and purchasing power necessary for a
thriving economy.
Ellen Brown is
an attorney and president of the Public Banking
Institute, http://PublicBankingInstitute.org. In
Web of Debt, her latest of eleven books, she shows
how the power to create money has been usurped
from the people, and how we can get it back. Her
websites are http://webofdebt.com and
http://ellenbrown.com.
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